Transfer pricing adjustments can lead to tax risks

The Czech drug distributor sold drugs in the Czech Republic and Slovakia. He also invoiced marketing services to his Swiss drug supplier. Due to the price regulation, the purchase price of drugs bought from a Swiss supplier was higher than their subsequent sale price in the Czech market.

In the course of a tax audit that was focused on transfer pricing, the distributor claimed that the carried-out marketing activities represented an inseparable part of the drugs distribution. Following that, during the VAT tax audit, the Tax Authorities considered marketing services as an ancillary supply to the main supply which is the sale of goods. The Tax Authorities further claimed that marketing services are provided directly to the final buyers of drugs.

The court stated that due to the drug price regulation the distributor could not demand payment of a price that includes all its components (including marketing), and therefore the marketing activity was reimbursed by the Swiss supplier. The Tax Authorities thus reclassified the service with the place of supply in Switzerland to the consideration received from a third party for goods supplied in the Czech Republic, which is subject to the Czech VAT.

The court also considered the whole business model to be artificially created and application of other (more advantageous) tax regime for part of the consideration as incorrect.

The case will now be dealt with the Supreme Administrative Court, as this is a judgment of the Municipal Court in Prague.

Please contact us should you wish to discuss whether your business model contains similar risks.