European Court further clarifies interplay between VAT and transfer pricing

Background

In recent years, the interplay between VAT and transfer pricing (TP) has become a trending topic for multinational businesses that is subject to ongoing debate. This has led to several cases being brought before the Court of Justice of the European Union (CJEU).

In the Arcomet Towercranes case (C-726/23), the Advocate General recently advised the CJEU that – under circumstances – TP adjustments are within the scope of VAT. If the CJEU follows this advice, this would result in increased compliance requirements for businesses and, in case of upwards adjustments of the price, VAT leakage for companies that are not (fully) entitled to reclaim VAT (see our newflash). These developments underscore the importance for businesses of understanding and analyzing the VAT implications of their TP policy. The more cases on this topic are decided by the CJEU, the more clarity should exist in the legal VAT landscape for intra-group transactions.

Högkullen case

Högkullen AB provided services to its subsidiaries consisting of company management, financing, real estate management, IT, and HR. As consideration, Högkullen AB received a fee that was from a TP-perspective based on the ‘cost-plus’-method. Costs not related to the services, such as shareholder costs, were not included in this fee calculation. The subsidiaries could not fully deduct the input VAT due to their partially exempt activities.

As a general rule, VAT is levied on the consideration received for a supply. Member States may however opt to apply the open market value if related parties perform supplies below the open market value and the customer cannot (fully) deduct the VAT. The open market value consists of the price of a comparable supply or, if no comparable supply exists, at least the full cost price of the services. Sweden has implemented such option.

The Swedish Tax Authorities revalued the VAT taxable amount on the intra-group services performed by Högkullen AB and applied the open market value. They considered the services provided as one single supply for which there is no comparable. The Swedish Tax Authorities therefore based the open market value on all costs incurred, including expenses which were not related to the output transactions.

The CJEU ruled that Högkullen AB provided multiple distinct services instead of a single service Even though one overall price was charged using the cost-plus-method, each of the five services must be assessed individually for VAT purposes. Accordingly, for each service the open market value should be based on the price for comparable services, instead of the full cost base of Högkullen AB.

Implications for Practice

This ruling is particularly relevant for companies established in Member States where the open market value rule has been implemented, and for corporate groups with affiliates in those jurisdictions. The open market value is implemented in full in Luxembourg and to a certain (more limited) extent in the Netherlands and Belgium. The open market value aims to achieve an objective price in transactions occurring between parties with close ties. This appears similar to the arm’s length principle that is applied from a TP perspective, where transactions between related parties need to be conducted under the same conditions that would apply between independent parties. The open market value is however only based on prices that would have to be paid to an independent supplier for comparable supplies at the same marketing stage, in that Member State, in fair competition - which shows some similarity to the ‘comparable uncontrolled price’ (CUP) method used for TP purposes - or is at least the cost price. From a TP perspective, it is often difficult to apply the CUP method in practice due to the comparability requirement and therefore for services often the net cost-plus method is applied, which results in a profit-margin on top of the allocable costs. It therefore seems likely that the Swedish referring Court will eventually decide that the original consideration for the services – as based on the ‘cost-plus’ method – appears to be correct.

In light of these developments, businesses are advised to maintain robust documentation that supports both the arm’s length nature of their intra-group transactions and the corresponding VAT treatment.