Switzerland vs “Kraftwerke A. AG”, June 2024 , Federal Supreme Court, Case No 9C_37/2023

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Category: Transfer Pricing Methods | Tag: , , ,
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In the case of Kraftwerke A AG, the issue was whether taxes should be included in the cost base when applying the cost-plus method to determine whether Kraftwerke A AG had invoiced its services to the shareholders/partners in accordance with the arm’s length principle (pursuant to Art. 58 para. 3 DBG).

Judgment

The Federal Supreme Court ruled that taxes should be included in the cost base when applying the cost plus method pursuant to Art. 58 para. 3 DBG.

Excerpt in English

“3.4.4 Despite all deductibility, the fact remains that taxes are actually incurred and are to be borne by the partner organisation at the expense of the income statement. As can be seen from the annual financial statements, the taxpayer recognised profit taxes of CHF 4,288,000 (2009), CHF 3,186,000 (2010) and CHF 2,220,000 (2011) in the three tax periods (facts, lit. A.d). A fundamental difference to other expenses or costs – such as interest on borrowed capital – is not apparent. Consequently, it is clear from Art. 6 para. 2 lit. b of the partner agreement of 17 March 2008 that taxes are also considered part of the “annual costs charged to the partners”. If all expenses are to be covered, this must also include taxes. It is not only clear from business management theory, but also from the judgment 2C_495/2017 / 2C_512/2017 of 27 May 2019, that the full costs must be sought. This is because the cost basis pursuant to Art. 58 para. 3 DBG is made up of the “respective production costs” (“coût actuel de production”, “prezzo di costo”; see E. 2.3.1 above). These are based on a clear economic concept that places the “cost price” or “full costs” at the centre. In this way, the legislator indicates that all items relating to the generation of electricity, including taxes, should be included in the cost base. As explained above, the same is already apparent from the partner agreement of 17 March 2008, to which the taxpayer must adhere.
3.4.5 In summary, the interpretation of Art. 58 para. 3 DBG shows that the recognised and accrued taxes must be included in the cost base. The previously rather unclear “Swiss practice” (see E. 3.4.2 above) must be confirmed.
3.4.6 Non-operating expenses and extraordinary operating expenses, on the other hand, are not included in the cost base (NADIG, loc. cit., p. 5; case 4).”

Statement issued by the Swiss tax authorities

A statement has later been issued by the Swiss tax authorities (FTA) clarifying that the Supreme Court judgment does not apply to arm’s length pricing of international transactions, but only for the specific purposes of the case.

Excerpt in English

“The hypothetical/calculatory approach applied by the Federal Supreme Court in the above-mentioned judgment does not correspond to the comparison with actual transactions that is fundamentally provided for in the OECD Transfer Pricing Guidelines (OECD-TPG). Therefore, different requirements must be set for the comparability of the cost base in a national or international context. In this context, the same standards for comparability of the cost base cannot be applied as in international situations, where comparative values are typically available from benchmarking studies. The FTA’s view is based on the following considerations:
Article 58(3) DBG as a (special) rule of purely unilateral law: Article 58(3) DBG is a rule of purely unilateral law which – as also considered by the Federal Supreme Court in its judgment 9C_37/2023 of 11 June 2024 – is not designed for international situations. This is because the hypothetical arm’s length principle under Article 58(3) of the DBG concerns an aspect of unilateral federal law, which is to be interpreted and applied in accordance with the rules applicable to a federal law (see judgment of the Federal Supreme Court 9C_37/2023 of 11 June 2024, E. 2.3.6).
Clear rules in the OECD TPG for controlled transactions in an international context: According to the OECD TPG, the cost-plus method compares the gross profit (see OECD TPG 202 2, para. 2.54 and para. 2.59), which related parties realise in an intra-group transaction, with the gross margin that unrelated parties would realise in a comparable transaction. Conceptually, the OECD-TPG assume that only costs that are closely related to the provision of services can be passed on to the recipient. Therefore, a fundamental distinction must be made between operating costs, i.e. expenses that a company incurs on a regular basis to keep business processes and systems running and to provide services that generate value, and non-operating costs (operating costs that are not part of a company’s core business). Tax expenses are not related to the functions to be tested and must therefore be excluded from the relevant assessment base for determining the cost mark-up.
Comparability of the cost base – methodological aspects of applying the arm’s length principle: Applying the cost plus method requires that comparable cost mark-ups be applied to comparable cost bases. For the arm’s length use of transfer pricing studies in the context of transactions in which Swiss companies are involved, the cost base must be determined according to the same principles (identical profit level indicator), since otherwise the comparability of the determined ranges is not given. If, in line with the Federal Supreme Court’s ruling, the recorded and deferred taxes are included in the cost base, this has a decisive effect on the comparability of benchmark studies in which the tax burden is not taken into account in the calculation methodology. Moreover, such a restriction on the comparability of benchmark studies cannot be meaningfully remedied by adjustment calculations.
In the opinion of the FTA, any prejudicial effect of the judgment of the Federal Supreme Court 9C_37/2023 of 11 June 2024 that goes beyond the scope of Article 58 paragraph 3 DBG should be rejected. The practice applied by the Federal Supreme Court in this judgment regarding the formation of the cost base is not in line with the OECD-TPG and will not be applied by the FTA in international matters. Therefore, the Federal Supreme Court’s practice for intercompany transactions in an international context remains unchanged and non-operating costs such as taxes are still not included in the cost base.”

 

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