After years of reading thousands of pages on direct taxation under the BEPS project and the EU initiatives to counteract aggressive tax planning, I have welcomed as a relaxing read the consultation sent by the EU Commission to the VAT Committee on VAT implications of transfer pricing.
This document is very well-written (you can find it here), and in just 24 pages it clearly shows the different approaches towards market value governing direct and indirect taxation.
The EU Commission reminds us that, while the arm’s length principle is the core rule that multinational groups must abide for direct tax purposes, in the case of VAT, the taxable base of transactions is the consideration agreed by the parties.
Any VAT specialist learns in the first month of practice that consideration is the subjective value the parties give to a transaction and not a value estimated by objective criteria (ECJ cases, e.g, Naturally Yours and Astra Zeneca). By contrast, all transfer pricing practitioners will tell you that the price agreed between related parties has no real value for direct tax purposes when it deviates from market value.
Moreover, in the field of VAT, it is unimaginable that the rules would force someone to pay a price it has not agreed to. This was clarified by the EU Court of Justice in the Tolsma case, my favorite ECJ judgment of all times. The idea of a tax inspector admonishing a street musician for not having charged VAT on the coins passers-by drop in a tin has always amused me. The lesson from this case is clear: in the VAT world, it is impossible to presume the existence of a price when there is no legal obligation binding a supplier and its client. However, in the world of direct taxation, we constantly see the tax authorities claiming that a company is performing services for the benefit of its related parties, and despite the lack of any legal obligation to carry out such tasks, they justify reallocations of income.
The consultation acknowledges that article 80 of the VAT Directive envisages an anti-abuse rule under which the tax authorities can argue the application of an open market value for certain transactions among related parties. But the scope of such exceptional rule is limited to those cases where one of the parties involved (either the supplier or the recipient) is not entitled to full VAT deduction, and by deviating from market value, someone obtains a higher than fair VAT deduction.
The consultation raises many other interesting questions, such as the tax treatment of secondary adjustments. While for direct tax it is clear that deviating from market value usually involves an unjustified payment that should be taxed according to its underlying cause (usually a hidden dividend or an informal capital contribution), nothing in the VAT Directive would prompt a similar conclusion.
Although the Commission does not deal with this issue in detail, it stresses that in the Customs Code, there are rules that bring to mind the market price used in corporate taxation. Obviously, since the customs value is the VAT taxable base of imports, all transfer pricing adjustments made by customs officers have a direct impact over VAT. Those of you with a deeper interest in Customs are surely aware of what will certainly be a ECJ landmark case on transfer pricing and customs: case C-529/16 Hamamatsu Photonics Deutschland GmbH, pending decision.
The differences highlighted by the Commission regarding VAT and income taxation treatment of internal transactions (more accurately, internal allocations) between companies and their foreign permanent establishments are also noteworthy. While in the VAT world, these are close to science fiction (as the AG Léger stated in its opinion on FCE Bank), the OECD Model Convention strongly supports them under the “separate enterprise” approach.
To sum up, the EU Commission acknowledges that the interaction between transfer pricing and VAT is a complex matter where all of us need guidance. In any case, we can all agree that the amounts of VAT that a tax administration could claim after applying a corporate tax transfer price adjustment would be so huge that clarifying this matter is of the essence. The mix of VAT and transfer pricing today is probably as bad as oil and water, but this may change soon and, sadly enough, not for the benefit of taxpayers. Therefore, let us stay tuned on this topic!