SGGE W T is a Spanish branch of SGG that carries out distribution and marketing activities related to the information technology network products and services. SGG is part of the KF group which “is an international group that provides solutions and services in the Information Technology (IT) sector, starting its activity in . .. as a distributor of access and communications networks”. The group “is the result of several corporate operations, mainly company acquisitions and mergers carried out to increase its share in world markets” and “is mainly organized in three divisions (SGG, QR and …) according to the IT areas (Technology, Integration and Consulting) in which they operate”.
Following an audit of FY 2015 and 2016 the tax authorities issued assessments of additional income to the Spanish branch. One of the issues identified was SGGE’s remuneration for its sales and marketing activities. According to the tax authorities, the income of the Spanish branch was below the lower quartile of the range established under the TNMM. On this basis, the income was adjusted to the median. The tax authorities had also disallowed deductions for the cost of intra-group services.
An appeal was filed by SGGE W T.
Judgment of the Court
The Court partially upheld and partially dismissed the appeal.
Excerpt from the judgment concerning IQR and Median
“Thus, this Court only appreciates, from the motivation of the Inspection, that there would be -according to the assessment- some defects of comparability that persist, unavoidable as a consequence of the selection process of comparable elements through databases, and of the limits of the available information, but it is not detailed what errors or circumstances concur in the selection of the comparable elements or what limits the available information has.
It should be noted that when the Inspectorate, as transcribed above, refers to the fact that there are still defects in comparability, given that the resulting range does not include relatively equal results, it adds, paraphrasing the Guidelines, that these are defects that cannot be identified and quantified.
Rule 3.57 of the OECD Guidelines – also transcribed above – refers to defects in comparability that cannot be identified or quantified and are therefore not susceptible to adjustment.
Notwithstanding the foregoing, regardless of the possibility of identifying or quantifying such defects, the choice of the median, provided for in rule 3.62 of the OECD Guidelines, requires – as clearly stated by the Audiencia Nacional and this TEAC – that the Inspectorate must disclose the defects of comparability, and reasons must be given for the defect or defects of comparability that are found to persist and that cause the range not to include very reliable and relatively equal results.
We have seen that when section 3.57 of the Guidelines refers to defects that cannot be identified or quantified, it immediately links it to the fact that this makes a specific adjustment impossible. This is perfectly logical, because if they could be concretely identified and quantified, the adjustment would be feasible.
It is one thing if they cannot be identified in the sense of being precisely specified and quantified so that they can be adjusted or corrected, and another if elements or areas are detected which, due to their special circumstances or lack of documentation, allow us to conjecture that there is still a deficiency in comparability that cannot be corrected, for which reason there is no other recourse but to resort to the median.
Therefore, the mere appeal to this generic reference cannot be considered sufficient; otherwise, the requirement to state reasons that the Audiencia Nacional and this TEAC maintain would be sterile.
At the very least, it should be explained what errors or failures in the process of selecting comparables, or what limitations in the information available, determine, as a consequence, that there are such unidentifiable or unquantifiable defects in comparability.
In the present case, the reasoning contained in the assessment notification -page 148- only talks about defects that are a consequence of the selection process and the limitations of the available information, but does not detail any aspects that could allow this reviewing body to assess which are the specific circumstances of the selection process that allow to consider that it will lead to unidentifiable or quantifiable defects of comparability; nor the specific circumstances of the available information from which it can be extracted that the limitations of the same (not identified by the Inspection in the aforementioned motivation) will lead to unidentifiable or quantifiable defects of comparability.
Likewise, it is striking that the Inspection refers to defects derived from the process of selection of comparables when, in the Fourth Ground of Law of the agreement, in response to allegations, a table is drawn up in which five entities selected by the Inspection, which are the object of allegations by the taxpayer, are eliminated from the comparables, indicating that “the interquartile range derived from the remaining entities would not offer values very different from those resulting from the entities taken by the Inspection”.
Also noteworthy is the statement made on page 209 of the contested resolution in which, in response to the allegation that the services of one of the comparable entities (…, S.A.) represent around 40% and 49% of the total income, in 2015 and 2016, respectively, it is stated that this “in no way implies that in all the other entities selected as comparable by the inspection this same circumstance is present”, indicating that in case it were so (that the percentage of 40% or 49% of the income from the provision of services were present in the other entities) “in no way would invalidate the sample of entities selected by the inspection since they are entities that carry out activities similar to those of the obligor and that constitute the best possible comparable”.
It is striking that the Inspectorate states that the selected entities “constitute the best possible comparable” and that, nevertheless, the adjustment is based on the choice of the median “as the point in the range that best reflects the arm’s length principle”, as a consequence of comparability defects that “are a consequence of the process used to select comparable elements (databases) (…)” -as well as the limits of the available information-“. -as well as the limits of the available information.
Such statements would not be consistent with the expression that the set of entities used by the Inspectorate “constitute the best possible comparable”.
Thus, this Court finds that the choice of the median to carry out the regularization is not sufficiently motivated, nor is there any reasoning to rule out, on the part of the Inspection, the choice of any other point of the range by stating that there is “no element that would lead the inspection to choose another point”.
Therefore, the agreement should be annulled in this respect, and a regularization should be carried out using the lower quartile resulting from the comparables used by the Inspection, excluding those mentioned in the NINTH Ground of Law of this resolution.”
Excerpt from the judgment concerning intra group services
“Thus, even when the good governance of the multinational group is mentioned in parentheses, as a general statement of the activity to which the expenses for “management services” correspond, it is clear from the analysis of the costs that make up the basis of distribution and the services rendered, that there is an interest of the parent company or the shareholder in these expenses and services. Thus, the mention of the shareholder’s interest in the share acquisition process, the reference to the link to the remuneration and travel costs of directors and other FK management personnel, or the assessment that it is a question of supervision of the activity of the group entities, in relation to the item “FK Management Fees”; the coincidence of the amount of “restructuring” with the amount of compensation for dismissal of a “director” or advisor of the company; the absence of a clear description regarding the concepts “CEO/MD Office and Finance Function” -page 70 of the assessment notification-, the assessment of the control function of QRG SERVICES T sobre the accounts of QR SPAIN, S.L.U.; the assessment by the Inspection that the concept “Share Based Payments” refers to expenses derived from remuneration programs based on equity instruments that the QR group offers to some of its employees; the assessment that the concept “Recruitment” refers to the costs of searching and hiring personnel assigned to the provision of services; and the assessment that the concept “Travel overseas” includes the travel expenses of the directors and management personnel of QRG SERVICES T.
It also highlights the reference to the Guidelines on low value-added services approved by the EU Joint Transfer Pricing Forum with respect to the item “Internal Audit”, in order to specify in the agreement that there is no evidence that any of the circumstances foreseen in said Guidelines are present in order to appreciate that it is to the benefit of the subsidiary.
And it highlights the reference to paragraph 7.11 of the OECD Guidelines in relation to duplicity of expenditures.
In the analysis of each of the categories of services received by the subsidiary from QRG SERVICES Tse makes reference to the fact that they are related to the shareholder activities and the control function of the Spanish subsidiary, not being services for which the subsidiary would be willing to pay (“Financial administration services”); they are intended to protect the interests of the parent company or shareholder, and to coordinate the human resources policies of the different subsidiaries of the group, not being services for which the entity would be willing to pay an independent third party (“Human resources”); and the concurrence of a control of the investments made by the shareholder (“Corporate business services”).
Therefore, the claimant’s allegations on this point should not be upheld, since, without prejudice to the references to the good governance of the group, certain circumstances relating to the interest of the shareholder or the parent company in the costs and services analyzed by the Inspectorate were found in the basis for the regularization.”
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