Transfer pricing perspective on business model changes

The taxpayer had initially acted as a subcontractor, providing the processing of raw material for its fellow subsidiary to be further used for the production of an automotive part. For this ‘toll manufacturing’ the taxpayer charged a fixed rate per minute of work. During the taxable period, the production was fully moved to the Czech Republic, and the business model changed: the taxpayer now assumed the role of a fellow subsidiary and became an independent manufacturer of the entire automotive part and its final supplier to customers.

In a tax inspection, the tax administrator assessed the price of services provided by the taxpayer in the original ’toll manufacturing’ model. The tax administrator concluded that the provider was below cost and assessed additional income tax; the price was set by reference to the price of the complete supply in the new business model while the tax administrator attempted to make relevant price adjustment.

The regional court vacated the tax administrator's decision, stating that the tax administrator had not proceeded correctly in determining the reference price. The tax administrator filed a cassation complaint against the decision.

The SAC first dealt with the correct determination of the reference price, explaining that it is crucial to take as a basis primarily existing uncontrolled transactions that are, at least in their essence, comparable to the controlled transaction. The SAC stated that despite the tax authority’s best efforts to clean the transaction comprising the sale of goods (after the change in the business model), the transaction could not be considered essentially comparable to the (original) controlled transaction comprising the provision of subcontracted services. The tax authority was in effect comparing the incomparable, as they did not consider the difference between the status of the taxpayer as a subcontractor merely working for the fellow subsidiary, and as an independent producer bearing all the risks associated with production.

Furthermore, the SAC stated that the tax administrator had wrongly chosen only one independent transaction rather identifying a range of reference prices in similar subcontracting transactions.

The SAC thus ruled consistently with its previous case law. Therefore, please note that any argumentation to substantiate transfer prices should be supported by the documentation of the business model, including an analysis of functions and risks in the context of the adopted transfer pricing methodology.