By: Manyl Benredouane, Alexandre Lamarre and Thomas Rousset, University of Montpellier, Centre du Droit de l'Entreprise, Program of Master 2 "Droit du Commerce International"
Overview
In most business transactions, lawyers are not involved in determining the ultimate price. However, in some situations, this amount can raise a red flag as it might subject the parties to sanctions. Due consideration must be given in particular to tax (I) and contract (II) law.
I. Business Transactions and Tax Law
In tax law, guidance for the determination of the price can be found for international (I) and national (II) transactions.
A. International Transactions
From an international perspective, special attention must be given to applicable rules of transfer pricing. Transfer pricing is defined as a way to transfer income within a multinational group of companies through excessive prices for goods or services provided by one to another entity of this group of companies. In transfer pricing, an overprice will be determined by comparing it to what would be a "normal price", using comparables. To permit the adjustment of the price, efforts have been made at different levels.
At the Organisation for Economic Co-operation and Development (OECD) level, recommendations to tax administrations have been published in 2017 regarding methods of calculation of transfer pricing.
At the EU level, the EU Joint Transfer Pricing Forum released in March 2017 a Report On The Use Of Comparables In The EU. It contains recommendations for taxpayers and tax authorities to increase the transparency of comparable searches in the EU.
Internal comparables may be used when the Comparable Uncontrolled Price (CUP) method or another method is used to determine the margin. Internal comparables tend to be dismissed by tax administrations, due to lack of data or material differences in comparability factors. These comparables are directly available to the taxpayer. Processing such information can be less costly than searching and adjusting external comparables. In case of third party transactions by taxpayers, Recommendation 2 of the Report suggests that taxpayers provide sufficient details on the evaluation of internal comparables (documenting the approach, the results and the reasons for using or disregarding potential internal comparables).
At a national level, we also observe efforts to control transfer pricing. In 2016, the German legislator implemented the action items from OECD's Base Erosion and Profit Shifting project (BEPS) into national law (BEPS 1 Transformation Act). Article 1(3) states that the price comparison method, the resale price method or the cost plus method must be preferably applied.
Standards and best practices are also used to determine transfer prices using internationally agreed methods. Section 90(3) of the German General Fiscal Code provides that when taxpayers use databases to determine transfer prices, they shall disclose; the applied search strategy, the applied criteria, the search results and the selection process. This search process must be clear and testable by the tax authority during any tax audit.
In France, Article 57 of the French General Tax Code relates to irregular management actions and creates a presumption of profit transfer. Article L13 AA of the French Procedure Tax Code (FPTC) provides that companies part of important economic groups must hold a particular documentation relating to transfer pricing and to address a simplified version, each fiscal year, to the tax authority. The FTA accept the CUP, resale price, cost-plus, profit split method.
The control of excessive transfer pricing is often at the origin of the most important tax adjustments of companies. Some taxpayers are tempted to use overstated prices to allocate profits in a country with advantageous tax legislation. Article 238 A of the French General Tax Code establish a presumption of undue profit transfer regarding such remunerations for companies established in a state considered as tax-friendly. The company then has to prove the sincerity of such operation, i.e. the reality of services paid for, and the normal character of the stipulated remuneration. Failure to provide complete information (Article L 13B of the FPTC) may result in penalties such as reassessment of the company's taxable profit based on the information possessed by the FTA.
Thus, an excessive price will be detected using comparables. A price in excess of the comparable will be penalised. As consequence, the comparables must be chosen wisely.
B. National Transactions
In national transactions, irregular management actions can be sanctioned based on the amount of the price of transactions.
In Germany, Section 8(3) of the German Corporate Income Tax punishes hidden transfer of money by subjecting it to tax if a business transaction within a group results in a loss or a forgone increase in net asset contrary to what a prudent managing director would do, commonly referred as the arm's length principle.
In France, this concept derives from section 39 of the French General Tax Code and was developed by the Conseil d'Etat in the case Renfort Service. It is possible to deduct expenses only if they are for the benefit of the business or within the framework of normal commercial management. An actual transfer of profits with the intention to allocate profits or losses to another taxpayer must be proven. Tax deduction may be refused for charges not incurred for the benefit of the business, or not incurred during normal commercial operations.
II. Business Transactions and Contract Law
Resulting from the parties' freedom to contract, the amount of the price is fixed freely by the parties. However, general contract law (A) as well as usages (B) provide for some indications as to the price
A. General Contract Law
General contract law has provided mechanisms to remedy excessive or abusive contractual prices. One of them is the theory of unpredictability.
This theory allows for judicial review of contracts whose execution is rendered too expensive due to time or new economic circumstances. Going against the pacta sunt servanda's principle, it was for a long time not recognised in the European Union.
However, after WWI, a movement initiated by the German courts led to mitigate the pacta sunt servanda principle and to admit the theory of unpredictability. Among the innovative national legislations, mention must be made of Article 373 of the Swiss Federal Code of Obligations, which allows for the revision of contracts, Article 1467 of the Italian Civil Code, which provides for the termination of contracts that have become manifestly unbalanced, Article 6.5 of the new Civil Code of the Netherlands, and Article 388 of the Greek Civil Code. In France, after long hesitations, the theory has finally been consecrated by article 1195 of the Civil Code by the contract law revision of 2016.
B. Examples of Usages in Determining Fees in Specific Contracts
Usages can be relevant in determining the amount of fees. This is the case for commercial agents (1), lawyers (2) and arbitrators (3).
1. Commercial Agents
When the contract does not contain any price, the price will have to be set in accordance with usages. For example, in France, article L134-5 para. 3 of the Commercial Code states that the commercial agents' fee has to conform to the usages of the activity sector comprised within its mandate, where it exercises its activity.
2. Lawyers
Lawyers, when charging their client fees (be they fixed hourly rate or success fees for example), do that as the counterpart to the services they have provided. The question then is to know if they can fix them freely or if they must comply with some rules.
In the case European Commission v Italy of March 2011, the European Court of Justice (ECJ) ruled that Member States implementing rules on maximum lawyers' fees is not contrary to EU law.
In Italy, some provisions establishing maximum fees amounts for lawyers, were deemed to be contrary to article 49 and 56 of the Treaty on the Functioning of the European Union (TFEU) by the Commission. These two articles respectively prohibit Member States from implementing restrictions on freedom of establishment and freedom to provide services.
The ECJ decided that such regulations do not amount to a restriction within the meaning of the TFEU solely by the fact that other Member States apply less strict, or more commercially favourable rules to lawyers established in their territory. The existence of such a restriction cannot be concluded only on the basis that lawyers established in Member States other than Italy must become accustomed to Italian rules applicable for the calculation of their fees for services provided there.
In France, under article 10 of the Law No. 71-1130 of December 31, 1971, Reforming Certain Judicial and Legal Professions, lawyers fees' must "take into account, according to usages, the wealth situation of the client, the difficulty of the case, the costs incurred by the lawyer, his notoriety and his diligences". There is no general rule that limits the maximum amount of lawyers' fees in France. However, there is a specific one that applies when a lawyer works in cooperation with a sport agent to help an athlete sign a contract. In that case, the same article provides that his or her fees must not exceed 10% of the amount of this contract.
3. Arbitrators
The amount of arbitrator's fees is fixed contractually. To avoid excessive amounts, arbitral institutions sometimes try to help the parties in determining what would be a reasonable price. It is the case of the International Chamber of Commerce for example, which makes available a simulator relying on the scales in the Appendix III to its arbitration rules. The French Association for Arbitration (Association Française d'Arbitrage) also has a scale depending on objective factors as the amount of the dispute. As soft law, these factors are not binding and still permit the parties to take into account additional/subjective factors.
Conclusion
Companies are usually considered as rational economic actors, in the sense that their purpose is to maximize their benefits. However, be aware that it is forbidden for entities of the same group to charge between themselves excessively high fees. Tax administrations are paying close attention to the amount of fees charged, using comparables. It is recommended for companies, when determining the amount of fees, to pay attention to the comparables likely to be used by tax authorities.
Even if companies are considered as rational economic actors, rules are also set up not to take advantage of the co-contractor. When the price is not determined in the contract, the price will be set according to customary practices applicable to the contract.
It appears that, more broadly, alongside the general principle allowing price to be determined freely by the parties, there are several limits in different law areas to ensure that they do not reach an excessive amount.
Additional Sources
Bibliography
European Commission, 'Study on Sports Agents in the European Union', 2009
French General Tax Code
German General Fiscal Code
Le déséquilibre significatif entre dans le Code civil : de quoi s'agit-il ?
Transfer pricing in Germany: overview
OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017, OECD Publishing
Case law
European Union
European Commission v Italy (C-565/08) Unreported March 29, 2011 (ECJ)
France
Conseil d'Etat Assemblée Plénière, 27 juillet 1984, Renfort Service, N° 34588
Books
J.M. Mousseron, Technique contractuelle, 5th edition by P. Mousseron, J. Raynard, J.B. Seube, éditions Francis Lefebvre, 2017