C. spółka z o.o. is part of a larger group and mainly (95%) sells products (boxes, metal enclosures, etc.) and related services to related parties. According to its transfer pricing documentation the “cost-plus” method had been used to determine the prices of products sold to related parties.
The company was audited for FY 2016. According to the tax authorities, the company did not provide enough evidence to support the cost-plus method. The tax authority instead used the transactional net profit method to estimate the company’s income for the year 2016, taking into account factors such as characteristics of goods or services, functional analysis, contractual conditions, economic conditions, and economic strategy by comparing the company’s performance with similar companies over a 3 year period by using EBIT margin. As a result, the authority adjusted the company’s loss and established income based on a EBIT margin of 3.66%, resulting in additional taxable income of PLN 1,803,592.08.
C. spółka filed an appeal with the Administrative Court. The Administrative Court predominantly dismissed the appeal and found in favor of the tax authorities. However, the tax authorities have wrongly determined the income of the complainant, by referencing to its entire activity, despite the fact that 5% of the transactions are not subject to regulation under the arm’s length provision. Because of this, the court repealed the decision of the first-instance authority and stated that when re-examining the case, the authority should take into account the position expressed.
An appeal was then filed by C. spółka with the Supreme Administrative Court.
Judgement of the Supreme Administrative Court
The Court dismissed the appeal and upheld the decision of the Administrative Court.
“The company completely ignores in the cassation complaint that the tax documentation of the transaction submitted by it did not confirm its use of the “cost-plus” method of calculating the sales price to related parties with a mark-up of 30% on the direct costs constituting the cost base (depreciation, value of materials and energy used, third-party services, salaries and wages with mark-ups). The submitted tax documentation shows that in the Company, the valuation of the value of the products sold to related customers should follow the reasonable margin “cost-plus” method. In addition, the Company, in describing the method and manner of calculating income and determining the price of the subject of the transaction, explained, among other things, that in 2016, in transactions to related parties (i.e. to: C. GmbH,. P.GmbH, R. mbH), the price was the sales value of individual finished products, determined each time on invoices issued by the Applicant. The price for the individual products was determined on the basis of pre-agreed price lists or on the basis of ongoing arrangements and negotiations, taking into account changing market conditions. This was to be the method provided for in Article 11(2) of the A.p.d.o.p., consisting in setting the price for the sale of goods and rights and the provision of services in transactions with a related party at the level of the sum of the cost base and profit mark-up, comparable to the cost base and profit mark-up established between independent parties, which take into account comparable functions, risks incurred and assets involved. In the explanations submitted during the tax proceedings, the Company additionally stated that it calculated the selling prices of finished goods taking into account the following elements: – material costs; – third-party service costs; – labour costs; – a mark-up of 30%. It further explained that the 30% mark-up applied by it was established in 2005 and was not updated, and was applied in transactions carried out for related parties and independent parties under individual orders and orders. At the same time, it did not submit any documents related to the calculation of the sales prices of finished goods applied to related parties. It should also be emphasised that the Appellant, when preparing the profit and loss account in the comparative variant, did not separate in it such an item as management costs within the meaning of the Accounting Act, the determination of which is necessary in the event of a reliable application of the “cost-plus” method to transfer pricing settlements. The tax authority was therefore correct in concluding that the sales prices to related parties were not correctly calculated based on market standards. At the same time, it must be emphasised that the Company did not have any long-term contracts with customers, and production and sales were based on current orders from customers, including related and independent entities. In the business relationship concerning the production and sale of products to the related party C. GmbH (as parent company), the Applicant acted as a subcontractor, and these processes were planned on the basis of long-term contracts concluded by C. GmbH with its customers. The company did not in any way contractually secure its own turnover volume or even the planning of the supply of its products and services in the medium term. Most importantly, however, it is apparent from the evidence gathered, including the documentation obtained from the Applicant, that sales were made at amounts that did not take into account all costs incurred and that there was no rational reason for such sales prices. According to the tax authority’s calculations, the revenues obtained by the Company according to the reasonable “cost-plus” margin method indicated by itself should have been higher by approximately PLN 4.5 million. Meanwhile, the margin realised by the Applicant was negative and actually amounted to -6.80%. This indicates that the Company’s method of pricing to related parties, contrary to its position, did not assume the achievement of an adequate profit, and the tax documentation submitted for the Complainant’s transactions with related parties did not assume a mark-up of 30%, which would have translated into a profit for 2016 rather than a loss. Therefore, it is not possible to agree with the Company’s position that only objective factors influenced the negative financial result and were the only reason for the application of Article 11(1) of the A.T.C. Properly interpreted and applied in the tax case, the income determination mechanism presented by the Company itself should lead to the determination of income, not loss. Therefore, it became necessary to determine the income of the Appellant and, consequently, also the tax due without taking into account the conditions established and resulting from relations with the entities indicated in Article 11(1)(2) of the A.p.d.o.p. In this context, the tax authority rightly assumed, which was accepted by the Court of First Instance, that the position of the Company was characterised by contradiction, since, on the one hand, it indicated that the prices applied by it were agreed on the basis of price lists or on the basis of current arrangements and negotiations taking into account changing market conditions. On the other hand, it stated that in the process of production and sales to the main customer and a related party, C. GmbH (the parent company) acted as a subcontractor, i.e. these processes were planned on the basis of long-term contracts by C. GmbH with its customers and not with the Appellant, which had no influence whatsoever on their shape and the level of prices offered in them. The sales prices of finished goods to C. GmbH therefore depended not on internal calculations made by the Company, but had to take into account the prices that resulted from the long-term contracts concluded between C. GmbH and its contractors. In addition, the problems with ensuring the level of employment and production realisation indicated as the reason for the loss do not correspond to the reason for the loss, as stated by the Applicant, resulting from a decrease in orders from affiliated entities. Indeed, the tax authority correctly noted that since there had been a decrease in the planned turnover, the staff shortage should therefore be irrelevant in view of the reduced demand for the goods produced. However, also in this context, the authorities’ findings on staffing levels do not support the thesis of staff shortages in 2016, as the level of production staff increased by almost 20% during the period of that year. There is also no basis for assuming that the prices in transactions with unrelated parties, which accounted for approximately 5% of revenues, were indicative of market conditions for all transactions carried out by the Company in 2016. The passive role of the Company during the tax proceedings, which was unable to indicate the overall cost base in the transactions for both related and unrelated parties, must be emphasised in this context. On the other hand, it emphasised the individual valuation of each order or assignment. There was also no indication, in respect of transactions with unrelated parties, of the cost base by type and value of costs incurred, price spreadsheets, correspondence and agreements with counterparties for individual transactions. The Company’s assertions that it used the “same prices” for transactions with unrelated parties, on which sales volumes were in fact marginal, could therefore not be accepted a priori as credible.”
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Click here for other translationII FSK 974_22 - Wyrok NSA z 2022-11-23