Recharacterization of transactions – a real threat? Yes, but only since 1 January 2019?
- INSIGHT, Transfer pricing
- 4 minuty
In the ruling no. I SA/Gl 233/22 of 31 August 2022, the District Administrative Court in Gliwice repealed the decision of the Head of the Silesian Customs and Tax Office in Katowice on the reduction of CIT in 2016. The case concerned the acquisition and lease of trademarks from a related entity where the costs related to amortization and lease were recognized as tax deductible. The Head of the Customs and Tax Office decided that the company overestimated tax deductible costs and determined loss in income tax at PLN 212,033,684.97. It claimed that the actual subject of the transaction was not sale and lease yet intermediation services for ordering promotional materials provided by a related entity to the company.
When changing the assessment of the actual nature of the transaction, the authority referred to OECD guidelines whereby if the facts of the case, including the conduct of the parties, differ from the written terms of anyagreement between them, the actual transaction must be deducted from the facts as established, including from the conduct of the parties (OECD Chapter VI. B.1. 6.36).
The District Administrative Court reminded that the OECD Guidelines are not a source of law. They are auxiliary to the provisions of the CIT Act and as such are used as a “set of good practices”.
Moreover, the DAC believed the authority established the facts of the case based not on the facts and evidence collected. In fact, it simply assumed that the taxpayer was guided by the intention to obtain an unauthorized tax benefit and not by economic and business reasons. The District Administrative Court highlighted that in the legal status valid until the end of 2016, the authority was not authorized to recharacterize the transaction – at that point in time neither the abuse of law clause nor the clause preventing tax avoidance were in force.
Consequences – new transaction valuation and additional income assessment
The authorities critically assessed actions taken by the company and related entities – by challenging their economic (business) sense and recharacterizing them, they established that the remuneration in actual transactions was determined as a result of relationships in an amount different from the conditions that would have been established between third parties. The remuneration in a transaction should result from the split of assets, functions and risks between the transacting parties. The authority decided that the split of assets, functions and risks in the field of trademarks – as described in the documentation prepared by the company – is inconsistent with the facts. So, the authority made its own analysis and valuation of the functions, assets and risks involved by the parties to this transaction and determined remuneration based on it.
According to the authority, by providing intermediation services for ordering promotional materials, the related entity did not perform independent activities creating added value in the field of trademarks, but only purchased services from external entities – independent parties. The authority believed the service provided by the related entity did not differ significantly from the simple re-charge of costs, so the mark-up for such a simple service should be small. It was unjustified to involve large (disproportionate) costs of specialized analyses in the situation of estimating very simple and at the same time not expensive tasks. The economics of the proceedings required referring to services with low added value.
However, in the opinion of the District Administrative Court, since it was not justified to make the recharacterization, it is also unfounded to establish arm’s length valuation of the transaction on its basis and to determine the resulting amount of the tax liability.
Fine line between the permitted form of tax avoidance and tax evasion
The court shared the view already expressed in the case law: tax optimization involving legally lawful instruments may be one of the elements of business planning.
In the administrative courts’ case-law, attention is paid to the need to distinguish and point the boundaries between permitted form of tax avoidance and tax evasion. Thus, it is the circumstances of a specific case that should be decisive about whether a taxpayer is trying to reduce taxation in a manner consistent with the intentions of the legislator or is attempting a tax evasion.
Performing various types of activities as part of seeking tax optimization is not prohibited by law.
The most important conclusion for related parties
In the case at hand, the District Administrative Court ruled that under the analyzed legal status in force until 31 December 2016, the authority was not entitled to recharacterize the nature of the transaction and, consequently, to determine the amount of the company’s loss, disregarding the fees for using trademarks constituting its tax-deductible cost. Regulations introducing the so-called ‘recharacterization’ or ‘non-recognition’ of a specific transaction by the tax authority entered into force on 1 January 2019. So, according to the court, only from that date onwards the authorities are equipped with such a tool.
Agnieszka Walska
Manager, Transfer Pricing Team
Tel.: (+48) (22) 322 68 88