Pitfalls of managing transfer prices by means of marketing services

The Municipal Court in Prague confirmed the tax administrator’s approach reclassifying marketing services contracted and provided to abroad to ‘consideration received from a third party’. In the court’s opinion, the services were rendered directly to the Czech recipients of the goods. The consideration received from abroad shall thus enter into the tax base of local sales of the goods, and shall be subject to Czech VAT.

A Czech pharmaceutical distributor sold drugs in the Czech Republic (and in Slovakia, but this is not our area of focus). At the same time, they invoiced marketing services to Switzerland, to their Swiss supplier. The distributor was purchasing drugs from the supplier at a price higher than the regulated selling price of the drugs in the Czech market.

Both the Appellate Financial Directorate and the Municipal Court were of the opinion that the case did not involve the provision of marketing services to Switzerland. In fact, the services were provided directly to the Czech buyers of the drugs (for the Swiss supplier, the marketing was only a secondary benefit). The marketing services therefore comprised an ancillary supply to the main supply, which was the local sale of drugs. The consideration received from the Swiss supplier thus constituted a consideration received from a third party for the ancillary supply, and should have been subject to the same VAT treatment as the local sale of drugs. This means that the consideration received from the Swiss supplier should have in the final effect been subject to Czech output VAT.

The Court also noted that due to the regulated prices of the drugs in the Czech market, the distributor was unable to demand from their customers a consideration including all its usual components (such as the mentioned marketing services), which is why the situation was dealt with on the group level,   whereby the marketing costs were paid to the distributor by the Swiss supplier.
The originally declared provision of services with a place of taxation in Switzerland (therefore not subject to Czech VAT) was thus reclassified as a supply of goods, where consideration received is subject to Czech VAT. Furthermore, based on the evidence gathered, the court concluded that the entire business models was artificial.

Notably, this is so far only a judgment by the Municipal Court in Prague, and the matter is yet to be dealt with by the Supreme Administrative Court, which will decide, finally and conclusively, whether the tax administrator’s approach is in accordance with legislation.

For the sake of completeness, it should also be noted that the additional assessment of VAT resulted from a tax inspection of transfer prices: in the course of the tax inspection, among other things, evidence was submitted that was held implausible, even contradictory. Under these circumstances, the tax administrator concluded that the supplies did not in fact take place as invoiced, and attributed the consideration to local supplies.

 

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