RKS, whose business consists of the manufacture of very large custom bearings for the civil and military industries, is controlled by the Swedish group SKF through (SAS) SKF Holding France.
RKS was subject to a tax audit for FY 2009 and 2010, at the end of which the tax authorities adjusted the prices at which it had invoiced its products to the SKF group’s distribution companies abroad. According to the tax authorities, RKS was a simple manufacturing company that did not have control over strategic and operational risks, at therefore should not have losses resulting from such risks.
In a 2018 judgment the Montreuil Administrative Court discharged the additional taxes. However, this decision was set aside by the Versailles Administrative Court of Appeal in a judgment of 22 June 2020 in which the appeal of the tax authorities was granted. This judgement was then appealed by SKF to the Supreme Court.
Judgement of the Supreme Administrative Court
The court decided in favor of SKF Holding and annulled the decision of the Versailles Administrative Court of Appeal.
“It is clear from the documents in the file submitted to the court that the administration applied a “transactional net margin method” (TNMM) during the audit of RKS, which consisted of comparing the ratio of net margin to turnover of this company for the transactions in question with that of eight companies operating at arm’s length and in similar fields of activity. In doing so, it found that the company’s net margin ratio was -10.46% in 2009 and -21.87% in 2010, whereas it was 2.33% in 2009 and 2.62% in 2010 for the average of the companies compared. Consequently, the administrative court of appeal was able to hold, without any error of law, that the service, at the end of this comparison, of which it noted that no criticism was addressed to it, had established a presumption of transfer of profits for the transactions in question, up to the difference between the amount of revenue recorded and that which would have resulted from the application of the average net margin rate of the panel of comparable companies.
However, RKS argued before the court, in order to justify this difference, that it had a more important functional role than that of a simple production unit within the SKF group, which meant that it had to assume a development and commercial risk and that this risk had affected its operating profit for the years in dispute.
Firstly, as recommended by the OECD Transfer Pricing Guidelines, in order for it to be considered established that a company belonging to a group is in fact intended to assume an economic risk which the group’s transfer pricing policy leads it to bear, and that this policy is therefore in accordance with the arm’s length principle, it is necessary for that company to have effective control and mitigation functions over that risk, as well as the financial capacity to assume it. In holding that RKS was not liable for economic losses related to the operation of its business on the sole ground that it did not have the status of ‘main contractor’ within the SKF group, without investigating whether its functional position within the SKF group was such that it could not be held liable, without investigating whether its functional position within the group gave it the right to bear the specific risks it invoked, namely, on the one hand, strategic risks linked to the choice to develop new products, and, on the other hand, operational risks linked to the efficiency of the production processes, the court vitiated its judgment with an error of law.
Secondly, in holding that the negative margin rate of the company RKS was not the result of the realisation of a risk that it was intended to assume, the Administrative Court of Appeal noted that the consolidated result of the SKF group, all activities taken together, was at the same time between 6 and 14%, that the company’s purchases of raw materials had been stable and that its sales had not suffered a drop in volume except for wind turbines. In so doing, it did not respond to the argument that the company raised to justify the drop in margin over the two financial years in question, according to which it had suffered the consequences of a strategic risk linked to its choice to reorient its sole activity towards the wind power sector. It therefore vitiated its judgment by failing to state adequate reasons.”
France vs RKS October 2021 Conseil d'État, 8ème - 3ème chambres réunies, 04_10_2021, 443130