Auto-Electronics was was part of a Germany based group. It manufactured electronic components for the automotive industry and also carried out R and D activities for affiliated and independent parties. For FY 2018, the transfer pricing documentation covered manufacturing transactions and intra group services charged as a fee described as a license fee for listed support activities, but the individual intra group service contracts were not included in the local documentation and only a framework agreement without specific content was available. In the documentation it applied TNMM and stated a profitability range between minus 0.32 percent and plus 70.45 percent, using operating profit relative to total operating costs as the profit level indicator.
The tax authority audited FY 2018 and issued a corporate tax adjustment with related sanctions and imposed penalties linked to transfer pricing record keeping. The Curia record states that the first instance tax authority considered the company’s database research unsuitable and carried out its own comparable screening, and concluded that under normal market conditions the company should have realised a minimum profitability of 4.79 percent instead of the minus 14.7 percent it had achieved, increasing the corporate tax base by HUF 49,825,256,000. It recorded a corporate tax deficit of HUF 308,884,000 and other amounts and sanctions. On appeal, the tax authority changed the corporate tax deficit to HUF 303,529,000 and imposed a tax penalty of HUF 76,253,000 and default interest of HUF 277,000, while leaving certain other parts of the first instance decision unaffected. In the later court decision, the tax authority treated the relevant profile as low risk manufacturing and framed the transfer pricing issue around an asserted “tolerance” arrangement, meaning that the company undertook manufacturing for car manufacturers on conditions negotiated by a related group entity and adhered to those conditions.
The company brought an administrative action challenging the corporate tax adjustment and related sanctions and also challenged the record keeping penalty. The Supreme Court judgment describes that a first instance judgment of the Veszprém General Court dated 13 October 2023 had annulled the tax authority decision and ordered new proceedings, and that the tax authority sought review. The Supreme Court set aside that 13 October 2023 judgment and ordered the first instance court to conduct new proceedings and issue a new judgment, citing inconsistencies between the operative part and reasoning, annulment of parts not challenged, and missing fact finding and reviewable evaluation of evidence. The Curia instructed the first instance court to establish the relevant facts and then refer to, evaluate, and if necessary contradict the evidence from the administrative procedure and the lawsuit.
Judgment
In the retrial following the Supreme Court’s remittal, the court annulled the tax authority appeal stage decision in respect of the corporate tax shortfall and related sanctions and also annulled the record keeping related penalty, and ordered the tax authority to conduct a new procedure.
The court held that the tax authority reasoning did not clearly establish whether it had recharacterised an existing related party transaction or asserted a new transaction, and that the content of the claimed “tolerance” transaction was uncertain because the specific related party transaction was not precisely defined. The court treated this as a reasoning defect affecting the merits that could not be cured in court, and instructed the tax authority that in the new procedure it must precisely define and delimit the related party transaction and structure under review, apply the arm’s length analysis only to related party transactions, and work out profit margins for related party relationships separately from those in transactions with independent parties.
The court also found that the record keeping penalty was not imposed in the required manner and instructed that any new decision must make the reasonableness of any such penalty evident.
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