VAT and transfer pricing: still unclear

The CJEU has rejected the argument that a transfer pricing adjustment amounted to consideration for a separate supply of services in Stellantis Portugal SA v Autoridade Tributaria e Aduaneira (Case C-603/24), noting that the domestic courts might consider the adjustments to be merely a subsequent amendment of the price paid by the recipient of the original supply of motor vehicles.

However, unlike the AG in this case, the CJEU has not offered wider comment on the interaction of VAT and transfer pricing adjustments outside the context of this case, leaving each case to be determined on its facts. This may be seen as something of a missed opportunity as the judgment fails to bring much more clarity regarding transfer pricing adjustments in the VAT context. In principle, therefore, it appears that a number of options are possible depending on the particular circumstances and contractual arrangements, including adjustments being outside the scope of VAT, an adjustment to the consideration for a previous supply or a consideration for a separate supply.

Background

Stellantis Portugal (SP) was a national sales company within the General Motors Group (GMG). SP purchased vehicles from manufacturers of vehicles within GMG which it then on-sold within Portugal to independent dealers. It appears that the contractual arrangements between SP and the vehicle manufacturers included provisions adjusting the initial price to be paid for vehicles. That initial price appears to have itself been calculated by assuming a certain level of costs to be incurred by SP, including costs incurred in relation to defective vehicles. The adjustments were based on a variety of actual costs incurred by SP, including distribution costs, operating costs and the cost of repairing defective vehicles. Depending on those costs, an adjustment was made at the end of each period to ensure that the actual operating profit of SP matched the operating profit target amount. That adjustment might be an upwards adjustment of the price (with a debit note issued by manufacturers to SP) or a downward adjustment (with a credit note issued to SP).

For the year of assessment under review, it appears that the arrangements led to a downward adjustment with SP receiving payments from manufacturers in respect of increased cost of repairs to vehicles sold. The Portuguese tax authority took the view that these payments received by SP were consideration for supplies of services made by SP to the manufacturers of arranging for the necessary repairs. SP appealed that assessment.

In the earlier case of SC Arcomet Towercranes SRL (Case C-726/23), the AG suggested that it was not possible to give a principled answer to the question how the VAT system should treat payments made for transfer pricing purposes. A case by case approach was necessary. On the facts, the CJEU held that payments made between related entities for transfer pricing purposes amounted to consideration for tax-able supplies. Even though the payments in that 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. For our review of this earlier case, see VAT and transfer pricing adjustments. Against that background, AG Kokott suggested that had been a missed opportunity to provide a broader, principled answer to the question of the consequences under VAT law of a transfer pricing adjustment, which would help ensure that the situation "does not necessarily have to be decided afresh, on a case-by-case basis, each time".

Decision of the CJEU

The decision of the CJEU focusses very much on the argument that the adjusting payments received by SP amounted to consideration for a separate supply of repair services. On this issue, the Court noted that the agreement between SP and manufacturers did not appear to include any obligation to repair the vehicles it purchased from manufacturers. As such, there was no evidence of the necessary legal relationship giving rise to reciprocal performance of repair services in return for consideration.

The Court went on to note that even if there were other evidence of a legal obligation on SP to carry out repairs for the manufacturers, it would still be necessary for the adjustments to be consideration for such a service which requires a direct link to the service. That direct link might be broken by either the uncertain nature of any payment or difficulty in quantifying the payment. The Court noted that in this case it appeared the adjustment took into account not just the repair costs but other operating costs of SP. As such, the repair costs only appeared to be one factor in calculating the adjustment and might result in either a debit or credit note. In addition, the costs were taken into account only to guarantee a particular profit margin, such that it did not appear that SP was guaranteed that all the relevant costs would be reimbursed. Taking into account those features of the arrangements, the CJEU commented that even if there was a link between a repair service and the adjustments, it would appear to be at most indirect.

An adjustment of the original purchase price of the vehicles?

The opinion of the AG in this case focussed on the broader impact of transfer pricing adjustments on the VAT position, seeking to provide a "principled" answer on the interaction of the two. Disappointingly, though unsurprisingly, the Court has adopted a much narrower approach to this issue. Having answered the specific question referred to it, the Court has restricted itself to simply observing that if the referring court consider that the adjustments are a subsequent amendment of the original price paid by SP for the purchase of vehicles, then, as noted by the AG, "it will be for the competent national authorities, where appropriate, to assess the effect of such an amendment on the determination of the taxable amount of the transaction consisting in the supply of those vehicles".

AG opinion

Since the CJEU has very much limited itself to the specific question, it is worth recalling the AG opinion in this case where AG Kokott attempted to provide a principled answer to the interaction between VAT and transfer pricing adjustments. Indeed, the AG appeared to criticise the court in Arcomet Towercranes for reformulating the question referred into a more straightforward question and, as a result, providing a rather straightforward answer, stating, "It is doubtful whether that rather straightforward answer was also a useful answer".

The AG noted that the question asked in this case, in essence, seeks to ascertain how transfer pricing adjustments to a sale price agreed between two intra-group companies are to be treated for the purposes of VAT law where that price adjustment serves primarily to allocate the profit between the two affiliated undertakings in an appropriate manner for corporate tax purposes. The answer is that there are some circumstances where such adjustments can have VAT consequences and some where it does not and these can be distinguished based on a number of situations, including:

A. Where separate services are made with a view to generating inputs and outputs to influence profits appropriately, recognising, however, that the parties might only invoice on paper in order to steer profits upward or downwards ("where a supply of services in one direction is difficult to imagine")

B. Where a tax authority makes an adjustment for transfer pricing purposes, usually without any real payment flows, leading to an attribution of profits or expenses

C. Where the existing purchase price is subsequently adjusted for transfer pricing purposes on account of variables that were open when the initial purchase price was set.

As regards situation A, the AG noted that this appears to have been the situation in Arcomet Towercranes. There was an underlying contract providing for the provision of services with a positive payment made for those services. In the present case, however, there was no such contract. SP simply buys and resells vehicles, bearing the warranty/repair costs. The tax authorities argument that SP provided a service of managing repair costs in favour of the manufacturers makes no sense where SP's profits exceed the prescribed range and SP is required to make a payment to those manufacturers. Indeed, the AG appears to question the commercial reality of any such contractual arrangement even if it existed. "If something of that nature had been contractually agreed, that would rather militate in favour of a fictitious supply of services, so that such a contract would rightly be irrelevant to the taxation of the expense of a consumer good under VAT law."

As regards situation B, the AG noted that as long as such an adjustment occurs only in connection with the taxation of company X's profits in jurisdiction A, it is a pure fiction and has no VAT consequences. As the AG points out, there would be no necessary corresponding adjustment in the jurisdiction of the other contracting party. VAT law, in contrast, requires that any adjustment to the price must have effect for both parties. Therefore, such transfer pricing adjustments must be outside the scope of VAT law. The AG notes that the VAT Expert Group recognised a distinction should be drawn between a mere tax authority adjustment and cases where the adjustment is provided for by contract. In the latter case, there is an adjustment of the taxable consideration for the previous supplies made.

Scenario C also involves a subsequent adjustment to the price of a supply, where at the time of the supply the price was variable upwards or downwards based on various parameters used for transfer pricing purposes. This is the situation confronting the court in this case where the price to be paid by SP was to be adjusted based on its operating profit taking into account a variety of variables with a view to ensuring that SP ultimately retained a specific operating profit margin. As the AG notes, the VAT Directives already expressly provide for the subsequent adjustment of the taxable consideration pursuant to Articles 90 and 73 of the Principle VAT Directive. In those cases, the adjustment made between the related parties only impact the taxable amount of the underlying transaction and cannot amount to a separate supply.

The AG then distinguishes the Arcomet Towercranes decision, suggesting that it did not involve the adjustment of a transfer price but consideration for a supply of services for consideration if the profit was too high or too low. "Irrespective of whether the result is actually convincing in that specific case or whether fictitious services were in fact invoiced, the Court ultimately held only that there is a supply of services for consideration where the parties have contractually agreed on a supply of services for consideration, presumably on the assumption that the service was actually supplied."

It is perhaps worth noting that the situations in this case and Arcomet Towercranes were somewhat different. This case clearly involves a supply (of vehicles) where the consideration is subsequently adjusted by payments going in either direction. In Arcomet Towercranes, there was an underlying contract which provided responsibility to each party for certain activities (including a variety of support services provided by the parent to the subsidiary) and also provided for payments in either direction dependent on the profitability of the Romanian subsidiary. However, it seems that, in that case, there was no fundamental underlying supply for consideration being made between the parties. As such, payments made in that case from the Romanian subsidiary to its parent were going in the "right" direction for the supply of support services the contract provided for and had not previously charged for. (It is notable that both the AG and Court ignored the issue of how any payments required to be made from the parent to the subsidiary might have been treated for VAT purposes in Arcomet Towercranes.) However, in Stellantis Portugal, the payments were going in the "wrong direction" (at least in the relevant years). They were being made by the supplier of the vehicles to its customer. The attempt by the Portuguese tax authorities to "manufacture" a supply of services in such a scenario was, therefore, somewhat artificial and failed compared with the much simpler analysis that the payments were simply adjusting the price for the existing supply.

Comment

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.

The AG in this case memorably described determining the correct transfer price as less a matter of law and more a "matter of faith", contrasting this with the position under VAT law in the latest referral to tack-le the interaction of VAT and transfer pricing and suggested that the opportunity should be taken to provide a principled answer to the question.

Against that background, it is disappointing that the CJEU has not provided a broader answer to the question of the VAT treatment of transfer pricing adjustments outside the facts of this particular case. However, whilst the AG's willingness to consider a broader spectrum of scenarios is certainly welcome, ultimately the answer to the question how transfer pricing adjustments interact with the VAT system will still be "it depends". Clearly, adjustments merely required by a tax authority without any underlying change to the subjectively agreed consideration will not impact the VAT treatment. However, in other cases, it will depend on the contractual mechanism used to make the necessary adjustments, subject to the AG's suggestion that economic and commercial reality might intervene to ensure that payments are treated simply as adjustments to the consideration for the underlying supplies, rather than consideration for a separate supply of services.