TP dispute trends in Europe: how to manage the rising tide

There has been a noticeable increase in tax audit activity recently in Spain, Sweden, Poland, Germany, and Switzerland, based on the accounts of Taxand transfer pricing (TP) experts provided in this article. The trend underscores the need for more thorough preparation, documentation, and management, as well as a greater focus on securing upfront legal certainty by taxpayers.

Although the TP audit environment varies in different ways, it remains very active in the jurisdictions discussed below. Driven by the countries' need for additional revenues, especially after the pandemic years, tax authorities are increasing their scrutiny on TP.

TP issues are increasingly the subject of tax audits. From a transaction perspective, German tax auditors have recently focused on several types of controlled transactions. Among the companies surveyed last year, remuneration for supplies to distributors (61%; choice of TP method, operating margin, loss-making situations), remuneration for services (46%; e.g., benefit test, shareholder costs, pass-through), and remuneration for the licensing of intangible assets (45%; e.g., benefit test, royalty rate, royalty base) are particularly contentious.

Furthermore, 34% and 32% of the companies surveyed were confronted with income adjustments in tax audits in the field of business restructuring (e.g., conversion of entities to contract manufacturers or contract R&D entities) and financing (e.g., debit and credit interest rates for loans, allocation of synergy benefits for cash-pooling arrangements), respectively.

As a standard procedure, the tax auditor requests the taxpayer’s entire TP documentation covering all cross-border intercompany transactions. Afterwards, the tax auditor selects those transactions that may require an in-depth examination, at the discretion of the individual auditor.

Currently, German tax auditors are likely to examine in detail the following inbound situations:

• When a German subsidiary’s income has declined sharply or the German subsidiary has suffered losses;

• When a German subsidiary has carried out intercompany transactions with related parties situated in low-tax countries;

• When a German taxpayer has applied the transactional net margin method and downward year-end adjustments;

• When a German subsidiary has transferred material intangible assets or shifted business functions involving substantial operations; or

• When a taxpayer has carried out corresponding or secondary adjustments.

Tax audits of German subsidiaries typically involve a review of the taxpayer’s compliance with formal requirements. This includes requesting written intercompany agreements; in particular, concerning loan, licence, and service arrangements. German tax auditors normally check the contracting parties’ adherence to the terms of their contracts.

In German TP audits, the intensity and level of aggressiveness have significantly increased over recent years. Nevertheless, German tax audits can still be successfully managed by avoiding international double taxation during the tax audit. Taxpayers are well advised to think strategically when responding to information requests concerning specific audit issues. They should also respond to audit findings lacking detailed legal analysis by presenting counter-arguments and negotiating with the tax auditors.

In the case of international double taxation, competent authority proceedings (or mutual agreement proceedings – MAPs) are a well-established instrument for resolving TP disputes in Germany, while tax court proceedings still remain the exception but are increasing. For instance, to eliminate international double taxation affecting limited-risk distributors, about 50% of companies surveyed last year have conducted MAPs to date. Bilateral advance pricing agreements (APAs) increasingly serve to prevent (ex ante) disputes in tax audits in Germany.

In Poland, there has been a continuous increase in the tax administration's focus on TP audits. Statistics indicate a 40% rise in new TP audits in 2023 compared with 2022. This surge in the number of TP audits is accompanied by their growing effectiveness, evidenced by an increasing number of tax assessments resulting from these audits.

Since 2019, tax authorities have been equipped with a powerful new tool, which they have been actively utilising to select taxpayers and transactions for TP audits. Although there was a slowdown due to the COVID pandemic, this tool has significantly enhanced the authorities' ability to scrutinise TP practices.

The selection of taxpayers for TP audits is now facilitated by the information on related-party transactions form (the TPR form), an obligatory reporting tool that has been imposed on taxpayers since 2019.

Filed annually, TPR forms provide detailed information on related-party transactions that are subject to TP documentation requirements. In essence, they offer a structured and standardised summary of each intercompany transaction. Most importantly, TPR forms include details on the transfer price of each intercompany transaction and its alignment with an arm’s-length pricing range derived from a comparability study, the results of which are also reported in the TPR form.

Additionally, taxpayers are required to disclose their overall profitability using selected profit level indicators, information on TP adjustments to the reported transactions, and more.

This comprehensive data is served almost on a silver platter to the tax administration. The combination of data from TPR forms, financial statements, and corporate income tax returns allows tax authorities to classify taxpayers and their transactions into risk groups, facilitating the selection process for TP audits.

Polish TP auditors are predominantly interested in:

• Goods transactions where the Polish entity operates as a limited-risk party;

• Service transactions where charges are imposed on the Polish entity from abroad (such as management fees); and

• Financial transactions, particularly the pricing of loans and guarantees.

Additionally, compliance with the arm's-length principle is frequently scrutinised in the context of withholding tax (WHT) audits, particularly concerning service charges, royalties, and interest payments. Auditors aim to demonstrate that reduced WHT rates are applicable only to payments made in line with the arm’s-length principle.

Fortunately, not many TP cases in Poland result in court proceedings. When they do, disputes are rarely about the merits of the case; instead, they often focus on the formalities of the tax audit process and the lack of sufficient evidence on either side. However, the increasing efficiency of tax authorities in conducting TP audits and their growing expertise may change this situation in the future.

In recent years, Spain has witnessed a notable increase in TP litigation, driven by heightened scrutiny by the Spanish tax authorities and the growing complexity of related-party transactions.

TP has become a central focus in tax audits, especially for multinational companies with Spanish subsidiaries, leading to a surge in cases subject to adjustments.

A key driver behind this increase in TP disputes is the specialisation of the Spanish Tax Agency through the National Office for International Taxation. The creation of dedicated teams solely focused on TP has significantly enhanced the agency’s expertise.

These specialised teams now conduct more thorough audits, challenging sophisticated TP policies and frequently resulting in significant adjustments.

Another major factor contributing to the rise in disputes is the growing body of Spanish case law on TP. Recent rulings have clarified the application of TP methods and the interpretation of the arm’s-length principle.

These legal precedents serve as critical reference points, guiding tax authorities and taxpayers in future disputes.

Some of the key areas under scrutiny by the Spanish tax authorities include:

• Recurring loss-making companies or activities;

• Financial intercompany transactions;

• The valuation of intragroup transfers or the assignment of assets, particularly intangible assets;

• Payments for royalties related to the licensing of intangibles or for intragroup services; and

• Business restructurings.

In addition, special attention is being given to cases:

• That may reveal a lack of declaration of income (for example, unrecognised or undervalued services provided, the licensing of intangible assets not being remunerated); or

• Where tax bases are eroded due to the set-up of structures abroad in which generated profits must be taxed in Spain.

Given this landscape, Spanish taxpayers must be proactive. Designing and implementing solid TP policies supported by strong documentation has become essential when facing TP tax audits.

This includes drafting formal TP compulsory documentation and collecting practical evidence – such as contracts, emails, and internal memos – to substantiate a taxpayer’s position during an audit.

An increasingly important instrument to avoid disputes in Spain is the use of APAs, which provide certainty by establishing agreed-upon TP methodologies and policies with tax authorities in advance. This is particularly valuable for complex issues, such as financial transactions and intangible asset valuations, which are often the focus of tax audits.

In conclusion, the rise in TP disputes in Spain is fuelled by increased regulatory focus, more sophisticated audits, and evolving legal precedents. Multinational companies must adapt by implementing well-documented TP policies and considering proactive strategies, such as APAs, to navigate the challenges posed by Spain’s evolving TP landscape.

In recent years, Sweden has experienced a relatively high frequency of TP audits, with a notable focus on intangible property (IP) and restructurings. In these cases, the Swedish Tax Agency (STA) has adjusted pricing by applying the accurate delineation of the actual transaction guidance.

For example, a Swedish company is acquired, and its IP is subsequently transferred to a foreign group entity, which then licenses it back to the Swedish company. In one such case, the sales price of the IP was taxed in Sweden, while a deduction for the royalty costs paid by the Swedish company to the new IP owner was denied. In another case, although the IP had not formally been transferred, an analysis of the activities of the Swedish and foreign companies led the STA to conclude that a transfer of the economic ownership had occurred. Consequently, a TP adjustment was made, corresponding to the value of the IP.

These audits and court procedures are time consuming and therefore costly for the taxpayers. They show the need to conduct a comprehensive development, enhancement, maintenance, protection, and exploitation analysis, together with a restructuring analysis, to fully support the chosen pricing structure. It is also important to consider the burden of proof, as a substantial amount of material is collected in these audits through various documents, interviews, and public information (e.g., details about employees on LinkedIn).

The possibility of making a statement in the tax return should also be evaluated, since the tax penalty on the additional tax is normally 40% in TP cases. A statement in the tax return could mitigate this risk. Applying for a bilateral APA to provide certainty should also be considered.

There are ongoing discussions regarding the application of the accurate delineation guidance and its conformity with Swedish legislation, as the Swedish ‘adjustment rule’ does not allow recharacterisations. These can only be achieved through another tax regime and in very limited situations. Consequently, the STA has refrained from recharacterising the legal definition of transactions, instead asserting that the adjustment is solely a price adjustment. This view has been challenged by advisers and taxpayers but accepted by the secondary courts. However, the issue has not been assessed by the Supreme Administrative Court (SAC).

A ruling from the SAC is desirable since it could increase legal certainty for taxpayers regarding the extent to which the accurate delineation of the actual transaction guidance is applicable. If the SAC deems that the guidance does not conform to Swedish legislation, the legal basis should be reviewed by the legislator, as differences in the application of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations between countries are not desirable.

For many years, TP was of minor importance in Switzerland, mainly because of the relatively favourable corporate income tax rates. Transfer prices were mainly reviewed with regard to outbound transactions with offshore jurisdictions. However, this has recently changed.

Increasingly, Swiss tax authorities, both federal regarding the Swiss WHT and cantonal regarding federal and cantonal/communal income taxes, are also scrutinising inbound transactions in Swiss tax audits, leading to more tax disputes and primary adjustments in Switzerland. This focus comes paired with a professionalisation of the Swiss tax authorities in TP theory and practice, and the publication of a TP paper and Q&A by the Swiss Federal Tax Administration (FTA) in early 2024. This section of the article sheds light on recent case law exemplifying this focus and provides an update on recent practice concerning profit repatriations after a MAP.

In a case concerning a transfer of functions ruled on by the Administrative Court of Zurich on October 4 2023, the cantonal tax authority had assumed a hidden profit distribution with reference to the downgrading and relocation of functions. From the taxpayer’s perspective, it was required to pay something for the liabilities transferred to the acquirer. No goodwill was considered on the transferred functions. Due to a lack of sufficient cooperation by the taxpayer, an estimate was made based on the share purchase price according to the Securities and Exchange Commission filing of the US acquirer (Form 10-K).

The court supported the correction by the cantonal tax authority. The case is legally effective. Thus, despite the lack of a legal requirement to prepare a master and local file in Switzerland, taxpayers should prepare a TP documentation file to be able to shift the burden of proof to the tax authority.

The FTA has amended its practice regarding profit repatriation in cases of primary adjustments that are partly or fully confirmed in a MAP. If a primary adjustment made by a Swiss cantonal tax administration is confirmed in whole or in part in the MAP, constituting a hidden profit distribution, the question of the secondary adjustment arises; i.e., the levying of Swiss WHT. The mutual agreement may provide for the taxpayer to repatriate the funds in the amount of the confirmed primary adjustment, generally within 60 days of the mutual agreement being concluded (however, the taxpayer is not automatically entitled to such clause).

If the taxpayer carries out this profit repatriation, the secondary adjustment will not be made; i.e., the FTA will not levy WHT on the amount of the adjustment confirmed by the MAP, which is relevant in case a residual WHT would still result based on the respective double taxation agreement.

Based on the above trends in TP disputes in several European countries, taxpayers are advised to ensure TP policies are well documented, aligned with the arm's-length principle, and backed by robust comparability studies. Especially for complex transactions such as a transfer of intangibles or financial transactions, the obtaining of upfront legal certainty via APAs should be considered.

Tax risks should be regularly assessed to anticipate scrutiny of the transactions and to properly prepare for audits.

During tax audits involving TP matters, taxpayers should strategically respond to requests by presenting strong counter-arguments with the support of TP specialists. In cases of (risks of) double taxation, MAPs could be initiated to resolve disputes effectively.