Latvia vs SIA Informācijas Tehnoloģijas, September 2014, Supreme Administrative Court, Case No A420529010 SKA-813/2014

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Informācijas tehnoloģijas purchased computer hardware from its Lithuanian affiliate TD Baltic, which in turn purchased it from unrelated wholesalers (manufacturers). The goods received were resold by Informācijas tehnoloģijas to unrelated companies.

Following an audit, an assessment was issued where the tax authorities found that Informācijas Tehnoloģijas had purchased goods and services from related companies at a prices higher than the market price. The resale price method was applied by the tax authorities in determining the arm’s length price of the controlled transactions.

An appeal was filed by Informācijas Tehnoloģijas with the Regional Administrative Court where, in a decision of 14 April 2014 the Court ruled in favor of the company.

An appeal was then filed by the tax authorities with the Supreme Court.

Judgement of the Supreme Court

The Court annulled the decision of the Regional Court and remanded the case to the Regional Court for reconsideration.

Excerpts

“The Authority has indicated in its decision why the transaction values and the market price values were assessed according to the resale price method. Since the court is required to examine whether the reasons for the administrative act issued by the authority are consistent with the facts and the legal provisions (Section 250(1) of the Law on Administrative Procedure), the court was required to examine whether, in the facts of the present case, it was justified to adjust the taxable income using the resale price method.

However, the court wrongly refers to paragraph 12 of the Supreme Court’s judgment of 18 January 2013 in Case No SKA-29/2013, which states that “the task of these proceedings is not to examine the correctness of the method and conclusions chosen by the State Revenue Service, but whether the State Revenue Service had grounds to doubt the applicant’s study and the actions taken on its basis” in order to argue why the State Revenue Service’s decision is flawed, i.e. that the State Revenue Service has not provided reasons why the method chosen by the applicant is inapplicable. As is clear from the judgment itself, in Case No SKA-29/2013, the decision of the tax authorities questioned the validity of the method chosen by the applicant, i.e. the transfer pricing policy chosen. However, in the present case, the applicant has not, either during the audit or during the contestation procedure, indicated to the Service the method used to adjust its taxable income. The applicant has merely put forward reasons why the method chosen by the service would not be correct. These considerations were furthermore refuted by the Service in its decision. The Court thus wrongly concluded that the reasoning of the decision of the Service was seriously flawed, i.e. that the Service should have first justified in its decision why the method chosen by the applicant was not applicable in the present case and then justified why the method chosen by the Service was the most appropriate in the present case.

According to paragraph 85 of the Regulation, the resale price method is based on the price at which goods (products) purchased from a related undertaking are resold to an unrelated trader. That price is reduced by the gross profit from which the reseller bears selling and administrative expenses, making an appropriate profit taking into account the functions performed in support of the transaction, the risks involved, the assets used and other factors affecting the value of the transaction. The result is the market value of the transaction (or the market price of the good, product).

The Court held that, since the norm used the term ‘gross profit’ and the Authority used data on the applicant’s operating profit, the decision should in any event be annulled.

It should be noted here that the gross profit is the profit calculated on the net turnover less the cost of production (the difference between the amounts shown under ‘Net turnover’ and ‘Cost of production of products sold’). Operating profit is the profit obtained by deducting from the gross profit the operating expenses or fixed expenses (expenses which do not depend on the quantity of goods produced or sold – salaries, office expenses, depreciation of assets). Operating profit is an important measure of how much a company earns from its operating activities, taking into account all total income and expenditure. The gross profit ratio is used to get an overall picture of the efficiency of a company, while the operating profit ratio reveals how profitable a company really is.

This is why the description of the method in Regulation 85.1 states that the price should be reduced by the gross profit from which the reseller covers selling and administrative expenses, making an appropriate profit taking into account the functions performed in support of the transaction, the risks involved, the assets used and other factors affecting the value of the transaction. Thus, the Authority is right to argue in its appeal that the norm provides for the use of both gross profit and operating profit indicators to determine the market price, but the Court has not examined the reasoning of the decision in this respect.”

 

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