Intra-group Services and Transfer Pricing. Distribution of Expenses Amongst Affiliated Enterprises

In the most recent practice of our company, we have legally assisted clients both in the course of ongoing tax control procedures, and in what we prefer to call the preventive stage of due diligence, regarding issues related to transfer pricing.

In a nutshell, on grounds relating to economic optimisation, groups end up sharing certain expenses within themselves, without outsourcing certain services. We refer, in particular, to consultancy in legal, tax or accounting matters, as well as management, IT, advertising and other services.

Such services, although, as a matter of principle, they are considered to be provided for the benefit of the group as a whole, may be deductible even at the level of the affiliated companies, as long as they can prove the existence of their own benefit. The OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations refer, in this case, to the notion of ”benefits’ test”.

From a practical point of view, any analysis as such has as a starting point the determination whether intra-group services have in fact been rendered. In other words, one cannot talk about the existence of benefits, of commercial / economic improvements at the level of the affiliated enterprise if the services are not actually provided. In accordance with this view, the Romanian legislator stipulates, within the Methodological Norms for the Application of the Romanian Tax Code, that ”the mere existence of the services within a group is not sufficient, because, as a general rule, the independent persons pay only for the services that were in fact provided”.

There are several ways to prove the rendering of the services. One clue consists of the organisational structure of the affiliated companies. Thus, it must be checked whether the affiliated entities intended to benefit from the services contain specialised compartments for the rendering of the said service. At a micro level, the same is true regarding the lack of specialised personnel. In addition, the effective provision of services must be doubled by supporting documentation such as service contracts lato sensu, invoices, activity reports etc., which are of crucial relevance in performing this test.

Some services are ab initio considered as producing minor benefits for the affiliated company (or, in the words of the OECD Guidelines, low-value adding intra-group services), given that they do not fit its field of activity. The nature of the services therefore becomes important for the benefits test. However, we consider that the nature of the services must remain a subsidiary criterion compared to the organisational structure, for example, since even if their rendering does not require the use of valuable intangible assets, they may still be indispensable for the functioning of the affiliates.

The Romanian legislator refers to this benefits test when regulating the establishing of the proper market price for a particular category of intra-group services: advertising services. According to the Methodological Norms for the Application of the Romanian Tax Code, the advertising expenses are deducted by the affiliated persons which are to benefit from the publicity; if the advertising benefits more than one affiliate, the expenses are allocated in proportion to the benefit.

In determining the proportions of the advertising expenses incurred by the affiliated enterprises properly, one must take into consideration the markets on which the advertising was made and the market share of the affiliated enterprises in the sales of goods and services regarding to which the advertisement was made. Nevertheless, in the case in which the parent company incurs advertising expenses on behalf of the entire group, they cannot be considered deductible to the individual affiliate.

We can conclude that, in the case of intra-group advertising services, the benefits test is doubled by a proportionality test, which precisely reflects the sharing of common expenses between the affiliated persons.

Regarding the intra-group services of administration, consultancy and management, the Romanian legislator chooses to monopolise the expenses of these services at the level of the parent company, given their very nature. In other words, it starts from the presumption that a consideration cannot be requested for these services, given that they constitute the very essence of the legal relationship between the affiliated enterprises. The exceptions regard the situation in which companies provide additional services to their affiliates, as well as when the price of goods or the value of the services provided include administrative services or costs, in which cases the expenses can also be deducted individually.

A particular hypothesis is the rendering of management services (including consultancy) by a holding company. To the extent that such services are provided by such a company precisely because of its position and its shareholder interest, they cannot be considered services that benefit the group, which is why they cannot justify an expense at the level of an affiliated company, but only an expense at the level of the holding company. Of course, such services have a certain specificity and are limited, for example, to the following activities: stock exchange listing of the parent company, audit services at the level of the parent company and, in general, services auxiliary to corporate governance.

Returning to the benefits test, we consider that it is capable of substantiating the issue of the remuneration of intra-group services in accordance with the arm’s length principle. In determining the market price, the competent tax authorities are obliged to examine, first of all, whether independent enterprises, conducting an appropriate behaviour, would have concluded such a transaction under the conditions established by the affiliated enterprises, taking into account the usual charge for each type of activity or, as the case may be, the standard charges existing in certain areas. The Romanian legislator, within the Methodological Norms for the Application of the Romanian Tax Code, establishes as a method to be used in determining the transfer price for intra-group services, in the absence of comparable prices, the cost plus method.

Thus, the operation of distributing intra-group expenses, in compliance with the arm’s length principle, is correctly finalised. We cannot fail to notice that the services provided within a group of enterprises remain a challenge for the affiliated companies regarding the distribution of expenses in order to grant the deduction regime. We therefore recommend to all those interested to undertake the necessary diligence in such an endeavour, by resorting to specialised legal services offered by our team.

The legal advice in this case was provided by a team of lawyers consisting of Atty. Cosmin Flavius ​​Costaș, PhD, Atty. Alexandra Tomuța and Atty. Irina Galiș, all affiliated with the Arad Bar Association.

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