Key International Court Rulings on Transfer Pricing: Insights for German Enterprises

The second part of 2024 witnessed several decisive international court rulings in the field of transfer pricing. These rulings, originating from various jurisdictions, can be significantly impactful for German multinationals, as they not only provide valuable insights for German headquarters with global operations – particularly in the countries where these decisions were made – but also offer precedents that can be beneficial in discussions during German tax audits. By understanding these cases, German businesses can gain strategic advantages in navigating the complex transfer pricing landscape, shaping their strategies and ensuring compliance. Our team has compiled and summarized some of the most notable cases from overseas, organized by topic for easy reference.

1. Business Restructurings

1.1. Netherlands vs. Holco BV (1)

On July 11, 2024, the Amsterdam Court of Appeal issued a notable ruling in case 22/2419, siding with the Dutch tax authorities. This decision serves as a reminder to taxpayers of the critical importance of maintaining robust, comprehensive, and consistent transfer pricing documentation in relation to business restructurings to withstand scrutiny during tax audits and avoid impactful tax adjustments.

The case focused on a business reorganization where a Dutch company transferred assets and liabilities – including inventories, ongoing sales and purchase contracts, as well as some employees – to a related company in Switzerland. Although the taxpayer argued that only specific assets and liabilities were transferred for legitimate business reasons, the Court of Appeal concluded that more was involved. The Court understood that "something of value" on top of the market value of the assets and liabilities, such as essential business functions and profit potential, was transferred both contractually and economically. This conclusion was supported by a significant change in the function and risk profile of the entities involved, as well as the fact that, after the reorganization, the Dutch entities experienced a notable decrease in profit and cash flow, while the Swiss entity saw an increase. The Court's approach is consistent with Chapter 9 of the OECD Guidelines, which addresses the need for a thorough analysis of the functions, assets, and risks involved in business restructurings, and employs a similar approach to the German transfer of functions rules, which emphasize evaluating the full scope of the transferred business value, including intangible assets and potential profit shifts.

Also, an interesting aspect of this case is that, prior to filing its tax return, the taxpayer submitted an Advance Pricing Agreement (APA) request to the Dutch tax authorities. This request included a detailed description of the functions, assets, and risks both before and after the reorganization, along with a transaction valuation of approximately 7.7 million euros. Without reaching an agreement on the APA, the taxpayer then filed its tax return without including the mentioned functional analysis and reported a taxable amount of approximately 1.8 million euros. This inconsistency led the Court of Appeal to determine that the Dutch company did not prepare the appropriate corporate income tax documentation, thereby shifting the burden of proof to the taxpayer. Overall, the decision serves as a critical reminder for multinational companies to ensure robust transfer pricing analyses and documentation that aligns with all other information available to the tax authorities, ensuring no gaps exist in the written records, thus ensuring avoidance of substantial tax liabilities.

When it comes to the valuation, the Lower Court engaged an independent valuation expert to determine the minimum value of the transferred business, who set a value of EUR 84.7 million. However, the premises used by the expert were questioned by both parties and the Court of Appeal ultimately ruled that the value should be EUR 128 million, based on their understanding that: (i) a reasonable estimation was more appropriate than the expert's median price approach, given the specifics of the case; (ii) it was justified to follow the Dutch tax authorities' method to gross-up the purchase price by 80% for tax amortization, due to the taxpayer's failure to provide sufficient information on the Swiss company's tax treatment of the reorganization; (iii) the tax authorities' projected inflation expectation of 2% was deemed reasonable, as opposed to the taxpayer's insufficiently substantiated rate of 1%. This case shows that even with an independent valuation expert appointed by the court, it might be important for parties to hire another valuation expert to challenge valuation assumptions, as this could provide additional perspectives and potentially highlight any overestimations or underestimations in the court-appointed expert's analysis.

1.2. Portugal vs “A Mining S.A." (2)

On October 2, 2024, the Supreme Administrative Court in Portugal issued an important ruling in the case 0120/12.9BEBJA 01224/16, siding with the taxpayer and overturning a previous decision by the Administrative Court. The case addressed the timing of when companies are considered related parties for transfer pricing purposes.

The case centered around the sale of a mining wash plant to a company, with which the taxpayer was associated until shortly before the sale. The tax authorities had classified the transaction as a controlled sale, as it was negotiated while the companies were still related, and adjusted the agreed price based on Portuguese arm's-length rules.

However, the Supreme Court understood that the assessment of 'special relationships' — which implies significant influence over management decisions — should be determined at the time the deal is concluded, and not when it is negotiated. Since the companies were no longer related at the point of sale, the Supreme Administrative Court ruled that the pricing adjustment was unjustified. The Court also noted that if the Portuguese tax authorities believed the sale price was unjustifiably low or the transaction was carried out with abuse of legal forms, they should have considered other mechanisms, such as the 'general anti-abuse clause.'

This ruling highlights the crucial need for taxpayers to carefully document the timing of relatedness in their transfer pricing records, ensuring these records accurately reflect the status at the time transactions are carried out. It also stresses the importance for tax authorities to consider alternative approaches, such as the 'general anti-abuse clause,' when evaluating the legitimacy of transactions, rather than automatically resorting to transfer pricing adjustments. This is due to the necessity of aligning the legal form of transactions with their economic substance, urging tax authorities to focus on the actual economic impact rather than merely the formal aspects.

Furthermore, the Portuguese ruling indirectly confirms the possibility of applying the CUP method to transactions conducted under equal terms and conditions before and after a change in ownership, echoing older German jurisprudence.

2. Economic Analysis and TP Methods

2.1. Italy vs Convergys Italy S.R.L (3)

On July 16th, 2024, the Italian Supreme Tax Court issued a landmark decision on case 19512/2024 that challenged the Italian tax authorities' approach to transfer pricing benchmarking analyses. The Court definitively rejected the practice of automatically excluding loss-making companies from the set of comparables, deeming it inconsistent with the OECD TP Guidelines. This ruling came in favor of the taxpayer, which had been providing call center services to a related Dutch company with a 5% mark-up on costs. The Italian tax authorities had argued that this mark-up was below the arm's length value, based on a benchmarking analysis in which they excluded companies with operating losses in at least two out of three years or those lacking financial data for some years. This exclusion led to a revised arm's length mark-up of 7.42%.

The case underwent several rounds of appeals, with the tax authorities challenging a provincial tax court decision that favored the taxpayer. The company subsequently appealed the regional tax court's decision to the Supreme Tax Court, citing an unlawful violation of the arm's length principle. In its decision, the Supreme Tax Court emphasized that the exclusion of certain companies was not justified and did not align with the OECD TP Guidelines. The Court highlighted that business strategies, as recognized in Paragraph 1.59 of the OECD Guidelines, may involve incurring losses to achieve future gains, and such situations should not automatically disqualify companies from being considered comparable. The Court further clarified that only companies in "special situations," such as start-ups, bankrupt companies, or those in liquidation, should be excluded from comparability, as per Paragraph 3.43 of the OECD Guidelines.

This decision underscores the importance of a nuanced approach in transfer pricing analyses, ensuring that exclusions are justified and aligned with international standards. By demanding a more rigorous justification for exclusions, the ruling promotes a fairer and more transparent approach to transfer pricing, ensuring that assessments accurately reflect market realities and do not unfairly disadvantage taxpayers. It serves as a reminder to tax authorities in Italy and worldwide to apply a balanced and well-reasoned methodology in their analyses, thereby reducing the potential for disputes and fostering trust in the tax system. In this context, taxpayers in Germany, who often face similar challenges from the German tax authorities, can leverage the reasoning of the Italian court, particularly the interpretation of the OECD Guidelines, to defend their cases when economic analyses include loss-making comparables.

2.2. UK vs Refinitive and others (Thomson Reuters) (4)

On November 15th, 2021, the UK Court of Appeal issued a significant ruling concerning the legitimacy of a tax assessment imposed on three UK-based companies within the Thomson Reuters group. The central issue was whether the tax assessments for the fiscal years 2015-2018 were inconsistent with an Advance Pricing Agreement (APA) previously established between the companies and tax authorities in January 2013.

This APA, which was in effect from October 1, 2008, to December 31, 2014, outlined a specific transfer pricing method for certain intercompany services between UK companies and a Swiss entity within the Thomson Reuters group. The UK companies provided intellectual property (IP) services to the Swiss company, which held the group's main IP assets. In 2018, the Swiss company sold the IP at a significant profit to one of the related UK companies. The tax authorities argued that the IP services provided by the UK group companies increased the value of the IP held by the Swiss company, leading to substantial profits being allocated to it, including contributing to the capital profits from the IP sale in 2018. Since the Swiss company was taxed at lower rates than the UK companies, the authorities argued that the UK companies did not receive appropriate compensation for these services, as would have been the case if the services had been provided at arm's length.

Following the expiration of the APA, the UK tax authorities determined that a cost-plus methodology for the IP services provided by the UK companies was no longer suitable. Instead, they proposed a profit-split methodology. The companies objected, asserting that the tax authorities were bound by the transfer pricing method specified in the APA. However, the Court of Appeal concluded that the accounting period was outside the temporal and effective scope of the APA, rendering the agreement inapplicable for that period. Consequently, there was no legal objection to the tax assessments made by the UK tax authorities for that timeframe.

This judgment underscores the importance of monitoring the duration of APAs and stresses that expired agreements do not bind tax authorities when assessing future periods. It also highlights the necessity for companies to consider renewing their APAs, if applicable, or even reviewing and updating their transfer pricing arrangements to align with changing business conditions, regulatory requirements, and changes in the interpretation and application of the arm's length principle. This decision, for instance, highlights a trend towards a shift in how high-value-adding services are assessed and treated, drifting away from the previously common acceptance of a cost-plus approach.

3. Financial Transactions

3.1. Switzerland – Safe Harbor Interest Rates (5)

The Swiss Federal Supreme Court issued a landmark judgement on intragroup loan interest rates in the case 9C_690/2022 on July 17, 2024. The ruling centered around a Swiss company that had been granted loans within its group at interest rates higher than the administratively established safe harbor rates, which led to a tax assessment by the Zurich authorities. The assessment was justified based on recalculations to fair-market rates (i.e., arm's length rates), resulting in significant tax liability for the company.

The Court's decision emphasized that if safe harbor interest rates are exceeded, then the entire arm's-length interest rate must be reassessed, and not just the excess. In other words, the Swiss Supreme Court rejected the taxpayer's argument that only the excess over the safe harbor rate should be disallowed. The ruling reflects a "quid pro quo" approach, meaning only compliant taxpayers can expect tax authorities to adhere to the safe harbor circulars. Non-compliance with these rates frustrates the objective of administrative simplification, as tax authorities must then verify whether the agreed interest rate aligns with the arm's length principle.

By clarifying the conditions and extent under which safe harbor rates are binding in financial transactions in Switzerland, this Supreme Court decision serves as an important reminder for multinationals to carefully evaluate, on a case-by-case basis, whether it is worthwhile to apply the safe harbor rules to their intercompany loans or not. Additionally, it underscores the importance for taxpayers to maintain thorough documentation and justifications for interest rates applied within group transactions to mitigate the risk of adverse tax assessments. Similar considerations make sense also for other safe harbor rules, highlighting the need for careful evaluation and documentation across various contexts.

Takeaways

Staying informed about international transfer pricing court cases is crucial for German businesses operating globally. These rulings provide valuable insights and precedents that can influence transfer pricing strategies and compliance.