Background to VAT and transfer pricing

The time of filing corporate tax returns is approaching, when, in addition to the traditional closing adjustments to the tax base, it is necessary not to forget the adjustments related to price adjustments if these have not already been reflected in the closing accounting work.
Most companies belonging to multinational corporations are already fully aware of the importance of properly calculated and accounted for price settlements.

However, the VAT implications of such transactions are not fully understood. Currently, there are no clear guidelines in the Czech Republic, at the EU level or within the current OECD methodology on how to approach price adjustments from a VAT perspective. Should they be subject to VAT at all?
In the Czech Republic, only the historical Coordination Committee from 2006 can be traced with the following conclusion of the tax administrator:

"If a legal entity provides funds to another legal entity for the purposes of adjusting the income tax (1) base, because the prices at which the legal entity provides services to related persons (close persons) differ from the prices agreed between independent persons in normal business relations, this is not a provision of funds which is not subject to tax within the meaning of the VAT Act, but a part of the consideration for the "shared services" provided to individual customers (related persons). The taxable amount is, according to Section 36 of the VAT Act, everything that the taxpayer receives or is to receive as consideration from the person for whom the supply is made or from a third party, and therefore the funds provided by the third party (parent company) to compensate for the cost of the supplies made to connected persons enter the taxable amount of those supplies."

The Czech tax administration has not published any further official interpretation on this issue.

In 2018, one of the views of the OECD VAT Expert Group (2) emerged that subsequent transfer adjustments (called adjustments) should be treated as financial transactions that are not subject to VAT, provided that both parties to the transaction are fully entitled to deduct input VAT on the transaction to which the adjustments relate.
In practice, however, there are situations where it may be difficult to identify what is the subject of a transaction entitling to a price settlement in favour of another member of the group.

The Romanian (3) or Swedish (4) case currently pending before the EU Court of Justice may provide some legal certainty.

For example, let us imagine a situation where a foreign parent company invests in the Czech Republic in the establishment of a manufacturing subsidiary that will provide all the manufacturing know-how as well as the right to supply products to customers it has acquired in the past through its business activities. It will then strategically supervise the management of the Czech company and approve its annual production plans.
If a routine production entity achieves above-market profitability, it can be assumed that there should be a price adjustment in favour of the parent company, which is the vehicle for the business strategy. Will such a price adjustment be subject to VAT? Who will issue the price adjustment document and what will be the subject matter of the transaction?
The Romanian tax administration dealt with just such a case when it considered whether a price settlement by a Romanian subsidiary (a crane rental company) in favour of its Belgian parent company should have been subject to VAT. The Belgian parent company indicated the supply of services as the object of the transaction on the price settlement document issued. Subsequently, the Romanian company itself charged VAT under the reverse charge scheme, which it subsequently claimed as a deduction. The Romanian tax authority questioned the whole procedure, claiming that it had not been proven that the supplies on the invoice were actually necessary for the economic activity of the Romanian company and did not recognise the claim for deduction.
Thus, the question decided by the court in the above case was: Whether the price settlement in favour of the parent company gives rise to an object of supply which is in the nature of a supply of services and, if so, what evidence is to be adduced by the recipient of the services to meet the burden of proof of the taxable supply?
Another court case dealing with the relationship between VAT and transfer pricing is that of a Swedish parent company which provided services to subsidiaries and excluded certain specific costs from the cost base to which it applied a mark-up when determining the remuneration for those services. The Swedish tax authority did not agree with this practice.
The issue before the court in this case is, inter alia, the interpretation of the open market concept enshrined in Article 80 of the Council Directive and its consistency with transfer pricing methods.
Why do we consider the above court cases from abroad important?
In a situation where there is no uniform binding methodology within the EU and the OECD on the issue of the relationship between VAT and transfer pricing, it is reasonable to assume that EU Member States will respect these decisions of the CJEU. We therefore consider it important for you to follow these cases so that we are able to apply the recommendations arising from them correctly to our clients' situations.

At the beginning of the article we asked the question whether price settlements should be subject to VAT or not. Unfortunately, there is no simple and unambiguous answer. Therefore, the current situation forces us to assess each price settlement separately and to prepare an explanation of our conclusions for their possible control by the tax authorities.
(1) KOOV No 116/29.3.2006 VAT treatment of the contribution for the purpose of adjusting transfer prices between related parties
(2) VAT EXPERT GROUP - Possible VAT implications of Transfer Pricing, taxud.c.1(2018)2326098
(3) C-726/23 (Arcomet Towercranes)
(4) C-808/23 (Högkullen)

Author: Lenka Lopatová, Petr Linx