Court's duty to give reasons for its decision

The Supreme Administrative Court of Bulgaria, vide its judgment of January 6, 2025, set aside the judgment of the Court of First Instance in a transfer pricing matter, holding that the Court of First Instance did not set out its own reasoning and conclusions but reproduced in full the reasoning and legal conclusions set out by tax authorities.

The Court held that the failure to state reasons constitutes an infringement of the procedural rules of the substantive kind since, in addition to constituting a failure by the judge to fulfil the imperative duty imposed on him to state reasons for his decision, it infringes the rights, and the opportunity of the parties to defend themselves precludes the possibility of cassation review and infringes the principle of the two-instance nature of judicial review.

The decision notes interesting facts about the pricing of the transfer of ownership of a trademark within an MNE group, the analysis carried out by the tax authority to make a transfer pricing adjustment, and the objections raised by the taxpayer.

Facts of the case

KAMENICA AD, a Bulgarian company, had acquired ownership of the trademark “KAMENICA” from its related party STARBEV NETHERLANDS B.V. (STARBEV NETHERLANDS B.V.)? under a Trademark Purchase Agreement of 10.09.2014 for EUR 40,100,000, with a currency equivalent of BGN 78,428,783, to be paid by KAMENICA S.A.

The Company had determined the present value of the KAMENICA brand to be ￡56,153,000 using a discount factor of 4.5% and future interest costs of ￡22,276,000.

Taxpayer’s documents

During the tax audit, the audited company submitted a document containing written explanations on the choice of the most appropriate transfer pricing method, by which it was assumed that the transaction complied with the arm's length principle. According to the written explanations, the comparable uncontrolled price method was rejected because, according to the analysis, the trademark is a uniquely high-value intangible asset, and neither internal nor external comparable uncontrolled transactions between independent entities were identified.

The explanation noted that the KAMENICA trademark was purchased by CVC Capital Partners from? ?Interbrew?Central Europe Holding B.V. and Anheuser-Busch InBev SA (Belgium) [ABI] in December 2009 at EUR 12 750 000. According to the analysis, the transaction was agreed upon when the brewing companies' values were very low and gradually increased in the following years. Furthermore, the historic sale of the KAMENICA trademark by ABI was an integral part of a highly complex sale of business operations in nine Central European countries, including shares, rights, loans, etc., held by several entities of the ABI Group to CVC Capital Partners, valued at over USD 2.2 billion. The company submitted a valuation report of certain brands as of 1 July 2014, prepared on 16 September 2014 by Ernst & Young LLP. The valuation was carried out by applying the relief-from-royalty method and determined a fair value as of 01.07.2014 of the trade mark of EUR 40 100 000.

The Star Bev Group of breweries (including KAMENICA Plc.) was acquired by MSBC Group from CVC Capital Partners on 15.06.2012 in an arm’s length transaction. Ernst & Young LLP, a consulting firm, was engaged to determine the fair value at the valuation date of certain identified tangible and intangible assets that will become the property of MSBC as a result of the transaction. Valuation analysis of certain identified tangible and intangible assets of?Star Bev?Group was provided on 09.08.2013. According to the same, the total fair value of the?Star Bev?Group's brand assets, considered as a collection of various intangible assets (property rights, trade names/brands, production recipes, packaging design, etc.), was EUR 1 953 600 000. The estimate was based on forecasts made by the management of MSBC Group of the expected sales volumes, price levels and costs for the period 2012-2016 related to the sales of products under the various brands of the?Star Bev?Group in each geographical market (in each country in which the Group operates) separately. The multi-period excess earnings method has been applied, estimating the estimated free cash flow attributable to each brand after excluding amounts representing the expected return for the remaining tangible and intangible assets used in generating revenue from sales of the respective products. It is noted in the valuation that management's projections for the forecast period do not include royalty expenses paid to date to the companies owning the relevant trademarks. In this respect, based on the relief-from-royalty method (which was also used in the 2014 valuation), an additional valuation of only the legal ownership of the trademarks in question has been made, resulting in a fair value of the legal ownership of the trademark 'KAMENICA' with an unlimited useful life, a royalty rate of 4.39% and a Dutch (Netherlands) corporate tax rate of 26%, set at EUR 25 500 000.

Audit by tax authorities

The tax authorities have identified a material difference of 57% between the two Ernst & Young LLP valuations prepared using the same method (fair value as of 15 June 2012 of EUR 25 500 000 and fair value as of 1 July 2014 of EUR 40 100 000). They accepted that there were significant differences between the underlying assumptions about the expected future values of the financial indicators used in applying the royalty savings method. Considering that the results of the 2014 valuation were primarily consistent with the requirements of Dutch tax law, it was considered that these results were not based on entirely objective and fair assumptions that would be adopted in pricing comparable arm's length transactions.

To assess the Agreement's compliance for purchasing the trademark "KAMENICA" of 10.09.2014 with the terms and conditions that comply with the objective of Article 4 of Regulation No. H-9/14.08.2016 (Transfer Pricing Regulations), the audit team carried out a comparative analysis of the methodology applied by Ernst & Young in 2013 and 2014. The analysis referred to data provided by the audited entity, including those contained in the 5-year strategic development plan of KAMENITZA S.A. of May 2014, which, according to the Bulgarian company, were used by Ernst & Young to estimate the fair value of the legal ownership of the KAMENITZA brand as of 01.07.2014.

Based on the analysis, the revenue authorities have accepted that the 2014 valuation has significant deficiencies. Therefore, the method chosen by the company to determine the market price in the transaction of 10.09.2014 does not lead to a result that would be achieved in an ordinary commercial or financial relationship between independent persons under comparable conditions. It is concluded that, based on the provision of Article 62(2) of Ordinance No H-9/14.08.2016, a valuation method should be applied which is consistent with the purpose of Article 4 of the Ordinance. In this regard, it is held that, in this case, there is undisputed comparability between the transaction in 2009 and the one in 2014 since the same asset was transferred. Therefore, a comparable uncontrolled price method is applicable to determine the transaction's market value.

Based on the analysis prepared, tax authorities considered that the market price of the transaction concluded on 10 September 2014, by which?Starbev?Nederlands?B.V. transferred the ownership of the trademark KAMENICA to KAMENICA S.A., the taxpayer (Bulgarian company) should be set at EUR 12 750 000 or the value at which it was acquired in 2009 as a result of an arm's length transaction. In this respect, it is considered that although STARBEV NEDERLANDS B.V. can be identified as the legal owner of the trademark, it is not always the legal owner of the intangible asset who should receive the proceeds from the disposal of that asset. It has been pointed out that where other members of the multinational group of undertakings to which the legal owner belongs perform functions, use assets or take risks that contribute to the value of the intangible good, they must be compensated for their contribution in accordance with the arm's length principle. Paragraphs 6.51, 6.53 and 6.54 of the OECD Guidelines of 2017 concluded that if the legal owner neither controls nor performs the functions related to the development, enhancement, maintenance, protection or exploitation of the intangible asset (so-called DEMPE functions), it will not be entitled to any ongoing benefits related to the outsourced functions. Considering these provisions in the Guidelines, the audit authority analysed the functions performed and risks assumed concerning the development, enhancement, maintenance, protection and exploitation of the 'Kamenica' trademark during the audit proceedings.

Based on that analysis, it was concluded that, during the period in which the legal owner (Dutch company)? was the proprietor of the trademark, it did not carry out any functions relating to the development, enhancement, maintenance, protection and exploitation of the trademark, nor did it outsource such activities to third parties and/or exercise any control over them. At the same time, a gain of EUR 27 350 000 was realised on the sale as a result of the inflated value of the 2014 valuation, without any contribution to the eventual increase in the value of the trademark during the period between its purchase and its sale. Furthermore, as the owner of the trademark for about 5 years, the Dutch company generated a significant amount of royalty income of BGN 16 425 531, from which it follows that it received compensation for the period in the form of royalties as well as through the recalculation of the withholding tax due. In that sense, the Dutch company should receive minimal compensation solely because it holds ownership of the asset.

The Revision Authority considered the analysis and decision of the tax authority. It concluded that further adjustments should be made to the market price of the trademark, as adopted by the audit team in the RA, taking into account the parties to the 2014 transaction and the functions they performed. Based on the cash flows generated by the Dutch company about the KAMENICA trademark, namely: cash outflow - the amount paid upon acquisition of the trademark in December 2009 ?and cash inflow, including royalties received by KAMENICA plc, less any corporate tax paid in the Netherlands on this income at a rate of 25%, and the proceeds from the sale of the KAMENICA trademark in September 2014, the revenue authorities have assumed that at a sales price of EUR 12 750 000,00, the company would have realised an annual rate of return of approximately 10,32 % for the period 12.2009 - 09.2014. This is much higher than the risk-free rate of return to which the company is entitled according to its functions, which is calculated at approximately 2,576%. To achieve a market result consistent with the parties' functions and contributions to the transaction, the transfer of the KAMENICA trademark in the course of March 2008 was carried out per the terms of the transaction. It is concluded that the sale price should not be higher than EUR 7 727 088,00, with a currency equivalent of BGN 15 112 870,52.

Decision of the Court of First Instance

Aggrieved with the tax authority's audit finding and the Revision Authority's decision, the taxpayer appealed to the Court of First Instance.

The Court of First Instance held that competent authorities issued the audit order in the form prescribed by law without any material breaches of the administrative procedural rules and in accordance with substantive law.

On the contrary, by accepting the preparation of an assessment based on the application of the method of royalty savings as permissible under the norm of Article 65 of the Ordinance, the revenue authorities have carried out an analysis as to whether the method so used leads to a result that would be achieved in a normal commercial or financial relationship between independent persons under comparable conditions. In this regard, a comparison has been made between the final conclusions of the trademark valuations under the royalty savings method prepared by the consultancy firm as of 01.07.2014 and 15.06.2012, respectively, the price of the trademark 'KAMENICA' was set at EUR 40 100 000 and in the valuation prepared as at 15.06.2012, the same was set at EUR 25 500 000, which led to the conclusion of a significant divergence of results. However, the two valuations were made within about one year by the same consultant, based on the same methodology, and the difference between the two dates on which the respective fair value was determined was only two years. It is noted that the key assumptions in applying the royalty savings method are the useful life of the brand, the discount rate, the royalty rate, the growth rate of sales revenue, and the present value of tax benefits. Concerning the assumptions for the above indicators, the revenue authorities have identified differences in the preparation of the valuations that result in a material increase in the determined market value of the KAMENICA trademark for the purposes of the 2014 related party transaction compared to the 2012 arm's length transaction.

The Court noted that it has also been established that for the period from the purchase of the trademark until 31.12.2020, the asset is depreciated by BGN 9 560 000,00, which in itself is an indication that the value at which the trademark was acquired in 2014 is not market value. The impairments carried out by the appellant in the course of acquiring the ownership of the trademark 'KAMENICA' reflect the adjustments in the book value at which the asset was recorded after its acquisition in 2014 compared to the recoverable value of the same asset. This, in turn, means that they can serve as evidence that the market price at which the company can realise the KAMENICA trademark is not materially different from the price paid in the 2014 transaction. However, they do not in any way take into account whose contribution it was for the recoverable value of that intangible asset to be such - whether that of the legal owner of the brand prior to the 2014 transaction or of KAMENICA plc, which assumed the risks and performed the functions relevant to the increase in the market value of the brand.

Concerning the dispute between the parties regarding the comparability between the controlled transaction in 2014 and the uncontrolled transaction in 2009, it is concluded that purchasing the KAMENICA trademark in 2009 occurred in the context of a complex sale of business operations in nine European countries. In contrast, its purchase by the appellant in 2014 took place in the context of a transaction which had the transfer of ownership only of the intangible asset trademark as its object. The transfer in 2009 was the result of a separate contract between?Interbrew?Central Europe Holding B.V. and Anheuser-Busch InBev SA (Belgium) as transferors and?CVC Capital Partners as transferees. This contract is solely for the transfer of the know-how, domain name and rights to the trademark 'KAMENICA' and expressly specifies a price for the transfer of the trademark. It is valued on a stand-alone basis and not as part of a transaction for the transfer of shares, loans, rights, etc., so as to argue that the 2014 transaction is not comparable to the 2009 transaction.

The objection of lack of comparability in the economic conditions under which the 2009 and 2014 transactions were carried out is also unfounded. The auditors' finding that the brewing industry is much less affected by the economic conditions in which the transaction was carried out, as opposed to other industries such as automotive, metallurgy or construction, is justified. Therefore, no adjustment to the 2009 price is necessary to achieve comparability.

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Judgment of the Supreme Administrative Court

The taxpayer took the dispute to the Supreme Administrative Court.

The Court noted that the appellant rightly points out that the court of first instance did not set out its own reasoning but reproduced in full the reasoning and legal conclusions set out by the Director of the Directorate of the ETRS Sofia in the decision confirming the RA. In the contested judgment, there is no ruling on issues of substance, as the administrative court referred to the ruling of the decision-making body on the appellant's objections, which, however, cannot correctly replace the need for the court to set out its own reasons and legal conclusions. The failure to state reasons constitutes an infringement of the procedural rules of the substantive kind since, in addition to constituting a failure by the judge to fulfil the imperative duty imposed on him to state reasons for his decision, it infringes the rights, and the opportunity of the parties to defend themselves precludes the possibility of cassation review and infringes the principle of the two-instance nature of judicial review.

In addition, the judgment does not rule at all on the Appellant's objection concerning the valuation of the trademark used by the Revenue Administration as a market analogue in 2009 instead of the valuation of the same asset in 2012. It has been categorically established that the conclusion of the auditing authorities on the non-market nature (non-arm’s length) of the price of the 2014 transaction was formed after comparison with the valuation of the 2012 transaction. The question of why the latter was not used as a comparable uncontrolled transaction in this case, but the 2009 one, is essential for adequately resolving the dispute. In this regard, the court did not provide any reasoning, i.e. it did not decide whether the 2012 valuation of the intangible asset, prepared by the same valuer as that of the 2014 transaction at issue, should be taken into account in determining the market value under the comparable uncontrolled price method applied by the revenue authorities.

In its ruling on the merits, the court was first obliged to answer the disputed question referred to above - whether there are grounds for applying the 2012 valuation of the asset in the transaction between independent traders when determining the asset's market value in the 2014 transaction. Instead, the administrative court only discussed the legality and reasonableness of the market value determined based on the 2009 valuation of the trademark without providing its own reasoning on another of the company's main complaints - the application of the OECD Guide, as revised in 2017, in assessing the terms of the 2014 transaction at issue. In this respect, the general reasoning of the tax director is reproduced in full, but the court forms no definitive conclusion as to whether the valuation method - the DEMPE functions, which the OECD Guidelines introduced in its 2017 edition - was correctly applied by the auditing authorities in determining the market price of the asset.

For the reasons set out above, the Supreme Administrative Court finds that the infringements of the rules of court procedure committed by the court are substantial since the case, in the part above, has remained unresolved both in fact and in law, which prevents the possibility of an effective review of the correctness of the contested decision and the lawfulness of the revision act under appeal. It is inadmissible for the cassation instance to make the factual findings (Article 220 of the Code of Civil Procedure), as well as for the cassation decision to draw conclusions of law on issues which are essential to the dispute, which would lead to a restriction of the rights of defence of the parties to the case and a breach of the principle of two-instance judicial review. Under Article 209(3) of the Code of Civil Procedure, there are grounds for setting aside the judgment under appeal. The case must be referred back to a different court formation. On the retrial of the case, the Court of First Instance must consider the evidence adduced in the case, give specific instructions to the parties concerning the allocation of the burden of proof and then rule on the merits of the dispute.

The Court reversed Decision No 670/10.04.2023 rendered in Administrative Case No 2060/2022 of the Administrative Court—Plovdiv, in so far as it dismissed the appeal of KAMENITZA AD against Revision Act No R-29002919008230-091-001 of 30.12.2021, issued by the revenue authorities at the Tax Directorate "GDO" at the Central Directorate of the National Revenue Agency on the issue of transfer pricing adjustment concerning pricing of trademark transfer.

REMANDS the case to another panel of the Administrative Court - Plovdiv.

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