Spotlight on VAT treatment of transfer pricing adjustments

Current practice

Transfer pricing adjustments refer to the corrections made to prices quoted between related entities within a corporate group to ensure compliance with the arm’s length principle. Traditionally, such adjustments were not considered taxable events for VAT purposes. This perspective was primarily rooted in the belief that transfer pricing adjustments were merely a means of establishing suitable profit margins rather than genuine transactions. However, the opinion of the advocate general calls this understanding into question.

Arcomet Towercranes case

The case concerns two entities from the Arcomet group: Arcomet Belgium (parent) and Arcomet Romania (subsidiary), both operating in the crane sales and rental market. Over the years, the parent company provided its subsidiary with essential management services, such as negotiating contracts and managing suppliers. To ensure the subsidiary’s profit margins matched the levels set in the group’s transfer pricing agreement, Arcomet Belgium issued invoices based on the transactional net margin method, as recommended by the Organisation for Economic Co-operation and Development (OECD). However, upon inspection, the Romanian tax authorities challenged the VAT deductions claimed by the subsidiary, arguing that it failed to establish a direct link between the services provided by the parent company and its own taxable transactions.

Questions referred to the CJEU

The case is currently pending before the Court of Appeal in Bucharest, which has applied to the Court of Justice of the European Union (CJEU) for a preliminary ruling addressing the following questions (summarised):

1. Can a profit margin adjustment resulting from aligning profits with the risk-bearing method (according to the transactional net margin method) be considered as a payment for a service subject to VAT?
2. Can the right to deduct VAT be conditional on presenting additional documents that establish a connection between the service provided and taxable transactions?

Advocate general’s opinion

Before the CJEU examines a case, it is usually reviewed by an advocate general who issues an opinion based on the facts and applicable law. While such opinions are not legally binding, they offer valuable insight into the relevant points of law and often foreshadow how the case will be resolved. 

In the matter at hand, the advocate general stressed the need for a case-by-case analysis of transfer pricing adjustments, pointing out the importance of distinguishing between adjustments related to prior supplies and those connected with cost reconciliation, especially in areas such as marketing or administration, which could indeed be subject to VAT.

He also found that the services rendered by Arcomet Belgium to Arcomet Romania ought to be classified as taxable supplies and subject to VAT. The net margin method was used to determine the remuneration for the parent company’s services, and the invoices were directly tied to the services provided. The advocate general concluded that the adjustments made by Arcomet Belgium should likewise be subject to VAT.

Implications for other taxpayers

The advocate general’s opinion represents a significant development at the intersection of transfer pricing and VAT. If the CJEU follows these recommendations, the VAT treatment of transfer pricing adjustments could change considerably, with transactions previously considered exempt potentially becoming taxable, and tax authorities adopting a stricter approach to the documentation required for VAT deductions.

It is important to note that this case involved a parent company providing services to its subsidiary, rather than the usual transfer pricing adjustments based on subsidiary profitability. Even so, the implications for cross-border transactions within corporate groups could be massive. Businesses may need to maintain much more detailed records to avoid their VAT deductions being challenged. 

As we await the final ruling, it would be prudent for companies to reassess their VAT and transfer pricing policies to avoid being caught off guard by the evolving tax landscape.

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Piotr Prokocki specialises in comprehensive services for M&A, and develops effective structures for financing transactions, capital withdrawal, and profit distribution.