Additional Tax Assessment Following Transfer Pricing Control Audit
October, 04th 2016
Our lawyers have successfully defended interests of a client (subsoil user) in litigation on tax dispute. According to the results of tax audit on application of transfer pricing, taxes in the amount of 800 mln. tenge were charged by the State Revenue Department (SRD). According to the SRD, the subsoil user during the oil export (1) wrongfully included some types of expenses into the differential, and (2) overcharged the amount of some types of expenses, included into the differential. According to results of the court proceedings, the court recognized that additional taxes were charged illegally and obliged the SRD to re-calculate the taxes taking into account supporting documents and data from the official source of information.
Dear colleagues, in this newsletter we would like to share an interesting experience that occurred in our recent litigation practice. Our lawyers have represented interests of a taxpayer in a dispute re additional tax assessment following the application of transfer pricing during oil export. During the court proceedings there were some curious issues from practical standpoint. For example, obligation of the SRD to disclose evidence in the court, application of data from supporting documents by the SRD; application of official sources of information, containing differing data.
The acceptance of documents supporting components of a differential
The SRD has consistently held the position that despite availability of the documents supporting components of a differential, the amount of components is determined according to the official sources of information. At that, the SRD reasoned its position as follows: in accordance with Article 18-1 of the Law "On transfer pricing", officially recognized information sources on market prices shall be used in order of priority for determining market prices of goods and another data necessary for methods of determination of market prices.
The taxpayer in turn reasonably specified that in accordance with Article 13-6 of the Law "On transfer pricing" a differential shall be confirmed by documents or by information sources. At that, in accordance with Article 18-1 of the Law "On transfer pricing" supporting documents shall are not included in sources of information. Consequently, priority rules of the sources of information do not cover supporting documents, but supporting documents themselves shall be considered as an equal alternative for purposes of supporting a differential.
Unfortunately, the court did not make unambiguous judgment for this issue. Despite the fact, that elimination of certain expenses from the differential and reduction of the amount was recognized by the court as illegal, the court reasoned that not on grounds that supporting documents are equal to official sources of information, but on grounds that the amounts of components of differential supported by documents are in range of prices established by official sources of information.
The SRD applied an average priceat determining market price upon data from official sources of information, which does not conform to legislation. For instance, in accordance with Article 13-4(1) of the Law "On transfer pricing", a market price shall be determined as a price from source of information with taking into account range of prices. Range of price means range of values of market prices limited by minimum and maximum values and determined as a result of applying one of methods of determination of market price or information sources. Thus, legislation directly provides for an option when price of a transaction brought by differential in comparable economic conditions with market price can fluctuate within range of market prices. Considering this issue, the court clearly ruled that tax bodies while applying the method of comparable uncontrolled price shall take into account the range of prices.
The following finding of the Court was very interesting: "...in cases, when the data of supporting documents is within the range of prices taken from the official source, then the data from supporting documents shall be taken into account. In case if data from supporting documents exceeds maximum value of the range of prices, then such maximum value of range of prices shall apply."
It implies that when the price of a deal is brought in the comparable economic conditions by a differential, and when such differential is confirmed by documents, does not exceed maximum range of market prices, such situation cannot be regarded as a deviation from market price.
Another issue concerning supporting documents was non-recognition of indisputable costs by the SRD on formal grounds. For instance, the SRD did not deny that port charges in port of departure are inevitable and legitimate costs in maritime transportation. However, the SRD entirely excluded these costs arguing that port authorities charged port fees not to one of the parties of a transaction. A taxpayer presented the following objections.
Firstly, exception of this cost in full amount due to absence of supporting documents issued on the name of one of the parties of transaction is illegal. Even accepting that available supporting documents are disregarded, the SRD was obliged to include this cost in the differential as a legitimate and determine its amount basing on other sources of information.
Secondly, in accordance with Article 13-5 of the Law "On transfer pricing", differential includes legitimate and confirmed by documents and (or) information sources costs, which are necessary for delivery of goods to a relevant market. Thus, legislation does not set any requirements for a design and contents of supporting documents with regard to mandatory reference of one of the parties. In our opinion, main requirement for supporting documents is the possibility to determine amount of costs related to delivery to relevant market of each separate shipment of goods. For example, in maritime transportation under FOB there is a reference on number and date of bill of lading in all supporting documents, which allows to link expenses with certain shipment regardless of reference on parties of a transaction.
The court did not make clear judgment on this issue. However, it supported all arguments of a taxpayer indirectly, ruling that these costs shall be included into the differential regardless of link to one of the parties of a transaction, while the amount shall be determined basing on data from official information sources. Thus, from practical standpoint it appears that there is no sense to request supporting documents by exporters, if there is no direct reference to one of the parties in the documents. At the same time, possible option will be to include reference on one of the parties (buyer) in all supporting documents.
Application of data from third information sources
Decision of the court to use data on amount of expenses included in differential from information source, not previously referred to by parties was curios from practical standpoint. A taxpayer as an evidence of its position provided data from one of officially recognized sources of information. The SRD in its turn used data from another officially recognized source of information. However, the court did not take into account data from any of these sources, but used third officially recognized information source. At that such third source of information was chosen jointly by both parties.
The court referred to Article 18-11 of the Law "On transfer pricing". At the same time it should be pointed out that legislation does not set priority of certain officially recognized sources over the others. Therefore, choice and use of data from certain officially recognized sources is at sole discretion of a court.
It seems that the court based its decision on use of third officially recognized information source on the following:
Firstly, both parties agreed to use the new source of information. Thus, the court allowed the parties to adjust their positions taking into account new data. From the point of SRD, the legitimacy of this change of position appears to be doubtful, because at the moment of assessing additional taxes the SRD applied completely another data. However, a taxpayer did not focus on that, since a significant part of additional taxes was abolished as a result of applying data from the new information source.
Secondly, the new officially recognized information source contained a range of costs included in the differential. Accordingly, the court held that the data taken from that very officially recognized information source was the most objective one.
From all the above the next practical conclusion raises: while receiving expert opinions from officially recognized information sources about the amount of expenses included in the differential, it is necessary to indicate not the average, but the range of maximum and minimum values of each expense.
Burden of proof
A very interesting issue during the court proceedings was a refusal of the SRD to provide documents that were the basis for additional tax assessment. At that, the SRD referred to confidentiality of these documents and commercial secret. For instance, the SRD while determining market price and the amount of differential used inter alia expert opinions of agencies included in the list of official sources of information, letters of other exporters about export pricing, letters of pipeline, transport and forwarding companies, letters of port and railway authorities about average tariffs of transportation and related services in oil export.
We will not go deep into discussion about relevance of such evidences. However, we believe that in case when such documents were stated as evidences for justification of arguments of one party of the litigation, general provisions of civil procedural legislation on evidences shall apply to such documents.
Unfortunately, the court did not make judgment on this issue. The court also did not interpret data, contained in this evidence in favor of a taxpayer in accordance with Article 66 of the Code of Civil Procedure (valid on the date of making decision).
In our opinion, such approach of the SRD violates several principles of civil procedural legislation and the court had to take more coherent position.
For example, the principle of publicity. Civil court proceedings are held openly, which also implies an open examination of all evidences by court. If one of the parties believes that any evidence is a state or a commercial secret, this party has the right to file a petition about considering a case in closed proceedings. However, even in that case no party has the right to refuse to provide evidences at all.
Further, in accordance with the principle of equality and competitiveness of parties, court creates necessary conditions for fulfillment of parties' rights for full and objective investigation of circumstances of the case, while a court shall base its decision only on those evidences which each party was able to examine. Obviously, non-submission of evidences by one party violates this principle of civil procedural legislation.
And, finally, there is an obligation established by the civil procedural legislation that each party shall prove circumstances they use as grounds for their claims and objections. At the same time, in cases on challenging decisions of state bodies it is a state body that bears the burden of proof. Obviously, that in case of refusal of a state body to provide evidences, the stated requirements are not met.
Besides abovementioned provisions of civil procedural legislation, the position of the SRD contradicts with provisions of civil legislation. For instance, information which can be considered an official or a commercial secret is information, which has real or potential commercial value because of the following: its uncertainty to third parties, no free access to this information on legal basis and adoption of measures by a holder for protection of its confidentiality.
Taking into consideration that the SRD has already disclosed the contents of documents and that such kind of documents cannot have any commercial value neither for the SRD nor for a taxpayer, we do not see any grounds for recognizing such documents as confidential.