The European Union’s top court provided “an important clarification” on the conditional compatibility of domestic and bloc wide law when it ruled that Germany must allow multinational companies to justify their transfer pricing arrangements.
The Court of Justice of the European Union (CJEU) rendered its decision in the Hornbach Baumarkt case (C 328/16). The case deals with German legislation, according to which the income of a German taxpayer resulting from its business relationships with non-resident related companies is adjusted, as far as the relationships are not in line with the arm’s length principle, whereas such adjustment is not made in the case of business relationships between German related companies.
According to the taxpayer, such legislation constitutes a restriction of the freedom of establishment, as the income adjustment is only made in the case of cross-border business relationships. Furthermore, they argued that the German legislation is not proportionate as it excludes any possibility of putting forward commercial justifications for transactions that are not at arm’s length. However, in line with the Advocate General’s Opinion in the case at hand, the Court decided that the German rules in question are not, in principle, contrary to the freedom of establishment.
In response to the ruling, the European Tax Advisers welcomes the Court’s decision in Hornbach as an important clarification of the conditional compatibility of arm’s length-based domestic transfer pricing legislation with the freedom of establishment. According to the advisers, Hornbach follows and confirms the previous doctrine formulated in the SGI judgment and did not adopt the Advocate General’s approach that would have denied comparability of domestic and cross-border situations in transfer pricing cases and, hence, preventing scrutiny of domestic transfer pricing legislation under the fundamental freedoms.
Moreover, the association welcomes the requirement that Member States have to grant taxpayers the opportunity to provide evidence “of any commercial justification” for non-arm’s length transactions, so that denial of that opportunity through automatic transfer pricing adjustments would render these incompatible with EU Law. In that context it is further welcomed that “commercial justifications” may include “economic reasons resulting from its position as a shareholder of the non-resident company”. At least in cases of non-arm’s length transactions such as interest-free loans or gratuitous guarantees that are aimed at replacing equity, the Hornbach judgment clearly suggests that such a shareholder interest in the financial success of the foreign subsidiary may serve as such justification.
Source: Tax Adviser Europe (CFE)
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