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
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