SKM2022.195.ØLR
Release date 19 Apr 2022 13:30
Date of
judgment/order/decision/control signal 28 Mar 2022 10:46
SKM number SKM2022.195.ØLR
Authority Østre
Landsret
Responsible authority Skattestyrelsen
Case number BS-41577/2018-OLR and
BS-41574/2018-OLR
Document type Judgment
Parties
Case BS-41577/2018
(22nd Section)
H1-A/S
(formerly H1-A/S)
(v/advokat
Jakob Krogsøe)
v
Ministry of Taxation
(represented by: Steffen Sværke,
lawyer)
and
case BS-41574/2018
(22nd Chamber)
H2-A/S
(v/advokat
Jakob Krogsøe)
v
Ministry of Taxation
(represented by: Steffen Sværke,
lawyer)
Judgment of the Court
Karen Hald,
Alex Puggaard and Kasper Madsen (QC)
By order of
26 October 2018, the cases, brought before the Copenhagen District Court on 15
May 2018, were referred back to the Østre Landsret for judgment pursuant to Article 226(1) of the
Code of Criminal Procedure.
The cases
have been heard in conjunction with each other pursuant to Section 254(1) of
the Code of Judicial Procedure.
The cases
concern the tax authorities' discretionary increase in H1-A/S's (formerly
G1-A/S's) income for the 2006-2008 tax years (case BS-41577/2018) and a
consequential increase in the parent company, H2-A/S's, joint taxable income
for the tax years in question (case BS-41574/2018).
By decision
of 26 June 2012, SKAT (now Skattestyrelsen) made an
estimated increase in the taxable income of G1-A/S for the income years
2006-2008 with missing profits etc. by a total of DKK 1,302,178,000. SKAT based
the estimate on the profits realised by the group
entities in Y1-land and Y2-land on the basis of G1-A/S's work and assets. In
addition, by decision of 5 July 2012, SKAT amended the joint taxable income of
H2-A/S for the income years in question. On 16 February 2018, the Regional Tax
Court confirmed the decisions.
Claims
The
applicant, H1-A/S, makes the following submissions:
Principally:
The
Ministry of Taxation should recognise that H1-A/S's
taxable income for the income years 2006-2008 is reduced by the increases of
DKK 506,431,000, DKK 327,562,000 and DKK 468,185,000 respectively.
In the
alternative:
Refer the
assessment of H1-A/S's taxable income for the 2006-2008 tax years back to the
Tax Administration for reconsideration.
The
applicant, H2-A/S, claims that the Court should
Principally:
The
Ministry of Taxation should recognise that H2-A/S's
jointly taxable income for the income years 2006-2008 is reduced by the
increases made of DKK 506 431 000, DKK 327 562 000 and DKK 468 185 000
respectively.
In the
alternative:
Refer the
assessment of H2-A/S's joint taxable income for the income years 2006-2008 back
to the Tax Administration for reconsideration. The assessment of H2-A/S's
income subject to corporation tax calculated in accordance with Chapter 2 of
the Hydrocarbon Tax Act and income subject to hydrocarbon tax calculated in
accordance with Chapter 3a of the Hydrocarbon Tax Act be referred back to the
Tax Administration for reconsideration.
The
Ministry of Taxation's plea of inadmissibility is rejected:
The
Ministry of Tax and Customs Administration's motion to dismiss H2-A/S's
alternative claim, second paragraph, is denied.
The defendant,
the Ministry of Taxation, claims that the action should be dismissed. The
Ministry of Taxation also seeks the dismissal of H2-A/S's alternative claim,
second indent.
Facts
The
companies in question and their oil activities
H1-A/S,
formerly G1-A/S (hereinafter referred to as G1-A/S), was a wholly owned
subsidiary of H2-A/S (hereinafter referred to as H2-A/S), which was the
management company in the joint tax arrangement. G1-A/S, which was the parent
company of a number of subsidiaries (hereinafter referred to as G1-A/S), was
established in 1962 when the present (ed. information 11 removed) Group
obtained a licence to explore for and develop oil and
gas deposits in the Y3 area. The company was incorporated as G2-A/S and changed
its name to G1-A/S in 1984. In 2018, G3 company, of which G1-A/S was a part,
was sold to G4 company.
The
activities of G1-A/S consisted of three main areas in the period until 2018:
first, G1-A/S was the operator on behalf of the parent company H2-A/S in the
Danish part of the Y3 area (G23-virksomhed (hereinafter referred to as
G23-virksomhed)). In addition, G1-A/S carried out preliminary explorations in
various parts of the world with a view to finding new oil fields, after which
subsidiaries/branches were established with a view to further exploration for
oil and the commencement of oil production. Furthermore, G1-A/S provided a
number of technical and administrative services (so-called timewriting)
to other companies in the group, including to H2-A/S and to its subsidiaries in
Y1-land and Y2-land.
G1-A/S's
subsidiary, G5-K/S, entered into a consortium with the oil companies
G6-virksomhed and G7-virksomhed in 1990. G15-A/S was the general partner of
G5-K/S, and G1-A/S, among others, was a limited partner. In 1994, the assets
and liabilities of the limited partnership, including the oil rights, were
transferred to G15-A/S, a wholly owned subsidiary of G1-A/S.
G15-A/S
participated in two partnerships with partners G6-Enterprise, G9-Enterprise and
the state-owned company G10-Enterprise through its local branch during the
relevant income years 2006-2008. The company G6-virksomhed was the operator and
G15-A/S and its local branch in Y1-land had no employees in Y1-land.
The
subsidiary of G1-A/S, G25-A/S, was established in 1992 and a local branch was
set up. G25-A/S entered into an oil extraction agreement with the State of
Y2-land in 1992, and its branch operated on its own and was the operator of an
oil field called the Y12 field. Oil production started in 1994. The company's
branch employed an average of 286, 455 and 543 people respectively in the
2006-2008 financial years. G25-A/S is a wholly owned subsidiary of G1-A/S.
Rulings by
the Tax Court
The Tax
Tribunal's decision of 16 February 2018 concerning G1-A/S's appeal against
SKAT's decision of 26 June 2012 states:
"
Complaint
SKAT's decision Company's view Tax Tribunal's decision
2006
Estimated
remuneration from subsidiary
branches in
Y1 country and
Y2 country
DKK 506,431,000 0 DKK 506,431,000
2007
Estimated
remuneration from subsidiary
branches in
Y1-country and
Y2-country
DKK 327,562,000 0 DKK 327,562,000
2008
Estimated
remuneration from subsidiary
branches in
Y1-country and
Y2-country
DKK 468,185,000 0 DKK 468,185,000
[...]
Factual
information
[...]
G1-A/S's
turnover (operator's fees etc.) in 2006, 2007 and 2008 amounted to DKK 196
million and DKK 196 million respectively. DKK 250 million. DKK 250 million, and
DKK 256 million. DKK 256 MILLION. In the same year, the company's pre-tax
profit was DKK 9 175 million and DKK 1 000 million respectively. DKK 3,410
million. DKK 3,410 million and DKK 7,119 million respectively. DKK and after
tax DKK 627 million and DKK 7 119 million respectively. DKK 3,330 million. DKK
3,330 million and DKK 7,381 million respectively. DKK 7,381. Before financial
items and tax, the result was DKK -271 million and DKK -271 million
respectively. DKK -213 million. DKK -213 million and DKK -303 million
respectively. DKK.
It has been
reported that, in addition to its activities in the Y3 area, the G1-A/S group
operates an international oil business, searching for oil and gas deposits
throughout most of the world. The business has developed into an
internationally oriented company.
According
to information provided by the company, SKAT has prepared the following
breakdown of the turnover of the G1-A/S group:
USD million
2008 2007 2006
H2-A/S (not
part of G1-A/S group) 4,721 3,698 3,620
G1-A/S 50
46 33
Y1 country
1,063 882 772
Y2-country
6,494 3,422 1,532
Y10-country
2 1 0
Y7-land 2 0
0
Y16-land 0
2 0
Y17-country
10 3 12
Y18-country
0 1 0
Y19-country
55 39 41
Y9-country
1 0 0
Y20-by 1 0
0
Expl. Y5-land - 4
0
Y5-land 1 544 1
466 954
Eliminations
___ -20 -18 -13
Total
13,923 9,546 6,951
SKAT has
made increases in relation to G25-A/S and G15-A/S foreign branches' use of
G1-A/S intangible assets, etc., following an inspection of the company.
SKAT has
chosen to disregard the oil producing units in (ed. information 1 removed), as
this is insignificant oil production.
Furthermore,
the use of intangible assets of G1-A/S by the UK oil producing entities is
excluded, even though these entities have substantial oil production. It is
noted that for the years in question, the income of the companies at EBIT level
is negative, according to the Amadeus database. Subsequently, the company has
questioned whether the UK companies are profitable, see below.
Finally, no
income adjustment has been made in respect of the transactions with the parent
company H2-A/S in relation to the G23 business cooperation, see below.
With regard
to G15-A/S, it is stated that the company was founded in 1990 and in the same
year entered into an agreement to participate in a consortium in Y1 country
with G6 as operator. Since 1990, G15-A/S has had a branch in Y1 country without
employees. In 1995 the company extended its involvement in an adjacent
concession area. In 1997, nine exploration wells were found to contain
hydrocarbon deposits and production started in 1998. In 2000, G15-A/S sold a
13,75 % interest in a licence in Y1-land for a profit
of EUR 335 million. DKK. In the company's annual report for 2008, the
management report states, inter alia:
''G15-A/S
participates with a 12,25 % interest in the exploration and production of oil
and gas under a production sharing contract for two blocks (404a, 208) in
Y1-land together with partners G6-company, G9-company and state-owned
G10-company. The operations are carried out by G6 Company and G10 Company in
cooperation. In addition, exploration work is carried out in block 403 c/e,
where G15-A/S participates with a 25 % share in a production sharing contract
together with G6-enterprise and G10-enterprise"
With regard
to G25-A/S, it is stated that the company was established in 1992 and in the
same year entered into a contract for offshore exploration and production
rights in Y2-land. The company carries out the operator work. The company
operates through a branch in Y2-land with an average of 543 employees (in
2008). The company's 1993 annual report states that previous rights holders
demonstrated the presence of hydrocarbons in the block. Actual production and
sales from the Y12 field began in 1994 and the field has been continuously
expanded with increasing production.
On the
global oil industry, the company has stated:
It is a
characteristic of the industry that those players in it who wish to maintain or
increase their market share are always obliged to invest in exploration for oil
and gas. This is because the oil and gas producing fields will be depleted over
time.
These
exploration costs amount to very substantial sums. In turn, the revenues from
the fields where relevant oil and gas deposits exist are and have been such as
to cover the costs of the significant exploration activities undertaken.
Exploration
for potential oil and gas deposits is a lengthy process, typically lasting ½-4
years, before it is possible to assess with a reasonable degree of certainty
whether there is a basis for bidding for a licence,
if a project is offered.
In cases
where, based on the outcome of the preliminary studies, it is decided to bid
and possibly subsequently invest in a local licence,
a branch or subsidiary is established in the country concerned.
It has been
the established business policy of G1-A/S from the inception of its
international activities that investments in licences
and subsequent exploration and production of oil shall be made through
independent legal entities. It has also always been the policy of the G1-A/S
group that earnings from production outside Denmark should be repatriated as
soon as possible.
From the
moment a company or branch is established, the local entity bears the full risk
of the project and consequently all costs associated with it. Revenue from the
sale of produced oil, etc., is recognised in the
local unit.
The G1-A/S
group has set up special competence centres in
Denmark (Y4 city), Y5 country and Y6 country. When G1-A/S competence centres provide services to other Group entities, this
service is invoiced according to the industry's international guidelines on a
time spent basis (timewriting), see below.
By letter
dated 30 August 2010, the Company provided additional information to the
Company's transfer pricing documentation. This shows that oil exploration
activity is carried out in three main phases:
Phase 1
involves preliminary surveys and site assessments prior to applying for a licence. Work in this phase is carried out by G1-A/S from
its headquarters in Y4 City. In Phase 1, external data is collected, analysed and processed by experts in G1-A/S.
In phase 2,
the possibility of acquiring a licence is explored
when the phase 1 analyses show potential. The work in this phase is mainly of
an economic and legal nature in the form of due diligence. This work is also carried
out by G1-A/S.
Licences
are obtained through bidding rounds and are often acquired together with other
(independent) players in joint ventures.
If a licence is obtained, the Group establishes a local business
entity (in the form of a subsidiary or branch) which is the rights holder and
cost bearer in relation to the exploration and extraction work going forward.
G1-A/S is also responsible for negotiating the licence
and its terms and also acts as guarantor. It is G1-A/S that ultimately
guarantees and warrants that the obligations under the licence
right to the oil country and the contract with the independent joint venture
participants are fulfilled by the local G1-A/S subsidiary or permanent
establishment.
Phase 3 is
the exploration work that follows the acquisition of the licence
for further exploration and extraction.
In the
period leading up to the licence
Exploration
work in phases 1 and 2, i.e. the phases prior to the acquisition of the licence, is carried out by G1-A/S, while exploration work
in phase 3 is carried out by subsidiaries (or branches thereof). Thus, G1-A/S
does not bear any Phase 3 costs. Phases 1 and 2 will typically have a duration
of ½ to 4 years.
The
company's expenses related to Phase 1 and 2 total USD 126,566,000 in the period
2006-2008, stated in the complaint to be approximately DKK 900,000,000. No part
of the expenses is charged to other group companies, etc., which is because the
expenses are not considered to be related to the work of existing group
companies and therefore cannot be allocated to them. The expenditure is
considered to be incurred as a natural part of G1-A/S's own business activities
as the parent company of an international oil business with the aim of securing
revenue from potential oil and gas deposits around the world. There is also no
subsequent invoicing in cases where a licence is
subsequently obtained and a subsidiary/branch established as part of further
exploration. It is thus the company's view that no transaction takes place in
transfer pricing terms. The costs are therefore not included in the G1-A/S
group's transfer pricing documentation.
Licence
If a licence is subsequently concluded, the entire work will be
carried out by G1-A/S, including the negotiation of the licence,
the terms thereof, etc. The licence is acquired by
the local branch/subsidiary, which thus also becomes party to the contract
concluded with the oil country. All costs related to the licence
are borne by the local entity.
Guarantee,
etc.
G1-A/S
guarantees and warrants that the obligations under the licence
right towards the oil country and the contract with the independent joint
venture participants will be fulfilled by the local G1-A/S subsidiary or
permanent establishment.
G1-A/S does
not receive any remuneration for the intra-group guarantee (and the related
risk). The Company has never incurred any costs in relation to parent company
representations to its subsidiaries.
As an
example of such a guarantee, SKAT referred to Appendix E (parent company
guarantee) to the concluded "(ed. information 2 removed)" concerning
oil exploration and production in Y2 country. It is stated that G1-A/S has
conducted all negotiations with the Government of Y2-land for the conclusion of
the joint venture and that the local affiliated company G25-A/S could only
become a party to the agreement on condition that G1-A/S provided an
irrevocable guarantee for the obligations of the subsidiary under the
agreement, including a guarantee for the supply of the necessary technology and
specialists.
G1-A/S has
informed SKAT, upon request, that the concluded "(ed. information 2
removed)" with annexes be provided, that the agreement is governed by the
law of Y2-country and contains a non-disclosure clause, which makes it legally
impossible for G1-A/S to disclose the agreement to SKAT. The content of the
agreement and a breach of the non-disclosure clause are of significant
commercial importance for the business of G1-A/S and the possibility of
regaining the licence, which is currently under
renegotiation. The agreement cannot therefore be disclosed.
However,
Appendix E to "(ed. information 2 removed)" has been disclosed. It
states:
"(ed.
information 3 removed)
GUARANTEE
Whereas
G25-A/S (the "Subsidiary") will, contemporaneously with the execution
and delivery of this Guarantee, enter into an Exploration and Production
Sharing Agreement (the "EPSA") relating to that area generally known
as (red. information 4 removed); and
Whereas the
State of Y2-land (the "Government") conducted with G1-A/S (the
"Parent") all preliminary negotiations leading up to the execution of
the EPSA with the Subsidiary, a corporation wholly owned by G1-A/S; and
Whereas the
Parent desires that all of the rights and obligations under the EPSA be the
rights and obligations of the Subsidiary; and
Whereas the
Government does not object to the Subsidiary enjoying the rights and assuming
the obligations under the EPSA provided that such obligations are guaranteed by
the Parent.
In
consideration of the Government accepting the Subsidiary as the Party to the
EPSA the Parent hereby, as a primary obligor, unconditionally and irrevocably
guarantees to the Government the due and timely performance of all of the
obligations of the Subsidiary under and arising out of the EPSA.
2. The Parent further guarantees that the
Parent will provide the Subsidiary with all technology and specialist personnel
necessary for the Subsidiary to fulfill its obligations under the EPSA.
3. This Guarantee is a continuing guarantee
and shall remain in force until all obligations of the Subsidiary under the
EPSA have been discharged in full.
4. The obligations of the Parent hereunder
shall not be affected by any act, omission or circumstance which, but for this
provision, might operate to release or otherwise exonerate the Parent from the
obligations hereunder or affect such obligations including without limitation
(i) any time or indulgence granted to or composition with the Subsidiary or any
other person, (ii) the taking, variation, compromise, renewal or release of, or
refusal or neglect to perfect or enforce the EPSA or any rights, remedies or
securities against or granted by the Subsidiary (iii) any unenforceability of
any obligations of the Subsidiary under the EPSA (iv) the bankruptcy or
insolvency of the Subsidiary or any amendment, modification, extension, waiver,
indulgence or concession made or granted to the Subsidiary.
5. The Parent waives any right it may have of
first requiring the Government to proceed against or claim payment from the
Subsidiary or enforce any guarantee or security granted by any other person
before enforcing this Guarantee.
(...)"
In relation
to Y1-land, a letter dated 23 January 1991 from G1-A/S to G10-company was
provided, which stated the following:
"Dear
Sir.
We refer to
the documents provided by G6-virksomhed in order to effect a transfer of
interest to G15-A/S equal to twenty-five percent of G6-virksomhed's rights and
obligations under the G10-virksomhed Agreement dated October 23, 1989. This
letter is provided to assure G10-virksomhed that G1-A/S will support G15-A/S
the full technical and financial capacities needed by G15-A/S in order to
commit to and comply with its share of obligations under the G10-virksomhed
Agreement dated October 23. 1989."
In the
period after obtaining the licence
After the
establishment of a local entity (branch or company), all costs related to the
work performed are borne by this entity.
The
functions of the local entity depend on whether the entity has an operating
role or whether the entity participates as a non-operating participant in a
joint venture. Regardless of the role, the local entity will rely on specialist
assistance in relation to the further analysis work and execution of
exploration wells and subsequent possible oil production.
The
analytical work will include further processing of the analyses carried out in
the initial phases (seismic, geological, geophysical data, and environmental
work) with a duration of 3-10 years, during which time preliminary wells may
also be planned and drilled to investigate the subsurface composition.
If there is
a basis for expanding the activity, the assistance required will be of a more
technical nature (test drilling, including ensuring the safety of local staff),
requiring specialists from G1-A/S to be made available to the unit and
requiring a local presence in the form of a service provider, etc. It is the
local unit that chooses any service provider. As an example, on 1 January 2008,
Y2-land had 62 external consultants on its payroll, representing approximately
10% of the total workforce. All related costs are borne by the local unit. This
phase will typically have a duration of 5-8 years.
In addition
to services of a technical nature, G1-A/S provides a number of administrative
services, which vary according to the administrative functions performed
independently by the foreign entity.
All
services provided by G1-A/S or one of the other competence centres
in either Y5 country or Y6 country during the post-licensing period are settled
as hourly payments on an ongoing basis between the local branch or company and
G1-A/S. The services are priced on the basis of internationally recognised industry practices.
Timewriting
According
to the company, there is basically a time registration system applicable to all
G1-A/S companies providing support to other group companies or independent
parties. These are typically departments with staff employed in specialist
functions. These employees, who are subject to time registration, record daily
time spent on projects so that it can be defined whether the time spent relates
to local, global or country-specific activities. The hours recorded are
reported to the Finance Department, which consolidates the figures and issues
invoices to the beneficiary companies concerned. Invoicing is done on a monthly
basis.
The
calculation of the hourly rates for the employees' work is made on the basis of
an average cost related to the hourly recorded employee. All employees who
register for hours will therefore belong to a category which matches the
average cost for that particular category. Each category thus has a separate
hourly cost that matches the average cost of that employee. In addition to the
difference in wages and other direct costs, indirect costs are also included,
which are typically the same whether an employee is high or low skilled.
Joint
Operating Agreement (JOA)
When
several oil companies wish to cooperate in the exploration of oil and gas
deposits, specific guidelines (Joint Operating Agreements, JOAs) have been
developed for the conclusion of such agreements. JOAs stipulate how obligations
are to be fulfilled and how costs incurred by the operator are to be calculated
and allocated.
A template
agreement for the JOA, prepared by (ed. information 10 removed) ("(ed.
information 10 removed)"), sets out the methods for calculating the costs
that can be charged to the other partners. The template agreement issued by
(redacted) is the basis for all JOAs concluded by the G1-A/S group around the
world.
Article
4.2.B.5 of the AINP Model Agreement states that the operator of a joint venture
"neither (shall) gain a profit nor suffer a loss as a result of being the
Operator..." This general principle is elaborated in Annex A to the
Template Agreement, International Accounting Procedure, Section 2, Direct
Charges. Section 2.1.2 thus states that "Any charge by Operator to the Joint
Account shall exclude profit to Operator...". There are two modifications
to this; rental of the Operator's equipment under Article 2.7.1 and 2.7.2, and
outlays for services of third parties under Article 2.8.1, which may not exceed
market rates for equivalent services. Section 3, Indirect Charges, regulates
the basis and possibilities for the operator to charge its indirect costs at
cost price (operator fee) to the cooperation. Section 4, Acquisition of
Material, sets out the details of how the Operator may invoice its net costs of
purchased material to the Collaboration. Article 15.3 provides that all
intangible assets (know-how, etc.) related to the collaboration shall, as a
general rule, be jointly owned and may be used and exploited by each joint venture
partner without restriction.
G1-A/S has
prepared TP documentation for the relevant income years. The documentation
shows (consistently for all years):
"6. Description on controlled transactions
6.1 TP 1
Time-writing
The man
hours consist mainly of time-writing hours from specialist work (geologist,
geoscientists, engineers etc.) within the oil sector and their knowhow in this
area.
Time-writing
of man hours are mainly made from the "specialist" departments:
PED -
Petroleum Engineering Department (part of G23-virksomhed)
PDD -
Production Development Department (part of G1-A/S) EXPL - Exportation and New
Business (part of G1-A/S)
The
subsidiaries have the main risks (and opportunities) regarding the work of the
specialists.
E.g.: If
the exploration shows potential oil production, the G1-A/S subsidiaries will
benefit from this as they have the ownership and will receive income from sale
(according to agreement with local authorities etc.), where
as G1-A/S has the costs of education, vacation, illness etc. of the
specialists, which is included in the calculation of the hourly rates.
The Timewriting are normally being audited yearly by the other
joint venture partners ((red. information 5 removed) etc.)."
According
to the company's transfer pricing documentation, the following timewriting and administration fees exist between G1-A/S
and group affiliates:
Revenue
(USD 1,000) 2008 2007 2006
Timewriting
subsidiaries 22,328 19,292 13,668
Timewriting
other H2-A/S entities 60 90 0
Administration
fee subsidiaries 1,560 1,362 1,401
Administration
fee H2-A/S Administration fee others 10,913 9,962 8,761
H2-A/S
units 239 230 151
Total
35,100 30,936 23,981
Or a total
for the years in question of $90,017 million.
In SKAT's
case, using an allocation formula corresponding to the external turnover of the
entire G1-A/S group (the turnover of H2-A/S, G1-A/S itself and the elimination
item are not included in the allocation formula), the total costs are allocated
as follows:
(DKK 1,000)
2008 2007 2006
Total costs
in G1-A/S
excl. daughters
and fin. items -559,102 -462,834 -466,166
Calculation
breakdown:
Y1-country
-64,798 -70,141 -108,692
Y2-country
-395.858 -272.134 -215.695
Y10-country
-122 -80 0
Y7-country
-122 0 0
Y22-land 0
-159 0
Y17-land
-610 -239 -1.690
Y18-land 0
-80 0
Y19-country
-3.353 -3.101 -5.773
Y9-country
-61 0 0
Y20-by -61
0 0
Expl.
Y5-country 0 -318 0
Y5-land
-94.118 -116.583 -134.316
-559.102 -462.834
-466.166
Key figures
SKAT has
established that G1-A/S has had chronic and increasing deficits over a period
of at least 10 years, and in the period 1988-2012 has had a positive result
before financial items and tax in only 3 out of 25 years (1990, 1994 and 2001).
Overall,
over the period 1986-2010, the company realised a
loss before financial items and tax totalling EUR
-2,27 billion. DKK. In the subsequent years, losses have continued to be realised with USD -196.9 million in 2011 and USD -171.6
million in 2012, respectively, or an additional loss from these years totalling approximately USD -2.05 billion. DKK.
During the
same period, the G1-A/S group as a whole has realised
large profits totalling DKK 120.2 billion. DKK in the
period 1986-2010, as well as a profit before financial items and tax of USD 4.6
billion in 2011 and of USD 2.8 billion in 2012.
In the
contested financial years 2006-2008, G1-A/S (the parent company) and the G1-A/S
group respectively had the following results before financial items and tax:
(USD 1,000)
2008 2007 2006
G1-A/S
-59,404 -39,039 -45,507
G1-A/S
Group 5,265,744 2,573,439 1,628,636
The company
points out that by Act No 426 of 6 June 2005 Denmark changed from the global
income principle to the territorial income principle for the purpose of
determining the taxable income of companies, cf. Article 8(2) of the
Corporation Tax Act. This meant that, as from the 2005 income year, income from
branches in Y2 country and Y1 country, among others, no longer had to be
included in the calculation of taxable income in Denmark.
The
consequence of this change in the Danish tax rules is that tax losses are
accumulated in Denmark, as G1-A/S, in the course of its business as the parent
company of an internationally operating oil business, incurs substantial
expenses in securing income through outreach and preparatory studies around the
world, while the income from the producing companies/branches is received in
the form of tax-free dividends/internal transfers.
Thus, tax
losses arise as a consequence of objective Danish tax rules on the treatment of
dividends/internal transfers, and not as a consequence of the business set-up.
The result
of the total oil and gas production of the H2-A/S group after tax amounts in
2006 to EUR 9,6 billion. DKK 8.7 billion in 2007. DKK 8.7 billion and in 2008
DKK 15 billion. DKK 15 billion, of which the Danish oil and gas activities in
the Y3 area account for DKK 9.2 billion. DKK 9.2 billion in 2006, DKK 5.3
billion in 2007 and DKK 5.3 billion in 2008. DKK in 2007 and DKK 7.6 bn. DKK in
2008.
The H2-A/S
group and the G1-A/S group have thus for a number of years, including the years
at issue in this case, jointly operated an oil business which has generated
after-tax profits and has made large tax payments to the States, including
Denmark, where the valuable natural resources of oil and gas are located.
SKAT's
decision
SKAT has
increased the taxable income of G1-A/S for the income years 2006-2008 by
missing profits, etc., estimated at a total of DKK 1,302,178,000, see above.
During the
proceedings before the Tax Agency, the Chamber's counsel on behalf of SKAT has
recommended that the decision be confirmed or, alternatively, that the case be
referred back to SKAT for the purpose of determining a marketable profit.
SKAT has
based the estimate on the profit realised by the group
entities in Y2-land and Y1-land on the basis of G1-A/S's work and assets. The
overall approach has been that G1-A/S should have the same level of profit as
achieved in Y2-country and Y1-country.
It has been
pointed out that this is a relaxed estimate, based on the after-tax profit
rate. The total increase is therefore only about 6,5 % of the after-tax results
of the local Y2-country and Y1-country units, noting that the local units were
initially empty legal shells and that the entire business base and all income
generation is based on and enabled by contributions from G1-A/S, just as G1-A/S
continues to play a role in the income generation of the local units (through
guarantees and expertise) in the further course.
The
increase is the result of various calculations, shown here for 2006, where the
increase totals DKK 506 431 000:
Increase
for 2006: ___________________________________ Y2-land Y1-land
(DKK 1,000)
_____ _
Estimated
turnover 1)
Calculated
share of total 352.426 290.071
G1-A/S A/S
costs -215,695 -108,692
Profit
before tax excl. subsidiaries and excl. fin. items 136,732 181,378
Tax, 25 %
(28 % for 2006) -34,183 -45,345
Profit
after tax excl. subsidiaries and excl. financial items items
102,549 136,034
Profit
margin (matching oil producing units)
profit
rate), see table below Increase: 29.1% 46.9%
New
calculated turnover: 352.426 290.071
Share of
booked turnover -90,475 -45,592
Increase
261,952 244,479
1) Turnover
is calculated so that the after-tax profit rate matches the profit rate of the
oil producing units as shown in the table below:
The total
increase for 2006 is therefore the sum of the DKK 261,952,000 DKK 244,479,000,
or a total of DKK 506,431,000.
Profit
rates for 2006: (DKK 1,000)
Income
statements according to annual accounts Y2-country Y1-country
Turnover
9,110,153 4,590,244
Total
operating costs -2,241,956 -534,538
Result
before financial items 6,868,197 4,055,706
Financial
items 89,276 38,477
Profit
before tax 6,957,473 4,094,183
Tax
-4,239,652 -1,912,648
Result
after tax
Profit
after tax adjusted for fin. items 2,717,821 2,181,535
including
tax
Profit
margin (adjusted result after 2,650,864 2,152,677
tax/turnover)
29.1% 46.9%
Reasons for
the estimates
According
to SKAT, there are 3 facts in the case, which individually and together lead to
the fact that SKAT has been entitled to exercise an estimate of the taxable
income, namely the lack of profit in G1-A/S, which corresponds to the company's
contribution to the value creation in the G1-A/S group and in H2-A/S as a
whole, and the disregard of the company's TP documentation regarding this lack
of profit or for the intra-group guarantees, as well as chronic losses in the
company for a number of years.
Lack of
profit
The
preliminary investigations
The
investigations carried out by G1-A/S in the preliminary investigations (phase
1) are of central and essential value to the very basis of the business of the
G1-A/S group, and are thus necessary to maintain or increase the market value
of the group. If the investigation were not necessary, the group would not
charge G1-A/S EUR 900 million. DKK in 2006-2008.
G1-A/S is
thus the focal point for the Group's know-how, expertise, research and
development.
As stated
by the company, G1-A/S purchases data from external parties, i.e. data to which
other actors also have access, but G1-A/S differs from them in the subsequent
processing/refinement.
The
importance of G1-A/S's technical know-how in general and of the horizontal
drilling in particular, which is crucial for the commercial success achieved in
Y2-land, is highlighted in several places in the publication 'G3 business -
below the surface', inter alia, by reference to the following: (SKAT
underlining)
"The
origins of horizontal drilling are an interesting story in themselves. But in
this context the point is that although the G3 company partners had helped them
with the technique and to a large extent had the expertise, they did not drill
horizontally to extreme lengths. The G3 company did and now it was a matter of
finding other places in the world reminiscent of the structures in the Y3 area.
(...)
After an
unsuccessful attempt to get a field in Y7 country, we discovered that a field
in the Y2 country part of Y8 area was to be contracted out to pre-qualified
international companies. One of them was the Y11-country company G22-company.
They had most of the data, we had the technical knowledge. In the summer of
1990 we met in Y13 town and I became more and more excited the more I learned,
because I could see that the field in Y2-land was even better and even more
promising than the limestone fields of Y3-area," LJ says. This was despite
the fact that G17-A/S had already produced an eight-volume study of technical
geological studies of the so-called Y12-area field, which said on the very last
page: ''This field cannot be exploited." LJ, Senior Vice President, G3
Company)
(...)
In the
strata above the gas field, G17-A/S had made an oil discovery some years
earlier, but they could not get production going. Their test wells showed a
potential of only 200-300 barrels a day, and that was too little to make it
worthwhile. Internationally, however, G3 was clearly "a technological lead
dog in horizontal well drilling at the time,"
(...)
In the Y3
area, after some years of trials, the company had found that the recovery rate
could be increased from 5 to 25 per cent. "It was really break
through" says NL. The Y2 field is unique because it is one of the few
places in the world where there are rocks similar to the writing chalk in the
Y3 area. The Play, as geologists call it, was right."
(NL. Head
of Exploration, G3 company)
"The
horizontal drilling started in Y3 area and was used in 2008 with such success
in Y2 country that G3 company today (ed. information 6 removed)."
(IH,
Drilling Manager, G3 Company)
Basically,
of course, it's about being better than the others at finding oil, and that's
where we've shown that we've been able to crack the code in both Y3 area and Y2
country. These fields are an important part of our corporate culture, our brand
if you like. There have been issues that looked pretty hopeless at first and
where others backed off. For example, the G11 company pulled out of the G23
business in the early 1980s. Therefore, an important part of the G3 story is
that we have shown the ability to step in where others have given up."
ST, CEO G3
Company, Annex I, page 97 4 paragraphs)
Reference
is also made to the brochure "(redacted information 7)" which
describes, inter alia, the technical skills and technologies developed by
G1-A/S and their importance for the Group's oil business and to the audio file
on the Group's website under "(redacted information 8)".
This
underlines that G1-A/S is entitled to a share of the profits made or equivalent
remuneration for these services provided.
However,
the oil business of the G1-A/S group is based on a set-up whereby G1-A/S incurs
early stage exploration costs which are deducted from the Danish company's
Danish income. For tax purposes, income related to these activities is included
in other group entities.
The tax
set-up of the group thereby leads to the placement of deductions in a Danish
company, which can effectively use these deductions with a resulting tax
saving. Income is placed in other companies/entities that do not pay corporate
income tax, but only a profit-related tax for the right to oil exploration.
Consequently, a deduction for payment by the Y2-land and Y1-land entities to
G1-A/S has no tax value for these entities.
The costs
are then covered by oil revenues on a group basis, but not in G1-A/S, which is
loss-making year after year.
However,
according to Article 2 of the Tax Act and the TPG, it is incorrect to start
from a valuation on a group basis, instead a separate entity valuation must be
applied, i.e. a valuation must be made for the individual taxpayer - the
individual company or permanent establishment - and thus not on a group basis,
see e.g. TPG preface, art. 6. Tax payments at group level do not constitute
evidence that the remuneration of G1-A/S - or the lack thereof - is at arm's
length.
In this
context, any dividends from subsidiaries do not constitute consideration for or
return on the investment in the form of exploration expenses. In other words,
G1-A/S must share in the income itself, but not in the form of dividends as a
shareholder or by the group of which G1-A/S forms part receiving income from
G1-A/S's expenditure.
It follows
from the arm's length principle that it is the taxable income that is the
subject of the test, cf. in this respect TPG section 1.6 and the preparatory
works to Section 2 of the Equalisation Act, Folketingstidende 1997-98, 2 samling,
tillæg A page 2452:
"The
purpose of the bill is to establish in law that parties in interest, when
determining taxable income, must apply prices and terms to their transactions
that are equivalent to the prices and terms that independent parties would fix
for similar transactions (arm's length principle.)" (SKAT emphasis added)
When G1-A/S
has not been remunerated on arm's length terms - in this case not remunerated
at all - SKAT must fix the missing income discretionarily, cf.
The company
has referred to four contractual relationships as evidence that free
preliminary investigations have been carried out for non-consolidated entities.
It is
stated at the outset that the value of any preliminary studies will be present
in the licence even if a new party subsequently enters
the project. There will therefore not necessarily be - and it may even be
unlikely that there will be - any separate payment for preliminary studies
carried out, since it is probably - as the company itself describes it - the
future expected return on the investment that will determine the agreement. The
outcome of the studies will thus influence whether a given partner wishes to
enter and on what terms, i.e. be an integral part of the conclusion of the
agreement.
Against
this background alone, the contractual circumstances mentioned do not
demonstrate that the prior studies do not have a value for which an independent
party would pay.
The first
of the contractual relationships highlighted by the company concerns the
acquisition of the G12 business by G1-A/S. This situation is not seen to
involve preliminary studies prepared by G1-A/S.
It does not
appear whether G1-A/S purchased companies or activities/assets. It appears that
G1-A/S paid a total of EUR 18 billion for the European part of the G12 group of
companies. DKK. When a total amount is paid, it obviously includes all assets,
including the value of all feasibility studies. Thus, it is stated, no
'separate' payment was made for intangible assets in the form of know-how or
similar. The agreement, of which only 19 pages (12 of which are pages of
definitions) out of the total agreement of 129 pages are provided, states in
Clause 1: Definitions and Interpretation of and Part B: IP/IT, inter alia
"1
GENERAL
So far as
G12-company is aware and save as set out in clause 10.7, no material
Intellectual Property or information technology other than the Licences-ln and the Internal IT Systems is required to run
the business(es) of the Target Companies in the manner in which they have been
run in the 12 months prior to the Completion Date." Licences-in
is defined as:
"any
material license of Intellectual Property Rights which has been granted by a
third party to a Target Company in relation to its business or any part of it;)
"6
INFORMATION TECHNOLOGI
The
Internal IT Systems are either owned by, or licensed or leased to, a Target
Company with the right for all relevant Target Company to use the Internal IT
Systems..."
This does
not prove that no initial studies were paid for or that the company did not
receive any other consideration.
The second
contractual relationship referred to concerns the transfer in 1981 of the
activities of the G23 business to the two shipping companies, G13-A/S and
G14-A/S, which included "capitalised
investigation expenditure." at a book cost of EUR 387,6 million. DKK.
According
to the company, only the depreciated amount of DKK 121,8 million was included.
The company stated that the amount written off was DKK 121.8 million, as it
related to test drilling and was otherwise modest in relation to the revenue
subsequently generated.
The
company's statement that the costs related to test drilling is unsubstantiated,
and the arguments as to the amount are not adequate to demonstrate that no
separate payment was made for exploration costs.
A third example
is G1-A/S's investment in Y2 land. The licence for
the Y12 field was obtained primarily after the field had been abandoned and
returned by other oil producers, including G17-A/S, which had carried out an
eight-volume study of technical geological surveys prior to the abandonment.
G1-A/S then partnered with a Canadian oil company, which had most of the data,
while G1-A/S had the technical knowledge. However, the Y11 country company
decided to drop out of the project at the last minute, even though this company
alone had committed itself to a 15% share.
Nor does
this example deal with a situation where no payment is made for the value of
exploration to an independent party. Nor, as far as can be seen, has the
company stated that G17-A/S carried out research for G1-A/S or entrusted its
study to G1-A/S as part of an agreement with G1-A/S.
Furthermore,
G1-A/S has not indicated that it was aware of the eight binders in question
when the development of the oil field in Y2-land was started. On the contrary,
it is mentioned that it was the Y11-land company in question, with which G1-A/S
cooperated, that possessed most of the data.
The example
thus does not document that no exploration is paid for.
The example
only shows that G1-A/S, by virtue of its particular technical expertise and on
the basis of the data contributed by the Y11-country company, was able to
establish a commercially very successful oil field in Y2-country - unlike
G17-A/S.
As the
fourth and final example, G1-A/S has highlighted the sale of a licence on Y14-land. In particular, the company argues that
the sale agreement does not mention costs incurred by G1-A/S for preliminary
studies prior to the establishment of the Greenlandic subsidiary.
Nor has the
company provided any evidence that it has incurred any preliminary
investigation costs in this case. Nor can it be seen whether these possible
costs for preliminary studies are otherwise included in the basis of the
agreement.
Overall, it
has been concluded that the examples highlighted by the company do not
demonstrate that the company has incurred preliminary investigation costs for
the concert parties without compensation.
The
examples relating to the G12 business, the G23 business and the Y14 country
concern transfers of licences, etc. The value of a licence may be low at any given time because it is
considered unlikely that oil will be found in the area concerned. However, this
is not a relevant consideration in the present case, which is about the fact
that no independent party would accept the business model of G1-A/S.
As regards
the Y2-land example, it appears from the company's descriptions that if the
initial investigations were of no value to either G17-A/S or the other
companies, this is because, unlike G1-A/S, these companies did not have the
technical expertise to make the Y2-land oil field profitable.
The example
shows that the value of a given licence depends to a
large extent on the technical capability of the individual oil company. In this
case, it was G1-A/S which, unlike G17-A/S and all other oil companies,
possessed the necessary know-how.
It can
therefore - again - be concluded that if G1-A/S had been an independent party,
the current business model would not have been accepted. On the contrary,
G1-A/S would have remained involved in the individual projects for a longer
period in order to obtain a share of the potential profits from the licences.
That G1-A/S
is entitled to a share of the profits from the oil wells in Y2-land and Y1-land
by virtue of the arm's length principle is further underlined by the fact that
it has in fact also been continuously involved in the licences
concerned.
Contracting
and parent company guarantees
The role
and importance of G1-A/S in the contacting process is described in several
places in the publication 'G3 Business - below the surface', see inter alia:
(SKAT emphasis added):
"'We
have built up an oil business with some special expertise, commitment and
credibility, which we are now using as a basis for internationalisation.'
(JN, Group
CEO H2-A/S).
"Being
part of a global company and being identified with the seven-pointed star
opened doors globally. G3 companies have benefited from this when they go
around the world. What the group offers is a global presence and a global
brand. If you want to enter a new market in some country, we are already there.
H2-A/S has a great reputation for being a punctual, accurate and skilled
supplier of the things we deal with - not just because we are considered a
respected and skilled supplier. In many cases, our port and transport solutions
also make us one of the enablers for emerging economies to play a role in the
global economy."
(JN, Group
CEO H2-A/S)
"Through
my work with G17-A/S, I had met SJ, the vat head in Exploration &
Production in G8 company. When I came to Y23 city in 1992 to negotiate, SJ sat
opposite me. The oil world is small. He knew we knew what we were talking about.
SJ accepted the technical bid prepared by G3 company and then the financial
negotiations started which led to an agreement being signed in the summer of
1992." (LJ, Senior Vice President, G3 Company).
"There
is still an advantage in G3 being a respected, solid company from a small
neutral nation. We are known for a range of professional skills and for
delivering on time within an agreed budget. Our partners appreciate this very
much. We have the classic (ed. information 11 removed) virtues, and we take good
care of our employees."
(VH, Head
and Geoscience, G3 company)."
It appears
that the local governments base the agreements on a trust that G1-A/S, by
virtue of its expertise and reputation, will guarantee the operation of the oil
field in question for the benefit of the government and the local entity.
This is
also reflected in the parent company guarantees given by G1-A/S in the context
of the conclusion of the contract.
The purpose
of the guarantee is to safeguard the group's reputation globally and that
G1-A/S will therefore always support its subsidiaries in the event of default.
Successful cooperation obviously increases the possibility of recovering the licence, which is why, as the company points out, it is
understood that it is important to fulfil the contractual obligations.
It is
G1-A/S which is the driving force behind the conclusion of the contract itself
and, as a direct and natural consequence, it is also G1-A/S which ensures that
the project is carried out in a manner satisfactory to the local government.
This shows
that G1-A/S is entitled to a share of the oil revenues from Y2-land and Y1-land
and that an independent would not provide performance and/or loan guarantees
without compensation. Providing performance guarantees thus requires significant
industry knowledge and, in particular, the ability to manage the risk of the
extractive activities and thus, effectively, the access to manage the
production companies.
The fact
that, presumably because of G1-A/S's ongoing involvement, the guarantees have
never been called and that default would entail costs for the local entities
does not, of course, mean that the guarantees are free of charge, as the
company claims.
Nor, of
course, can non-payment mean that there is no intra-group transaction, as the
company also appears to claim.
Services
after obtaining a licence
As regards
the post-licensing period, the company has argued that know-how which is not
patentable has no competitive or commercial value in the oil industry. Since
know-how is generally of significant importance for the generation of income in
the business world, it is therefore argued that something special applies in
the oil sector.
It has been
argued that competitors in the oil sector have similar resource requirements in
terms of skills, experience and economics to be able to build up know-how. With
regard to horizontal drilling, it was pointed out in particular that this was
an old technique which could not be patented and was already known when G1-A/S
invested in Y2-land.
The company
has thus so far given the impression that technical know-how is generally of
minor/no importance in the oil industry and has thus not been decisive for the
economic results achieved in, for example, Y2-land.
The company
has also stated that competition in the oil industry is about developing ways
to reduce production costs and maximise production.
The
importance of technical know-how in general and of horizontal drilling in
particular has been highlighted in several places in the publication 'G3
Business - Below the Surface'. It is clear that G1-A/S and H2-A/S themselves
consider technical expertise to be of crucial importance for both the business
base and commercial success.
In the
publication, senior executives of H2-A/S and G1-A/S repeatedly emphasise that it is precisely G1-A/S's technical expertise
- in particular in the form of horizontal drilling - which is the absolute core
competence that is decisive for the economic results achieved.
Accordingly,
G1-A/S characterises itself as a knowledge-based company
and emphasises in particular the continuous
development of technical skills as a core area of any healthy oil business.
Indeed, it
was through a new world record in horizontal drilling that G1-A/S transformed
Y2-land into a commercial success, despite the fact that G17-A/S and a large
number of other oil companies had abandoned the exploitation of the oil field.
The company claims that G17-A/S had carried out in-depth studies on which
G1-A/S later relied. However, it appears from the publication that it was
G1-A/S which had the necessary technology.
Against
this background, it has been concluded that the company's successful commercial
performance in Y2-country and Y1-country was and is crucially dependent on
technical expertise in a particular field in which G1-A/S is a world leader.
G1-A/S is
therefore also entitled to a share of the profits made or equivalent
remuneration for the services provided.
G1-A/S thus
lacks profit in relation to the expert and management assistance provided by it
to the group companies, e.g. there is no profit in developing and maintaining
highly specialised skills and technologies and making
them available to the newly created (and initially empty) entities.
No
independent third party would make such highly specialised
skills available without profit, and the remuneration at cost is therefore not
at arm's length within the meaning of Section 2 of the Tax Act.
The company
argues that in relation to services provided on an hourly basis, there is
allegedly an industry custom. According to the company, the purpose of
invoicing only for costs incurred is to ensure that all partners have the same
incentive to maximise the probability of economically
successful oil production rather than to make a profit from performing the
operator's work.
However, in
relation to the activities in Y2-land and Y1-land, it is characteristic that
for G1-A/S there is precisely no expected future return from oil production, as
this income is placed in the local entities. Under these circumstances, it is
clear that no independent party would be willing to participate in such a
scheme.
The
company's argument that G1-A/S is not entitled to a share of the profits from
Y1-land and Y2-land is equivalent to the fact that its only activity was to
provide the services in question without being involved in the oil licensing
itself. No independent party in such a situation would provide the services in
question at cost price without mark-up.
There are no
independent parties when G1-A/S invests in a group entity which is part of a
joint venture; in that situation the group obtains an advantage through the
participation of the subsidiary/group entity.
The fact
that the receiving local group entity may agree on an inter partes
allocation of expenses and/or remuneration in the joint venture does not
indicate the intra-group relationship between G1-A/S and the related entity.
There are many relationships in a joint venture, and any reimbursement of one
service at cost may be offset by other services.
When G1-A/S
misses a profit in connection with expert and administrative assistance as well
as guarantee provision, SKAT can accordingly fix the missing taxable income,
cf.
Tp
documentation
SKAT has
disregarded the company's TTP documentation on the grounds that there is no
timely TTP documentation for any profit in G1-A/S corresponding to the
company's contribution to the creation of value in G1-A/S and in the H2-A/S
group as a whole or for the intra-group guarantees.
The
documentation for 2006-2008 contains a general description of the H2-A/S group,
the G1-A/S group and the industry respectively.
The
controlled transactions are then identified and analysed.
G1-A/S's
controlled transactions are, in the company's opinion, 1) the ongoing expert
advice remunerated by the hourly writing fee and 2) the administrative tasks
remunerated by the administration fee.
The
documentation thus includes neither the investigation work in phases 1 and 2
nor the free guarantee provided by G1-A/S to the subsidiaries.
After
defining what is considered as controlled transactions, the company performs a
comparability analysis.
With regard
to the timewriting fees, it is found that the
Company's transactions with G23 companies constitute an internal CUP, as the
participants in G23 companies are predominantly external (61 % owned by
external in 2006) and the transactions with G23 companies are therefore on
market terms. As the time writing is settled at cost with the G23 company, the
company believes that it is also at arm's length to settle the services without
mark up intra-group.
As far as
administration fees are concerned, they are settled on a cost allocation basis.
The
documentation does not therefore cover the disputed transactions and thus does
not satisfy the documentation requirement of Section 3B(5). SKAT has therefore
made an estimate of the income from the transactions. According to the
preparatory works for Section 3B, the controlled transactions referred to in
the provision thus include all relations between the controlled parties, cf. FT
1997-98, Appendix A, page 1906.
Therefore,
where G1-A/S invests its knowledge and resources in subsidiaries/branches and
thereby provides their revenue base, and there is no remuneration/return from
the local companies to G1-A/S for this, this relationship constitutes a
controlled transaction subject to documentation.
Indeed, the
company itself treated the exploration as a valuable asset by agreement in
1981, whereby 'capitalised exploration expenditure'
was included in the transfer of the activities of the G23 business to the two
shipping companies, G13-A/S and G14-A/S. "The transfer was included as an
element in the commercial price between the parties.
Furthermore,
the documentation does not contain any information on the intra-group
guarantee, which is also a transaction subject to documentation pursuant to
Article 3(B).
SKAT is
therefore entitled to make an assessment of the missing taxable income in
accordance with Section 2 of the Equalisation Act and
Section 3B(5) and (8) of the Tax Control Act, cf. Section 5(3).
Chronic
deficits
The company
has had chronic and increasing losses over a period of many years, while the
group as a whole has realised even quite substantial
profits over the same period. This creates a strong presumption of income
distortion in the group and a lack of taxable income in the Danish parent
company.
A company
with such continuous losses would thus not have been continued by an
independent third party under unchanged conditions over a 25-year period.
Reference is made to TPG 1.70 - 1.71: (SKAT underlining)
"1.70
When an associated enterprise consistently realizes losses while the MNE group
as a whole is profitable, the facts could trigger some special scrutiny of
transfer pricing issues. Of course, associated enterprises like independent
enterprises, can sustain genuine losses, whether due to heavy start-up costs, unfavourable economic conditions, inefficiencies, or other
legitimate business reasons. However, an independent enterprise would not be
prepared to tolerate losses that continue indefinitely. An independent
enterprise that experience losses will eventually cease to undertake business
on such terms. In contrast, an associated enterprise that realizes losses may
remain in business if the business is beneficial to the MNE group as a whole.
1.71 The
fact that there is an enterprise making losses that is doing business with
profitable members of its MNE group may suggest to the taxpayers or tax
administrations that the transfer pricing should be examined. The loss
enterprise may not receiving adequate compensation from the MNE group of which
it is a part in relation to the benefits derived from its activities. For
example, an MNE group may need to produce a full range of products and/or
services in order to remain competitive and realize an overall profit, but some
of the individual product lines may regularly lose revenue. One member of the
MNE group might realize consistent losses because it produces all the
loss-making products. An independent enterprise wxould
perform such a service only if it were compensated by an adequate service
charge. Therefore, one way to approach this type of transfer pricing problem
would be to deem the loss enterprise to receive the same type of service charge
that an independent enterprise would receive under the arm's length
principle."
The reason
for the chronic deficits is that the company is not remunerated for the
services it provides within the group and that G1-A/S bears the costs of the
investigation while other group companies realise the
profits related to it.
Such a
division of expenses and profits between different companies has no impact at
group level, but for the expense-bearing company it is not at arm's length, cf.
section 2 of the Tax Act and the separate entity consideration required under
the TPG, cf. TPG, preface, art. 6.
The company
has referred to previous years' joint taxation and returns from capital
investments in the form of dividends, but this is, as mentioned, irrelevant for
an assessment of whether the pricing in the context of the company's
intra-group trade is in accordance with § 2 of the Equalisation
Law. Nor has the company referred to any rules that would support such an
interpretation
Furthermore,
with reference to TPG, paragraph 1.70, it is stated that there may be a
business justification for the chronic deficits and that this is not
necessarily related to the intra-group trade policy. However, the company's
submission does not provide any information as to what these commercial reasons
might be.
The TP
set-up of the company and the group does not allow G1-A/S to become profitable
for tax purposes at all, as the only profit is in fact the operator's fee from
the G23 business, and this fee does not at all compensate for the high
exploration costs incurred by the company without any prospect of (share in)
the corresponding revenue.
Here again,
SKAT can exercise discretion over the marketable income derived from the
controlled transactions.
-------
In the
present case, these three factors, individually and together, lead to the
conclusion that SKAT was entitled to value the controlled transactions.
The company
therefore bears the burden of proving that the estimate exercised was unlawful.
Reference is made in this respect to UfR 2011.1472 H,
which illustrates that a correctly made tax estimate can only be set aside if
it is manifestly unreasonable or made on a clearly erroneous basis.
The company
argues that the decision in question concerns issues of withheld turnover in a
pizzeria and is therefore not relevant to the present case.
However,
the specific reason for the exercise of discretion in that case is not relevant
to the present case. The decision is cited because the Supreme Court determines
the extent to which a properly exercised tax assessment can be set aside.
That a
properly made tax assessment can only be set aside if the taxpayer proves that
it is manifestly unreasonable or made on an erroneous basis is of course true
of any discretion exercised by the tax authorities. To illustrate this,
reference can be made to the Supreme Court's judgment in SKM2010.433H, where
the authorities had exercised an estimate on an expense item for planting
Christmas trees. The estimate was upheld as it was not based on an erroneous
basis and could not be considered manifestly unreasonable.
As regards
the company's argument that the Landsskatteret, as
the appeal authority, is 'obliged to make an independent, complete and
unrestricted assessment, entirely unbound by the assessment made by SKAT (the
subordinate authority)', it is noted that the Landsskatteret
- like the courts - is traditionally reluctant to overrule SKAT's assessment.
The fact
that a full review is undertaken by an appellate body is not the same as the
appellate body always choosing to substitute its own discretion, or that the
appellate body is not reluctant to overrule such necessarily highly
discretionary assessments.
There is no
difference here between the situation of the courts and that of the Tax
Tribunal. The courts may, of course, well choose to think that the right thing
to do is to try the estimate in full.
When the
courts do not do so, it is (among other things) because the SKAT is obliged to
exercise a tax estimate due to lack of evidence, cf. also in this area the Tax
Control Act § 3 B, paragraph 9, cf. § 5, paragraph 3. By its very nature, there
is no single correct result and the specific estimate depends on a choice which
must be made because SKAT lacks the correct figures.
In the
present case, there are no comparable third-party transactions as an expression
of market value. Nor has the company provided the Tax Tribunal with any other
(let alone better) estimate.
The
estimate made
On the
basis of the above, the SKAT has chosen to base the estimate on the profit realised by the group entities in Y2-land and Y1-land on
the basis of the work and assets of G1-A/S. Please refer to the calculations
above for the 2006 increase.
Compared to
the producing subsidiaries/group entities, G1-A/S holds much more significant
assets in the form of the group's core know-how, other intangible assets,
bargaining power and expertise, as well as bearing significant risks.
SKAT agrees
with the company that exploration for potential new oil fields is high risk. As
stated by the company, the probability of economic success increases the closer
to production one is.
Conversely,
the risk for G1-A/S is high in the initial stages, which inevitably involve
some wasted expenditure. A commercially successful business requires that the
wasted costs of projects that do not lead to income-generating production are
covered by the revenues from the projects that do succeed.
An
independent third party would not undertake such a risky business without the possibility
of (a share in) correspondingly high profits.
G1-A/S's
exploration work is thus the initial, but supporting, measures in the value
chain of the oil business, which extends over a long time horizon.
This
investment must be offset by a market return when it is made available to other
group entities.
The G1-A/S
is thus the supporting entity and the constant factor in the Group's oil
business, where the local producing units are set up as needed - identified by
the G1-A/S - and are initially empty companies, which are then filled out to
varying degrees.
The Group's
know-how, experience and market and negotiating position, acquired over many
years in the industry, are anchored in G1-A/S, which has been a player since
1962.
It is thus
G1-A/S that locates where the group will invest; G1-A/S that negotiates local
contracts into which newly created companies/entities are then inserted; G1-A/S
that provides guarantees for other group companies; G1-A/S that has the
experts; and G1-A/S that owns the intangible assets.
Such
know-how, market position and intangible assets have a crucial value for the
Group and for the individual Group entities, irrespective of whether the
intangible assets may be legally protected or not and irrespective of whether
other oil companies may have similar experience.
Thus, the
value (and existence) of intangible assets cannot necessarily be measured by -
and limited to - registered legal protection, see TPG 9.80:
"Transfers
of intangible assets raise difficult questions both as to the identification of
the assets transferred and as to their valuation. Identification can be
difficult because not all valuable intangible assets are legally protected and
registered and not all valuable intangible assets are recorded in the accounts
(...)"
The fact
that other - competing - players may also possess valuable knowledge and assets
does not, of course, mean that G1-A/S's experience and reputation, which are
essential to its core business, are therefore worthless.
The
companies in Y2-land and Y1-land did not have any intangible assets, knowledge
of oil exploration or a 'name' in the industry at the outset. Such a company
would never have won an oil exploration licence on
its own.
Nor, of
course, would such a company, in an arm's length negotiation with an
independent party (similar to G1-A/S), have received all the profits from
participation in the joint venture.
A
market-based allocation of profits must reflect the contributions and
bargaining power of each party, see in this respect TPG 9.149:
"The
conditions that would be agreed between independent parties would normally
depend on the functions, assets and risks of each party and on their respective
bargaining power."
SKAT has
estimated that the profit of the parent company should be at least equal to the
profit of the profitable subsidiaries, whose profit is (inter alia) the result
of G1-A/S's investment. These companies are the subsidiaries of G25-A/S and
G15-A/S in Y2-country and Y1-country.
SKAT has
included the oil tax paid in Y2-country and Y1-country as a cost to be deducted
in the calculation of the profit rate. SKAT has done this even though the oil
tax in these countries in fact constitutes a profit share and thus cannot be
characterised as a genuine operating cost entailing any commercial risk.
The total
profit margin used by SKAT for its increase can be estimated at around 26 %.
The actual
results achieved in Y2-land and Y1-land leave ample room for SKAT to have
disregarded the oil tax when calculating the profit rate and thereby increased
the company further. If this less lenient approach had been taken, the average
profit margin would have been approximately 78 %.
It has been
pointed out by the company that the investment and risk profile of G1-A/S is
very different from the entities in Y2-country and Y1-country and that this
makes the basis for comparison inapplicable. However, SKAT's approach is not
based on the idea that the foreign entities constitute a meaningful basis for
comparison. In SKAT's view, it is G1-A/S and not the local entities that
possess the competences etc. necessary to make the activities in question
profitable. It is therefore also the view that G1-A/S's contribution to the
value creation of the activities in question entitles it to a substantially
higher share of the group's total profit than the profit resulting from SKAT's
increase.
The total
increase for the three income years is therefore approximately EUR 1,3 billion.
DKK, while the total profit after tax in Y2-country and Y1-country is approx.
DKK (2.7 bn. DKK 5.1 bn. DKK in 8.2 bn. DKK 2.2 bn. DKK 0.6 bn. DKK 1.1bn DKK).
Thus, the
total increase represents only about 6.5% of the local units' profit after tax.
This has to
be seen in the light of the fact that the local units were initially only empty
legal companies and that their entire business basis and income generation is
based on knowledge and assets provided by G1-A/S.
G1-A/S's
result after the SKAT increase is therefore disproportionately low and the
profits of the local units disproportionately high.
SKAT's
estimate is therefore in any event lenient.
----------
As regards
the company's other arguments, it is noted:
That there
is no basis for including G23 business in the benchmark. G1-A/S has thus been
remunerated by the sale in 1981 for exploration costs incurred and the sale of
intangible assets. The ongoing services to the G23 company (after phases 1 and
2), unlike the intra-group services, have also been provided on market terms,
since G1-A/S has been remunerated through the operator's fee. In this context,
it is irrelevant that operator fees are also received in Y2-land and Y1-land,
as this remuneration is not received by G1-A/S, which is not an operator in/for
these companies.
Furthermore,
it is irrelevant that not all the investigation costs incurred in G1-A/S are
directly related to the generation of income in Y2-country and Y1-country.
Thus, an independent third party would seek to recover all expenses - including
those incurred in vain - from the income actually generated in order to make
the business profitable overall.
It is also
irrelevant that the Y5 companies may be profitable, as the company claims,
since this does not affect the calculation of the mark-up for Y2 and Y1
respectively. SKAT, referring to extracts from the Amadeus database, has not
included these companies, as the income of the companies at EBIT level is
negative.
The fact
that G1-A/S, notwithstanding having transferred and been compensated for all
assets and liabilities relating to the activity in Y1-land at an earlier stage,
continues to play a decisive role in the oil activity in connection with the
conclusion of the contract and via the parent company guarantees provided.
Moreover, it is not clear exactly which assets are covered by the transfer in
question.
That the
company's view on SKAT's estimate should take into account the fact that it is
to be expected that earnings will be diminishing during the period in which oil
is extracted from the wells etc. in question cannot be accepted. The increase
in the company's income reflects the minimum income that G1-A/S would have been
expected to earn during the three years in question if it had received market
remuneration for the very significant services provided to the local entities.
Any future decline in earnings from the oil fields concerned would therefore
have to be reflected in G1-A/S's share of profits only in respect of such later
income years.
The company
further argues that the SKAT increase is not proportionate to any deficiencies
in the company's transfer pricing documentation.
The company
has referred to Lars Apostoli in TfS 2003 401,
"Det skatteretlige skøn",
which states, inter alia, that "(t)he decisive factor is whether the
accounting deficiencies are so serious that the accounts do not constitute a
reliable basis for the assessment of income".
This
describes the situation in the present case very well, as the company has
completely failed to address in the transfer pricing documentation provided the
fact that the activities in Y2-country and Y1-country are crucially dependent
on a number of services provided by G1-A/S. The consequence of this, as
acknowledged by the company itself, is that G1-A/S is left with large tax
losses, while the foreign companies and the group as a whole make large
profits.
The Tax
Control Act also states unequivocally what the legal consequence is of the
company's failure to comply with the transfer pricing documentation
requirements, namely that the SKAT has discretion, cf. It is therefore wrong to
claim that SKAT's discretion is disproportionate.
The
company's view
[...]
SKAT's
further comments
[...]
Further
comments by the company
[...]
Decision of
the Tax Tribunal
The
contested decision concerns G1-A/S's tax assessments for the income years
2006-2008 in relation to its subsidiaries' branches in Y1-country and
Y2-country.
The taxable
income is generally considered to be the total income of the taxpayer, whether
or not derived from elsewhere, consisting of money or property of monetary
value. This is stated in Article 4 of the State Tax Act.
Affiliated
companies and permanent establishments situated abroad must, in determining
taxable income, apply prices and conditions for commercial or economic
transactions (controlled transactions) in accordance with what could have been
obtained if the transactions had been concluded between independent parties.
This is stated in Article 2(1) of the Tax Act.
The arm's
length principle in the provision is to be understood in accordance with
Article 9(1) of the OECD Model Tax Convention, the OECD Commentary thereto and
the OECD Transfer Pricing Guidelines.
G1-A/S and
its subsidiaries and branches are covered by the definition of persons in
Article 2(1) of the Tax Act, which concerns group companies and permanent
establishments abroad, it being irrelevant whether the subsidiaries and
branches form part of local joint ventures.
G1-A/S
bears the costs of exploration and studies into the possibility of obtaining licences for extraction. The expenditure is incurred in the
course of the company's business of exploring for oil and gas deposits. The
company is entitled to deduct the costs in accordance with Section 8B(2) of the
Danish Income Tax Act. G1-A/S is responsible for negotiating licences and the terms thereof and bears the costs incurred
in this connection. If a licence is obtained,
subsequent expenditure is borne by a subsidiary or branch thereof, and this
company or branch receives all income from extraction. G1-A/S shall ensure that
the obligations under the licence right towards the
State concerned (or a company established by the State for this purpose) and
the contract with the independent joint venture participants are fulfilled by
the local G1-A/S subsidiary or permanent establishment. G1-A/S has revenues
from services provided to the subsidiaries, etc. These services are remunerated
at cost.
This
business model means that G1-A/S will never make a profit from its operations.
It must be assumed that the company would not enter into such a business model
with independent parties. It should be noted that dividend income is not
considered to be business income.
SKAT has,
as a starting point for the adjustment of the company's taxable income,
declared a controlled transaction between G1-A/S and the branches in Y1-country
and Y2-country. A controlled transaction should only be declared in exceptional
cases, see OECD Transfer Pricing Guidelines 2010, point 1.64. The situations in
which tax authorities may treat a transaction as controlled are defined in the
OECD Transfer Pricing Guidelines 2010, paragraph 1.65. as those in which the
economic substance of an actual transaction is inconsistent with the form of
the transaction and those in which the circumstances of the actual transactions
differ from the way in which independent parties, acting under a presumption of
rational commercial behaviour, would have acted:
'The second
circumstance arises where, while the form and substance of the transaction are
the same, the arrangements made in relation to the transaction, viewed in their
totality, differ from those which would have been adopted by independent
enterprises behaving in a commercially rational manner and the actual structure
practically impedes the tax administration from determining an appropriate
transfer price' (point 1.65)
As stated
above, the company's operating results and the allocation of functions and
risks within the group are not considered to be in accordance with a commercially
rational manner and SKAT has therefore been entitled to declare a controlled
transaction.
4 members
of the court - including the president of the court - give their opinion.
SKAT's
increases are described in the decision as being consideration for the use of
G1-A/S's intangible assets.
The
branches in Y1-country and Y2-country have used intangible assets which must be
considered as owned by G1-A/S. These intangible assets can be characterised as
know-how and oil exploration rights in the form of licences.
It is considered that between independent parties a consideration would have
been paid for the use of this type of intangible assets in the form of
royalties or similar. In this respect, it is considered that the branches are
established in the context of obtaining licences in
the given country and therefore the branches cannot be considered to have built
up such intangible assets themselves. G1-A/S has incurred all costs for
exploration and studies of possibilities for obtaining licences
for extraction. It is thus G1-A/S which owns the know-how used to establish
whether oil and gas for extraction existed at all. It is also G1-A/S which has
negotiated and concluded licensing agreements in the given country, and
therefore the rights to the extraction itself must be considered to be owned by
G1-A/S and made available to the subsidiaries. In addition, G1-A/S' guarantees
the obligations of the subsidiaries through performance bonds.
SKAT's
increases correspond in total over the period 2006-2008 to a royalty rate of
approximately 1,7 % of the branches' turnover. Such a royalty rate is
considered to be in line with the arm's length principle, given that a large
part of the profits from the oil extraction operations are still located in the
branches in Y1-country and Y2-country and that the company itself has not set
an arm's length price for making the intangible assets available to the
branches.
The mark-up
on the timewriting and administration fee is
considered to be an element of the consideration for the use of the intangible
assets and therefore should not be priced separately. It should be noted that
these services are considered to constitute payment for, inter alia, know-how
provided by G1-A/S to the branches.
These
members of the court therefore consider that the decision of SKAT should be
confirmed.
2 members
of the court state:
SKAT's
increases are calculated on the basis of G1-A/S's expenditure on research etc.
for the current income years. The costs are allocated to the subsidiaries in
proportion to turnover. A profit rate was then calculated for the branches in
Y1-country and Y2-country, and the same profit rate was used to calculate a
'calculated turnover' for G1-A/S. The increase is thus not justified by a
pricing of a specified service from G1-A/S.
SKAT's
increases cannot be accepted. In this respect, it has been taken into account
that G1-A/S's expenses for exploration etc. in the years concerned relate to
other geographical areas and that therefore the expenses cannot be allocated to
the existing subsidiaries/branches. Furthermore, it is considered that there is
no evidence that G1-A/S would have the same profit rate as the branches, as the
parties are not comparable in terms of activity, risk, etc. Finally, SKAT has
not specified which intra-group benefit is the result of the increase. SKAT's
methodology to characterise the controlled
transaction is thus not in line with methodologies described in the OECD
Transfer Pricing Guidelines.
These court
members also consider that the increases are not based on any legal basis. The
Group's set-up is - and has been long before the introduction of the current
rules, including on the taxation of dividend income - commercially motivated.
Against this background, there appear to have been no artificial shifts between
parties with vested interests which might otherwise have formed the basis for
transfer pricing regulation.
With regard
to the time and administration fee, it should be noted that G1-A/S has provided
specialist support etc. to subsidiaries, branches and H2-A/S and has received
time and administration fees at cost. It is considered that the subsidiaries
and branches - within the joint venture they are part of - apply cost prices
for such services in accordance with the AINP template agreement (JOA) and industry
practice. This practice applies to the players in a joint venture who together
hold a licence to extract oil and gas and have a
common interest in ensuring that none of the players should profit from the
services but that profit should be made solely on the extraction.
Notwithstanding the fact that the operators are generally independent parties,
they are considered to have a common interest in this respect. The duty is
therefore not transferable to parties outside the joint venture. As G1-A/S is
not part of the joint ventures in question, the cost price cannot be considered
to reflect the market price between G1-A/S and the subsidiaries/branches. The
price between independent parties is considered to include a profit. Therefore,
G1-A/S's income from hourly writing and administration fees must be added to a
profit.
According
to the company's transfer pricing documentation, the timewriting
and administration fee income from subsidiaries, branches and H2-A/S for the
2006-2008 financial years amount to USD 23,981,000, USD 30,936,000 and USD
35,100,000 respectively.
Mark up on timewriting and administration fees is set at 5% in the
absence of other market price information, see EU Joint Transfer Pricing Forum
report: Guidelines on low value adding intra-group services of February 2010
section 7.7.2. point 63. The mark up for 2006-2008 is thus estimated at USD
1,199,050, USD 1,546,800 and USD 1,755,000 respectively.
These
members of the court therefore consider that the company's income should be
reduced by the increases made by SKAT and increased by the amounts mentioned
for the mark up on the hourly writing and administration fee.
One court
member states:
This court
member agrees with the above 2 court members that SKAT's increases cannot be
accepted.
This court
member considers that the case should be referred back to SKAT for
reconsideration, so that remuneration is calculated on the basis of a
calculated total level of profit in G1-A/S's subsidiaries, etc.
The
decision is taken by majority vote. SKAT's decision is confirmed.
The Tax
Tribunal's decision of 16 February 2018 regarding H2-A/S's appeal against
SKAT's decision of 5 July 2012 states:
"
Complaint
SKAT Complainant's view Tax Tribunal's decision
2006
Joint tax
income
Additional
income in
G1-A/S
506,431,000
DKK 0 DKK
506,431,000
2007
Co-tax
income
Additional
income in
G1-A/S
327,562,000
DKK 0
327,562,000 DKK
2008
Co-tax
income
Additional
income in
G1-A/S
468,185,000
DKK 0
468,185,000
[...]
Decision of
the Tax Tribunal
The Tax
Tribunal has in a simultaneous decision for the subsidiary, G1-A/S, j.nr.
12-0192129, ruled that additional income in the subsidiary for the income years
2006-2008 is confirmed.
Consequently,
the joint tax income is confirmed."
Accounting
information
The accounting
result of G1-A/S for the financial years 2006-2008 was as follows:
G1-A/S
profit and loss account
(USD '000)
Income year
2006 Income
year
2007 Income
year
2008
Operator
fees etc. 32,880 45,954 50,253
Administrative
expenses 28,801 30,792 38,828
Investigation
costs 49,328 53,951 70,590
Depreciation
258 250 239
Result
before financial items and taxes -45,507 -39,039 -59,404
Result of
subsidiaries 1,698,203 742,372 1,500,472
Other
financial income 2,733 9,227 3,558
Other
financial charges 112,510 86,415 48,428
Profit
before tax 1,542,919 626,145 1,396,198
Tax on
profit for the year 1,437,442 14,700 -51,477
Profit for
the year 105,477 611,445 1,447,675
As stated
in the Landsskatter Court's decision, G1-A/S realised a total loss of DKK 2.27 billion in the period
1986-2010. During the same period, G1-A/S has had income in the form of
dividends received from the subsidiaries in Y1-land and Y2-land totalling almost DKK 35.4 billion.
For the
2006-2008 financial years, the accounting result of G1-A/S was as follows:
G1-A/Ss
income
statement (USD '000) Income year
2006 Income
year
2007 Income
year
2008
Net sales
3,294,856 5,767,327 9,147,266
Other
operating income 36,564 80,856 55,197
Production
costs 449,072 633,670 1,067,376
Gross
profit 2,882,348 5,214,513 8,135,087
Administrative
expenses 47,200 69,755 70,319
Investigation
costs 199,521 310,570 695,107
Depreciation
and amortisation 1,006,991 2,260,749 2,103,917
Profit
before financial items and tax 1,628,636 2,573,439 5,265,744
Other
financial income 56,599 32,842 92,189
Other
financial charges 142,317 99,204 78,049
Profit
before tax 1,542,918 2,507,077 5,279,884
Tax on
profit for the year 1,437,441 1,895,632 3,832,209
Profit for
the year 105,477 611,445 1,447,675
As stated
in the Landsskatter Court's decision, G1-A/S realised a total profit of DKK 120.2 billion in the period
1986-2010.
G1-A/S's
annual reports for 2006-2008 state under notes that the parent company
guarantees the obligations of subsidiaries through performance guarantees,
which vary over time and may involve substantial amounts.
The audit
notes to G1-A/S's annual reports for 2006-2008 state that G1-A/S has issued
performance guarantees for the obligations of subsidiaries, including to the
governments of Y2-country and Y1-country. For Y1 country, the contingent
liability for the Group is USD 7 million in 2006 and USD 5 million in 2007. For
Y2 country, the amount for both years is disclosed as USD 0. No amount is
disclosed for the income year 2008.
Rights to
oil licenses
Y1 country
A Joint
Operation Agreement concluded between G5-K/S, G6-Enterprise and G7-Enterprise
with effect from 1 January 1990 states that the rights holder/obligor in
relation to oil exploration in Y1-land was G5-K/S (and from 1994 G15-A/S).
It also
appears from an audit report dated 6 June 1990 concerning G1-A/S's annual
report for 1990 that the exploration concession rights are held by the wholly
owned subsidiary G15-A/S, established in 1990, but are exploited by agreement
by the limited partnership. Similar information is contained in an audit report
dated 6 April 1992 concerning the 1991 annual report of G1-A/S.
The annual
reports of G15-A/S for the financial years 2006-2008 include oil rights as an
intangible fixed asset in the company's balance sheet. No intangible assets
appear in G1-A/S's annual reports.
Y2 country
It appears
from an Exploration and Production Sharing Agreement concluded on 22 June 1992
that the parties to the agreement are the Government of the State of Y2-land
represented by the company G16-enterprise and G25-A/S, and that the right
holder/obligor in relation to oil exploration in Y2-land was thus G25-A/S.
It also
appears from an audit report dated 28 March 1994 concerning G1-A/S's annual
report for 1993 that the concession agreement was concluded between G25-A/S (49
%) and G16-virksomhed (51 %).
G1-A/S's
preliminary studies abroad The course of an oil project is described as
follows:
The content
of these eight phases is specified:
Phase 1-2 -
preliminary feasibility studies
In the
first phase, referred to as the 'Regional Survey', seismic and magnetic images
and data are obtained or acquired for a geographical region to be investigated
in more detail. This phase typically lasts 1-2 years.
In the
second phase, called "Feasibility and commitment", additional seismic
data for selected blocks are acquired or purchased. This phase also typically
lasts 1-2 years.
The licence from the local government is usually obtained after
the completion of the first two phases of the project, collectively referred to
as "preliminary studies". At this stage, there is considerable
uncertainty as to whether the oil field covered by the licence
contains oil or gas deposits, the quantity of such deposits, and whether
extraction of the deposits would be commercially viable at all.
Phase 3-4 -
Exploration
The third
phase, called 'Exploration', involves obtaining additional seismic data and, in
principle, more in-depth analysis to increase the likelihood that subsequent
exploration wells will be drilled in the right locations. This phase typically
lasts 3-6 years.
In the
fourth phase, called "Appraisal", additional so-called appraisal
wells are drilled on promising hydrocarbon deposits and the potential for
production is further assessed. In many cases, these appraisal wells and the
subsequent analytical work will show that a discovery cannot be commercially
exploited. This phase, which is risky and costly, typically lasts 2-3 years.
Phase 5-8 -
Development, production and decommissioning
If a field
proves to be suitable for commercial oil or gas production, the licensee
establishes production facilities and local infrastructure around the field and
the final production wells are drilled. This fifth phase, called
"Development", typically lasts 3-5 years.
In the
sixth phase, called "Production", actual oil production begins,
typically lasting between 15 and 40 years.
The seventh
phase, called "Extended Oil Recovery", examines the feasibility of
continuing oil production for a period beyond the originally expected
decommissioning date. This typically requires the development of new technology
and significant investment. Such an extended production phase can last between
5 and 30 years.
In the
eighth phase, called "Abandonment", the licensee leaves the field
after it is no longer profitable to carry out further extraction. The
decommissioning of a field, including the removal of the installed production
facilities, can take several years
G1-A/S's
initial feasibility studies abroad relate to phases 1 and 2. All other costs
relating to the subsequent phases are borne by G1-A/S's subsidiaries and their
branches.
The amount
of G1-A/S's expenditure on initial feasibility studies in phases 1 and 2 in
relation to Y1 country and Y2 country has not been quantified. Investigation
costs incurred by the subsidiaries in Y1-land and Y2-land in the subsequent
phases in the period 1986 to 2010 are specified as follows in the annex to the
SKAT decision of 26 June 2012:
(DKK 1.000)
G1-A/S
1986 6.106
1987 11.585
1988 21.624
1989 28,415
G25-A/S G15-A/S
1990 19.187
2.767
1991 41.629
4.525
1992 56.581
52.488 2.798
1993 63.137
139.156 4.238
1994 41.607
76.482 41.575
1995 52.859
2.965 107.615
1996 54.544
350 138.521
1997 92.679
67.432 245.091
1998
106.131 47.825 251.188
1999 87.412
119 35.210
2000 93.741
57.375 -134.267
2001
109.728 40.057 -60.722
2002
125.557 0 -82.443
2003
113.827 0 0
2004
152.190 0 0
2005
152.143 10.134 39.430
2006
293.352 -975 49.193
2007 293.793
33.670 71.233
2008
359.913 0 32.045
2009
433.783 0 12.499
2010
540.925 0 -1.384
Total
3,352,448 527,078 759,112
G1-A/S'
provision of technical and administrative assistance (timewriting)
G1-A/S
provides ongoing technical and administrative assistance to group companies,
including H2-A/S (G23 company) and to its subsidiaries and subsidiaries'
foreign branches, including in Y1 country and Y2 country during the 2006-2008
income years in question. G1-A/S provides the technical and administrative
assistance at cost.
As to the
background of the provision of technical and administrative assistance by
G1-A/S to the G23 business, where G1-A/S acts as operator, it is stated that on
28 December 1977 G2-A/S, G14-A/S, G13-A/S, G17-A/S, G18 business and G11
business entered into a consortium agreement (Joint Operating Agreement)
concerning the south-western part of the Danish part of the Y3 area. The
agreement, as subsequently amended, which was valid for the 2006-2008 income
years, stipulated, inter alia, that G2-A/S (G1-A/S) was to act as the operator
of the G23 business and that the costs incurred by G1-A/S in this connection, which
were to be kept in a separate accounting ledger within G1-A/S, were to be
reimbursed by the consortium members without any addition of profit. In
addition to the reimbursement of all direct costs incurred, G1-A/S was entitled
to receive an amount to cover a number of specified indirect costs, the amount
of which was equal to 1 % of the direct costs incurred by G1-A/S.
For the
financial years 2006-2008, the participation ratio of the consortium partners
in the G23 company was such that the share of G17-A/S was 46 %, the share of
H2-A/S was 39 % and the share of the G18 company was 15 %.
It has been
stated that the tax treatment of G1-A/S's services to the G23 company provided
at cost is based on the assumption that the services were provided on market
terms.
Information
was provided to the Regional Court on an industry practice for cost sharing in
joint ventures in the oil and gas sector, according to which the operator's
services are provided at cost. In particular, a letter dated 28 May 2015 from
the industry association (ed. information 9 removed) to the OECD in connection
with the OECD's work on "BEPS [Base Erosion and Profit Shifting] Action 8:
Cost Contribution Arrangements" has been submitted. The letter states,
inter alia:
"CCAs
[Cost Contribution Arrangements] are arrangements that allow participants to
share in the benefits and risks of joint development of assets or services. In
the Oil & Gas sector (O&G sector), widespread use is made of CCAs for
the development of technology, and the rendering of technical and non-technical
services.
Unrelated
parties enter into large consortia, often in joint ventures that include
government owned companies ("National Entreprises"),
to share benefits, costs and risks. An operator is appointed to run operations
and provide technical and non-technical services, including R&D, on behalf
of the joint venture (JV). ...
All activites undertaken and technology developed within these
CCAs are, ultimately, for the benefit of the cost sharers' own oil and gas
exploration and production operations. CCAs are driven by and fundamental to
the business.
...
2. In the
O&G sector, CCAs are fundamentally linked to 'at-cost' contributions
...
In the
O&G sector, it is common that the operator's contributions are valued on an
'at cost' basis, without a profit from undertaking the activities. This is
contractually laid down between the unrelated JV parties. The practice of
at-cost services in the O&G sector has been in place since as early as the
1950s. Production sharing agreements and similar contracts, which stipulate
responsibilities of partners in a project, are testament to this claim.
One of the
key reasons why 'at cost' has remained a feature of O&G sector CCAs for so
long, is that it is recognized that projects typically take a very long time to
mature; 20 years between exploration and production is not uncommon, and in
this time, only a few initiatives actually will reach operating status. By the
time a project starts generating income, the link between services income and
cost has gone, which makes cost the only practical way of pricing contributions
into a CCA."
A template
for a consortium agreement (JOA) published by the industry association (ed.
information 10 removed) ((ed. information 10 removed)) was also provided. The
2002 template, which was effective for the 2006-2008 income years, states, in
part:
"4.2
Rights and Duties of Operator
...
(B) In the
conduct of Joint Operations the Operator shall:
...
(4) subject
to Article 4.6 and the Accounting Procedure, neither gain a profit nor suffer a
loss as a result of being the Operator in its conduct of Joint Operations,
provided that Operator may rely upon Operating Committee approval of specific
accounting practices not in conflict with the Accounting Procedure;"
Finally,
the reply of the Minister for the Environment and Energy to the Energy Policy
Committee of the Folketing in connection with the 4th tender round in 1995 for
applications for licences for the exploration and
production of oil and gas has been submitted, which states, inter alia:
"The
operator will be reimbursed for costs associated with the operator work by the
individual rights holders, but is not expected to make a profit on the
work."
G1-A/S's
transfer pricing documentation
G1-A/S's
transfer pricing documentation first provides an overview of the group
structure and the oil activities of G3 companies, including G1-A/S. The
transfer pricing documentation does not deal with G1-A/S's expenditure on
initial feasibility studies or the provision of performance bonds, but only
with ongoing technical and administrative assistance. G1-A/S's transfer pricing
documentation, which is consistent for all years 2006-2008, states, inter alia:
"1.3.4
Summary of inter-company transactions
The
transfer pricing set-up and the identified types of inter-company transactions
in G1-A/S are illustrated in figure below.
As can be
seen from the figure, the following inter-company transactions are included
- TP1- Time
writing fee, and
- TP2-
Administration fee comprising inter-company transactions in which G1-A/S
functions as provider of services etc. ...
1.3.5 TP 1:
Time writing fee
Description
of services rendered by G1-A/S
G1-A/S
functions as manning service provider (i.e. specialist man hours) towards
related parties. The man hours consists mainly of timewriting
hours from specialists work (geologists, geoscientists, engineers etc.) within
the oil sector.
Selection
of most appropriate transfer pricing method
Based in
the description of the services provided by G1-A/S and the identification of
internal uncontrolled comparable transactions, the comparable uncontrolled
price method (hereinafter referred to as the CUP method) was selected as the
most appropriate transfer pricingmethod.
Economic
analyses
According
to a comparison with identified internal uncontrolled comparable transactions,
it should be appropriate to conclude that the applied time writing fees towards
related parties is consistent with the arms length
principle.
1.3.6 TP 2:
Administration fee
Description
of services rendered by G1-A/S
G1-A/S
renders administrative services towards related parties. The services consist
of miscellaneous administration work (e.g. finance, accounting, legal,
marketing and commercial) from different administration departments in G1-A/S.
Selection
of most appropriate transfer pricing method
Based on
the description of the services provided by G1-A/S, an indirect allocation
method for administrations services was selected as the most appropriate
transfer pricingmethod.
Economic
analysis
According
to the overall split of the total administration costs in G1-A/S combined with
the description of G1-A/S' workload and use of resources towards each entity
receiving administrative services, it should be appropriate to conclude that
the allocation of administration fees towards related parties is consistent
with the arms length principle.
...
6. Description on controlled transactions
6.1 TP 1
Time-writing:
The man
hours consists mainly of time-writing hours from specialists work (geologists,
geoscientists, engineers etc.) within the oil sector and their knowhow in this
area.
Time-writing
of man hours are mainly made from the "specialists" departments:
PED -
Petroleum Engineering Department (part of G23-virksomhed)
PDD -
Production Development Department (part of G1-A/S) EXPL - Exploration and New
Business (part of G1-A/S)
The
subsidiaries have the main risks (and opportunities) regarding the work of the
specialists.
E.g.: If
the exploration shows potential oil production, the G1-A/S subsidiaries will
benefit from this as they have the ownership and will receive income from sale
(according to agreement with local authorities etc.), where
as G1-A/S will only receive income from man hours actually spent. G1-A/S
has the costs of education, vacation, illness etc. of the specialists, which is
included in the calculation of the hourly rates.
The Timewriting are normally being audited yearly by the other
joint venture partners (G17-A/S, G18-virksomhed, G19-virksomhed etc.).
6.2 TP 2
Administration fee:
6.2.1
G1-A/S subsidiaries
Many of the
G1-A/S subsidiaries have a limited in house organization and no or only a few
employees, whereas the major production subsidiaries have a more or less full
in house administration organization capable of carrying out all administrative
functions and compliance issues in relation to finance, legal, commercial and
business services.
The scope
of services rendered by G1-A/S to each G1-A/S subsidiary - comprising more
routinely tasks - is defined in written service agreements amended from time to
time. Such inter-company agreements set forth the general terms, e.g. regarding
invoicing and termination.
Finance
Amongst
other the administrative services rendered by the finance department in G1-A/S
comprise, e.g.
-
Accounting and financial reporting, Tax returns etc.
- Payments,
financial analysis and review
Legal
The
administrative services rendered by the Legal department in G1-A/S comprise,
e.g.
- general
legal counsel, including legal advice regarding various contracts etc.
Commercial
The
administrative services rendered by the Commercial department in G1-A/S
comprise, e.g.
- marketing
and sale of oil (only relevant in relation to oil producing G1-A/S
subsidiaries)
Below is a
more detailed analysis of services rendered to each G1-A/S subsidiary.
G25-A/S
(0.5 mill. USD)
G25-A/S
(G25-A/S) is working as an operator in a Joint Venture with G19-virksomhed,
operating producing oil fields of the coast of Y2-land.
G25-A/S has
a branch in Y2-land with own employees, handling the daily business in Y2-land.
The branch
has its own Administration organization including Finance department in
Y2-land, handling all accounting regarding the branch. Accordingly, the finance
department in G1-A/S does not render services to the branch. However, G1-A/S
finance takes care of the daily accounting in G25-A/S including incorporation
of the branch. The work performed in G1-A/S Finance is on the whole independent
of the activity level in the Branch (increasing as of end 2005, due to new
field development plan with QP in Y2-land) as the number of upload sheets
received from Y2-land to be booked in G25-A/S are unchanged (booked monthly in
G1-A/S Finance). Reconciliation work etc. is also almost the same, disregard of
the activity level.
...
Based on
the above mentioned services rendered by G1-A/S to G25-A/S, the administration
fee for 2006 is fixed at USD 0.5 million USD (DKK 3.0 million) [2007: 0.5
million USD (DKK 3.0 million); 2008:
0.7 million
USD (DKK 3.5 million)].
G15-A/S
(USD 0.4 million)
G15-A/S has
a branch in Y1-land, participating in different blocks and Joint ventures,
however not acting as operator (G6-virksomhed/G10-virksomhed is operators in
the different oil fields), Therefore G15-A/S has no employees.
The
operators provide G1-A/S Finance with monthly Partner Reports to be booked in
G15-A/S.
G1-A/S
Finance takes care of the daily accounting in G15-A/S including incorporation
of the branch. The work performed in G1-A/S Finance is generally independent of
the activity level in the Branch as the number of partner reports received from
Y1-land to be booked in G15-A/S are unchanged (booked monthly in G1-A/S
Finance). Reconciliation work etc. is also almost the same, regardless of the
activity level.
...
Based on
the above mentioned services rendered by G1-A/S to G15-A/S, the administration
fee for 2006 is fixed at USD 0.4 million USD (DKK 2.5 million) [2007: 0.4
million USD (DKK 2.5 million); 2008: 0.5 million USD (DKK 2.5 million)].
...
7. Comparability Analysis
7.1 TP 1
Time-writing
...
7.1.1
G1-A/S towards subsidiaries
...
According
to oil sector standards, it is trade custom to render time writing services at
cost between independent joint venture parties. According to sector standard,
i.e. Joint Operating Agreements (JOA), which is used by G1-A/S Group in various
joint venture agreements, it is stated that charges for services should be at
cost. As a consequence, all timewriting from G1-A/S
is made at cost price.
In G1-A/S
Group, time writing rates towards subsidiaries are the same as well as towards
external parties, e.g. G23-virksomhed.
...
7.1.3
Selection of most appropriate transfer pricing method
The OECD
guidelines do recognize the inherent difficulty in identifying appropriate
comparable transactions for purposes of applying the CUP method but they assert
that practical concerns prescribe a more adaptable approach to enable the CUP
method to be employed. Therefore, every effort should be made to adjust the
data so that it may be used appropriately in a CUP method.
As G1-A/S
has been able to identify similar internal CUP's, the CUP method has been found
the most appropriatetransfer pricing method.
7.1.4
Selection of uncontrolled comparable transactions
As
described above, G1-A/S renders time writing services to G23-virksomhed and in some
cases to other external parties.
The terms
and conditions are similar for time writing towards internal and external
(G23-virksomhed) parties. It appears from the G23-virksomhed joint venture
agreement, that all time writing should be made at cost. The two G23-virksomhed
partners as well as other external partners audit the time rates in G1-A/S.
Furthermore,
G3-virksomhed companies participates in joint ventures with other joint venture
parties rendering similar manning services, e.g. in Y1-land, Y9-land and
Y24-land. In such joint ventures, G3-virksomhed companies are acquiring manning
services at costs.
Accordingly,
it should be appropriate from a transfer pricing perspective to consider such
transactions as internal uncontrolled comparable transactions for the purpose
of applying the CUP method.
7.1.5
Economic analysis
Given that
G1-A/S applies the same hourly rate per grade of specialist for the rendering
of time writing services towards related parties as applied towards external
parties (i.e. independent parties), it should be appropriate to conclude that
the cost rate arrangement between G1-A/S and related parties is consistent with
the arm's length principle.
7.2 TP 2
G1-A/S administration fee
...
7.2.1
Implementation of pricing method
Due to the G1-A/S
organization, internal accounting system and the character of the management
services rendered to G1-A/S subsidiaries etc., it is difficult for G1-A/S to
utilize a direct-charge method for valuing and charging for such administration
services.
According
to the OEDC Guidelines (section 7.23), cost allocation or apportionment
methods, i.e. indirect-charge methods, which to some degree estimates or
approximates the charges for inter-company services, may be acceptable provided
that sufficient regard has been given to the value of the services rendered.
Based on
the characteristics of the services provided, it has been concluded that it
should be appropriate to calculate the administration charge based on a cost
allocation, i.e. an indirect charge method, based on;
- the
estimated headquarter costs incurred in G1-A/S rendering administration
services, and
- the best
estimate for the allocation of such cost among recipients of such services
Accordingly,
the administration fee invoiced to G1-A/S subsidiaries etc. is based on the
best estimated of the workload required to service each subsidiary as agreed
and the costs connected hereto.
...
As
mentioned in section 6.2.2, the administration fee towards H2-A/S
(i.e. DK
OIL) is quite different compared to administration fee towards G1-A/S
subsidiaries (including G20-virksomhed and G21-virksomhed). Whereas the latter
administration service is a more routine and standardized administration
service (book keeping, annual reports, tax returns etc.), the administration service
rendered towards H2-A/S (DK OIL) is more complex and includes different, more
extraordinary elements, which requires more resources and skilled employees.
Furthermore, G1-A/S administration departments is partly organized and
established with the purpose of being able to provide H2-A/S (DK OIL) with
prompt and high quality service.
...
7.2.2
Selection of most appropriate transfer pricing method
...
The G1-A/S
indirect allocation method for administration service rendered by the head
quarter in Y4-by to subsidiaries are based on a statement of total head quarter
costs incurred providing the administration services based on sound accounting
principles and the best estimate for allocating such costs to the recipient of
administration services based on workload and resources utilized. Therefore, it
should be appropriate to conclude that the applied indirect charge method is in
alignment with the arm's length principle as defined by the OECD.
7.2.3
Economic analysis
For both
parties, i.e. G1-A/S and the recipients of administration service, it should be
appropriate to conclude that the indirect charge method represent economic
benefits.
G1-A/S
benefits from economies of scale as total costs incurred at headquarter are
allocated among more entities, which result in lower administration cost pr.
"activity". Furthermore, recipients of administration services
acquires administration services which are valued based on workload and
resources utilized to render such services.
Accordingly,
it should be appropriate to conclude that indirect charge method chosen could
lead to a result that is consistent with what comparable independent parties
would have been prepared to accept."
For the
purpose of SKAT's examination of the case, G1-A/S submitted additional
information to the transfer pricing documentation, which described, inter alia,
G1-A/S's investigative activities as follows:
"G1-A/S
has ... income from the following activities:
-
Time-writing income
- Operator
income
-
Administrative income
- Other
income
- Dividend
income from subsidiaries
- Financial
income
...
Research
activities
G1-A/S
carries out general exploration activities in the G1-A/S group.
Conducting
initial exploration expenditures (surveys) in connection with international
exploration for oil and gas deposits is an integral part of G1-A/S's core
business as an international oil company. Exploration expenditures do not
include drilling, but primarily analyses of seismic, geological and geophysical
data as well as financial and legal analyses carried out at the headquarters in
Denmark.
Preliminary
studies include both expenditures that subsequently result in obtaining an
exploration licence and expenditures that do not
result in obtaining a licence. At this stage, it is
not possible to know with certainty which legal entity will be responsible for
any licence acquired.
The
subsequent direct exploration for oil and gas deposits in a field rarely
results in success. Both the costs associated with successful projects and the
costs associated with unsuccessful exploration are expensed.
Phases
Exploration
activity takes place in the following 3 broad phases:
Phase 1:
Preliminary surveys, which include the following costs associated with
assessing sites prior to applying for a licence:
- Costs of
studies and analyses (not related to specific licences
or projects)
-
Expenditure on staff, including in-house geologists and engineers (salaries,
etc.)
- Costs of
external consultants
- Costs of
purchasing data
It should
be noted that the work in Phase 1 is mainly office work carried out at the
headquarters in Y4 city.
Phase 2: If
the geographical area is of geological interest, the possibility of acquiring licences from the relevant authorities or entering into a licence in relation to an existing project is investigated.
Costs incurred in this phase, in addition to costs incurred in phase 1, are the
following:
- Internal
costs for economists and lawyers for screening potential projects
- Costs of
external consultants
- Due
diligence costs
Again, the
work is mainly carried out at the headquarters in Y4 city.
Phase 3: If
a license is obtained, a new legal entity is usually created, in the form of a
local branch (owned by a G1-A/S subsidiary) or a local company (owned directly
by G1-A/S), which becomes the owner of the license. The branch/local/new
company decision often reflects local regulatory requirements. Future costs,
including the purchase of the licence, are borne by
this company - this could be, for example:
- Costs of
seismic drilling and development of oil and gas discoveries
- Costs of
personnel (administrative and technical), including time writing in G1-A/S
(2005: tUSD 11,307)
-
Expenditure on technical studies and analyses (of specific licence)
- Purchase
of technical assistance
- Purchase
of local financial and legal assistance"
Legal basis
Ligningsloven
Article
2(1) of the Ligningsgesetz reads:
"§
2. Taxable persons,
1) over
which natural or legal persons exercise a controlling influence,
2) which
exercise a dominant influence over legal persons,
3) which is
affiliated with a legal person,
4) which
has a permanent establishment situated abroad,
5) is a
foreign natural or legal person with a permanent establishment in Denmark, or
(6) a
foreign natural or legal person with a hydrocarbon-related activity covered by
Section 21(1) or (4) of the Hydrocarbon Tax Act,
shall, in
determining the income subject to tax or dividend, apply the prices and
conditions of commercial or economic transactions with the parties referred to
in points 1 to 6 (controlled transactions) in accordance with what could have
been obtained if the transactions had been concluded between independent
parties.
..."
The
provision was introduced by Article 1(1) of Act No 432 of 26 June 1998 amending
the Equalisation Act, the Corporation Tax Act and the
Tax Control Act. The explanatory memorandum to that amendment, as set out in
the general comments on draft Law No 101 of 2 June 1998, states, inter alia,
that
"General
comments Introduction
The purpose
of the bill is to establish in law that, in determining taxable income, related
parties must apply prices and conditions to their transactions which are
equivalent to those which independent parties would apply to similar
transactions (arm's length principle).
Secondly,
it is proposed to lay down rules to prevent the arbitrary shifting of tax
liabilities from Denmark to abroad by financing subsidiaries of foreign groups
in such a way that, as a result of a manifest mismatch between debt and equity (thin
capitalisation), disproportionate interest deductions
arise in Denmark.
Legalisation of the arm's length principle
It follows
from the general principles of tax law - contained in Articles 4-6 of the State
Tax Act - that every taxpayer is taxed only on its own income, but must be
taxed on all its taxable income. These principles have hitherto led to the
conclusion that, in the event of transactions between two taxpayers with an
interest in each other which are not carried out at arm's length, the tax
authorities may, when determining the taxable income, adjust it so that the
income corresponds to what could have been obtained if the transactions had
been carried out at arm's length. These principles correspond to the basic OECD
principles of transfer pricing, i.e. trade between related parties across
borders.
...
Following
the judgment of the Supreme Court [TfS 1998.199],
there is a need for a legal confirmation of the generally accepted principle of
the application of arm's length conditions in the determination of the taxable
income for transactions between related parties.
Law No 131
of 25 February 1998, amending the Tax Control Act and the Tax Administration
Act (Duty to provide information on intra-group transactions), adopted on 3
February 1998, concerns cross-border transactions between parties in interest
(L 84). The Act introduced an extended tax reporting obligation and an
obligation to draw up and keep written documentation on the prices and terms of
intra-group transactions. The purpose of the Act is to enhance the ability of
tax authorities to ensure the correct pricing and hence the correct
determination of taxable income in cross-border intra-group transactions.
However,
the law does not affect the substantive rules of the arm's length principle.
The law presupposes that the tax authorities have the power to correct prices
and terms if they do not correspond to what independent parties would have
agreed in a similar situation. The draft law set out the rationale for transfer
pricing adjustments.
It stated
that:
"It
follows from the general principles of tax law that every taxpayer is to be
taxed only on his own income, but must be taxed on all his taxable income.
Where transactions are carried out between two taxpayers which are not at arm's
length, an adjustment will be possible. In other words, there has been a
"hidden" transfer of income from one taxpayer to another. However,
the correction presupposes that the two taxpayers are linked by an interest. If
one of the companies is foreign, only the Danish company will be eligible for
adjustment.
The general
principles of tax law are contained in Articles 4-6 of the State Tax Act, which
apply to all communities of interest. Section 12 of the Corporation Tax Act
provides for an adjustment in respect of transactions of a Danish company or
branch with a foreign controlling company. This provision was introduced with effect
from the tax year 1962/63 at the same time as the introduction of the
Corporation Tax Act. The comments on the provision stated:
"The
provisions of paragraphs 1 and 2 are intended to deal with attempts to evade
tax liability in cases where business activities are carried on in this country
by a subsidiary of a foreign parent company or as a branch of a principal
establishment situated abroad, and where it may be feared that accounting
manipulations and arbitrary calculations are being used to reduce the
accounting profits of the subsidiary or branch and hence the income subject to
tax in this country. The provision provides an explicit legal basis for the tax
authorities to disregard the accounts in such cases and to assess income on the
basis of an estimate of the profit which, under free conditions, may be assumed
to have been made on the basis of the turnover recorded. This principle is
already followed in practice and must be said to have gained general
international acceptance, notably also in the conclusion of double taxation
agreements."
It follows
that the aim was not to change the principles already in force but merely to
provide a specific legal basis for the adjustment of the taxable income of
controlled Danish companies or branches. This legal basis still exists, but in
practice has proved to be insufficient as a basis for correction, often lacking
the necessary documentation.
Section 12
of the Corporation Tax Act does not directly cover the reverse situation, where
a Danish company has a controlling influence over a foreign company or branch
located abroad. However, as the provision reflects the general tax law
principles contained in Articles 4-6 of the State Tax Act, a Danish controlling
company may be subject to an adjustment along similar lines.
It is an
internationally recognised principle that parties in
interest should act at arm's length. The OECD has issued guidelines on the
principles and approaches that can be internationally accepted for the equation
in transfer pricing cases. These guidelines are based on the arm's length
principle. All OECD countries - including Denmark - have endorsed these
guidelines. The new Danish rules introduced by Act No 131 of 25 February 1998
amending the Tax Control Act and the Tax Administration Act are thus also in
line with the OECD guidelines.
The special
comments on the same bill state, inter alia:
"To §
1
To
paragraphs 1-3:
...
The
controlled transactions referred to in the provision shall include all
relations between the parties. Examples include the provision of services, loan
relationships, the transfer of assets, intangible assets made available, etc.
With regard
to transactions between a permanent establishment in Denmark and a head office
abroad, or a permanent establishment abroad and a Danish head office, only
those transactions which, according to the rules on the determination of the
income of a permanent establishment, have to be carried out at arm's length,
will be covered by the proposed rules."
Tax Control
Act
Section 3B
of the current Tax Control Act was introduced by Section 1(1) of Act No 131 of
25 February 1998 amending the Tax Control Act and the Tax Administration Act.
The provision was worded as follows:
"§ 3
B. Taxable persons who:
1)
controlled by foreign natural or legal persons, or
2) control
foreign legal persons, or
3) is
affiliated with a foreign legal person; or
4) has a
permanent establishment situated abroad, or
5) is a
foreign natural or legal person with a permanent establishment in Denmark,
must
provide information in the tax return on the nature and extent of commercial or
economic transactions with the abovementioned foreign natural and legal persons
and permanent establishments (controlled transactions).
Paragraph
2. Control shall mean the ownership or control of voting rights as referred to
in Section 32(1)(2) and (3) of the Corporation Tax Act and Section
16H(1)(2)-(4) of the Equalisation Act.
Paragraph
3. A legal or natural person shall be deemed to be foreign if that person is
resident in a foreign State, Y15 country or Y14 country, including under the
provisions of a double taxation convention.
Paragraph
4. Taxable persons shall draw up and keep written records of the prices and
conditions applied to the controlled transactions. The written documentation
shall be made available to the tax authority at its request and shall be of
such a nature as to enable an assessment to be made as to whether the prices
and conditions have been determined in accordance with what would have been
obtained if the transactions had been concluded between independent parties.
Paragraph
5. Where the taxpayer has not prepared documentation in accordance with
paragraph 4, Article 5(3) shall apply in respect of the controlled
transactions. In all cases where the tax administration wishes to amend the
taxable income in accordance with the prices and conditions which could have
been obtained if the transactions had been concluded between independent
parties, prior approval must be obtained from the central customs and tax
administration.
Paragraph
6. Paragraphs 1 to 5 shall not apply to foreign insurance undertakings carrying
on insurance business in this country and computing their taxable income in
this country in accordance with Article 12(3) of the Corporation Tax Act."
The
explanatory memorandum to Section 3B of the current Tax Control Act, as set out
in the general comments to Bill No 84 of 14 November 1997, states, inter alia:
"General
comments Introduction
The purpose
of the bill is to increase the tax authorities' ability to ensure correct
pricing and hence correct assessment of taxable income in cross-border
intra-group transactions (transfer pricing).
An extended
tax reporting obligation is proposed, as well as an obligation to prepare and
keep written documentation on prices and terms of intra-group transactions.
The
proposed legislation would require taxpayers with interests in companies,
persons, etc. abroad to disclose in their tax returns the nature and extent of
commercial or economic transactions with them (controlled transactions). This
information will be purely summary. Special information boxes will be prepared
for tax returns, on the recommendation of the Tax Council, in which this
information must be entered.
Furthermore,
in the case of controlled transactions, documentation will have to be provided
on how prices and conditions have been determined. The written documentation
must be such that it can form the basis for an assessment of whether prices and
conditions have been determined in accordance with what might have been
obtained if the transactions had been concluded between independent parties. As
a minimum, the entity should explain how prices and terms for controlled
transactions are actually determined. The rules generally leave it to the
taxpayer to assess what further documentation is necessary. This assessment
should be made taking into account that the tax authorities will apply the
principles of the OECD Transfer Pricing Guidelines (Organisation
for Economic Cooperation and Development) in the assessment. The tax
administration may request additional documentation or information if the
documentation provided by the taxpayer is not deemed to be sufficient to assess
the controlled transactions.
If the
taxpayer has not prepared the written documentation, the taxable income in
respect of the controlled transactions may be estimated. In all cases where the
tax administration wishes to change the taxable income in accordance with the
prices and conditions that could have been obtained if the transactions had
been concluded between independent parties, prior approval must be obtained
from the central customs and tax administration.
...
Background
to transfer pricing rules
...
The written
documentation must be such as to enable an assessment to be made as to whether
prices and conditions have been determined in accordance with what might have
been obtained if the transactions had been concluded between independent
parties. As a minimum, the company must explain how prices and conditions for
controlled transactions were actually determined. The rules generally leave it
to the taxpayer to assess what further documentation is necessary. This
assessment should be made taking into account that the tax authorities will
apply the principles of the OECD Transfer Pricing Guidelines in the assessment.
...
If
information for the assessment of whether the internal transactions have been
carried out in accordance with the arm's length principle is not provided by a
company in Denmark, this may, according to the general rules on the burden of
proof, have the effect of prejudicing the proceedings of the company in
Denmark. This means that the burden of proof for the tax authorities is
weakened. However, notwithstanding this reduction in the burden of proof, the
tax authorities must still prove that the transaction was not carried out at
arm's length. This can be particularly difficult where part of the comparative
evidence is missing because it originates from the foreign company or because a
number of years have elapsed. By requiring a basis of documentation in the
company in Denmark, the tax authorities' work is made easier and the company is
aware of what documentation will be required if a transfer pricing case is
initiated.
If the
taxpayer has not prepared documentation in accordance with paragraph 4, Article
5(3) shall apply in respect of the controlled transactions. The taxable income
relating to the controlled transactions may then be determined on an estimated
basis. This is similar to what applies in the case of non-compliance with the
accounting requirements of the Minimum Requirements Order.
In all
cases where the tax authorities wish to amend the taxable income in accordance
with an estimate of what could have been obtained if the transactions had been
completed between independent parties, prior approval must be obtained from the
central customs and tax administration. The taxable income may be modified if
the tax authority is of the opinion that the prices and terms established are
not at arm's length or if the documentation is not a sufficient basis for the
prices. However, the individual case must be submitted to the central customs
and tax administration for approval before the discretionary amendment is made.
If the taxpayer considers that the change is unjustified, the taxpayer must
prove that the transaction was made at arm's length. This means that the burden
of proof may shift between the taxpayer and the tax authorities, depending on
the circumstances. Finally, the assessment of the evidence is subject to
judicial censorship."
The special
comments on the same bill state, inter alia:
"To §
1
...
To
paragraph 5:
If the
taxpayer has not produced the documentation referred to in paragraph 4, Article
5(3) shall apply in respect of the controlled transactions. The taxable income
relating to the controlled transactions may thus be determined on an estimated
basis if no documentation has been produced.
In all
cases where the tax administration wishes to amend the taxable income in
accordance with an estimate of the prices and conditions which could have been
obtained if the transactions had been concluded between independent parties,
prior approval must be obtained from the central customs and tax
administration. Section 3B(5)(2) shall apply where no documentation has been
produced and where documentation has been produced but the tax administration
disagrees with the determination of the price and conditions.
The
requirement of an approval from the central customs and tax administration
before the taxable income can be changed is inserted in order to allow the
customs and tax administration to coordinate the rules. This approval cannot be
challenged independently, but the discretionary assessment of taxable income
can be challenged under the general rules of the Tax Administration Act.
The
circular to the Corporation Tax Act, CIR No 136 of 7 November 1988, point 46,
states that, in the light of recent case-law, the rule in Article 12 of the
Corporation Tax Act has been interpreted as meaning that it does not confer the
right to discretionary increases without a clear evidential basis for an
incorrect tax return. Furthermore, it is stated that it is established that the
burden of proof lies with the tax authorities.
This
statement is a somewhat unbalanced description of the legal situation. Point 46
of the Circular will therefore be repealed following the adoption of this Law.
The opinion has probably had the effect that tax authorities have been more
reluctant to question companies' pricing and terms in controlled transactions
than is necessary, as there appears to be no basis for the burden of proof
rules in transfer pricing cases to differ from other areas of tax law.
The
proposed rules are designed to enable the tax administration to investigate and
assess the price and terms set by companies. By requiring the preparation of a
documentary basis, the determination will be "brought to light" and,
furthermore, there will be no doubt in the future that companies have a duty to
document the determination of price and terms."
Act No 408
of 1 June 2005 amending the Tax Control Act and various other acts amended the
current Tax Control Act in Article 3B. Paragraphs 5 and 6 of the provision
became paragraphs 8 and 9. The explanatory memorandum to the above amendment,
as set out in the general comments on Bill No 120 of 2 March 2005, states,
inter alia:
"General
comments
...
2. Existing
rules
...
If the
taxpayer has not produced documentation, the tax authorities may, under the
current Tax Control Act, make an estimate in respect of the controlled
transactions. In addition, failure to comply with the documentation obligation
may lead to a reversal of the burden of proof, so that the taxpayer has to
prove that the transactions are at arm's length.
As
mentioned above, the consequence of insufficient documentation is, inter alia,
that the tax authorities (customs and tax administration) are entitled to make
an assessment on the best possible basis that the tax authorities (customs and
tax administration) can find. The estimate must always be exercised in
accordance with the principles of the OECD Guidelines on Transfer Pricing,
which state, inter alia, that the tax authorities (customs and tax
administration) should not make marginal increases. Where possible, an increase
could for example be based on a database study using information from
commercial databases (e.g. accounting information from the Bureau of Commerce
or from the Amadeus database).
The fact
that the tax authorities (customs and tax administration) have the power to
make an estimate does not mean that an estimate is automatically made. Such an
estimate of income is made if the tax authorities (customs and tax
administration) consider that the transactions have not been at arm's length.
This will always depend on a specific assessment, including for example whether
the company is a group company with reasonable profits or, conversely, a group
company which has had low or negative profits over a long period without any
clear business justification. It is noted in this context that independent
companies, for example, will not accept losses year after year. In such
situations, the activity will cease."
Article
1(2) of Law No 1104 of 20 December 1995 amending the Tax Control Act and
various other laws amended Article 5(2) of the Tax Control Act.
3 was
inserted. The provision was worded as follows:
"§ 5.
...
Paragraph
3. If a tax return is not available at the time of appointment, the taxable
income and assets may be estimated."
The
preparatory works for Article 5(3) of the current Tax Control Act, cf. the
special comments in Bill No 104 of 1 December 1995, state, inter alia:
"To §
1 To no. 2
...
...
Re Article
5(3): It is proposed that the tax authorities should be able to assess a
taxpayer's estimated taxable income or assets, as under current law, if the
taxpayer has not declared the income or assets at the time of recruitment or if
an accounting or bookkeeping officer has not filed annual accounts at that
time.
This shall
also apply in cases where 'a tax return or annual tax return' is so incomplete
that it cannot be treated as a tax return or annual tax return, as the case may
be, within the meaning of paragraphs 1 and 3.
In such
cases, according to the general principles of evidence, it is normally for the
tax authority to prove that the estimated statement is not less probable than
other statements - in the light of the information available to the tax
authorities.
It should
be noted in this respect that, in a situation such as this, the tax authorities
are not normally obliged to make use of the special powers of control conferred
on the tax authorities to obtain information from third parties, whether from
another public authority or from a private company. The tax authorities may
base their estimate directly on the information in their possession concerning
the tax year in question and previous tax years."
The current
Order No 42 of 24 January 2006 on the documentation of the pricing of
controlled transactions states, inter alia:
"§ 4.
The documentation must contain a description that gives the customs and tax
administration an overview of the group and the business activities.
Paragraph
2. The description shall include:
1) A
description of the legal structure of the group, including the geographical
location of the group entities.
2. a
description of the organisational structure,
including the primary business activity of the taxpayer and of the related
parties with which the taxpayer has had controlled transactions.
3) A
summary showing the last 3 years of turnover and profit from the principal
activities of the taxpayer and of the related parties with whom the taxpayer
has had controlled transactions.
4) A brief
historical description of the group and the business, a description of any
restructuring and changes in significant functions and risks, and an
explanation of any deficits.
5) A brief
description of the industry conditions of the group, including an indication of
the main competitive parameters.
§ The
documentation shall include a description of the controlled transactions.
Paragraph
2. Several transactions may be described under one (aggregated). It must be
described which transactions are aggregated.
Paragraph
3. The controlled transactions shall be identified as to how much has been
transferred and between which related parties.
Paragraph
4. The controlled transactions shall also be described in terms of:
1)
characteristics of products (goods, services, assets, intangible assets, etc.).
2) A
functional analysis (functions, assets and risks.) 3) Contractual terms.
4) Economic
circumstances. 5) Business strategies.
Paragraph
5. Cost-sharing agreements, if any, must be described.
Paragraph
6. Any other factors which are specifically considered to be of importance for
an arm's length assessment shall be described.
§ The
documentation shall include a comparability analysis which, together with the
descriptions in paragraphs 4 to 5, may form the basis for an assessment of
whether the pricing principles for the controlled transactions are consistent
with the arm's length principle, as set out in paragraphs 2 to 4.
Paragraph
2. The analysis shall include a description of the pricing of the controlled
transactions. The analysis shall also include an explanation of why the pricing
is considered to be consistent with the arm's length principle, including an
explanation of comparable independent transactions used and justification for
the choice of methodology.
Paragraph
3. For the purposes of paragraph 2, the taxpayer's own transactions with
independent parties, as well as transactions between independent parties and
including transactions of other related parties with independent parties, shall
be used. In addition, the possible comparable independent transactions which
the enterprise has opted out of shall be indicated, together with the reasons
for the opt-out.
Paragraph
4. The taxpayer is not obliged to prepare database searches, without prejudice
to Article 10. If database searches are nevertheless carried out, they must be
attached to the documentation."
The current
Order No 1297 of 31 October 2018 on documentation of the pricing of controlled
transactions states, inter alia:
"Article
4. The joint documentation shall contain a group diagram showing the legal and organisational structure of the group, including an
indication of the countries in which each related party operates.
Paragraph
2. The joint documentation shall contain a general description of the business
activities of the group, including the following:
1) The
significant drivers of business profit in the group.
2) A
description of the group's supply chain for the five largest products and/or
services by revenue and all products and/or services that represent more than
five percent of the group's consolidated revenue. The description may be
illustrated by a diagram.
3) A list
with a brief description of the significant service agreements between the
related parties of the group, other than research and development service
agreements, as well as a description of the significant services that the main
service centres of the group provide or can provide
and the transfer pricing policies applied for the allocation of service costs
and the determination of transfer prices for the intra-group services.
4) A
description of the main geographic markets in terms of turnover for products
and services, as referred to in point 2.
5) A brief
functional analysis describing the primary contributions to the Group's overall
value creation, indicating which of the Group's individual related parties
contribute in terms of significant functions, risks and assets.
6) A
description of significant restructurings, acquisitions and disposals occurring
during the year.
Paragraph
3. The joint documentation shall include the following for the group's
intangible assets (as defined in Chapter VI of the OECD Transfer Pricing
Guidelines):
1) A
general description of the group's overall strategy for the development,
ownership and exploitation of intangible assets, including the geographical
location of the group's primary research and development facilities and the
location from which these activities are managed.
2) A list
of the intangible assets or groups of intangible assets of the group that are
relevant to related party transactions and identifying the entities of the
group that are the legal owners of those intangible assets.
3) A list
of significant agreements between the related parties relating to intangible
assets, including primary Cost Contribution Arrangements (CCAs), research and
development service agreements and licensing and royalty agreements.
4) A
general description of the Group's overall transfer pricing policies in
relation to research and development activities and intangible assets.
5) A
general description of all significant transfers of rights to intangible assets
between related parties during the financial year, together with an indication
of the entities and countries involved in the transfers and the payments made in
respect thereof.
Paragraph
4. The common documentation shall contain the following in respect of the
financial activities of the group:
1) A
general description of how the group is financed, including a description of
the most significant financial arrangements with independent lenders.
2)
Identification of all related parties that have a key financing function in
relation to the group, including the countries under whose laws these entities
are organised and the location from which the
entities are managed.
3) A
general description of the group's transfer pricing policies in relation to the
financial arrangements between the related parties.
Paragraph
5. The joint documentation shall contain the following with respect to the
accounting and tax position of the group:
(1) the
consolidated financial statements of the group for the year, if prepared for
financial reporting, internal control, tax reporting or other purposes
2) A list
and brief description of the group's existing unilateral Advanced Pricing
Agreements (APAs), tax treaties and rulings with prospective effect relating to
the allocation of income between countries.
§ 5
...
Paragraph
2. The country-specific documentation shall provide the following information
for each category of controlled transactions in which the taxpayer is involved:
1) A
description of the controlled transactions (e.g., purchases, production, sales,
provision or receipt of services, loans, guarantees, purchases and sales of
intangible assets, royalty payments, etc.) and a description of the context in
which the controlled transactions occurred."
OECD
Transfer Pricing Guidelines
The OECD
has issued guidelines on the application of transfer pricing rules by companies
and tax administrations entitled "Transfer Pricing Guidelines for Multinational
Enterprises and Tax Administrations" (TPG). The 1995 TPG states, inter
alia:
" 5. Business strategies
...
ii)
Recognition of the actual transactions undertaken
1.36 A tax
administration's examination of a controlled transaction ordinarily should be
based on the transaction actually undertaken by the associated enterprises as
it has been structured by them, using the methods applied by the taxpayer
insofar as these are consistent with the methods described in Chapters II and
III. In other than exceptional cases, the tax administration should not
disregard the actual transactions or substitute other transactions for them.
Restructuring of legitimate business transactions would be a wholly arbitrary
exercise the inequity of which could be compounded by double taxation created
where the other tax administration does not share the same views as to how the
transaction should be structured.
...
vi) Losses
1.52 When
an associated enterprise consistently realizes losses while the MNE group as a
whole is profitable, the facts could trigger some special scrutiny of transfer
pricing issues. Of course, associated enterprises, like independent
enterprises, can sustain genuine losses, whether due to heavy start-up costs, unfavourable economic conditions, inefficiencies, or other
legitimate business reasons. However, an independent enterprise would not be
prepared to tolerate losses that continue indefinitely. An independent
enterprise that experiences recurring losses will eventually cease to undertake
business on such terms. In contrast, an associated enterprise that realizes
losses may remain in business if the business is beneficial to the MNE group as
a whole.
...
B. Main
issues
...
i)
Determining whether intra-group services have been rendered 7.6 Under the arm's
length principle, the question whether an intragroup service has been rendered
when an activity is performed for one or more group members by another group
member should depend on whether the activity provides a respective group member
with economic or commercial value to enhance its commercial position. This can
be determined by considering whether an independent enterprise in comparable
circumstances would have been willing to pay for the activity if performed for
it by an independent enterprise or would have performed the activity in-house
for itself. If the activity is not one for which the independent enterprise
would have been willing to pay or perform for itself, the activity ordinarily
should not be considered as an intragroup service under the arm's length
principle.
The 2010
TPG states, inter alia:
"Chapter
I: The arm's length principle B. Statement of the arm's length principle
...
B.1 Article
9 of the OECD Model Tax Convention
1.6 The
authoritative statement of the arm's length principle is found in paragraph 1
of Article 9 of the OECD Model Tax Convention, which forms the basis of
bilateral tax treaties involving OECD member countries and an increasing number
of non-member countries...
By seeking
to adjust profits by reference to the conditions which would have obtained
between independent enterprises in comparable transactions and comparable
circumstances (i.e. in "comparable uncontrolled transactions"), the
arm's length principle follows the approach of treating the members of an MNE
group as operating as separate entities rather than as inseparable parts of a
single unified business. Because the separate entity approach treats the
members of an MNE group as if they were independent entities, attention is
focused on the nature of the transactions between those members and on whether
the conditions thereof differ from the conditions that would be obtained in
comparable uncontrolled transactions. Such an analysis of the controlled and
uncontrolled transactions, which is referred to as a "comparability
analysis", is at the heart of the application of the arm's length
principle. ...
D.Guidance
for applying the arm's length principle
...
D.2
Recognition of the actual transactions undertaken
1.64 A tax
administration's examination of a controlled transaction ordinarily should be
based on the transaction actually undertaken by the associated enterprises as
it has been structured by them, using the methods applied by the taxpayer
insofar as these are consistent with the methods described in Chapter II. In
other than exceptional cases, the tax administration should not disregard the
actual transactions or substitute other transactions for them. Restructuring of
legitimate business transactions would be a wholly arbitrary exercise the
inequity of which could be compounded by double taxation created where the
other tax administration does not share the same views as to how the
transaction should be structured.
...
D.3 Losses
1.70 When
an associated enterprise consistently realizes losses while the MNE group as a
whole is profitable, the facts could trigger some special scrutiny of transfer
pricing issues. Of course, associated enterprises, like independent
enterprises, can sustain genuine losses, whether due to heavy start-up costs, unfavourable economic conditions, inefficiencies, or other
legitimate business reasons. However, an independent enterprise would not be
prepared to tolerate losses that continue indefinitely. An independent
enterprise that experiences recurring losses will eventually cease to undertake
business on such terms. In contrast, an associated enterprise that realizes
losses may remain in business if the business is beneficial to the MNE group as
a whole.
1.71 The
fact that there is an enterprise making losses that is doing business with
profitable members of its MNE group may suggest to the taxpayers or tax
administrations that the transfer pricing should be examined. The loss enterprise
may not be receiving adequate compensation from the MNE group of which it is a
part in relation to the benefits derived from its activities. For example, an
MNE group may need to produce a full range of products and/or services in order
to remain competitive and realize an overall profit, but some of the individual
product lines may regularly lose revenue. One member of the MNE group might
realize consistent losses because it produces all the lossmaking products while
other members produce the profit-making products. An independent enterprise
would perform such a service only if it were compensated by an adequate service
charge. Therefore, one way to approach this type of transfer pricing problem
would be to deem the loss enterprise to receive the same type of service charge
that an independent enterprise would receive under the arm's length principle.
...
Chapter
VII: Special Considerations for Intra-Group Services B. Main issues
...
...
B.1
Determining whether intra-group services have been rendered 7.6 Under the arm's
length principle, the question whether an intra-group service has been rendered
when an activity is performed for one or more group members by another group
member should depend on whether the activity provides a respective group member
with economic or commercial value to enhance its commercial position. This can
be determined by considering whether an independent enterprise in comparable
circumstances would have been willing to pay for the activity if performed for
it by an independent enterprise or would have performed the activity inhouse
for itself. If the activity is not one for which the independent enterprise
would have been willing to pay or perform for itself, the activity ordinarily
should not be considered as an intragroup service under the arm's length
principle."
Applicant
In support
of its claims, H1-A/S and H2-A/S submitted essentially the same pleadings as
those set out in its summary pleading, which states, inter alia
"6.1 Overall
In support
of the principal claim, the applicant submits, first, that there is no basis or
legal basis for making a discretionary increase in G1-A/S's income for
2006-2008 by means of fixed income from G15-A/S and G25-A/S.
G1-A/S's TP
documentation complies with all the requirements of the law, and there was
therefore no basis for making a discretionary assessment. The Ministry of
Taxation has not demonstrated that G1-A/S had intra-group transactions with the
two subsidiaries and their branches in 2006-2008 beyond what is explained in
the TP documentation and that the arm's length principle has not been
respected.
The
Ministry of Taxation has therefore also not demonstrated that there are grounds
for an adjustment of G1-A/S's income under Section 2 of the Equalisation
Act, see also SKM2019.136.HR and U2020.3156H.
G1-A/S's
business model, as further described below, is essentially commercial and the
fact that G1-A/S realises tax losses is not a
consequence of the commercial setup not being at arm's length. The loss does
not constitute evidence that the arm's length principle is not respected, see
also U2020.3156H [...].
The
Ministry of Taxation has not demonstrated that G1-A/S's work on initial
feasibility studies (phases 1 and 2) constitutes an intangible asset in the
form of know-how made available to the subsidiaries, for which G1-A/S can claim
remuneration. There is therefore no transaction between related parties within
the meaning of Article 2 of the Tax Code. Nor is there any basis for
considering, as the Tax Tribunal has done, that the oil licences
are in fact owned by G1-A/S and made available to the subsidiaries and their
branches.
The only
services provided by G1-A/S to the subsidiaries and their branches during the
income years in question were technical and administrative assistance. These
are provided, as documented, on the same terms as apply to G1-A/S's services to
H2-A/S/G23 company, which SKAT and the Ministry of Tax have assumed are at
arm's length. These services are thus provided at prices and conditions corresponding
to what an independent party could charge for similar services, as defined in
Section 2 of the Tax Act.
There is
therefore no basis for concluding that G1-A/S - by virtue of this work and
these services - makes know-how available to the subsidiaries in breach of the
arm's length principle.
Secondly,
it is argued that even if it were to be assumed that the TP documentation is
deficient and that the conditions for discretionary assessment are met, then
G1-A/S has demonstrated that the arm's length principle is respected and that
there is no basis for a discretionary increase in income.
In the
event that the Court of Appeal finds that there has been no arm's length, it is
argued in support of the subsidiary claim that a correct TP adjustment - in
accordance with Article 2 of the Tax Act and the OECD Transfer Pricing
Guidelines (as reproduced above) - must be made on the basis of an actual
valuation, identified intra-group transactions between G1-A/S on the one hand
and G1-A/S' subsidiaries/branches and H2-A/S on the other hand (in line with
the result reached by the minority in the Tax Tribunal). In any event, SKAT's
assessment is not in line with Section 2 of the Equalisation
Act and the TPG and must be rejected.
6.2 The main claim
6.2.1 The
TP documentation is not deficient and there is no basis for a discretionary
assessment
It is
submitted that G1-A/S's TP documentation for 2006-2008 is complete and in
compliance with the applicable legislation.
The TP
documentation [...] duly sets out the controlled transactions which G1-A/S had
with its group companies during the income years in question and the pricing
thereof.
The
services provided by G1-A/S to H2-A/S/G23 and to its subsidiaries in the form
of technical and administrative assistance and the basis on which these
services are charged for have thus been adequately described. It is quite clear
that G1-A/S provides these services (hourly writing) on the same terms as the
corresponding services provided to H2-A/S and G23, which are considered - also
by the tax authorities - to be in line with the arm's length principle.
It has been
explained that the services are provided in accordance with industry practice,
which, as described above, applies in the oil industry at cost, i.e. without a
profit. This is considered to be at arm's length when G1-A/S provides the
services to H2-A/S and G23 company and these supplies of equivalent services to
independent parties are taken as the basis of comparison (CUP) on which the
pricing of the equivalent services to G1-A/S's subsidiaries is based.
There is no
basis for concluding that the documentation of these actual intra-group
transactions is inadequate and that the tax authorities are not able on this
basis to assess whether the arm's length principle has been complied with
pursuant to Section 3B(8) of the current Tax Control Act [...].
As regards
the preliminary investigations and the preliminary investigation (phases 1 and
2), there is no intangible asset made available to group companies, as claimed
by SKAT and the Ministry of Taxation. The expenditure was incurred in G1-A/S's
own interest and, moreover, at a time when the subsidiaries had not come into
existence. In relation to the subsidiaries concerned by the present case
(Y1-land and Y2-land), the work in phases 1 and 2 was carried out prior to the
establishment and acquisition of licences by the
subsidiaries in 1990 and 1992.
This work
does not therefore constitute an 'economic transaction' with these subsidiaries
and for this reason alone should not be referred to in the TP documentation.
In any
event, there are no transactions between G1-A/S and the subsidiaries/branches
in 2006-2008, where it is undisputed that G1-A/S did not carry out any
feasibility studies or investigations concerning Y1-land and Y2-land.
If so, it
is a different but separate question whether a controlled transaction could
exist at the time when a completed feasibility study for a specific oil field
is made available to the subsidiary acquiring the licence
for that field; i.e. to the entities in Y1-land and Y2-land in 1990 and 1992
respectively. This is simply not an issue in the case, which concerns the
2006-2008 income years.
Therefore,
it can never be a deficiency of the TP documentation that the preliminary
feasibility studies and investigations in Y1-land and Y2-land are not mentioned
in the TP documentation for 2006-2008. Moreover, the preliminary investigations
are mentioned in the supplementary information to the TP documentation [...].
As regards
the performance bonds, these are not mentioned either, as they do not
constitute 'economic transactions' between G1-A/S and its subsidiaries (Y1-land
and Y2-land). As explained above, these are not payment guarantees in favour of the subsidiaries, but rather a declaration by the
parent company to the oil State concerned that it will ensure that the
licensing subsidiary will be able to meet its obligations under the agreement.
It is not a guarantee in favour of the subsidiary,
but in the interest of G1-A/S.
A
declaration to provide the necessary technical and financial support at a given
future date does not constitute a transaction in relation to the subsidiary any
more than a declaration by a parent company to further capitalise
its subsidiary does. In any event, a transaction could only be contemplated at
the time when G1-A/S might deliver under the guarantee.
In
addition, neither the current Transfer Pricing Order [...] nor its guidance
[...] provide for performance guarantees or parent company declarations to be
mentioned in the TP documentation.
Finally, it
should be noted that it follows from the Supreme Court's case law that the fact
that the tax authorities believe that there are controlled transactions that
should have been priced or disagree with the TP documentation does not render
the TP documentation deficient when it is clear from the TP documentation that
the transactions that the tax authorities claim/state are not included in the
intra-group settlement, see SKM2019.136.HR [...] and U.2020.3156H [...].
In other
words, the tax authorities cannot claim an intra-group transaction and conclude
on this basis that the absence of mention of this "claimed"
transaction thus renders the TP documentation deficient.
On this
basis, it is argued that it can be assumed that the TP documentation is proper
and in accordance with the law.
The tax
authorities were therefore not entitled to assess G1-A/S's income on a
discretionary basis in respect of the controlled transactions.
It is
therefore up to the Ministry of Taxation to demonstrate that G1-A/S has had
intra-group transactions that are not priced in accordance with the arm's
length principle and that the tax authorities' estimates are in accordance with
the arm's length principle, as set out in Article 2 of the Tax Code.
The
Ministry of Taxation has stated during the preparation that the basis for the
review by the Regional Court is the Tax Tribunal's discretion. Only if this
discretion can be overruled does one 'fall back on' the discretion of the SKAT.
It should
be noted that the majority of the Tax Tribunal did not exercise any
'discretion'. The majority of the Tax Tribunal has merely confirmed (with a
slightly different reasoning) SKAT's estimate with the small addition that this
estimate 'corresponds ... to a royalty rate of 1,7 % of the turnover of the branches'
[...].
But this is
of no consequence. The Ministry of Taxation must demonstrate that there is a
basis for an adjustment of G1-A/S's income and that G1-A/S has provided
know-how without an arm's length payment to justify the increase.
The
Ministry of Taxation has not met this burden of proof, see below.
6.2.2 The
business model (investment activity) is fully commercial and at arm's length
The
decision rests on the (erroneous) basic view that G1-A/S's business model is
not at arm's length, because no independent party would accept a business model
that generates tax losses year after year due to the expenses incurred for
feasibility studies and initial exploration for oil and gas deposits. The tax
loss in itself gives rise to a TP adjustment.
In this connection,
the Ministry of Taxation has referred to the fact that the National Tax Court
has also concluded that the business model means that G1-A/S will never make a
profit from its activities and that 'it must be assumed that the company would
not enter into such a business model with independent parties' [...]. In this
context, the Tax Tribunal rejected the view that G1-A/S's income from dividends
could be considered to be business income.
However,
the Tax Tribunal minority (two members of the court) considered that "the
group's set-up is - and has been long before the introduction of the current
rules, including on the taxation of dividend income - commercially
motivated." [...].
The
Ministry of Taxes' argument is, in effect, that the Ministry of Taxes does not
accept that G1-A/S carries on an investment business and argues that, in
assessing the commercial nature of the business, account should be taken of the
substantial returns on investments [...] which G1-A/S receives in the form of
dividends and which show that G1-A/S carries on a quite profitable investment
business.
Nowhere
does it follow from either the TP rules or the TPG that an investment
enterprise must recover its investment costs from taxable income. On the
contrary, it would be contrary to the TP rules and to basic tax principles if
an investment firm 'wiped' its expenses for feasibility studies, due diligence
etc. on the companies (the target companies) in which the investment firm
invests or has already invested.
The fact
that the business model leads to the generation of a (tax) loss is not in
itself proof that there is no arm's length dealing, see in this respect also
expressly the majority of the Supreme Court in U.2020.3156H [...].
G1-A/S's
business model of investing in geographical areas/oil licences
is fully commercial and the business model has - unchanged - been the same
since the beginning, and as the Tax Tribunal minority correctly states:
"... long before the introduction of the current rules." [...].
The deficit
can be explained. In addition to the significant activity as operator of G23
business (at cost) and the provision of technical/administrative assistance to
the subsidiaries/branches, G1-A/S's business is, as explained, an investment
business investing in companies engaged in the exploration and extraction of
hydrocarbons.
The
expenditure side consists of the costs of investigating which companies
(geographical areas) to invest in. These costs are incurred in the own interest
of G1-A/S - and there are no group companies to pass on such costs. The income
side consists of dividends.
This in
itself is fully commercial and [...] G1-A/S [has] received over the years
substantial dividends far exceeding the operating and tax losses.
G1-A/S is
an investment company. In an investment business, the expenditure side consists
of the cost of investigating future investment opportunities and the income
side consists of dividends. This is, so to speak, the 'business' of an
investment firm.
It is
therefore necessary to look at the specific type of enterprise in order to
assess whether dividend income should be included in the operations for the
purposes of the TP.
This can be
illustrated by an example: a venture company incurs expenses for financial
analysis, competitive research, due diligence, etc. in order to identify
companies in which the venture company should invest. All these expenses are
incurred in the interest of the venture company itself - there is no one to
pass the bill on to. In particular, it would not be justified to send the
invoice to the company invested in. The incurring of these costs therefore
immediately results in a negative operating result for the venture company.
However, the expenses are incurred in the expectation that later dividends (or
profit on the sale of the shares) will exceed the expenses incurred.
It is
obvious that such an investment enterprise has a fully commercial set-up, even
if it is the dividends that economically justify the expenditure.
This is
primarily because this is how a venture company is actually run.
The
research costs incurred by the investment company are, as a rule, not
deductible as operating costs under Section 6(a) of the State Tax Act.
Reference can be made to the Supreme Court's judgment in U2012.647H [...]
concerning an investment company which specifically obtained a deduction for
the costs of managing the portfolio companies. The question in the case was
whether the costs of managing the portfolio companies were deductible when the majority
of the income was tax-free. The Supreme Court emphasised
that the company's income consisted of taxable and tax-exempt income and that
the expenses could be operating expenses "even though some of the disposal
proceeds are tax-exempt..." [...].
The
starting point would therefore be that the investment company would not incur a
tax loss because the costs of the investments were not deductible. There is
thus symmetry between the tax treatment of expenditure and income. The research
costs are not deductible and the profits are correspondingly tax-free.
However,
the oil business, where exploration costs are incurred, differs from this - and
this explains why G1-A/S realises a tax loss in an
otherwise profitable business.
This is
because G1-A/S - unlike a venture company in the example above - has a right to
deduct all exploratory expenditure. This follows from the special rule in
Section 8B(2) of the Tax Code [...], which allows an extended right of
deduction for this type of expenditure: 'In determining taxable income,
expenditure incurred in the search for raw materials in connection with the
taxpayer's business may be deducted'. The special rule is that if the
expenditure exceeds 30 % of the taxpayer's profits in the year in which it is
incurred, it must be written off over a number of years, unless the SKAT authorises a one-off deduction in the year in which it is
incurred. G1-A/S has been granted this authorisation,
see below.
This
provision of the Equalisation Act means that, unlike
the example above, a tax loss may be incurred in this case.
The tax
loss is not due to the fact that there is something wrong with either the
business set-up or the TP set-up of G1-A/S, but only to the fact that the
company treats the costs incurred in accordance with the special rule in
Section 8B(2) of the Tax Act.
G1-A/S's
tax treatment of the costs of preliminary studies has, as mentioned above, been
approved by the Ligningsrådet, which has consistently
allowed [...] G1-A/S to deduct these costs in full in the year in which they
were incurred, in accordance with Section 8B(2) of the Ligningswet.
In the example of such authorisation provided, the Ligningsrådet justified the authorisation,
inter alia, by [...]:
"...
that the exploration activity abroad must be regarded as a continuation of the
company's previous activities..."
The
conclusion is therefore that G1-A/S's business model concerning investment in
companies engaged in exploration and extraction of hydrocarbons is fully
commercial, approved by the tax authorities (Ligningsrådet)
and thus at arm's length. The costs incurred by the company for initial
feasibility studies are incurred in the company's own interest in order to find
the best investment opportunities and the income justifying the incurring of
these costs appears as dividends.
G1-A/S's
business model, which has remained unchanged since its inception,
notwithstanding changes in tax rules, has obviously not been driven by tax
considerations.
Until 1
January 2005, Danish corporate taxation was based on the global income
principle, which meant that a Danish company was taxable in Denmark on its
income, regardless of where in the world it originated. The global income
principle meant that the income of G1-A/S's subsidiaries was subject to Danish
taxation.
With effect
from 1 January 2005, the global income principle was abolished in favour of the territorial principle [...], according to
which Denmark taxes only what is done on Danish territory. Branches in Y1-land
and Y2-land were thus no longer subject to Danish taxation.
The fact
that SKAT has pointed out that G1-A/S has a tax loss, while the foreign
branches of its subsidiaries have profits which are taxed only abroad, is
therefore due solely to the change in Danish tax law and not to the fact that
G1-A/S has organised itself or its operations
accordingly.
In
conclusion, there is no basis to conclude that G1-A/S's business model is not
commercially (well) justified and not at arm's length. The tax loss has an
explanation in the Danish tax rules and the Ministry of Taxation has not only
demonstrated with the reference to this loss that the Danish company lacks an
income from intra-group transactions.
6.2.3
Transactions between G1-A/S and the subsidiaries (Y1-country and Y2-country)
Section 2
of the Ligningslovens provides for a correction of
the pricing of specific intra-group transactions and not a general power to
correct taxable income [...].
SKAT's
correction is largely based on alleged but non-existent intra-group
transactions. The only actual transactions that have taken place between G1-A/S
and the two subsidiaries in 2006-2008 are the ongoing technical and
administrative assistance (timewriting).
It is an
undocumented postulate based on a non-existent transaction that G1-A/S, by
virtue of the preliminary research prior to the establishment and acquisition
of the licences by the subsidiaries, provides
valuable know-how to the subsidiaries.
For the
same reason, it was necessary for the majority of the Lands Tax Court to
"statute" this transaction. Precisely in recognition of the fact that
no "economic transaction" actually existed on this basis between
these parties in 2006-2008, see below in detail.
However,
non-existent transactions cannot justify an adjustment under section 2 of the Equalisation Act, see also SKM2020.397.VLR (Ecco judgment
[...]). At most, it can be the actual transactions between the parties, i.e.
the ongoing technical/administrative assistance that G1-A/S has actually
provided to the subsidiaries/branches. However, there is no basis for correcting
these transactions, as they are provided under the same conditions as the
corresponding services provided to H2-A/S/G23, see also below.
6.2.3.1
Preliminary studies (phases 1 and 2) do not constitute know-how and do not
provide know-how to the subsidiaries
G1-A/S's
work on initial feasibility studies (phases 1 and 2) does not constitute an
intangible asset in the form of know-how, and no asset is made available to the
subsidiaries/branches through this or through the acquisition of an oil licence.
It is not
disputed that G1-A/S's initial feasibility studies and exploration are based on
a specific competence and thus have a value for G1-A/S. On the contrary, it is
contested that these are costs which, according to the arm's length principle,
can be allocated to other entities of the group.
The
expertise of G1-A/S's specialists does not represent proprietary knowledge or
the like, but their specialist competence and experience. This does not
constitute know-how or an intangible asset, nor is such an asset recorded on
G1-A/S's balance sheet.
The work
carried out during phases 1 and 2 is comparable to the due diligence carried
out prior to and as a basis for negotiating and carrying out an acquisition.
As
explained above in section 2.3.2.2, Phases 1 and 2 are preliminary feasibility
studies of a potential oil field, where G1-A/S investigates what oil projects
are in progress in the area concerned, reviews and analyses available
seismic/geological data - and it is agreed that the data base on which the
studies are carried out is 'shelf goods'. The preliminary studies will only
serve as a basis for a decision on whether to proceed with the project and to
enter into negotiations with the oil state for obtaining a licence.
The studies
are carried out by G1-A/S specialists and it is not disputed that they possess
considerable specialist competence. However, the analytical work is done on the
basis of experience/specialist knowledge, but not on the basis of specially
protected knowledge. This is no different from the case where a law or
consultancy firm has built up specific experience and competence in carrying
out due diligence/research/managing acquisition negotiations. Nor is this done
on the basis of proprietary knowledge or the like, and the competence possessed
by these firms - and their employees - does not constitute know-how made
available to the company or group which may be the subject of the subsequent
acquisition. Nor can the costs be claimed by anyone other than the company for
which and in whose interests the work is carried out.
It is and
remains the expense of the investor - in whose interest the expense is also
incurred.
The same
applies to the costs incurred by G1-A/S for the work in phases 1 and 2. This
work may lead to an oil licence, but neither the
initial work nor the oil licence itself represents
know-how or any other intangible asset in relation to the subsidiary
established in connection with the granting of the oil licence.
Moreover,
it is a fundamental misunderstanding for SKAT/Skatteministeriet
to assume that the licence is the very basis of the
revenue subsequently realised from oil production.
The oil licence does not in itself represent any
value at the time of issue, but merely confers a right - and an obligation - to
commence actual exploration and attempted extraction in Phase 3 and beyond.
In
addition, there is - undisputedly - no link between the initial exploratory
work carried out by G1-A/S in 2006-2008, which both SKAT and the Ministry of
Taxation have highlighted as part of their argumentation, and the oil
production in Y1-land and Y2-land.
It is a
fact that none of the local entities in Y1-country and Y2-country has benefited
in any way from the expenses (DKK 900 million) incurred by G1-A/S for
preliminary feasibility studies in other parts of the world during the income
years 2006-2008. Thus, the fact that G1-A/S has assessed new opportunities in
e.g. Y9-country and Y10-country in 2006-2008 has not created any value for the
entities in Y1-country and Y2-country in the same period. On the contrary,
these entities have incurred their own exploration and production costs during
these years.
It is even
a fact that the initial feasibility studies in Y1-land and Y2-land were carried
out before the subsidiaries came into existence in 1990 and 1992. For this
reason alone, it does not make sense to claim that this work (Phases 1 and 2)
constitutes an economic transaction between controlled parties within the
meaning of Section 2 of the Tax Act.
For the
same reason, the Landsskatterret had to construe
(declare) a controlled transaction in the income years in question [...]:
"It is
thus G1-A/S that owns the know-how used to establish whether oil and gas were
available for extraction at all. It is also G1-A/S which has negotiated and
concluded licensing agreements in the given country, so that the rights to the
extraction itself must be considered to be owned by G1-A/S and made available
to the branches."
[...]
However,
this construction/fiction is not supported by the facts and law. G1-A/S is not
and has never been the holder of the licence rights
and therefore does not make intangible assets in the form of these rights
available to the subsidiaries or their branches, nor has there been any
'transfer' of the licences, as the Ministry of
Taxation argued in Procedural Document A [...]. The Ministry of Taxation has
subsequently changed its position and has now followed the reasoning of the Tax
Tribunal.
The fact is
that the investigation work in phases 1 and 2 is carried out before the
subsidiaries are established and acquire the oil licences.
It is the
subsidiaries that have concluded the agreements with the oil states, acquired
the licences and are obliged under them, and it is
the subsidiaries that have carried out the work at their own expense and risk
from the time of the licence, i.e. from phase 3
onwards, see also SKAT's decision [...].
Even if it
were assumed that G1-A/S's work in phases 1 and 2, including the negotiations
with the oil states for the licences, is also
provided for the benefit of the subsidiaries, the fact remains that the work is
provided and completed at the latest at the time when the subsidiary obtains
the licence.
As stated
above, a second and separate question, which is simply not an issue in this
case, which concerns the 2006-2008 income years, is whether a controlled
transaction could exist at the time when a completed feasibility study for a
specific well field is made available to the subsidiary and the subsidiary
obtaining the license; i.e., for the entities in Y1-land and Y2-land in 1990
and 1992, respectively.
Nevertheless,
it is the Treasury's view that the TP rules provide a basis for fixing a
current income to G1-A/S for a service/work which, even if it were considered
to have been also provided for the benefit of the subsidiaries, predated the subsidiary's
obtaining of the licence and does not constitute
controlled transactions in the income years at issue.
This is
manifestly not in accordance with Article 2 of the Law, nor is it possible to
provide the necessary legal basis by constructing a justification divorced from
the fact that G1-A/S must then be regarded as the real owner of the licences made available on an ongoing basis to the
subsidiaries.
There is no
- objective - justification for the constructed increase in G1-A/S's income by
profits from Y1-land and Y2-land and the exploration and investigation costs
actually incurred in 2006-2008. SKAT's model, described in more detail below,
leads to the completely unacceptable result that the subsidiaries (Y1-land and
Y2-land) are required to pay for expenses that are not remotely connected to
these companies, pursuant to SKAT's and the Ministry of Taxation's
interpretation of the TP rules.
The
performance guarantees [...] given by G1-A/S to the oil states do not involve a
'financial transaction' in favour of the subsidiaries
either and cannot, any more than the preliminary investigation work, justify a
conclusion or assumption that know-how is thereby made available to the
subsidiaries.
There is no
'payment guarantee' in favour of the subsidiary. It
is a capitalisation commitment whereby the parent
company guarantees that the licensing subsidiary will have the necessary
resources to meet its obligations.
Such a
commitment or guarantee does not constitute a transaction between G1-A/S and
the subsidiary within the meaning of Section 2 of the Tax Act. A commitment by
a parent company to capitalise its subsidiary does
not constitute a transaction which can or must be priced in relation to the
subsidiary.
It is
common practice in the oil industry to require such guarantees and, as stated
above, the Danish State also requires them.
There is no
cost to G1-A/S for providing the guarantee, nor is there any saving to the
individual subsidiary from G1-A/S providing a performance guarantee. Unlike a
financial guarantee - to which the Treasury seems to compare it - the guarantee
cannot be purchased from a bank or an insurance company.
This does
not constitute an economic transaction within the meaning of Section 2 of the
Tax Act, nor is the performance guarantee, as claimed by the Treasury, evidence
that the licences are effectively owned by G1-A/S.
The
performance guarantee is in fact a framework condition for operating an
international oil business, given in G1-A/S's own interest in order to enable
investment and secure future returns.
However,
even if it were to be concluded that there is a performance, this may only
become relevant at the point in time when the parent company would deliver on
the commitment. The mere declaration of an intention to capitalise
does not therefore constitute a transaction between controlled parties, even in
the TP context.
The
Ministry of Taxation has therefore not demonstrated that the fact that G1-A/S
did not receive remuneration for these performance guarantees in 2006-2008 is
not in line with the arm's length principle.
6.2.3.2 The
actual services provided in the form of technical/administrative assistance (timewriting)
As stated
above, the only services provided by G1-A/S in 2006-2008 to subsidiaries
Y1-land and Y2-land and their branches are technical and administrative
assistance (timewriting). As described above, these
services are mentioned in the TP documentation for 2006-2008.
As
explained in the TP documentation [...] and as described above, G1-A/S provides
technical and administrative services to H2-A/S/G23 company and to its
subsidiaries.
G1-A/S's
services to H2-A/S/G23 are remunerated in accordance with industry practice
(described above in section 2.2.2) at cost. G1-A/S provides the corresponding
services to its subsidiaries under the same conditions, i.e. in accordance with
the industry practice and the conditions applicable to the services provided to
the G23 company.
However,
while SKAT agrees that the services to the G23 business are provided to
independent parties and thus on arm's length terms, this is not the case for
the corresponding services provided to the subsidiaries.
SKAT's
decision [...] justifies this as follows:
"SKAT
agrees that the transactions with G23-virksomhed are conducted on market terms,
as G23-virksomhed must be considered an independent party in this respect, as
the total ownership of the other parties in G23-virksomhed amounts to 61%, and
these parties conduct annual audits of the costs invoiced from G1-A/S to
G23-virksomhed.
SKAT,
however, does not agree that there is a CUP concerning the G23-enterprise
cooperation. SKAT therefore does not consider the transactions to be
comparable, as the terms are not the same. For the G23 business, G1-A/S is
guaranteed a market profit through the agreed operator fee, which is not the
case for the work for the foreign branches of the G1-A/S subsidiaries.
Thus, no
independent party would agree to perform the time-writing tasks for the
subsidiaries without receiving a market profit for doing so.
The fact
that the subsidiaries may have agreed in their joint venture agreements with
independent parties that costs can only be included in the joint venture accounts
at cost does not alter the fact that a profit should be made between G1-A/S and
the subsidiaries' branches. The subsidiaries have to bear an additional cost
because they cannot themselves provide the specialist service to which they
have committed themselves as operators.
SKAT's
reasoning and its premise are wrong. G1-A/S does not receive any profit on its
supplies to the G23 company, not even through the 'operator fee', see above
(section 2.2.3). As documented, G1-A/S's services to G23 and H2-A/S are in all
respects settled on the basis of industry practice, i.e. at cost prices without
profit. The operator fee, as documented, is a reimbursement of G1-A/S's
indirect costs, which are also without profit element.
SKAT's view
that the intra-group transaction must be settled with a profit, irrespective of
the fact that the external - corresponding - transaction is settled without
profit, is not in line with the arm's length principle in Section 2 of the Equalisation Act.
In
addition, during the preparation of the case, the Ministry of Taxation rejected
the comparability of the services provided to the G23 company/H2-A/S on the
following grounds [...]:
"It
may be customary in the oil industry for the participants in a joint venture,
including the operator, to provide services at cost price, since money is not
to be earned on the services but on the oil production itself. This is just not
relevant to the situation of G1-A/S. After all, G1-A/S is not a participant in
a joint venture and G1-A/S - unlike the participants - has no prospect of
sharing in the potential revenues from oil production.
Nor does it
appear from Annex 32 that it is industry practice for a company which is not a
participant in a joint venture and which does not share in the potential oil
revenues to work for free for the companies in the joint venture.
[...]
It goes
without saying that an independent company will not work for free in order for
other companies to make money."
The
Treasury's reasoning is remarkable. The Treasury's reasoning for an operator to
agree to pay for its services without profit in accordance with custom is that,
as a participant, it derives an income from the oil revenues.
According
to the Ministry of Taxation, the crucial difference between G1-A/S's services
to the G23 company and its subsidiaries is thus that, in relation to the G23
company, it earns money on its services through oil revenues. G1-A/S does not
do so in relation to its subsidiaries (dividends).
However,
G1-A/S is not an economic participant in the joint venture either in relation
to the G23 company or in relation to Y1-land or Y2-land, and G1-A/S does not
benefit from the oil revenues either in the G23 company or in relation to the
subsidiaries.
There are
simply no relevant differences, including tax differences, between the
assistance provided by G1-A/S as operator to the G23 business and as provider
of technical/administrative assistance to the subsidiaries/branches in
Y1-country and Y2-country.
The only
difference is that G1-A/S does not even receive returns in the form of
dividends as G1-A/S does from the subsidiaries. Compared to the G23 company,
G1-A/S neither receives a share of the oil revenues in the form of a share of
the operating revenues nor a return in the form of dividends, but only recovers
its costs. Nevertheless, this is considered by SKAT and the Ministry of
Taxation to be at arm's length.
If the
Ministry of Taxation agrees that the industry code applies in relation to G23
companies and that G1-A/S's services to G23/H2-A/S are at arm's length, this
must also apply in relation to G1-A/S's corresponding services to branches of
its subsidiaries. Otherwise is simply not possible under Article 2 of the Tax
Act.
On this
basis, the Ministry of Taxation's burden of proving that there are grounds for
correcting the agreed pricing must be regarded as increased. The Ministry of
Taxation has not discharged that burden of proof.
***
In summary,
it is submitted that the Ministry of Taxation has not demonstrated that G1-A/S
provided know-how to the subsidiaries in 2006-2008 in addition to that provided
in the form of ongoing technical/administrative assistance. The Ministry of
Taxation has not demonstrated that this assistance is paid for in breach of the
arm's length principle.
If the
Court were to find that G1-A/S's TP documentation had been deficient and that
the conditions for a discretionary assessment had been met in principle, it
would be argued, in the light of the above, that G1-A/S had demonstrated that
there were no grounds for an adjustment to G1-A/S's income.
6.3 The alternative claim
In the
event that the Regional Court finds that there was no arm's length dealing
between G1-A/S and the subsidiaries (Y1-land and Y2-land) in 2006-2008 and that
a basis for an adjustment has been established, it is submitted that SKAT's
assessment cannot be upheld in any event.
If so, a TP
adjustment in accordance with Article 2 of the Equalisation
Act and the TPG must be based on a pricing of the actual identified intra-group
transactions, see also above, between G1-A/S and the subsidiaries (Y1-country
and Y2-country). However, such an adjustment must necessarily also include the
intra-group transactions between G1-A/S and H2-A/S, which could not be upheld
as being at arm's length if the corresponding transactions between G1-A/S and
the subsidiaries (Y1-country and Y2-country) are considered to be in breach of
the arm's length principle, see further below.
6.3.1 SKAT's estimation
method and estimation cannot be upheld
SKAT's
methodology rests on an incorrect basis and is not based on the transactions
provided to the group companies for tax purposes. Specifically, the
subsidiaries with branches in Y1 country and Y2 country.
SKAT's
approach is to increase the income of G1-A/S so that the profit rate of the
company is equal to the profit rate of the group companies that realise profits from the alleged use of the company's
intangible assets (know-how). The profit rate is defined as the profit (before
financial items but after tax) as a percentage of turnover.
G1-A/S
should thus earn - proportionally - the same as its best-performing
subsidiaries/foreign branches.
After
reviewing and excluding a number of loss-making group companies and branches,
SKAT concludes that only the branches in Y2-country and Y1-country should pay
for the use of G1-A/S's claimed know-how.
SKAT then
calculates the profit rate of each of the two branches. SKAT then uses the
profit rates calculated by SKAT for calculation purposes to find out what
G1-A/S's turnover with each of the two branches would have been if these profit
rates were also to be realised for G1-A/S.
This
notional turnover is then compared with the part of the booked turnover of
G1-A/S which is attributed to the two branches, and the difference in each
income year then constitutes the income increase for that year. This method
then leads to an income increase for the period 2006-2016 of approximately DKK
7.6 billion for Y2 country and of approximately DKK 2.5 billion for Y1 country,
in total approximately DKK 10.1 billion.
However,
SKAT's calculations are not based on the actual services provided to the two
branches.
Instead,
the total book costs and turnover of G1-A/S are allocated between the two
selected branches on the basis of a key figure, which is the branch's share of
the total external oil turnover of the producing entities.
The costs
and turnover attributed to each branch for the purpose of calculating G1-A/S's
new turnover (and hence the additional turnover constituting the SKAT increase)
are thus fictitious figures which have nothing whatsoever to do with reality.
For example,
the increase in G1-A/S's income in relation to the branch in Y2-country would
have been exactly the same if G1-A/S had not provided any services to this
branch at all and thus had not incurred any costs in relation to the branch.
The
services actually provided to each branch are thus - according to the SKAT
method - of no relevance to the amount of the increases resulting from the SKAT
method.
For this
reason alone, the method leads to a completely arbitrary and, moreover,
manifestly unreasonable result.
6.3.2 G1-A/S's objections to
SKAT's method of regulation
SKAT's
methodology suffers from several fundamental flaws, each of which leads to the
methodology and estimate being set aside.
6.3.2.1
None of the local entities benefited from the costs incurred by G1-A/S in
2006-2008 for preliminary investigations
SKAT's
methodology is - according to SKAT itself - based on the crucial assumption
that the local units have exploited G1-A/S's intangible assets (know-how).
In simple
terms, the approach is that the local units should not only pay G1-A/S's costs,
including first and foremost the costs of preliminary studies, but that there
should be an overpayment such that G1-A/S obtains the same level of profit as
the branches.
Thus, in
SKAT's methodology, G1-A/S's costs for initial feasibility studies are a proxy
for G1-A/S's intangible assets, even though these are not reflected in G1-A/S's
accounts.
As emphasised several times above, it is a fact that none of
the local entities in Y1-country and Y2-country has benefited in any way from
the expenses incurred by G1-A/S for preliminary feasibility studies in other
parts of the world during the 2006-2008 income years. Thus, the fact that
G1-A/S analysed potential new opportunities in, for
example, Y9-country and Y10-country in 2006-2008 has not created any value for
the entities in Y2-country and Y1-country in the same period.
It would
therefore be clearly contrary to the arm's length principle if G1-A/S's
subsidiaries were to pay for G1-A/S's investigations into its own future
business opportunities elsewhere in the world.
It follows
that SKAT's basic assumption that the local entities have exploited G1-A/S's
intangible assets (represented by G1-A/S's costs for initial feasibility
studies) is wrong.
SKAT's
methodology even has the - absurd and arbitrary - consequence that the more
costs G1-A/S incurs for preliminary investigations around the world, which are
completely unrelated to the oil business in Y2-land and Y1-land, the more
Y2-land and Y1-land have to pay. And conversely, the more G1-A/S slows down and
fails to seek new business opportunities, the less Y2-land and Y1-land will
pay.
G1-A/S's
costs for preliminary investigations thus say nothing whatsoever about the
exploitation of G1-A/S's claimed know-how by its subsidiaries. What it does use
are the services actually provided to the branches. Any TP regulation must
therefore - in accordance with G1-A/S's alternative claim - be based on the
identified, actually carried out transactions, as further explained below.
For this
reason alone, SKAT's approach must be rejected.
6.3.2.2 The
profit rate of the local units is not a relevant benchmark for G1-A/S's profit
rate
G1-A/S also
argues that it makes no sense to compare G1-A/S's profit margin with that of
the local units. It is like comparing apples and oranges.
When
carrying out comparability analyses, it is a basic assumption that the entities
being compared are identical in terms of functions performed, risks assumed and
assets employed. Where differences exist, it must be possible to make
adjustments with reasonable accuracy to offset the economic effect of those
differences.
However,
G1-A/S is not comparable to the local entities on any of these parameters.
G1-A/S is
the operator of the G23 business on behalf of H2-A/S and the provider of
technical and administrative assistance to the local units, and in this respect
it recovers its costs.
In
addition, G1-A/S searches for potential new oil fields around the world and, in
this context, bears the costs of preliminary feasibility studies (phase 1-2),
see above section 2.3.2.2.
By
contrast, the subsidiaries and their branches are involved in all post-licence activities, i.e. exploration, appraisal,
development, production and decommissioning (phases 3 to 8), see above sections
2.3.2.3 and 2.3.2.4.
G1-A/S and
its subsidiaries/branches thus operate at different stages of the value chain.
The
activity in phases 3 to 8 involves economic risks, costs and investments that
far exceed the costs incurred by G1-A/S in the initial phases 1 and 2. [...]
G1-A/S [incurred] in 2006-2008 costs for initial feasibility studies of just
over DKK 0,9 billion, while the subsidiaries with their branches incurred costs
totalling DKK 39,5 billion in the same period.
The
differences are so large that it is not possible to make the adjustments
required to offset the economic impact of these differences. On this basis
alone, it makes no sense to compare the profit rate generated by G1-A/S with
the profit rate generated by the local units.
The profit
rate of the local units is therefore not at all a relevant benchmark for the
profit rate of G1-A/S.
6.3.2.3
SKAT's methodology is an expression of irrational "cherry picking"
SKAT
assumes that all local units - both those still in the exploration phase and
those producing (and thus profitable) - benefit from G1-A/S's intangible
assets.
Nevertheless,
the method chosen by SKAT is to compare the profit rate of G1-A/S only with the
profit rate of those units which realise profits.
These are therefore the entities which have succeeded in finding oil and which
have already incurred all the significant costs of exploration, appraisal and
setting up production facilities and which have therefore now achieved a profit
at stage 6 of the value chain.
It goes
without saying that this choice of methodology is wrong and unfair, since the
profitability of the producing/profitable entities does not approximate the
average risk of operating in the oil business.
6.3.2.4 It
is wrong and inappropriate for H2-A/S not to be included in the SKAT regulation
The most
significant manifestation of SKAT's cherry picking is that SKAT has failed to
include H2-A/S in the TP regulation itself, even though H2-A/S is covered by
SKAT's methodology.
As
explained above, SKAT's reasons for not including H2-A/S are wrong.
If the
industry standard is disregarded as a basis for pricing G1-A/S's services to
its subsidiaries, this must necessarily also apply to G1-A/S's corresponding
services to H2-A/S/G23, as further explained below in section 6.3.2.7.
6.3.2.5
SKAT's method leads to completely arbitrary results
As
mentioned above, SKAT's regulatory methodology has the arbitrary consequence
that the more costs G1-A/S incurs for preliminary investigations around the
world, which are completely unrelated to the oil business in Y2-country and
Y1-country, the more Y2-country and Y1-country have to pay. And conversely, the
more G1-A/S slows down and fails to seek new business opportunities, the less
Y2-land and Y1-land will pay.
It also
leads to arbitrary results when the methodology does not take into account at
all the actual draw that each local entity has had on G1-A/S's services, but
instead allocates G1-A/S's costs and turnover on the basis of an allocation key
based on the external turnover of the local entities. This has nothing to do
with reality.
In the
2006-2008 financial years, Y2-land received approximately DKK 70 million in
services and Y1-land approximately DKK 40 million, as explained above.
Similarly, G1-A/S has provided technical and administrative services (in the
form of operator services) to H2-A/S - corresponding to the services provided
to Y2-land and Y1-land - for more than DKK 1,1 billion in the same period.
[...]. Yet, according to SKAT, only Y2-land and Y1-land have to pay for the
alleged know-how.
Finally, it
should be mentioned that SKAT's method leads to G1-A/S receiving not only the
same - but a higher - level of profit than the branches in Y2-land and Y1-land.
This is because SKAT has not been aware that their own TP regulation itself
leads to lower profit rates for branches.
For these
reasons, it is a fact that SKAT's methodology rests on a wrong basis, leading
to clearly arbitrary and wrong results.
6.3.2.6
SKAT's method leads to a manifestly unreasonable result
It follows
from the shortcomings of SKAT's methodology already discussed that it also
leads to a manifestly unreasonable result.
It may
further be mentioned that SKAT's method leads to G1-A/S being taxed for the
income years 2006-2008 on a total amount of DKK 1,3 billion relating to the
branches in Y2-land and Y1-land, which is 16 times higher than the amount of
DKK 82,7 million that SKAT itself considers to be an appropriate arm's length
remuneration to G1-A/S for being the operator of G23 business during the same
period.
However,
G1-A/S's operator services to the G23 company are far more extensive than the
services provided by G1-A/S to Y2-land and Y1-land, which themselves bear their
own operator costs.
Any
increase vis-à-vis Y2-land and Y1-land for the income years 2006-2008 should
therefore only be a fraction of the DKK 82,7 million.
The fact
that the upper limit for G1-A/S's preliminary investigation costs for Y2-land
and Y1-land is DKK 128,5 million, as explained above, must also be taken into
account.
Even if it
were to be assumed that G1-A/S incurred initial feasibility studies for Y2-land
and Y1-land amounting to DKK 128,5 million and made the completed feasibility
studies available in 1990/1992 to the newly established companies which
acquired the licence for the respective fields, see
section 2.3.3, it would be out of all proportion and reasonableness to tax
G1-A/S on an amount of DKK 10 billion for the period 2006-2016 on this basis.
For these
reasons, too, the method must be rejected and SKAT's discretion thus set aside.
6.3.2.7 A
TP regulation must be based on the services actually provided and include the
services provided to H2-A/S
As stated
above, a TP-regulation must - in accordance with Article 2 of the Equalisation Act and the TPG - be based on a pricing of the
actual transactions.
Such an
adjustment can only include the actual transactions that have taken place
between G1-A/S and the group companies during the income years at issue in the
case.
Therefore,
there would be no basis for a pricing of the performance guarantees or the
preliminary investigations because there are no transactions between G1-A/S and
the subsidiaries. These are costs incurred in the own interest of G1-A/S which,
under Article 2 of the Equalisation Law, cannot
justify a price assessment. And G1-A/S has - undisputedly - not incurred
expenses for preliminary studies concerning Y1-land and Y2-land during the
income years in question.
However, if
the Court were to find that G1-A/S was not entitled to provide
technical/administrative assistance to the group companies at cost price, a
mark-up must be applied to the services provided by G1-A/S of this nature. In
this case, the mark-up may appropriately be set at 5 %, as proposed by the
minority in the Tax Tribunal and in the Skatteankestyrelsen's
prior recommendation to the Tax Tribunal [...].
However, a
correction would necessarily also have to include G1-A/S's services to H2-A/S.
This was also the conclusion reached by the Tax Agency and the minority in the
Tax Court.
As
explained above, since 1981 G1-A/S has performed the task of operator of the
G23 business on behalf of H2-A/S, without G1-A/S having received any profit
therefrom. These services and the other services provided by G1-A/S to H2-A/S
have been invoiced at cost on the basis of industry practice.
The same
practice has been applied in relation to G1-A/S's other group companies.
Therefore, if the Regional Court were to find that G1-A/S's services to the
subsidiaries cannot be provided at cost price, this would amount to a breach of
the industry standard. This infringement must also apply in relation to
H2-A/S/G23's business.
In that
case, an adjustment would also have to be made to G1-A/S's remuneration for the
services provided to H2-A/S/G23 in 2006-2008.
As far as
the operator services are concerned, this means that H2-A/S will have to
purchase its proportional share of the operator services, i.e. 39 % of the
operator services corresponding to H2-A/S's share of the G23 business, with a
mark-up of 5 %.
In its
decision [...], SKAT has rejected the inclusion of the transactions between
G1-A/S and H2-A/S/G23 business in an adjustment. In SKAT's view, this is
justified by two factors which distinguish the relationship from that of G1-A/S
with its subsidiaries.
First, SKAT
claims that when G1-A/S sold its share of the G23 business to the two shipping
companies in 1981, it received arm's length compensation for the sale of any
intangible assets [...].
This is
incorrect. It follows from the transfer agreement [...] that the shipping
companies paid DKK 93,7 million corresponding to the book value of the assets
minus the liabilities. No know-how or similar intangible assets were
transferred. The transfer agreement was submitted to the State Tax Directorate,
which approved the tax valuation of the transferred assets [...].
Secondly,
SKAT claims that G1-A/S received a 'market remuneration via the operator fee'
[...]. As stated above, this is not a correct assumption either. The operator's
fee constitutes only a compensation of G1-A/S's indirect costs.
Thus, none
of the justifications for excluding H2-A/S from regulation are tenable.
***
Therefore,
TP regulation would have to involve pricing of actual identified intra-group
transactions between G1-A/S and G1-A/S' subsidiaries, and also between G1-A/S and
H2-A/S.
A
regulation on this basis would imply that the mark-up applied is set aside and
replaced by a mark-up based on a pricing of the actual transactions, as
outlined above. In relation to the fixing of an arm's length remuneration on
the services between G1-A/S and H2-A/S, the counterpart would be that H2-A/S's
income (hydrocarbon tax income) should be reduced by a corresponding deduction.
G1-A/S and
H2-A/S filed a specific amount claim in Procedural Document I, covering
respectively the increase of G1-A/S's income and the reduction of H2-A/S's
income. The amounts claimed are detailed in statements prepared by the
companies [...].
However,
the numerical determination of this pricing has not been subject to an
assessment by the tax authorities. Consequently, G1-A/S and H2-A/S have
abandoned the specific amount claim (formerly the subsidiary claim) and have
instead each made a subsidiary claim for repatriation (formerly the more
subsidiary claim, now the subsidiary claim).
In
substance, the subsidiary claim concerns the same situation as the previous
amount-specific claim and thus the determination of an increase of G1-A/S's
income by a mark-up profit on the services actually provided to G1-A/S's
subsidiaries (Y1-land and Y2-land) as well as H2-A/S, and a corresponding
reduction of H2-A/S's hydrocarbon tax income.
7. "New issue" and the
Ministry of Taxation's plea of inadmissibility
The
Ministry of Taxation has claimed that the part of the claim concerning an
increase in relation to H2-A/S and a corresponding reduction in H2-A/S's
hydrocarbon income should be dismissed on the grounds that it constitutes a
'new issue' within the meaning of Section 48 of the Tax Administration Act
[...].
It is the
view of the Ministry of Taxation that the case only concerns whether G1-A/S has
acted at arm's length with its subsidiaries/branches (Y1-land and Y2-land), and
not G1-A/S's trade with H2-A/S. It is stated
'Neither
the SKAT nor the Tax Tribunal increases concern the trade between G1-A/S and
H2-A/S.'
It is
correct that neither SKAT's increase nor the Tax Tribunal's confirmation of it
concern the trade between G1-A/S and H2-A/S. However, this is not decisive for
the question to be raised in the proceedings.
What is
decisive, pursuant to Article 48(1) of the Tax Administration Act, is whether
there is a 'new question'. If it is a new issue, it may be raised in the
proceedings with the leave of the court if it has a clear connection with the
issue which gave rise to the proceedings and it is considered excusable that
the issue has not been raised before or there is reason to believe that a
refusal of leave would result in a disproportionate loss of justice for the
party.
However,
the subsidiary claim - the adjustment against H2-A/S and a corresponding
reduction in H2-A/S's (hydrocarbon tax) income - is not a 'new issue'. This
issue has been part of the administrative proceedings since the beginning of
the case. The fact that SKAT in its decision maintained that there should be no
increase in relation to G1-A/S's services to H2-A/S, concerning the operator
role in G23's business, which was settled according to the industry custom
without profit, and that the Tax Tribunal (the majority) in the decision failed
to take an explicit position on this issue, does not mean that there is thus a
'new issue' within the meaning of the Tax Administration Act.
Section
48(1) of the Tax Administration Act is a continuation of the provision in
Section 31(1)(2) of the current Tax Administration Act. The commentary on this
provision [...] states that 'there are no special restrictions on the
submission of new claims and pleas in respect of matters which have been
included in the administrative appeal procedure [...].
The
decisive factor is therefore not whether the Landsskatteret
has expressly ruled on the question, but whether the question has been included
in the administrative appeal procedure. Thus, to the extent that the Tax
Tribunal chooses not to rule on a given issue, this does not mean that the
issue has not been raised - in the same way as if a decision of the Tax
Tribunal is justified by a 'because', after which other claims and pleas that
may have been raised become superfluous. In such a situation, the taxpayer is
not prevented from repeating these claims/arguments in a later court case.
There is no
doubt that the issue of this correction has already been part of the case
during the administrative appeal procedure. Reference can also be made to the
submissions before the Tax Tribunal [...]. The fact that the Tax Tribunal has
chosen in its decision to limit its decision to the branches of G1-A/S (Y1-land
and Y2-land) does not change this fact.
In the view
of G1-A/S and H2-A/S, the fact that there cannot be a 'new question' follows
directly from the fact that, in its proposal for a decision [...], the Tax
Agency took as a basis and recommended to the Tax Tribunal that there should be
such a regulation. It further follows that the minority of the Landsskattert [...] based its finding on such a regulation.
It must
therefore be clear that this is not a 'new question' and that the alternative
claim - which also includes this regulation - can be heard without leave of the
court, pursuant to Section 48(1) of the Tax Administration Act.
If the
Ministry of Taxes is making such great efforts to avoid the issue being brought
into the proceedings, the reasons must presumably be sought in the following
statements in the Ministry of Taxes' Procedural Document B [...]: "The
only reason why the dealings between G1-A/S and H2-A/S are being brought into
the proceedings is that G1-A/S is making a subsidiary claim in this respect,
which in isolation involves an increase in G1-A/S's income for the purpose of
obtaining a deduction from H2-A/S's hydrocarbon tax income. " [...].
The 'sore
toe' for the Ministry of Taxation is that the deductible value of the deduction
from the hydrocarbon tax income exceeds the value of the increase and that the
consequence of such a TP regulation would thus be detrimental to the State
overall.
This must
be assumed to be the real reason why SKAT and the Ministry of Taxation have left
out the question of what - seen in the light of SKAT's and the Ministry of
Taxation's reasoning in the case in general - would have been the natural
consequence.
If the
Regional Court were to find that - despite the circumstances and the course of
the case - there is a new question, it is argued on the same basis that all the
conditions in Article 48(1) of the Tax Administration Act are met for allowing
the question to be withdrawn. It is a question which forms a direct and
integral part of the basis on which the case otherwise rests.
***
The
Ministry of Taxation has also objected to the reduction being allowed, since
the conditions for reassessment of H2-A/S's income for the tax years in
question are not met.
This is
contested.
The
consequence of increasing G1-A/S's income by a profit on G1-A/S's services to
H2-A/S/G23 company would be, as a direct consequence, that H2-A/S's hydrocarbon
taxable income would have to be reduced by a corresponding amount. This
additional cost must be treated for tax purposes in the same way as the
consideration already paid by H2-A/S to G1-A/S for the services relating to the
G23 business - and deducted from its hydrocarbon taxable income for the income
years at issue in the case.
If it is
considered that H2-A/S has underpaid for the services provided by G1-A/S to
H2-A/S/G23 business and G1-A/S' income is increased on that basis, there should
be no dispute as to the substantive merits of a corresponding deduction.
Formally,
the change in H2-A/S's hydrocarbon taxable income would be a direct consequence
of the change (increase) in G1-A/S's income, cf. Section 27(1)(2) of the Tax
Administration Act [...].
Prior to
the decision of the Tax Court, H2-A/S formally requested a reopening of the
case in order to interrupt the time limits in the event that a decision was
taken on an increase in G1-A/S's income which would entitle H2-A/S to a
corresponding deduction (and not merely a derivative correction of the joint
tax income) [...].
The
Ministry of Taxation's objection that the reaction period under Section 27(2)
of the Tax Administration Act [...] has been exceeded is also contested. The
reaction period would in that case only run from the time when the change of
employment is made in relation to G1-A/S. This will only occur with the judgment
of the Regional Court in the case, see also SKM2018.2013 H [...].
***
In summary,
it is thus submitted in support of the alternative claim that if the Regional
Court finds that the Ministry of Taxation has demonstrated that there is a
basis for a TP regulation, this must necessarily be based on a pricing of the
actual identified intra-group transactions. These are only the services of
G1-A/S (technical and administrative assistance/timewriting),
which G1-A/S has provided at cost price.
An arm's
length profit, if any, must be determined as a mark-up of 5%, as held by the
minority in the Tax Tribunal, but which includes not only G1-A/S's services to
the subsidiaries (Y1-land and Y2-land), but also H2-A/S with a corresponding
reduction in H2-A/S's hydrocarbon income. The industry practice cannot be
overruled merely in relation to the subsidiaries. It would not be in line with
the arm's length principle.
The
numerical calculation of the increase or decrease must therefore be referred
back to the Tax Administration."
In support
of its claims, the Ministry of Taxation has essentially proceeded in accordance
with its statement of objections, which states, inter alia:
"Related
parties must, in determining their taxable income, apply prices and conditions for
their intra-group transactions that are equivalent to the prices and conditions
that independent parties would set for similar transactions, in accordance with
the arm's length principle in Section 2(1) of the Equalisation
Act [...].
Prices and
conditions between related parties cannot simply be taken as a basis, cf. UfR 1998.1299H [...], and Section 2 of the Equalisation Act [...] therefore provides for a correction
option for the tax authorities, so that the controlled transactions can be
brought to arm's length.
As stated,
for the 2006-2008 tax years, SKAT adjusted the transfer prices between G1-A/S
and G1-A/S's subsidiaries and their foreign establishments in Y2-country and
Y1-country. The adjustment is made because the internal trade is not at arm's
length. For some of the internal transactions no price at all is fixed.
Three main
arguments lead in the present case to the conclusion that SKAT was entitled
(and obliged) to estimate the income from the controlled transactions on a
discretionary basis.
First,
there was no arm's length relationship between G1-A/S and its subsidiaries and
their permanent establishments within the meaning of Section 2 of the Equalisation Act [...]. Independent parties would not
accept such terms with certain losses and no profit on large transactions as in
the situation of G1-A/S. It is G1-A/S which performs the functions essential to
the generation of income, owns the essential intangible assets and provides the
expertise on an ongoing basis for the performance of the licence
agreement, with no prospect of ever making a profit, the income being generated
entirely by the subsidiaries.
Second, the
TP documentation of G1-A/S is missing for some of the controlled transactions
and missing for others to such an extent that it does not provide a sufficient
basis for the tax authorities to assess whether the arm's length principle is
respected, cf. For several of the transactions, it is true that these are
completely unmentioned in the TP documentation. In the case of the transactions
mentioned, it is clear from the description of the non-profit character alone
that the transactions are not on market terms, since the services are
remunerated at cost price.
Thirdly,
G1-A/S has not discharged the burden of proof incumbent on it to show that
there is a basis for setting aside the estimates of the Tax Tribunal or SKAT,
which are identical in amount. G1-A/S has not proved that the estimate was made
on the wrong basis or that it is manifestly wrong. The estimate is even lenient
towards G1-A/S.
G1-A/S's
taxable income must therefore be increased in accordance with the Tax Court's
decision because payment would have been made between independent parties for
the services provided by G1-A/S to its subsidiaries' foreign permanent
establishments within the meaning of Section 2 of the Equalisation
Act [...].
The
arguments are set out below in sections 3.1.1, 3.1.2 and 3.2.
In
addition, G1-A/S and H2-A/S have submitted an alternative claim for referral
back to the Tax Agency for reconsideration. The companies' subsidiary claim for
referral back is relevant only in the event that the Ministry of Taxation is
unsuccessful in its main claim.
The
companies submit that the taxable income for the years 2006-2008 should instead
be remitted and increased by a substantially smaller amount in respect of the
time-writing services between G1-A/S and H2-A/S, which have not been subject to
review by the Tax Tribunal, and that the issues are therefore in the nature of
new issues requiring leave of the court on withdrawal under Section 48 of the
Tax Administration Act [...], and there are no grounds for granting such leave.
No
objection is made to G1-A/S's alternative claim for referral back and H2-A/S's
alternative claim 1, since G1-A/S submits that the discretion of SKAT/Tax
Tribunal may be overruled, the consequence of which would be referral back.
As regards
the alternative claim, second indent, made by H2-A/S, concerning the
determination of the company's income subject to hydrocarbon tax, it is
requested that the claim be dismissed, since neither the SKAT nor the Landsskatten have dealt with the company's hydrocarbon tax
and the issue cannot therefore, as a rule, be raised in the course of the
proceedings, in accordance with Section 48 of the Tax Administration Act [...].
Furthermore,
there is no legal basis for granting extraordinary review under Article
27(1)(2) of the Tax Administration Act, since the changes in the tax
assessments of the two companies as a result of the merger are not a direct
consequence of the changes in assessment in the present case. Nor has the
six-month time limit laid down in Article 27(2) of the Tax Administration Act
been complied with
This is
described in more detail below in section 4.
3.1 Discretion
There are
two independent reasons and grounds for SKAT (and the National Tax Court) to
have been entitled (and obliged) to estimate the controlled transactions on a
discretionary basis, cf. on the one hand that there has been no action at arm's
length (section 3.1.1), and on the other hand that the documentation obligation
in section 3 B. of the Tax Control Act has not been fulfilled by G1-A/S
(section 3.1.2).
3.1.1
G1-A/S has not acted on market terms with its subsidiaries
The OECD
Transfer Pricing Guidelines for Multinational Enterprises and Tax
Administrations, hereinafter referred to as the TPG, are used to determine what
constitutes arm's length conditions under Section 2 of the Tax Act [...]. This
has been established in the legislative grounds for Section 2 of the Danish Equalisation Act [...] and by the Supreme Court in
UfR2021.3179 H [...].
This
implies a fundamental principle that each entity in a group should be treated
as an independent entity for tax purposes in the context of price and rate
determination, see for example TPG 2017, point 1.6 [...]:
"By
seeking to adjust profits by reference to the conditions which would have
obtained between independent enterprises in comparable transactions and
comparable circumstances (i.e. in "comparable uncontrolled transactions"),
the arm's length principle follows the approach of treating the members of an
MNE group as operating as separate entities rather than as inseparable parts of
a single unified business." [...]
Basically,
G1-A/S does not comply with the "separate entities" principle. G1-A/S
does not set prices and conditions on the basis of what independents would have
done, but on the basis of what is in the best interest of the group. This is
precisely what the TP rules aim to curb.
As an
example of G1-A/S's 'groupthink' [...] [G1-A/S states]:
"Thus,
if a subsidiary/branch comes close to breaching an agreement, G1-A/S will step
in, with the sole aim of safeguarding the group's reputation and thus
protecting its own interests as the owner of the company in question. G1-A/S,
as owner, has coinciding interests with the local company/branch in increasing
the likelihood of economically advantageous oil production." [...]
It is clear
- and acknowledged by G1-A/S - that it is acting in the best interests of the
group and not in the best interests of G1-A/S as 'a separate entity'.
The
Treasury does not dispute the business rationale for G1-A/S to provide security
for the obligations of its subsidiaries and to step in if a subsidiary is in
breach of contract. However, Article 2 of the Tax Act [...] entails that G1-A/S
must be remunerated for providing, for example, performance guarantees. An
independent company would not gratuitously provide a guarantee for the
obligations of another company, and that is what matters.
Similarly,
G1-A/S's basic view applies in relation to the preliminary investigative work
carried out by G1-A/S. In this respect, G1-A/S states [...]:
"These
exploration costs amount to substantial sums, but the revenues from the fields
where relevant oil and gas deposits are found are, in turn, usually of such a
magnitude as to cover the costs of the substantial exploration
activities."
Exploration
costs are indeed recovered on a group basis, namely in the subsidiaries, but it
is precisely not in the company which bears the costs. G1-A/S is loss-making
because the exploration costs are not covered by this company.
G1-A/S has
been running large tax losses for a number of years. Thus, since 1991, the
company has only made a profit before interest in one year (2011 with a profit
of DKK 11 million), whereas the G1-A/S group has realised
substantial profits, cf. SKAT's decision, section 2.2.1 [...].
The chronic
losses of G1-A/S show in themselves that the remuneration of the company has
not been at arm's length. It is strongly presumed that an independent company
with large and persistent losses would continue to operate on unchanged terms
over a 25-year period, see inter alia SKM.2020.105Ø [...]. The business set-up
of G1-A/S also means that the company would not make money in the future
either.
As stated
in the OECD Transfer Pricing Guidelines (2017), para.
1.129-1.131
[...], the persistent losses are a clear indication that something is wrong
with the company's earnings and that the losses may be due to three factors: 1)
the company has too low transfer prices; 2) the company performs functions for
other group companies without being remunerated for it; or 3) there are quite
exceptional circumstances in markets that require that an independent third
party would similarly continue operations. In the present case, factors 1 and 2
apply.
TPG 2017,
para 1.129 [...] states, inter alia:
"an
independent enterprise would not be prepared to tolerate losses that continue
indefinitely. An independent enterprise that experiences recurring losses will
eventually cease to undertake business on such terms. In contrast, an
associated enterprise that realizes losses may remain in business if the
business is beneficial to the MNE group as a whole."
From point
1.130 [...] it appears inter alia:
"The
loss enterprise may not be receiving adequate compensation from the MNE group
of which it is a part in relation to the benefits derived from its
activities."
Similarly,
TPG 2010, point 1.70 f. [...] and TPG 1995, point 1.52 f. [...].
Furthermore,
German tax law has adopted a "restrictive practice according to which
losses for a period of more than three years create a rebuttable presumption
that the arm's length principle has not been observed", see Jens Wittendorff: Transfer Pricing, 2018 Karnov
Group, 2nd edition, Chapter 11, point 11.6, last paragraph [...].
Independent
parties would not accept such terms in G1-A/S's situation. In particular, not
when it is G1-A/S that performs the functions essential to the generation of
income (exploration work, ongoing technical advice, etc.), assumes the risks
(in relation to performance and loan guarantees, etc.) and owns the essential
intangible assets (in particular, know-how relating to exploration, bidding for
and negotiating oil licences and the production of
oil).
The
know-how of G1-A/S is described, inter alia, in the publication 'The G3
Business - under attack' [...].
JN, former
Group CEO of H2-A/S, states [...]:
"Originating
in the dense calcareous clay of the Y3 area, G3 Company developed its expertise
in production from difficult fields in mid-depth water, which brought the
company to Y2 country." [...].
LJ, former
senior vice president of G3, states [...]:
"After
an unsuccessful attempt to get a field in Y7 country, we discovered that a
field in Y2 country's part of Y8 area was to be contracted out to pre-qualified
international companies. One of them was the Y11-country company G22-company.
They had most of the data, we had the technical knowledge. In the summer of
1990 we met in Y13 town and I became more and more excited the more I learned,
because I could see that the field in Y2-land was even better and even more
promising than the limestone fields of Y3-area," LJ says. This was despite
the fact that G17-A/S had already produced an eight-volume study of technical
geological studies of the so-called Y12-area field, which said on the very last
page: 'This field cannot be exploited'. [...]
G1-A/S was
thus able - on the basis of its experience and technical know-how - to foresee
the potential of the very oil field which G17-A/S had concluded was not
exploitable. The project in Y2-land is described [...] as one of the group's
'golden eggs' and the most profitable of all the group's oil projects.
The fact
that G1-A/S could foresee the potential of the oil field was due in particular
to G1-A/S's special know-how in relation to horizontal drilling in the subsoil,
see NL, Head of Exploration [...]:
"The
Y2 countries had decided that a bidding round should be held for the world's
largest gas field, located in the Y8 area close to the border with Iran. In the
strata above the gas field, G17-A/S had made an oil discovery some years
earlier, but they were unable to get production going. Their test wells showed
a potential of a paltry 200300 barrels a day, too little to make it worthwhile.
Internationally, however, the G3 company was at the time clearly "a
technological lead dog in the drilling of horizontal wells," as NL puts
it." [...]
The basic
story is the same for the 15 different employees of the group [...]. It is
G1-A/S that is unique and has the technical know-how that is crucial to the
group. This is particularly mentioned in relation to Y2-land, which is also the
company's biggest success.
It is
important to note that G1-A/S does not merely realise
temporary losses in a start-up or transitional phase. G1-A/S realises large and permanent (chronic) losses and has no
prospect of ever realising profits, see accordingly
also SKAT's decision [...] and the Tax Tribunal's decision [...].
G1-A/S
argues [...] that the business model is not driven by tax considerations. Even
if this were true, which has not been proven, it is not a relevant objection. A
transfer pricing regulation is not conditional on the internal prices and
conditions being driven by tax considerations. The only relevant factor is
whether the internal prices and conditions correspond to what independent
parties would have agreed, and they do not do so in the present case.
Furthermore,
the fact that G1-A/S realises an overall profit when
the (tax-free) dividends received are taken into account is irrelevant in the
transfer pricing context. Dividend payments are received by G1-A/S as owner and
do not constitute payment for goods or services. Dividend payments are returns
on capital investments and thus not business income, cf. also the Joint Opinion
of the Tax Tribunal [...]. Independent parties would pay/receive remuneration
for services rendered, and this is how the entities in the G1-A/S group must
also act, cf. § 2 of the Tax Act [...].
G1-A/S's
view that G1-A/S is a 'venture company' which naturally invests in companies
and whose income consists of dividends [...] is therefore not tenable. Nor has
G1-A/S provided any examples of independent companies which perform services
for others free of charge and pass on the profits to others.
A more
obvious comparison is with the invention of new medicines by pharmaceutical
companies, which similarly go through different stages. If a foreign parent
company owning a Danish subsidiary claims that it does not have to pay for the
first stages of research as they become larger in subsequent years, this would
not be a venture investment. In our case, G1-A/S not only bears the costs of
the first phases of exploration, but also provides guarantees to the affiliated
companies that have been granted the oil licence and
provides ongoing expert assistance.
________________________________
The Tax
Tribunal (the majority), referring to TPG 2010, para.
1.65 [...],
that:
"The
company's operating results and the placement of functions and risks within the
group are not considered to be in accordance with a commercially rational
course of action, as mentioned above, and SKAT was therefore entitled to
declare a controlled transaction" [...].
The
Ministry of Taxation does not agree that SKAT has 'declared' transactions. The
transactions have been there all along. SKAT has merely established the
transactions. There is therefore no situation in which SKAT has disregarded the
structure established by the group, as TPG 2010, para.
1.65 [...].
This was done by the Supreme Court in the Jysk case UfR 2000.393 H [...], where the majority of the Supreme
Court chose to disregard a contributed sales company.
As
described above, G1-A/S has indeed provided a number of services to the controlled
subsidiaries and their foreign establishments. The services consist, inter
alia, of the following:
1. Phase 1
and 2 investigations
2.
performance guarantees to oil countries
3. Guarantees to banks and other financial
institutions
4. Ongoing expertise
5. Administrative tasks and
6. Operational tasks
The
services provided by G1-A/S have in common that G1-A/S know-how is made
available to the subsidiaries.
G1-A/S
submits that the services provided by G1-A/S in the form of exploration
activities and performance guarantees do not constitute intra-group services
provided by G1-A/S to the subsidiaries, since the services are provided in the
company's own interest [...]. This is not correct.
It is the
subsidiaries and their permanent establishments which derive a commercial
advantage from the work carried out by G1-A/S. For this reason alone, it is an
intra-group service.
There is an
intra-group benefit for transfer pricing purposes if the recipient obtains an
'economic or commercial value to enhance or maintain its business position' as
a result of the supplier's efforts, see TPG 2017, point 7.6 [...]:
"Under
the arm's length principle, the question whether an intragroup service has been
rendered when an activity is performed for one or more group members by another
group member should depend on whether the activity provides a respective group
member with economic or commercial value to enhance or maintain its business
position. This can be determined by considering whether an independent
enterprise in comparable circumstances would have been willing to pay for the
activity if performed for it by an independent enterprise or would have
performed the activity in house for itself. If the activity is not one for
which the independent enterprise would have been willing to pay or perform for
itself, the activity ordinarily should not be considered as an intra-group
service under the arm's length principle." [...]
Similarly,
TPG 2010, pt. 7.6 [...] and TPG 1995, pt. 7.6 [...].
Whether the
recipient (the subsidiary) has obtained such value is thus determined by
whether, leaving aside the activity of the supplier (G1-A/S), the recipient
would either have carried out the activity itself or would have paid a third
party to carry it out.
There is no
doubt that, if G1-A/S had not carried out the investigation work, the subsidiaries
would either have purchased the services from a third party or would have
carried out the investigation work in-house if the subsidiaries had the skills
to do so. The exploration work is a prerequisite for the further development of
the oil project and thus also for the existence and profitability of the
subsidiaries.
It is
therefore clear that G1-A/S's work in exploring for new oil fields constitutes
a service to the subsidiaries, etc., which actually benefit from the services
in the form of profits from oil production.
The same
applies to the other intra-group services. The licensor even requires G1-A/S to
provide performance guarantees covering all risks of oil exploration and
obliges G1-A/S to provide the necessary technology and specialists [...].
The
services provided by G1-A/S to the subsidiaries and their permanent
establishments as well as the non-market remuneration are described in detail
in sections 3.1.1.1-3.1.1.3.
3.1.1.1
Lack of remuneration for G1-A/S's initial investigation work in phases 1 and 2
G1-A/S has
provided services to the subsidiaries in the form of the initial exploration
work necessary for the subsidiaries to produce and sell oil.
In
2006-2008, G1-A/S has incurred just over DKK 900 million in preliminary
exploration [...], and has previously incurred expenses for the preliminary
exploration work in relation to Y2-land and Y1-land.
With the
established set-up, G1-A/S has no prospect of ever recovering these costs.
G1-A/S will receive neither remuneration for the service itself nor a share of
the subsequent potential oil revenues. Nor does G1-A/S receive payment for the
actual insertion of the local entity in the oil licence
obtained. Therefore, G1-A/S realises chronic losses,
as also described in the previous paragraph.
It is clear
that no independent company would undertake services without receiving
remuneration for them and without sharing in the profits derived from the
potential oil production. It must even be assumed that, in similar
circumstances, an independent party would charge even very high fees, since it
is G1-A/S which possesses the decisive know-how in the group.
In other
words, it is G1-A/S's services and know-how which form the basis of the whole
group's activities and thus also of the subsidiaries and their foreign
operators' earnings.
When G1-A/S
invokes Section 8B of the Equalisation Law [...] on
expenditure incurred for experimental and research activities in connection
with the taxpayer's occupation as a basis for deducting the expenditure
deducted by G1-A/S and links it to the company's business view [...], this is a
post-rationalisation. The fact that G1-A/S has used
Section 8B of the Equalisation Act as a basis for
deduction is rather an expression of the fact that G1-A/S's business is
research. Since business is about making money, G1-A/S must of course be paid
for its work in accordance with the Landsskatterret's
decision.
The fact is
that G1-A/S has placed the oil licences in its
subsidiaries. It is clear that G1-A/S should have had either a high payment for
the licence when the subsidiaries became licence holders or a share of the future revenues to cover
the exploration costs.
It is
undisputed that G1-A/S did not receive payment for the placement of the licence with subsidiaries and their foreign entities, and
therefore G1-A/S should now receive payment in line with the turnover of its
operations. This corresponds to the reasoning of the Landsskattert,
according to which G1-A/S should receive a share of the turnover of the
branches [...].
The oil licence is placed in the subsidiaries, which are newly
created companies at the time of the conclusion of the licence
agreement. The foreign entities will also cease to exist upon completion of the
project. The subsidiaries are thus initially 'empty', which shows that it is
G1-A/S which possesses the decisive know-how, experience and expertise from the
outset in relation to the potential of the oil field for the negotiation and
subsequent exploitation of the licences. In other
words, G1-A/S is the sustaining force in the group.
Once it has
been established that a service has been provided, the supplier must of course
receive arm's length compensation for it. G1-A/S provides services to its
subsidiaries in connection with investigative work, thereby conferring on them
an advantage which they would otherwise have had to obtain from a third party.
G1-A/S may
confuse the dividend payments with the paragraphs of the TPG dealing with the
concept of benefits in relation to shareholder activities, see TPG 2017, points
7.9 and 7.10 [...].
These
points imply that there is no internal service in the transfer pricing sense if
(1) the supplier (G1-A/S) has undertaken the activity solely as a result of its
ownership of the recipient (the subsidiaries) and (2) the recipient has no need
for the activity and would not be willing to pay for it if the recipient had
been independent.
In Wittendorf, Transfer Pricing, 2016, p. 287,
"shareholder activities" are described as follows [...]:
"Shareholder
activities are characterized by being performed by or on behalf of a parent
company solely because of its status as a shareholder in the subsidiaries, in
that they do not confer utility on the subsidiaries."
In the
present situation, there is no doubt that if the subsidiaries had been independent,
they would still have needed the investigation and would therefore have either
carried out the work themselves - if they had the skills to do so - or
purchased the investigation work from a third party. In other words, the
investigative activities carried out by G1-A/S provided the subsidiaries with a
benefit for which an independent party would have paid.
Since
G1-A/S thus provides a service of value and incurs significant costs in doing
so, it is clear that G1-A/S should be remunerated. An independent company would
not work for free and incur non-profit costs without any prospect of profit,
within the meaning of Section 2 of the Equalisation
Act [...]. 3.1.1.2 G1-A/S assumes guarantee obligations without being
remunerated
When
G1-A/S, on the basis of its exploration work and negotiations with the oil
State concerned, etc., obtains the right to a licence,
the licence is placed in a foreign group entity.
In order
for the oil State to allow the licence to be placed
in the foreign entity, the State requires G1-A/S to assume all the obligations
of the subsidiary [...].
As stated
in G1-A/S's annual report for 2006 [...], note 12, the subsidiary obligations
for which G1-A/S is liable may involve 'significant amounts'. At the same point
in the annual report, it is stated that G1-A/S guarantees the loans of its
subsidiaries.
These
guarantees are provided by G1-A/S free of charge.
It is clear
that an independent company would not guarantee the obligations of other
companies without charging a fee. There is no commercial rationale for taking
on a risk when there is no possibility of profit, as provided for in Article 2
of the Equalisation Law.
It is
equally clear that an independent company would not be able to obtain free
'insurance' in the same way as G1-A/S's subsidiaries do. An independent
(insurance) company would have demanded remuneration for the deposit based on an
assessment of the associated risk, etc.
Indeed, it
appears from the audit notes to G1-A/S's annual report that G1-A/S has in the
past prepaid a premium in connection with an insurance policy relating to
political risk in Y2-land [...], just as Rederiaktieselskaber
have guaranteed the subsidiaries' drawings on a loan facility for which the
subsidiaries paid a premium of DKK 1 888 000 in 1999 and DKK 1 559 000 in 1998
[...]. This shows that G1-A/S should be remunerated accordingly for the
performance guarantees provided.
It is
irrelevant that G1-A/S states that these guarantees do not cost G1-A/S anything
[...]. The provision of a guarantee for another never does so in itself. What
is relevant is that the guarantor assumes a risk which is assumed free of charge
only in a community of interests. Independents will of course have to pay for
this.
It is wrong
for G1-A/S to claim in the same paragraph that the guarantees 'in fact' do not
'extend... G1-A/S's risk because G1-A/S would not be able to let a subsidiary
default on its obligations anyway'. When countries and lenders require this
kind of guarantee and do not simply rely on the oil companies involved to meet
the obligations of subsidiaries, this is obviously for business reasons and
because of the risk of non-payment of the subsidiaries' obligations. Moreover,
there is a difference between a legal obligation such as a guarantee and an
independent commercial choice between the cost to the group of allowing a group
company to default on its obligations versus the cost of meeting the group
company's obligations.
It is also
noted that this performance guarantee, together with G1-A/S's obligation to
make all technology and specialists available to the oil country, is a
requirement for the oil country to accept that it is not G1-A/S that is the
licensee [...].
It is
therefore clear that G1-A/S does not receive any income for the guarantees
provided, within the meaning of Section 2 of the Equalisation
Act [...].
3.1.1.3
G1-A/S provides ongoing expertise and administrative services (timewriting) without profit
G1-A/S
provides ongoing expertise to its subsidiaries and their permanent
establishments. It is undisputed that G1-A/S does not make any profit from the
ongoing consultancy services [...], where it is stated that the services are
provided at cost price.
It is
clearly not a commercial activity to provide its services at cost price. It is
therefore clearly not selling at arm's length prices to sell its services at
cost prices.
It can be
assumed that the technical consultancy services provided by G1-A/S have an
essential value for the subsidiaries. It is G1-A/S which possesses the
technical know-how in relation to all stages of an oil project [...].
By
contrast, it is the subsidiaries, which were newly established at the time of
the acquisition of the oil licence, without existing
know-how, which derive the benefit. In some cases, there are not even any
employees in the foreign entities, as is the case for the branch in Y1 country.
The nature
and extent of the specific services provided depends in particular on whether
the foreign entity is an operator in the oil consortium concerned and on
whether the entity has its own employees.
As regards
the technical services provided by G1-A/S to the foreign entities which are operators,
G1-A/S [...] states that the services consist of the analysis of seismic,
geological and geophysical data, environmental analysis, assistance in the
execution of exploration wells, ensuring the safety of local employees and the
monitoring and maintenance of both wells and the production equipment used.
These services are therefore quite central to oil exploration.
If the
foreign entity is not an operator but a passive investor in the oil field
concerned (this is the case, for example, of the branch in Y1 country, where
there are no employees), the time-keeping consists mainly of attending meetings
with the operator, checking that the contract is being complied with by the
operator and checking that the branch is complying with local rules (oil state
legislation, etc.) [...].
In
addition, G1-A/S continuously develops new technologies on behalf of its
subsidiaries in the context of optimising production
and developing solutions adapted to the individual oil fields, see inter alia
the publication 'G3 Business - below the surface' [...], which describes the
know-how of G1-A/S.
[...] ST,
former CEO of G1-A/S, [refers to] G1-A/S's horizontal well technology as
'state-of-the-art'. Furthermore, ST states [...]:
"We
are good at using our specialist knowledge to go in where the big guys might
have given up because they were making discoveries they thought were too small
to develop. The trick is to go in where value can be created, and hopefully our
experience in the Y3 area can teach us something here. After all, you can in
principle go into the value chain from exploration of a completely new area to
a very mature field, and we are doing that. (...)
Basically,
of course, it's about being better than the others at finding oil, and that's
where we've shown that we've been able to crack the code in both Y3 area and Y2
country. These fields are an important part of our corporate culture, our brand
if you like. There have been issues that looked pretty hopeless at first and
where others backed down (...). So an important part of the G3 story is that we
have shown the ability to step in where others have given up" [...]
[...] ST
[describes] G1-A/S as a "distinctly knowledge-based company".
[...] MA,
Head of Group Public Affairs, H2-A/S [states]:
"With
the introduction of new methods and technologies in mining, the mood in the G3
company changed to the more optimistic. Through the recruitment and training of
its own technicians, the company matured and by the 1990s had specialised to the point where it had an edge over its
competitors in specific technological areas which made G3 a leader in the
extraction from the dense limestone layer in the Y3 area." [...].
Thus,
according to the group's own employees, G1-A/S's experience and technical
know-how are crucial for the actual exploitation of the oil fields.
It is clear
that G1-A/S's technical services to the foreign entities are crucial for the
creation of value. This is true both when the subsidiary is the operator and
when it is not.
G1-A/S
points out that it is customary in the oil industry for the participants in a
joint venture, including the operator, to provide services at cost, i.e.
without profit [...]. In the same place, G1-A/S states that it is customary in
the oil industry for services, including technical services, to be provided
between group companies at cost price. G1-A/S's view is not correct.
The fact
that it may be customary in the oil industry for the participants in a joint
venture, including the operator, to provide services at cost price, where money
is to be made not on the services but on the oil production itself, is not
relevant to G1-A/S's situation. After all, G1-A/S is not a participant in a
joint venture and, unlike the participants, G1-A/S has no prospect of sharing
in the potential revenues from oil production.
Nor does
the letter from (ed. information 9 removed) to the OECD [...] indicate that it
is industry practice that a company which is not a participant in a joint
venture and which does not receive a share of the potential oil revenues should
work on a non-profit basis for the companies in the joint venture.
On the
contrary, it appears that the cost settlement only applies to the participants
in the joint venture [...]:
"In
the O&G sector, it is common that the operator's contributions are valued
on an "at cost" basis, without a profit from undertaking the
activities. This is contractually laid down between the unrelated JV parties.
[...]
The JV
partners, all of whom share in the JV costs and benefits, exercise the
operator's contributions within this governance framework through, amongst
others, budget approval, monitoring and auditing rights." [...]
Similarly,
G1-A/S's own TP documentation states [...]:
"According
to oil sector standards, it is trade custom to render time writing services at
cost between independent joint venture parties." [...]
Also
according to the TP documentation, the trade custom in question covers only the
participants in the joint venture, i.e. the companies which receive a share of
the profits from the oil sales.
It is noted
that the oil industry was in any case a high profit industry where the
significant risks of starting exploration have to be offset by very high
profits when the project succeeds.
It goes
without saying that an independent company will not work on a non-profit basis
in order for other companies to make money.
Overall, it
can therefore be assumed that an independent, like G1-A/S, providing costly
technical services that are essential for value creation, would charge a (high)
price. The fact that G1-A/S has provided the services at cost price is
therefore in breach of Article 2 of the Equalisation
Act.
The same
applies to the administrative services provided by G1-A/S.
3.1.2
Failure to comply with the documentation obligation in Section 3 B of the Tax
Control Act
The fact
that the company's TP documentation is partly missing and partly inadequate
leads to the SKAT being entitled to exercise an estimate of the income of
G1-A/S in respect of the controlled transactions, cf. the current Tax Control
Act, Section 3 B, paragraph 5, cf. paragraph 8 [...], cf. Section 5, paragraph
3 [...].
It follows
from the first paragraph of Section 3B(5) of the Tax Control Act that G1-A/S
was required to draw up and keep written records of how prices and conditions
were determined for the controlled transactions. The TP documentation must,
according to the second paragraph of the provision [...], be of such a nature
that it can form the basis for an assessment of whether prices and conditions
have been determined in accordance with what could have been obtained if the
transactions had been concluded between independent parties.
G1-A/S's TP
documentation is missing for some of the transactions checked and suffers from
a number of serious deficiencies for other transactions checked, which means
that SKAT could not assess from the documentation whether prices and conditions
were set in accordance with the arm's length principle. SKAT was therefore
entitled to value the verified transactions on a discretionary basis, see
U.2019.1446H [...].
There are
two very central flaws in G1-A/S's TP documentation:
First,
G1-A/S's services in the form of initial investigation work and ongoing
guarantee work are not mentioned at all in the TP documentation [...].
TP
documentation is directed at the individual transactions checked. The
requirement for TP documentation must therefore be fulfilled for each and every
controlled transaction, unless it is insignificant, in which case the type must
be indicated, cf. the Documentation Order, § 3 [...]. Obviously, in
multi-billion dollar oil projects, the transactions are not insignificant, nor
are they specified.
When the
individual controlled transaction is not mentioned in the TP documentation, a
TP documentation has obviously not been prepared for the specific controlled
transaction not dealt with. Then SKAT is entitled to exercise discretion as to
whether the internal controlled prices are at arm's length, see above on the
current Tax Control Act § 3 B paragraph 5, cf. paragraph 8 [...], cf. § 5
paragraph 3 [...].
In all
cases, the TP documentation must be considered so deficient that it must be
equated with the absence of a TP documentation, cf. UfR
2019.1446H [...], UfR 2020.3156H [...] and UfR 2021.3179H [...].
The
services provided by G1-A/S, as referred to above in section 3.1.1, are
services that must be described in the TP documentation. This is already the
case because the subsidiaries benefited from them in a tangible manner during
the years in question. The initial exploration work is a prerequisite for the
further development of the oil project and hence the oil extraction in the
income years concerned. The subsidiaries and their permanent establishments
have also benefited in practice from the performance guarantees required of the
oil-producing countries until the end of the project [...].
In the
opinion of the management of G1-A/S, the activities associated with the
international exploration and production of oil are subject to significant
risks [...]. Whether or not G1-A/S has incurred actual costs in connection with
the performance guarantees, G1-A/S has provided a guarantee for the
subsidiaries' obligations which must be described - and paid for.
It also
follows from G1-A/S's annual reports and the corresponding audit reports that,
through the performance guarantees, G1-A/S guarantees the subsidiaries'
obligations, which both vary over time and may involve substantial amounts
[...].
[...]
G1-A/S has incurred expenditure of DKK 350 million. "350 million 'to meet
the parent company's potential liabilities to this company [G15-A/S] and the
group's other international exploration activities'.
Secondly,
the TP documentation does not contain a useful comparative analysis identifying
specific independent transactions in respect of the technical and
administrative assistance services (timewriting)
provided by G1-A/S. Where it is not possible to identify independent reference
transactions which are without significant differences compared to the
provision of the timewriting services by G1-A/S, the
CUP methodology is not an applicable methodology and the pricing cannot
therefore be relied upon, see TPG 2017, point 2.15 [...].
Failure to
carry out a comparability analysis is a serious deficiency which in itself
leads to SKAT being entitled to estimate the remuneration for the technical and
administrative services, see e.g. UfR 2021.3179H
[...]. The Supreme Court found that the company's TP documentation was
deficient to such a significant extent that it did not provide the tax
authorities with a sufficient basis for assessing whether the arm's length
principle had been complied with.
The Supreme
Court stated [...] that:
"The
Supreme Court finds that the TP documentation prepared by TPH for the tax years
2005-2009 does not contain a comparability analysis, and the indication of what
constitutes a reasonable profit margin for the sales companies thus rests
solely on TPH's own discretionary assessment. Thus, there is no comparability
analysis in the TP documentation of what profit margin a sales company could
achieve in similar transactions between independent parties'.
TPG 2010,
point 1.6 [...] further states:
"Such
an analysis of the controlled and uncontrolled transactions, which is referred
to as a "comparability analysis", is at the heart of the application
of the arm's length principle."
Timewriting
services provided to subsidiaries are referred to in the TP documentation [...]
for the years in question. It appears that the services are provided at cost
and thus without a profit element. The remuneration is based on the CUP method.
G1-A/S refers to the prices and conditions of the independent parties to the
G23 joint venture [...] and states that these are internal CUPs.
G1-A/S
carries out the operation of the G23 business on behalf of its parent company
H2-A/S, whose share in the G23 business is 39 %. G1-A/S has therefore not
performed a matching analysis identifying independent transactions performed
under comparable conditions. When there are several investors in the same
project bearing the risk and reward, it is not unnatural that only the actual
costs are recovered from the investors. On the other hand, it does not make
sense for others who are not part of the project to provide non-profit services
when the project partners - if doing well - are earning very well. It should be
noted that G1-A/S is not an investor in G23 either.
Furthermore,
G1-A/S has not identified transactions where an independent company, which does
not share in the potential revenues from oil production, provides non-profit
technical and administrative services. The G23 joint venture is therefore not a
suitable CUP.
On this
basis, SKAT (and Tax Tribunal) has been entitled to assess the controlled
transactions on a discretionary basis, in accordance with the current Tax
Control Act § 3 B, paragraph 5, cf. paragraph 8 [...], cf. § 5, paragraph 3
[...].
3.2 SKAT's discretion cannot
be overruled
As a result
of the above findings, SKAT has made an estimated increase in G1-A/S's taxable
income for the 2006-2008 tax years.
According
to settled case law, tax estimates can only be set aside if the taxpayer proves
either that the estimate was made on an incorrect or defective basis, or if the
estimate is manifestly unreasonable, cf. the general description of the right
of review in UfR 2016.191H [...]. That the same
applies in transfer pricing cases such as the present one is clear from UfR 2021.3179 H [...].
The burden
of proof is heightened due to the complete coincidence of interests between
G1-A/S and the subsidiaries, cf. inter alia UfR
2007.2379H [...]. The burden of proof is further increased by the very
exceptional circumstances invoked by G1-A/S, including the fact that it is
market practice to realise chronic deficits and to
incur expenses without any prospect of profit.
This burden
of proof has not been met by G1-A/S. On the contrary, SKAT's discretionary
mark-up is based on a lenient estimate, see further below under section 3.2.2.
In this
case, as in most other tax cases, it is the decision of the Tax Tribunal that
is under review, see UfR2001.2379H [...]. The Tax Tribunal's (majority)
reasoning for the discretion itself is that the increases over the period
2006-2008 correspond to a royalty rate of approximately 1.7% of the turnover of
the permanent establishments and that such a royalty rate is considered to be
in line with the arm's length principle [...].
G1-A/S has
not discharged its burden of proving that the Tax Tribunal's (or SKAT's)
discretion can be overruled.
G1-A/S
submits that the Tax Tribunal's assessment rests on an erroneous basis, since
'the majority of the Tax Tribunal took as its basis that G1-A/S makes available
to its subsidiaries an intangible asset in the form of licences
and that this is the reason for including royalty income... However, it is a
fact that G1-A/S never obtains the licence rights
and, for the same reason, G1-A/S does not make a licence
available to the subsidiaries or transfer the licences
to the subsidiaries' [...].
From the
reasoning of the Tax Tribunal (majority) [...], the following appears:
"The
branches in Y1-land and Y2-land have used intangible assets which must be
considered to be owned by G1-A/S. These intangible assets can be characterised
as know-how and oil exploration rights in the form of licences.
It is considered that between independent parties a consideration would have
been paid for the use of this type of intangible assets in the form of
royalties or similar. In this respect, it is considered that the branches are
established in the context of obtaining licences in
the given country and therefore the branches cannot be considered to have built
up such intangible assets themselves. G1-A/S has incurred all costs for
exploration and studies of possibilities for obtaining mining licences. It is thus G1-A/S which owns the know-how used to
establish whether oil and gas for extraction existed at all. It is also
Y21-city that has negotiated and concluded licensing agreements in the given
country, therefore the rights to the extraction itself must be considered to be
owned by Y21-city, and made available to the branches."
The Tax
Court found that it was in fact G1-A/S that acquired the rights to the licences, which G1-A/S (together with its other expertise
and know-how) made available to the foreign branches. However, the Tax Tribunal
did not assume that the licences were formally held
by G1-A/S.
As the Tax
Tribunal also points out, it was G1-A/S that provided the entire basis for
obtaining the licences. First, in investigating
whether the oil field had commercial potential, then in bidding for a licence and subsequently negotiating the terms of the licence and then supplying the technology and specialists
necessary for the oil exploration. The group companies, which, moreover, were
only set up when the licence agreements in question
were concluded, could not obtain the rights to the licences
on their own.
This is
also reflected in the performance guarantees given to Y2-land [...]:
"Whereas
the State of Y2-land (the ''Government") conducted with G1-A/S (the
"Patent") all preliminary negotiations leading up to the execution of
the EPSA with the Subsidiary [G25-A/S]; and
Whereas the
Parent [G1-A/S] desires that all of the rights and obligations under the EPSA
be the rights and obligations of the
Subsidiary;
and
Whereas the
Government does not object to the Subsidiary [G25-A/S] enjoying the rights and
assuming the obligations under the EPSA provided that such obligations are
guaranteed by the Parent [G1-A/S]." [...].
The Tax
Tribunal's reasoning is therefore correctly based.
3.2.1
G1-A/S has not proved that SKAT's discretion was exercised on an erroneous
basis or was manifestly unreasonable
Only if
G1-A/S were to bear the burden of proving that the Tax Tribunal's discretion
can be overruled does one "fall back" on SKAT's decision, cf. UfR 2001.2349H [...].
Moreover,
G1-A/S has not discharged the burden of proving that SKAT's discretion can be
overruled, nor has G1-A/S provided a better basis for its discretion.
SKAT's
estimate basically states that G1-A/S's profit should (at least) correspond to
the profit rate of the profitable subsidiaries, whose profit is (inter alia) a
result of the services provided by G1-A/S. The subsidiaries and their permanent
establishments in Y2-land and Y1-land had a combined profit rate of 35,1 %
(2006), 24,3 % (2007) and 24,1 % (2008) respectively, see Annex 4 to SKAT's
decision [...].
This is
particularly lenient in that G1-A/S, which owns all the intangible assets
essential for oil exploration and production, only needs to have the same
profit rate as the permanent establishments. As the owner of the essential
know-how, G1-A/S should earn substantially more than the permanent
establishments within the meaning of Section 2 of the Equalisation
Law [...].
SKAT's
increase in G1-A/S's income is allocated to the transactions with the permanent
establishments in Y2-land and Y1-land as follows [...]:
DKK 1,000 2008 2007 2006 Branch of G25-A/S
409,744 282,328 261,952 Branch of G15-A/S 58,441 45,235 244,279 Total increase:
468,185 327,562 506,431
The
increases represented only very small proportions of the after-tax results of
the Y2-land and Y1-land companies [...]. The results can be broken down as
follows (increase/pre-tax result x 100 %):
Y2 country
2006:
261.952.000/2.717.821.000 x 100 % = 9,63%
2007:
282.328.000/5.127.776.000 x 100 % = 5,50%
2008: 409.744.000/8.220.243.000
x 100 % = 4,98%
Y1-country
2006:
244.479.000/2.181.535.000 x 100 % = 11,20%
2007: 45.235.000/583.496.000
x 100 % = 7,75%
2008:
58.441.000/1.145.104.000 x 100 % = 5,10%
Furthermore,
the estimate is lenient, as SKAT has based its estimate on the subsidiaries'
profit after tax. SKAT has thus included in the estimate the local oil tax paid
to Y2-country and Y1-country as a cost. SKAT did not need to do this when the
tax (oil tax) in Y2-land and Y1-land is profit-dependent and thus without risk
for the two local establishments.
G1-A/S's
objection to the estimate made, namely that the subsidiaries did not derive any
concrete benefit from the preliminary exploration costs incurred by G1-A/S (more
than DKK 900 million) in the years in question, 2006-2008, is irrelevant to the
estimate. G1-A/S has in the past incurred significant exploration costs in
relation to Y2-land and Y1-land. If G1-A/S acted as an independent, it would
seek to recover all costs, including unsuccessful ones, from the revenues
actually obtained subsequently.
The
relationship can be viewed in the following way:
When G1-A/S
set up the establishments in Y2-land and Y1-land, G1-A/S should have
conditioned itself on a payment. An independent would not have given away the
oil licence and thus the revenue potential. At the
time of obtaining the oil licence it was uncertain
whether profitable oil production would ever take place, it is obvious that an
independent would have conditioned himself on a percentage of the potential
future profits. This percentage should of course be (at least) equivalent to
G1-A/S covering its current - and future - costs of initial exploration etc.
It seems
natural that, in a company like G1-A/S, payment should not be made all at once,
but that the company should wait and see how the investment goes and then
receive payment in line with the turnover of its operations. The revenue
potential of the sites has been created solely as a result of the services provided
by G1-A/S and, since G1-A/S has never left the cooperation, G1-A/S remains part
of the investment and must receive payment for the services provided.
G1-A/S
further submits that the entities in Y2-land and Y1-land are not a relevant
benchmark for G1-A/S's profitability as they and G1-A/S have different
functions, assets and risks [...]. G1-A/S also criticises
the fact that SKAT's estimate only includes the profitable establishments
[...].
In this
respect, it is noted that SKAT's estimate reflects a calculation model which
implies that G1-A/S should not earn less than (any of) the permanent
establishments. This is in line with the fact that G1-A/S has much more
value-creating functions and assets etc. SKAT's estimate does not reflect that
G1-A/S has comparable functions etc. to the permanent establishments.
Nor does
the Ministry of Taxation dispute that the assets, functions, etc. of G1-A/S are
different from those of its subsidiaries. On the contrary, it is G1-A/S which
performs all the essential functions of preliminary studies and ongoing
technical assistance in connection with oil production (timewriting).
If G1-A/S
did not undertake these functions, the subsidiaries would have neither access
to oil fields nor knowledge of how to pump oil from the subsoil. In addition,
it is noted that the foreign entity in Y1-land has no employees. In other
words, without the functions and assets of G1-A/S, the subsidiaries could not
exist at all, let alone make money.
In making
its assessment, SKAT disregarded the oil-producing units in (ed. information 1
removed), as there is insignificant oil production in these countries.
Furthermore, SKAT disregarded the UK oil producing entities, as these entities realised overall tax losses. There is no deficiency or
error of assessment when SKAT did not include the loss-making establishments,
see, inter alia, OECD Transfer Pricing Guidelines 2017, para 3.65 [...], which
highlights that when comparing loss-making transactions, further investigation
is required to determine whether it may be a comparative circumstance.
SKAT's
estimate is therefore made on a correct basis.
G1-A/S has
had operating losses of DKK 270 million and DKK 270 million respectively in the
financial years 2006-2008. (2006), DKK 212 million (2007) and DKK 302 million
(2006). (2008) [...]. A total deficit of just under DKK 800 million. The SKAT
increase offsets this deficit and adds ½ billion in profits (for 3 years).
In the same
period, the group's operating profit on the oil fields in Y2-land and Y1-land
is DKK 57-58 billion. [...]. The profits of the whole G1-A/S group in the years
2006-2008 are DKK 9,6 billion, DKK 14 billion and DKK 26,8 billion
respectively. [...]. This gives a total operating profit of approximately DKK
50 billion.
SKAT thus
places 1 % of the profits in G1-A/S, which is a lenient estimate if the Landsgericht agrees that it is not possible to have a
chronic loss-making company which at the same time performs the essential
functions and possesses the valuable intangible assets.
G1-A/S has
not provided any evidence that SKAT's estimate is manifestly unreasonable. On
the contrary, it is very reasonable for G1-A/S as mentioned.
_____________________________
In the
event that the Landsrätten finds that the income
should be determined on an estimated basis, but that SKAT's estimate was not
made on a correct basis, it is submitted that the estimate should be referred
back to the Skattestyrelsen for reconsideration with
reference to G1-A/S's alternative claim for referral back.
4. THE TAX MINISTRY'S PLEA OF
INADMISSIBILITY AND DIRECT CONSEQUENCE
4.1 New issues
It is
submitted in general that the arguments behind H2-A/S's alternative claim,
point 2, are based on new issues that require the court's permission upon
withdrawal, pursuant to Section 48 of the Tax Administration Act [...].
H2-A/S's
subsidiary claim, 2nd indent, according to which H2-A/S is entitled to
additional deductions in the determination of both its income subject to
corporate tax and its income subject to hydrocarbon tax, equal to the payment
for the invoiced hourly writing services provided by G1-A/S to H2-A/S, is an
issue which the Tax Tribunal has not examined. G1-A/S has put forward similar
considerations as H2-A/S, and these considerations/questions are, in the
Ministry's view, not entitled to be examined by the Landsgericht.
G1-A/S's alternative
claim and H2-A/S's alternative claim in point 1 are 'pure' claims for referral
back, which are relevant in the event that the Regional Court concludes that
transfer pricing can be estimated, but that the estimate itself can be set
aside.
The present
case concerns whether G1-A/S has acted at arm's length with its subsidiaries
and their foreign establishments in Y2-country and Y1-country, within the
meaning of Article 2 of the Tax Code. Neither SKAT's nor the Tax Tribunal's
decisions [...] regulate the trade between G1-A/S and H2-A/S, and the question
cannot therefore be raised in the proceedings as a matter of principle, cf.
section 48 of the Tax Administration Act [...].
Furthermore,
G1-A/S and H2-A/S have not been granted leave by the court to raise the new
issues, pursuant to the second indent of Article 48(2) of the Tax
Administration Act [...].
This is
clear from the SKAT decision [...]:
"The
case concerns the determination of an arm's length profit under Section 2 of
the Danish Income Tax Act in G1-A/S for making valuable know-how etc. available
to the foreign branches of its subsidiaries."
As follows
from the Tax Tribunal's initial vote [...]:
"The
appealed decision concerns G1-A/S's tax assessments for the income years
2006-2008 in relation to its subsidiaries' branches in Y1-country and
Y2-country."
The Tax
Court did not rule on the issue of G1-A/S's trade with H2-A/S. There is
agreement in the case [...]. This is not because - as otherwise claimed by
G1-A/S - the Tax Tribunal's decision is justified by an "already
because" and on that basis the Tax Tribunal did not continue its
assessment to the trade with the parent company, H2-A/S, cf. the majority vote
in the Tax Tribunal's decision [...].
The Tax
Court's proposal for a decision [...] does not change this either. The Tax
Board also agreed that the case concerned only trade with the permanent
establishments of the subsidiaries in Y2-land and Y1-land [...].
The Tax
Agency recommended that a consequential amendment be made under Article 45(1)
of the Tax Administration Act, so that G1-A/S's income from time-writing and
administration fees was added to the profit in respect of remuneration from the
subsidiaries, branches and H2-A/S. The Tax Board's proposal did not concern
deductions from H2-A/S's hydrocarbon taxable income, as now follows from
H2-A/S's alternative claim.
The Tax
Tribunal did not follow this recommendation. When the issue has not been tried
by the Tax Tribunal, the issue is new and can only be raised during the trial
with the permission of the court under Section 48 of the Tax Administration
Act, see for example UfR 2008.935H [...] and
SKM2015.84.VLR [...]. In UfR 2008.935 [...], the
Supreme Court - which was joined by the Supreme Court - stated the following
about the current Tax Administration Act's Section 31(1), second indent, which
corresponds to Section 48 of the Tax Administration Act [...]:
"The
applicants' more subsidiary claim for relief under section 33 of the Ligningsgesetz has not been tried by the Tax Tribunal and
can therefore only be withdrawn during the proceedings with the court's
permission under section 31(1)(2) of the current Tax Administration Act."
It takes a
lot for such permission to be granted. According to UfR2008.935H [...] the
question must have "such a close connection with the other issues in the
case that there are grounds for granting such permission".
G1-A/S has
argued during the administrative proceedings that G1-A/S's operator services in
the G23 business on behalf of H2-A/S constitute a CUP in relation to the
dealings with H2-A/S. This argument supports the overruling of the tax
authorities' decision and does not change the novelty of the issue. The trade
between G1-A/S and H2-A/S constitutes an independent claim which the Tax Court
has not examined.
The only
issue in relation to H2-A/S is that H2-A/S is the management company in the
joint taxation. H2-A/S, however, is not a party to the proceedings as a
contracting party.
By decision
of 5 July 2012, SKAT increased [...] H2-A/S's joint taxable income for the
years 2006-2008 as a result of the transfer pricing arrangements with G1-A/S.
The decision also concerned the increase of H2-A/S's joint tax income in
relation to some other subsidiaries. H2-A/S's hydrocarbon taxation and the
trade between H2-A/S and G1-A/S, on the other hand, have no connection with
G1-A/S's tax assessment [...]. The question of the interaction between G1-A/S
and H2-A/S is not a prerequisite for the review of the validity of the Tax
Tribunal's decision [...]. This illustrates precisely that the question is new
in relation to the Tax Tribunal's decision.
Furthermore,
there is no clear link between the question whether G1-A/S has acted at arm's
length with the group entities in Y2-land and Y1-land and the question whether
G1-A/S' has acted at arm's length with the parent company H2-A/S, including
whether H2-A/S is entitled to additional deductions from the hydrocarbon taxed
income. Different trading relationships between different parties are involved,
relating to different transactions.
4.2 The direct consequence
rule
If the
Court of Appeal finds that there is a sufficiently clear link between G1-A/S's
trade with its subsidiaries and its trade with H2-A/S, it will have to decide
whether H2-A/S's tax assessments can be reopened on an extraordinary basis
pursuant to Section 27 of the Tax Administration Act [...] on extraordinary
reopening, since the ordinary reopening period in Section 26 has expired, cf.
also H2-A/S's request for reopening [...].
The
relevant objective condition in Section 27(1) of the Tax Administration Act is
point 2, on direct consequence.
The
provision on direct effect only applies if the requested (secondary) amendment
is a direct consequence of the primary amendment, see UfR
2019.3137H [...] on Section 32(1)(2) of the Tax Administration Act, which is
the same provision as Section 27(2)(2) but concerns taxes etc.
The primary
assessment relating to G1-A/S's transactions with Y2-country and Y1-country.
H2-A/S's
tax assessment, including the hydrocarbon tax, is therefore not a direct
consequence, within the meaning of Section 27(1)(2) of the Tax Administration
Act [...], of the primary increase in respect of G1-A/S, which does indeed
arise from the transactions with Y2-land and Y1-land and not H2-A/S.
The trade
between G1-A/S and H2-A/S in relation to the G23 business cooperation differs
both factually and legally from the present case. A change in prices in this
relationship is not an automatic reaction resulting from the increase vis-à-vis
G1-A/S's controlled transactions with Y2-land and Y1-land. The Report of the
Delay Committee No 1426 [...] mentions that it is the automatic effects that
constitute a direct consequence [...].
There is no
direct link between what is being added to G1-A/S, namely the trade between
G1-A/S and its subsidiaries in Y2-land and Y1-land, and the G23 cooperation.
The increase in relation to H2-A/S in relation to H2-A/S's own affairs is
therefore not a direct consequence within the meaning of Article 27(1)(2).
It is
further argued that the reaction period in Section 27(2) of the Tax
Administration Act [...] has not been observed. It follows from Article
27(2)(1) of the Tax Administration Act that a request for a review must be made
by the taxpayer within six months of the taxpayer becoming aware of the fact
justifying the derogation from the time limits laid down in Article 26.
By SKAT's
decision of 5 July 2012 [...], H2-A/S's joint taxable income was increased as a
result of the transfer-pricing regulation of G1-A/S. H2-A/S was therefore aware
of both the increase at G1-A/S and the increase of the joint tax income at
H2-A/S. H2-A/S did not file a request for reopening within the six-month
period, but only on 12 September 2017 [...], i.e. approximately 5 years after
the tax assessment became available."
Reasons and
outcome of the Regional Court
The cases
concern the tax authorities' discretionary increase of G1-A/S's income for the
2006-2008 income years (case BS-41577/2018) and a consequential increase of the
parent company H2-A/S's joint taxable income for the income years in question
(case BS-41574/2018). The increases are based on a transfer pricing adjustment
arising from G1-A/S's trade with its two subsidiaries and their permanent
establishments in Y1-country and Y2-country respectively, pursuant to Article
2(1) of the Tax Code.
It follows
from Article 2(1) of the Equalisation Law that group
companies and permanent establishments situated abroad must, when determining
taxable income, apply prices and conditions for commercial or economic
transactions (controlled transactions) in accordance with what could have been
obtained if the transactions had been concluded between independent parties. It
is undisputed that G1-A/S, its subsidiaries and their branches are included in
the group of persons referred to in Article 2(1) of the Tax Act, which concerns
affiliated companies and permanent establishments abroad.
The tax
authorities have found that there is a basis for a discretionary increase in
G1-A/S's taxable income for the tax years 2006-2008, and the cases before the
Court of Appeal raise the general questions whether there was a basis for a
discretionary assessment and whether, if so, the discretionary assessment was
exercised on an incorrect basis or was manifestly unreasonable.
The tax
authorities consider that the business model of G1-A/S means that G1-A/S will
never be able to make a profit from its activities, since the tax authorities
consider that dividends are payment for capital investments and not for
services provided, and that income from dividends is not considered to be
business income.
It can be
assumed that G1-A/S's profit before financial items and tax in the period
1986-2010 has essentially been negative, including in the income years in
question 2006-2008, whereas G1-A/S's profit including financial items,
including dividends, in the same period has been positive, and the Regional
Court accepts that income from dividends cannot be regarded as business income
in the sense that dividends received by G1-A/S as owner do not constitute
payment for transactions covered by section 2 of the Equalisation
Act.
However,
the Regional Court considers that the fact that G1-A/S's profit before
financial items and tax for the period 1986-2010 has been essentially negative
cannot in itself justify allowing the tax authorities to make a discretionary
assessment.
Transactions
covered by Article 2 of the Equalisation Law
SKAT found
that G1-A/S provides valuable know-how to the subsidiaries, including the
initial feasibility studies (phase 1 and 2), the establishment of the
subsidiaries, negotiations with the oil state, provision of guarantees and
ongoing technical and administrative assistance (timewriting),
and SKAT's discretionary increase is justified by the non-payment by the
foreign branches for the use of G1-A/S's intellectual property rights. SKAT
considered that an independent party would claim a share of the future revenues
as payment for this.
The
majority of the Landsskattert considered that the
branches in Y1-land and Y2-land have used intangible assets which must be
considered as owned by G1-A/S and that these intangible assets can be
characterised as know-how and rights to oil extraction in the form of licences. The majority of the Regional Tax Court considered
that between independent parties a consideration would have been paid for the
use of this type of intangible assets in the form of royalties or similar. The
majority of the Landsskattert placed emphasis on the
fact that G1-A/S had incurred the costs of preliminary studies, known as phases
1 and 2, which formed the basis for obtaining licences,
and that G1-A/S made the rights of extraction available to the branches.
Furthermore, the majority of the Landsskattergericht
has placed emphasis on the fact that G1-A/S guarantees the subsidiaries'
obligations through performance guarantees.
The
question before the Regional Court is whether and, if so, to what extent there
were transactions between G1-A/S and the subsidiaries' branches in Y1-land and
Y2-land during the 2006, 2007 and 2008 income years, which are covered by
Section 2 of the Tax Act. In this respect, the parties agree that the provision
of technical and administrative assistance (timewriting)
by G1-A/S in the 2006-2008 tax years constitutes transactions covered by
Section 2 of the Tax Act.
Following
the evidence, the Regional Court considers that the subsidiaries are the formal
as well as the real owners of the licenses for oil extraction in Y1-land and
Y2-land respectively. In so doing, the Regional Court has placed emphasis on
the contractual basis submitted and the companies' accounts. It must therefore
also be regarded as undisputed by the Regional Court that G1-A/S is not the
licensee. It cannot therefore be assumed that there was a transaction between
G1-A/S and the subsidiaries in the 2006-2008 income years covered by Article 2
of the Tax Act in the form of the oil extraction licences
being made available to the subsidiaries by G1-A/S.
It must be
considered undisputed that the preliminary studies carried out in phases 1 and
2 concerning Y1-land and Y2-land were completed by G1-A/S in 1990 and 1992
respectively and that G1-A/S did not incur any expenses for the subsequent
phases (phase 3 and onwards). Thus, the preliminary studies do not constitute
transactions within the meaning of Section 2 of the Danish Income Tax Act in
the 2006-2008 income years, but, as mentioned above, the tax authorities
assumed that a consideration would have been paid for them between independent
parties in the form of a share of profits, royalties or similar.
Following
the evidence, the Regional Court considers that no annual consideration would
have been paid between independent parties for the preliminary studies in
phases 1 and 2 in the form of royalties or profit shares from the subsidiaries
in Y1-land and Y2-land, which would constitute a transaction in the income
years 2006-2008 covered by Section 2 of the Tax Code.
In this
respect, the Regional Court emphasises the nature and
content of the preliminary studies in phases 1 and 2 in comparison with the
subsequent phases, including the related costs, as well as the uncertainty that
remains after phases 1 and 2 with regard to the oil deposit and its
exploitation.
The costs
incurred by G1-A/S for the feasibility studies in relation to Y1-land and
Y2-land are not detailed, but the total exploration costs incurred by G1-A/S in
the years 1986-1991, including Y1-land and Y2-land, are estimated at
approximately DKK 128,5 million. The costs of further exploration, production,
etc. are borne by the subsidiaries, and the total exploration costs borne by
the subsidiary in Y1-land for the period 1990-2010 have been calculated at a
total of approximately DKK 759 million, while the total exploration costs borne
by the subsidiary in Y2-land for the period 1992-2010 have been calculated at a
total of approximately DKK 527 million.
In
addition, G1-A/S has carried out similar exploratory work, which has resulted
only in limited or even loss-making oil production, which the tax authorities
have chosen to disregard. Finally, no other examples have been provided of
ongoing royalty or profit-sharing payments in similar cases for the relatively
limited work carried out in phases 1 and 2.
Conversely,
the Court considers that the performance guarantees provided by G1-A/S must be
regarded as constituting controlled transactions within the meaning of Section
2 of the Equalisation Act, for which an annual fee
would have been paid between independent parties. The Court emphasises
that the guarantees must be regarded as having been provided in the interest of
and for the benefit of the guarantee applicant (the subsidiary). Moreover, the
guarantees are, by their nature, unlimited parent company guarantees which
constitute more than a mere capitalisation
commitment. The Court notes in this respect that G1-A/S has not argued that the
two guarantees in question are different in content.
Transfer
pricing documentation
It follows
from the current provisions of Section 3B(8) of the Tax Control Act, cf.
Section 5(3), that if the taxpayer has not prepared the legally required
documentation for pricing transactions between related parties (transfer
pricing documentation), the tax assessment may be made on a discretionary
basis. In its judgments of 31 January 2019 (UfR
2019.1446) and 25 June 2020 (UfR 2020.3156), the
Supreme Court has ruled that transfer pricing documentation that is so
substantially deficient that it does not provide the tax authorities with a
sufficient basis for assessing whether the arm's length principle has been
complied with must be equated with a lack of documentation.
The
Regional Court considers that G1-A/S's transfer pricing documentation
concerning the technical and administrative assistance (timewriting)
in the 2006-2008 tax years was not deficient to such a significant extent that
it could be equated with a lack of documentation. In this respect, the Regional
Court has emphasised that the fact that the tax
authorities disagree with or raise justified doubts about the comparability
analysis in relation to G1-A/S's provision of technical and administrative
assistance does not in itself imply that the documentation is materially
deficient, cf. the Supreme Court's judgment of 25 June 2020 (UfR 2020.3156). Nor has the Ministry of Taxation
demonstrated in detail the significance of any missing or insufficient
functional analyses for the concrete assessment of whether the arm's length
principle has been complied with.
G1-A/S's
transfer pricing documentation concerning the technical and administrative
assistance (timewriting) does not therefore provide a
basis for estimating G1-A/S's income pursuant to Section 3 B(8) of the current
Tax Control Act, cf. Section 5(3).
As stated
above, the performance guarantees provided by G1-A/S and the technical and
administrative assistance (timewriting) provided by
G1-A/S constitute controlled transactions covered by Section 2 of the Tax Act.
The
performance guarantees, which are provided free of charge to the benefit of the
subsidiaries, are not mentioned in the transfer pricing documentation, and the
Regional Court considers that this provides grounds for G1-A/S's income
relating to the performance guarantees to be assessed on a discretionary basis
pursuant to Section 3B(8) of the current Tax Control Act, cf. Section 5(3).
Assessment
of arm's length conditions
Since the
Regional Court notes that it is not disputed that the performance guarantees -
if they are regarded as transactions covered by Section 2 of the Tax Act - were
not made available on arm's length terms, the question is whether the Ministry
of Taxation has established that the payments made by the subsidiaries to
G1-A/S for the technical and administrative assistance (timewriting)
are not in line with what could have been obtained if the transactions had been
concluded between independent parties (arm's length principle), cf. Section
2(1) of the Tax Act.
G1-A/S has
referred in its transfer pricing documentation to the fact that G1-A/S's
operator services in the G23 business on behalf of H2-A/S constitute a CUP in
relation to the transactions with subsidiaries. Reference has also been made to
an industry practice for cost sharing in joint ventures in the oil and gas
sector, whereby the operator's services are provided at cost.
Already
because G1-A/S neither participates in a joint venture nor acts as an operator
in relation to the oil extraction in Y1-land and Y2-land, the Regional Court
considers that G1-A/S' provision of technical and administrative assistance to
the subsidiaries is not comparable to the stated industry practice or G1-A/S'
provision of services to G23 company, where G1-A/S acts as an operator.
Against
this background, the Regional Court considers that the Ministry of Taxation has
demonstrated that G1-A/S's provision of technical and administrative assistance
(timewriting) to the subsidiaries at cost price is
outside the scope of what could have been obtained if the agreement had been
concluded between independent parties, cf.
Conclusion
In summary,
the Regional Court considers that there are grounds for making an estimate of
G1-A/S's taxable income for the 2006-2008 tax years, and that there are therefore
no grounds for upholding G1-A/S's main claim. However, the tax authorities'
assessment is wrongly based and manifestly unreasonable, and the case must
therefore be referred back to the tax authorities for reconsideration in
accordance with G1-A/S's alternative claim.
For the
same reasons, the Regional Court finds that there are no grounds for upholding
H2-A/S's principal claim, but that the assessment of H2-A/S's joint taxable
income for the 2006-2008 tax years be referred back to the tax authorities for
reconsideration in accordance with H2-A/S's alternative claim, first indent.
In view of
the above - and as the case has otherwise been submitted - the Regional Court
does not find reason to rule on H2-A/S's alternative claim, second indent,
including whether Section 48 of the Tax Administration Act prevents the issue
from being referred back.
Costs
Following
the outcome of the proceedings, the Ministry of Taxation is to pay H1-A/S DKK
3,004,000 in costs before the Regional Court. DKK 3,000,000 of the amount is to
cover the costs of legal assistance excluding VAT and DKK 4,000 for court fees.
The Ministry of Taxation is also ordered to pay DKK 3 004 000 in costs to
H2-A/S. DKK 3 000 000 of this amount is to cover the costs of legal assistance
excluding VAT and DKK 4 000 for court fees.
In addition
to the value of the case, the amounts for the lawyer have been determined
taking into account the size, complexity and importance of the cases and the
fact that H1-A/S and H2-A/S have been represented by the same lawyer.
THI IS
HEREBY DECLARED TO BE LAW:
The
assessment of the taxable income of H1-A/S for the tax years 2006-2008 and the
assessment of the joint taxable income of H2-A/S for the tax years 2006-2008
are referred back to the tax authorities for reconsideration.
The
Ministry of Taxation is ordered to pay within 14 days DKK 3 004 000 in costs to
H1-A/S and DKK 3 004 000 to H2-A/S.
The amounts
shall bear interest in accordance with Article 8a of the Interest Act.