CJEU ruling on VAT and Transfer Pricing adjustments

What does this mean for your organisation?

In essence, the CJEU confirms that where there is a legal relationship involving reciprocal performance and identifiable services against a payment, this payment constitutes consideration for taxable services subject to VAT. This is not affected by the fact that the consideration is based on TP-arrangements and dependent on the operational profit of the subsidiary, nor by the fact that the payment is reversed in case of a profit margin below -0,71%. 

However, the CJEU also emphasizes that the VAT implications of TP-adjustments must be determined on a case-by-case basis. In our view, the Court's decision should not be interpreted as establishing a general principle that all TP-adjustments are subject to VAT. This particular judgment applies specifically to situations where there is a contractual (service) agreement with reciprocal performance obligations and actual payments between the parties. Notably, the CJEU did not address situations where TP-adjustments relate to previous transactions that have already been completed, nor did it cover cases where adjustments are made exclusively for direct tax purposes without any actual payment being made between the parties involved.

For businesses, this judgment highlights the importance of reviewing intercompany service agreements and their VAT treatment from the outset. Companies should ensure that TP-arrangements are properly documented not only for direct tax purposes but also with VAT implications in mind. Additionally, this judgment confirms that tax authorities can require documentation beyond invoices to substantiate VAT deductions, provided this is done proportionately. Organizations should ensure that they maintain robust supporting documentation that clearly evidences both the existence of services and their use for taxable transactions.

Background

SC Arcomet Towercranes SRL (‘Arcomet Romania’), part of the Arcoment group, purchases and leases cranes which it then sells or rents to its customers. Arcomet Services NV Belgium (‘Arcomet Belgium’), a parent company of Arcomet Romania, is responsible for sourcing suppliers and negotiating contractual terms on behalf of Arcomet Romania.

Following a TP-study in 2010 based on the transactional net margin method (‘TNMM’), the arm’s length operating profit margin of Arcomet Romania should be between -0,71% and 2,74%. In 2012, Arcomet Belgium and Arcomet Romania concluded a contract under which each party committed to their respective activities and responsibilities. This contract essentially guaranteed that the operational profit of Arcomet Romania complies with the TP-study by stipulating payments if the profit deviates from this range. If the operating profits of Arcomet Romania would exceed 2,74%, an annual settlement invoice would be issued by Arcomet Belgium to adjust the operating profits of Arcomet Romania to be within the margin. Conversely, if the losses of Arcomet Romania would fall below -0,71%, it would issue a settlement invoice to Arcomet Belgium.

In 2011, 2012, and 2013 Arcomet Romania’s profits exceeded the agreed margin. Arcomet Belgium issued annual settlement invoices without VAT to Arcomet Romania and declared them as supplies of services. Arcomet Romania declared the first two invoices received as intra-Community acquisitions of services and self-assessed Romanian VAT under the reverse-charge mechanism. However, Arcomet Romania considered that the third invoice was for a transaction outside the scope of VAT.

Following a tax audit, the Romanian tax authorities imposed VAT assessments to Arcomet Romania, including interest and penalties. The authorities argued that reverse charged VAT is due and cannot be recovered by Arcomet Romania as it did not sufficiently substantiate that the services as invoiced had actually been supplied and that those services were necessary for its VAT taxable supplies.

The case was brought before the Court of Appeal of Bucharest, which sought a preliminary ruling from the CJEU on whether the invoices issued by Arcomet Belgium to Arcomet Romania should be seen as consideration for VAT taxable services and whether additional documentation beyond the invoices could be required to substantiate the right to deduct VAT.

CJEU ruling

As a starting point, the CJEU reiterates that a service is VAT taxable if it is performed ‘for consideration’, i.e. if the remuneration received by the provider constitutes the actual consideration for – and is directly linked to – identifiable services supplied to the recipient. Arcomet Belgium performed commercial services and bears the main economic risks related to the operational activities of Arcomet Romania. According to the CJEU, this resulted in an identifiable benefit for Arcomet Romania, as these services had an impact on its operating margin through savings or the improvement of its services to end customers. In return, Arcomet Romania paid an amount corresponding to the operating profits exceeding 2,74%. The Court considered this to be a reciprocal performance between these entities. This constitutes consideration for a VAT taxable supply, according to the CJEU.

The Court rejected the notion that the remuneration, which was due to Arcomet Belgium based on the TP-adjustments, could be seen as mere adjustments to the operating margin of Arcomet Romania without constituting remuneration for corresponding services. The CJEU emphasized that compliance with OECD TP-principles does not, in itself, determine the VAT treatment. Where intragroup services are provided, a TP-based charge may well constitute the VAT taxable consideration for such services and this must be assessed on a case-by-case basis. The Court recalled that the mere holding of shares is not an economic activity, however this is different where the parent company such as Arcomet Belgium actively provides commercial services to its subsidiary.

Arcomet Romania was only required to pay an amount for these services if and insofar its operating profits would exceed 2,74%. However, according to the CJEU this uncertainty as to the existence and the amount of the charge does not break the direct link with the services as supplied by Arcomet Belgium. The CJEU argued that the remuneration is objectively determinable and agreed in advance, rather than gratuitous, random or uncertain as addressed in the cases of Tolsma (C-16/93 and Bastova (C-432/15). This direct link is also not broken by the hypothetical scenario that a reverse payment would have been due if the losses of Arcomet Romania would fall below -0,71%. 

On the second question, the CJEU held that the tax authorities may not refuse VAT deduction solely for invoice errors if the VAT recovery conditions can still be verified, but where the invoice requirements are not met, they may require additional, necessary and proportionate evidence to this end. Therefore, the Romanian tax authorities may require Arcomet Romania to provide additional evidence to support the fact that the services were actually rendered by Arcomet Belgium and used for taxed transactions of Arcomet Romania.