RKS, whose business consists of the manufacture of very large custom bearings for the civil and military industries, is controlled by the Swedish SKF group 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 took the view that the results reported by SAS RKS (losses since 2005) had not been determined in accordance with the arm’s length principle. It therefore increased SAS RKS’s results from 2006 to 2010 to the median net margin observed in a benchmark of eight comparable companies, equal to 4.17% in 2006, 4.32% in 2007, 3.38% in 2008, 2.33% in 2009 and 2.62% in 2010.
SAS SKF France Holding applied to the Administrative Court for a discharge, and in judgment no. 1608939 of April 23, 2018, the Montreuil Administrative Court upheld the claim.
In ruling no. 18VE02849 of June 22, 2020, the Versailles Administrative Court of Appeal upheld the appeal lodged by the the authorities against this ruling.
By decision no. 443133 of October 4, 2021, the Conseil d’Etat, hearing an appeal lodged by SAS SKF France Holding, set aside the decision of the Versailles Administrative Court of Appeal and referred the case back to it.
Judgment of the Administrative Court of Appeal
In accordance with the guidance provided in the decision of the Conseil d’Etat, the Administrative Court of Appeal ruled in favor of SKF Holding and annulled the assessment of the additional taxable income.
Excerpts in English
“6. In addition, as mentioned above, the tax authorities have found that SAS RKS has had a negative net margin since 2005, with the exception of 2008. It then carried out a functional analysis of SAS RKS’s intra-group relations, taking the view that SAS RKS performed only limited production functions, and that it was therefore not likely to receive negative remuneration in view of the risks associated with this role. Lastly, it applied a “transactional net margin method” (MTMN), comparing SAS RKS’s ratio of net margin to sales for the operations in question with that of eight companies operating at arm’s length in similar fields. In doing so, it noted that the company’s net margin ratio was -19.32% in 2006, -6.44% in 2007, 1.41% in 2008, -10.46% in 2009 and -21.87% in 2010, compared with 4.17% in 2006, 4.32% in 2007, 3.38% in 2008, 2.33% in 2009 and 2.62% in 2010 for the median of the companies compared. In view of these factors, and as stated in the Conseil d’Etat’s decision of October 4, 2021, in the absence of any criticism of the comparables used by the tax authorities, the latter have established a presumption of profit transfer 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.
7. However, SKF Holding France maintains that its subsidiary SAS RKS in fact assumes a more important functional role than that of a simple production unit within the SKF group, which meant that it had to assume higher development and commercial risks, which materialized in 2009 and 2010 and led to significant operating losses.
8. It is clear from the investigation that SAS RKS, founded in 1932 and acquired by the SKF group in 1965, has long-standing technical expertise and manufactures very specific products, often made-to-measure, for civil and military engineering, whose clientele, made up exclusively of professionals, is in fact limited to around fifteen companies, thus requiring no sales prospecting expenditure on the part of the distributing companies. In addition, SAS RKS owns all the tangible assets required for production, bears the risks associated with production, such as product quality defects, organizes the transport and logistics of its products at its own expense, and bears the inventory risk, as recognized by the French tax authorities when they accepted the principle of a provision for inventory depreciation during the audit. While it is common ground that the intangible assets, including patents, required for this production are held by AB SKF in Sweden, it is nevertheless clear from the investigation that SAS RKS carried out research and development work during the period under review, that it participated, through its parent company SKF Holding France, in an agreement to share research and development costs organized at group level, and that it therefore benefited free of charge from all the intangible assets thus held by the Swedish parent company. Furthermore, while it is common ground that the Swedish parent company periodically sends SAS RKS a schedule of margins to be applied to production costs, depending on the country of invoicing. This schedule is intended to guarantee a margin of 3% for the distribution companies, it is clear from the investigation that SAS RKS is free to determine its own production costs, known as “standard production costs”, which serve as the basis for negotiations with the end customer, carried out jointly with the distribution companies. It also emerges from the investigation, and in particular from the results of computer processing carried out by the tax authorities, that this scale, while applied in the majority of intra-group transactions, is not systematically applied. Furthermore, the company, which bears the exchange rate risk, maintains, without being contradicted, that it can freely refuse to contract with a customer if the final price negotiated does not suit it. On the other hand, it appears from the investigation that the distributing companies are limited to managing sales in practical terms, for example by drawing up contracts and invoices, and to assisting end customers in their negotiations with SAS RKS. As a result, SAS RKS enjoys relative autonomy within the Group, and assumes a high level of risk due to its production activities. Furthermore, it is clear from the investigation that the standard production cost defined by SAS RKS, which serves as the basis for the final price agreed with the customer, is determined at a very early stage, and that the price of raw materials represents a significant proportion of the cost price of products. However, steel prices rose sharply and rapidly during the period under review. Finally, the company points out that the number of orders from its traditional customers fell from 2006 onwards, and that this decline was only partially offset by a reorientation of its industrial base towards onshore wind power, which failed from 2009 onwards. In support of its assertions, the company produces invoicing and purchase order figures, as well as documents on the creation of a new production line and public announcements on the company’s repositioning in 2012. These documents are corroborated by references in the rectification proposals to a failure in the onshore wind power sector, and to figures showing a sharp contraction in raw materials purchases and a significant reduction in inventories over the period in question. As a result of the foregoing, the losses incurred in the years in dispute reflect the operational and strategic risks assumed by SAS RKS as a result of its production activity. Consequently, the French tax authorities have no grounds for claiming that SAS RKS renounced revenues that would have constituted a transfer of profits within the meaning of article 57 of the French General Tax Code to distributing companies belonging to the same group.
9. It follows from the foregoing that the Minister responsible for public accounts is not entitled to complain that, by the judgment under appeal, the Montreuil Administrative Court wrongly discharged SAS SKF France Holding from the corporate income tax assessments made against it in respect of the 2009 and 2010 financial years.”
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