In an individual tax interpretation, the tax authorities denied “H. Services Sp. z o.o.” the ability to treat year-end adjustments to four intra-group service and licensing agreements as transfer pricing adjustments under Article 11e of the CIT Act. Therefore, they could not recognise the adjustments in the relevant period.
The dispute hinged on whether year-end adjustments that align the tested party’s profitability or cost-plus charge with arm’s length results qualify as ‘transfer pricing adjustments’ under Article 11e which could be recognised in the relevant year, as opposed to ordinary cost corrections which would be recognised in later years.
Not satisfied with the interpretation, an appeal was filed by “H. Services Sp. z o.o.” with the Administrative Court.
Judgment
The court overturned the individual tax interpretation issued by the tax authorities and remanded the case for reconsideration.
According to the court year-end adjustments designed to bring profitability within a benchmark range, or to reconcile cost-based charges to actual figures, can qualify as transfer pricing adjustments under Article 11e.
The court held that the notion of a transfer pricing adjustment is grounded in economic substance and functional profiles, rather than the form of the accounting document. It is a retrospective adjustment made when a price set on market terms ex ante proves to be non-arm’s-length ex post due to significant changes in circumstances, or when actual costs or revenues that form the pricing base only become known after the end of the period in budget-based models. Errors in accounting or obvious mistakes never justify a transfer pricing adjustment and must be corrected under the general rules.
Applying these principles, the court found that the tax authority had erred by failing to distinguish between the two alternative premises in Article 11e(2), and by dismissing adjustments arising from year-end adjustment to actual figures in budget-based pricing models. In such cases, provided that the conditions of Article 11e are met — including reciprocal adjustments by the counterparty and, where relevant, an exchange of information — the taxpayer may recognise the adjustment in the relevant period.
The court also noted consistency with the OECD’s guidelines on compensating adjustments.
Excerpt in English
“The OECD guidelines define a compensating adjustment as an adjustment in which the taxpayer indicates a transfer price for tax purposes which, in his opinion, reflects the arm’s length principle in transactions between related parties, even if this price differs from the price actually applied between related enterprises. This adjustment would be made before filing the tax return (see OECD Guidelines, p. 21). This refers to a subsequent adjustment of transfer prices determined at the time of the transaction. Compensatory adjustments can make it easier for taxpayers to report taxable income in accordance with the arm’s length principle, taking into account the fact that information on comparable uncontrolled transactions may not be available at the time when related enterprises determine prices for controlled transactions. Therefore, in order to file a correct tax return, the taxpayer could make a compensatory adjustment that would reflect the difference between the market price and the actual price recorded in its books and records (point 4.38 of the OECD Guidelines, p. 185). The practical problems associated with compensating adjustments are also highlighted in a document by the European Commission, Eu joint transfer pricing forum. Report on Compensating Adjustments, DOC: JTPF/009/Final/2013/EN, Brussels, January 2014, which states that the decision on whether to require the taxpayer to make such an adjustment remains at the discretion of the Member State.”
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