VAT and possible implications transfer pricing rules OECD: an update
On March 29, 2017 the European Commission published Working Paper No 923 in which the Commission wishes to discuss the possible VAT implications of transfer pricing. The members of the VAT Committee are requested to give their opinion on the issues raised in the Working Paper.
7 April 2017
The European Commission requests the VAT Committee to discuss the possible VAT implications of transfer pricing rules laid down for the purposes of direct taxation. Such rules are aimed at ensuring that the conditions of the transactions within a multinational enterprise group, including the price, match comparable market conditions and that profits are fairly divided between the jurisdictions in which a multinational enterprise operates.
The purpose of the Working Paper is to examine whether the application of such transfer pricing rules could have VAT implications for EU Member States, in an attempt to provide legal certainty for businesses and tax administrations. According to the European Commission the main aspect which should be looked at is whether transfer pricing adjustments could be seen as consideration given in exchange for a supply.
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 naturally not binding. They 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.
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 actually received.
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, according to the European Commission, 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 regards the interaction between transfer pricing and VAT, transfer pricing adjustments (upwards or downwards) might have VAT implications, for instance, where such an adjustment could be seen as more or less consideration given in exchange for a taxable supply of goods or services already made. If an adjustment is found to constitute more or less consideration for a supply, this could arguably lead to an increase or decrease in the VAT taxable amount of that transaction.
For there to be any VAT implications, though, it is necessary for there not only to be a supply for consideration but also for the consideration to be directly linked to that supply. According to the European Commission, this should be assessed on a case-by-case basis. In order to assess whether the above requirements are met, several aspects should be taken into account:
- Interaction between direct and indirect taxation
Although the European Court of Justice has never expressly dealt with this issue, it has in the past limited the potential correlation between a direct tax rule and the rules laid down in the VAT Directive.
- Existence of the arm's length principle in the VAT Directive
While the VAT Directive acknowledges the possibility that the price at arm's length may have to be used under certain conditions in order to determine the taxable amount of a supply of goods or services based on the arm's length value, the general rule laid down in the VAT Directive is that the taxable amount is everything which constitutes consideration, understood as the subjective value actually received.
- Existence of consideration
For a transfer pricing adjustment to possibly be seen as more or less consideration given in exchange for a supply, it seems that such adjustment must not only be made for tax purposes, but it has to be reflected in the accounts of the parties to the transaction. In other words, there has to be an actual element which could be identified as extra consideration for the supply already made.
- Existence of supply
A payment, either in money or in kind, could only be seen as consideration where made in return for a taxable supply of goods or services. Therefore, it must be possible to link that payment to a specific transaction. Where transfer pricing adjustments are made on the basis of aggregated amounts, it should be possible to allocate them to individual transactions in order for them to have VAT implications.
- Existence of a direct link between supply and consideration
To fall within the scope of VAT, there must be a direct link between such payment and the goods or services received. According to the European Court of Justice such a direct link is established if there is a legal relationship between the provider of the service and the recipient pursuant to which there is reciprocal performance, the remuneration received by the provider of the service constituting the actual consideration given in return for the service supplied to the recipient. Based on the existing case-law of the European Court of Justice as regards the existence of a direct link, it is unclear whether transfer pricing adjustments would always meet this requirement.
This Working Paper, which was only recently published by the VAT Committee, provides the basis for a discussion during meetings of the VAT Committee. These meetings will presumably result in VAT Committee Guidelines, which ultimately might lead to changes in the EU VAT legislation. However, it usually takes more than a year before these Guidelines are published and these VAT Committee guidelines are not binding.
Transfer pricing and its possible VAT implications is very much alive within the European Union taking into consideration the potential VAT implications of the BEPS project outcome and the VAT Action Plan. VAT consequences of transfer pricing adjustments is something that you should take into consideration when making and administering transfer pricing adjustments. We are of course happy to help you with this.