The Curia
as a court of review
judgment
Case number: Kfv.I.35.504/2018/6.
Presiding Judge: Péter Hajnal,
President of the Chamber, Éva Oláh
Huszárné, Judge-Rapporteur, Péter
Sisák, Judge
The applicant:
Representative of the applicant: Horváth & Társai Law Office (managing lawyer: Dr. András
Nemescsói)
Defendant: National Tax and Customs Board of Appeal
Representative of the defendant: Dr. Andor Iván
Iván Kovács, Bar Counsel
Subject-matter of the proceedings: administrative decision in a tax
matter
Party requesting the review: defendant under No 16
Final decision sought: Judgment of the Administrative and Labour Court of
Budapest No 2.K.33.507/2017/15
Operative part
The judgment of the Administrative and Labour Court of Budapest No
2.K.33.507/2017/15 is upheld.
Orders the defendant to pay the applicant 100,000 (one hundred thousand)
forints (one hundred thousand HUF) for the costs of the review proceedings
within 15 days.
The review procedure fee shall be borne by the State.
There shall be no review of the judgment.
Reason
The facts on which the review is based
[1] On 2 December 2013, the applicant filed an application for an advance
pricing arrangement, in which it requested the determination of the arm's
length price for the provision of administrative services in the context of its
on-lending activities for Hungarian corporate tax purposes. It submitted that
the lower arm's length range for the administration fee (interest margin) was
10,00 basis points and the upper arm's length range was 22,50 basis points. The
applicant sought to apply an administration fee of 15 basis points. In its
Decision No 2511768785 of 18 July 2014 ('the APA Decision'), the National Tax
and Customs Board's Directorate for Special Taxpayers, Normal Market Price
Determination and Transfer Price Control Division, determined the normal market
price for the administrative service for the period from 2 December 2013 to 1
December 2018, partially differently from the application. Accordingly, the
normal market price is not a specific basis point, but a range of 12,50 to
22,50 basis points, subject to other conditions. In point 4.1 of the decision,
the method used was the determination of the notional interest expense, and in
point 4.2, the method used was the calculation of the normal profitability.
[2] In the course of the applicant's management, the price applied was in
some cases outside the normal market value range established and exceeded the
upper limit. The applicant took into account the difference of 15 basis points
to adjust the pre-tax profit.
[3] The tax authority of first instance carried out a posteriori
examinations of the applicant's returns for all taxes and budgetary aid for the
period from 1 July 2013 to 30 June 2015, except for VAT for the period from 1
April 2014 to 30 June 2014. The audit made different factual findings for each
tax category. With regard to the arm's length price, it was found that since it
exceeded the range of values under the APA Decision, the applicant had to make
an adjustment. Once the 22.50 basis points were reached, the adjusted price was
to be considered as market price and could not/should not be further adjusted
by another market price, as all values in the range were equally market. The
upper value of the market range was the closest to the price applied and had to
be taken into account in the adjustment of the pre-tax result. The other
conditions laid down in the APA Decision were not contested by the revision.
[4] The tax authority of first instance assessed a total of HUF
31,513,000 in tax deficits for the audited period, of which HUF 30,974,000 in
corporate tax deficits were incurred for the 2014 and 2015 financial years. The
tax authority imposed a tax penalty and charged a late payment penalty.
[5] By decision No 2233697472, the defendant upheld the first instance
decision. It based its decision on Section 18(1)(aa) of Act LXXXI of 1996 on
Corporate Tax and Dividend Tax ('the Tao Act'). It reasoned that the correct
interpretation of the statutory provision is that if the price applied by the
taxpayer is within the arm's length range, no adjustment is warranted. If it is
outside that range, the adjustment to the taxable amount should be determined
by reference to the closest value in the market price range to the price
applied. This interpretation is also supported by Resolution No 5885/2010/1 of
the Income Tax Department of the Ministry of Finance and the handbook issued by
S. Zrt.
The claim
[6] The applicant sought judicial review of the defendant's decision with
regard to transfer pricing.
The judgment at first instance
[7] By its final judgment, the Court of First Instance annulled the
defendant's decision, including the decision of the Court of First Instance, in
respect of the years 2014 and 2015, in relation to the corporate tax rate, the
related tax penalty, the late payment penalty and the provisions relating to
the change in the pre-tax result and the corporate tax base, and ordered the
tax authority of first instance to initiate new proceedings in this regard.
[8] It held that, since the action could be decided as a matter of law
without any specific economic context being established, it had not heard the
private expert opinion submitted by the applicant.
[9] It found that the defendant had clarified the facts and had not
violated the fundamental provisions of Articles 97 and 121 of Act XCII of 2003
on the Tax Code (hereinafter: Art.) and Act CXL of 2004 on the General Rules of
Administrative Procedure and Services.
[10] The Court of First Instance presented the calculation formula used
in the APA Decision, noting that there was no dispute between the parties as to
the numerical data and the amount. The actual dispute was over the question of
what the normal profit for the on-lending activity, defined as a range,
directly affecting the transfer price could or should be if the actual price
used by the claimant fell outside the extremes of normal profit. The
consideration applied, against which the notional interest expense (arm's
length price) of the interest-free loan was to be determined, was identical to
the 'actual administration fee' derived from the applicant's accounting
records.
[11] In the case at issue, it follows from point I of the operative part
of the APA decision and from point 4.1 of the grounds that the relevant arm's
length price for the purposes of Article 18(1)(a)(aa) of the Tao Law can be
determined within a range by defining one (and only one) element of the series
of transactions (the arm's length administration fee) as a range. Therefore,
the applicant unnecessarily claimed that the defendant wrongly considered the
transfer price as a range (instead of taking it as a reference indicator),
because the transfer price itself is not a range, but the price can only be
legitimately determined within a range as a result of the foregoing. It was
therefore not relevant to what extent the defendant had applied the concepts
set out in point 4.1 of the APA Decision's reasoning in a correct manner, but
whether the applicant itself had calculated the presumed interest expense (the
transfer price) for both tax years in accordance with the APA Decision - the
relevant point 4.1 of the APA Decision.
[12] There is no recommendation in the OECD Transfer Pricing Guidelines
('the Guidelines') that the mid-point should be used as a guide when
determining the arm's length price range. However, in the case at hand, the
court of first instance considered relevant the first sentence of paragraph
3.62 of the Guidelines, which states that "In determining this range, if
the range contains relatively uniform results of high confidence, it may be
argued that any point within the range is consistent with the arm's length
principle." The APA Decision accepted the range of the arm's length price
(imputed interest expense on a non-interest bearing loan) as being between
12.50 and 22.50 basis points. The range thus defined contained relatively
uniform results with a high degree of confidence with respect to point 3.62 of
the Guidelines, so that any point in the range complied with the arm's length
principle.
[13] Compared with the method of adjusting for the marginal value, which
induced a tax differential for and against the applicant, the applicant did not
infringe the law either, because each element of the range determined by the
arm's length administrative charge corresponded to the 'arm's length price'
within the meaning of Paragraph 18(1) of the Tao.tv. Neither the law nor the
APA decision, which is binding on the applicant's tax liability, gave
preference to the individual elements of the range in terms of how the
consideration actually applied (which in the present case is the actual
administration fee calculated from the applicant's accounting statements)
compares with the theoretically determined marginal rates of the presumed
interest expense. The applicant has argued on the basis that if the price
applied, i.e. the consideration applied in accordance with Paragraph 18 of the
Tao.tv, is outside the arm's length price range, the adjustment can be made for
any element of the arm's length price range without limitation.
[14] In that way, the method of adjusting for the marginal value
presented in the defendant's decision, based on the PM's position in another
case without binding force and on the publication of S. Zrt.
Nor is there any normative basis of comparison against which the defendant's
application of the law - namely, the classification as unlawful of the
applicant's tax liability calculated by means of a legally correct transfer
pricing calculation - could be regarded as legally binding and, consequently,
lawful in the present case.
[15] In summary, the Court of First Instance found that the plaintiff had
wrongly pleaded a violation of the clarification of the facts, but that it did
not follow from the APA decision, the Guidelines or the Tao.tv. that, in the
case of several arm's length prices (which can be defined in a range), the
adjustment for a consideration applied outside the range can only be made to
the marginal value. The defendant is not wrong in that, in general, for an
effective consideration (arm's length price) within a range, no adjustment can
be made to the lower end of the range solely for the purpose of reducing the
tax liability, but there is no normative basis for the fact that, where an
arm's length price is not applied, the pre-tax result can only be taken into
account at the value in the range which is least favourable to the taxpayer.
The transfer pricing calculation used by the applicant in relation to the
on-lending activities in the financial years 2014 and 2015 complied with
Section 18(1)(a)(aa) of the Tao.tv.
[16] In the new proceedings, the assessments and the legal consequences
(including the legal consequences for the tax categories not affected by the
action) for the corporate tax tax category concerned
by the action for 2014 and 2015, as well as the change in the pre-tax result
and the corporate tax base, must be recalculated taking into account the fact
that the applicant correctly considered the arm's length administration fee to
be 15 basis points.
Request for review and counterclaim
[17] In its application for review, the defendant sought to have the
final judgment of the Court of First Instance set aside and the applicant's
action dismissed. In its view, the Court of First Instance did not draw the
correct conclusion from the facts established, contrary to Article 206(1) of
Act III of 1952 on the Code of Civil Procedure (hereinafter 'the Code'). It
annulled an administrative decision which did not infringe either the legal
provisions applicable at the time it was adopted or the interpretation of the
law by the courts. It argued that the court of first instance had correctly
held that the issue in the dispute was a question of law and had correctly
disregarded the private expert opinion submitted by the applicant.
[18] The final judgment concluded that there was no normative basis for
the defendant's finding because, within the arm's length price range, since all
points in the range are equally reliable, the plaintiff could make an
adjustment for any point: on the contrary, the defendant's finding was correct
under the Guidelines. The absence of national legislation does not mean that
the applicant can arbitrarily determine the market price it considers to be the
relevant market price within the range on the basis that any point in the range
is a uniform market price. The Guidelines provide guidance on this transaction
as a legal aid.
[19] The APA decision states that all points in the range established are
market prices, so that if the consideration actually charged is within the
arm's length price range, the applicant does not need to adjust its corporate
tax base. This is different from the case, which is not covered by the APA
Decision, where the consideration applied is outside the market price range. As
a consequence of points 3.61 and 3.62 of the Guidelines, it is only appropriate
to adjust the arm's length price for such transactions to a level close to the
mid-point of the range if there are shortcomings in comparability. However, no
such shortcomings were found and the court of first instance also considered
the comparables to be reliable, i.e. all values in the market price range were
considered to be market prices. The interpretation which the Court of First
Instance considered to be the correct one treats taxable persons applying
values inside and outside the market price range differently, as well as the
tax base adjustment which they can make, which is both discriminatory and open
to abuse, since it encourages all rational multinational companies to apply
artificial prices outside the market price range, thus allowing them to choose
any value within the range.
[20] When applying Article 18(1) of the Tao Law, the principle of Article
1(2) of the Tao Law must be taken into account, since the applicant applied a
reduction of the tax base in the price adjustment. The APA decision does not
contain a binding provision on the consideration to be applied within the price
range and the applicant should therefore have explained the reasons for
applying a tax base adjustment higher than the one which achieves the objective
of the tax base reduction, on the basis of which the reasons relating to the
material terms of the transaction were relevant. The Székesfehérvár
Administrative and Labour Court 2.K.27 .128/2016/84, based on the expert
opinion in the transfer pricing register litigation, it is argued that all
elements of the interquartile range are considered to be arm's length, which,
in the light of Article 18(1) of the Tao.tv., implies that if the applicant's
profitability is outside the interquartile range, the profitability must be
adjusted to the element of the range that is closest to the profitability.
[21] The cited PM Resolution and Saldo Manual
were not cited as a legal basis, but as a technical source of interpretation in
the absence of uniform detailed international rules.
[22] In its cross-appeal, the applicant sought to have the final judgment
upheld. It stressed that the defendant had established in the APA decision, and
did not dispute in the present action, that all the values of the price range
on which the action was based were market prices.
[23] The defendant's approach that the transfer price adjustment
constitutes a tax advantage is erroneous: the transfer price adjustment under
section 18 of the Tao.tv is not a tax advantage or tax benefit, it is a legal
provision that a price other than the market price between related enterprises
is not influenced by the taxpayers of the individual taxpayers.
[24] The defendant's approach that the final judgment would allow for
abuse is also erroneous. Indeed, if the purpose of two related undertakings
were to deliberately circumvent the transfer pricing system and the price
range, as the defendant assumes, the simplest way for them to do so would be to
contract at the most favourable value in the price range, in which case they
would not have to make any adjustment, assuming that the defendant would not
reserve to itself a right that would allow the tax authority to adjust to
another value within the range even in such a case. At the group level, the
effect of a transfer pricing adjustment is neutral.
[25] He submitted that the case law of the Székesfehérvár
Administrative and Labour Court in the present case is inconsistent, although
it shows the practice of the defendant to always interpret the correction for a
given element of the price range depending on which method provides a higher
tax revenue.
The decision of the Court of
Appeal and its legal reasoning
[26] The defendant's application for review is unfounded.
[27] The Curia reviewed the final judgment in the context of the
application for review on the basis of the documents available, in accordance
with Articles 272(2) and 275(2) of the Civil Code. The starting point for its
procedure was Section 18(1)(a)(aa) of the Tao.tv. in force at the time of the
proceedings.
[28] In accordance with Art. § According to Article 18(1)(a)(aa) of the
18.1: the taxpayer shall reduce its pre-tax profit before tax by an amount
equal to the difference calculated on the basis of the arm's length price and
the consideration applied, irrespective of any other items increasing or
decreasing the pre-tax profit before tax provided for in this Act, provided
that the consideration applied has the effect of increasing its pre-tax profit
before tax to a level higher than that which it would have had if the arm's
length price had been applied.
[29] The methods for determining the arm's length price are listed in
section 18(2) of the Tao.tv. The applicant had applied for the determination of
the arm's length price under Art. 132/B, so that it was for the tax authority
to select and apply the method. The findings on the method are set out in
paragraph 4 of the grounds of the APA decision. The decision was issued on 18
July 2014, so that it could not yet directly apply Article 18(9) of the Tao.tv,
which allows for further narrowing of the interquartile range, effective from 1
January 2015. However, there was no obstacle to the application of the method,
which is not yet regulated by law, on the basis of the Directives at the time
of the litigation. The method of determining the normal market price in the APA
Decision, its level, the use of a range or a specific value, and thus the method
of calculation used, could only have been challenged in an independent judicial
review of the Decision, which was not carried out. As pointed out by the Court
of First Instance, the binding force of the APA decision cannot be challenged
in the present proceedings. Consequently, in the review proceedings, the Court
of Appeal did not assess on the merits whether the range determined by the APA
Decision was interquartile or not, but considered it necessary to examine
whether and how the Guidelines should have been applied in selecting the most
appropriate value from the range.
[30] Pursuant to Article 31(2)(b) of the Tao.tv., this Act contains the
Guidelines for the Adjustment of Prices between Related Enterprises for
International Enterprises and Tax Authorities, promulgated by Act XV of 1998,
which take into account the Guidelines for the Adjustment of Prices between
Related Enterprises, in accordance with the Organisation for Economic
Co-operation and Development (OECD) Convention, its Protocols and Declarations
of Accession. In view of this provision of the Tao.tv, the Curia did not see
any obstacle to the interpretation of the Tao.tv by direct application of the
Guidelines following the defendant's request for review. On the basis of
Article 28 of the Fundamental Law, the Curia also took into account that, when
interpreting a law based on Hungary's international obligations, it must also
be assumed that the purpose of the law is in accordance with common sense and
the public good, and that it serves a moral and economic purpose. The
interpretation of Article 18(1)(a)(aa) of the Tao.tv. was carried out
accordingly. In its interpretation, the Curia took into account the PM
Resolution and the Saldo Manual, as indicated by the
defendant, only as a possible professional source of interpretation, giving
priority to the criteria required by the Fundamental Law.
[31] Defendant has already stated in the grounds of its decision that if
the price applied by the taxpayer is within the arm's length range, there is no
room for adjustment. This statement is identical to the one set out in point
3.60 of the Guidelines and is fully in line with Article 18(1) of the Tao.tv.
[32] According to paragraph 3.61 of the Guidelines, cited by the
defendant in the request for review, where the relevant term of the transaction
under review (e.g. price or margin) falls outside the arm's length range
established by the tax authority, the taxpayer should be given the opportunity
to argue that the terms of the transaction satisfy the arm's length principle
and that the result is within the arm's length range (i.e. the arm's length
range is different from the one established by the tax authority). If the
taxpayer is unable to demonstrate this, the tax authority must determine the
value within the arm's length range, according to which the terms of the
controlled transaction must be adjusted.
[33] This rule of the Guidelines only applies in cases where the taxpayer
does not consider the arm's length range to be appropriate and wishes to demonstrate
that the arm's length price or margin is different. It may use the price/margin
obtained as the arm's length price if it can show reasonable grounds to justify
this qualification. In this case, the taxpayer does not adjust the achieved
price itself, it does not count back into the arm's length range. The tax
authority may determine the relevant value under paragraph 3.61 of the
Guidelines, and only within the range, if the taxpayer applies a price/markup
different from the range and cannot show justification for considering this
price different from the range as the arm's length price.
[34] In the case at hand, the applicant did not seek to have the
consideration different from the range accepted as the arm's length price, but
adjusted the consideration to the arm's length range as set out in the APA
Decision. As a result of the different facts, point 3.61 of the Guidelines is
not applicable to the plaintiff's proceedings.
[35] Paragraph 3.62 of the Guidelines provides guidance on how the tax
authority should determine the value within the arm's length range according to
which the terms of the controlled transaction should be adjusted. According to
paragraph 3.62, in determining this value, if the range contains relatively
uniform results of high confidence, it may be argued that any point within the
range is consistent with the arm's length principle. If there are comparability
gaps, as described in paragraph 3.57, it may be appropriate to determine this
value in the context of the mean of the range (e.g. median, mean or weighted
mean, etc., depending on the specific characteristics of the data set) to
minimise the risk of error arising from unknown or unquantifiable comparability
gaps.
[36] How taxpayers are to determine the value within the arm's length
range according to which the controlled transaction condition should be
adjusted is not addressed in the Tao.tv. or the Guidelines. However, in the
absence of an express statutory provision, not only are taxpayers not precluded
from making the adjustment, but Article 18(1) of the Tao.tv. requires the
taxpayer to calculate the amount corresponding to the difference between the
arm's length price and the consideration paid. It can also be concluded that
there is no reason, consistent with common sense and the principle of equality
of arms, why they should derive this calculation differently from the tax
authorities.
[37] Defendant argued in its application for review that, under
paragraphs 3.61 and 3.62 of the Guidelines, it is only appropriate to adjust
the arm's length price for such transactions to a level close to the mid-point
of the range if there are comparability gaps. In the present case, however, the
defendant has not established that there are any shortcomings in comparability,
so the first turn of point 3.61 applies: any point in the range, including the
mid-point, is in line with the arm's length principle. In other respects, the
defendant argues that, even if there are no shortcomings in comparability, only
the extreme values of the range can be used, and not other values, such as the
mean value: this cannot be combined with the interpretative criteria required
by Article 28 of the Fundamental Law.
[38] In its application for review, the defendant also argued that the
principle of the proper exercise of rights under Article 1(2) of the Tao Law
must be taken into account when applying Article 18(1) of the Tao Law. However,
no breach of that fundamental principle of the Tao Law was found in the
decision of the defendant which was the subject of the judicial review, nor is
it found in the upheld decision of the first instance. Page 37, paragraph 3 of
the first instance decision states in general terms, without mentioning the
place of the legislation, that "The tax authority's ... transfer pricing
adjustment up to the nearest point of the band is not based on Article 97(6) of
the Tax Code, but on the relevant provisions of the Tao. In the absence of a
specific provision of authority to that effect, the court of first instance
could not rule on the matter by a final judgment and, consequently, it cannot
be the subject of a review procedure. In the absence of a final judgment, the
Curia also failed to analyse the question, following the applicant's
counterclaim, whether transfer pricing can be regarded as a rule or tax
advantage (tax exemption, tax reduction) affecting the tax liability or tax
liability affected by Section 1(2) of the Tao.tv.
[39] In addition to the facts of the case, the applicant was required to
determine the value according to which the condition of the controlled
transaction had to be corrected, pursuant to Article 18(1) of the Tao.tv. In
the absence of a provision in the Tao.tv., the method of correction was, by
virtue of § 31(2)(b) of the Tao.tv., the first turn of point 3.62 of the
Guidelines: any point within the range corresponds to the arm's length price.
On the basis of the actual content of Article 18(1) of the Tao Law, the Court
of First Instance correctly concluded that neither the APA Decision, nor the
Guidelines, nor the Tao Law, implied that, in the case of several normal market
prices that can be designated in a given range, the adjustment for a
consideration applied outside that range can only be made to the nearest
extreme value.
[40] In the light of the above, the Curia upheld the judgment of the
court of first instance on the basis of Paragraph 275(3) of the Hungarian Civil
Code.
Content of the decision in
principle
[41] In the case of an arm's length price set in a decision fixing the
arm's length price (advance pricing arrangement), the consideration applied
outside the arm's length range may be adjusted not only to the nearest extreme
value but also to any element of the range, in accordance with Section 18(1) of
the Tao.tv.
Closing part
[42] The defendant in default is subject to the provisions of the Pp.
Pursuant to § 78 (1) of the law applicable to the successful plaintiff, the
defendant was ordered to pay the costs of the review.
[43] The review procedure fees not charged by virtue of the right to
charge the fees in question shall be borne by the State, subject to the
exemption from fees granted to the defendant under Article 5(1)(c) of Act XCIII
of 1990 on Fees, pursuant to Article 14 of Decree 6/1986 (VI.26.) IM on the
Application of Legal Aid in Judicial Proceedings.
[44] The application for review was examined by the Curia at a hearing on
the defendant's application.
Budapest, 17 October 2019.
Péter Hajnal,
Judge-Rapporteur, Péter Sisák,
Judge-Rapporteur, Huszárné Dr. Oláh
Éva, Judge-Rapporteur