In last October the European Commission released a partial decision in the Amazon case. The dispute is led in that way if Luxembourg, as member country of EU, provided an unauthorized state support by a tax treaty in the sphere of transfer prices (so-called APA) concluded in year 2004 with the company Amazon.

Basically the logic in the background of the case is very simple. When a member country concluded a tax treaty with a multinational group concerning setting their transfer prices, the treaty should not support another setting than independent persons acting under usual market terms have agreed. When it is not the case, then the certain multinational group may get a competitor advantage by the fact that it reaches a lower tax burden then its competitors (they have the same duty). In other words: the agreed way of setting the internal transactions by any EU member country has to be in compliance with the arm´s length principle.

What is interesting about the decision? The European Commission expressed its opinion concerning the tax treaty concluded between Luxembourg and Amazon from the standpoint of its compliance with the basic principle claimed in the area of transfer prices, the so-called arms length principle. According to this principle prices charged between related parties have to be comparable to prices charged by independent entities. This principle is also established in the Luxembourg tax legislation.

Short situation description

The Amazon company was founded in America in 1994. Its European headquarters are located in Luxembourg. There Amazon employs approx. 1 000 people. In Luxembourg Amazon has a few companies, among those also the companies Amazon EU Sarl. (hereinafter referred to as „Lux OpCO“) and Amazon Europe Technology Holding SCS (hereinafter referred to as „LUX SCS“). These two companies are the most important in the story.

The company LUX SCS is 100% parent company of LUX OpCO. The function of the company LUX CSC is possession and assistance when using and developing intangible assets in form of an IP licence through the so-called cost-sharing agreement with the headquarters in US where the development is, in point of fact, carried out. On the other part the company LUX OpCO is a company operating the European website by which means the products are being sold and offered to end customers. One of the functions of LUX OpCO is also the ownership of the whole goods in all Amazon´s European head offices. As LUX OpCO uses at its activity intangible assets of LUX SCS, it pays to it a licence fee whose amount is specified below. The licence fee is a tax deductible expenditure of LUX OpCO. Exactly the amount of this licence fee should have been approved in the tax agreement with the Luxembourg tax office. However, the point of the story is that whereas the income of LUX OpCO is taxed in Luxembourg, in case of income of LUX SCS this is not the case. In addition, basically the income of LUX SCS is not taxed anywhere.

Amount of licence fee

According to the tax agreement the amount of licence fee is calculated each year as a percentage of revenue achieved by the sale through the European website in EU. To understand it, we state at least the basis of the agreed calculation of the remuneration. The amount of the licence fee rate is computed under the following rules:

1. The base for the calculation of the remuneration of LUX OpCO corresponds to the smaller of the below stated amounts: a) 4 – 6 % of operative costs, b) the total operative profit.
2. The licence fee paid to LUX OpCO corresponds to its operative profit reduced by the remuneration of LUX OpCO (art. A).
3. The amount of the licence fee rate from revenues of LUX OpCO corresponds to the amount of the licence remuneration under art. B divided by the income amount from the sale in EU.
4. Regardless of the above stated facts the amount of remuneration of LUX OpCO in any year can´t be lower than 0,45 % of the income from sale in EU and not higher than 0,55 % of the income from sale in EU. When the remuneration of LUX OpCO is not in this scope, this profit is adjusted so that it is in this scope.

According to the complicated calculation we can feel the try to restrict the remuneration amount of LuxOpCO to the pre-stipulated value. Any residual profit above this pre-stipulated value flows to LUX SCS as licence fee.

Decision of the European Commission

For the time being, the decision of the European Commission is not final. It involves a partial decision where Luxembourg is entitled to express itself and to strew fears of the European Commission. However we state the partial conclusions from which the remarks and deficiencies derive which have been found by the European Commission in the tax agreement concluded between Luxembourg and Amazon, among others also the fact that it was not provided with all materials needed for the final decision.

• Luxembourg didn’t submit to the European Commission any documentation concerning the way of creation of transfer prices prepared by Amazon in order to support its application for agreeing a tax agreement in the sphere of transfer prices. As this documentation is missing, the European commission has doubts about the way of the review of the application by Luxembourg tax authorities, that’s whether they were concerned with the review of observing the arm´s length principle at all. In addition it notes that tax authorities of Luxembourg have analyzed the application and they concluded the agreement in 11 days as of the submission of the application.
• The description of intangible assets provided to LUX OpCO on the part of LUX SCS is not clear from the tax agreement.
• The tax agreement does not contain any reasons for the choice of the correct method of stipulation of a transfer price. Based on materials which the Commission keeps at disposal, it is not possible to agree that the used method corresponds to any method named in the OECD guideline on transfer prices.
• Although in the tax agreement the stipulation of the licence fee rate is taken as a percentage of the revenues (see art. B above), then actually it derives from the way of setting the licence fee calculation that the licence fee is set as a residual profit above the pre-stipulated profitability of LUX OpCO. According to art. 6.16 of the OECD guideline on transfer prices, in most cases the licence fees depend on the achievement of the user, on his revenues and in some exceptional cases on the amount of the user´s profit. However, in the given case only the licence fee amount stipulated based on revenues was presented. However, the amount of the licence fee was not calculated with respect to the contribution of the immaterial asset in order to reach these revenues. Instead of that, the amount of the licence fee is calculated as the residual profit.
• The complex functional analysis is not available based on which it would be possible to decide which amount of remuneration appertains to LUX SCS and which amount of remuneration appertains to LUX OpCO. For the exact determination an extensive functional analysis and the risk analysis is needed.
• For stipulating the amount of remuneration of 4 – 6 % of the operative costs no comparative analysis is available.
• The stipulation of the minimum and maximum limit for the remuneration of LUX OpCO in the amount of 0,45 – 0,55 % of revenues is not in compliance with any of the methods approved by the OECD guideline.
• The agreement has not been updated for the longer time than 10 years.

Conclusion

We can close this article with two important facts. The European Commission gives a fully definite signal towards single member countries that it is very interested in the current practise of agreeing the tax agreements in the sphere of transfer prices. Some countries could be very friendly towards investments on the part of multinational concerns, namely insomuch that the arm´s length principle which should be connected with the tax agreement like blood with a body, could be put in background. Some changes have already been included in the proposal of the European Commission concerning the tax transparency. Further, in general, these decisions give also a good instruction to tax administrations how to think about the ways of setting the transfer prices by individual groups in the context of the currently valid wording of the OECD transfer price guideline also without considering the new initiatives within BEPS we have informed you about already in our previous editions of the Newsletter.

Should you be more interested in this issue, we are at your disposal.