In a landmark decision, the Irish Tax Appeals Commission ("TAC"), have delivered their determination in the first ever transfer pricing case to be heard in Ireland (59TACD2024).1 Matheson represented the taxpayer in this case.
This decision is undoubtedly ground-breaking in an Irish context, given it is the first of its kind in this jurisdiction. This decision of the TAC will also have a wide-ranging impact beyond these shores, and in particular, for publicly listed multinational groups that offer stock / equity incentives to employees of their subsidiaries and don't have recharge arrangements in place between the parent entity and lower tier subsidiaries. We expect that this decision will be of great interest to multinational taxpayers and the international tax community in general.
Stock based awards - inclusion in cost base
The primary issue which fell to be decided was whether a service fee which was based on the transactional net margin method ("TNMM") was an arm's length amount in the circumstances. The Irish Revenue Commissioners ("Revenue") raised assessments on the basis that an Irish company which provided certain services to its US parent company, had not included in its marked up cost base, the value of certain stock based awards (SBAs) which had been provided by the US parent company directly to employees of the Irish subsidiary. Revenue pointed to the audited financial statements of the Irish company and concluded that amounts representing the equity incentives in the Irish company's financial statements had to be included in the cost base, even though the Irish company did not incur any actual costs for the provision of those incentives to its employees by the US parent. Revenue therefore argued that the appellant's revenues were understated to the extent of the accounting costs of the SBAs (plus the mark up on those costs) with no corresponding notional deduction.
Economic Cost vs Accounting Expense
In a comprehensive, 145 page determination, the TAC ruled in favour of the taxpayer in granting the appeal and overturning the assessments. In reaching the decision, the Commissioner looked to whether the issuance of SBAs by the US parent company to Irish based employees of its Irish subsidiary created an economic cost for that Irish subsidiary. The Commissioner relied on OECD Guidance and determined that one must look to the functional analysis and not the financial statements of the Irish company to determine if an economic cost arose. In this context, the Commissioner concluded, based on detailed evidence and a robust functional analysis of the respective parties, that the US parent had not only borne the risk of providing the SBAs, but had deployed the relevant assets and also performed all of the necessary functions to administer the plan. The Commissioner favoured the OECD functional analysis approach over deferring to the accounting treatment, as the accounting treatment is "blind to the question of who bears the legal and economic risk."
While the Commissioner accepted that the correct accounting treatment was applied (under FRS 102), the accounting treatment did not deal with the key question (from a transfer pricing perspective) of who bore the legal and economic risk and who should be entitled to earn the profits referable to this cost, in accordance with the OECD guidelines. The Commissioner went on to note that the SBAs should be considered to be "notional costs in the accounts of the Appellant" and that the "arm's length principle required that they are excluded from the Appellant's cost base in providing the services to the parent company under the services agreement."
It should be noted that Revenue did not challenge the use of TNMM as the most appropriate pricing methodology in the circumstances and also agreed that the margin applied in each of the taxable periods was within an appropriate arm's length range. As a result, the Commissioner concluded that Revenue's dissatisfaction with aspects of the comparability analysis was irrelevant in these circumstances, as the parties were in agreement on the appropriate arm's length margin to apply and a comparability analysis was only relevant in that context. In other words, where a taxpayers results fall within an appropriate arm's length range, a transfer pricing adjustment should not be required.
Time Limits
A separate time limit issue arose in the context of one of the years assessed by Revenue. Irish tax laws generally preclude Revenue from raising an assessment outside of a four year window, unless certain exceptional circumstances arise. One such exception is where tax officials are not satisfied with the "sufficiency of the return". In this case, this somewhat newer concept in Irish legislation was considered.
Revenue's basis for opening up an "out of time" year was that, in their view, the return was not sufficient on the basis that the transfer pricing documentation which supported the tax return may not have been correct, due to what they perceived as inconsistencies in the comparability analysis. The Commissioner, citing a long line of case law on statutory time limits, ruled that "insufficiency" in the context of a tax return could not equate to what a Revenue official in his or her opinion considers to be "incorrect". It should also be noted that while the comparability analysis and transfer pricing documentation must now be prepared on a contemporaneous basis and no later than the date on which a tax return is due, there is no obligation to file such pricing documents when a tax return is filed in Ireland.
Other Secondary Issues
A number of other important issues arose and were considered in the context of the proceedings which were relevant and influential in the overall determination, including the admissibility of expert witness testimony from economists which referred to OECD rules on the application of economic principles in a transfer pricing context. Revenue had sought to argue that this evidence was inadmissible, on the basis that such evidence constituted legal submissions as the OECD guidance forms part of Irish transfer pricing laws. In Irish judicial proceedings (including in TAC cases), legal submissions which relate to Irish laws can only be made by counsel and not expert witnesses. However, the TAC adopted a practical approach and determined that it would hear all of the evidence and exclude anything which the Commissioner considered to be a legal submission.
Significance of Decision
The decision marks a counterview to the Israeli case of Kontera2 which has been cited by a number of tax authorities in recent times (including Revenue in this case), as an authority that stock based compensation should be included in the cost base of service companies that do not actually incur any costs in relation to those equity awards. The comprehensive nature of the TAC determination and the fact that it is firmly grounded in OECD principles, rather than purely domestic rules, means that it should also serve as a helpful international precedent.
Footnotes
1. https://www.taxappeals.ie/en/determinations
2. Israel vs Kontera and Finisar, April 2018, Supreme Court, Case No. 943/16
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