VAT and transfer pricing adjustments

The CJEU has followed the Opinion of the AG in SC Arcomet Towercranes SRL (Case C-726/23) (note the decision is not yet available in English) in holding that certain payments made between related entities for transfer pricing purposes amounted to consideration for taxable supplies. Even though the payments in this case were made to satisfy OECD transfer pricing requirements, they nevertheless amounted to consideration for VAT purposes for services that the related party had agreed to provide to the entity making the adjustment payments under the terms of a clear contractual arrangement between those parties. It seems clear, therefore, that whether or not transfer pricing adjustments give rise to VAT consequences will very much depend on the particular circumstances in each case.

However, on a separate question, the CJEU has also stressed that a tax authority is not entitled to seek to deny an input VAT deduction on the basis that the taxpayer had failed to show that the payments were made for services that were necessary or appropriate for the purposes of carrying on its taxable business.

Background

There have long been questions over the VAT treatment of transfer pricing adjustment payments between related entities. Do such payments amount to consideration (or an adjustment of consideration) for VAT purposes or do they fall outside the scope of VAT? The issue has been considered on a number of occasions, most recently by the VAT Expert Group in a 2018 report in which it recommended that transfer pricing adjustments should be considered as outside scope of VAT where both parties have a full right to recover VAT. No action has been taken, however, to make specific provision for such adjusting payments and different Member States have taken different approaches to the issue.

This case concerns the Arcomet group, which operates in the field of crane rental. Within the group, Arcomet Romania (AR) buys or leases cranes for resale or lease to its customers, whilst Arcomet Belgium (AB) looks for suppliers for its subsidiaries, including AR, and negotiates contractual terms with them. However, the sale and lease contracts are concluded between AR and its suppliers and customers.

A transfer pricing study between AB and its subsidiaries carried out in 2010 showed that the subsidiaries should record, under the transfer pricing rules, an operating margin of between -0.71% and 2.74%. As a result, a contract was concluded in 2012 between AB and AR under which AR was guaranteed an operating margin within that range and, to achieve this, an annual adjustment invoice was to be issued by AB in the event of a profit in excess of 2.74% or by AR in the event of an excess loss below -0.71%.

The 2012 contract contained provisions under which each party undertook to provide certain services. For example, AB agreed to assume commercial responsibilities, such as strategy, planning, negotiation of (framework) contracts, negotiation of financing contracts etc. AR, however, purchased its own products and was responsible for sale and rental of the products.

In several years following, AR recorded a profit higher than the range forecast and received invoices (excluding VAT) from AB, which it ultimately declared as supplies of services. AR treated the earlier invoices as intra-Community purchases of services for which it applied the reverse charge mechanism, but later took the view that such invoices had been issued in the context of transactions outside the scope of VAT. It then appears that the Romanian tax authorities refused to accept that the input VAT claimed by AR on the earlier invoices was properly deductible on the basis that that AR had not justified the provision of the services invoiced or their necessity for the purposes of the taxable transactions, on account of the failure to produce supporting documents.

Following an appeal, the Romanian courts referred questions to the CJEU concerning whether the amounts paid in this situation amounted to consideration for a supply for VAT purposes. The AG took the view that it was not possible to provide a “principled answer” to the question whether or not transfer pricing adjustments are subject to VAT. Instead, an assessment must be carried out on a case by case basis and, in this case, the payment were consideration for taxable supplies under the contractual arrangements between AB and AR.

Decision of the CJEU

The CJEU has confirmed that, in this case, the payments by AR to AB should be treated as consideration for supplies of services under the contractual arrangements put in place between them. In particular, the CJEU noted that AB “undertook to provide a certain number of commercial services and to bear the main economic risks associated with Arcomet Romania's activity as an operating company” and AR “undertook to pay at the end of each year an amount corresponding to the share of the operating margin achieved by it in excess of 2.74%”. There was, therefore, the necessary legal relationship between AR and AB.

Furthermore, the payments made by AR to AB were for specific services received by AR which enabled it to make or improve services it provided to its end customers. Consequently, it was clear that the amounts received by AB constituted the actual consideration for the service provided to the AR, such that the necessary direct link between the services provided and the amounts received existed.

The CJEU rejected AR’s alternative arguments that the payments in these circumstances did not amount to consideration for VATable supplies. In particular, this was not a case where the amounts payable were merely intended to adjust, in accordance with the OECD principles, an entity’s operating margin in order to comply with the arm's length principle without having as its counterpart a specific activity to be provided in return.

In addition, the analysis was not affected by the uncertainty over the amount of the payment or the possible lack of any payment. The CJEU agreed with the AG’s analysis that, although the amount of the payment was uncertain, the terms of the payments were free from uncertainty. As such, the payments were consideration for the supplies made by AB.

As regards the point that the arrangements required payments to go in the opposite direction (from AB to AR) where the profit margin was -0.71% or less, the CJEU essentially followed the same approach as the AG. This factor did not affect the analysis of the actual invoices, because it simply was not the situation that arose in the years in dispute. The AG had noted that if that situation arose, it would be necessary to analyse whether those payments amounted to financing or consideration for services, but that was not the case here.

The second question referred related to the Romanian tax authorities’ decision to disallow input VAT recovery by AR on the basis that it had not shown that the expenditure was necessary or appropriate for the purposes of AR’s taxable transactions. On this issue, the CJEU held that, where a taxpayer holds a VAT invoice, it remains open to a tax authority to take steps to ascertain whether the substantive conditions of the right to deduct are satisfied and to require the production of additional evidence by the taxable person for that purpose. However, those tax authorities cannot require the taxpayer to also establish the necessity or appropriateness of those services for its taxable transactions. The Court stressed that the VAT Directive does not make the exercise of the right of deduction subject to a criterion of economic profitability.

Comment

In the absence of any specific provisions dealing with transfer pricing adjustments for VAT purposes, it is not surprising that the CJEU has held that it is necessary to take a case-by-case approach based on the actual arrangements between the relevant entities. In this case, the existence of a clear contractual framework setting out obligations to provide services and obligations to make payments (albeit conditional on profitability levels) was sufficient to indicate that the payments made were consideration for the services received and subject to VAT.

It is important to note, however, that this analysis will not always be in point. There may be many different ways of making transfer pricing adjustments and these may, or may not, actually adjust the contractual amounts paid for goods or services.