In practice, the VAT treatment of transfer pricing compensation is not harmonized across jurisdictions and leads to regular disputes with the tax authorities, including questions of possible taxable versus out-of-scope services, reductions in the taxable base for prior supplies, or the possibility and conditions of input VAT deduction following the transfer pricing adjustments.

While the CJEU’s decision provides some clarity on the VAT impact, and particularly suggests that adequate contract language underlying transfer pricing adjustments can help to mitigate risks, many questions remain unanswered. Multinational companies may review their contracts and VAT risks, including the preparation of adequate documentation for input VAT deduction.

In more detail

The SC Arcomet Towercranes SRL case (C-726/23) concerns compensation payments made between affiliated companies to adjust the profit margin to the arm’s-length principle enshrined in the OECD Guidelines.

The facts of the case

The case concerned two affiliated companies of the international Arcomet group. Arcomet Romania is part of the Arcomet group, specialized in the purchase and rental of cranes. It resells or re-rents the cranes to its customers in Romania.

The groups’ parent company (Arcomet Belgium) entered into a contract with Arcomet Romania, under which each party committed to carry out a certain number of services for the other. The contract expressly provided for remuneration for these functions and activities. This remuneration was to be determined by mutual agreement between the parties, based on proper VAT invoicing at the end of each year, and calculated based on the transactional net margin method laid down in the OECD Guidelines (transfer pricing).

The special feature was the fee for the contractually defined services. Which of the two parties would raise the invoice, and for which amount, was contractually dependent on Arcomet Romania’s profit or loss situation. In this regard, the contract specified the following:

• Arcomet Belgium had to raise the invoice if Arcomet Romania’s operating profit margin was greater than 2.74% in order to recover the excess profit.
• Arcomet Romania had to raise the invoice if the margin was less than -0.71% in order to cover any excess loss.
• No payment was due, and no invoice needed to be raised, within a defined margin of -0.71% to 2.74%.

Consequently, the direction of payment was determined by the profit or loss that would arise at the level of the Romanian company before the transfer price adjustment.

In the years under dispute, Arcomet Belgium raised the invoice and received the transfer pricing adjustments (as Arcomet Romania recorded an operating profit margin greater than 2.74%). The invoice was issued without VAT, and Arcomet Romania self-declared the VAT (of two of the invoices) as purchases of cross-border services under a “reverse charge”. The invoices did not specify the nature and further details of the services.

The Romanian tax authorities assessed additional VAT against Arcomet Romania. They classified these invoices as payments for services and applied VAT through the reverse charge mechanism. However, they refused the company’s input VAT deduction right, arguing that Arcomet Romania had not demonstrated that the services invoiced had actually been supplied and that those services were necessary for the purposes of Arcomet Romania’s taxable transactions.

The CJEU had to address two essential questions raised by the Romanian courts, which, in simple terms, focus on the following points:

1. Is the amount invoiced to an associated company, if calculated using the margin method (transfer pricing adjustment), a payment for a taxable service or does this fall outside the scope of VAT? This addresses the general question of under which conditions a subsequent transfer price adjustment may be a VATable supply.
2. Regarding the input VAT deduction of the service recipient (Arcomet Romania), are the tax authorities entitled to require additional documents (beyond the invoice) to justify the input VAT deduction right? This relates to the general question of under what conditions it is possible for the receiving company to recover the input VAT?

Background: transfer pricing adjustments

Transfer prices are remunerations for goods and services between affiliated entities. From a (corporate) income tax perspective, arm’s-length transfer pricing aim at ensuring that multinational companies distribute their profits in line with actual economic activities. Transfer pricing is at arm’s length if the conditions between affiliated companies are structured in the same way as they would have been agreed between independent third parties. In some cases — e.g., the CJEU’s case — the arm’s-length nature of a transaction is measured by one of the entities involved meeting a net margin that is considered to be at arm’s length. This aim is to appropriately reflect the tax burden in the countries involved. In general, the matter of transfer pricing is accompanied by extensive obligations to document the determination of transfer prices and the surrounding circumstances. If transfer prices set by the taxpayer are not in line with the arm’s-length principle, the tax authorities may adjust. Mispriced intercompany transactions can trigger extensive audits and, in some instances, also fines. Therefore, multinational companies often perform regular transfer pricing adjustments to ensure tax compliance and avoid penalties. Various recognized transfer pricing systems use compensation payments to ensure that a group company operates within a predefined arm’s-length margin corridor.

VAT consequences of transfer pricing adjustments: grey area

Both the VAT and the transfer pricing systems are relevant in cross-border group structures. However, the two systems have different objectives and, hence, employ different approaches to taxation. A taxable supply for VAT purposes is linked to performance and consideration. On the other hand, transfer pricing serves to ensure the correct distribution of profits to individual group companies for income tax purposes.

The VAT treatment of transfer pricing adjustments is controversial, and there are currently no uniform EU regulations on the VAT treatment of transfer pricing payments.

As a result, divergent approaches and legal opinions exist across the EU, and there are typically no separate domestic legal specifications on the VAT treatment of transfer pricing payments in the individual EU member states.

Generally, the VAT treatment of transfer pricing adjustments should depend on the analysis of the contractual documentation, the nature of the functions performed and whether there is a direct link with specific supplies. It is often argued that price adjustments may either indicate a separate service (if separately agreed on) or rather just lead to a change in the taxable base for the services actually provided by the recipient of the transfer pricing adjustment in the period in question, i.e., irrespective of their underlying income tax/transfer pricing implications and causes. Under certain conditions, adjustments have been considered entirely outside the scope of VAT or as compensation for general taxable services.

For example, if the customs value of specific goods has been adjusted upon import following a transfer pricing adjustment, this may indicate a direct link with specific supplies of goods, which should trigger VAT implications.

In any event, it is regularly very challenging to properly allocate the transfer pricing adjustments to different types of supplies rendered in the past, namely if these supplies related to different VAT treatments, and if the transfer pricing adjustment is not clearly calculated and contractually linked to these individual groups of services.

Particularly when transactional profit methods (Transactional Net Margin Method (TNMM), profit split) are applied, significant challenges may arise for VAT. These methods measure the arm’s-length nature on a profitability level. Therefore, these methods often lack a direct link to specific supplies, making reconciliation with VAT difficult, especially in the context of intra-group transactions involving goods of varying natures, potentially subject to different VAT rates.

Therefore, it could be argued that TNMM year-end adjustments aimed to reach the agreed profit should be considered out-of-scope VAT. They should be viewed as mere accounting corrections to align profit margins with the arm’s-length range rather than payments for specific supplies, due to the lack of a direct link with specific supplies (for example, see the position of the VAT Expert Group, VEG No. 071 REV2, p. 10).

Against this background, many consider the Arcomet judgment a “landmark” case. For the first time, the CJEU recognized that a transfer pricing adjustment based on the TNMM can constitute consideration for VAT purposes, where the adjustment remunerates identifiable intra-group services.

The CJEU’s statements on the VAT impact

Transfer pricing adjustments linked to taxable supplies

In the judgment Arcomet Towercranes, the CJEU rules that compensation payments to adjust the profit margin to the arm’s-length principle enshrined in the OECD Guidelines could constitute remuneration for a taxable supply. The court states that transfer pricing adjustments are indeed subject to VAT if they are directly linked to a specifically agreed service. Hence, profit-based adjustments cannot be considered generally irrelevant for VAT purposes.

The CJEU concludes that Arcomet Belgium supplied taxable services to the Romanian subsidiary, for which remuneration was agreed and paid by the Romanian entity. Under the contracts, Arcomet Belgium undertook to provide a certain number of commercial services and to bear the main economic risks associated with Arcomet Romania’s activity. The CJEU regarded this arrangement as a sufficient “legal relationship between the provider of the services and the recipient pursuant to which there is reciprocal performance”. The remuneration also constituted the actual consideration for the service, given that Arcomet Romania received a “specific advantage”.

• The effect of the payment as a transfer pricing adjustment did not negate this service relation for VAT purposes, based on the economic and commercial reality. Under these conditions, the transfer price can constitute the actual consideration for a service supplied.
• The court conceded that an uncertain payment could “break the direct link between the service … and any payment which may be received”. However, in the case at hand, the court did not consider the payment uncertain in this sense. Even though the remuneration presupposed the existence of a positive operating profit margin and thus depended on Arcomet Romania’s profits and losses, the court considered this “remuneration … neither voluntary nor uncertain; nor … difficult to quantify”. The detailed rules for that remuneration had been laid down in advance according to precise criteria, hence the remuneration was certain.
• Likewise, the possibility of a payment in the opposite direction (i.e., in the event of an operating profit margin of less than -0.71%) did not “break the direct link between the supply of services at issue and the consideration”, as this situation did not arise in the years under dispute (as there had always been a relevant positive operating profit margin).

Conditions for input VAT from transfer pricing adjustments

In the judgment Arcomet Towercranes, the CJEU points out that the tax authorities were allowed to require further information prior to granting the input VAT deduction. A taxable person who seeks the deduction of input VAT may need to prove that the invoiced services exist and were used (i.e., for business or for reasons permitting input VAT deduction). However, this requires that this further evidence be necessary and proportionate in the individual case.

Hence, the tax authority was allowed to require that Arcomet Romania provide evidence that the services had actually been
provided by Arcomet Belgium and that Arcomet Romania had actually used them for its own taxable transactions.

On the other hand, Arcomet Romania could not be required to establish the necessity or appropriateness of those services for its
taxable business. Considering that Arcomet Romania sought the deduction of input VAT, the company had the burden of proof in this regard.

The evidence that the tax authorities could require may include documents held by the service provider (here, Arcomet Belgium). However, the evidence required must be necessary and proportionate for the review of the input VAT (the national courts must assess these questions in each individual case).

In some member states, once services purchased across borders (as was the case in Arcomet) are correctly classified as taxable and self-declared under the “reverse charge”, input VAT deduction would be allowed without much further scrutiny. In these member states, the topic of the input VAT deduction may be more relevant for transfer pricing adjustments between domestic companies.

Conclusions and discussion following the judgment

The European Court of Justice (ECJ) clarifies that transfer pricing adjustments are subject to VAT if they are directly related to a specific supply. However, as pointed out by the advocate general, it is not possible to give a blanket answer to the question of whether transfer pricing adjustments are subject to VAT. Not surprisingly, it appears to be the key takeaway that (as was to be expected) a case-by-case assessment is required to determine whether the conditions for a taxable supply of services are met, or whether a transfer pricing adjustment is outside the scope of VAT or might lead to a reduction of the taxable base of prior supplies.

The VAT expert group at the European Commission had suggested (as a legally non-binding recommendation for the EU member states) that transfer pricing adjustments made by the tax authorities should (in all cases) be considered outside the scope of VAT. This may be different if these adjustments have a contractual basis or may be regarded as a reduction of the taxable base.

The CJEU’s judgment gives rise to the following observations and discussions:

• Does the Arcomet ruling indeed allow the general conclusion that, where there is clear agreement on the services provided (and the corresponding invoicing), a taxable service for VAT purposes generally exists — even if the remuneration is based solely on transfer pricing criteria, even if a total non-payment would have been possible under the contract, and even if the contract would have provided for a payment obligation in the other direction? Or is such a conclusion restricted to scenarios in which these alternative scenarios do not happen?
• Is it correct that, in the case of a total non-payment (i.e., the agreed conditions for a payment in one of the two directions are not met), no taxable service would have been supplied?

What would be the VAT impact if the compensation payment were made in the other direction, i.e., from Arcomet Belgium to Arcomet Romania? Who would raise the invoice if Arcomet Romania’s margin were too low? Would Arcomet Romania have supplied the service in this case?

• Could a (local) court interpret the (admittedly very specific) payment arrangements in the Arcomet case as a barter transaction, considering that services in both directions have been agreed on (and are arguably being supplied), and one of the two parties may have to make an additional payment?
• What if the services had not been clearly specified and agreed on in the contract, but the parties simply agreed to invoice the transfer pricing adjustment later on as a “service”? Is it safe to assume that, under the circumstances, a taxable supply would still be possible if the invoicing company has, as a matter of fact, performed a service?
• It was not debated in the judgment if and how a (typical, regular, annual, “flat-rate”) transfer price adjustment may need to be allocated to different types of services, namely if the services can be subject to different VAT treatments, such as different tax places, rates, exemptions, times of supply, etc. (some hints may be found in the Attorney General’s (AG) opinion in the case Högkullen (C808/23)), in which the AG argued against the treatment of the adjustments as a single service but rather for an individual assessment of the service elements.

It was not addressed in the judgment whether transfer pricing adjustments might also qualify as deductions of the taxable base for prior supplies rendered by the paying company to the company receiving the transfer pricing adjustment.

Multinational groups should review the VAT impact of their agreements and practice related to transfer pricing adjustments. If the adjustments were treated as non-taxable, it should be reviewed whether this can be upheld in light of the CJEU’s decision and the relevant general principles of VAT law. If the adjustments were considered taxable and input VAT was deducted, the link to a specific supply may need to be sufficiently agreed on and documented (depending on the county). If the adjustments were treated as reductions of the taxable base, it should be reviewed whether taxable supplies and out-of-scope services could indeed be ruled out.