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Intra-group services: two case law reminders on the limits of tax deductibility

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The rulings handed down by the Paris and Nancy Administrative Courts of Appeal (Foncière Vélizy Rose and Eco NRJ cases respectively) illustrate the constant vigilance of tax judges with regard to the reality and usefulness of intra-group services. In both cases, the requesting companies had their deduction claims rejected, as the tax authorities had characterized an unjustified impoverishment, or even a deliberate intention to evade tax.

The legal framework: stronger evidentiary requirements for taxpayers

The two rulings reiterate the main principles laid down in Articles 38 and 39 of the CGI, according to which taxable profit is established by deducting expenses that are justified by their reality, their amount and their interest for the company. It is up to the taxpayer to provide precise information on the nature, purpose and counterpart of the expenses. When the tax authorities question an expense, they must substantiate their doubts before the judge; but in the case of services, the initial burden of proof lies with the taxpayer.
In both cases, the judge considered that this demonstration was lacking: the companies had limited themselves to producing terse invoices, unsigned documents or documents not attributable to the service provider, and no elements enabling the services actually rendered to be quantified or qualified.

Redundant or imprecise services, with no clear link to business needs

In the Foncière Vélizy Rose case, the company had signed an asset management contract with Obélisque Immobilier, a company with no resources of its own and headed by the same manager. This contract, which was supposed to cover the monitoring of a single building leased in its entirety to Thalès, duplicated services already entrusted to a property manager (AAM), without Obélisque's added value being demonstrated.
The same logic was applied in the Eco NRJ case, where the French company paid €6,500 a month to its Luxembourg sister company, Eco NRJ Lux, for commercial and management services. The generic nature of the invoices, the weakness of the supporting documents produced and the lack of evidence of any actual consideration led the judge to disallow the deduction of expenses.
In both cases, the tax authorities were able to establish a clear lack of economic substance behind the contractual relationship, and a legitimate doubt as to the real purpose of the intra-group financial flows.

Situations of joint control and confusion of interests

Both decisions also emphasize the capital-intensive and personal context in which these agreements were concluded.

    • - Foncière Vélizy Rose: the company's managing director was also the managing director of Obélisque Immobilier, a company set up by his brother. AAM, another service provider involved, was co-managed by his sister.
    • - Eco NRJ: both companies were managed by the same person. The payment of fees was not justified by a decision of the competent corporate bodies, leaving doubt as to whether the director was being paid indirectly.

In both cases, family or management ties reinforced the administration's analysis of the existence of an abnormal act of management: a choice that impoverishes the company, has no economic justification, and is motivated by considerations unrelated to the company's own interests.

Confirmation of penalties for wilful default

Lastly, both courts confirmed the application of the 40% surcharge for deliberate failure to comply (art. 1729 CGI). This penalty presupposes a clear intention to evade tax, which the tax authorities have demonstrated in each case by :

    • - the significant amount of the expenses concerned ;
    • - the absence of concrete justification despite reminders;
    • - a clear community of interests between the entities concerned;
    • - the lack of formal governance, in particular the absence of any decision by the corporate bodies validating these financial flows.

The judge dismisses arguments relating to the formal validity of the contracts or the parallel taxation of income in other entities: what counts is the absence of proven usefulness for the debtor company.

Practical lessons: precautions to take to secure intra-group services

These decisions illustrate the precautions that companies must take to avoid requalification and reassessment:

    • - Formalize intra-group agreements (purpose, nature, frequency, deliverables) ;
    • - Maintain documented traceability of services rendered (letters, reports, identifiable deliverables);
    • - Avoid redundancies with other service providers or with the manager's functions;
    • - Isolate the governance decisions (minutes of board meetings or general meetings) justifying the use of services and their terms and conditions;
    • - Maintain real autonomy for service providers, with identifiable human and material resources.

Over and above the risk of a tax reassessment, these rulings serve as a reminder that intra-group services must respond to a clear economic rationale that can be verified and defended before the tax authorities.

Our opinion and recommendations

These two cases illustrate a consistent line of jurisprudence: the mere existence of a contract or invoice is not sufficient to justify the deductibility of an intra-group expense. The taxpayer must demonstrate the reality, usefulness and value of the services received, particularly where there are capital or personal links between the entities.
To avoid such recharacterizations, we recommend :

    • - Precise, dated contracts, specifying the concrete services expected and their frequency.
    • - Tangible proof of execution: signed reports, e-mails, time-stamped and identifiable documents.
    • - No redundancy with other functions or service providers.
    • - Validation by the corporate bodies in the event of a link with the executive (e.g. indirect compensation).
    • - Clear economic justification of the interest for the beneficiary company.
    • - Annual review of intra-group agreements and documentation included in tax and transfer pricing files.

When it comes to intra-group services, document transparency and anticipation of tax arguments are key. This upstream work limits the risk of tax adjustments and penalties for deliberate non-compliance.

CAA Paris, 7th chamber, April 29, 2025, 23PA02275, Société Foncière Vélizy Rose
CAA Nancy, April 24, 2025, 22NC02867, Société Eco NRJ

The importance of the value chain in transfer pricing analysis

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The Conseil d'Etat has ruled in favor of Amycel in a dispute with the French tax authorities. This case, which concerned transfer pricing issues and the discrepancy in sales prices observed by the tax authorities for the same products vis-à-vis sister companies and non-affiliated companies, is a reminder of the imperative need to carry out a detailed comparative analysis of transactions and the economic conditions surrounding them.

The background to the case

The case concerns Amycel France, a subsidiary of the American Monterey group specializing in the production and marketing of mycelium. The tax authorities had reintegrated into the company's results, for the 1998 to 2001 financial years, sums considered as profits indirectly transferred to foreign companies in the same group, pursuant to Article 57 of the CGI. To this end, the tax authorities noted that for the same products, the company charged lower prices to its sister companies in the Netherlands and the United Kingdom than to its third-party customers in France and elsewhere.

The judicial process

After a succession of unsuccessful attempts before the Orléans Administrative Court and the Nantes CAA, Amycel appealed to the Conseil d'Etat. The Conseil d'Etat not only annulled the CAA's decision on the grounds of insufficient reasoning, but also ruled in the company's favor on the merits of the case.

The decisive arguments

The Conseil d'Etat emphasized that the tax authorities had correctly established that the prices charged by Amycel France to its sister companies were lower than those charged to its other customers. However, the tax judge accepted the company's argument that neither the tax authorities nor the CAA had examined whether the independent customers to whom Amycel sold its products at a higher price were in a similar economic situation to its sister companies. This difference in situation was likely to influence the price charged, not only because of the combination of functions and risks borne by the sister companies and third-party customers, but also because of their place in a global value chain.

The implications of the decision

This is a valuable decision, as it reminds us that in the case of a remunerated transaction (i.e. one not carried out free of charge), the demonstration of an anomaly by the tax authorities must necessarily involve highlighting an advantage by comparison.
Now, in addition to reviewing the functions, risks and assets of the parties to the transaction (the functional analysis), this comparative analysis must necessarily involve a study of the economic circumstances of the transaction, as well as the economic strategy of the parties. In this case, the third parties to whom Amycel sold its products were end consumers, whereas its sister companies were wholesalers, and therefore positioned at a different stage of the value chain. This positioning most certainly explained the price differential, enabling them to generate their own margins when reselling to consumers on their markets.

For international groups, this decision is also a reminder of the importance of carefully documenting their transfer pricing and payment terms policies, taking into account the specificities of their business sector.

R&D in France: The Austerity Tax Shift

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Under the guise of fiscal consolidation, the Senate Finance Committee is proposing a drastic reduction in tax incentives for innovation, potentially further weakening French competitiveness.

🚨 Les Coups de Rabot Fiscaux

For the time being, the proposal maintains the Research Tax Credit (CIR) despite the criticism and attacks it receives every year in the run-up to the Finance Acts. However, the system is being trimmed a little more each year.

    • - Hard blow for research: "Young Doctors" scheme abolished, discouraging recruitment of scientific talent
    • - Budgetary restrictions: Exclusion of certain expenses such as technology watch and patent costs, automatically reducing the base eligible for the CIR.
    • - Marginalization of Innovation: Reduction in flat-rate operating costs (from 43% to 40%).

 

💢 A Blow to the Innovative Ecosystem

No sooner born than discouraged! The preferential tax regime set out in article 238 of the French General Tax Code, commonly (and falsely) referred to as the IP Box, has not even had time to pass through the forks of case law, due to a lack of anteriority, before it has already been reformed. The commission is proposing to increase the tax rate on the assets concerned (mainly patents and software) from 10% to 15%, thus returning to its historical rate when the corporate income tax was still 33.33%.
It should be remembered that the reduction in the tax rate for these assets was intended not only to align with the practices of other countries, but also to mark an attractive difference in relation to the standard corporate income tax rate. Wouldn't raising this preferential rate be a prelude to a rise in corporate income tax?

🔍 Critical Analysis

After the government, it's now the Senate's turn to take the tax shift to the detriment of innovation, foreign investment and business stability. Behind the technical cloak lies a purely budgetary rationale that risks undermining France's attractiveness in terms of innovation.

Is summer in Brazil a good time for tax reflection?

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Meeting for the third time in Rio on July 25 and 26, the G20 reaffirmed its strong commitment to fair global tax reform.

The G20 continues to play a crucial role in reshaping the international tax system to meet the challenges posed by economic globalization and digitization. By supporting the OECD's BEPS initiative, the G20 is focusing on two key pillars:

  • - Reallocation of taxation rights: Digital companies will now be taxed where their consumers are located, even if they have no physical presence in those countries. A major step towards fairer taxation!
  • - Global minimum tax rate: A minimum tax rate is introduced to prevent companies from taking advantage of tax havens. A key measure to put an end to the race to the bottom.
  •  
  • These reforms aim to ensure that all companies pay their fair share of taxes, wherever they operate, while strengthening international cooperation to combat tax evasion. In this way, the G20 is leading the way towards a fairer, more transparent global tax system.

CARA'porteur public: what are the effects of settlement periods in transfer pricing analysis?

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The Administrative Court of Appeal has ruled in favor of the Clarins group in a dispute with the French tax authorities. The case, which concerned transfer pricing and payment deadlines between subsidiaries, could have major repercussions for international groups operating in France.

The background to the case

The case dates back to the 2005 and 2006 tax years, when the tax authorities carried out an audit of Clarins SA's accounts. The tax authorities criticized Clarins for granting its foreign subsidiaries abnormally long payment terms, without interest, while incurring factoring costs for these receivables. The tax authorities saw this as an indirect transfer of profits abroad, a practice sanctioned by article 57 of the CGI.

Judicial reversal

After an initial rejection of its request by the Montreuil Administrative Court, Clarins appealed the decision. The CAA not only annulled the court's decision on grounds of insufficient reasoning, but also ruled in Clarins' favor on the merits of the case.

The decisive arguments

The court noted that the comparisons provided by the tax authorities, which were intended to prove the abnormal nature of the payment delays, were deemed irrelevant. The Court considered that these comparisons did not take into account the specificities of Clarins' business sector and the particular nature of its transactions.

The implications of the decision

This decision is a landmark in the field of transfer pricing tax audits. It underlines the importance for tax authorities of providing precise and relevant comparative data when seeking to demonstrate the existence of an advantage granted between related companies.

For international groups, this ruling is a reminder of the importance of carefully documenting their transfer pricing and payment terms policies, taking into account the specific features of their business sector.

Transfer pricing: the importance of a substantiated functional analysis (CAA Paris, Engie)

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An adequate and well-founded functional analysis, enabling a precise assessment of the nature of the functions, risks and assets of the parties to an intra-group transaction, and their intensity in the group's value chain and business, is and always will be the cornerstone of any transfer pricing demonstration.

The resulting functional classification determines the selection of the most appropriate transfer pricing method, and hence the allocation of large value pools between the parties and their respective capacity to withstand market volatility and losses over the longer or shorter term.

The obvious, which is now almost a truism, was once again pointed out by the tax judge in the Engie case.

In this case, the French tax authorities challenged the cost-plus method applied within the group to "single voice" contracts, which grouped together various services rendered to subsidiaries in the United States and Luxembourg. Taking the view that the French company was not merely a service provider (or "broker" in the ruling), but had a "strategic function", holding "intangible assets of unique value", the tax authorities substituted the profit split method. This substitution mechanically shifted the profitability hitherto captured by the subsidiaries to the French company, which was then remunerated on the basis of the overall contract and no longer its incurred costs.

Following a detailed analysis of the parties' roles and their importance, the Paris CAA rejected the administration's characterization and overturned the lower court's decision.

The functional analysis revealed that the French company did not mobilize any strategic functions, and that the subsidiaries remained the final decision-makers for all transactions.

The ruling reiterates the imperative need for a precise description of the parties' roles in the light of the value chain in which they are involved, and the importance of materializing these roles through the resources deployed internally (substance enabling the functions to be performed and the inherent risks to be controlled).
CAA Paris June 27, 2024 n°21PA01277

Enforceability of transfer pricing documentation. Yes, but from when?

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The Finance Act for 2024 has enacted the tightening already observable in the field with regard to transfer pricing, by reinforcing the documentary system weighing on companies. In addition to lowering the thresholds for transfer pricing, documentation is now formally enforceable against companies. In order to make companies more accountable for the documentation they produce, and to reinforce the effectiveness of tax audits, Article 116 of the 2024 Finance Act has supplemented Article 57 and made transfer pricing documentation enforceable for financial years commencing on or after January 1, 2024.

But are we to understand, then, that documentation covering financial years beginning on or after January 1, 2024 will henceforth be enforceable; or that all documentation produced from that date onwards, irrespective of the financial year it covers, will be enforceable?

While the law does not settle the matter, it seems fairly certain to us that the event to be taken into account is not the fiscal year, but the duty to communicate. As a result, any documentation, even relating to a past or even an old financial year, will now be enforceable against the company, as long as it is produced to the tax authorities after January 1. Thus, in the context of an accounting audit, in the event of a discrepancy between the pricing policy declared by the company and the one it actually applies, the difference between the result recorded and the amount it would have reached if the documentation had been respected is now presumed to constitute an indirect transfer of profits, which the tax authorities can reintegrate even for the past.

In support of this position, it should be noted that this measure does not create a new obligation for the taxpayer, but rather clarifies its scope. It is therefore not subject to the non-retroactivity rules of tax law. Above all, the tax judge had already settled the question, relying on the content of the documentation produced during the audit operations to assess the validity of the rectifications made by the administration. In two recent cases before the Cour administrative d'appel, the judge referred to passages in the taxpayer's transfer pricing documentation to assess the correct application of the remuneration method used. In the Sumitomo case, for example, the Lyon CAA noted that the net margin method, although included in the documentation, had not in fact been applied (no. 21LY02821). In the Itron ruling, the Paris CAA relied on the explanation provided in the documentary report for transfer pricing adjustments to discredit the interpretation made by the tax authorities (no. 21PA04452). In these two cases, therefore, it was the content of the documentation that steered the debates and gave rise to an obligation on the part of the taxpayer. Even before opposability was conferred by the Finance Act, it had already been established in practice.

Deductibility of intra-group interest : The proof is clearer and more flexible!

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THE FACTS

Following an audit of GEII Rivoli Holding's accounts for the 2013 and 2014 financial years, the tax authorities questioned the deductibility of the difference between the 5.08% rate applied and the 2.79% corresponding to the value mentioned in 3° of 1 of Article 39 of the CGI.
During the litigation phase, the company produced an initial analysis based on the RiskCalc tool developed by Moody's, identifying the risk rating that could have been assigned to it, as well as a rate range established by reference to those obtained by fifteen non-financial companies, belonging to heterogeneous business sectors.
A second corroborative analysis was submitted to the Paris CAA, based on the calculation of two financial ratios, one of which, known as the "loan-to-value" (LTV) ratio, was based on bond market data taken from the Standard & Poor's Capital IQ financial database.

THE RULE

A trend in case law built up around the 2020s has redrawn the contours of proof with regard to the deductibility of rates charged to majority shareholders.
Specifically, the borrowing company may rely on the rates of bank loans granted, under arm's length conditions, to companies in the same non-financial sector, which have obtained credit ratings close to that which can be determined for it, even though these other companies may belong to heterogeneous business sectors.
The borrowing company may also take into account the yield on bonds issued by companies in comparable economic conditions, where such bonds represent a realistic alternative to an intra-group loan.

THE JUDGES

The TAA de Paris in 2021, then the CAA de Paris in 2022, rejected the company's claims and confirmed the rectifications made.
Firstly, the judges noted that, in order to justify the 5.08% rate applied to its parent company, GEII Rivoli Holding had produced a report using the RiskCalc tool developed by Moody's, which identified the risk rating that could have been awarded to the company, i.e. Baa1. However, this risk rating had been obtained without entering the applicant's business sector in the RiskCalc tool. Thus, the CAA was able to dismiss this method as inconclusive on this ground, without committing an error of law, since such a circumstance meant that the company's particular economic situation was not taken into account.
Secondly, in rejecting the corroborative method proposed by the company, the CAA considered that the company did not justify that a bond issue would have constituted a realistic alternative to an intra-group loan.
Finally, the CAA considered that the company had not been provided with any precisely identified comparables whose relevance it would have been able to assess.

THE CONSEIL D'ÉTAT'S SOLUTION

The EC accepted the first argument of the lower courts, rightly considering that the company's sector of activity is an important parameter to be taken into account when calculating the credit rating on the RiskCalc tool.
However, it rejected the rest of the arguments, thus validating the company's economic and statistical demonstration. More specifically, the EC emphasized:
- "The size of a company is not in itself such as to hinder access to this market, and that the realistic nature, for a company having recourse to an intra-group loan, of the alternative hypothesis of a bond issue can only be assessed in the light of the specific characteristics of this company and of the transaction, the rates observed on this market having to be adjusted if necessary".
- The arm's length rate put forward by the company as corresponding to its level of risk was based on the use of rate curves established on the basis of all the transactions recorded, for loans of the same duration contracted by companies with the same risk profile, and it was not argued that the recording of transactions in this database was unreliable".

OUR ANALYSIS

THE RISKCALC TOOL IS USEFUL, BUT NOT ALL-POWERFUL

Developed by Moody's, the RiskCalc tool has gained legitimacy among tax judges since the Studialis ruling by the Paris CAA in 2020 (no. 18PA01026).
This tool can be used to determine a borrower's risk rating, which is the first essential step in demonstrating the arm's length nature of a rate charged to majority shareholders. However, this tool requires a detailed analysis of the borrower's intrinsic parameters, both quantitative and qualitative, including in particular its business sector.
This latter indicator has a major influence on the past and future prospects for growth, profitability and therefore risk, of the players making up a given market. If this essential criterion was not included, the analysis produced initially could not be relevant or complete, as it necessarily misunderstood the company's economic situation.
It is interesting to note, however, that neither the contemporaneity of the analysis nor the relevance of the tools cited were discussed, thus validating, and no doubt definitively, the praetorian trend initiated by the aforementioned Studialis, BSA de la CAA de Versailles (n°20VE03249), and Willink du Conseil d'Etat (n° 446669) rulings.
Above all, it should be noted that the demonstration that finally won over the Conseil d'Etat was based on an alternative financial ratio known as "loan to value" (LTV), which relates the level of indebtedness to the value of the company's real estate assets. In this case, this indicator led to an estimate, based on a comparison with the ratios of listed French and European property companies, that the financial rating it could have obtained would not have exceeded BBB, i.e. a level close to that initially proposed by RiskCalc.
In this case, the LTV ratio had been calculated taking into account a financial debt corresponding exclusively to the loan whose rate had to be assessed. One might have thought that the calculation was flawed because it was circular. However, by focusing on the principal loan (the purpose and amount of which were not in dispute), without taking into account the interest (the rate of which was at the heart of the debates), the ratio was indeed relevant and valid.

THE CONSECRATION OF THE BOND MARKET

In its July 2019 Wheelabrator opinion, the Conseil d'etat paved the way for a pragmatic approach, in line with OECD practice, to the taxpayer's demonstration of the "arm's length" nature of an interest rate charged in the context of intra-group financing, allowing in particular the use of bond benchmarks.
However, this opinion, as well as subsequent rulings, seemed to contain a reservation, by making reference to the bond market conditional on demonstration that "these loans constitute, in the hypothesis under consideration, a realistic alternative to an intra-group loan". In other words, the taxpayer appeared to have to prove that issuing bonds was a realistic alternative to taking out a conventional loan with a bank or credit institution.
In recital 10, however, the CE seems to reinforce the burden of proof on the tax authorities. The judge considers that "the realistic nature, for a company having recourse to an intra-group loan, of the alternative hypothesis of a bond issue can only be assessed in the light of the specific characteristics of the company and the transaction, with the rates observed on this market having to be adjusted, where necessary, to take account of the specific features of the company in question". In order to disregard the reference to the bond market, it would seem that the tax authorities would have to demonstrate that, given its specific and intrinsic parameters, this option would have no purpose, or would be inappropriate.
In our view, such proof is impossible.

BENCHMARKS FOR ALL?

While the two-step economic analysis now seems to be well recognized by the tax judge, both in its credit risk calculation component and in its search for comparables on bond markets, it should be remembered that this approach is only valid if the lender is a majority shareholder within the meaning of Article 212-I. Minority shareholders cannot use this analysis to justify a different rate from that referred to in article 39-1-3 of the CGI (see CAA Versailles, Sté Financière Lilas, n°19VE00546). This trend further reinforces the difference in treatment between taxpayers.

France v/s. SAS Itron France January 2024

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Facts, Procedures, and the Decision

STATEMENT OF FACTS

SAS Itron France ("Taxpayer") (a manufacturer and distributor of water, electricity and gas meters) was the subject of a tax audit for the financial years 2012 and 2013, which resulted in an assessment. The tax authorities ("TA") considered that the transfer pricing applied by the group had resulted in an understatement of taxable income in France and a transfer of profits to a Hong Kong-based distributor of the group. An appeal was filed by SAS Itron France and in a ruling handed down on December 2, 2021, the Administrative Court annulled the assessment. The TA filed an appeal against this ruling. The Administrative Court of Appeal dismissed the appeal and decided in favor of SAS Itron France. The TA concluded that the Taxpayer had granted an unfair advantage to its related party distributor within the meaning of Article 57 of the French Tax procedure Code.

ARGUMENTS OF THE TAX ADMINISTRATION

The Taxpayer is a manufacturer as well as a distributor of water, electricity, and gas, therefore it is in a situation of mutual dependence with its Group entities. The TA tested the Taxpayer's relations as a producer with group distributors and followed a "profit-sharing" method. It further functionally analyzed the Taxpayer and then attributed the following distribution margin between the manufacturer and the distributors:
(i) 53% and 47% for "gas" product line respectively;
and
(ii) 51% and 49% for water and electricity respectively.
The TA stated that the Taxpayer's profit as a manufacturer was insufficient in relation to the overall margins determined by the TA (i.e., 53% and 51%).

THE DECISION

The Court rejected the adjustment sought by the TA in terms of the group's transfer pricing policy as such adjustment can only be warranted in the event of a significant differences between the transfer price resulting from this method and the economic reality, such adjustments are provided for only in exceptional circumstances and under a procedure that derogates from the "cost-plus" method. The Court observed that the TA failed to demonstrate whether any special circumstances arose during the period of assessment (FY2012 and FY2013) which could justify the adjustment. The Court ultimately stated that the TA had failed to interpret tax law as they could not establish any consistency to their allegations. The case was therefore dismissed in the final appeal.

CARA ANALYSIS

BREAK DOWN OF THE DECISION

On one hand, the Court gave consideration to the Taxpayer's claim that in order to reconstitute the transfer prices between SAS Itron France as a manufacturer and its related party distributors, the TA used the margin of the distributing entities after deducting the sale price of SAS Itron France's products, without taking into account the distributor's own operating expenses (such as cost of discounting ; commissions paid to agents; rebates and discounts; product shipping costs; insurance costs incurred in transporting products; customs duties; product packaging costs), even though these expenses contribute to the distributors' share of the Group's net margin to which they should be entitled.
On the other hand, the TA deducted their direct expenses from the margin of the manufacturing entities, including SAS Itron France, to which the gross margin rates mentioned in the previous point apply under the cost-plus method.
Without calling into question the parameters used by SAS Itron France to determine its transfer prices as a producer (costs used and margin rates mentioned) determined within an arm's length interval), the TA had carried out a comparison of heterogeneous margins, gross for the distributing entities and net for the producing entities. Moreover, for an adjustment to be applied, three conditions must be met:

  • existence of new markets or invitations to tender;
  • existence of a turnover exceeding 10% of the distributor's revenue;
  • existence of a variation in the distributor's turnover of at least 500,000
    euros.

The Court observed that the TA failed to demonstrate the existence of the above elements.

THE CONCLUSION

At CARA we always stress on the importance of really understanding the functions and risks undertaken by the parties to a given controlled transaction, as it is extremely crucial not only in determining the range but also in applying the correct methods and profit level indicators (PLIs) to derive the range. This decision of the Court is a case in point for the same.
Different methods and PLIs test different functions of the tested party, especially when the tested party has dual profiles. Therefore, one must be sure to test the correct profile (for e.g., distributor or manufacturer) and the risks associated with that profile, as demonstrated by this case law.
Moreover, experience has shown us that the application of most methods will be imperfect, even, for example, by applying the CUP method which bases itself on very precise internal and/or external comparables. The reason for the same is that
(i) comparable data available for testing such method may certainly not take into account the various risks undertaken by the parties; or
(ii) it may not reflect the economic reality at a given period of time.

However, we may conclude that clear and cogent functional and risk characterization is key in determining a relevant interquartile range, and is therefore, THE antidote to tax assessments.

Should the 10% penalty for late SAR reporting be automatic?

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CAA Lyon, 5th ch. 21/12/2023; n°21LY02821; Sumitomo
Chemicals Europe

THE FACTS

Following an audit of the accounts of Sumitomo Chemicals Europe (SCAE), the tax authorities considered that the intra-group transactions in which the company was involved did not comply with the arm's length principle. The advantages thus granted were classically qualified as "deemed distributed income", which, in view of the applicable tax treaties, gives rise to a withholding tax. Insofar as the company obviously failed to declare this withholding tax, the existence of which only came to light following the rectification, the penalty provided for in article 1728 of the CGI.

THE RULE

As a reminder, when the tax authorities make an adjustment under Article 57 of the CGI, they consider that an indirect profit transfer has taken place, which must then be treated in the same way as dividend distributions. A withholding tax is then levied, in addition to corporate income tax, the rate of which is calculated by reference to the tax treaty applicable to the case in question. This is a collateral consequence of transfer pricing rectifications, which has been validated on numerous occasions by the tax judge, and which we will not discuss here.
The penalty referred to in article 1728 of the CGI penalizes failure to file within the prescribed time limit a declaration or document indicating the elements to be retained for the assessment or liquidation of tax. This penalty, expressed as a percentage of the amount of duty payable by the taxpayer or resulting from the late filing of the return or deed, is equal to 10% in the absence of formal notice, which is the case following an adjustment highlighting income deemed to have been distributed.

THE JUDGES' POSITION

In 2021, the Lyon TAA ruled in recital 20 that "By merely pointing out the non-voluntary nature of this omission and its right to make a mistake, the applicant company is not contesting the validity of the penalties imposed on it on the basis of the aforementioned provisions". In many cases, however, the taxpayer is not claiming good faith or the right to make a mistake, nor is he asking for the penalties to be reduced, which the tax judge has always refused to do. On the contrary, it is a question of the relevance of an automatic penalty, linked to an offence whose existence and quantum the taxpayer cannot know prior to the rectifications.
The CAA persists, however, and considers that "the aforementioned provisions proportion the increase to the taxpayer's actions by providing that its amount is set as a percentage of the duties evaded. Moreover, it is clear from the provisions of article 1728 that the rates of increase applied vary according to whether the failure to declare within the time limit was noted without formal notice to the interested party or after one or two unsuccessful formal notices, so that the law itself has thus ensured, to a certain extent, the modulation of penalties according to the seriousness of the penalized behaviors. It follows that the argument based on the automatic nature of the application of a 10% surcharge can only be rejected".

OUR ANALYSIS

A PENALTY IMPOSSIBLE TO PREDICT IN PRINCIPLE...

Insofar as the penalty under article 1728 of the CGI is applied automatically, in a situation where the taxpayer is unable to comply with it, it exceeds in our view the objective that this article is supposed to pursue, and therefore creates an error in the assessment of the legal basis.
It seems to us that the tax merits of an automatic penalty should be reconsidered, since it sanctions behavior that is not only involuntary on the part of the taxpayer, but above all unavoidable, given that the taxpayer can be unaware of either the existence or the amount of the withholding tax to be declared.
In fact, this penalty affects the withholding tax, which is itself a collateral consequence of a main corporate tax adjustment, and whose existence and quantum are only known at the end of the
audit procedure:
On the temporal aspect on the one hand: this withholding tax arising from the indirect transfer of profit can logically only be known to the taxpayer at the end of the tax audit, i.e. after the administration has considered that an indirect transfer of profit has taken place. It is therefore materially impossible for the taxpayer to produce the withholding tax within the time allotted to him, since the event giving rise to the withholding tax is then unknown to him. In the case in point, the French tax authorities brought to light the existence of the withholding tax in its proposed rectification of August 4, 2014, i.e. for the 2010 tax year, 44 months after the deemed taxable event; and 32 months after the taxable event for the 2011 tax year. In order to comply with article 1728 of the CGI, the taxpayer should theoretically have declared the transfer of profits before the fifteenth day following the month of the transfer, i.e. before January 15, 2011 for 2010 and before January 15, 2012 for 2011.

NOR IN ITS QUANTUM!

Secondly, in terms of quantum: the penalty is expressed as a percentage of the withholding tax, itself calculated by reference to transfer pricing adjustments.
More precisely, this withholding tax is applied to the basic adjustment made under article 57 of the CGI, which is then qualified as deemed distributed income. However, transfer pricing is a subjective discipline, the limits of which are not clearly defined. Whether we are talking about transactions falling within the scope of transfer pricing, or the calibration of deemed profit transfers, the taxpayer cannot rationally know in advance the exact amount of an indirect profit transfer, and hence the theoretical amount of withholding tax he should have declared.

BENCHMARKS FOR ALL?

Finally, we would like to remind you that tax penalties, which are synonymous with sanctions, are intended to punish the taxpayer's behavior. This is the very essence of the difference with interest on arrears, which is intended to compensate for financial loss. The case law of the Conseil d'Etat is clear on this point, underlining a contrario the intrinsic link between tax penalties and the taxpayer's behavior. However, in our case, the taxpayer's behavior can in no way be voluntary, nor can it be modifiable or anticipated. In this respect, we believe that article 1728 of the CGI cannot be applied in such cases, as its provisions should be limited to cases where the taxpayer is aware of the obligations incumbent upon him.
Maintaining the sanctions of article 1728 would mean removing their status as tax penalties, and turning them into real taxes. In effect, these penalties would be dissociated from conduct, which constitutes the intrinsic element for falling within the scope of tax penalties, but would in reality automatically apply a rate (in this case 10%) to a base (the deemed transfer of profit), just like a tax.