Successive confinements and the boredom they seem to have generated in some households have led to the emergence of challenges, sometimes implausible, often absurd, widely relayed by social networks. Among these is the "Nana Challenge", which involves performing a sort of jig by hopping alternately on both feet to counter the opposite movements of one's partner. While it's safe to assume that this gesticulation will soon be consigned to the pantheon of useless dances, as soon as bodies have been decontaminated and spirits restored, the tax authorities seem determined to continue dancing on two feet, and in a number of tax cases, both form and substance have taken precedence.
This is the case when, under an intra-group transaction, the contract signed mentions a remuneration that does not reflect the actual behavior of the related parties. For example, the agreement may include a remuneration expressed as a percentage (based on sales or costs), the quantum of which clearly does not reflect arm's length standards that contemporary economic analyses would have highlighted. Depending on the direction of payment (whether the French taxpayer is the creditor or the debtor of the transaction), the French Treasury may be harmed, or on the contrary, it may benefit.
A contract out of step with the arm's length principle
To illustrate this situation, let's take the example of an administrative services provider located in France and providing services to a related party established abroad. An old contract between them mentions a remuneration defined according to the cost-plus method as described by the OECD guidelines, designed to cover a cost base increased by a 15% margin. To make matters even more comical, it should be pointed out that the contract is clearly the result of a sometimes approximate translation of a version existing elsewhere in the Group (doubtless between two other entities abroad) and dates from the early 2000s, i.e. before the modern concepts developed by the OECD in terms of transfer pricing; the documentation and reporting obligations as they are practiced today; and the work of the European Joint Forum. Aware of the work carried out by these bodies, and motivated by a desire to do the right thing, the parties decided to apply a margin of 5% rather than 15%, on the grounds that the services rendered fell into the category of " low value-added intra-group services ".
Indeed, since 2010, the European Joint Forum has been suggesting that an arm's length measure for such services could be " between 3% and 10%, with a median of 5% 1. More than a decade later, the OECD followed suit, considering that " To determine the arm's length pricing of low value-added intra-group services, the member of the multinational group providing such services should apply a profit margin to all costs deferred in the cost pool. The same margin must be used for all low-value-added services, regardless of the categories concerned. The margin retained by the taxpayer should not be less than 2% nor more than 5% of the cost concerned "2.
The matter might seem to be settled, and the parties, backed by the work of prolific international bodies, might naively think that they have achieved fis- cial serenity. But as surely as the road to hell is paved with good intentions, this attitude can, depending on the circumstances, be overturned by the tax authorities during an accounting audit.
Let's take an initial example. If the service provider is a French taxpayer, the tax authorities will be tempted to rely on the cardinal concepts of contract law. It would then be in a position to argue that these " take the place of law to those who have made them "3. On this occasion, the tax authorities would certainly be entitled to claim the differential between the margin actually applied (5%) and that stated in the contract (15%), in addition of course to applying a withholding tax on income deemed to have been distributed; penalties for deliberate failure to comply of 40% in view of the liberality granted; and the whole cascade of taxes and levies whose basis is based on common aggregates, disguising - let's not forget - a double or even triple taxation of the same profits.
The binding force of the contract or the prevalence of form
This position stems from the theory of the binding force of contracts, according to which a legally-formed agreement creates obligations for the parties, who must then scrupulously adhere to it. This is an ancient civil law concept, dear to the written law states, and permeates our entire corpus of private law.
Are we being lied to? Is the autonomy of tax law nothing more than a chimera sold on the benches of law faculties to flatter the egos of apprentice tax lawyers and boast of their singularity? From the pantheon from which he observes us, the much-lamented Professor Maurice Cozian would no doubt object that, although not autonomous, tax law is nonetheless special. Admittedly, its mainsprings are imbued with economics, and in this respect it differs from other themes. However, it cannot be dissociated from other branches of law, and more particularly from the law of obligations, which forms the basis of all relations between private individuals; nor can it be detached from public law, which governs relations between individuals and the emanations of the public force, of which the tax authorities are one.
Of course, one could always argue that related parties would certainly not charge (or no longer charge) 15% mark-ups for administrative services. To corroborate this point, the taxpayer could then go to great lengths to produce comparable research based on specialized databases. However, we find this demonstration questionable. Article 57 of the French General Tax Code, under which transfer pricing adjustments are notified, provides for the possibility of benchmarking intra-group remuneration against independent and comparable references only " in the absence of precise information "4. Whatever the consulting firms may say, the way our positive law is constructed means that economic analyses are in reality only of subsidiary importance. This is regularly reiterated by the tax judge, who, in validating the administration's failure to seek comparables, points out that the administration can alternatively demonstrate a discrepancy between the price charged and the market value of the product or service5. In the case in point, it could be considered that the market value of the service is that appearing in the contract, since the latter is deemed to have been duly formed between the parties...
Last but not least, the binding force of contracts still has a certain resonance even in OECD transfer pricing principles. Indeed, in its so-called " BEPS " work aimed at understanding tax base transfers and combating tax evasion, the Organization still recognizes a significant role for intra-group agreements in assessing the arm's length nature of a transaction. To cite just a few examples, contracts are referred to as factors of comparability (the cornerstone of the arm's length concept); the qualification of functions and the attribution of correlative risks; or the legitimacy of a party to receive the income linked to the exploitation of an intangible asset.
It seems to us a rather shortcut to conclude that the contract should be de facto binding on the parties, even though it contains a tax-related anomaly. As certainly as what has been done can be undone, the contract duly formed between the parties could be attenuated or even profoundly modified by a new agreement of will. A defense could then consist in explaining that this written contract has in the meantime been amended or novated by another contract, this one oral, to which the repetition of behavior between the bound parties has offered its legitimacy and binding force. This strategy would be further strengthened, we believe, if the original contract contained a so-called " hardship " clause, which in essence allows the contract to adapt to certain circumstances.
The substance and actual conduct of the parties
But imagine the opposite situation. One in which the French taxpayer is the debtor in the transaction and therefore deducts a margin of 15%, in accordance with the contract, but at variance with arm's length standards. Contrary to our first hypothesis, in such circumstances the tax authorities would be quick to shelve the contract. The particularity of tax law would here take on its full dimension, offering the administration, with the blessing of the tax judge, the possibility of making the real intention of the parties prevail in order to give an agreement its just qualification.
This is a freedom derived from a long tradition of case law, which allows the tax authorities to depart from the rigor of the abuse de droit rule, which only allows them to simply disregard the contract6. By allowing the auditor to reclassify an agreement, the judge gives him the opportunity to put the parties back in a " normal " management situation. Indeed, it can be postulated that the parties would necessarily seek a fair and appropriate balance, in line with the law, and therefore an arm's length balance. Any agreement that imposes an obligation on one of the parties that appears out of step with this principle would indirectly, but necessarily, vitiate the purpose of the agreement, in addition to highlighting clauses that are probably unfair to the beneficiary party.
A recent ruling by the Riom Court of Appeal seems to add to this trend, allowing the tax authorities to disqualify a contract without resorting to the abuse of rights procedure, provided that it was signed shortly before the tax transaction in question. In this case, the aim was to prevent the application of the Dutreil mechanism applicable to "holding companies animatrices", by highlighting the fact that the strategic coordination, management and commercial assistance agreement between the holding company and its subsidiary had been signed just twelve days before the donation of the parent company's shares7. Although this decision was rendered on tax grounds other than transfer pricing, there should be nothing to prevent a holistic application of the solution. Thus, in order to disregard an intra-group contract, the tax authorities will now be able to rely on a temporal element, in addition to the behavior of the parties.
Finally, to echo the previous section and be totally exhaustive, it should be pointed out that, although taken into account by the OECD principles, the conventions establish at most a simple presumption. Actions 8 to 10 of the BEPS program clearly tend to give greater importance to the actual behavior of the parties, and thus to give precedence to operational reality over contractual appearance. This is particularly evident in the construction of the functional analysis and the weighting of functions, particularly with regard to the exploitation of intangible assets (the famous " DEMPE " functions) and, consequently, the attribution of correlative taxable profits.
The last dance
The porous nature of tax law enables it to incorporate concepts from other branches of law, such as the binding force of contracts. This enables the tax authorities to enforce contractual clauses against the parties, and to draw the necessary conclusions from them, if they entail remuneration. Conversely, the authorities now have extensive means at their disposal to thwart agreements which, in their view, do not reflect arm's length conditions, either by requalifying them or simply setting them aside. Substance and form thus seem to complement each other perfectly, as if in a duet dance. In a final graceful movement that seems to remain in suspension, we will borrow from the excellent Emilie Bokdam-Tognetti's recent conclusions in the Ferragamo case, reminding us that " the transfer pricing principles defined by the OECD do not constitute standards and have no legal effect in domestic law. While they cannot be used to interpret the provisions of article 57 of the CGI, they are nevertheless a useful source of inspiration "88. With the frenetic pace of international taxation in recent years, it will be difficult to know who will lead the way in terms of form or content.
(1) "In cases where it is appropriate to use a markup, this will normally be modest and experience shows that typically agreed mark ups fall wit- hin a range of 3-10 %, often around 5 %.". EU Joint Transfer Pricing Forum, Guidelines on low value adding intra-group services, DOC: JTPF/020/REV3/2009/EN, §63.
(2) OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, §7.61.
(3) Art. 1103 new Civil Code. It should be added that the new article 1194 specifies that contracts are binding as to what is expressed therein and as to all consequences which equity, usage or the law give to them.
(4) Article 57, paragraph 4: "In the absence of precise elements for making the rectifications provided for in the first, second and third paragraphs, taxable income is determined by comparison with that of similar businesses normally operated".
(5) See in particular CE 8e et 3e ch. réunies, May 29, 2017, n° 401491, Galerie Ariane.
(6) See for example CE, July 20, 2007, n° 232004.
(7) CA Riom, 1er ch. civile, Jan. 26, 2021, n° 19/01179.
(8) Conclusions rendered under CE 9e et 10e ch., Nov. 23, 2020, no. 425577, Sté Ferragamo France.
