Transfer pricing tax audit - Management Fees
Apr 5, 2022
Transfer pricing tax audit - Management Fees
Unlike tangible goods, transactions relating to the common services of a group cannot be intercepted or controlled at the borders. These costs are generally referred to as "management fees" and consist of costs incurred in the context of services of interest to the parent company and its subsidiaries.
If they are important in transfer pricing, it is because of their obvious existence in a group that naturally seeks for reasons of economies of scale to centralize common services, including administrative, technical, financial, or commercial services, such as management, coordination, and control services for the whole group, on the one hand, and account of the inherent risks associated with them.
Such expenses relating to the provision of such services may be initially borne by the parent company, by a member or more of the group specially designated “a group service center” or by other group members.
Intra-group services may differ considerably between multinational companies, and so may the real or expected benefits to one or more group members. It all depends on the facts and circumstances of each case and the modalities in force within the group. For example, in a decentralized group, the parent company may limit its intra-group activities to monitoring its investments in its subsidiaries as a shareholder. On the contrary, in a centralized or integrated group, the board of directors and the general management of the parent company may make all important decisions concerning the activities of the subsidiaries and the parent company may accompany the implementation of these decisions by carrying out activities of a nature for its subsidiaries general and administrative as well as operational activities such as cash management, marketing or supply chain management[1].
In addition to the problem of the identification of the service, its actual performance, and the conformity of the invoicing, if any, with the principle of arm’s length competition, attention should be drawn to the services which concern make it necessary to consider in particular because of their quasi-similarity to intra-group services, and making it very difficult to separate the transfer of service from the transfer of know-how. Also, consideration of transfer prices associated with intra-group transactions becomes more complicated if intra-group services have been rendered under a cost-sharing agreement[2] that the members of a multinational enterprise jointly purchase, produce, or supply goods, services, and/or intangibles[3] sharing the costs of these activities between the different parties to the agreement[4].
What we already see is that the invoicing of intra-group services is not without complexity compared to the services previously processed. The taxpayer is not necessarily obliged to demonstrate, in the case of a tax audit of its transfer prices, that the transaction prices in question are not exaggerated or reduced, so long as the demonstration and the method of comparison made by the administration is «radically flawed in its principle»[5]. The error of method leads to the «same legal effects as an irregularity of procedure or an error of law»[6].
To assess the abnormality of a transaction, the tax administration may refer to the abundant jurisprudence of "acte anormal de gestion" (abnormal management act), which is applicable in Tunisia. However, proving the related economic facts can be tedious. Jurisprudence on the invoicing of intra-group services at cost price illustrates this difficulty, as the French Council of State considers it a normal practice when the billing is done by the parent company to its subsidiary [7], whereas a subsidiary must invoice its parent company at the market price[8].
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[1] OECD (2017), OECD Transfer Pricing Principles for Multinational Enterprises and Tax Administrations 2017, op. cit., p.351
[2] Ibid., p.25-Glossary; A Cost Sharing Agreement (“CRA”) is a contractual agreement between commercial enterprises to share the contributions and risks associated with the development, joint production, or acquisition of tangible and intangible assets or services, on the understanding that such tangible and intangible assets or services are expected to generate benefits for the undertakings of each participant.
[3] CAA Versailles, 3e ch., 8 July 2014, no. 11VE01187, Sté Carrefour SA, concl. F. Locatelli: JurisData no. 2014-021483, DF no. 40, 2 October 2014, comm. 562; The Carrefour case illustrates the case perfectly. In this case, the administration had identified abnormal transactions characterized by a waiver of acceptance, on concession operations for the use and exploitation of the Carrefour brand and commercial logo, not subject to payment of commercial royalties from its foreign subsidiaries, established throughout the world (China, Japan, Brazil, Italy and Mexico in particular). The transactions were initially framed by a concession contract of the brand, before being incorporated into cost-sharing contracts, providing for the provision by Carrefour France of general and commercial assistance services invoiced as a percentage of the turnover generated by each foreign subsidiary. However, no remuneration was paid for Carrefour brand concessions. The administration concluded that there was a presumption of a profit transfer. However, to establish these presumptions, the administration must prove that the mark does have a “local market use value” and provide a market value to that intangible right, which is at least equivalent to the amounts of the presumptions of transferred profits. ; Damien Jousset. The use of presumptions in the fight against international tax fraud and evasion; Law. Université Panthéon-Sorbonne - Paris I, 2016. French, p.281
[4] Ibid., p.359
[5] Damien Jousset. The use of presumptions in the fight against international tax evasion and avoidance, op. cit., p.280
[6] Patrick Fumenier, note under CE, 8th and 3rd ss-sect. , 26 Sept. 2011, no. 328762, min c/SARL Holding Financière Séguy, JCP E n°47, 24 November 2011, no. 1848, pt. 4.
[7] Conseil d’État, 24 February 1978, No. 2372: FDF No. 30, 1978, Comm. 1212, Concl. P. Rivière; RJF No. 4, 1978, Comm. 161.
[8] Conseil d’État, 26 June 1996, min. c/SARL Rougier-Hornitex, no. 80178: RJF n°8-9, 1996, comm. 973.
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Position of the Tunisian tax administration
In Tunisia, the Tunisian tax authorities remain allergic to seat fees and management fees. It is as if these billings lend themselves to consider the taxpayer guilty of transfer pricing manipulation until proven otherwise. Indeed, many of the positions that have to be taken on the questions asked by taxpayers and the answers, all of them, were severe and bring rather draconian conditions for deducting management fees, as follows[1] ;
The re-invoicing of common expenses is only permitted to companies that have benefited from such services that are necessary for operation, which must not include[2] :
The re-invoicing of common expenses is permitted only to undertakings that have benefited from such services necessary for operation, which should not include
Direct general expenses incurred by the head office exclusively for the benefit of the permanent establishment or the subsidiary;
All expenses and expenses not related to the activity of the company that receives the debit note, and;
All benefits that constitute a duplication at the subsidiary company[3].
Apportionment is permitted only when done using an objective apportionment method, for example, based on the turnover of each company concerned by the apportionment. The allocation may also take place based on the area occupied by each company in the case of a charge relating to the occupation of premises or based on timesheet for certain services;
The apportionment of common charges may not take place based on a fixed rate of the turnover of each company determined in advance under an agreement concluded for that purpose[4] ;
The distribution must be made at cost price, regardless of whether it is made by the parent company or one of the sister companies. The doctrine also denies the deductibility of common expenses exaggerated to the service rendered[5] ;
The distribution must comply with the following formal requirements:
It is carried out based on a debit note for each company, including its share of the calculated costs;
The existence of a written agreement between the member companies of the group which must include the details of the services rendered to the benefit of the company which has borne all the expenses, the services provided to each of the companies concerned by the distribution of costs, the distribution key adopted and, where applicable, the amounts invoiced for the services rendered to the company that has borne all the costs, and;
The note must be accompanied by a copy of the invoice issued by the supplier to the company that bore all the charges.
The doctrine, although implicit, considers that intra-group services relating to common expenses can only be admitted at a cost price. Indeed, the administration[6] of The Court of First Instance held that no group is an actual service provider. Indeed, it is not a question of burden sharing but of invoicing for services rendered.
To this end, all tax obligations regarding invoicing, withholding tax, and VAT must be respected[7].
Action 10 of the BEPS Action Plan called on G20 and OECD countries to establish transfer pricing rules to guard against the most frequent types of payments that erode the tax base, including management fees and head office expenses.
The directives of Action No. 10 draw attention to the « activities carried out as a shareholder »[8]. Simply, a group company does not have to bear and pay amounts relating to services invoiced by the parent company that do not benefit and are not related to its activity.
[1] Text no. DGI 2013/22 - Joint Note no. 22/2013
[2] Position paper - DGELF no. 1434 of 19 October 2010
[3] In this respect, the nature of the transfer must be analyzed to reduce any risk of duplication. Indeed, the granting of a know-how license is likely to include technical assistance or marketing advice. In addition, a company cannot both pay royalties and assume directly the corresponding expenses; TA Dijon, January 6, 1998, No. 95-2123, RJF 06/98 No. 695; CAA Bordeaux, February 15, 2000, No. 97-237, SARL Periplast.
[4] Position statement DGELF No. 579 dated April 29, 2010, pertains to private sector engagement in tax refunds. Instead of reimbursing corporations, which entails administrative burdens, it is deemed necessary to distribute refunds directly to the beneficiaries of the service provided. If a corporation opts to consolidate its refunds, it may do so by establishing an equitable distribution method, contingent upon the aggregation of transactions related to the company's operations or any relevant subsidiaries. However, it is impermissible to distribute consolidated refunds based on a fraction of transactions for any specific company. Moreover, refunds cannot be allocated against a subset of transactions.
[5] Company pre-selection is conducted within a predetermined framework. Prise de position DGELF No. 338 dated March 1, 2013, stipulates that member companies benefiting from services provided by the parent company in exchange for the reimbursement of shared expenses are eligible for tendering, provided they comply with the general conditions of the tender. This includes ensuring that the services rendered are reasonably priced compared to those offered by the parent company.
[6] Text No. DGI 2013/22 - Common Note No. 22/2013].
[7] In this regard, reference should be made to Common Note 33/2010.
[8] OECD (2016), Aligning Transfer Pricing on Value Creation, Actions 8-10 - Final Reports 2015, OECD/G20 Project on Base Erosion and Profit Shifting, OECD Publishing, Paris, p.160
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Costs related to shareholder activities
The following are examples of costs related to shareholder activities[1] :
Costs relating to the legal structure of the parent company itself, including the organization of meetings of shareholders of the parent company, the issue of shares of that company, the listing of that company on a stock exchange, and operating expenses of the supervisory board;
Costs relating to the parent company’s obligations regarding the presentation of accounts and activity reports (including financial reporting and audit engagements), including consolidation at the group level;
Costs of the audit of the subsidiary’s accounts by the parent company if the audit is carried out exclusively in the interest of the parent company;
Costs related to the preparation of consolidated financial statements of the MNE group (in practice, however, the costs incurred locally by the subsidiaries are not necessarily passed on to the parent company or holding company if the identification of these costs involves disproportionate costs);
Costs relating to the mobilization of the resources required by the parent company for the acquisition of its shareholdings and costs relating to its investor relations, such as the parent company’s communication strategy with its shareholders, financial analysts, funds, and other stakeholders in the parent company;
Costs relating to the compliance of the parent company with the tax laws in force, and;
Ancillary costs related to corporate governance of the MNE group as a whole.
Action No. 10 also dealt with the duplication of services invoiced and the linking of costs to the expected benefits. Concerning the margin to be applied, to determine arm’s length pricing of low value-added intra-group services, the member of the group of undertakings providing such services shall apply a profit margin to all costs carried forward in the cost group, except any cost passed on[2]. The approach is based on a general agreement on the composition of the cost base and an increase of 5 %.[3]
[1] Ibid.
[2] Where an associated undertaking acts only as an agent or intermediary in the provision of services, it is necessary, where a cost-based method is applied, the performance or margin is at a level that is appropriate for the performance of agent duties and not for the provision of the services themselves. In such a case, it is not always necessary to determine the arm’s length price by applying a margin to the cost price of the services, but rather to apply the margin to the costs inherent in the agent function itself. For example, an associated company may incur expenses related to the rental of advertising space on behalf of group members, expenses that group members would have directly incurred had they been independent. In such a case, it may be appropriate to pass these expenses on to the beneficiaries of the group without applying a margin and to apply a margin only to the expenses incurred by the intermediary for the performance of his duties as agent.
[3] OECD (2016), Aligning Transfer Pricing on Value Creation, Actions 8-10 - Final Reports 2015, op. cit., p.176
