Wages payment is not a controlled transaction! How the court took the side of adequacy and took away the opportunity for the tax authorities to fine persons for non-existent violations
For some time, there has been an unresolved issue between taxpayers and tax authorities on the matter of referring of wages to the area that falls under the transfer pricing control (hereinafter – TP). We remind you that the Ministry of Finance supported the State Fiscal Service in a letter as of February 1, 2019 No. 11420-08-63/2874, where it indicated that transactions on the payment (accrual) of wages to individuals – non-residents can be considered controlled transactions (hereinafter – CT), if the cost criteria for recognizing the CT are met, and therefore it is necessary to submit a Report on CT for such transactions.
Previously, we have argued against such a conclusion in the material “Are TP rules applied to wages payment? The Ministry of Finance of Ukraine assumes “yes”. What’s wrong with this position?”. It seems that the Court has the same opinion that this interpretation of the law by the supervisory authorities and the Ministry of Finance is groundless and unlawful.
In its decision as of August 4, 2021, in the case No. 640/847/19, the Court of Appeal upheld the position of the taxpayer in this case and took the side of the taxpayers. KM Partners represented interests of plaintiff company in a dispute with the Main Department of the State Tax Service in Kyiv and proved that it was not necessary to include the wages to the Report on CT, as the TP rules do not apply to labor relations.
As regards wages, the case concerned the fact that the tax authority recognized the wages payment to a related non-resident individual as a business transaction. As the amount of such “transaction” and “annual income” of the enterprise exceeded the threshold for the CT recognition, the plaintiff, in the opinion of the tax service, had to report this “transaction” in the annual TP report. As the transaction was not included to the Report, the supervisory authority applied penalties to the plaintiff.
The Court did not agree with the “arguments” of the supervisory authority and noted the following:
- on the impossibility of filling the Report on CT in case of payment (accrual) of wages to individuals – non-residents:
– “In accordance with paragraph 18 of Section IV of the Procedure the columns 14, 15 indicate the same date – the date of change of ownership of goods or the date of the act or other document issued in accordance with applicable law, which confirms the performance of works or provision of services.
In the case of accrual of wages such a document and date do not exist, which indicates on the impossibility of recognizing the labor relations as controlled”.
– “It is also impossible to fill in other mandatory columns in the case of analysis of labor relations (for example, column 10 “Code of origin of the subject of the transaction”, column 11 “Terms of delivery”, column 12 “Trademark of the subject of the transaction…”, column 13 “Manufacturer of the subject of the transaction…”, column 17 “Quantity”, column 18 “Unit of measurement”, column 22 “Profitability index”, etc.)”.
- on the TP Guidelines of the Organization for Economic Cooperation and Development (hereinafter – OECD):
– “TP rules that provided by Art. 39 of the Tax Code of Ukraine are based on the OECD Guidelines. According to the letter of the State Fiscal Service as of August 15, 2017, No. 1615/6/99-99-15-02-15/ІПК OECD Guidelines are the main recommendatory and methodical international document in the area of TP regulation. … According to the OECD Guidelines, CTs are defined as transactions between two enterprises that are associated in relation to each other. The definition of the “arm’s length” principle contains an indication of the need to comply with this principle in commercial and financial relations between enterprises.
Thus, in the sense of the OECD Guidelines, CTs are exclusively transactions between related enterprises”.
- on comparable uncontrolled transactions:
– “The Judicial Board draws attention to the fact that the condition for the application of the methodology and procedures of the TP is the need to establish comparable uncontrolled transactions. … The board of judges draws attention to the fact that the provisions of the Tax Code of Ukraine (refers to paragraphs 22.214.171.124 and 126.96.36.199 of Article 39 of the Tax Code of Ukraine) show that they relate to relations within business activity on the basis of agreements under civil law.
Such rules cannot be applied to relations under employment contracts with individuals as in the present case with the plaintiff and his employee”.
- on sources of information:
– “That is, the sources of information are defined in Article 39 of the Tax Code of Ukraine (refers to the sources provided for in paragraph 188.8.131.52 of Article 39 of the Tax Code of Ukraine) in such a way that they should provide an opportunity to compare commercial and financial conditions of transactions, while such conditions do not exist in the case of labor relations.
Thus, it is impossible to make a comparison of transactions for labor relations, without which it is impossible to apply the methods of TP.
The Act of tax audit does not provide any comparable uncontrolled transactions that could be compared with the wages payment to a non-resident individual, and such a comparison is a basic principle of TP, enshrined in Article 39 of the Tax Code of Ukraine”.
- on the impossibility of adjusting the financial result in the case of payment (accrual) of wages to individuals – non-residents:
– “In addition, TP rules have been introduced to properly identify the object of income tax. The meaning of their application to certain transactions exists only if it is possible to adjust the financial result in accordance with paragraphs 140.5.1 and 140.5.2 of Article 140 of the Tax Code of Ukraine.
The subject of regulation of labor relations is the performance by the employee of a certain labor function for a certain salary. In this case, there is no contractual value, which is determined by a certain result, as well as purchased goods (works, services) in labor relations. The Tax Code of Ukraine does not provide for adjustments based on the TP rules for salary expenses within the labor relations”.
So, the Court stated that:
“The abovementioned arguments indicate that the extension of TP rules to labor relations is impossible under current legislation”.
Thus, we see the absolute victory of common sense over fictional violations. In the case of cassation proceedings, we hope that the Supreme Court will not stay aside and will only increase the number of arguments against the position of the tax authorities.
The above commentary presents the general statement for information purposes only and as such may not be practically used in specific cases without professional advice.