Hungary vs “Auto Parts Ktf”, May 2020, Supreme Court (Kúria), Case No. Kfv.I. 35,618 / 2019/11

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Auto Parts Ktf’s principal activity is the manufacture and sale of passenger cars and spare parts. Between 1 January 2013 and 31 December 2014, it sold its products to its affiliated undertakings and to unrelated parties. Auto Parts Ktf had prepared transfer pricing documentation, in which it determined the arm’s length price using the transaction net margin method (TNMM). Auto Parts Ktf identified 9 comparable companies for 2013 based on a benchmark using the Amadeus database version of 17 April 2014, and based on the financial documents of these companies for 2010-2012, it defined the interquartile range of the normal price range as the market price range between 2.13% and 9.78%. For 2014, it did not update its benchmark, but fixed the minimum-maximum range as in 2013 and considered this as the market price range. For both years, the applicant examined the total operating profit of the manufacturing activity on a consolidated basis, which showed a profit of 2,22 % in 2013 and 1,52 % in 2014. As this fell within the interquartile range for 2013 and 2014, it made no adjustment.

The tax authority examined the applicant’s transfer pricing documentation during the course of its audit, and accepted that the sales of the two products should be treated as a single transaction and priced using the TNMM method. It did not accept, however, that Auto Parts Ktf had examined the arm’s length nature of its overall operating results. The tax authority found that Auto Parts Ktf made a loss of -0.92% on its related party transactions in 2013 and 0.84% in 2014. It recorded that the net profit margin realised on related party transactions was below the lower end of the market price band (lower quartile 2.10%) in both years. In view of this, it increased its corporate tax base by HUF 6,665,000,227 in 2013 and HUF 8,331,347,000 in 2014. It assessed a total of HUF 1,071,880,000 in corporate taxes against the applicant, on top of which it charged a tax penalty and a late payment penalty.

The Administrative Court decided in favour or Auto Parts Ktf and an appeal was then filed by the tax authorities with the Supreme Court.

Judgement of the Supreme Court.

The Court dismissed the appeal of Auto Parts Ktf and remanded the case to the court of first instance.

“[24] One of the main areas of international taxation is the determination of the appropriate price for tax purposes and the adjustment of the taxable amount in the light of this determination. The adjustment is essentially based on a comparison of the transfer price between related enterprises under Article 9 of the Model Convention (the price at which an enterprise supplies goods or intangible assets or services to its related enterprise) with the arm’s length price between unrelated parties. The purpose of the transfer pricing analysis is to review and analyse in detail whether the parties in the related party transaction have deviated from the terms and conditions that would also apply to unrelated parties and whether and to what extent this has had the effect of causing the taxable tax base of the taxpayer to differ from what it would have been had the terms and conditions not been different. By adjusting these differences, the effect of any distortions of the tax base due to related party transactions is neutralised. The Court of First Instance erred in accepting the applicant’s method of calculation, namely that the operating result and, in that context, the statement of profit margin were calculated for the company as a whole, for the total operating result, and not examined separately. In doing so, it ignored the essence of transfer pricing, namely that the profit rate in related party transactions must be calculated separately from the profit rate in unrelated party transactions. A calculation which works out the profit rate on the basis of total operating profit is wrong and cannot lead to an appropriate result for transfer pricing purposes.

[25] The aggregated approach relied on by the applicant does not provide guidance as to the basis for the calculation, namely the operating result, but defines the cases in which it is possible to depart from the main rule of a transaction-by-transaction analysis and when they can be treated as a whole. The Curia fully agrees with the defendant’s position in this respect, which is set out in detail in paragraph 4 of page 14 of the defendant’s decision. The method of calculation can be followed precisely on page 43 of the decision of the first instance, and the statement of profit margins for affiliated undertakings is substantiated and correct.

[26] In its decision, the defendant correctly recalculated the operating result between the applicant’s affiliated undertakings, accepted the method and filtering used by the applicant and the market price range determined on this basis, including the application of the applicant’s calculated interquartile range for 2013. All these factors were used to determine the adjusted profit and the corporation tax payable.

[27] The Curia agreed with the defendant that the plaintiff’s incorrect determination of the operating result between related companies led to the tax difference in the decision. In its application for review, the defendant did not challenge the first instance court’s rejection of the use of the interquartile range in determining the 2014 result, and the Curia therefore did not address the relevant part of the first instance court’s judgment. Therefore, the order of the Court of First Instance to set aside the judgment of the Court of First Instance and to initiate new proceedings is correct, as explained above, as amended. In the new procedure, the corporation tax difference for 2014 for the applicant must be determined by taking into account the minimum-maximum market price range worked out by the applicant and accepted by the defendant, on the basis of the operating profit adjustment carried out by the defendant.”

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