What consequences may arise from an informal group decision?

In practice, changes to the way business is conducted within multinational groups are far from uncommon. Adjustments to operating models, changes in business profiles or the reallocation of functions between entities have become part of everyday reality for large organisations – particularly in such a dynamically evolving economic environment. 

From a tax perspective, however, such decisions may give rise to significant risks, including transfer pricing. A good example is the case of the Czech company Hitachi Astemo1. 

Background to the case – from televisions to automotive components 

Hitachi Astemo is a contract manufacturer expected to achieve a low but stable level of profitability. As a result of a strategic decision taken at the group level, the company was required to cease the production of LCD televisions and transition to the manufacture of automotive components. 

This change necessitated the company incurring substantial capital expenditure, including in particular: 

• • adaptation of existing infrastructure, 

• • purchase and installation of new machinery, 

• • employee training. 

The outcome? A tax loss – and, consequently, the interest of the tax authorities. 

From the perspective of the case, it was also significant that these changes did not arise from a standard commercial agreement. No price was agreed, no remuneration was determined, and no form of compensation was provided. 

In practice, this amounted to an informal group instruction, the economic consequences of which were borne solely by the company. Meanwhile, the potential benefits components –  in the form of the production and sale of components – were expected to materialise only in the future. 

The authorities ask: where is the remuneration? 

The Czech tax authority concluded that such a situation breached the arm’s length principle. Based on domestic regulations and the OECD Guidelines, it stated that an independent enterprise would not accept bearing such significant costs and risks without: 

• • appropriate remuneration, or 

• • safeguards in the form of legally enforceable compensation. 

As a result, the tax authority made an adjustment, reducing the company’s tax loss by nearly PLN 12.5 million. It assumed that the costs incurred in connection with the change in production profile should be treated as a reflection of hypothetical remuneration that the company should have received under market conditions. 

First Court ruling – no transaction, no adjustment 

The company challenged the tax authority’s decision and succeeded before the regional court. The Court held that the situation in question did not constitute a controlled transaction within the meaning of transfer pricing regulations. 

According to the Court, this was merely a managerial decision of the parent entity, rather than a commercial or financial relationship between related parties. The absence of a formal agreement and an agreed price was considered to preclude the application of transfer pricing rules. 

A turning point – actual conduct prevails over formal agreements 

The tax authority disagreed with this ruling and filed a cassation appeal. It argued that: 

• • controlled transactions may arise from the actual conduct of the parties, not only from formal agreements, 

• • informal group instructions may have real economic consequences. 

The Supreme Administrative Court upheld the tax authority’s position, emphasising that the key consideration is how a given event affects the operations of the subsidiary. 

In the Court’s view, the group instruction resulted in an arrangement under which the company: 

• • incurred investment expenditure, 

• • acted for the benefit of the group, 

• • received neither remuneration nor any form of protection or compensation. 

Such conditions, according to the Court, would not be acceptable to an independent entity. 

Second approach of the regional court – the mere assertion of non-arm’s length conditions is not sufficient 

Upon reconsideration of the case, the regional court shifted its focus to the quality of the analysis conducted by the tax authority. 

The court held that the tax authority should clearly demonstrate: 

• • that the conditions of the transaction deviated from market terms, 

• • what the appropriate transfer price should be, 

• • on what basis the level of hypothetical remuneration was determined. 

In particular, the court emphasised the need to use appropriate comparables and to apply a proper transfer pricing method. In this case, the tax authority failed to do so—it relied primarily on the company’s accounting data, without conducting a reliable comparability analysis. 

As a result, the court concluded that the tax authority had not met its burden of proof. Consequently, the tax decision was annulled, and the case was remitted for reconsideration by the tax authority. 

Practical conclusions for taxpayers 

The Hitachi Astemo case demonstrates that tax authorities assess the actual economic effects of actions or changes implemented within a group, rather than their formal structure. Situations in which an entity bears costs or risks without appropriate remuneration are particularly high-risk. 

At the same time, the case confirms that tax authorities cannot act arbitrarily. They are required to: 

• • correctly identify the transaction, 

• • perform a comparability analysis, 

• • base their conclusions on reliable data, 

• • justify the selection of the transfer pricing method. 

Only once the burden of proof has been met by the tax authorities is it possible to make a transfer pricing adjustment. 

How to mitigate the risk? 

It is crucial to remain vigilant with respect to changes introduced within a group. 

Each time, it should be verified whether such changes generate new tax risks and whether they have appropriate business justification. It should also be assessed whether a given change may qualify as a restructuring within the meaning of tax regulations. 

At the same time, proper documentation of such actions is essential, as it constitutes the primary safeguard in the event of a tax audit.