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