The Supreme Administrative Court agreed with a tax adjustment made by the tax administration in a case involving a "toll manufacturer" (contract manufacturer) that claimed losses due to unfavorable developments in the target market.
The controlled entity manufactured cables using raw materials provided by the parent company and, according to the transfer pricing documentation, operated as a detached manufacturing plant. The transfer price was set as the price per minute of manufacturing service, and the transfer price was updated every six months. In 2008, the manufacturer incurred a loss due to a significant drop in production volume.
The tax administration levied additional tax based on a percentage of actually incurred costs, using the tax administration’s own data-based comparative analysis. The tax administration did not accept the reduction in output as a valid contention, but instead asserted that the manufacturer did not control the utilization of its production capacity. Moreover, the documentation explicitly stated that the “detached manufacturing plants do not bear any other risks but those linked to their production function."
The Supreme Administrative Court upheld the adjustment made by the tax administrator (5 Afs 194/2015). According to underlying documentation submitted by the manufacturer during the tax inspection, the cost plus method was to have been applied, taking into account all production costs. According to the court, it was appropriate to base remuneration on the total production activity.
Tax professionals have noted that a positive aspect about the tax administration’s approach is that it compares the Czech manufacturer’s profitability against the lowest values of profitability for entities selected within a comparative analysis. However, an unfavorable aspect, for taxpayers, is that the tax administration did not address in much detail the activities that were in fact conducted by the companies being benchmarked, but relied solely on the provided code of classification of economic activities.
This decision reflects the tax administration’s consistent, long-term approach towards companies whose functions are significantly restricted—particularly when such facts also emerge from their transfer pricing documentation.
Tax professionals expect that the decision will be viewed as support for the tax authorities and that loss-making companies operating as contract manufacturers or toll manufacturers will continue to be a focus of the tax administration in the future. Timely and diligent preparation for a transfer pricing inspection as well as consistent arguments to support any losses, therefore, need to be considered.
For more information, contact a tax professional with the KPMG member firm in the Czech Republic:
Jana Pytelková Svobodová | firstname.lastname@example.org | +222 123 483
Zdeněk Řehák | email@example.com | +222 123 531
Veronika Červenková | firstname.lastname@example.org | +222 123 591
© 2018 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.
The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.