Favourable Tax Court Decision made with respect to tax inspector’s denial of VAT refund on the grounds of disguised profit distribution through transfer pricing with regard to imported raw materials

 January 01, 2013

Subject:

Favourable Tax Court Decision made with respect to tax inspector’s denial of VAT refund on the grounds of disguised profit distribution through transfer pricing with regard to imported raw materials

(an important decision for pharmaceutical companies recently exposed to VAT assessments)

As it is already known especially within the pharmaceutical industry, tax inspectors have prepared VAT assessment reports for a number of pharmaceutical companies towards the end of 2011 (after the end of the application period for Tax Amnesty) covering the years 2006-2009 on the ground that those portions of the input VAT incurred on imports of raw materials corresponding to so-called disguised profit distribution through transfer pricing, cannot be deducted as input VAT and therefore cannot be refunded back to the taxpayer, either (as a reminder; taxpayers are normally entitled to get a VAT refund in cases where raw material purchases realized with 18% input VAT result in VAT carried forward since delivery of finished pharmaceutical products manufactured are subject to 8% VAT).

As a result of these VAT assessments imposed especially on those taxpayers in pharmaceutical industry, a number of pharmaceutical companies have applied to tax courts and opened lawsuits against the denial of VAT refund corresponding to so-called disguised profit distribution through transfer pricing.

According to a very recent tax court decision issued in December 2012 by one of the tax Courts in Istanbul, two of the three judges (including the head of the three judges evaluating the case) have found that the taxpayer is right in claiming the VAT refund for the relevant period in 2006 (which was subject to examination and assessment) since the tax inspector’s challenge as to the existence of disguised profit distribution cannot be proved based on objective and concrete data and evaluation. Accordingly, a favourable tax court decision was made with favourable opinions of the majority of the judges (2 against 1).

This Tax Court Decision is important since it inherently confirms the fairness of the following claims of the taxpayer against the Tax Administration:

a) Tax inspection has not been completed within the period as specified by the relevent recent rules in the Tax Procedures Code governing the timing and procedures of tax inspections.

b) There is no rule preventing taxpayers from claiming the refund of VAT arising from the input VAT already paid to the Customs Administration and thus actually collected by the Turkish Treasury at the time of the import (accordingly, there is no loss to the Treasury).

c) The comparables determined so as to support tax inspector’s claim that there is disguised profit distribution actually do not qualify to be the appropriate comparables for the transaction concerned and therefore it cannot be claimed that there is disguised profit distribution through transfer pricing.

In summary, this favourable tax court decision inherently provides taxpayers with a legal confirmation that there is actually no disguised profit distribution through pricing of raw materials imported and accordingly that there should not be any denial of input VAT refund, as a result.

We believe that this favourable tax court decision would serve as a fair example for the similar cases still pending at the tax courts and help other taxpayers having similar situations (especially those in pharmaceutical industry) defend their status against the similar claims of the Tax Administration. However, it should be noted that the Tax Administration will certainly apply to the High Court for appeal of such tax court decisions in favour of the taxpayers. Such cases will be finalized after the appeal procedures are also finalized in favour of the taxpayer. Accordingly, the final result of the appeal is important.

Please feel free to contact us in case you need further information about the recent VAT assessments arising from the underlying claims of disguised profit distributions through transfer pricing.

Yours sincerely,
Deloitte Turkey