Case law on transfer pricing: Judgment 7 Afs 31/2024-27 (RR Donnelley Czech s.r.o.)

In its judgment No 7 Afs 31/2024-27, the Supreme Administrative Court (SAC) dealt in detail with the question of the correctness of the determination of the reference interest rate in the context of transfer pricing and the definition of the burden of proof of the tax administrator. Specifically, it assessed whether the tax administrator had sufficiently demonstrated the application of the reference rate within the meaning of Section 23(7) of the Income Tax Act (ITA) in relation to funds “moribund” in inventories when providing services with remuneration determined by the cost plus method.

Subject of the dispute

The dispute concerned the company RR Donnelley Czech s.r.o. (RRD), which was assessed to tax for the 2015 tax year in relation to the ownership of part of its stock in transactions with a related party based in Ireland. The key issue was whether the tax administrator correctly used the USD LIBOR interest rate in calculating the reference price and whether its methodology complied with the arm’s length principle.

RRD typically assembled and configured hard disk drives (HDDs) for the related party without acquiring title to the inventory. It was entitled to a mark-up of 12.5 % on production costs for this activity. However, in the 2015 tax year, 10.5% of production transferred ownership to RRD, while the amount of the surcharge remained unchanged.

Despite this change, the company treated all HDDs identically and did not distinguish, which drives it owned. However, the tax administrator considered this fact to be economically relevant – arguing that RRD had tied up its funds in inventory and therefore the appropriate remuneration should have been determined through the reference interest rate.

Procedure of the tax administrator

The tax administrator used the USD LIBOR rate as a proxy for the return on funds in a risk-free environment. It likened the riskiness of the transaction to short-term interbank operations. It argued that the company effectively provided an interest-free loan to its related party by tying up the funds in the HDDs it purchased, which were used in the course of the agreed activity.

At the same time, however, the tax administrator did not compile any comparative sample of similar deposit transactions. Without further analysis, it used the 12-month average USD LIBOR rate and applied no risk premium, concluding that the HDD purchase did not pose a material risk. The result was an additionally calculated remuneration for tying up funds in stocks.

Opinion of the Supreme Administrative Court

The SAC agreed with the conclusions of the Regional Court in Brno, which stated that the tax administrator did not sustain the burden of proof within the meaning of Section 23(7) of the ITA. Crucially, no relevant comparative analysis was provided and there was no justification for the use of USD LIBOR rate. The Court pointed out that the rate in question serves as a reference rate for short-term interbank loans, neither RRD nor the Irish counterparty being banking institutions.

Conclusion and significance of the decision

The SAC concluded that the use of USD LIBOR was not based on the economic reality of the transaction. There was also no supporting comparative sample or explanation as to why it was not possible to construct such a sample. For this reason, the court found the tax administrator’s procedure unreviewable.