A recent judgment from the Norwegian Supreme Court provides guidance on the court’s legal control of the tax authority’s exercise of discretion when setting an arm’s-length price under Norwegian tax law.
A/S Norske Shell (ASNS), a subsidiary in the Royal Dutch Shell group (Shell), carried out upstream activities on the Norwegian continental shelf (NCS). ASNS were charged a proportional amount of Shell’s research and development (R&D) costs, set inter alia based on the expected use of the technology, totalling circa 5% of the total R&D costs in the group. The case concerned ASNS’ own R&D costs. Approximately 40% of these costs were charged to the other license holders, while the remaining 60% were borne by ASNS.
The High Court had decided that the pricing was not at arm’s length, which gave the Norwegian tax authorities (NTA) the right to discretionarily determine what the correct price should be for income tax purposes.
Before the Supreme Court, the admitted question was whether the NTA had used its discretionary competence correctly, when adjusting the income of ASNS.
Judicial review in TP cases
Under Norwegian tax law, the tax authorities may discretionarily assess a taxpayer’s taxable income or wealth, if the wealth or income of the taxpayer has been reduced as the result of a direct or indirect commonality of interest with another person, company or undertaking. It is the NTA that has to, under the first step, demonstrate that these conditions have been met, and that this assessment is subject to full judicial review by the court. The second step in a transfer pricing (TP) case is to discretionarily assess what the arm’s-length price should have been for tax purposes.
As opposed to the first step, the judicial review of the second step is more limited. The judicial review of the second step is limited to a re-examination of (i) the facts and circumstances, (ii) the application of legal rules and (iii) any abuse of authority (ulterior considerations, etc.).
Reasoning in the Shell case
In the administrative decision under review, the NTA had increased the income of ASNS, arguing that the other group companies should have covered, under the cost contribution agreement, 95% of ASNS’ gross R&D costs, disregarding the fact that the other license holders also had covered 40% of the same costs.
The rationale was that the gross amount did represent the value for the other group companies. ASNS argued before the Supreme Court that other group companies should only cover 95% of the company’s net R&D costs, thus after reduction of the costs covered by the other license holders. This was, according to ASNS, in line with legal agreement and how cost contribution agreements should work, whereby it is only the actual costs that have to be shared with the other participants in the scheme.
The Supreme Court stated that the review of legal rules also covered whether the OECD TP Guidelines had been applied correctly, more specifically the guidance on cost contribution agreements. The NTA had treated the controlled transaction as a sale under the gross R&D cost approach. This was found to be in breach of the TP Guidelines, as the Supreme Court sided with the taxpayer’s net R&D cost approach. The Supreme Court annulled the reassessment, which meant that the NTA will need to carry out another reassessment in line with the directions given in the judgment.
Lessons from the Shell case
The Shell case shows that the application of the OECD guidelines are subject to judicial review by the courts. This can be the second line of defence, while the first line of defence is normally that the NTA has not demonstrated that there is an income or wealth reduction caused by the community of interest.
The two other reasons mentioned in connection to the discretionary assessment, wrong facts and abuse of authority, normally do not lead to the annulment of a reassessment. Moving forward, the judgment will make it easier to prevent the incorrect use of the TP guidelines.
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