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In this edition of our News Flash, we would like to introduce a significant decision by the Supreme Court of the Slovak Republic concerning the allocation of costs to related parties from a transfer pricing perspective in Slovakia. This decision addresses the ruling of the Regional Court in Nitra, which dismissed the lawsuit filed by FERPLAST SLOVAKIA s.r.o. regarding transfer pricing and the recognition of expenses for royalty fees. The court upheld the tax authority’s approach during a tax audit focused on controlled transactions between related parties within an international group of companies and questioned the economic justification for certain costs charged by the company.
In the case of the royalty fee for the use of the “Ferplast” trademark, the fee was associated with marketing-related intangible assets. The plaintiff, as the Slovak subsidiary of the Italian company Ferplast SpA, operated as a contract manufacturer whose primary role was to produce products according to instructions from the parent company. Within the group, it sold 90% of its products to related companies, with the parent company setting the prices, discounts, and sales conditions.
The parent company, Ferplast SpA, subsequently invoiced its Slovak subsidiary for the trademark and associated marketing activities to ensure product sales. The amount of the royalty fee was calculated based on revenue generated with both related (90%) and independent (10%) companies.The court confirmed the tax authority’s conclusion that the plaintiff, as a contract manufacturer without marketing functions and without the ability to influence product sales, should not bear the costs of the marketing tool in the form of a trademark license, particularly for the portion calculated based on revenue from related companies. In this context, the costs were not recognized as tax-deductible because they did not serve to achieve, secure, or maintain the Slovak company’s income.
The court also assessed a second controlled transaction involving an Oracle software license, which the plaintiff was invoiced by the related company FIVAC SRL. The tax authority found that FIVAC SRL purchased software services from third parties and subsequently invoiced them with a 10% markup. However, the plaintiff could not adequately justify the economic rationale for the increased costs, nor could it provide relevant documentation to demonstrate the appropriateness of the license fees and cost allocation by FIVAC SRL for obtaining and managing the Oracle software (available documents included an invoice, a notice of license fee increase, and a contract). Because the plaintiff failed to demonstrate the actual costs of the supplier, a related party, the tax authority disallowed the expenses in their entirety.
The court’s essential finding was that the costs borne by a related company must be connected to the functions it performs and can influence. If a company lacks marketing or sales functions and serves solely as a contract manufacturer with guaranteed sales, it should not bear costs for royalty fees related to trademarks or other marketing tools. This ruling, therefore, represents an important precedent in the area of transfer pricing and the appropriate recognition of expenses in related-party transactions. When setting transfer prices within a group, it is essential to consider that tax authorities may require proof that every charged expense is functionally linked to the company’s activities and serves to generate income.
Significant decision by the Supreme Court of the Slovak Republic confirms that the tax authority had the right to exclude certain expenses from tax costs because they did not comply with the arm’s length principle and were not economically justified. This ruling will impact future tax audits, as tax authorities may refer to it when evaluating similar related-party transactions.
If you are unsure about the accuracy of cost allocations within an international corporate group and would like further information, our transfer pricing experts are available to provide guidance in this area.
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