Context
There is a complex interplay between TP adjustments and VAT, especially since Transfer Pricing focuses on profits at the corporate level, while VAT is applied to individual transactions.
To fall within the scope of VAT, there must be a direct link between a payment and the goods or services received. In other words, if the price of goods or services is adjusted, there are VAT implications at play. For instance, the Court of Justice in the World Comm Trading judgment decided that price adjustments must be fully detailed and reported for VAT purposes (CJEU 28 May 2020, C-684/18, World Comm Trading).
The current case involves "general" TP adjustments that align the profit of an operating company with the activities performed and risks undertaken according to the OECD guidelines on transfer pricing.
The Romanian case
SC Arcomet Towercranes SRL (“Arcomet RO”) is part of the international Arcomet group and specializes in the rental and sale of tower cranes. Arcomet RO faced a (Romanian) tax audit for the period 2011-2014. The dispute revolved around three "Transfer Pricing" invoices issued by the Belgian parent company of Arcomet RO, Arcomet Service NV (“Arcomet BE”). These invoices resulted from a transfer pricing study conducted by a consultancy firm, intended to adjust profit margins between related parties in accordance with the OECD guidelines for transfer pricing.
In the declaration submitted to the Belgian tax authorities, Arcomet BE initially reported the three invoices as intra-community supplies of goods. Later, in 2015, Arcomet BE corrected the declaration in the original return to "service transactions". In turn, Arcomet RO reported invoices 1 and 2, issued in 2012, as services for which it applied the reverse charge mechanism. It did not declare invoice 3, issued in 2013, because it believed that it related to transactions that fell outside the scope of VAT.
The Romanian tax inspectors argued that the aforementioned adjustment invoices related to management services that Arcomet RO had purchased from Arcomet BE. They requested the submission of evidence showing that the services were actually performed and were necessary for the taxable activities of Arcomet RO.
The Romanian tax authorities also exchanged information with their Belgian counterparts about the reporting of the adjustment invoices in VIES. It turns out that the Belgian tax authorities had determined that these invoices concerned a provision of services according to Arcomet BE.
Regarding invoices 1 and 2, for which the reverse charge mechanism was applied, the tax inspectors refused the right to deduct the corresponding VAT but retained the collected VAT (paid under the reverse charge mechanism) with the argument that no provision of service was demonstrated, nor was a necessity shown for these to be performed for taxable transactions. For invoice 3, the tax inspectors believed it also related to the purchase of services from Arcomet BE. They collected VAT without granting the right to deduction.
The reason was the same as for invoices 1 and 2, namely that it was not demonstrated by documents that there was a service provision and that it was performed for the taxable activities of Arcomet RO. It is noteworthy that the Romanian fiscal authorities recognize a service provision but still refuse Arcomet RO the right to VAT deduction because the Romanian legislation apparently requires only the existence of an invoice to exercise the right to VAT deduction.
Arcomet RO went to court to contest the assessment. During the appeal process, the competent court decided to pose preliminary questions to the Court of Justice.
Preliminary questions
The Romanian judge seeks clarification on Article 2(1)(c), and Articles 168 and 178 of the VAT Directive 2006/112/EC, particularly regarding:
1 The nature of adjustment payments: Should adjustment payments between related enterprises, aligning the profit of an operating company with the activities it has performed and the risks undertaken according to the OECD guidelines, be considered as the compensation for a service subject to VAT?
2 The evidence of the right to VAT deduction: To what extent may the tax authority require additional evidence, on top of the invoice, to demonstrate the use of purchased services for VAT-taxable activities?
Question 1: Is VAT Applicable to Transfer Pricing adjustments?
The Advocate General begins by cautioning against a one-size-fits-all approach. He stresses that not every transfer pricing adjustment automatically falls within or outside the scope of VAT. According to him, the Court must assess the context and nature of each specific transaction.
He highlights the fundamental distinction between direct and indirect taxes. Transfer pricing is a mechanism for tax adjustments under direct taxation, whereas VAT applies to economic transactions carried out for payment.
The Advocate General also clarifies that, in this case, the issue does not concern a retroactive adjustment of the transfer price, as is common in standard transfer pricing corrections. Instead, the TNMM method is applied from the outset to determine the compensation for the services rendered—essentially, it acts as the pricing mechanism itself. This means the price is not adjusted retroactively; it represents the original and sole compensation for the service provided. This distinction is crucial.
The Advocate General confirms that a service falls under VAT if there is a direct link between the service provided and the compensation received, where the payment corresponds to the actual value of the service rendered.
In the Arcomet case, Arcomet Belgium provided operational services to Arcomet Romania under the agreement of 24 January 2012, including strategic planning, supplier negotiations, and fleet management. In return, Arcomet Belgium receives a payment based on TNMM, with Arcomet Romania paying VAT on this compensation.
The Advocate General concludes that the services provided by Arcomet Belgium are individualized, as they involve specific tasks that contribute to the operation of Arcomet Romania. The relationship between the service and the compensation is clear, even though the compensation is dependent on a fluctuating profit margin. He further emphasizes that the methodology for determining the compensation is clearly defined in the agreement, so it cannot be deemed uncertain.
Even if the profit margin is negative, this does not affect the application of VAT, as the terms for the payment were clearly agreed upon in advance. The fact that the profit margin is based on market conditions makes it unlikely that the margin will fall below the contractually agreed threshold of -0.71%.
Moreover, the services provided by Arcomet Belgium contribute to cost savings and support the operations of Arcomet Romania, reinforcing the direct link between the services provided and the compensation received.
Finally, the Advocate General concludes that the compensation is subject to VAT.
Question 2: documentation requirements for VAT deduction
The Advocate General confirms that the right to VAT deduction depends on the services being used for taxable activities. While a direct link between the services and taxable activities is required, services that are part of the general business expenses may also be eligible for VAT deduction.
The Advocate General stresses the proportionality principle, noting that tax authorities can request additional evidence, such as contracts or work reports, to confirm the use of services for taxable activities, but such requests must be reasonable and proportionate.
Ultimately, the Advocate General concludes that while the VAT directive allows for more than just invoices as proof, any requests for further documentation must align with the principle of proportionality and be justified by the facts of the case.
Conclusion
Businesses should be aware of the VAT implications of transfer pricing adjustments, which are often overlooked. In this case, the transfer pricing adjustment represented the only compensation and involved clearly documented service transactions, which led the Advocate General to conclude that these fall within the scope of VAT.
Furthermore, the case underscores that thorough documentation is essential for VAT deductions, as tax authorities may require more than just standard invoices to substantiate the use of services for taxable activities.
Transfer pricing adjustments and VAT remain a complex and challenging area, often considered one of the greyest zones in VAT legislation.
Ultimately, the conclusion of the Advocate General is an important guiding opinion, but it remains to be seen how the Court of Justice will rule, especially given the controversial nature of this subject.