(At least partial) clarification of the VAT regime for profit adjustments – CJEU rules

In April this year, we drew your attention to the opinion of the Advocate General of the Court of Justice of the European Union in Case C-726/23 and to the fact that the decision of the Court of Justice of the European Union could clarify at least some of the VAT implications in cases of profit adjustments for transfer pricing purposes. Last week, the Court of Justice of the European Union issued a decision confirming the conclusions of the Advocate General.

First, we briefly summarize the main circumstances of the case in question, which concerns the multinational Arcomet Group, operating in the field of crane rental. The parent company, Arcomet Service NV Belgium, also seeks out suppliers and negotiates terms with them for its subsidiaries, which include the Romanian entity SC Arcomet Towercranes SRL. Subsidiaries then enter into contracts with suppliers and customers on their own behalf.

A contract was negotiated between Arcomet Belgium and Arcomet Romania, under which Arcomet Belgium is obliged to assume most of the commercial and operational responsibilities such as planning, negotiating financing, fleet management, quality and safety management, etc., while also bearing the main economic risks associated with the activities of the Romanian entity. On the other hand, Arcomet Romania has undertaken to purchase and own the products necessary for its operations and to be responsible for their sale, rental and provision of services. The contract set the remuneration for the activities carried out by both parties on the basis of the Transaction Net Margin Method (TNMM). Arcomet Belgium was entitled to issue an invoice if the operating margin of the Romanian entity was higher than 2.74% for the purpose of transferring excess profit, or Arcomet Romania was entitled to issue an invoice if the margin was lower than -0.71% for the purpose of reducing the loss. If the operating margin of the Romanian entity had been between -0.71% and 2.74%, no profit adjustment (“TP adjustment”) would have been made.

Over a period of 3 years (2011-2013), Arcomet Romania recorded an operating margin higher than 2.74% and the parent company invoiced for each year. For the first two years, it issued an invoice for the provision of services within the EU, i.e. in the reverse charge regime, and for the last year for a supply outside the scope of VAT. During the audit of the Romanian entity, the tax administration questioned the claims for deduction made in the first two invoices because the company had not substantiated the actual provision of the invoiced services and their necessity for the purposes of its taxable supplies.

The key question, which the Court first examined, is whether such remuneration constitutes consideration for a supply of a service, which is subject to VAT. As a preliminary point, the Court points out that a supply of services is made for consideration, and is therefore subject to VAT, where there is a legal relationship between the supplier and the recipient, under which supplies are mutually provided, the consideration received by the supplier representing the actual value of the personalised service provided to the recipient. This is the case if there is a direct link between the service provided and the consideration received. And, according to the Court, those conditions are fulfilled, since Arcomet Belgium has undertaken to provide certain commercial services and to bear economic risks, in return for which Arcomet Romania has undertaken to pay at the end of each year an amount in excess of the agreed operating margin, thus satisfying the existence of a legal relationship between the parties. At the same time, the services provided by Arcomet Belgium had an impact on the operating margin of the Romanian entity and enabled it to achieve or improve its service to end customers. Despite the fact that the amount of the remuneration is variable, it is essential that it is not gratuitous, random, uncertain or difficult to quantify, and therefore the condition that the remuneration represents the actual value of the service provided to the recipient is also met. The remuneration in question, calculated in accordance with the method recommended by the OECD Directive, thus constitutes, according to the Court, consideration for the supply of services for consideration, which is subject to VAT.

With regard to the question of claiming a deduction for services received by a Romanian entity, the Court ruled that the tax administrator may require the submission of evidence proving their use for the purposes of carrying out taxable transactions, and not just the invoices themselves. However, such evidence must be necessary and proportionate.

What does the decision of the Court of Justice imply and how should it be interpreted?

First of all, it must be said that the decision concerns only the case at hand, but on the other hand, it provides the referring court with an answer on how to interpret the relevant provisions of the EU VAT Directive and, therefore, the VAT effects should be identical in a situation identical in content. However, the decision does not provide clear answers for situations that are not identical in content, for example, if the adjustment is regulated separately, outside the service contract itself between the parent and the subsidiary. Similarly, the decision does not provide a clear answer to the situation where the subsidiary’s margin would be lower than agreed and it would be the parent company that would pay the subsidiary. The question of the VAT regime for profit adjustments will thus remain open to some extent, but it is clear that in situations where the transfer pricing model is set up in a similar way to the case at hand and where, for example, the subsidiary pays remuneration to the parent company, which also provides management services and bears its business risks, in the event of exceeding the agreed operating margin, this will be a consideration for a service provided which is subject to VAT.

Please do not hesitate to contact us if the issue of profit adjustment affects you in any way. We will be happy to review the transfer pricing model and its VAT aspects with you, revise the related contractual documentation, if necessary, assess potential risks and recommend appropriate adjustments.

If you have any questions about the topic of this article, we are also fully at your disposal.