In 2008 “Lender Kft.” entered into a loan agreement with its Brazilian affiliate, S.B.S.C. Ltda. (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, which found the appeal well founded in regards of the new issues that had been added to the assessment by the tax authorities but upheld the decision in regards of the original issues.
An appeal was then filed with the Supreme Administrative court, which found that the court of first instance had erred in its decision and remanded the case.
Excperpts
“[35] The Curia found that in the main proceedings the applicant contested the tax authority’s determination of the open market price and the calculation of the tax on foreign income. By its final judgment, the court of first instance annulled the tax decisions of the first and second instance in relation to the determination of the arm’s length price and the calculation of the transfer price and, on the basis of the expert evidence submitted, decided that the tax authority must determine the arm’s length interest in the new proceedings, before which it cannot rule on the question – which was also disputed in the action – whether the tax law of the Tao. 28(3) and (4) of the Law on taxation of the applicant’s foreign source income. The Court of First Instance therefore ruled on the legality of the administrative decision in the main proceedings concerning the foreign source income only to the extent that the tax authority was obliged to determine it by taking into account the normal market interest to be determined in the new proceedings. As a consequence, the authority was also obliged to draw the consequences of the calculation of the normal market interest rate in the context of the tax liability on foreign income, the legality of which the court of first instance should have ruled on the merits on the basis of the claim brought by the applicant in the present action.
[36] The Court of First Instance based its judgment solely on the infringement of the earlier judicial guidance (as it stated in paragraph 33 of the judgment) and, as a consequence of its erroneous interpretation of the law, did not in fact examine the merits of the action in relation to the foreign tax and the procedural irregularities. It did not state the factual and legal grounds for paragraphs [34] to [36] of its judgment.
[37] The Curia therefore concluded that the final judgment was unlawful in a manner that had a bearing on the merits of the case and was therefore annulled by the Court of Appeal. The Court of First Instance annulled the decision of the Court of First Instance in its entirety on the basis of Article 121(1) of the Civil Procedure Code and ordered the court of first instance to conduct a new procedure and issue a new decision.
[38] In the new proceedings, the court of first instance is obliged to rule on the merits of all the claims of infringement of rights raised in the application. In its judgment, it must state the facts necessary for that purpose and the legal grounds for its decision.
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