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The ECJ: The VAT base is not the open market value in all related party transactions

11 June 2012

In its judgment of 26 April 2012 on joined cases C-621/10 and C-129/11, Balkan and Sea Properties and Provadinvest, the Court of Justice of the European Union (ECJ) ruled that for VAT purposes Member States could fix the tax base of supplies between related parties to the open market value only in the specific cases in which either the supplier or the recipient do not enjoy the right to full input VAT deduction.

Surely you would recall the good news we brought in our newsletter earlier this year regarding the amendments of the VAT Act that effective from 1 January 2012 taxpayers should not worry about the tax base of transactions with related parties for VAT purposes, provided that both parties in the transaction enjoy the right to full input VAT deduction.

The new text of Article 27(3) of the VAT Act now correctly transposes Article 80(1) of the EU VAT Directive 2006/112/EC. Previously, the open market value was applied to all supplies between connected parties. The lack of safe harbor deviation from the open market value was used in tax audits as a legal basis for the adjustment of VAT obligations reported by taxpayers in related party transactions.

Following the amendment of Article 27(3) of the VAT Act these practices will stay in the past. Now, on the basis of the ECJ judgment in Balkan and Sea Properties and Provadinvest, taxpayers may defend against such VAT adjustments also for periods before the amendment entered into force.

Тhe Judgment

Both cases concern transactions effected between related parties, where based on an appraisal commissioned by the tax authorities within a tax audit it was established that the prices agreed between the parties deviate from the market levels. Consequently, the tax authorities made adjustments to the tax base of the transactions. In Balkan and Sea Properties the authorities rejected partially purchase VAT deduction, while in Provadinvest they assessed additional sales VAT.

Against this background the ECJ was asked by the Varna Administrative Court, among other questions, to give a ruling on: (i) whether or not the Bulgarian rules requiring the application of VAT on the open market value of all supplies between connected parties were compatible with Article 80(1) of the EU VAT Directive 2006/112/EC and (ii) if Article 80(1) of the EU VAT Directive may be applied directly by national courts.

On the first of those questions the Court, unsurprisingly, ruled out that Member States are not allowed to fix the tax base of VAT supplies between related parties to the open market value, except in the specific cases outlined in Article 80(1) of the EU VAT Directive in which either the supplier or the recipient do not enjoy the right to full input VAT deduction.

Given that this incompatibility was remedied with the last amendments of the VAT Act, it is the answer to the second question that is of greater importance. In that regard, the Court stated that individuals can rely on the VAT Directive to oppose the application of national legislation provisions that are contrary to it. If both parties in a related party transaction have the right of full input VAT deduction, national courts should not apply provisions of the old Article 27(3) of the VAT Act that were incompatible with Article 80(1) of the EU VAT Directive.

The Implications

Since the judgment does not contain temporal limitations, taxpayers may base their defense before national courts on it in cases concerning VAT adjustments to open market value in related party transactions, even if these transactions took place in previous years (but not before 2007). In that regard, the judgment may be of relevance to both companies that are open to tax audit for the past 5 years and companies who are presently disputing such adjustments before the higher tax authorities or in court. The ECJ judgment may not be used as grounds to reopen settled disputes or undisputed tax assessments.

Despite the comfort coming with this ECJ judgment, we would advise that parties are wary of the prices negotiated with connected parties. On one hand, the transfer pricing adjustments remain perfectly legitimate for direct tax purposes. On the other hand, too low or high prices may nevertheless justify VAT adjustments on the basis of free of charge supplies.

If you are interested in further exploring the implications which this ECJ judgment may have on your business, please, do not hesitate to contact us.

For Information

Kalin Hadjidimov
Partner, Tax & Legal
Tel.: + 359 (2) 9697 700
Fax: + 359 (2) 9697 878
khadjidimov@kpmg.com

Arkadiusz Mierzejewski
Partner, Tax
Tel.: + 359 (2) 9697 700
Fax: + 359 (2) 9697 878
arekmierzejewski@kpmg.com

Ivan Vargoulev
Director, Indirect Taxes
Tel.: + 359 (2) 9697 700
Fax: + 359 (2) 9697 878
ivargoulev@kpmg.com

In this issue

Тhe Judgment

The Implications

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