By Brian Leonard

Spain’s National Court has issued a decision that provides guidance on the type and extent of evidence necessary to demonstrate that management support services have been provided by one member of a multinational group to other members and in establishing that the fees for the services were arm’s length (Appeal No. 623/2004). The taxpayer in the case was denied a deduction for the management fees because it failed to produce sufficient evidence.

Facts

The case involved corporate tax assessments issued by the Spanish tax authorities (for the years 1996-1999) increasing the tax base reported by the taxpayer company (a subsidiary of a French group) to include services and allocated costs associated with related party transactions between companies of the group.

According to background information contained in the National Court’s decision, during the inspection period, the taxpayer provided scant documentation on the actual services rendered and did not even file pleadings against the proposed tax assessment, preferring to contest it directly before the Central Economic-Administrative Tribunal.

The only matter at issue in the appeal to the National Court was whether expenses charged as management fees between related companies should be considered deductible. Both the tax authorities and the Central Economic-Administrative Tribunal concluded the expenses were nondeductible because of the taxpayer’s failure to produce evidence that the services actually were provided and that the amounts charged were at arm’s length.

Decision of the Court

In its decision, the National Court first reiterated that according to jurisprudence relating to the production of evidence, “all parties asserting their rights must submit evidence of the facts constituting such rights.”

Evidence submitted by the taxpayer’s at various stages of the proceedings basically consisted of the following:

• Documentation relating to attendance at meetings organized by the French parent company at which the group’s position was analyzed. According to the taxpayer, attendance at the meetings demonstrated the existence of coordination and centralization of criteria at a corporate level, to the benefit of the subsidiary.
• A report, in English and French, prepared by a multinational firm on the allocation of the expenses relating to the services, offering a reasonable and reasoned methodology for allocation of management support costs to foreign subsidiaries.
• A series of personal declarations by the heads of the departments involved in the services, confirming that the services were effectively provided and presenting an overview of the activities performed.
• A sworn declaration by the finance director of the French parent company, relating to the allocation of general head office expenses, and a sworn declaration of the director of the legal department, relating to the business years at issue in connection with the amounts charged for the services.
• Other documents of the Group Deputy Chairman for Southern Europe on the expenses charged by the group to the Spanish subsidiary.

With respect to the private consultancy report, the National Court stated that, not only was it commissioned by the interested party but, as the report was drafted in English, it failed to comply with article 144 of the Civil Procedure Law, which provides that all documents written in any language other than Spanish or, where appropriate, the official language of the corresponding autonomous community, must be accompanied by a translation.

The Court then held that, although the other documentation met the formal requirements (i.e. translations, etc.), it lacked the necessary impartiality and objectivity to be admitted as objective evidence.

On the issue of whether the taxpayer demonstrated that the amounts charged could be justified, the Court noted the contract provided that the management fees were to be calculated as a percentage of sales of the Spanish company, but that, in fact, the actual amount charged was different. The taxpayer company contended that the costs were originally to be calculated as a percentage of sales, but were, in fact calculated based on actual costs incurred by the French parent. However, the taxpayer did not produce any evidence to support that the expenses were actually incurred by the French company, so the Court concluded there was no direct link between the amounts paid and the benefit obtained.

The Court concluded that, on the basis of the background information and documents presented, there was insufficient proof for the expenses to be considered deductible.

Comments

This decision should be taken into account when taxpayers compile evidence of the existence of intragroup services, which should not be based exclusively on internal reports and documents. It is not apparent from the decision that there should be any additional effort on the taxpayer’s part to provide evidence other than that indicated.

A taxpayer must be able to demonstrate that intragroup services actually have been rendered. Once the tax authorities accept that the services have been provided, it must be determined whether the pricing of the services complies with the transfer pricing rules.

The tax authorities are scrutinizing such transactions much more closely, often concluding that the services were not actually rendered, and thus not having to analyze whether the amounts charged for the services meet the arm’s length principle. Accordingly, taxpayers must make greater efforts to demonstrate the reality of intragroup services, and hence their deductibility.

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