Spanish Supreme Court upholds tax penalties for not complying with the arm’s length principle

By Pilar Barriguete & Edland Graci, Duff & Phelps, Spain

On May 18, Spain’s Supreme Court resolved an appeal presented by an individual, D. Ricardo, against a transfer pricing adjustment imposed by the tax authorities related to intercompany transactions carried out during fiscal years 2007 to 2009.

This verdict is relevant to multinational taxpayers because it establishes case law related to the applicability of the specific penalty regime for intercompany transactions in Spain.

According to the presented facts, D. Ricardo, a well-known media figure in Spain, was the shareholder and sole administrator of a company dedicated to communication and marketing services in Spain.

All of the services provided by the company were related to professional activities in which D. Ricardo performed essentially all services, bore all risks, and contributed all valuable assets. The company remunerated D. Ricardo for the services provided and the use of his image rights as a TV presenter.

Based on Spanish corporate income tax law, the parties are considered related, and hence their transactions must be remunerated at arm’s length.

On February 28, 2012, the Spanish tax authorities started a tax audit to verify that the related party transactions complied with the transfer pricing rules.

As a result of the audit, an adjustment to the taxable base was proposed presuming that D. Ricardo had not been remunerated consistent with his contribution to the business. By analyzing the functions performed by the company aside from those of D. Ricardo, it was concluded that the company did not contributed any added value beyond that of the assumption of certain expenses.

D. Ricardo performed all essential services and assumed the main risks and contributed the main asset (his own qualities as a TV presenter). In the end, the tax authorities asserted an adjusted comparable uncontrolled price (CUP), starting from the income of the company and subtracting the reasonable expenses.

In addition, the tax authorities imposed a fine on D. Ricardo by applying the general sanctioning regime of the general tax law, specifically the conduct typified in article 191 consisting in failing to deposit the tax debt within the established term.

As a consequence, the taxpayer appealed the decision of the administration related to the fine up to the highest level. According to the taxpayer, there is a specific penalty regime in transfer pricing found in article 16.10 of the Spanish income tax law that should have been applicable rather than the general sanctioning regime.

 Additionally, he maintains that since he and the company do not exceed the limits established therein to prepare specific transfer pricing documentation (250,000 euro of total volume of intercompany transactions between related parties), there is no breach of the obligation to document; thus, his conduct should not be punishable for any reason, neither in accordance with article 16.10 of the Spanish income tax law nor by article 191 of the general sanctioning regime.

According to the Supreme Court, such a conflict between the two rules cannot exist when a certain sanctioning regime is not applicable.

At no point throughout the tax audit proceedings was it argued that the taxpayer or the company were obligated to document related party transactions, either because this obligation had not yet been developed by regulations (as occurred for the fiscal years 2007 and 2008), or because the limits that make it compulsory were not met (as occurred for the fiscal year 2009). The taxpayer’s argument was not sustained by the court, as it found that the sanctioning regime of article 16.10 of the Spanish income tax law could not be applied to those who could not breach it.

Consequently, the Supreme Court concluded that article 191 of the general sanctioning regime was applied appropriately with the principles established in the Spanish legal system.

Furthermore, according to the Supreme Court the exclusion of liability provided for in article 16.10 of the Spanish income tax law will be applicable only when the following three circumstances are present:

1. the formal obligation to keep the transfer pricing documentation has not been breached by the taxpayer;
2. that the value declared by the taxpayer on the income statement coincides with that stated in the transfer pricing documentation; and
3. that, despite the existence of the documentation, the arm’s length value that has been attributed to the intercompany transactions is incorrect and an adjustment has been made by the tax administration.

If all of these circumstances are present, the conduct of the taxpayer will not be punishable either under the specific transfer pricing sanctioning regime contained in art. 16.10 of the Spanish income tax law, or under the general sanctioning regime.

Conclusions

This Supreme Court decision creates case law defining the limits of the application of the specific penalty regime for intercompany transactions in Spain and clarifies the obligation of the taxpayer to comply with the arm’s length principle even when no documentation obligation exists.

Furthermore, this case further underlines the obligation of a shareholder to be remunerated by their companies in a way that is consistent with the arm’s-length standard, especially where the shareholder is the sole service provider and assumes the core functions and risks of the business.