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global tax insight, issue 3 | spain 05 Dec 2017 The latest relevant Spanish case law on transfer pricing

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According to recent jurisprudence of the Spanish Supreme Court, the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration are merely recommendations and have no binding value for the Spanish courts, not even when a tax treaty provision is interpreted by the courts.

The practical effects deriving from the above-mentioned jurisprudence of the Spanish Supreme Court result in a minimisation of the interpretative value of the aforementioned Guidelines.

The Spanish National High Court has refused to carry out a "dynamic interpretation" of Article 7(2) of the tax treaty for the avoidance of double taxation between Spain and the Netherlands (dating from 1971), when it comes to the attribution of profits to permanent establishments.

This article aims to highlight the most relevant rulings issued recently by the Spanish courts in relation to a matter as broad and complex as transfer pricing.

We will begin by noting that the Spanish Supreme Court (Tribunal Supremo) has recently issued several judgments that all follow similar reasoning regarding the interpretative value of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration (hereinafter the "OECD Transfer Pricing Guidelines").

In all these judgments the Spanish Supreme Court has concluded that the aforementioned Guidelines are merely recommendations that bind the Tax Administration, but not the courts. This statement implies minimising the interpretive value of the OECD Transfer Pricing Guidelines, which is of serious concern to the Spanish Tax Administration.

The first judgment dated 19 October 2016, was issued in the Zeraim case (hereinafter the "Zeraim Judgment"), in which the appellant company denounces the infringement of the OECD Transfer Pricing Guidelines, to the extent that secret comparables have been used in determining the market value of certain related transactions consisting of acquisitions of raw materials by the recurring company to its Dutch parent company.

Regarding secret comparables, we should remember that the OECD Transfer Pricing Guidelines state that information undisclosed to taxpayers may not be used by the Tax Authorities in order to calculate the arm's length price for their related transactions. Thus, paragraph 3.36 of the OECD Transfer Pricing Guidelines, which is included in Chapter III, titled "Comparability Analysis" (which is included in Chapter III, titled "Comparative Analysis) states that: "Tax administrators may have information available to them from examinations of other taxpayers or from other sources of information that may not be disclosed to the taxpayer. However, it would be unfair to apply a transfer pricing method on the basis of such data unless the Tax Administration was able, within the limits of its domestic confidentiality requirements, to disclose such data to the taxpayer so that there would be an adequate opportunity for the taxpayer to defend its own position and to safeguard effective judicial control by the courts."

In the Zeraim Judgment it is expressly stated that the offence invoked before the Spanish Supreme Court must fall on the rules of the legal system, that is, on the formal sources that comprise it and which are enunciated in Article 1.1 of the Spanish Civil Code, according to which "the sources of the Spanish legal system are the law, custom and general principles of law". The Spanish Supreme Court points out that within the substantive concept of "law" expressed in the aforementioned provision, it is possible to include the various, hierarchically ordered, manifestations of the regulatory power (Constitution, International Treaties, Organic Law, Ordinary Law, Regulations, etc.), but it is not possible to substantiate a plea in breach of the above-mentioned OECD Transfer Pricing Guidelines, given the lack of its legal nature. The Court also points out that in previous judgments (e.g. a judgment dated 18 July 2012, issued by the Spanish Supreme Court in the BICC case), it had already concluded that such Guidelines are considered to be merely recommendations to States, which are given an interpretative value.

In another judgment dated 21 February 2017, issued in the Citresa case (hereinafter the "Citresa Judgment"), related to Corporate Income Tax assessments for the financial years 2003, 2004, 2005 and 2006 (January and February), the Spanish Supreme Court ruled in favour of the appellant company on the grounds that in 2003, 2004, 2005 and 2006 (January and February) what is known as "Transactional Net Margin Method" could not be applied as a method of valuation of the market value of certain related transactions because this method was not provided for in the Spanish legislation applicable at that time, since it did not reach legal validity in Spain until "Law 36/2006, of 29 November, on measures for the prevention of fiscal fraud" entered into force on 1 December 2006.

Prior to 1 December 2006, the Spanish Corporate Income Tax Act (hereinafter the "CIT Act") established three valuation methods of related transactions (the "Comparable Uncontrolled Price Method", the "Cost Plus Method" and the "Resale Price Method") and if none were applicable it established the application of the "Transactional Profit Split Method". Thus, the "Transactional Net Margin Method" was not included at that time on the list of possible methods available to the Tax Authorities when establishing the market value of related transactions. However, the Spanish Tax Authorities applied the "Transactional Net Margin Method" based on the provisions of Article 3 of the CIT Act, which states that "what is established in the CIT Act shall be understood without prejudice to the provisions of international treaties and conventions that have become part of the internal system in accordance with Article 96 of the Spanish Constitution". According to the Spanish Tax Authorities, when a tax treaty for the avoidance of double taxation (hereinafter, the "Tax Treaty") is applicable, the OECD Transfer Pricing Guidelines are directly applicable because the Commentaries on the articles of the OECD Model Convention refer to them.

In the case in dispute, as the Tax Treaty between Spain and the Netherlands was applicable, the Spanish Tax Authorities considered that the OECD Transfer Pricing Guidelines could be directly applicable. Consequently, as the "Transactional Net Margin Method" was envisaged in the above-mentioned Guidelines, the Spanish Tax Authorities understood that this method could be used as a valid valuation method.

In the Citresa Judgment the Spanish Supreme Court clarifies that Article 3 of the CIT Act refers to those legal provisions that have been integrated in the internal Spanish system (international treaties and conventions), without the OECD Transfer Pricing Guidelines having legal nature. Therefore, the Supreme Court concludes that the "Transactional Net Margin Method" could not be applied in the financial years 2003, 2004, 2005 and 2006 (January and February).

Following the same rationale, the Spanish Supreme Court issued a judgment dated 2 March 2017, in the McDonald's case, in which it reiterates that it is not possible to substantiate a plea in breach of the OECD Transfer Pricing Guidelines before the Spanish Supreme Court, given the lack of its legal nature.

In addition to the above-mentioned rulings of the Spanish Supreme Court, it is also worth mentioning the judgment of the Spanish National High Court (Audiencia Nacional) dated 10 July 2015, issued in the ING case, concerning the Non-resident Corporate Income Tax assessments for the financial years 2002 and 2003 of a Spanish branch of a foreign bank. In this judgment the Spanish National High Court expresses its view on the application of the "dynamic interpretation" or "static interpretation" of Article 7(2) of the Tax Treaty between Spain and the Netherlands, which deals with the issue of the attribution of profits to permanent establishments.

The litigation which is the subject of the aforementioned judgment arises from the recharacterisation carried out by the Tax Inspectorate of a part of the interest-bearing debt of the bank branch as "free" capital, with the consequent reduction of the tax-deductible expenses for debt interest. All this, on the basis of a "dynamic interpretation" of Article 7 of the applicable Tax Treaty, since the Tax Inspectorate applied the relevant Commentaries on the OECD Model Convention approved in 2008 to tax situations which took place in 2002 and 2003. It is worth remembering that, for many scholars, the Commentaries on Article 7 approved in 2008 substantially modify the interpretation of Article 7 of the applicable Tax Treaty.

The Spanish National High Court, relying on the arguments of the appellant branch, refuses to carry out a "dynamic interpretation" of Article 7 of the applicable Tax Treaty (dating from 1971) because, in relation to "free" capital, it considers that very significant amendments have been introduced into the Commentaries on Article 7 of the OECD Model Convention of 2008 and into the OECD Report of 2006 on "Attribution of profits to permanent establishments". In this sense, the Spanish National High Court recalls that subsequent Commentaries will only affect previous Tax Treaties when the text of the article of the Tax Treaty that purports to be interpreted with the new Commentaries has not varied so that under the new Commentaries it has a meaning substantially different from the one it had in previous versions of the OECD Model Convention.

Finally, we would like to mention that it should not be inferred from the previous court ruling that, in general, Spanish courts always choose to apply a "static interpretation" of the provisions of Tax Treaties, although the fact is that to date they have only accepted the application of "dynamic interpretations" in cases of Tax Treaty provisions not related to Transfer Pricing matters.

Co-author: Lorena Viñas, Madrid.

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The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to. Readers should take legal advice before applying it to specific issues or transactions.

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