“Gas-Trader KtF” – a subsidiary in the E.ON group – had entered into loan agreements with other group companies and the related parties had determined the interest rate by application of the CUP method using the Thomson Reuters LoanConnector database. Comparable transactions was extracted from the database by searching for credit rating, type of debtor party, date of loan, maturity, transactions with completed status, and spread/provision fee.
An audit was conducted by the tax authorities for FY 2012-2013 and the interest rate determined by the group was found to be incompliant with the arm’s length principle. The tax authorities applied the same method as Gas-Trader but added further search criteria in the selection of comparable transactions – credit purpose and insurance coverage. This resulted in a different range and an assessment of additional taxable income was issued.
An appeal was filed by Gas-Trader KtF with the National Tax and Customs Board of Appeal where a judgement in favor of the tax authorities was issued. Then an appeal was then filed with the courts where the decision was annulled and the Board of Appeal ordered to initiate new proceedings. During these proceedings, an expert opinion was obtained which was in favor of Gas-Trader. However following objections from the tax authorities, the Board of Appeal dismissed the expert opinion and decided predominantly in favor of the tax authorities.
An appeal was then filed with Supreme Administrative Court.
Judgement of the Court
The Supreme Administrative Court set aside the decision and issued a judgement in favor of Gas-Trader.
In its judgment, the Court states
“[26] A large amount of data is needed to determine the transfer price. However, the available information may be incomplete, difficult to interpret, difficult to obtain for reasons of confidentiality, or may not exist at all, or the relevant independent enterprise itself may be missing. In the practical application of the arm’s length principle, the objective is always to determine an acceptable estimate of arm’s length profit based on reliable data. The ‘estimated’ nature of the transfer price means that it is never an exact tax act, but requires both the taxpayer and the tax authorities to subsequently take evidence that is clearly identifiable and realistic.
The Curia has stated in its judgment Kfv.I.35.550/2018/12 that the question of transfer pricing can be a technical question or a purely legal question depending on the underlying facts. In the case at hand, the defendant transformed the decision into a question of law by basing its decision not on an examination of the transfer pricing method, but on a different classification of the underlying legal relationship from that of the plaintiff in that case. In the present case, the Curia adds that, in the event of a substantive examination of the transfer pricing method by the tax authorities, the applicant may also submit a request for evidence on a technical point in the course of the judicial review.
[27] Among the methods of transfer pricing, both the Directives and the Tao [Corporate Tax and Dividend Tax] Law recognise the method of comparative independent prices. Pursuant to Section 18(2)(a) of the Tao Law, the arm’s length price is to be determined by one of the following methods: the arm’s length price method, whereby the arm’s length price is the price that independent parties would apply for the sale of a comparable asset or service in an economically comparable market. The problem in applying this method is the identification of the ‘economically comparable market’, which is ultimately achieved by applying the correction/constraint criteria within the scope of the method. Indeed, an independent transaction can only be compared with a controlled transaction using the method of comparable independent prices if one of the following two conditions is met: (a) none of the differences, if any, between the transactions to be compared or between the undertakings entering into those transactions can materially affect the free market price, or (b) relatively accurate adjustments can be made to eliminate the distortive effect of such differences. Therefore, where distorting differences exist between controlled and unrelated transactions, adjustments should be made to at least broadly eliminate price influencing factors and enhance comparability. Each of the narrowing methods should be assessed for their relative accuracy and only those adjustments should be made that are likely to improve comparability.
[28] In the case at bar, it is a fact that the defendant did not make a finding with respect to the plaintiff’s records that the plaintiff had developed what it considered to be an appropriate transfer price, that the defendant agreed to the use of the comparative independent pricing method. The court’s remedy resulted from a difference in the criteria considered by the parties to eliminate the distorting effect of the differences. It may also be noted that in the decision of the Court of Appeal ordering a new trial in the main proceedings, the defendant excluded the application of the interquartile range correction criterion of narrowing the range around the midpoint.
[29] Defendant used the data extracted by the plaintiff from the LoanConnector database to verify the transfer pricing. In its procedure, it considered the relevant aspects of the Directives to be relevant, according to the review request: in the expected audit practice, tax auditors should be flexible in their approach, take into account the business considerations of taxpayers and start their analysis from the perspective of the pricing method chosen by the taxpayer. If the taxpayer’s screening strategy is reproducible and the screening steps are suitable to produce a suitable sample for the transaction under consideration, the tax administration will use the taxpayer’s database screening as a basis. If, for any reason, the tax administration disputes the screening steps, it will attempt to make the necessary adjustments based on the taxpayer’s research to ensure that the results calculated from the improved sample are consistent with the market price principle. As a starting point, the tax administration does not therefore seek to determine the price or range of prices applicable to the transaction in question by rejecting the taxpayer’s research. In the present case, however, the defendant itself, by introducing the screening criteria it applied – credit purpose, insurance coverage – established the price range it considered necessary for determining the transfer price, which differed from that of the applicant. Of these, the plaintiff contested the application of the credit purpose criterion in its action, and the court of first instance gave final judgment on this point.”
…
“[41] In its assessment of the content of the expert evidence, the Curia found that the relevant elements of the evidence had been correctly summarised by the court of first instance and that, in applying the method of comparative independent prices, it was not appropriate to apply a reduction for the purpose of the loan, particularly in the case at issue, because that criterion was unreliable. The defendant’s submissions disputing this in its application for review are unfounded. The final judgment is not vitiated by a manifestly unreasonable assessment of the evidence or by an error of assessment contrary to the rules of logic.
[42] In view of the foregoing, the Curia has set aside the final judgment of the Court of Cassation and Justice. 121 (2), with the above-mentioned clarification of the reasoning concerning the Bloomberg database.
Content of the decision in principle
[43] An independent transaction may be compared with a controlled transaction by the method of comparable independent prices only if (a) none of the differences, if any, between the transactions to be compared or between the undertakings entering into those transactions is likely to affect the open market price materially, or (b) relatively accurate adjustments can be made to eliminate the distortive effect of such differences. Each of the narrowing methods should be assessed for their relative accuracy and only those adjustments should be made which are likely to improve comparability. An unreliable correction criterion should not be applied.
[44] If the transfer pricing method is examined on the merits by the tax authorities, it may be subject to a motion for a ruling on a technical point of law by the plaintiff in the course of the judicial review.”