Almost no guidelines on possible VAT implications of TP adjustments in EU
International operating businesses are confronted with Transfer Pricing rules and Transfer Pricing adjustments to ensure that profits are determined based on the so-called “arm’s length principle”. TP adjustments may also have VAT consequences. It is striking to see that guidance from the tax authorities in the EU on the VAT consequences of TP adjustments is almost absent. In a survey conducted by Deloitte only Austria responded that it has guidelines in place. But if there is no guideline from tax authorities, what can you as a business do?
28 November 2017
- The essential principles of transfer pricing
- Taxable amount and the arm’s length principle
- Potential impact of transfer pricing rules
- Deloitte survey
The essential principles of transfer pricing
The cornerstone of transfer pricing rules is the so-called "arm's length principle" which establishes that the conditions of a transaction between associated enterprises must not differ from those which would have governed a transaction between independent enterprises under similar circumstances. This principle is outlined in OECD Transfer Pricing Guidelines which are not binding. These Guidelines are a point of reference for national tax authorities in applying the arm’s length principle, and they are explicitly mentioned in the legislation or administrative guidance of many Member States for Corporate Income Tax purposes.
Where it is established that a transaction between associated enterprises is not at arm's length, adjustments must be made in order to replicate the conditions of that transaction, had it been carried out between independent parties. Adjustments can be made either by a tax administration after the company’s tax return is filed or by the taxpayer before the company’s tax return is filed.
At EU level, the European Commission has committed to work with EU Member States and businesses with a view to develop a coordinated and more concrete implementation of transfer pricing rules within the EU, reflecting the economic reality of the Single Market.
Taxable amount and the arm’s length principle
A supply of goods or services is subject to VAT when made for consideration by a taxable person acting as such, according to the VAT Directive. The general rule in the VAT Directive provides for the taxable amount to be everything which constitutes consideration, understood as the subjective value (the price actually paid).
There is one fundamental difference between the scope of application of the provisions in the VAT Directive and that of the transfer pricing rules: while the arm's length principle must be generally observed in all intra-group transactions under the transfer pricing rules used for the purposes of direct taxation, the scope of the arm's length principle set out under the VAT Directive seems much narrower. In fact, this rule is optional for EU Member States to apply, and it can only be used in order to prevent tax evasion or avoidance in a set of well-defined circumstances.
Therefore there is a tension between the transfer pricing rules set out for the purposes of direct taxation which, based on the arm's length principle seek to arrive at the arm's length valuation of a transaction (the open market value), and VAT rules, generally based on the existence of a supply for consideration, where consideration is seen as a subjective value (the price actually paid).
Potential impact of transfer pricing rules
As described earlier adjustments can be made by the tax authorities or by the taxpayer. When tax authorities make an adjustment this is a so called primary adjustment. The TP adjustment will also have an effect for the counterparty involved. An adjustment at the level of the counterparty is called corresponding adjustments. Those TP adjustments do not give rise to VAT consequences because the adjustments are limited to the balance sheet of the companies.
Tax authorities may want taxable persons to bring their books in reality to the adjusted situation and may require them to process the primary and corresponding adjustment as a dividend payment, informal capital contribution or notional loan in their books. This is called a secondary adjustment. Because the CJEU has considered a dividend payment not a remuneration for a supply of service and has also ruled that the granting of shares in return for a capital contribution is not a taxable supply for VAT these secondary adjustments will not have VAT consequences. A loan however is a taxable supply for VAT. This means that a notional loan may have VAT consequences.
VAT consequences are most likely to occur in case of compensating adjustments that the taxpayer makes himself. Compensating adjustment may result in a price adjustment of a supply of goods or services or a separate supply of services in itself.
An actual payment of VAT might not have to take place when e.g. the (underlying) supply is subject to an exemption/zero rate or the reverse charge legislation. Still there are reporting obligations and a lack of meeting those obligations might result in penalties.
In November 2017 Deloitte conducted a survey amongst the 28 Member States of the EU and Norway, Switzerland and Turkey. Austria and Turkey where the only two countries confirming that there is an official regulation or policy from the tax authorities on the VAT consequences of TP adjustments.
The Turkish guidance mainly focusses on VAT deduction of VAT amounts paid during importation regarding disguised profit distribution via transfer pricing.
The Austrian tax authorities published Transfer Pricing Guidelines which contain a section on VAT. TP adjustments are usually regarded as changes of the taxable amount as mentioned in art. 90 VAT Directive. The tax authorities state that usually no correction is necessary for VAT if the omission does not have an impact on the Austrian tax revenue and the VIES system, e.g. because the underlying transaction is a zero rated intracommunity supply of goods. It is unclear whether this simplification can be applied outside of tax audits. It is finally important to note that in the countries involved in the survey TP adjustments may also have an impact on customs valuation.
Because there are almost no guidelines from the tax authorities businesses are left with applying the general VAT rules on their TP adjustments. Deloitte has experience in the EU in supporting clients determining what the VAT consequences of TP adjustments are and obtains individual rulings with tax authorities on a regular basis. It must be noted that the position tax authorities take varies per Member State. The intended more coordinated approach of the European Commission would thus be welcome. In the meanwhile the VAT consequences of TP adjustments remain a grey area where business need to consider which action to take. We are happy to help you with that.