The case concerned the arm’s length nature of a royalty paid by a Luxembourg operating company (LuxOpCo) to a Luxembourg partnership (LuxSCS) – a tax transparent entity in Luxembourg – for the use of certain intangibles (technology, marketing-related intangibles and customer data).
In the 2003 tax ruling, the Luxembourg tax authorities had con rmed the arm’s length nature of the deductible royalty payments. The supporting transfer pricing analysis applied the transactional net margin method (TNMM), a one-sided transfer pricing method, with LuxOpCo as tested party. Hence, it determined an arm’s length remuneration for LuxOpCo and any business income in excess of that remuneration served to pay the royalty.
The Commission disagreed and considered that LuxOpCo’s tax base was unduly reduced. It relied on two lines of reasoning:
- Primary line: LuxSCS does not (and is not able to) perform any signi cant people function and bear any risk in relation to the intangibles. By contrast, LuxOpCo has numerous employees and operates Amazon’s EU business. Accordingly, LuxOpCo must be the entity entitled to the IP income and LuxSCS should just be entitled to recover its limited operating costs,
as well as the intangibles development costs it incurred on a pass-through basis; and
- Secondary line: even if LuxSCS were found to perform some signi cant people functions and bear some risks related to the intangibles, a pro t split would be more appropriate than using the TNMM transfer pricing method with LuxOpCo as tested party. Moreover, even if the TNMM with LuxOpCo as tested party were appropriate, LuxOpCo should earn a mark-up on the royalty expense. Finally, even if that were not required under transfer pricing rules, the fact that the 2003 ruling applied a ‘cap and a oor’ to LuxOpCo’s income (without such cap-and- oor mechanism being backed up by the transfer pricing analysis) also resulted in a selective advantage.
Motives for the annulment by the General Court
The General Court, after con rming that group companies may be taxed in accordance with the arm’s length principle, rejected all of these different lines of reasoning on the basis that the existence of a selective advantage was not demonstrated to the requisite standard:
- The functional analysis of the Commission wrongly depicted LuxSCS as merely a passive holder of intangibles, thereby ignoring the functions and risks borne by LuxSCS in exploiting them;
- The choice of LuxOpCo as tested party was also not wrong, given it was not easier to nd comparables for LuxSCS than for LuxOpCo;
- Furthermore, LuxSCS should not earn a mere reimbursement of the intangibles development costs, as such an approach ignores the posterior increase in value of the intangibles. Also, LuxSCS’s services were not low value-adding services; and
- The subsidiary lines relied on the same erroneous functional analysis (for the rst part) and did not show the requisite standard of evidence that the choice of the pro t level indicator or the application of the cap-and- oor mechanism reduced LuxOpCo’s tax base.
The Commission may appeal the judgment on matters of law before the Court of Justice. The Commission essentially lost on factual matters, which may complicate the appeal – it is likely that, just as in the Apple case, the debate around the burden of proof to demonstrate a selective advantage would be the main argument. For a further discussion of the impact of the Amazon case we refer to our news article.