VAT and Transfer Pricing – CJEU Rules on the application of open market value in intra-group transactions
Earlier this year, we explored certain aspects of VAT and transfer pricing in our article. The Court of Justice of the European Union (CJEU) has now delivered one of the preliminary rulings referred to therein, providing further clarification on these matters.
In the decision, the CJEU did not expressly rule whether a price established using a transfer pricing method can serve as the taxable amount for VAT purposes. However, in situations where the taxable amount is adjusted to reflect the open market value, the ruling is likely to prompt tax authorities to examine more closely the comparable prices available on the market. This approach is closely aligned with the application of the arm’s length principle in transfer pricing. The ruling appears to offer both multinational and domestic groups an opportunity to define the scope and pricing of their intra-group transactions for VAT purposes more effectively, provided there is a justified basis for doing so.
Open market value in value-added taxation
Article 80 of the VAT Directive allows Member States to use the open market value as the taxable amount instead of the actual consideration paid, where the parties are connected and the consideration differs from the open market value. The purpose of this provision is to prevent situations where at least one related party does not have the full right to deduct input VAT, and where an unusually low or high price is used with the aim of artificially reducing the amount of non-recoverable VAT.
Open market value is defined in Article 72 of the Directive. As a rule, it refers to the comparable arm’s length price that would be paid between independent parties under conditions of free competition. Where such a price cannot be determined, the open market value for a supply of a service is deemed to be the full cost incurred by the taxable person in providing the service.
In Finland, the provisions implementing the Directive are set out in Sections 73 c–73 e of the VAT Act, sometimes referred to as the “transfer pricing rules” of value-added taxation. However, the Finnish rules differ in certain respects from the Directive. They permit the application of open market value only in situations where the purchaser does not have full right to deduct input VAT and the agreed consideration is significantly lower than the open market value.
The ruling clarifies the application of open market value
In case C-808/23 (Högkullen), the parent company of a Swedish real estate group supplied its subsidiaries with administration, financing, property management, investment, IT, and HR services. Pricing was determined using the cost-plus method, under which the costs of providing the services were first identified and then a market-based mark-up was added.
The Swedish Tax Agency (Skatteverket) argued that the services supplied by the parent company to its subsidiaries constituted a single indivisible supply, and for which no comparable arm’s length price could be found on the market. Accordingly, it is considered that the taxable amount should be determined based on the total costs of supplying the services.
Skatteverket’s broad interpretation of the cost of supplying the services led to a taxable amount more than twelve times higher than the amount determined using the cost-plus method. This significant difference arose because the taxpayer included only the costs directly related to providing the services, whereas Skatteverket considered that, since the group company had no other business activities, all costs of the company were attributable to the supply of the services.
As the subsidiaries did not have the right to deduct input VAT, the re-determination of the taxable amount resulted in substantial additional costs, as part of the VAT resulted in an irrecoverable cost to them.
In its ruling, the CJEU held that the services provided by the parent company to its subsidiaries were not, in principle, so closely linked as to form a single indivisible economic supply which should objectively be regarded as a single service. Even though the services were supplied together, each had a clearly distinct and identifiable nature. The fact that the services were invoiced at a single price was not relevant. Accordingly, CJEU concluded that Skatteverket could not determine the taxable amount based on total costs on the grounds that no comparable market price could be identified for the services in question.
Significance for VAT and transfer pricing – Impact extends to domestic groups
The CJEU did not expressly address whether a price determined under a transfer pricing method can serve as the open market value for VAT purposes. Nevertheless, the ruling suggests that transfer pricing-based valuations may be acceptable as the taxable amount in value-added taxation, provided that the comparable data is properly gathered and documented.
In groups where at least one entity does not have full right to deduct input vat, it is important to treat intra-group services as separate supplies and seek to determine an arm’s length comparable price for each, rather than automatically include all costs of the supplying entity in the service price. Well-prepared documentation strengthens the taxpayer’s position and limits the tax authority’s ability to add cost items to the taxable base that would raise it above what is considered arm’s length in transfer pricing.
For groups applying transfer pricing, the ruling appears to create an opportunity to reassess their transfer pricing policy if the current structure gives rise to VAT leakage. By using different pricing methods, it may be possible to achieve a significantly more favorable VAT outcome, provided that intra-group sales are clearly separated in contracts, their pricing is properly justified, invoicing is carried out appropriately, and the transfer pricing documentation also takes VAT aspects into account so that, in the event of a tax audit or appeal, it can be demonstrated that the prices meet the definition of open market value under VAT legislation.
It is important to note that the implications of the ruling are not limited to multinational groups. Groups operating solely within one Member State may also wish to review their intra-group transactions from a VAT perspective where there is a justified reason, potentially avoiding unnecessary VAT costs.
If VAT issues related to intra-group transactions create uncertainty in your company, it is advisable to consult an expert and ensure that your group’s transfer pricing policy is properly aligned with VAT treatment in advance.
Kirjoittaja
