Analytics

This article is a continuation of a previous one “Important transfer pricing court practice: the cassation appeal of the tax office has been (partially) satisfied again by the Supreme Court – why is the case important and what significant nuances have not been taken into account?”.

The previous article on this case expressed our concern that the Supreme Court unexpectedly granted the cassation appeal of the Main Department of the State Tax Service (the Tax Office) partially and submitted the case for a new trial to the appeals court. Thus, while the case was generally developing in a positive way for the Taxpayer, it could have had a negative outcome. And such a result could have been detrimental for many taxpayers dealing with transfer pricing control.

It should be noted that the Tax Office position was based on the revision of the market profitability range calculated by Olympex Coupe International TOV (the Taxpayer) when applying the net margin method to substantiate transshipment services at the Commercial Sea Port of Odesa.

Along with the steps taken by the Taxpayer to pick out the comparable companies, the Tax Office applied two additional criteria: 1) the size of the company (namely, the amount of assets and the number of employees) and 2) the geographical location of the ports where the services are provided.

As a result of these “improvements” to the selection criteria, the Tax Office sample was left with three companies for 2014 and as many as two companies for 2015. Moreover, as it can be understood from the texts of the court decisions, the lower quartile of the net profitability ranges was 13.37 % in 2014 and impressive 44.39 % in 2015.

By contrast, the results of the Taxpayer’s research were as follows: the lower quartile of the range was 7.42 % in 2014, and 8.30 % in 2015.

Hence, the additional criteria applied by the Tax Office led to a dramatic narrowing of the sample and an increase in the lower edge of the range, by which the violation of Article 39 of the Tax Code of Ukraine was established.

As we have mentioned in the previous material, the courts in this case are faced with a fundamental transfer pricing practice issue: is it appropriate for the Tax Office to impose additional criteria significantly reducing the number of companies in the sample, whereby the range is significantly biased in the “pro-fiscal” way?

To our relief, the judiciary in this case resolved the issue in a favorable way for the taxpayers.

It should be reminded that the Supreme Court partially upheld the cassation appeal of the Tax Office, with the following reasoning:

“… the court of appeal should have investigated and analyzed all the circumstances forming the basis for the conclusion of the controlling authority on incomparability of individuals in the context of each of the business entities proposed by the plaintiff in the sample through the lens of geographical location of the markets and their volumes”.

On February 22, 2024, the Supreme Court finally brought the dispute to an end as a result of the re-examination of the case in the appellate instance (in which it confirmed the previous decision in favor of the taxpayer) (the court decision is available here).

According to the decisions, the court of appeal reviewed more thoroughly the assertions of the parties regarding two new criteria used by the Tax Office to narrow the sample.

Thus, as noted by the Supreme Court, the Court of Appeal examined in detail the companies shortlisted by the Taxpayer in terms of their comparability both by size and geographical location criteria.

Based on the size criterion, the appellate court ruled that “…the activities of the comparable companies listed by Olympex Coupe International TOV fully correspond to the Company’s activities, both under the Classification of types of economic activity (KVED) and with due regard to industry specifics and relevant activities (cargo handling and storehouse services, other supporting activities in the field of transport), and the majority of the above companies have fixed capital assets corresponding to “Olympex Coupe International TOV”. 

The Court of Appeal emphasized once again the “inventive” approach of the Tax Office to the method of picking up allegedly comparable companies according to this criterion: “the content of the tax audit act fails to explain why the defendant partially retained medium-sized companies in the sample and partially excluded them from it, while including companies with fewer employees than the removed ones, and it also fails to explain why the defendant did not retain only large companies in the sample”.

Similarly, the appellate court analyzed the criterion of the geographical location of the ports where the business activity was carried out.

Thus, the Court of Appeal ruled that (1) “the weighted average depths in the ports under consideration are close to the depths of the berths where the plaintiff operates”, and (2) “equality of access by port operators to berths is envisaged for all the ports and the port fee is collected pro rata to loading”.

As a result, the Supreme Court agreed that “…the court of appeal concluded correctly that under the factual circumstances established in the case at hand the defendant’s arguments about the need to exclude companies not operating in deep-water ports and ports of the Azov Sea from comparable enterprises are unjustified and have no basis in fact, and therefore the controlling authorities had no legal grounds to issue the contested tax notification-decisions”.

The Supreme Court concurred with the conclusions of the Court of Appeal and, as a result, dismissed the cassation appeal of the Tax Office.

Therefore, it can be concluded that this dispute has been brought to an end – the judiciary critically assessed the approach of the tax authorities to “invent” new criteria for narrowing the sample of comparable companies and found it unreasonable for this particular case.

Admittedly, such a decision is not universal and will not be a “safeguard” against further attempts to manipulate the sample of comparable companies by the tax authorities. At the same time, this decision gives grounds for confidence to those taxpayers who have to defend themselves against such approaches of the tax authorities. With proper legal support and solid evidence-based explanations, their position can be successfully defended in court.

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.

Kind regards,

© WTS Consulting LLC, 2024

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