CJEU Ruling Changes VAT Treatment of Transfer Pricing Adjustments

Internationally operating companies often provide services to other entities within the same corporate group, a practice known as intercompany services. The calculation of fees for these services is based on the transfer pricing rules that require related-party transactions to reflect arm’s length conditions using a method selected by the taxpayer.

Transfer pricing adjustments can take various forms. Some are voluntary and recorded through credit or debit notes. Others arise from internal accounting corrections or post-audit settlements. Some adjustments are not tied to individual transactions; others may involve corrections to provisional prices and could be linked to specific supplies.

Because the value-added tax treatment of transfer pricing adjustments depends on their nature and is not always clear, the clarification provided by the Court of Justice of the European Union in its September Arcomet Towercranes (C-726/23) ruling is welcome guidance for practitioners. The court held that non-transactional profit adjustments charged by a principal company to an operating company constitute payment for services in the scope of VAT.

The CJEU will further clarify the VAT treatment of transfer pricing adjustments in the pending Stellantis Portugal (C-603/24) case.

Transfer Pricing Adjustments May Be Subject to VAT

Under Article 2(1)(c) of the VAT Directive (2006/112/EC), VAT applies only where a direct link exists between the consideration paid and a specific supply of goods or services. To fall within the scope of VAT, there must be a direct link between a payment and the goods or services received.

According to the CJEU in the Arcomet Towercranes case, a direct link is established if:

1. There is a legal relationship between the provider of the service and the recipient pursuant to which there is reciprocal performance;
2. The remuneration is received by the provider of the service for identifiable services; and
3. A direct link exists between the actual consideration given in return for the service provided or the good supplied to the recipient.

Consequently, transfer pricing adjustments might change the taxable amount and require a VAT adjustment if there is a sufficiently direct link between any payments resulting from an adjustment and specific supplies. When a transfer pricing adjustment can be clearly linked to a specific transaction, it may constitute consideration for a supply of services. If so, this could trigger VAT consequences for both the supplier and the recipient.

Case Facts

Arcomet Service NV Belgium (Arcomet BE) is the parent company of an independent global group in the crane sales and rental industry. Arcomet BE sources suppliers and negotiates contracts for its subsidiaries, including Arcomet Romania (Acromet RO), which handles direct sales and rentals to their customers.

A 2010 transfer pricing study for Arcomet BE and its subsidiaries showed that, at market level, the subsidiaries should, in accordance with transfer pricing rules, record an operating profit margin between -0.71% and 2.74%. Arcomet BE and Arcomet RO contracted to guarantee Arcomet RO an operating profit margin in that range and for an annual equalization invoice to be issued by Arcomet BE in the case of a surplus profit above 2.74% or by Arcomet RO in the case of a surplus loss below -0.71%. The fees for the services provided by Arcomet BE to Arcomet RO were calculated based on the transactional net margin method (TNMM). Arcomet RO’s profits were adjusted in accordance with a range obtained from a TNMM benchmark study.

In the three subsequent years, Acromet RO recorded profits higher than the envisaged range and received from Arcomet BE three invoices exclusive of VAT which Arcomet BE declared as supplies of services. Arcomet RO declared the first two invoices as intra-community purchases of services for which it applied the reverse charge mechanism, but declared that the third invoice had been issued for transactions falling outside the scope of VAT.

Following an audit of the period in which the invoices were issued, the Romanian tax authorities argued that the reverse-charged VAT was due on the payments. The Romanian tax authorities denied the deductibility of VAT on the ground that Arcomet RO had not demonstrated that the services had actually been supplied and that those services were necessary for its taxable business. Arcomet RO was required to pay additional VAT in respect of refused deductions, together with interest and penalties.

The Bucharest court stayed the proceedings and referred the following questions to the CJEU for a preliminary ruling:

1. Is Article 2(1)(c) of the VAT Directive (2006/112/EC) to be interpreted as meaning that the amount invoiced by a company (the principal company) to an associated company (the operating company), equal to the amount necessary to align the operating company’s profit with the activities carried out and the risks assumed in accordance with the margin method of the OECD Transfer Pricing Guidelines, constitutes a payment for a service which therefore falls within the scope of VAT?

2. If the answer to the first question is in the affirmative, with regard to the interpretation of Articles 168 and 178 of the VAT Directive, are the tax authorities entitled to require, in addition to the invoice, documents, such as activity and works progress reports. justifying the use of the services purchased for the purposes of the taxable person’s taxable transactions, or must that analysis of the right to deduct VAT be based solely on the direct link between purchase and supply or between purchase and the taxable person’s economic activity as a whole?

CJEU Decision

The CJEU ruled that whether transfer prices and transfer pricing adjustments are subject to VAT should be assessed on a case-by-case basis and that the conditions required by Article 2(1)(c) of the VAT Directive must be satisfied, as discussed above.

The CJEU found that the parties entered into reciprocal commitments in this case. Arcomet BE undertook to provide certain services and to bear the main economic risks associated with the activity of Arcomet RO. Arcomet RO undertook to pay at the end of each year an amount corresponding to the part of the operating profit margin greater than 2.74% achieved by it. Further, the remuneration received by the provider of the service constituted the actual consideration for the service supplied to the recipient. Therefore, a direct link existed between the services performed and the payment received, making the services fall within the scope of VAT. The fact that the remuneration is determined by reference to an operating profit margin, or that the payment may be reversed in cases of excessive losses (meaning Arcomet BE would compensate Arcomet RO), does not alter this outcome.

The CJEU stated that the determination of VAT deductibility of transfer pricing adjustments is subject to an evaluation of the activity in question, supported by appropriate documentation. The burden of proof to demonstrate the correct VAT recovery lies with the VAT payer, and the tax authorities can request additional documents beyond invoices. However, the requested information should align with the objective pursued and adhere to the principle of proportionality.

The CJEU will further clarify the VAT treatment of transfer pricing adjustments in the pending CJEU Stellantis Portugal (C-603/24) case.

Implications for Business

If a direct link to a prior transaction can be established or if adjustments result in payments for goods or services, these adjustments necessitate steps to ensure VAT compliance such as correcting previously filed VAT returns and possibly other filings, such as European Union Sales listings. Implementing these adjustments may impose significant administrative and system-related burdens. It is crucial to ensure that appropriate documentation—such as contracts, invoices or credit notes—is correctly issued from the outset. Failure to properly manage these obligations can result in significant compliance burdens and exposure to VAT assessments, penalties, and interest on late payments.

Transfer pricing adjustments within VAT scope have material impact for businesses that are (partially) exempt and unable to recover their input VAT (fully), such as financial services and the healthcare sector.

Planning considerations

Companies should:

• Assess the VAT consequences of their transfer pricing arrangements;
• Analyze intra-group service agreements and invoicing practices to determine whether transfer pricing adjustments fall within the scope of VAT and (if so, analyze the VAT implications);
• Examine each transfer pricing adjustment individually to determine whether a sufficiently direct link exists between it and the underlying supply;
• Confirm that invoices for transfer pricing adjustments within scope are fully compliant with VAT requirements and accurately describe the nature of the services provided;
• Maintain clear evidence demonstrating that the services contribute to taxable business activities; and
• Ensure robust documentation is available to substantiate their VAT position, including correct VAT treatment, alignment of contracts with the character of services and remuneration, and VAT-compliant invoices.
  

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Dr. Aiki Kuldkepp is a senior manager in the VAT and Customs group of the International Tax Services practice.

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