VAT regime for transfer pricing settlements – is clarification finally coming?

In light of the recently published opinion of the Advocate General of the CJEU in Case C-726/23, we are revisiting the issue of the VAT treatment of profit settlements under transfer pricing contracts (“TP adjustments”). We consider profit settlements to be profit adjustment between related parties, ideally on the basis of transfer pricing documentation or a contract, usually made ex post. This brings us to an issue that has not yet been clearly grasped or even resolved and where it is still unclear whether the various types of payments on grounds of profit settlements constitute, from the perspective of VAT, a payment for a service, a change in prices for goods supplied if they are supplied between the entities, or a financial settlement that would be outside the scope of VAT. In our consulting practice, we commonly encounter all of the above-mentioned options, even when discussing the issue with colleagues from the neighbouring countries.

The fact that this is a topical and important topic is evident, for example, from the case law concerning the so-called parent company order, where the tax consequences of the proceedings by the related party are unfortunately only dealt with ex post. The aforementioned TP adjustments have to be applied differently within and outside the EU and the situation is often complicated by the fact (as in this case) that it is not possible to incorporate the adjustment into the price of the traded goods. It is important to consider that transfer pricing as a construct for income tax is based on the allocation of profits based on functions, risks and assets, whereas VAT is transaction-based and examines the actual transaction and its consideration. The VAT and TP regime is thus inherently contentious.

The domestic tax administration has not yet issued any generally binding assessment on VAT assessment of TP adjustments. The GFD guidelines address TP adjustments only from an income tax perspective. So far, perhaps only the VAT Expert Group at the European Commission has commented on the issue, but its conclusions are not binding and have not been subsequently adopted by representatives of individual EU Member States. Indeed, this is probably why the Advocate General began his reflections by saying “It might be tempting to give a fundamental answer to this question of whether transfer prices and their adjustments are subject to VAT or not”.

In the present case, the situation, is one in which a Romanian subsidiary purchases (or rents) cranes and resells or rents them to its customers, while the Belgian parent company seeks out suppliers for its subsidiaries and negotiates contractual terms with them. The TP study then stipulated that subsidiaries should have an operating margin within a certain range (-0.71% to 2.74%), which was thus guaranteed to the subsidiaries, with annual invoices being issued if this margin was exceeded (in the case of excess profits, the parent company would issue the invoice, and in the case of excess losses, the subsidiary would issue the invoice). In the case in question, the Romanian company made a higher profit and the Belgian parent company issued invoices for the respective years, two invoices without VAT for the supply of services (i.e. under the reverse charge regime) and one without VAT because the supply was outside the scope of VAT. The tax authority disputed the claims for deduction on the invoices received by the Romanian company. The fundamental question, which the Romanian national court referred to the CJEU, is whether the amounts invoiced by the parent company constitute consideration for services rendered, which are subject to VAT.

The Advocate General began by mentioning the difference between the OECD rules on transfer pricing and the methods of calculating them compared to the VAT principles. He also mentioned the fact that the proposals of the VAT Expert Group at the European Commission were not adopted and therefore it is necessary to assess in each individual case whether the general characteristics of a supply of services for consideration as defined by the VAT Directive are fulfilled. For this purpose, it is necessary to assess whether “a legal relationship exists between the provider and the recipient, under which mutual benefits are provided, the remuneration received by the provider representing the actual consideration for the personalised service provided to the recipient”. According to the Advocate General, these prerequisites were met in the present case, and it is not important that the amount of the remuneration is in itself indeterminate, nor that in the event of higher loss an invoice is issued by the subsidiary. The Advocate General therefore proposes that the Court should rule that “the remuneration for intra-group services provided by the parent company with commercial responsibility to the subsidiary, as set out in detail in the contract and calculated in accordance with the net margin method recommended by the OECD Directive, must be regarded as consideration for the provision of services for consideration ... and must be subject to VAT”.

Of course, it is not guaranteed that the CJEU will follow the Advocate General’s proposal in its decision, but in practice this is the case in the vast majority of cases. The decision of the CJEU will be known in a few weeks or months and it is clear that it will provide crucial guidance on how to approach the VAT treatment of settlements for transfer pricing purposes. Any changes or risks involved will then mostly affect groups where companies cannot claim full VAT deductions. In other words, the widespread application of the conclusion could have major financial implications, especially for financial institutions, insurance companies, health care facilities, etc.

We will, of course, keep you informed of the CJEU’s decision in this case, as well as any subsequent conclusions of our Tax Administration. In any case, we recommend to all those affected by the transfer pricing to monitor the development and, in particular, to consult the current settings. The starting point for the application of similar settlements and their subsequent defence is an adequately set up contractual relationship and well-drafted TP documentation. In the light of developments, it may be necessary to review these types of contracts or, where appropriate, to reconsider the VAT settings. Nevertheless, in practice, we often encounter the absence of adequate documentation or problematic historical settings, which are unfortunately not risk-free.

If you have any questions about this topic, please do not hesitate to contact us.