Invoicing between associated companies for Dummies.
Imagine that situation. You own two companies. One is based in Belgium and the other is based in the UK. However you noted that the taxation in Belgium is higher than in the UK and you would appreciate to transfer the Belgian taxable base to the UK by invoicing the Belgian company by the UK company.
That kind of situation falls under the Convention (90/463/EEC) on the elimination of double taxation in connection with the adjustment of profits of associated enterprises (The “EU Convention”).
Article 4 of this Convention provides that it is applicable in the situation where :
- an enterprise of a Contracting State participates directly or indirectly in the management, control or capital of an enterprise of another Contracting State
- the same persons participate directly or indirectly in the management, control or capital of an enterprise of one Contracting State and an enterprise of another Contracting State,
and in either case conditions are made or imposed between the two enterprises in their commercial or financial relations which differ form those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly.
Where an enterprise of a Contracting State carries on business in another Contracting State through a permanent establishment situated therein, there shall be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment.”
The goal of this EU Convention is to respect the principle “at arm’s length”. The application of these principles can result in double taxation (double taxation in the case of distinct companies). The company whose profits have recovered in a Contracting State will be taxed on profits on which an associate, the head office or other establishment in another Contracting State will normally have already been imposed. It is this double taxation as the EU Convention intends to eliminate .
The other source of the Law to analyze is the Convention for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income (the “Tax Convention”).
Article 9 of this Convention provides (with very similar words than the EU Convention) for:
- an enterprise of a Contracting State participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State, or
- the same persons participate directly or indirectly in the management, control or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State,
and in either case conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any income, deductions, receipts or outgoings which would, but for those conditions, have been attributed to one of the enterprises, but, by reason of those conditions, have not been so attributed, may be included in the profits or losses of that enterprise and taxed accordingly.
Where a Contracting State includes in the profits of an enterprise of that State – and taxes accordingly – profits on which an enterprise of the other Contracting State has been charged to tax in that other State and the items so included comprise income, deductions, receipts or outgoings which would have been attributed to the enterprise of the first-mentioned State if the conditions made between the two enterprises had been those which would have been made between independent enterprises, then the competent authorities of the Contracting States may consult together with a view to reaching an agreement on the adjustment of profits or losses in both Contracting States.
If the taxpayer is apparently trying to set its transfer prices at arm’s length and possesses supportive documents, the tax administration could a priori consider that the transfer pricing in question presents a low risk of tax evasion. The administration will therefore conduct a less thorough examination of the practices of multinationals regarding transfer pricing. On the contrary, a taxpayer who provides vague explanations, incorrect or unsubstantiated of its transfer pricing practices, should be subject to special care and attention. The taxpayer has therefore an incentive to provide for a wide and relevant documentation to support its transfer pricing policies.
The application of the “at arm’s length principle” mostly relies on a comparison between the conditions applied for transactions between associated enterprises and those practiced for the same transactions between independent contractors. The characteristics of the transaction that took place between associated enterprises have first to be determined. This analysis provides the basis to search for comparable transactions. This is the starting point for any inquiry regarding transfer pricing .
In a nutshell, setting a price similar to that of another independent company contracting with the Belgian company and proving the reality of the transaction and the justification of its amount are key.