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EU seeks opinions on whether transfer pricing adjustments are subject to VAT

Gareth Bevan 19 April 2017 No comments

European Commission transfer pricing working paper

The European Commission has issued a working paper asking the VAT Committee to consider whether transfer pricing adjustments carried out for direct tax purposes are within the scope of VAT.

The VAT Committee is being asked to examine the potential VAT implications with the aim of providing legal certainty to both businesses and tax administrations in the EU Member States.

The Commission has stated though that its working paper does not cover any possible VAT implications arising from the transfer pricing aspects of the Organisation for Economic Co-operation and Development (OECD) and G20’s Base Erosion and Profit Shifting (BEPS) project.

Transfer pricing and the “arm’s length principle”

Transfer pricing legislation details how transactions between connected parties are handled and is based on the internationally recognised “arm’s length principle”.  Under the “arm’s length principle” the conditions of a transaction between associated companies must not differ from those which would be applied to a transaction between independent companies trading under similar circumstances, essentially open market conditions.

Transfer pricing adjustments

Where it is established that a transaction between associated companies is not at arm’s length, adjustments must be carried out for corporation tax purposes in order to replicate the conditions of an arm’s length transaction.

Transfer pricing rules work by adjusting the amount of taxable profits of the companies on the basis of the “arm’s length” results of the relevant transaction.

Transfer pricing adjustments can be made either:

  • by a tax administration after a company’s tax return has been filed, or
  • voluntarily by the company before its tax return is filed.

An explanation of the main scenarios where these adjustments are required is included in the working paper.

Many transfer pricing methodologies however do not arrive at a particular price for the goods or services supplied but instead determine an appropriate arm’s length profit margin for the relevant businesses.  This is where it becomes difficult to ascertain the VAT implications, since VAT is a transaction-based tax on the supply of goods and services, and not a tax on profits.

The purpose of the working paper

The purpose of the working paper is to generate an initial exchange of views by Member States on whether transfer pricing rules could have VAT implications.  The main issue the Commission is concerned about is whether transfer pricing adjustments could be seen as being consideration given in exchange for a supply.

Tensions exist though between the concept of arm’s length valuation (i.e. open market value) of a transaction used in transfer pricing legislation for direct taxation purposes, and the concept of “consideration” used in VAT legislation to establish the value of a supply of goods or services for VAT purposes, where consideration is generally seen as a subjective value (i.e. price actually paid).

It is accepted that in order for transfer pricing adjustments to be seen as potentially subject to VAT, the adjustments would need to constitute more or less consideration for a supply of goods or services, i.e. an increase or decrease in the VAT taxable amount of the transactions concerned.  It is also necessary for there to be a direct link between the consideration and the supply for it to be within the scope of VAT.

With these considerations in mind the Commission is seeking opinions on the VAT implications of transfer pricing adjustments, specifically the following aspects :

  • The interaction between direct and indirect taxation
  • The existence of the arm’s length principle in the VAT Directive
  • The existence of consideration
  • The existence of supply
  • The existence of a direct link between supply and consideration.

Impact on businesses

Transfer pricing rules and adjustments have become increasingly significant for businesses and tax administrations with the growth in the value and volume of intra-group trade, particularly cross-border.  Should the European Commission ultimately conclude following this exercise that all transfer pricing adjustments are subject to VAT rules there are likely to be huge ramifications for businesses.

It could be a major undertaking for many businesses to identify and implement the required VAT adjustments.  In addition it could lead to a significant increase in the number of VAT invoices and credit notes businesses are required to produce.

Transfer pricing is a very specialist and highly technical area of tax legislation, adding VAT to the mix will only make it more complicated.

Businesses should monitor developments closely and be prepared to start an early dialogue with their direct tax colleagues to ensure that any emerging new requirements can be complied with.