ECJ rules on the Arcomet case concerning transfer pricing adjustments

Facts

A Belgian company belonging to the Arcomet Group provided intermediary services relating to the purchase of cranes to a Romanian company belonging to the same group. The remuneration for these services was based on the range of arm's length net profit margins. At the end of the year, a check was conducted to determine whether Arcomet Romania had achieved this. In the years under dispute, the Romanian company had made compensation payments to the Belgian company that had provided the intermediary services because Arcomet Romania had achieved a profit above the range. Arcomet Belgium issued three invoices. These invoices did not contain any information about the nature of supply, the hours worked, the resources used or the calculation method. Arcomet Belgium treated two of these invoices as reverse charge invoices for intra-Community services and declared the corresponding output and input VAT in its Romanian VAT return. With regard to the third invoice, Arcomet Romania assumed that it related to a non-taxable transaction.

The Romanian tax authority claimed on one hand that Romanian VAT was due on all invoiced amounts. On the other hand, Arcomet Romania could not deduct this VAT as it was not clear that the invoices related to supplies actually performed for VAT taxed activities.

The Romanian tax court referred the following questions to the ECJ for a preliminary ruling (simplified):

1. Is there a remuneration for a supply when such a transfer pricing adjustment is made?
2. If so, may the tax authorities request additional documents, apart from the invoice, to prove that the supply purchased was used for the purposes of the recipient's taxable transactions?

ECJ ruling

The first question essentially concerns whether a direct link exists between the services of Arcomet Belgium and the additional amounts charged under the transfer pricing adjustment. If so, the additional amounts charged were a taxable remuneration for a supply. The problem was that at the time the supply was provided, it was not clear whether Arcomet Romania's profit margin would fall within the range or whether and to what extent a compensation payment would have to be made.

The Advocate General had dealt with this in more detail in his opinion and cited ECJ judgment C-713/21 of 9 February 2023 as a reference: The plaintiff in this case took tournament horses into his care and invoiced the owners for this. He participated in tournaments with these horses, and any prize money was payable to the owners of the horses. The owners, however, assigned their claims to any prize money to the plaintiff on a pro rata basis from the outset. The ECJ ruled that the proportional prize money was remuneration for taking the horses into care and that the uncertainty as to whether and in what amount prize money would be paid did not negate the direct link between supply and consideration. Applied to the Arcomet case, this meant for the Advocate General that the uncertainty of the amount of remuneration should also be irrelevant here.

The ECJ takes up the issue and states that uncertainties regarding the existence of remuneration can, in principle, negate the direct link. In the Arcomet case, however, the remuneration was variable in nature, but neither random, difficult to quantify nor uncertain within the meaning of previous ECJ case law because the remuneration criteria were precisely defined in the contract between Arcomet Romania and Arcomet Belgium. As a result, the payments based on the transfer pricing adjustment were remuneration for the intermediary service (with regard to all three invoices).

With regard to the second question, the ECJ first notes that the invoices did not meet the formal requirements due to the lack of a description of the supply, but that this would only justify the refusal of input VAT deduction if it prevented proof of the material requirements. In order to verify these material requirements for VAT deduction, the tax authorities may request further evidence from the taxable person, who bears the burden of proof in this respect. However, this can only concern whether the supplies purchased were used for the purposes of the taxed output supplies, and not whether they were necessary or appropriate.

Evaluation

The VAT treatment of transfer pricing adjustments has always been fraught with uncertainty. Three alternatives are conceivable: the transfer pricing adjustment leads to a change in the taxable amount in accordance with § 17 of the German Value Added Tax Act (Art. 90 of the VAT Directive), increases are remuneration for an independent supply (an independent supply is of course out of the question in the case of reductions), or they have no effect at all. According to Federal Fiscal Court (BFH) case law, a change in the tax taxable amount only occurs if a subsequent event influences the direct link between the supply and the remuneration. There must be a subsequent agreement that is binding under civil law. However, lump-sum off-balance sheet adjustments, for example due to hidden dividends or hidden contributions, are not subsequent agreements between the parties. However, this case law does not specifically refer to transfer pricing adjustments.

In its recommendation of 18 April 2018, VEG N° 071 REV2, the VAT expert group holds that all types of transfer pricing adjustments in the B2B sector should be considered irrelevant for VAT purposes if the parties involved are fully entitled to deduct input VAT. However, this recommendation has not been implemented.

This situation is extremely unsatisfactory for businesses. Even if they treat the transfer pricing adjustment as a change in the taxable amount in accordance with § 17 of the German Value Added Tax Act /Article 90 of the VAT Directive, follow-up questions arise regarding a possible need to exchange documents and the timing of the correction. It should also be noted that the ECJ has only ruled on a very specific constellation of transfer pricing adjustments. The ruling cannot therefore be applied one-to-one to other situations. Above all, the treatment of cases in which the transfer pricing adjustment cannot be clearly assigned to specific supplies and cases of downward transfer pricing adjustments, i.e. potential reductions the price, remain open. No general answer can be given to the question of the degree to which uncertainty in the sense of a direct link is tolerable. 

One way to gain some certainty in this situation is to align the company's transfer pricing agreements as closely as possible with the Arcomet case. Existing transfer pricing regulations should be analysed accordingly. If transfer pricing adjustments deviate from the Arcomet case, it is essential to seek professional tax advice. Under certain circumstances, it may be advisable to disclose the chosen VAT treatment of transfer pricing adjustments to the tax office.

Author: Nadia Schulte