Stora Enso Wood Products vs Czechia

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Case Information

• Court: Supreme Administrative Court of the Czechia
• Case No: 7 Afs 358/2021 – 36
• Applicant: Stora Enso Wood Products Żdírec s.r.o.
• Defendant: Odvolací finanční ředitelství
• Judgment Date: 25 August 2023

Judgment Summary

The Supreme Administrative Court (SACC) of the Czech Republic annulled the judgment of the Regional Court in Hradec Králové, which had previously annulled the tax assessmentA tax assessment is a formal determination made by a tax authority to calculate the amount of tax an individual or entity owes. It is a comprehensive evaluation based on financial records, declared income, expenses, deductions, and any applicable tax laws or regulations. Tax assessments may arise from routine self-assessments by taxpayers, or they may be conducted by revenue authorities... decision of the Odvolací finanční ředitelství against Stora Enso Wood Products Ždírec s.r.o. The case was returned to the Regional Court for further proceedings. The primary issue was the misapplication of Section 23(7) of the Income TaxIncome Tax is a direct levy imposed by governments on the income generated by individuals, corporations, and other entities within a specific jurisdiction. It serves as a major source of revenue for governments and funds various public expenditures, such as infrastructure projects, healthcare, education, national security, and welfare programs. The tax is generally calculated as a percentage of the taxable... Act to transactions between Stora Enso and unrelated parties.

Key Points of the Judgment

Background

Stora Enso Wood Products Żdírec s.r.o. (the applicant) is part of the global Stora Enso group, which operates in the fields of packaging, biomaterials, wood products, and paper. For the 2012 tax year, the Czech tax authorities conducted an audit focusing on transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... between the applicant and its parent company, Stora Enso Wood Products GmbH (SEWP). The tax authorities concluded that the applicant did not act as an independent entity but rather as a producer with limited functions and risks, heavily influenced by its parent company.

Core Dispute

The core dispute revolved around the application of Section 23(7) of the Czech Income TaxIncome Tax is a direct levy imposed by governments on the income generated by individuals, corporations, and other entities within a specific jurisdiction. It serves as a major source of revenue for governments and funds various public expenditures, such as infrastructure projects, healthcare, education, national security, and welfare programs. The tax is generally calculated as a percentage of the taxable... Act, which pertains to transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... between related parties. The tax authorities adjusted the applicant’s tax baseThe tax base is a fundamental concept in taxation, representing the total amount of economic activity or assets upon which a tax is levied. It is the foundation upon which governments calculate the amount of tax owed, based on factors like income, property value, sales, or corporate profits. Understanding the tax base is essential for tax professionals, businesses, and policymakers,..., arguing that the prices set between the applicant and its parent company were not in accordance with the arm’s length principle. The applicant contested this adjustment, arguing that the tax authorities incorrectly applied the provision to transactions with unrelated third parties.

Court Findings

1. Application of Section 23(7): The SACC found that the tax authorities correctly applied Section 23(7) of the Income TaxIncome Tax is a direct levy imposed by governments on the income generated by individuals, corporations, and other entities within a specific jurisdiction. It serves as a major source of revenue for governments and funds various public expenditures, such as infrastructure projects, healthcare, education, national security, and welfare programs. The tax is generally calculated as a percentage of the taxable... Act to the relationship between the applicant and its parent company, SEWP, and not to transactions with unrelated third parties.
2. Influence of Parent Company: The court acknowledged that the applicant’s operations were significantly influenced by the parent company, which directed the production and sales activities, leading to transactions below operating costs without appropriate compensation.
3. Legal Misinterpretation by Regional Court: The Regional Court had erred in its interpretation by suggesting that the tax authorities applied the provision to unrelated third-party transactions.

Outcome

The SACC annulled the judgment of the Regional Court and remanded the case for further proceedings, instructing the Regional Court to reassess the case in line with the legal interpretation provided by the SACC.

Transfer Pricing Method Used

The tax authorities used the Net Margin Method (NMM) to determine the arm’s length price for the transactions between the applicant and its parent company. This method involves comparing the net profit margin of the controlled transaction to that of comparable independent transactions.

Significance of Intra-Group Losses

Intra-group losses were significant in this case as the applicant was selling products below operating costs due to the influence of its parent company. The tax authorities argued that this resulted in a loss that should have been compensated by the parent company to ensure the transactions were at arm’s length.

The case highlighted the importance of properly documenting and compensating intra-group losses to adhere to the arm’s length principle. The lack of adequate compensation for loss-making transactions with the parent company SEWP was a critical issue.

Major Issues or Areas of Contention

1. Application of Transfer PricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... Rules: Whether Section 23(7) of the Income TaxIncome Tax is a direct levy imposed by governments on the income generated by individuals, corporations, and other entities within a specific jurisdiction. It serves as a major source of revenue for governments and funds various public expenditures, such as infrastructure projects, healthcare, education, national security, and welfare programs. The tax is generally calculated as a percentage of the taxable... Act was correctly applied to the transactions between the applicant and its parent company.
2. Role of Unrelated Third Parties: The Regional Court’s misinterpretation that the tax authorities applied the transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... rules to transactions with unrelated third parties.
3. Compensation for Losses: The lack of compensation from the parent company for the losses incurred by the applicant due to below-cost sales.

Expected or Controversial Decision

The decision was somewhat controversial due to the complexity of transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... rules and the initial misinterpretation by the Regional Court. The controversy stemmed from the application of transfer pricing adjustmentsTransfer Pricing Adjustments are modifications made to the pricing of transactions between related entities within a multinational enterprise (MNE) by tax authorities or the MNE itself. These adjustments are carried out to ensure compliance with the arm’s length principle, which stipulates that prices for intercompany transactions should reflect what independent parties would have agreed upon under similar circumstances. The arm’s... and the influence of the parent company on the applicant’s operations.

Significance for Multinationals and Revenue Services

This case highlights the importance of adhering to transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... regulations and ensuring that intra-group transactionsIntra-Group Transactions are interactions between entities within the same multinational enterprise (MNE). Such transactions form the backbone of related-party dealings and are essential in managing global operations and aligning business objectives across jurisdictions. Understanding intra-group transactions is critical in international tax and transfer pricing, as they directly impact a company's tax obligations, profitability, and compliance standing. Tax professionals, accountants, lawyers,... are conducted at arm’s length. For multinationals, it underscores the need for proper documentation and justification of transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... practices. For revenue services, it emphasizes the necessity of thorough audits and clear legal interpretations to avoid misapplications of tax lawsTax laws form the backbone of any nation’s revenue system, setting the rules that govern how individuals and corporations contribute financially to support government functions. These laws define the types of taxes, the applicable rates, and the regulations regarding payment and compliance. They also outline the rights and obligations of taxpayers, ensuring a balanced and fair approach to funding public....

Value of Transfer Pricing Expertise

Transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... expertise is invaluable in ensuring compliance with tax regulationsTax laws form the backbone of any nation’s revenue system, setting the rules that govern how individuals and corporations contribute financially to support government functions. These laws define the types of taxes, the applicable rates, and the regulations regarding payment and compliance. They also outline the rights and obligations of taxpayers, ensuring a balanced and fair approach to funding public..., minimizing disputes, and providing robust documentation to support transfer pricing policiesTransfer Pricing Policies refer to the rules and methods established by multinational enterprises (MNEs) to determine the pricing of transactions between related parties, such as subsidiaries or divisions of the same company. These transactions may involve the transfer of goods, services, intellectual property, or financial arrangements. Transfer pricing policies are essential for ensuring that intercompany transactions adhere to the arm’s.... Expert advice can help multinationals navigate complex tax lawsTax laws form the backbone of any nation’s revenue system, setting the rules that govern how individuals and corporations contribute financially to support government functions. These laws define the types of taxes, the applicable rates, and the regulations regarding payment and compliance. They also outline the rights and obligations of taxpayers, ensuring a balanced and fair approach to funding public... and avoid costly adjustments and penalties.

Preventative Measures for Better Management

To avoid similar disputes, companies should implement a robust tax risk managementTax risk management is a structured process used by organizations, particularly multinational enterprises (MNEs), to identify, assess, and mitigate potential risks that arise in relation to tax compliance, reporting, and planning. It plays a crucial role in ensuring that a company’s tax obligations are managed in a way that minimizes risk exposure while maximizing efficiency and strategic value. process, including:

• Tax Steering CommitteeA Tax Steering Committee is a specialised governance group within an organisation responsible for overseeing and guiding the company’s tax strategy and operations. It typically includes senior executives such as the Chief Financial Officer (CFO), Head of Tax, General Counsel, and external tax advisors or auditors. In multinational corporations (MNCs), this committee becomes particularly crucial, given the complex tax environment...: Establishing a tax steering committeeA Tax Steering Committee is a specialised governance group within an organisation responsible for overseeing and guiding the company’s tax strategy and operations. It typically includes senior executives such as the Chief Financial Officer (CFO), Head of Tax, General Counsel, and external tax advisors or auditors. In multinational corporations (MNCs), this committee becomes particularly crucial, given the complex tax environment... to oversee tax strategy and compliance. Click here to download our FREE eBook: THE ESSENTIAL ROLE OF THE TAX STEERING COMMITTEE.
• Documentation: Maintaining comprehensive and accurate documentation of transfer pricing policiesTransfer Pricing Policies refer to the rules and methods established by multinational enterprises (MNEs) to determine the pricing of transactions between related parties, such as subsidiaries or divisions of the same company. These transactions may involve the transfer of goods, services, intellectual property, or financial arrangements. Transfer pricing policies are essential for ensuring that intercompany transactions adhere to the arm’s... and transactions.
• Regular Audits: Conducting regular internal audits to ensure compliance with transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... regulations.
• Training: Providing ongoing training for staff on transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... rules and best practices.