The relationship between transfer pricing (TP) adjustments and value-added tax (VAT) is often complicated. Recently, the Arcomet case, which was reviewed by the Advocate General of the Court of Justice of the European Union (CJEU), has highlighted this issue. This case offers a unique chance to clarify how VAT should be applied to intragroup transactions when TP adjustments are involved.
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The central question: Should TP adjustments be considered as (a correction of) the remuneration for goods or services, or rather as payments outside the scope of VAT? |
The Arcomet case involves an intra-group transaction between two members of the international Arcomet group, which specializes in leasing and selling tower cranes. Arcomet Belgium takes on the entrepreneurial risks and is responsible for key decisions regarding strategy, activity planning, servicing the tower cranes, and negotiating with third-party suppliers. Arcomet Romania purchases or leases the tower cranes from these suppliers based on the conditions agreed upon by Arcomet Belgium. Arcomet Romania then sells or leases the tower cranes to external customers.
A transfer pricing (TP) study has determined a guaranteed operating margin to remunerate Arcomet Romania for its sales activities, using the Transactional Net Margin Method (TNMM) as outlined in the OECD TP guidelines. This is documented in the transfer pricing documentation. According to the agreement between Arcomet Belgium and Arcomet Romania, a transfer pricing adjustment can be made if the actual operating margin realized by Arcomet Romania falls outside the range determined by the TP study.
The transaction flows can be depicted as follows:
Arcomet Romania is currently involved in a tax dispute about three invoices issued by Arcomet Belgium regarding such transfer pricing adjustments made.
Arcomet Romania received three invoices excluding VAT from Arcomet Belgium because the actual operating margin exceeded the agreed target margin. These intra-group transactions were classified as service transactions. Arcomet Romania reported the first two invoices as intra-group services and applied the reverse charge mechanism. However, it treated the third invoice as not subject to VAT.
The authorities denied the right to VAT deduction for the first two invoices, arguing that the services were neither sufficiently demonstrated nor necessary for Arcomet Romania's taxable transactions. The third invoice was treated as a service from Arcomet Belgium, but the deduction right was not granted, even though it was acknowledged as a service. According to Romanian law, the existence of an invoice is sufficient to exercise the right to VAT deduction.
Arcomet Romania decided to challenge the assessment, leading to preliminary questions being referred to the CJEU.
The Advocate General states that there is a direct link between the service provided and the compensation received, even if the profit margin fluctuates or is negative. He notes that the remuneration method was clearly defined to avoid any uncertainty. He emphasizes that TP adjustments do not automatically fall within or outside the scope of VAT but need to be assessed on a case-by-case basis. He advised the CJEU that these TP adjustments fall under VAT.
For VAT deductions it is necessary that the services are used for taxable activities. Services that are part of general business expenses are also eligible for VAT deductions. The Advocate General emphasizes the principle of proportionality, where authorities have the right to request additional evidence to verify that the services are used for taxable activities.
It remains to be seen if the Court of Justice will agree with the Advocate General.
Transfer pricing (TP) adjustments can be made as corrections of intercompany prices to ensure that a group entity achieves an arm’s length remuneration in line with its functional and risk profile. In this case, there is no underlying invoice between Arcomet Belgium and Arcomet Romania for the intercompany sale of goods or services during the year.
The correction invoiced by Arcomet Belgium to Arcomet Romania is the difference between the actual operating margin realized by Arcomet Romania and the guaranteed operating margin defined by the benchmark analysis. Arcomet Belgium, as the Principal entity, takes on the entrepreneurial role and related risks, realizing the residual result (which can be positive or negative) from the purchase and sale of products by Arcomet Romania to its clients.
The TP adjustments made are not connected to the actual costs incurred by Arcomet Belgium. Instead, these adjustments ensure that any profit or loss beyond the guaranteed operating margin is allocated to Arcomet Belgium as compensation for its entrepreneurial activities.
The lack of a clear cost-service link, combined with TP adjustments and varying fees, complicates VAT treatment.
The Advocate General has stated that the TNMM is a remuneration for a service, but also emphasized that this should be assessed on a case-by-case basis. This approach seems somewhat simplistic, especially since the CJEU has yet to decide whether the TP adjustments actually constitutes a service under VAT. It is essential to consider the specific circumstances of each case before drawing a general conclusion.
The transfer pricing policy between Arcomet Belgium and Arcomet Romania is based on adjustments depending on the actual operating margin achieved by Arcomet Romania compared to the target operating margin defined by the TP study.
If Arcomet Romania's operating margin exceeds the guaranteed margin, Arcomet Belgium invoices Arcomet Romania. Conversely, if Arcomet Romania's operating margin falls below the guaranteed margin, Arcomet Romania invoices Arcomet Belgium.
This approach may raise questions or highlight potential disparities in VAT treatment, as invoices can be issued by either entity depending on the actual operating margin achieved by Arcomet Romania. Would the same principles apply, or would there be different considerations due to the change in the direction of the transaction?
The VAT treatment of TP-adjustments has been a complex and often ambiguous area within EU tax law. Currently, in addition to this case, there are two other cases pending before the CJEU on this subject: Högkullen and Stellantis Portugal. And one was already decided on: Weatherford Atlas Gip SA[1]. The outcome of this Arcomet case can set an important precedent for the VAT treatment of TP adjustments across the European Union.
In the meantime, it is recommended for businesses to analyze the VAT aspects of their group TP policies and stay informed about the legal development to ensure compliance and prepare for potential changes in VAT treatment. It is crucial to ensure that their invoices are VAT-compliant. It is wise to draft a clear service agreement that outlines the nature of the invoiced amounts and the payment terms.
Authors: Tine Slaedts, Stefanie Van der Straeten and Gert Vranckx
[1] In the Weatherford case, the CJEU ruled that VAT deduction must be allowed if the conditions for deduction are met, regardless of the group structure. This confirms that a shared service centre for VAT services is permitted, provided the services are received and the conditions for deduction are fulfilled.