By Aldo Engels, Senior Associate, Loyens & Loeff, Brussels
During the last decade, the Belgian tax authority has consistently ramped up its transfer pricing audit capacity and frequency. Audits are carried out by both a dedicated transfer pricing cell within the tax authority as well as by trained auditors within the large companies department and by transfer pricing specialists active with the special tax inspectorate focusing on combating tax evasion and fraud. In the Belgian government’s October 2021 budget agreement, it was decided to further increase the effectiveness of transfer pricing audits of MNEs by adding additional capacity to the transfer pricing cell, which was followed by a new wave of transfer pricing audits initiated in the beginning of 2022. In light of these developments, an overview is presented below of the state of play and of recently observed trends in the Belgian transfer pricing audit practice.
Usual audit process
Many Belgian entities that are part of a multinational group have already been confronted with the standard detailed questionnaire from the Belgian tax authority, which are consistently issued to initiate a transfer pricing audit as part of the annual audit wave. This standardized questionnaire includes numerous questions focusing particularly on the company’s organizational structure, supply chain, segmented P&Ls per business units, functional and risk profile, financial transactions, and transactions involving intangibles.
Instead of directly answering such a questionnaire, an audit is often preceded by an informal pre-audit meeting during which a presentation is given with respect to the company’s intercompany transactions. The exact perimeter of the responses to be given is agreed in advance. The first written response is then usually followed by additional information requests and meetings. Audits resulting in an adjustment ( about one-third of initiated audits) are most often closed by concluding a settlement agreement.
New practices
The tax authority’s launch of the 2022 audit wave was accompanied by certain interesting changes to the transfer pricing cell’s standard approach.
First, rather than sending the standardized questionnaire, the Belgian tax authority now initiates the audit through a request to hold a pre-audit meeting (which was only optional in the past). As mentioned above, a pre-audit meeting allows the tax authority to gain some preliminary insights into how the company operates within the group and how the transfer pricing policies are applied. Such a meeting may be accompanied by an on-site visit. A pre-audit meeting is then followed by a more customized questionnaire, which notably refers to information available to the tax authority as included in the transfer pricing documentation (local file and master file) and country-by-country report, which the taxpayer already submitted. Asking tailor-made questions focusing on relevant specific topics rather than issuing lengthy broad questionnaires requiring significant resources to appropriately answer, is expected to increase the efficiency and effectiveness of the audits.
A second development concerns the announcement the Belgian Minister of Finance recently made regarding his ambition to double the capacity of the Belgian transfer pricing cell. In this respect, a series of experienced tax practitioners are being hired to strengthen the audit capacity with proper training on various technical topics of interest. Further investments are also contemplated in improved data mining techniques to select the taxpayers subject to audit (see below). This all implies an expected further increase in the number of audits accompanied by a less settlement-minded attitude as already observed in the market.
Selection of taxpayers
Companies can be selected for a transfer pricing audit based on the outcome of a software-based risk assessment analysis. The criteria used for such an analysis are confidential. Nevertheless, based on older circular letters, the relevant criteria will likely relate to structurally loss-making, declining, or highly volatile results, involvement in business restructurings (either indicated in the local file, derived from published accounts and/or publicly available information), as well as a presence in or payments to tax havens or low-tax-rate jurisdictions. Next to this, noncompliance with transfer pricing documentation obligations may also significantly increase the probability of becoming subject to an audit.
Transfer pricing topics audited
During such an audit, the Belgian tax authority investigates a broad range of topics, and notably tends to focus on the reconciliation between the transfer pricing policy and annual accounts, the reason and origin of losses, the allocation of synergies with respect to procurement activities, and the arm’s length character of intragroup service fees, including the cost base in a cost plus remuneration.
The fact that a taxpayer has obtained an advance ruling confirming the arm’s length character of its transfer pricing policies (which is frequently opted for in Belgium given the well-established ruling practice) has the advantage to narrow down the scope of a transfer pricing audit. In such a case, the tax authority will focus on examining whether the facts and circumstances underlying the ruling did not change and whether the transfer pricing policy as confirmed by the ruling has been correctly implemented in practice.
Financial transactions
In addition, particular focus is given to intragroup financial transactions. In this respect, based on recent experience, the tax authority carefully evaluates the applied interest rate to remunerate the financing and further tends to scrutinize the arm’s length character of a company’s intragroup debt level. Indeed, the delineation of a purported loan for transfer pricing purposes and the arm’s length debt level of a company is becoming increasingly part of the tax authority’s overall analysis, by making use of sector-based financial ratios found in databases and the financing at group level to assess how a company would be financed on an arm’s length basis. The tax authority further looks into the arm’s length character of cash pool arrangements; in particular, the appropriate allocation of cash pool benefits and the reclassification of structural cash pool deposit or borrowing in a term loan. In this respect, the tax authority takes the view that if during a twelve-month period, a participant has held a given amount as a deposit or as borrowing, such an amount can no longer be priced as a cash pool transaction but should be priced as a loan.
Burden of proof
In case the tax authority wishes to perform an upwards adjustment, it should prove that the taxpayer has granted a non-arm’s length benefit, which means that it should be established that a normal taxpayer placed in the same economic circumstances would not have granted such a benefit to an independent third party. The burden of proof lies with the Belgian tax authority, which should establish that the parties agreed on a price for a given transaction that is lower or higher than the price that would have been agreed to between independent companies.
Transfer pricing case law has learned that the Belgian tax authority should not take this burden lightly. Indeed, case law ruled that it is up to the tax authority to demonstrate that the transfer pricing method the taxpayer used is not appropriate or that the taxpayer misapplied it. Where more than one method is available to establish an arm’s length price, the tax authority may not conclude that there is a non-arm’s length benefit based on a different price or valuation achieved by applying another method, if it appears that the method the taxpayer applied is appropriate and has been correctly applied. In other words, the mere fact that the Belgian tax authority arrives at a different price by applying another method does not demonstrate the abnormal nature of the price the taxpayer applied. Furthermore, case law ruled that simply referring to the OECD transfer pricing guidelines to support that another method is more appropriate (e.g. because the OECD guidelines provide that the cost plus method may be appropriate to remunerate contract manufacturing or the provision of services) is not sufficient to meet the burden of proof. The tax authority should provide evidence for the fact that the applied method does not result in an arm’s length outcome and properly substantiate the application of an alternative transfer pricing method (by delivering supporting pieces evidencing the prices applied in comparable uncontrolled transactions).
Cash tax
It is further noteworthy that a transfer pricing adjustment in Belgium may result in unexpected cash tax effects.
Indeed, since 2018, upwards adjustments accompanied by a tax increase of at least 10% will constitute the taxpayer’s minimum taxable base to which no losses or other tax attributes may be offset. Thus, following this change in law, the amount of a transfer pricing adjustment will in each case be effectively subject to corporate tax, notwithstanding the tax position of the taxpayer.
Next to this, a particularity in Belgian tax law is that Belgian taxpayers are also taxable on the amount of the so-called received abnormal or benevolent advantages (i.e. when the Belgian company is being granted a non-arm’s length benefit). The amount of such advantage received will also constitute taxpayer’s minimum taxable basis which cannot be compensated with losses. This comes down to the BTA taxing transactions which are to the benefit of Belgian taxpayer.
Hence, particular attention should be given to applying the correct pricing with respect to transactions involving Belgian taxpayers as transfer pricing adjustments can be made in both ways (when the price the Belgian taxpayer charges is either too high or too low).
Takeaways and tips
Belgian companies can prepare for a transfer pricing audit by preparing solid supportive documentation for the arm’s length character of intercompany transactions and proactively reviewing their transfer pricing policy to identify any risks and weaknesses. As regards financial transactions, attention should be given to compliance of the applicable policy with the latest OECD guidance, notably regarding accurate delineation, and to avoiding structural cash pool deposits by periodically monitoring outstanding positions.
Should a taxpayer be selected for an audit, due consideration should be given to appropriately responding to the information requests. Careful preparation for the pre-audit meeting is essential as the meeting will have an impact on the entire audit process. Experience learns that providing a clear overview of the facts and the relevant terms of the intercompany transactions from the start is beneficial to the efficient and smooth running of the audit and may enable the scope of the customized transfer pricing audit questionnaire to be narrowed down. A constructive attitude while keeping an eye on the legal boundaries of information requests and the burden of proof principles is the key to an effective audit process.
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Aldo Engels is a senior associate at Loyens & Loeff in Brussels.
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