EU: Intra-group payments under the transactional net margin method subject to VAT (CJEU judgment)

The Court of Justice of the European Union (CJEU) today published its judgment in SC Arcomet Towercranes SRL (case C-726/23), in which it held that inter-company transfer pricing payments based on the transactional net margin method provided for in the OECD Transfer Pricing Guidelines are subject to value added tax (VAT). The CJEU broadly follows the nonbinding opinion of its Advocate General that was published earlier this year (read TaxNewsFlash).

Facts

The taxpayer, a subsidiary operating in the crane rental sector, entered into a contract with its parent company, under which the parent company provided strategic, commercial, and risk management services while assuming most economic risks, and the subsidiary managed the purchase, sale, and rental of cranes in Romania. The contract between the subsidiary and the parent company established that the subsidiary’s operating profit margin should be kept within a specific range, from -0.71% to 2.74%, based on the transactional net margin method under the OECD Transfer Pricing Guidelines. Each year, if the subsidiary’s profit margin was higher than 2.74%, the parent company would issue an invoice to the subsidiary to recover the excess profit, effectively transferring some of the profit to the parent company. Conversely, if the subsidiary’s margin was lower than -0.71%, it would invoice the parent company to cover the excess loss. No payment was required if the profit margin stayed within the set range.

In 2011, 2012, and 2013, the subsidiary’s profit margin exceeded the upper limit, resulting in invoices from the parent company for excess profit, which the subsidiary treated as intra-Community services for VAT purposes for the first two invoices and as outside the scope of VAT for the third invoice. Following a tax inspection, Romanian authorities denied the subsidiary’s VAT deductions on these invoices, arguing that the services invoiced were not proven to have been provided or necessary for the subsidiary’s taxable transactions, and imposed additional VAT, interest, and penalties.

Questions before the CJEU

• Should Article 2(1)(c) of the VAT Directive be interpreted to mean that an amount billed by one company to a related company, which aligns the operating company's profit with its activities and assumed risks according to OECD margin principles, constituting a payment for a service and is therefore subject to VAT?
• If the first question is answered affirmatively, can the tax authority require documentation beyond the invoice, such as activity reports or work statements, to justify the use of purchased services for taxable activities, or if the assessment of VAT deduction rights should solely rely on the direct link between the purchase and the taxable transaction or the overall economic activity of the taxpayer?

CJEU decision

First question

The CJEU notes that under the EU VAT Directive, a supply of services is subject to VAT only if there is (1) a legal relationship involving reciprocal performance, and (2) the remuneration received constitutes actual consideration for an identifiable service. Examining the facts, the CJEU finds that the contract between the parent company and the subsidiary involved reciprocal commitments: the parent company provided commercial services and assumed economic risks, while the subsidiary agreed to pay an amount corresponding to excess profit margin. These payments were directly linked to the services provided, which conferred specific advantages on the subsidiary, such as cost savings and improved customer service. Thus, the arrangement satisfies the requirement for a direct link between the service provided and the consideration received.

The court rejects arguments that the payments are merely for transfer pricing adjustments without specific activities in return, emphasizing that the economic and commercial reality must be considered. The remuneration, although variable and dependent on profit margins, is not uncertain or voluntary, as it is determined by precise contractual criteria. The situation is also distinguished from mere holding activities, as the parent company is actively involved in the management and provision of services to its subsidiary.

Therefore, the CJEU holds that, subject to verification by the referring court, the remuneration paid by the subsidiary to the parent company under the contract—calculated according to the OECD Guidelines and linked to the operating profit margin—constitutes consideration for a supply of services for VAT purposes under Article 2(1)(c) of the VAT Directive.

Second question

The court explains that the right to deduct VAT depends on both formal and substantive conditions: formally, the invoice must meet certain requirements; substantively, the services must (1) have actually been provided and (2) used for the taxpayer’s own taxed output transactions, though the necessity or profitability of the services is not a condition for deduction.

In this case, since the invoices did not specify the nature or quantity of the services, they did not meet the formal requirement. However, based on established CJEU case-law, tax authorities cannot deny a VAT deduction solely due to formal invoice defects if they have enough information to verify substantive requirements, but they may request additional evidence from the taxpayer to confirm those requirements. Therefore, the Romanian tax authority was entitled to ask the subsidiary for further proof that the services were actually provided and used for its taxable activities. The CJEU emphasized that the tax authority cannot require proof of their necessity or appropriateness. The burden of proof lies with the taxpayer, and tax authorities may require supporting documents, including those held by the service provider, as long as such requests are necessary and proportionate to verify the substantive conditions for VAT deduction.

Therefore, the CJEU held that the VAT Directive did not prevent tax authorities from demanding documents other than invoices to establish that services were provided and used for taxable transactions, provided these requirements were proportionate and justified by the need to verify the right to deduct.

KPMG observation

The VAT treatment of transfer pricing adjustments has for a long time been elusive and subject to several in-depth papers from the EU VAT Committee and the EU VAT Expert Group, arriving at slightly different conclusions. EU tax authorities have so far only published limited guidance on the matter. This case as well as other pending cases before the CJEU (e.g., Case C-603/24 Stellantis Portugal, S.A. dealing with transfer pricing adjustment payments) are thus providing some long-sought clarity on the VAT treatment of transfer pricing arrangements in the EU.

This case clarifies that intra-group transfer pricing payments, even those calculated using the transactional net margin method, are subject to VAT as they represent payments for services in this case. For businesses with limited ability to recover VAT, such as those in financial services or real estate, this decision results in an additional tax cost. However, for most businesses, the decision should not incur additional tax costs if they meet the proper documentation requirements because (1) most intra-group transactions occur cross-border, when the recipient typically self-assesses VAT under the reverse-charge mechanism, and (2) most businesses possess the full right to recover VAT, allowing the self-assessed VAT to be fully deductible in the same VAT return.

In this context, the answer to the second question emphasizes that VAT recovery necessitates proper documentation. Therefore, intra-group transactions based on transfer pricing agreements must be supported by VAT-compliant invoices that include sufficient details regarding the nature and quantity of the services or goods provided. This documentation is essential to demonstrate that the services or goods have been effectively provided and utilized by the taxpayer. If such details are absent, tax authorities may request additional information and potentially deny VAT recovery. This requirement will become more stringent as EU member states implement e-invoicing requirements, especially once the EU VAT in the Digital Age intra-EU e-invoicing and digital reporting mandate becomes effective in 2030.

Businesses may want to consider taking the following steps:

• Review inter-company agreements and determine on a case-by-case basis whether they result in transactions being subject to VAT. Arrangements using the transactional net margin method may need to be prioritized since the case is focused on these.
• If the arrangements are determined to be subject to VAT, review supporting documentation (invoices and other documents), so that (1) invoices have been duly issued for these transactions and (2) sufficient evidence exists that the goods/services are effectively provided for the benefit of the receiving entity.
• Include a review of the VAT treatment of intra-group transactions during e-invoicing implementation projects as these transactions are often carried out outside of the sales and purchase modules of Enterprise resource planning (ERP) systems and thus not always supported by proper VAT invoices.

For more information, contact a KPMG tax professional:

Philippe Stephanny | philippestephanny@kpmg.com

Chinedu Nwachukwu | chinedunwachukwu@kpmg.com