EUROPEAN COMMISSION

DIRECTORATE-GENERAL
TAXATION AND CUSTOMS UNION
Indirect Taxation and Tax administration
Value Added Tax

VAT Expert Group

taxud.c.1(2018)2326098 – EN

Brussels, 18 April 2018

VAT EXPERT GROUP

VEG NO 071 REV2

Paper on topic for discussion

Possible VAT implications of Transfer Pricing

Commission européenne, 1049 Bruxelles / Europese Commissie, 1049 Brussel – Belgium – Tel.: +32 2 299 11 11.
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1. EXECUTIVE SUMMARY - THE VAT EXPERT GROUP’S OPINION

The VEG welcomes the opportunity to discuss the possible VAT implications of transfer
pricing rules laid down for the purposes of direct taxation.

It is important to note that Transfer Pricing Adjustments are direct tax driven and direct
tax and VAT are conceptually totally different taxes. As such, a Transfer Pricing
Adjustment does not usually result in an adjustment in the consideration for any supply,
even though the profit adjustment may be an indirect consequence of goods being bought
or sold and other kinds of costs being incurred.

When defining the VAT treatment of a Transfer Pricing Adjustment, the VAT neutrality
principle should be recognized, meaning that neither businesses nor tax administrations
should suffer negative consequences from the proposed treatment.

An exception to this would be where Article 80 of Directive 2006/112/EC applies or when

there is an abuse of law (e.g. through artificially low pricing to reduce non-recoverable
VAT followed by a relatively large Transfer Pricing Adjustment) or a member state has a
derogation under Article 395.

The Opinion of the VAT Expert Group is that Transfer Pricing Adjustments should
be considered as “Outside scope of VAT” where both parties have a full right to
recover VAT, in accordance with the simplification practice that we suggest to be
adopted by the Member States (see 2.2.3). It is only when one of the traders does not have
a full right of recovery, that Transfer Pricing Adjustments might require a VAT
adjustment if there is a sufficiently direct link between any payments resulting from an
adjustment and specific supplies. Transfer Pricing Adjustments resulting from a tax audit
should always be treated as outside of the scope of VAT (see 2.2.1.1) unless the parties
agree to change the consideration accordingly.

2. INTRODUCTION

The VEG welcomes Commission Paper VEG No. 65 and the opportunity to discuss the
possible VAT implications of Transfer Pricing Adjustments as laid down for the purposes
of direct taxation.

The direct tax transfer pricing rules are aimed at ensuring that the conditions of the
transactions within a multinational enterprise group ("MNE group"), including the price,
match comparable market conditions and that, as a result, profits and losses are divided
between the jurisdictions in which the multinational enterprise ("MNE") operates as they
would have been, had the transactions under transfer pricing been performed between
unrelated 3rd parties

Besides Transfer Pricing Adjustments between affiliated parties, the scope of Transfer
Pricing Adjustments needs to be expanded to adjustments executed between 3rd parties
due to contractual arrangements. This may be the case for instance in case of guaranteed
profit margins for 3rd party distribution, toll and contract manufacturing arrangements.

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The aforementioned aim (proper allocation of income between related and unrelated
parties) clearly differs from the aim of the VAT system, i.e. taxation of consumption, with
the allocation of taxing rights based on the destination principle.

Nevertheless, Transfer Pricing Adjustments can also have VAT implications. Businesses
across the EU have, in practice, experienced Member States taking different approaches
on how to treat Transfer Pricing Adjustments for VAT purposes, such as:

1. Outside the scope of VAT – no taxable transaction for VAT purposes

2. Price adjustments – the adjustment is linked to a prior underlying taxable
transaction for VAT purposes (retroactive adjustment)
3. Further consideration for a subsequent supply (prospective adjustment)
4. Consideration for a separate service – separate taxable transaction for VAT
purposes

Annex 1 refers to a couple of real-life examples of issues in business practices on Transfer

Pricing Adjustments. The examples clearly show the lack of clarity on how to deal with
Transfer Pricing Adjustments from a VAT perspective. This uncertainty may cause a
significant monetary risk and a high administrative burden on businesses operating in the
European Union.

It is therefore important to examine this topic in further detail to provide legal certainty for
businesses and tax administrations.

This document deals with the VAT aspects only. We recognize that when it comes to TP
adjustments there is also a linkage to customs with potential VAT consequences 1.
However, the specificity of the rules2 applicable to customs transactions justifies a
separate treatment of this topic. Also, this document does not consider the impact of
Transfer Pricing Adjustments on Direct Tax.

2.1. Principles

Transfer Pricing Adjustments, while mainly related to the “Taxable Amount”, have a
much broader impact.

The notion “Transfer Pricing Adjustments” is not mentioned in VAT Directive

2006/112/EC (“VAT Directive”). There are also no CJEU cases available which
specifically deal with the handling for VAT purposes of Transfer Pricing Adjustments.

Below is an overview of the provisions in the VAT Directive which may have an impact
to define the correct VAT treatment of Transfer Pricing Adjustments.

1
See CJEU C-529/16, Hamamatsu, para. 26: “Furthermore, the Court has already stated that the customs
value had to be determined primarily according to the ‘transaction value’ method under Article 29 of the
Customs Code. It is only if the price actually paid or payable for the goods when they are sold for export
cannot be determined that it is appropriate to use the alternative methods laid down in Articles 30 and 31
thereof (see, in particular, judgments of 12 December 2013, Christodoulou and Others, C-116/12,
EU:C:2013:825, paragraphs 38, 41, 42 and 44, and of 16 June 2016, EURO 2004. Hungary, C-291/15,
EU:C:2016:455, paragraphs 24 and 27 to 30).”.
2
See Article 70 et seq. of REG EU (Recast) no. 952/2013.

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Taxable transaction

A supply of goods or services is subject to VAT when made for consideration by a taxable
person acting as such, pursuant to Article 2(1) of the VAT Directive.

Concerning the existence of consideration, from the settled case-law of the Court of
Justice of the European Union (CJEU), it is clear that a supply of services is effected for
consideration within the meaning of Article 2(1)(c) of the VAT Directive, and hence is
taxable, only if there is a direct link between the services supplied and the consideration
received.

Such a direct link is established if there is a legal relationship between the provider of the
service and the recipient pursuant to which there is reciprocal performance, the
remuneration received by the provider of the service constituting the actual consideration
given in return for the service supplied to the recipient.

Based on the existing case-law of the CJEU concerning the existence of a direct link, it
can be argued that Transfer Pricing Adjustments do not meet this requirement3.

Taxable person

A taxable person is defined as any person carrying out an economic activity, whatever the
purpose or results of that activity under Article 9 of the VAT Directive.

Taxable amount

The anti-avoidance rule in Article 80 of the VAT Directive is only applicable in the case
of transactions between persons with close (family, financial or legal etc) ties.

Also, according to the CJEU4, the conditions of application of Article 80 of the VAT
Directive are exhaustive and, consequently, national legislation cannot - on the basis of
that provision - provide that the taxable amount is to be the open market value of the
transaction in cases other than those listed in that provision, except if a Member State has
a derogation under article 395.

This is different from the direct tax concept and application of transfer pricing for intra-
group transactions.

Article 83 of the VAT Directive does not provide for a specific Transfer Pricing provision
either, as the taxable amount of an intra-Community acquisition of goods is determined in
the same way as that of supplies of goods or services.

3
See CJEU C-285/10, Campsa Estaciones de Servicio SA vs. Administración del Estado para. 27: “ It
follows that, where consideration has been agreed and actually paid to the taxable person in direct
exchange for the goods he has delivered or the service he has provided, that transaction must be
classified as a transaction for consideration, regardless of whether it is effected between connected
parties and the price agreed and actually paid is patently lower than the open market price. The taxable
amount of such a transaction must, therefore, be determined in accordance with the general rule stated in
Article 11A(1)(a) of the Sixth Directive.” (emphasis added).
4
See CJEU Joined Cases C-621/10 and 129/11

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Article 85 of the VAT Directive establishes the taxable amount for an importation of
goods by reference to the corresponding customs value.

Article 90 of the VAT Directive deals with Transfer Pricing Adjustments: “where the
price is reduced after the supply takes place, the taxable amount shall be reduced
accordingly under conditions which shall be determined by the Member States”.

Chargeable event and chargeability of VAT

Following Article 63 of the VAT Directive, the chargeable event shall occur, and VAT
shall become chargeable, when the goods or the services are supplied. Some subsequent
articles allow for derogations. Article 70 of the VAT Directive dealing with the chargeable
event for the Importation of Goods provides that “The chargeable event shall occur and
VAT shall become chargeable when the goods are imported”.

The chargeable event for Transfer Pricing Adjustments should in our opinion be the
moment when the decision is made to voluntarily adjust the taxable amount for VAT
purposes. At the same time, a debit/credit note is issued.

Invoicing, concept of an invoice – Deduction of VAT

Transfer Pricing Adjustments also have an impact on invoicing and deduction of VAT.

Article 219 of the VAT Directive mentions that “Any document or message that amends
and refers specifically and unambiguously to the initial invoice shall be treated as an
invoice”. Typically, a taxable person only has the right to deduct the VAT in case he
possesses an invoice or an import document in case goods are imported in the EU.

In our opinion, the deduction is a fundamental right of the VAT mechanism (neutrality
principle). A correction of the amount of deductible VAT via an adjusted invoice should
not result in a retro-active adjustment of the deductible VAT5. In line with the rules on
chargeable event, VAT should be deductible at the moment when the obligation or the
right to adjust the taxable amount for VAT purposes arises. The deduction of VAT should
not be impacted by the expiry of statutory limits in case of Transfer Pricing Adjustments. 6

Reporting requirements

Impact of Transfer Pricing Adjustments on VAT reporting such as the

monthly/quarterly/annual VAT return and the recapitulative statements should be carefully
considered to avoid a burdensome, complex and time-consuming process, particularly as
transfer pricing is typically a B2B transaction that, in most cases, will see its VAT impact
neutralized. Where unavoidable, the Transfer Pricing Adjustment should be reported in the
month the document adjusting the VAT liable/deductible is issued, there should be no
requirement for retroactive adjustment and/or reporting in the period the initial
transaction.

5
See AG Opinion in CJEU Case C-8/17, point. 71 Conclusion and AG Opinion in CJEU Case C-533/16,
point. 91 Conclusion
6
See Ecotrade C-95/07 and C-96/07 and Case C-85/97 SFI

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2.2. Considerations to define Transfer Pricing Adjustments as Taxable

transactions in/outside the scope of VAT

Based on the VAT Directive, it is not clear when a Transfer Pricing Adjustment is a
taxable transaction within- or outside the scope of VAT. In some cases it might be argued
that a Transfer Pricing Adjustment is an adjustment of a previous Taxable Transaction and
therefore constitutes additional consideration for the same Taxable Transaction. It may
also be arguable that the Transfer Pricing adjustment is consideration for a different
Taxable Transaction or alternatively is outside the scope of VAT.

In the absence of a specific provision to this effect, the proposed VAT treatment in this
document aims to bring certainty, simplicity and clarity on Transfer Pricing Adjustments.

2.2.1. Transfer Pricing Adjustments Outside the scope of VAT

Following Transfer Pricing Adjustments are not considered as taxable transactions and are
consequently defined as being outside scope of VAT:

 Non-voluntary adjustments (2.2.1.1.)

 Voluntary Prospective Compensating adjustments (2.2.1.2.)

2.2.1.1. Non-voluntary Transfer Pricing Adjustments

Generally, there is only a taxable transaction where there is “consideration” (which can go
beyond cash settlement). If there is no “consideration”, there is no taxable transaction and
the Transfer Pricing Adjustment is clearly “Outside the scope of VAT”. It is our
understanding that Primary, Secondary and Corresponding Adjustments7 do not qualify as
“consideration”, and as such do not lead to a “Taxable Transaction”. These adjustments
are therefore considered as being “Outside the scope of VAT”. In addition to the absence
of Taxable Transactions, there is no “reciprocal” performance.

These non-voluntary adjustments also typically occur after the tax return has been filed.

For instance, adjustments to the price of transactions or taxable basis upon audit of a
taxable person. This can happen if the profit margin is not correctly applied if goods or
services are invoiced on a cost+ basis. Typically, the taxable basis of the person under
audit is increased while there is no corresponding decrease in the taxable basis of the
counterparty.

Example - Reallocation of costs upon TP-audit

 Costs have been paid by Company A in MS 1
 During an audit, costs are from an income tax perspective rejected in the hands of
Company A
 Following audit report, considering account functions/risks, these costs are to be paid
by Company B in MS 2

7
See VEG no. 65, Possible VAT implications of Transfer Pricing, page 6-10, definitions of Primary,
Secondary and Corresponding Adjustments

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 There is compensation paid by Company B to Company A for the costs incurred by

Company A and rejected by the auditor

Potential VAT issues:

 Rejection of right of deduction of VAT in the hands of Company A in MS1
 Is there a requirement to re-invoice the rejected costs to Company B or a credit note to
be issued by Company B.
 What is the qualification of the taxable transaction?
 Will Company B have the right to deduct VAT in MS2?
 Can an invoice/CN still be issued considering Statute of limitations?

2.2.1.2. Voluntary Prospective Compensating adjustments

Compensating adjustments are defined8 as “An adjustment in which the taxpayer reports a
transfer price for tax purposes that is, in the taxpayer’s opinion, an arm’s length price for
a controlled transaction, even though this price differs from the amount actually charged
between the associated enterprises. This adjustment would be made before the tax return
is filed”.

In case of “prospective” compensating adjustments, the Transfer Pricing Adjustment is

included in the price of future supplies of the same (identical) products via a price
decrease/increase. The VAT treatment of the “prospective adjustment” would logically
follow the treatment of the “future” supplies. There is no impact on VAT at the moment
the Transfer Pricing Adjustment has been calculated, only at the time the invoice of the
future supply which includes the Transfer Pricing Adjustment is issued.

2.2.2. Impact of the link with the initial supply

The correct VAT treatment depends on whether there is a direct link with the initial
supply.

2.2.2.1. Direct link with the initial supply

Where the Transfer Pricing Adjustment can be linked to the initial supply, the VAT
treatment of the adjustment is the same as the initial supply. The “link” requires that the
Transfer Pricing Adjustment can be split so as to link (part of) the adjustment to each
single good being sold or service being provided. For goods, the price of each product can
be adjusted for each supply being made. For services, the cost of each service provided
can be adjusted.

2.2.2.2. No direct link with the initial supply

Where there is no direct link with the initial supply and no contractual obligation to make
a Transfer Pricing Adjustment payment, the assumption is that the adjusting payment aims
to reach an agreed profit margin, which is not a taxable transaction or taxable
consideration, and as such outside scope of VAT.

8
See VEG no. 65, Possible VAT implications of Transfer Pricing, page 10

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Where the contract refers to the treatment of Transfer Pricing Adjustments, the agreed
treatment as per the contract should be followed. Following options are possible:

Definition Transfer Pricing Adjustment VAT treatment

as per the contract
Contract defines adjustments to reach Adjustment relates to a "profit adjustment"
guaranteed profit margin - This is not a Taxable Transaction - No
debit or credit note or any other document
for VAT purposes to be issued
Contract defines adjustment for previous Taxable transaction - Supply of Goods (or
supplies - - reference is made to a period services) – Debit or credit note to be issued
during which transactions happened, list of - same VAT treatment as initial transaction
invoices numbers attached, breakdown of
the adjustment to each supply
Contract defines the adjustment as billing of Taxable amount is adjusted, ie further (less)
variances between actual and budgeted cost consideration for a "Supply of Services" -
of marketing or administrative expenses Debit or credit note to be issued

Contract defines the adjustment as a profit Adjustment relates to a "profit adjustment"

split (e.g. in case of a joint venture) - This is not a Taxable Transaction - No
debit or credit note to be issued

Documents may be desired for direct tax purposes to evidence payments that are made
between the parties but which are outside the scope of VAT. If such documents are
described as “invoices”, it is possible that tax authorities will assume that VAT must be
due. The VAT Expert group therefore considers that it would be helpful to both tax
authorities and business if there were an agreed description, such as “Transfer Pricing
Payment Request”, for documents requesting payments relating to transfer pricing
adjustments that are outside the scope of VAT.

See Annex 1, Example 1.

2.2.3. Simplification practice

Unless it has been otherwise contractually agreed, given the complexity of the treatment
of Transfer Pricing Adjustments for VAT purposes, we recommend treating all types of
Transfer Pricing Adjustments as Outside the Scope of VAT for B2B transactions where all
parties have a full right to deduct VAT.

Transfer Pricing Adjustments are Direct tax driven. Direct taxes and VAT are
conceptually totally different. This is correctly highlighted by the Commission in VEG
Paper No 65, which observes that VAT is a transaction based tax with businesses just
acting as tax collector and the VAT being borne by the final consumer. In principle, the
tax should therefore be neutral for businesses.

The VAT Expert Group’s preferred approach to Transfer Pricing Adjustments is to treat
them as being “Outside the scope of VAT’. Transfer Pricing Adjustments are executed to
determine the Taxable Basis for Direct Tax purposes. A Transfer Pricing Adjustment
should not necessarily result in a price adjustment for VAT purposes, even though the

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profit adjustment may be an indirect consequence of goods being bought or sold and other
kinds of costs being incurred.

Consequently, Transfer Pricing Adjustments do not lead to a “new” Taxable Transaction

nor do they adjust a past transaction. Transfer Pricing Adjustments should not be and,
generally, can’t be directly linked to a previous transaction. Unless there is a contractual
provision requiring a modification in the consideration originally due, even where a direct
link can arguably be established, Transfer Pricing Adjustments should in practice be
considered to be “Outside scope of VAT”, where both parties are Taxable Persons with
the full right to deduct VAT.

This approach is applied by at least one of the Member States. A tax authority states that
usually no correction is necessary for VAT if the omission does not have an impact on the
tax revenue and the VIES system, e.g. because the underlying transaction is a zero-rated
(exempt with credit) intracommunity supply of goods.

2.3. No negative consequences where the taxable basis for VAT should be
amended

Transfer Pricing Adjustments should not have adverse VAT impacts on businesses. Even
if adjustments are required for VAT purposes these should not lead to the application of:
 penalties;
 late payment interest; and
 If the adjustment is within the scope of VAT, the statute of limitations should be the
same for the payment of VAT and the right to refund/or deduct VAT due that arises
from the adjustment (see also under 2.1. Principles).

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ANNEX 1

Real-life examples of issues in business practices on Transfer Pricing Adjustments

Example 1:

 X is a multinational group operating worldwide in the confectionary market.

 Under the “Principal Operating Model” of the group:
- Local plants (TMs) operate on a toll manufacturing basis, e.g. without
acquiring the ownership of the input materials that belong to the “Principal”;
- Local distributor (LRDs) purchases finished goods from one single
counterpart, e.g. the Principal; being entrusted with typical limited risk
distribution functions, the LRDs are only responsible for the promotion of the
products within their local market.
 For direct tax purposes, the transfer price applied by the Principal to the LRDs
(located in different Member States) for the finished goods is set by applying a
transactional net margin method (TNMM) return on sales (ROS) basis, e.g. the
“Principal Operating Model” ensures that the LRDs receive an “arm’s length”
remuneration for the functions performed in the local market in accordance with
OECD Guidelines.
 Considering that the LRDs have a limited functional profile, the latter recharge
(through the issuing of separately invoices) to the Principal the costs of advertising
and promotion exceeding a certain “threshold”.
 At the beginning of each fiscal year the price of the finished goods sold by the
Principal to the LRDs, as well as their budget costs, are approved by the Principal.
 The parties agree that such a price does not change during the fiscal year.
 As LRDs are remunerated based on a TNMM method, the determination of LRDs
budget costs is of great importance. Thus, by the end of each fiscal year it is
verified if the actual remuneration of the LRDs (and the corresponding profit) is in
line with the “arm’s length” TNMM (ROS) established for transfer pricing
purposes.
 To target the “arm’s length” remuneration of the LRDs, by the end of each fiscal
year it is also possible that a “compensating adjustment”, is to be paid by the
Principal to the LRDs if their profit is lower than expected (also considering the
mentioned recharge of extra-costs). Even if the “compensating adjustment” is
reflected in the accounts of both parties of the transaction (in both Member States
involved), it could not be seen as consideration given in exchange for the taxable
supply of goods already made.

Proposed Assessment
 The recharge to the Principal of the costs for advertising and promotion exceeding
the “threshold” is a taxable transaction for VAT purposes, e.g. a “Supply of
Services” to be separately invoiced by the LRDs.
 On the contrary, the (additional, if any) “compensating adjustment” aimed to reach
the agreed LRDs profit margin (ROS) is not a taxable transaction for VAT
purposes, because:
- it does not constitute consideration given in exchange for the previous supply
of goods sold by the Principal to the LRDs (e.g. it is not an adjustment to the
price already paid by the LRDs to the Principal);

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- there is no direct link with the supply of finished goods sold by the Principal to
the LRDs.
 In such a scenario, the “compensating adjustment” is to be considered “Outside the
scope of VAT”.

Example 2:

 LRD adjustments – pricing adjustments between a non-EU principal and LRDs in

Member States X, Y and Z.
 All Member States have the same perspective – treating them as a “pricing
adjustment” – VAT relevant transaction.
 Practical issue – potential complication if there are more source countries or direct
plant shipments. A possible handling is to have the TP Adjustments raised
(debit/credit note) from each sourcing country, which would lead to a number of
debit/credit notes of which the amount would be difficult to determine. Also, some
adjustments may be insignificant.
 Some Member States also require the adjustments to be reported in the month that
the initial supply has taken place. VAT returns of these periods needed to be
adjusted retro-actively. Besides the administrative burden, there is a risk that a
Member State starts claiming late payment interest and penalties.

 Regional Cost Sharing and other service sharing adjustment

 This service allocation model works on the base of actual cost and forecasted sales.
So once forecasted sales deviate from the actual sales, a TP adjustment is required.
 Issue: Should such possible adjustment created at year-end be treated as TP
adjustment or the normal service invoice/credit note?

Example 3:

 Export. Principal manufactures its products in 10 different EU countries. These

goods are sold to 15 different affiliates outside EU (zero rated). The Principal
needs to issue a TP adjustment for the year to each of its affiliates (amounts might
vary greatly from one affiliate to another)
 In the current situation complexity, risk of error and extra work for all parties for
no amount at stake
- Principal needs to issue 15*10 = 150 credit notes
- Each affiliate will potentially receive 10 credit notes from the same legal
entity but from its different VAT numbers.
- On these 150 credit notes, the Principal will need to show the list of all
invoices for the TP adjustment (here an adjustment of the price of previous
supplies) relate to i.e. all invoices by affiliates, by sourcing plant.
- In some countries, the Principal will be required to refile all VAT returns for
the periods of the initial supply i.e. the past 12 VAT returns.
 Considering the current lack of clarity and existing practice we would end up with
150 transactions to be managed by the various parties (within and outside of the
EU) thus 300 bookings to be checked by the various tax authorities for no
monetary impact, as we assume all parties have full right to deduct.

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Example 4:

 TP adjustment between Principal and Distributor

 Principal is a non-EU established business. Principal ships from country A.
Distributor is located in country B, a country with use and enjoyment rules on
advertising services. TNMM is applied between the principal and the distributor.
TP adjustment from the principal to the distributor via a credit note – intra
community supply – Zero rated – reverse charge by distributor in B.
 The reason behind the adjustment is that the distributor, in agreement with its
principal, spent more on media advertising than initially planned.
 Tax authorities took the view that the adjustment is not an adjustment of the price
of previous supplies but in fact an extra service rendered by the distributor to the
Principal and that VAT was due on that service.
 Issue: The principal might be unable to deduct the VAT.

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