European Court: contractually agreed TP adjustments may have VAT implications

Background

The VAT treatment of transfer pricing (TP) adjustments is an important topic for multinational businesses. The question is whether TP adjustments should be seen either as (a correction of) the consideration for supplies of goods or services or rather as payments outside the scope of VAT. If TP adjustments attract VAT, this may result in substantial compliance requirements for businesses (credit invoices and VAT return corrections). For companies that are not (fully) entitled to reclaim the VAT on costs, TP adjustments may also result in additional VAT leakage.

In the absence of specific VAT rules for TP adjustments, the EU VAT Committee and the VAT Expert Group have shared their views on the VAT aspects of TP adjustments. Some EU countries have published their own guidelines on the interaction between TP adjustments and VAT in their jurisdictions. The Court of Justice of the European Union (ECJ) has now shed some light on the VAT aspects of TP related payments.

Arcomet case 

The case concerns Arcomet, an international group that is involved in the lease and sale of tower cranes. An intercompany agreement was concluded between Arcomet Belgium and Arcomet Romania under which they exchanged services. Arcomet Belgium’s activities include (among others) the strategy and planning of the activities, the servicing of the tower cranes and the negotiation of contracts with suppliers. The tower cranes are purchased or leased by Arcomet Romania and are subsequently sold or leased by Arcomet Romania to third parties. Arcomet Belgium bears the main economic risks associated with the group’s business.

Under the intercompany agreement, parties agreed that the operating profit margin for Arcomet Romania should be in a certain range that was determined based on the ‘transactional net margin method’ laid down in OECD TP guidelines. Arcomet Belgium would issue a year-end settlement invoice to Arcomet Romania if Arcomet Romania’s profit margin exceeded or fell short of the profit margin range agreed, thereby aligning it with the predetermined margin.

The ECJ was asked to answer the question whether such TP adjustments constituted a remuneration for the services provided by Arcomet Belgium to Arcomet Romania.

ECJ ruling

The VAT taxable amount for services is in principle based on the consideration actually received by the service provider for the provided services. The ECJ has ruled that the TP adjustments in the Arcomet case are a remuneration for the services provided by Arcomet Belgium to Arcomet Romania. This means that such TP adjustments are within the scope of VAT. In this context, the ECJ considered that the TP adjustments were contractually agreed and could be directly linked to the services provided by Arcomet Belgium to Arcomet Romania.

This conclusion is not altered by the fact that the significance of the year-end TP adjustment depends on Arcomet Romania’s profits or losses in a given year. According to the ECJ, what matters is that the remuneration modalities are contractually agreed according to precise criteria.

Relevance for practice

The ECJ has confirmed that TP adjustments may be subject to VAT when they are contractually stipulated in an intra-group agreement. This imposes more compliance requirements on multinational enterprises and may also lead to increased VAT leakage for businesses in certain VAT exempted industries. Situations may however still occur where TP adjustments should not attract VAT. We therefore recommend businesses to analyze the VAT aspects of their group’s TP policies and the VAT aspects of any TP adjustments.