In 2008 Lender Kft. entered into a loan agreement with its foreign domiciled affiliated company Kft. 1. According to the terms of the contract, the loan amounted to 53,174,516, the maturity date of the loan was 31 January 2013 and the interest was paid semi-annually at the semi-annual CDI rate fixed in the contract plus 200 basis points per annum.
In the years 2009-2011, Kft. 1 paid 15 % of the interest as withholding tax, and Lender Kft. received 85 % of the interest. In its books, Lender Kft. entered 100 % of the interest as income, while the 15 % withholding tax was recorded as other expenses. According to Lender Kft’s transfer pricing records, the normal market interest rate range was 8,703 % to 10,821 % in FY 2009, 10,704 % to 12,598 % in the FY 2010 and 10,704 % to 12,598 % in FY 2001, and the interest rates applied in the loan transaction were 10,701 % to 12,529 %, 12,517 % to 14,600 % and 12,517 % to 14,600 % in the same years. In other words, according to the records, the interest rates applied to the transaction were partly within and partly above the market price range.
Lender Kft. used the CUP method to determine the transfer price, taking into account external and internal comparables. As an external comparison, it used a so-called risk premium model based on the rating of the debtor party and the terms and conditions of the loan, taking into account publicly available data. For the credit rating of the related company, it used the risk model of the name, on the basis of which it classified the company between A1 and A3. It defined the range of interest rates to be applied in the loan terms and conditions, then the default rate and the rate of return, and finally, by substituting these data into the risk premium model formula, it defined the risk premium rates for each risk rating. In doing so, it used subordinated bonds. The benchmark interest rate range was defined as the sum of the risk-free rate and the risk premium. As an internal comparison, the applicant requested quotations from various commercial banks, as independent parties, before granting the loan, as to the amount of profit it could expect to obtain if it deposited its money with them (Bank1, Bank2)
The Tax tax authorities carried out an audit of Lender Kft for FY 2009, 2010 and 2011. In the view of the tax authority at first instance, the CUP method, although appropriate for determining the arm’s length price, was not the method used by the applicant. According to the tax authorities the rating of a debtor using public rating models may differ greatly from the rating carried out by the rating agency which created the model, which results in a high degree of uncertainty as to the method used by the applicant. A further problem was that Lender Kft had based its pricing on a rate for subordinated bonds, whereas a bank loan and a bond are two different financial instruments and cannot be compared. In this context, it was stated that the transaction under examination was a loan contract and not a bond issue. The tax authorities explained that the unit operating costs are the lowest in the banking market and that it had not been demonstrated that the cost of the applicant’s lending was lower than that of a bank loan. It also stated that the mere existence of information through a relationship does not imply a lower risk exposure. In relation to the internal comparables, it stressed that the loan granted by Lender Kft could not be classified as a deposit transaction and that the comparison with the deposit rate was therefore incorrect.
According to the tax authority, for the purposes of determining the normal market price, the … banking market best reflects the conditions under which the related undertaking would obtain a loan under market conditions, and therefore the so-called “prime rate” interest rate statistics calculated by the Central Bank of the country in question are the most appropriate for its calculation. This statistic shows the average interest rate at which commercial banks lend to their best customers. Accordingly, the tax authority at first instance took this rate as the basis for determining the difference between the interest rate applied to the transaction at issue and the normal market rate. As a result, the applicant’s corporate tax base was increased by HUF 233,135,000.00 in the financial year 2009, HUF 198,638,000.00 in the financial year 2010 and HUF 208,017,000.00 in the financial year 2011, pursuant to Article 18(1) of Act LXXXI of 1996 on Corporate Tax and Dividend Tax (‘Tao Law’).
Lender Kft. filed a complaint against the decision and requested that the decision be altered or annulled and that the defendant be ordered to commence new proceedings. In the complaint it stated that the method used by the tax authorities did not comply with points 1.33, 1.35 and 2.14 of the OECD TPG, nor with Article 7(d) of the PM Regulation.
By judgment of 20 April 2018, the Court of First Instance annulled the tax authorities first assessment and ordered the authority to initiate new proceedings in that regard. The court stated that the tax authority must determine whether the pricing of the loan at issue in the case was in line with the arm’s length price, taking into account the OECD Transfer Pricing Guidelines and the expert’s opinion in this context.
Under the revised audit process the tax authorities found other issued which were added to the new assessment.
Lender Kft. then filed an appeal with the Administrative Court.
Judgement of the Administrative Court
The Administrative court found the appeal well founded.
“The tax authority was only legally able to implement the judgment of the court in the retrial ordered by the court. The subject-matter of the action was the finding of the tax authority as a result of the audit carried out by the tax authority in respect of the applicant for the tax years 2009-2011, in respect of which the tax authority had the lawful opportunity, in the repeated procedure, to determine the tax liability of the applicant by applying the guidance of the court. In the original control procedure, the tax authority did not make a full finding on the crediting of the tax paid abroad on income from abroad, only the taking into account of the adjustment of the transfer price for interest received from abroad in the crediting was the subject of an administrative dispute between the parties to the litigation, and the court could not therefore examine the issues of crediting in general. In relation to this set-off, the court judgment did not create a legal basis for the defendant to re-examine it.”
“The judgment only provided for a new procedure in relation to the determination of the arm’s length price and the accounting of the transfer price. The operative part of the judgment and the reasoning of the judgment only obliged and empowered the tax authority to decide on the new procedure in the scope of the determination of the arm’s length price and the inclusion of the transfer price in the set-off of foreign income. If the tax authority had disagreed with this guidance of the judgment 14.K.32.030/2016/30 for any reason, it would have had the right to file a petition for review before the Curia, but the content of this guidance, the judicial guidance for a new procedure, can no longer be examined in the present case, in the present case the court had only to examine whether the tax authority had complied with this guidance, whether it had gone beyond it.”
The Court annuls the defendant’s decision No 2234875516 of 27 July 2019, including the decision of the first instance, and orders the tax authority of the first instance to initiate new proceedings.K.33691_2019_18