With the deadline for filing tax returns approaching, it is important to recall the case law of the Supreme Administrative Court (SAC) in the area of transfer pricing for so-called orders from the parent company. The most recent decision of the SAC in this respect dealt with the issue of loss-making companies within groups of companies and the influence of the parent company on these losses. In the tax audit, the tax administrator questioned the pricing policy of a long-term loss-making trading company and found that the parent company had interfered with the company’s pricing policy towards independent customers and adjusted the tax base accordingly. The SAC upheld the tax administrator’s decision.

For taxpayers, the key point here is that even transactions with unrelated parties can be classified as controlled by the tax authority if their terms were determined by another related party, typically the parent company. The circumstances of such transactions are then subject to the provisions of Section 23(7) of the Income Tax Act.

Arguments of the tax administrator

The tax administrator justified its position in the context of the case with the following facts:

• The trading company’s losses were incurred due to incorrect purchase and sales price settings, both with independent suppliers and customers of the goods. The parent company was directly involved in negotiating these prices.
• In order for the company to continue its business activities in spite of long-term losses, the parent company financed it with non-standard repayment loans.

On the basis of Section 23(7) of the Income Tax Act, the tax administrator inferred the existence of a service provided by a trading company upon order from the parent company. This service consisted in the unprofitable sale of goods below the cost of selling them. Thus, in that case, the company’s loss should have been compensated by the remuneration for the services of operating unprofitable sales, which, according to the tax administrator, would have been received by an independent undertaking on the basis of the arm’s length principle. However, there was no compensation for this unprofitable sales service in the case of the trading company under examination, which the tax administrator demonstrated by comparing it with the profitability of the business activities of comparable independent companies. The reason for the difference was not sufficiently documented to the tax administrator and therefore the tax base of the company was adjusted.

Implications for taxpayers

Taxpayers in multinational groups must take into account that even transactions with unrelated parties may have transfer pricing implications if the terms have been dictated by the group. This may be linked to possible VAT implications, where the financing of the loss may be considered as part of the consideration for the performance or directly as consideration for a separate service, in this case consisting in the surrender of rights to the goods sold.