The Dutch appeals court ruled fully in accordance with a compromise reached between the Dutch Tax Administration (DTA) and the taxpayer during the court hearing, resulting for 2010, in an additional Dutch taxable profit of 122 million euros ($134 million). This compromise triggered the Dutch Ministry of Finance to issue a clarifying statement on April 30, 2020, which the authors will also discuss in this article.
Under Dutch law the burden of proof rests with the party who stipulates certain facts or circumstances.
As a rule of thumb the DTA has the burden proving the circumstances that increase the tax base and the taxpayer has the burden of proving the deductions.
In transfer pricing cases it is the DTA who must convince the court that a higher profit needs to be reported.
The initial burden of proof may shift to the taxpayer in certain circumstances, notably where the latter does not fully comply with relevant Dutch administrative and tax reporting requirements.
In the 2017 district court case addressing the business conversion to a Swiss principal company, the DTA effectively argued and sought to convince the district court that the conversion/goodwill payment the taxpayer received in 2010 was too low, but the district court did not agree. The DTA in December 2017 lodged an appeal against the verdict of this District court.
The case has been settled by compromise, which was confirmed in a court of appeals case in March, 2020, which case the authors discuss in this article.
We discuss this higher court case (Gerechtshof’s-Hertogenbosch, case no. 17/00714, Judgment of March 13, 2020, ECLI:NL:GHSHE:2020:968), but also refer to the relevant prior case law in our Feb. 8, 2018, article, “
BUSINESS CONVERSION TO A SWISS PRINCIPAL COMPANY
Zinc Smelter District Court Case 2017
The burden of proof issue was part of the discussion in the Zinc Smelter court case September 2017. All the relevant facts of this district court case—to the extent made publicly available—are again summarized below.
This case concerns an adjustment imposed by the DTA, with the DTA increasing the taxable profit for 2010 from 42 million euros ($46.1 million) to 188 million euros ($206 million), the district court initially reduced the tax assessment to a taxable profit calculated at 42.6 million euros ($46.8 million). However, in the appeals court case this was again increased to 122 million euros ($234 million). Before the authors discuss the specifics, the paragraphs below first reflect the facts of the Zinc Smelter case at hand.
The Dutch taxpayer is the parent company of a fiscal unity for corporate income tax purposes. The taxpayer’s operating activities consisted of processing zinc concentrate and associated raw materials. A BV, a member of the fiscal unity, operated a zinc smelter in the Netherlands.
Situation Before 2003—Before 2003, the taxpayer fulfilled all the essential functions of the entire value chain of a smelter as the owner of relevant assets and bore all risks related to its activities. It independently concluded all relevant sales contracts, loan agreements, hedging arrangements, and the like.
2003 GMS Agreement—Since 2003 the Dutch taxpayer had gradually transferred activities other than its own production activities to a global organizational structure, the Global Marketing & Services team (GMS). This collaboration, laid down in a written agreement, meant that benefits of scale could be realized in the area of procurement, sales, and staff deployment, for example. The costs associated with GMS were recharged to the participating operating companies. The benefits derived from GMS were reported by the participating operating companies, including those companies in the Netherlands.
2007 Consultancy Agreement—Even after the taxpayer became a member of the C group in 2007, the collaboration was continued via the GMS. To this end, a consultancy agreement was concluded between A BV and the top holding company, A NV, listed on the Brussels stock exchange, in which it was, among other things, agreed that A NV would provide A BV with services in the area of strategy and business development, marketing, sales, finance, legal support, information technology, human resources, and environment.
A NV invoiced the costs of these services to A BV with a markup of 7.5%. A number of employees of A BV were also seconded to GMS. The authors assume that this change did not result in the Dutch taxpayer become significantly less profitable.
2009 B NV in Belgium, Business Transfer Agreement (BTA)—As part of project X, B NV was incorporated in April 2009. B NV was established in Belgium. It supplied, via GMS, support services to the smelters and managed and administered the procurement of all raw materials and the sale of all products, and byproducts.
In July 2009, B NV acquired, under a business transfer agreement (BTA), the working capital, that is the raw materials, work-in-progress, products and byproducts, and accounts receivable of the various smelters, including that of A BV.
B NV and A BV, among others, also concluded a cooperation agreement (CoopA). Under this CoopA, B NV supplied raw materials to the smelters, which processed the raw materials and returned the resulting product to B NV. Under CoopA, B NV was entitled to have its costs reimbursed with a 7.5% markup plus a fee of 3.487% on its equity. An “EBIT passback” clause in CoopA ensured that the results associated with the commercial procurement and sales process were refunded to the smelters. CoopA was valid for two years. As a consequence of the transfer of activities, a number of employees were also transferred from A BV in the Netherlands to B NV in Belgium. The authors assume that this change did not result in the Dutch taxpayer becoming significantly less profitable.
2010Swiss Principal Structure—In February 2010 the C group decided to relocate the group’s head office, which was partly established in London and partly established in Brussels, to Switzerland—in accordance with project Y—as of July 1, 2010. Under the new structure, the management of production planning, procurement, logistics, and sales was centralized at A AG in Zürich.
As of 2010, approximately 100 employees worked in Switzerland. In June 2010, A AG acquired the activities from B NV (under a BTA), and the CoopA was terminated by way of a termination agreement.
A BV received an amount of 28.4 million euros ($31.1 million) as compensation for damages resulting from the termination of CoopA (the conversion payment). The conversion payment was calculated on the basis of a remaining one-year term for CoopA. The Dutch taxpayer was significantly less profitable in the years after the conversion. A manufacturing services agreement (MSA) was concluded between A BV and A AG and the smelters. Under this MSA, the smelters were entitled to a fee based on the cost of their smelting activities, increased by a 10% markup. The Dutch taxpayer consequently only received a routine remuneration going forward.
DTA Adjusts Conversion Payment to 188 million euros ($207 million)—In June 2012 A BV filed its 2010 corporate income tax return, reporting a taxable profit of 42.6 million euros ($46.8 million), which included the conversion payment. After losses of 10.6 million euros ($11.6 million) were set off, a taxable amount of 32.1 million euros ($35.2 million) remained.
In November 2014 the DTA imposed the 2010 corporate income tax assessment for a much higher taxable amount of 188 million euros ($207 million). The DTA increased the conversion payment by 156 million euros ($171 million) to 185 million ($203 million) because the DTA considered that the key core functions were performed by A BV, even after the completion of project Y. According to the DTA, the Dutch taxpayer still performed all the essential functions of the value chain of a smelter as owner of the relevant assets and bearer of all risks related to its activities.
The Dispute—The DTA and A BV disagreed on:
(1) Was the DTA entitled to adjust the transfer prices used by A BV and the conversion payment?
(2) Does the tax treaty between the Kingdom of the Netherlands and Switzerland hinder an adjustment to the transfer prices used?
(3) Was the conversion taxed in the correct year?
A BV answered questions 1 and 3 in the negative and the second question in the affirmative. The DTA took the opposite positions.
Examination of the Dispute—Section 8b of the Dutch Corporate Income Tax Act 1969 (CITA) codifies the arm’s-length principle and it also includes the documentation obligation prevailing in the period 2002–2015 in paragraph 3: “The accounts and records of the entities referred to in subsections 1 and 2 will include information showing how the transfer prices referred to in that subsection were arrived at and which show whether the transfer prices were arrived at under conditions that would have been agreed by independent parties operating in the market.”
Administrative Obligations—The DTA asserted that A BV had not met the administrative and documentation obligation contained in Section 8b(3) CITA. However the district court did not agree with the DTA because A BV prepared and presented transfer pricing reports or had these prepared, in which the conditions for granting the conversion payment and the manner in which it was to be calculated were set out. In this way, A BV also substantiated its position regarding the use of the net cost-plus (10%) method. The district court concluded that A BV had complied with the above mentioned administrative and documentation obligation.
The district court also concluded that even if A BV had not complied with the administrative or documentation obligation, this would not lead to the imposition of the evidentiary penalty (Section 27e(1) of the General Taxes Act), because the DTA did not issue a decision requiring information establishing the administrative deficiencies. This is established case law in other areas of tax law and the district court rightfully applied the same rules to this transfer pricing case. The authors note that:
- because even the OECD recognizes that transfer pricing is not an exact science, the party on whom the burden of proof rests is seriously disadvantaged; and
- in order for the burden of proof to shift to the taxpayer, the DTA must issue the taxpayer with a formal decision in writing.
No Burden of Proof on DTA—The DTA disputed that A BV received an arm’s-length fee for the functions it performed. The taxpayer took the position that the DTA had the burden of proof in this respect.
Gradual Transfer—District Court Ruling—Given the facts and circumstances and the substantiation thereof, the district court deemed it plausible that A BV gradually transferred the activities associated with procurement, sales, and logistics to other members of the C group in the years before 2010. The transfer of those activities began with the GMS and was later completed with the termination of CoopA. The court concluded that in 2010 A BV was mainly involved with the smelting of zinc and was entrusted with a more advisory role with regard to the other activities, such as the procurement of raw materials. The final decisions, where group considerations may also play a role, were all taken in Switzerland. Based on those developments, the district court agreed with A BV and ruled that in the Netherlands there was predominantly an activity that strongly resembled toll manufacturing. All the risks related to the procurement of raw materials, the sale of zinc and other byproducts, including the Bonded Logistics Park or BLP, logistics, staff, the foreign exchange risks, and the risk of fluctuations in the price of zinc, were borne by A AG in 2010.
District Court Conclusion on Cost-plus 10%—The district court concluded that the net cost-plus method can be used to determine an acceptable arm’s-length fee for the activities performed by A BV.
District Court Conclusionon Conversion Payment—To calculate the size of the conversion payment, A BV assumed that CoopA had been terminated. The DTA argued that the calculation of the conversion payment must take account foregone profits and costs associated with, for example, procurement and sales activities. However, the district court concluded that this argument was not supported by sufficient facts. A BV had already gradually transferred these activities in the years before 2010.
As these activities were no longer performed by A BV in 2010, there was, contrary to what the DTA argued, no reason to still take them into account when determining the conversion payment for 2010.
The district court reduced the tax assessment to a taxable profit calculated at 42.6 million euros ($46.8 million) and a taxable amount of 32.1 million euros ($35.2 million) and set the loss set-off decision at 10.6 million euros ($11.6 million).
COURT OF APPEALS 2020
On March 3, 2020, the appeals court overruled the earlier district court negative decision on the DTA’s exit tax assessment, fully in accordance with a compromise between the DTA and the taxpayer reached during the court hearing.
The appeals court was to answer the following questions:
(1) Was the conversion payment calculated at arm’s-length?
(2) Does the cost-plus applied after July 1, 2010, constitute an arm’s-length remuneration for the taxpayer?
(3) Does the tax treaty between the Netherlands and Switzerland allow the tax inspector to adjust the cost-plus and the conversion payment?
New Additional Facts
According to Dutch administrative law, the court of appeals allows taxpayers to further specify or include factual information in order to substantiate their (filing) position. In this case merely the legal wording of the BTA and CoopA agreements seem to have been added as new facts for the Court of Appeals case. These agreements reflect the gradual transfer of the Dutch operations abroad to foreign jurisdictions.
The BTA, concluded in 2009, mentions that B NV acquired inventory, works in progress, contracts, accounts receivables, and the associated rights and obligations from A BV. However, the BTA also explicitly states that the existing goodwill, intellectual property (IP), and debts will not be covered by the BTA and will remain under the ownership of A BV in the Netherlands.
Furthermore, CoopA was concluded at the same moment between B NV and A BV. Based on the formal wording of the CoopA agreement, A BV was still the owner of the preexisting IP used for the conversion of the raw materials into products. Moreover, A BV remains responsible for maintaining the overall quality of their products and is financially liable for non-conformation to specific product specifications.
Only after the conclusion of the BTA in 2010, regarding the CoopA agreement and the MSA with A AG, based on its functions, assets and risks A BV could be regarded as a proper toll manufacturer for which a low routine remuneration based on costs was expected.
The authors believe that, taking into account the above and the risks and uncertainty of further litigation for the taxpayer, the DTA and the taxpayer settled in a comprise agreement. As a result both parties wished the following 10 items to be included in the appeals court judgment:
(1) In 2010 the taxpayer, being fully entitled to 100% of the profit from its business, transferred part of its business to an affiliated party.
(2) The functions remaining at the taxpayer after the transfer referred to in I cover more than those of a pure toll manufacturer/routine activity.
(3) A profit split remuneration is the right arm’s-length method for determining the remuneration for the functions and activities of the taxpayer after the partial transfer of its business to the affiliated party on July 1, 2010, and the subsequent joint activities with the affiliated party.
(4) In the present case, there are no routine activities by the taxpayer or the aforementioned affiliated party.
(5) The profit for purposes of the profit split will be determined on the basis of the total profit realized from the joint (smelting) activities of the taxpayer and the affiliated party.
(6) The total profit realized from the joint (smelting) activities of the taxpayer and the affiliated party will be determined by the contributions from the taxpayer and the affiliated party to the income resulting from the functions performed, the risks managed and controlled, and the assets used by them.
(7) The value of the business prior to the transfer on July 1, 2010, was determined on the basis of the cash value of the expected (smelting) profits.
(8) The functions performed, risks managed and controlled, and assets used by the taxpayer after the transfer, represent remuneration of 72% of the total profit realized from the joint (smelting) activities of the taxpayer and the affiliated party.
(9) On the basis of this profit-split remuneration of 72%, the taxpayer must take 28% of the total business value prior to the transfer on July 1, 2010, into account as the transfer value of the transferred part of its business.
(10) The transfer value to be taken into account in 2010 for the part of its business transferred by the taxpayer and the profit split of 72% as of July 1, 2010, through to year-end 2010 resulted in a taxable amount of 122 million euros ($134 million) for the 2010 tax year.
The DTA and the taxpayer unanimously agreed and stated that after the transfer on July 1, 2010, the profit split remuneration in the remaining months of 2010 is the right arm’s-length method for determining the fee for the taxpayer’s activities and that there is a direct relationship between the profit split percentage set and the calculation of the value of the part of the taxpayer’s business that was transferred to the affiliated company. The authors note that how the mentioned 72%/28% profit split allocation was determined and how any synergy benefits were divided between the taxpayer and affiliated party is a black box, meaning that this information is not published.
Court of Appeals Verdict 2020
In light of the above, the appeals court could only conclude that the appeal was well-founded and hence accepted the comprise in full, that the appeals court (conditional) cross-appeal was unfounded and that the judgment by the district court must be overturned.
After the hearing, the DTA and the taxpayer also reached agreement on the:
- court fees paid by the taxpayer in the appeals before both the district court and the court of appeals, such that DTA will not reimburse the taxpayer for these court fees; and
- costs of the notice of objection proceedings, for both the appeals before the district court and the court of appeals, such that each party will bear their own costs.
Response Ministry of Finance
On April 30, 2020, the Dutch Ministry of Finance issued a statement, affirming that it will not bring this case before the Supreme Court, as a compromise was reached. The Ministry of Finance acknowledged that each case has its unique characteristics. However, the Ministry of Finance did provide below clarification which may be of importance for other similar cases.
First, the Ministry of Finance stated that if a taxpayer has always presented itself—through transfer pricing documentation, annual accounts, and tax returns—to be entitled to the residual profit, it cannot retroactively claim that it was not entitled to this residual profit as a result of the gradual transfer of functions abroad in previous years.
Second, the Ministry of Finance considered it important that a (partial) transfer of functions and risks forming an enterprise must be taken into account for exit taxation purposes, so that the value of these transferred functions and risks and the related profit potential is duly reflected on an arm’s-length basis.
Third, the statement mentioned that even after partial transfer of functions and risks, the remaining enterprise could still be entitled to (part of) the residual profit.
Finally, the Ministry of Finance concluded by stating that Dutch taxpayers can still obtain advance certainty with respect the transfer prices (in case of a reorganization), within the Dutch ruling/advance pricing agreement framework, if they file a corresponding request with the DTA.
In the Netherlands, in practice many transfer pricing disputes eventually end up in a compromise between the DTA and the taxpayer, like in this case. The outcome of the case discussed in this article does mean for the taxpayer for 2010 an additional taxable profit of 122 million euros ($134 million). What is not publicly available information is whether the taxpayer seeks to obtain a relief from double taxation under Article 25 of the tax treaty between the Netherlands and Switzerland under a so-called mutual agreement procedure.
The authors point out that although terms and concepts like “Key Risk Taking Functions” or “Develop, Enhance, Maintain, Protect, and Exploit” (DEMPE) were not yet introduced by the OECD for the tax year 2010, the DTA could apparently sufficiently argue its exit taxation case on the basis of the general interpretation of the arm’s-length principle, as codified in Dutch tax law as per Jan. 1, 2002.
The OECD BEPS 13 transfer pricing documentation requirements that took effect on Jan. 1, 2016, have further improved the position of the DTA in terms of Dutch exit taxation. Under Dutch tax law, MNEs with a global consolidated turnover of at least 50 million euros must prepare and maintain both a master and a local transfer pricing file. In light of the above, MNEs operating in the Netherlands must carefully review their administrative and related internal procedures to determine whether they meet the BEPS 13 Dutch transfer pricing documentation requirements, which also cover business conversions and foreign principal structures. As this recent case again shows, the DTA considers the profit split method to be the most appropriate transfer pricing method, if companies fulfill, as entrepreneurs, important functions within the MNE.
The latest Dutch transfer pricing decree (issued May 11, 2018) is fully in line with the outcomes of the OECD BEPS project. The authors also refer to Chapter IX of the OECD 2017 transfer pricing guidelines “Transfer Pricing Aspects of Business Restructurings.”
Also, it is important to assess whether functions, assets, and risks that have (assumed) been transferred are not only reflected in intercompany agreements but can also be proven through the adequate level of (economic) substance abroad. Next, the new OECD credo is all about the accurate delineation and the pricing of the controlled transactions.
Finally, as a result of the current Covid-19 crisis, MNEs might be forced to close down or divest specific international business operations. This could lead to the transfer abroad of “something of value,” for which the DTA would expect some form of return (exit taxation). When restructuring within an MNE, it is important to document the underlying business rationale. The DTA asks more frequently why MNEs have taken certain strategic decisions and assesses whether and how these are driven from both a commercial business and tax perspective. Also it is important to take into account that even when functions or risks are transferred abroad, the DTA could still consider the remaining Dutch enterprise to be entitled to part of the residual profit if Dutch activities exceed routine activities. Part II. of Chapter IX. of the OECD transfer pricing guidelines specifically covers the arm’s-length remuneration of the post-restructuring controlled transactions.
The above has handed the DTA even more tools to scrutinize or audit these types of business restructurings.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Eduard Sporken is a Director, and Adriaan Bijleveld is a Consultant, at KPMG Meijburg & Co. in the Netherlands. This article represents the views of the authors only, and does not represent the views or professional advice of KPMG Meijburg & Co.