The High Court of Eastern Denmark overrules SKAT's decision to raise the taxable income of Microsoft Danmark ApS in a leading case concerning burden of proof and documentation requirements on transfer pricing.

Decision of the High Court of Eastern Denmark

On 28 March 2018 the High Court of Eastern Denmark rendered its decision in a leading case concerning transfer pricing. In this case, the Danish tax authorities, SKAT, increased the taxable income of Microsoft Danmark ApS with reference to the fact that the company had applied prices for controlled transactions in violation of the arm's length principle.

Documentation requirement and burden of proof

Microsoft Danmark ApS had prepared transfer pricing documentation for the income years 2004 and 2005 as well as collectively for the years 2006-2009. However, the transfer pricing documentation was not dated, and there were no indications as to when it had been drafted.

Firstly, the High Court established that the provision on preparation of transfer pricing documentation in s. 3 B (5) of the Danish Tax Control Act (skattekontrolloven) must be taken to mean that transfer pricing documentation is to be drafted on an ongoing basis and completed no later than at the time of submitting the income tax return. The High Court did not find it proven that Microsoft Danmark ApS's transfer pricing documentation was available at the time of submission of the tax return, and as such it had not been prepared in due time.

Under the circumstances, the fact that the transfer pricing documentation had not been prepared in due time did not mean that SKAT was entitled to make a discretionary tax as-sessment. The High Court attached importance to the fact that the tax authorities had not pressed for the transfer pricing documentation available at the time of the tax authorities' processing of the matter, and that no notice had been given of penalty payments or fines pursuant to s. 5(2) or s. 17(3) of the Tax Control Act.

The High Court also found that on the evidence there was not sufficient basis for considering the transfer pricing documentation insufficient to an extent that in itself would warrant discretionary tax assessment.

As such, it was up to the Ministry of Taxation to prove that the company had not complied with the arm's length principle. During the course of the proceedings, the Ministry of Taxation was unable to lift this burden of proof. On this basis, the Court found for Microsoft Danmark ApS in its claim that the price of the concerned services had been determined in accordance with the arm's length principle.

Facts

Pursuant to agreement with its Irish affiliate Microsoft Ireland Operation Limited, which sells Microsoft’s programs on the Danish market, Microsoft Danmark ApS marketed Microsoft’s products in Denmark.

The case brought before the High Court of Eastern Denmark concerned whether the fees received by Microsoft Danmark ApS for these marketing activities were on an arm's length basis.

The question in this case was rather whether Microsoft Danmark ApS, in addition to being subject to taxation on its commission on the Irish company's sales, would also be subject to taxation when a PC of multi-national manufacture with an integrated Microsoft operating system was sold in Denmark. In these cases, the PC manufacturer paid a license to an American company in the Microsoft group.

Comments by Bech-Bruun

The decision of the High Court of Eastern Denmark establishes that SKAT is not entitled to make a discretionary assessment in a situation where a company, based on a specific eval-uation, has prepared adequate transfer pricing documentation. If the documentation re-quirement was observed, the burden of proof passes from the company to SKAT.

If SKAT disagrees with the applied transfer pricing method in the produced documentation, it is up to SKAT to prove (or at least render likely) that the produced documentation is unsuited as basis for the settlements, in which connection SKAT must state a method that is more lawful than the one applied by the company.

Further, the decision of the High Court of Eastern Denmark establishes that the fact that the transfer pricing documentation was not prepared in due time is not in itself sufficient for SKAT to make a discretionary tax assessment. In this connection, the decision establishes that the steps taken by SKAT to obtain the documentation are of significance.

On several points, the decision of the High Court is remarkable, and it will be interesting to see whether the Supreme Court upholds the decision and its reasoning.