When are Transfer Prices Subject to VAT?

The Romanian company SC Arcomet Towercranes SRL (hereinafter as ‘Arcomet RO’) concluded a contract with its foreign parent company Arcomet Service NV Belgium (hereinafter as ‘Arcomet BE’) in which Arcomet BE undertook, among other things, to fulfil certain commercial obligations such as strategy and planning, negotiating (framework) agreements with external suppliers or negotiating the terms of financing agreements, while at the same time bearing the main economic risks associated with the activities of Arcomet RO. 

In connection with the net margin transaction method set out in the OECD guidelines, it was agreed that if operating margin of Arcomet RO exceeds 2.74%, Arcomet BE would issue an annual adjustment invoice to Arcomet RO. On the contrary, if operating margin of Arcomet RO was lower than −0.71%, Arcomet RO would issue an adjustment invoice. If the operating margin was between −0.71% and 2.74%, no remuneration would be paid. The question was whether these adjustments were subject to VAT or not.

According to the interpretation established by the Court of Justice, the provision of a service subject to VAT is conditional upon:

• the existence of a legal relationship between the provider and the recipient of the service, and
• the existence of a link between the service provided and the consideration received (remuneration), which must represent the actual consideration for the individualised service provided to the recipient. 

In the case in question, the Court of Justice only dealt with the situation where operating margin of Arcomet RO was higher than 2.74%, and therefore Arcomet BE was entitled to payment of the remuneration.

According to the Court of Justice, the first condition mentioned above concerning the existence of a legal relationship was fulfilled, as a contract was concluded under which Arcomet BE undertook to provide specific services in return for remuneration.

Attention was then focused on the existence of remuneration for the services provided. It was stated that the fact that the remuneration is variable and depends on the operating margin of Arcomet RO is not in itself problematic, as remuneration defined in this way is not gratuitous, random, difficult to quantify or uncertain, but its conditions are set in advance and according to precise criteria. It was further stated that the services provided by Arcomet BE affected operating margin of Arcomet RO by enabling costs savings or the improving the quality of services provided to end customers. According to the Court of Justice, the second condition was also fulfilled, and it was therefore concluded that the transaction in question was subject to VAT.

However, according to existing case law of the Court of Justice, testing the actual consideration is not so straightforward and requires a more detailed analysis, which is lacking in the Court of Justice's decision. In established practice, emphasis is placed on the specific conduct of the entity and the assessment of the connection between such conduct and the contractually defined remuneration. The VAT Committee, which consists of representatives of the Member States and the European Commission, and which took a rather uncritical stance on the Court of Justice's decision in the Arcomet case, did not provide complete clarity on this issue either.

There is no doubt that the application of transfer prices in most cases impacts VAT, as has always been the case. In specific cases, however, the condition of actual consideration will not be met. These cases require careful analysis, as incorrect application of VAT may affect the amount of VAT payable or, conversely, lead to an unjustified deduction claim. If you are interested in this topic, please do not hesitate to contact our experts. We would be happy to discuss your specific situation and review your contractual documentation.

Authors:

Eliška Šťastná, Senior Consultant, Tax Department

Petr Drahoš, Senior Manager, Tax Department