“Fertilizer B.V.” is part of a Norwegian group that produces, sells and distributes fertiliser (products). “Fertilizer B.V.” is the parent company of a several subsidiaries, including the intermediate holding company [C] BV and the production company [D] BV.
The case before the Dutch Supreme Court involves two points of dispute:
(i) is a factually highly effective hedge sufficient for mandatory connected valuation of USD receivables and payables?
(ii) is the transfer prices according to the supply and distribution agreements between [D] and a Swiss group company (AG) at arm’s length?
(i) Factual hedge of receivables and payables
“Fertilizer B.V.” had receivables, forward foreign exchange contracts and liabilities in USD at the end of 2012 and 2013. It values those receivables and payables at acquisition price or lower value in use. It recognised currency gains as soon as they were realised and currency losses as soon as a receivable was valued lower or a debt higher. The court has measured dollar debts and forward contracts coherently, but not dollar debts against dollar receivables from a Brazilian subsidiary arising from corporate financing.
The Court of Appeal does not consider a highly effective currency hedge (actual correlation) in itself sufficient for coherent valuation; in its view, this also requires a business policy connection between opposite currency positions, such as an intent of hedging or a business relationship between receivable and debt.
The Secretary of State believes that the reality principle means that in the case of an actual 100% correlation, debts and receivables in the same currency should be measured coherently. With all the disputed receivables and payables being denominated in USD, the currency hedge is very effective, so they should be measured coherently.
A-G Wattel believes that the reality of a highly effective currency hedge is that no foreign exchange risk is incurred as long as and to the extent that the hedge exists and that, therefore, the reality principle to that extent compels coherent valuation, irrespective of whether the entrepreneur intended hedging and irrespective of the existence or non-existence of prudential link between receivable and debt in the same currency. This, in his view, is in line with the case law on coherent valuation he has reproduced. He considers the cassation appeal of the State Secretary in both cases well-founded.
(ii) Transfer pricing
[D] produces fertiliser products and sells them to affiliated sales organisations. Transfer prices are based on the Transfer Pricing Master File (TP Master File) that says fully fledged producers like [D] are rewarded according to the comparable uncontrolled price (CUP). In 2008, it was decided to invest €400m by [D] in a plant, which was commissioned in early September 2011, enabling [D] to produce 39% more urea and fertiliser products (the surplus) than before. On 14 September 2011, following the commissioning of the new plant, [D] and AG entered into a Supply Agreement and a Distribution Agreement. AG is “related” to the interested party and to [D] within the meaning of Section 8 Vpb. Those agreements provide that AG buys the surplus for cost plus 5%, for five years, with tacit renewal. On that basis, [D] invoices 39% of its production at cost plus 5% to AG every month and remits the rest of its profit on the surplus to AG. According to the Inspector, this results in a monthly improper profit shift from [D] in the Netherlands to AG in Switzerland.
The court did not find it plausible that a fully fledged profitable producer like [D] would cede its existing and proven excess profit capacity – which was only improved by the new plant – on a large part of its production to a third party in the market. The party making that claim will have to provide a business explanation for the fact that the agreements leave only 5% margin to the group’s proven much more profitable ‘best performing’ entrepreneur which continued to perform all the functions it was performing before, except (on paper) 39% production risk control, and for the fact that [D]’s substantial residual profit was henceforth transferred by it on a monthly basis to an affiliated acquirer of 39% production risk, with no significance to [D]’s original 61% production and no significance to the core functions required for [D]’s 39% surplus production.
According to A-G Wattel, the Court of Appeal thus did not divide the burden of proof unreasonably or contrary to due process. Those who make remarkable contentions contrary to their own previous and 61% still held positions and contrary to their own TP Master File will have to provide an explanation. ‘The Court’s judgment implies, in the absence of sufficient explanation by the interested party, substantially (i) that a company that is unmistakably the most complex entity cannot be changed into a routine margin producer by mere contracting for an arbitrary percentage (39%) of its capacity while at the same time remaining fully fledged entrepreneur for the identical 61% remaining production and for the 39% surplus also effectively keeping everything as it was, and (ii) that neither can a Swiss group company which is not introduced to [D]’s production (processes), logistics, distribution and administration, and which is thus unmistakably the least complex entity, be turned into the true entrepreneur that [D] is by a mere contract for the same arbitrary percentage (39%) and also remains for that 39%, the less so as that contract is incompatible with the group’s TP Master File. Since, according to the Court, an unaffiliated entrepreneur would never agree to such a contract and, therefore, such contracts, according to it, are not concluded between unaffiliated parties, arm’s-length terms are difficult to conceive: no arm’s-length terms can be conceived for a non-existent transaction, so the situation without the said agreements must be assumed.
A-G Wattel considers these judgments correct insofar as they are legal, factual and not incomprehensible. He therefore does not find incomprehensible the Court of Appeal’s conclusion that, for tax purposes, the situation without the two agreements should be assumed, which are not thereby disregarded, but are regarded as a relative sham for civil and tax law purposes: two agreements were indeed concluded, but their purport is different (profit-shifting) from the civil-law sham. That opinion, based on the interpretation of the agreements, the TP Master File and the auditor’s and lawyer’s reports submitted, which were withdrawn from cassation scrutiny, and on the also withdrawn from cassation scrutiny of the established facts and evidence such as statements made at the hearing, does not seem incomprehensible to the Advocate General.
Conclusion: the appeals of “Fertilizer B.V.” is unfounded and the appeal of State Secretary is well-founded.
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1 comment on Netherlands vs “Fertilizer B.V.”, March 2023, Hoge Raad – AG Conclusion, Case No 22/01909 and 22/03307 – ECLI:NL:PHR:2023:226
The facts established that profit was shifted from the Netherlands to Swiss company without any commensurate contribution from the Swiss company to the apparatus of profit earning. Shifting of huge profits ( based on past results) in lieu of very low risk free fixed returns was totally unjustified. The claim of transfer of production risk was not substantiated because there was nothing on record to justify that there was not enough demand of the products and Swiss company assured to purchase the additional production to ensure the utilisation of full production capacity.
The agreement lacked substance which led the tax authorities to disregard the same for tax purposes.
Summary is nicely done.