Law & Numbers - News Tax

The legislator and the court agree – is the tax authority left on its own?

25.04.2014 (Hungary)

The tax authority lost a case related to the VAT treatment of year-end transfer pricing adjustments. The court stated that year-end transfer pricing adjustments share the characteristics of the original transaction; therefore, their VAT treatment is the same as the VAT treatment of the original transaction. The conclusions of the verdict go beyond the specific case: the judgment shows that, as opposed to the tax authority’s standpoint, the courts follow the logic of the legislator.

The case

The taxpayer produced and sold certain goods to its Austrian parent company. The products were delivered to Austria; therefore, the company did not charge VAT on the sales. The volume of the sales and the purchase price were determined at the beginning of the year. At the same time the parties agreed that if the parent company purchases less than the agreed quantity then it has to pay a so-called “compensation” to the Hungarian producer at the end of the year. In the audited year, the parent company purchased only half of the agreed volume and, consequently, paid compensation to the producer. The producer did not charge VAT on the compensation.

The tax authority challenged the invoicing of the compensation. It argued that the compensation was subject to Hungarian VAT, as the compensation is paid in exchange for a service provided by the producer: giving the right to the purchaser to purchase less products than agreed. Therefore, the compensation cannot be considered as the adjustment of the purchase price. As in 2009 services provided to foreign companies were subject to Hungarian VAT, the tax authority established tax arrears.

The case went to court. The court came to the conclusion that the compensation charged by the producer is, in its nature, a year-end adjustment of the purchase price. This also means that the parent company did not pay for a separate service but it paid for an increased price of the products purchased during the year. Thus, the court agreed with the taxpayer that the year-end adjustment is exempt from Hungarian VAT.

Companies limited by shares – types of shares are not restricted anymore

The case is an important piece in a long-debated tax issue. The year-end transfer pricing adjustments between affiliated companies have been in the focus of tax audits for years. Due to the fact that the applicable accounting and tax law provisions are rather ambiguous, such audits led to the establishment of tax arrears of millions of euros.

As a general principle, related parties must either apply arm’s-length price in their transactions or adjust their tax returns by the difference between the actual price and the arm’s-length price. As a consequence, at the end of the day, related parties shall pay taxes as if they had applied the arm’s-length price. Most of the company groups cannot, however, determine the arm’s-length price before the end of the year, as the fair market price depends on the annual profitability of the group members. Therefore, the price applied during the year needs to be adjusted at the end of the year. Although the tax laws make it possible to make the adjustments in the tax returns only, in practice the companies tend to actually settle the adjustments. This requires the year-end adjustment of the accounting of the transactions which causes several problems.

The accounting act has been amended two times recently to enable the year-end adjustment by one single accounting document. This solves the handling of year-end adjustments both for accounting and for corporate income tax purposes. However, the VAT treatment of the year-end adjustments is still unclear. Certain professionals argue that as a consequence of the amendment of the accounting act, year-end adjustments do not fall under the scope of the VAT any more. This standpoint seems, however, contradictory to the provision of the VAT Act stating that in case of year-end adjustments, the original invoices shall be adjusted.

In the analysed court case the tax authority did refer to this provision of the VAT Act and stated that in case of year-end adjustments, the previously issued invoices have to be adjusted. The court was not, however, convinced by this argument. The court focused more on the nature of the transaction carried out by the parties. As a result, the court decided the case on the basis of the economic substance of the transaction and did not consider how the company invoiced the year-end adjustment.

What’s next?

The judgment of the court may reduce the risks related to the tax treatment of year-end transfer pricing adjustments. Although the court did not relieve the company from the obligation to amend all the invoices affected by the adjustment, it is clear from the verdict that an administrative mistake cannot lead to the requalification of the transaction for VAT purposes.

The case is also unique as it shows that the court and the legislator are heading in the same direction: while the tax authority is fishing in troubled waters, the legislator and the courts are trying to clear up the issue. This is more than welcome, as taxpayers should not be faced with unpredictable tax requirements. Although the topic of year-end adjustments is far from being solved, it is good to know that the legislator and the courts are on the same side. All that is left is to convince the tax authority.

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