Czech Republic: Regional courts reject basis for transfer pricing assessments

Czech Republic: Courts reject basis for assessments

Czech tax authorities have recently been focused on transfer pricing inspections. As a rule, the tax authorities typically assess additional tax by challenging the taxpayer’s functional and risk profile or by pointing out the existence of group relations that in turn require the group to compensate for a local entity’s losses. These approaches by the tax authorities have been challenged in recent cases before the regional courts in the Czech Republic.

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Comparative analysis disputed

In one of the cases, the tax authorities assessed the arm’s length character of prices at which a Czech manufacturer sold its products to its parent company, to be in turn distributed in foreign markets. For the period under review, the manufacturer incurred an operating loss.

The tax authorities concluded that, with respect to the company’s functional and risk profile of a contract manufacturer, the loss was to have been compensated by the parent company. The tax authorities prepared several comparative analyses that, however, showed methodological deficiencies—for instance, the exclusion of companies with a negative earnings before interest and tax (EBIT), and a failure to conduct a proper quantitative analysis. The tax authorities also disregarded any objections as to the specific conditions and economic circumstances (such as the weather) that had a major effect on the demand for the company’s products.

The regional court confirmed that the tax authorities erred in preparing the comparative analyses. In the situation when it was not possible to find a sufficient sample of comparable uncontrolled companies, it was—in the court’s opinion— appropriate to examine the other part of the transaction (i.e., to test the profitability of the parent company as the distributor). 

As for the manufacturer’s functional and risk profile, the regional court concluded that the classification of entities as contract manufacturers or full-fledged manufacturer is only a model classification—what is important is the analysis of the entities’ actual behaviour, which must be taken as the most conclusive evidence supporting the actual risk distributions.

Sales of products at a loss

In another case, the tax authorities assessed additional tax for a company that supplied to a significant customer—an unrelated party—at a loss. In the tax authorities’ opinion, this was initiated on the group level, with the sale of the products by the Czech company at a loss allowed the group to supply other products to the same customer at a profit. 

According to the tax authorities, the arrangement involved a kind of service provided by the Czech company to the group, for which it ought to have been compensated. The tax authorities then assessed additional tax on this fictitious revenue. 

The regional court rejected the tax authorities’ position, and concluded that: (1) the tax authorities had failed to prove that the prices of products were set at the group level without any influence of the Czech company; and (2) the group as a whole profited from trading with the given customer.

KPMG observation

Both judgments show that, in certain instances, it may be worthwhile for taxpayers to challenge an incorrect approach by the tax authorities to transfer pricing. Effective arguments can often be found in the procedural area—experience reveals that the tax authorities still frequently err in evidence proceedings and do not respect the distribution of the burden of proof as stipulated by law. Such deficiencies are usually enough for the court to find for the taxpayers.

 

For more information, contact a tax professional with KPMG’s Global Transfer Pricing Services practice in the Czech Republic:

Daniel Szmaragowski | +420 222 123 841 | dszmaragowski@kpmg.cz

Zdeněk Řehák | +420 222 123 531 | zrehak@kpmg.cz

Jana Pytelková Svobodová | +420 222 123 483 | jsvobodova@kpmg.cz

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