P.B. had deducted licence fees paid for the use of the trademark “B” which was owned by a related party.
Following an audit, the tax authority issued an assessment where deductions for the fees had been disallowed. The tax authority stated that the transactions carried out by the P.B. in 2015 concerning the trademark, both in terms of the disposal of this asset and in terms of the subsequent acquisition of the right to use it, escape the notion of rational management and that these activities occurred under conditions that were clearly different from market conditions. According to the authority, their undoubted result was an unjustified transfer of income to the related entity B. sp. z o.o.
An appeal was filed with the Administrative Court which later upheld the tax assessment, and P.B. then filed an appeal with the Supreme Administrative Court.
Judgment of the Supreme Administrative Court
The Court ruled in favour of P.B. by setting aside the decision of the administrative Court and the tax assessment.
Excerpt
“It follows from the case file that the authority did not question the effectiveness of the concluded agreements related to the right to use the trademark, but only questioned their tax consequences. There is no doubt that the Company used the trademarks and the expenses incurred in the form of licence fees were necessary to obtain revenue. Since the transaction of disposal of the right to the “B.” trademark was legally effective (the validity of these agreements was not challenged), it means that there was a transfer of ownership of these rights to another entity. The trademark licence agreement concluded between the Company and B. sp. z o.o. should be assessed similarly. In such circumstances, the licence fee documented by the invoice of […] December 2015 was charged to deductible costs and understated the Company’s income and thus the complainant’s tax base in 2015. It is undisputed that, in light of the accepted facts, the exclusive holder of the rights to use the trademark “B.” was the trademark company, and under the undisputed licence agreement, the Company was obliged to pay royalties. Moreover, it is undisputed that it used the right to the trademark in its operations, even in the form of a licence, and therefore the prerequisites for including this expense as a deductible cost were met.
The provision of Article 25(1) u.p.d.o.p. authorised the authorities to determine only the conditions (prices) of these activities differently – and thus to replace the prices specified in the parties’ agreements (transactions) with prices that would correspond to hypothetical conditions (prices) agreed by unrelated parties. The occurrence of the prerequisites referred to in Article 25(1) of the u.p.d.o.p. provided the basis for estimating the Company’s income by possibly reducing the amount of its tax costs. However, this provision cannot be used to disregard the tax consequences of the legal actions performed between related parties in 2015, the effectiveness of which was not questioned by the tax authority. In this provision, the legislator exposed the arm’s length principle, which requires that prices in transactions between related parties be determined as if the companies were operating as independent entities, operating at arm’s length. However, in the facts of the case under consideration, the tax authorities and, following him, also the Court of First Instance, relying on the content of Article 25(1) of the u.p.d.o.p., critically assessed the legal transactions performed by related entities, undermining not only their economic sense (with which the Supreme Administrative Court agrees), but also, in essence, reclassified the legal transaction performed, in the form of a valid licence agreement, into an agreement for the provision of low-value services .
In the opinion of the Supreme Administrative Court, Article 25(1) of the u.p.d.o.p. could not constitute a self-contained basis for “redefining” the disputed transaction. Challenging the scheme of operation applied by related parties must have a clear legal basis. Tax authorities may not use other provisions as a solution equivalent to a circumvention clause (cf. the NSA judgment of 8 May 2019, ref. II FSK 2711/18).
The tax authorities, as well as the Court of first instance, did not present argumentation from which it would follow, by applying what rules of interpretation, they came to the conclusion that such a manner of application of Article 25(1) u.p.d.o.p. is legally possible and justified in the case under consideration. This provision, in fine, provides for the determination of income and tax due without ‘(…) taking into account the conditions resulting from these connections’, and does not allow for the substitution of one legal transaction (trademark licence agreement) for another transaction (provision of low-value services) and deriving from this second transaction legal consequences in terms of determining the amount of tax liability. It should be emphasised that the statutory determination of the subject of taxation, resulting from Article 217 of the Constitution of the Republic of Poland, is unquestionable. Therefore, the provisions from which the powers of tax authorities to change (reclassify) the subject of taxation are derived should be approached with great caution.
The transfer pricing regulations (chapter 4b of the u.p.d.o.p.), introduced by the amending act of 23 October 2018 and effective as of 1 January 2019, constitute in some aspects a significant novelty. Although the content of Article 25(1) corresponds to the content of Article 23o(2), the regulations contained in Article 23o(4) u.p.d.o.p. do not find their counterpart in the previous provisions. The provision of Article 23o Paragraph 4 contains the wording “(…) without taking into account the controlled transaction, and where justified, determines the income (loss) of the taxpayer from the transaction relevant to the controlled transaction”. This is the explicitly expressed competence of the tax authorities to carry out the so-called recharacterisation (reclassification), i.e. reclassification of the transaction, which is what the tax authorities actually did in the present case.
Even more so, such powers were not granted to the authorities by the Transfer Pricing Ordinance. Pursuant to Paragraph 9(2) of this regulation, the terms and conditions of the agreement subject to modification by the authorities were: the terms, conditions and forms of payment (point 1), the period over which the transaction is executed and factors related to the passage of time (point 2), the timeliness of the execution of the transaction (point 3) and the security of the execution of the transaction (point 4). Despite the fact that this list is not exhaustive, due to the phrase “in particular” used in this provision and the fact that it is included in the act implementing the Act, it should be noted that the examples of modification of contractual terms indicated there, in terms of their importance, are far from the possibility to make a change in the legal nature of the transaction (here, from a trademark licence agreement to the provision of low-value services).
It should be emphasised that in cases involving legal states prior to 2016, the administrative courts, as evidenced by the case law that has already been handed down, have been critical of the inferences drawn from various tax provisions (e.g. Articles 11(1), 15(1) u.p.d.o.p. or Articles 22(1), Art. 25(1) of the u.p.d.o.p.) the competence of tax authorities to perform procedures consisting in redefining (reclassification) for the purposes of determining the tax consequences, valid and effective under civil law, of various types of civil law transactions performed with the participation of taxpayers. The Supreme Administrative Court, sitting in this case, shares these views. To sum up, the Supreme Administrative Court considered as well-founded the charges of the cassation appeal which concern the infringement of substantive law, i.e. Article 25(1) and Article 22 of the AOF. If, from the perspective of Article 22(1) of Ustawa o.p.d.o.f. (the Act on Combating Unfair Competition), what matters is only whether the expenditure incurred under the concluded trademark licence agreement fulfils the prerequisites of this provision, and in particular whether there is a causal link between the expenditure incurred and the revenue obtained, which the authorities did not question in any way, then the allegation of a breach of this provision should also be deemed justified.
In making recommendations to the authority that will reconsider the case in question, the Supreme Administrative Court notes that the tax authorities may determine the taxpayer’s income and the tax due without taking into account the conditions established or imposed as a result of the links between the contracting entities. This income would have to be determined by way of an estimate, using the methods described in Article 25 of the u.p.d.o.p., but without questioning the validity and effectiveness of the trademark licensing agreements themselves. The authority may question only the amount of the price of this transaction, i.e. the amount of the fee for granting the licence. This is because these are not provisions creating abuse of rights or anti-avoidance clauses. They only allow a different determination of transaction (transfer) prices. Therefore, it is a legal institution with strictly defined characteristics and can only have the effects provided for in the provisions defining it (as it stood in 2015).
As indicated above, Article 25(1) of the u.p.d.o.p., as in force in 2015, authorised the authorities to define the conditions (prices) of these activities differently – and thus to replace the prices specified in the parties’ agreements (transactions) with such prices that would correspond to the hypothetical conditions (prices) agreed by unrelated parties. The occurrence of the prerequisites referred to in Article 25(1) of the u.p.d.o.p. provided the basis for estimating the Company’s income by possibly reducing the amount of its tax costs. However, this provision cannot be used to disregard the tax consequences of the legal actions performed between related parties in 2015, the effectiveness of which was not questioned by the tax authority.”
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