How Intra-Group Transfer Pricing Adjustments May Create Indirect Tax Exposure
Business groups operating in multiple jurisdictions are required to manage intra-group transactions in accordance with transfer pricing rules – meaning that transactions between group entities should be priced as unrelated parties would price them in comparable circumstances. This principle, known as the arm’s length principle, forms the basis of transfer pricing policy in most OECD countries. At the end of each year, and sometimes during the year as well, pricing adjustments are made to ensure that the actual pricing falls within the prescribed range.
The discussion around these adjustments usually takes place in the context of direct income tax – namely, whether the price applied meets regulatory requirements and whether there is exposure to tax assessment adjustments. In practice, however, the implications are broader. When a year-end adjustment is made, or when the price of an intercompany transaction is corrected after the fact, a question may arise that is not always examined: does this correction also have value added tax (VAT) implications? And perhaps customs implications as well? In our experience, quite a few business groups are surprised to discover that the answer is sometimes yes.
When Income Tax and VAT Look at the Same Transaction Differently
The Starting Point Is That Transfer Pricing and VAT Analyze the Same Transaction Using Different Tools and From Different Perspectives
Transfer pricing examines the transaction price in relation to the annual result, the functions performed by each group entity and the risks it assumes. This analysis is usually annual and reflects an overall picture. VAT, by contrast, is inherently a transactional tax – it is assessed by reference to each specific transaction, the consideration paid for it and the direct link between the supply and the consideration.
This gap creates an inherent tension. An adjustment that appears entirely reasonable from an income tax perspective may, in certain circumstances, create an unintended VAT event. The problem becomes more acute when the transfer pricing policy and the intra-group agreements were designed solely for direct tax purposes, without reflecting the logic of indirect tax. This is not a theoretical issue – it arises in practice whenever an intercompany pricing adjustment is made without being clearly connected to the underlying transactions.
When Does an Intercompany Pricing Adjustment Become a VAT Event?
There is no single answer to this question. The outcome depends on several substantive questions: can specific supplies of goods or services be identified? Can the adjustment itself be identified as consideration for an existing supply? And is there a direct link between the adjustment and the underlying supply?
In the European context, Articles 72 and 80 of the European Union VAT Directive (Council Directive 2006/112/EC) address transactions between related parties. The first defines the concept of open market value, and the second allows Member States to adjust the taxable amount where transactions between related parties may distort VAT outcomes. The European Union VAT Committee published, in Working Paper No. 923, an analysis of when a pricing adjustment may give rise to a VAT event, setting out substantive conditions that must be examined according to the circumstances of each case.
The analysis requires a careful factual review, and no general conclusion can be reached without examining the contractual structure, the pricing method applied and the group’s true-up mechanisms.
Recent European Case Law on the Issue
The Court of Justice of the European Union has begun to define the boundaries of this issue, but the case law is still developing and raises open questions that businesses must consider.
In its judgment of 4 September 2025 in Arcomet, the Court considered a case involving transfer pricing adjustments made under the transactional net margin method (TNMM). The Court held that adjustments of this type may, in certain circumstances, constitute a supply of services subject to VAT – particularly where they are integrated into a contractual framework based on reciprocal obligations and reflect the true value of services provided within the group. The key takeaway is how critical the drafting of intra-group agreements is, as well as the ability to demonstrate that the transaction exists in substance – not only on paper.
The Customs Risk
Beyond VAT, transfer pricing adjustments may also affect customs calculations – an exposure that is sometimes discovered only after the adjustment has already been made, at a stage when the available options are more limited.
Customs is generally calculated based on the import price declared at the time of import. When an adjustment is made after the fact, the question may arise whether the import declaration must be amended – and what the implications are in terms of additional customs duties, penalties and interest. No less important is the issue of the origin of goods. Changes in the composition of a product’s added value as a result of pricing adjustments may undermine eligibility for preferential origin status under free trade agreements – thereby affecting the group’s supply chain and commercial relationships.
Why a Tailored Professional Analysis Is Essential
The Issue Described Here Is Not Unique to Large Groups
Any business that carries out transactions with related companies outside Israel – whether an Israeli group with foreign subsidiaries, a foreign company operating in Israel, or a relationship between an Israeli entity and a parent company, sister company or other related party – may be exposed to these types of risks.
The main problem is that the exposure may be embedded in a pricing policy that appears entirely reasonable at the income tax level but does not examine the VAT and customs implications. A policy designed for only one purpose may create inconsistencies that tax authorities identify and use in audits – and sometimes, they use for this purpose the very agreements that were intended to provide protection.
It is also worth noting the developing trends in digital reporting. Under the European Union’s VAT in the Digital Age (VIDA) package, which is expected to enter into force on 1 July 2030, a unified digital reporting system for VAT purposes will be established. This will enable tax authorities to identify more easily discrepancies between VAT reporting and transfer pricing reporting. Groups operating in European Union countries should therefore ensure consistency between their pricing policy and VAT policy – already now.
A tailored professional analysis of the group structure, the contractual arrangements, the transfer pricing method applied, and the true-up mechanisms is the tool that makes it possible to identify exposures before they become a real problem, and to design a policy that takes the full picture into account.
Transfer Pricing, VAT And Customs Are Three Areas That Often Touch the Same Transaction, Examine It from Different Perspectives and May Reach Inconsistent Conclusions. Proper Risk Management in Today’s International Environment Requires an Approach That Integrates All Three Aspects from The Outset – Not Only After an Audit Begins
Nimrod Yaron & Co. is a firm specializing in Israeli and international taxation. Our team is composed of professionals with years of experience at the Israel Tax Authority, alongside experience at leading firms and law firms, bringing together legal and economic perspectives. We advise private and public companies, Israeli and foreign companies, global venture capital funds, as well as clients seeking focused advice in clear and accessible language. We also work with a professional network of accounting firms and law firms around the world, allowing us to provide comprehensive support in cross-border matters.
If your group manages intercompany transactions and applies a transfer pricing policy, it is worth examining whether the VAT and customs implications are being taken into account within the same framework. We offer targeted exposure reviews, support in building a comprehensive and coordinated pricing policy, and representation before the tax authorities when required.
Questions and Answers
Is every group that carries out intercompany transactions exposed to VAT risks?
Not every group is exposed to the same extent, but every group that makes intercompany pricing adjustments should ensure that they are also examined from a VAT perspective. The exposure depends, among other things, on the transfer pricing method applied, the drafting of the intra-group agreements and the true-up mechanism selected.
What is the difference between a profit allocation and a pricing adjustment for VAT purposes?
A retrospective price adjustment to existing transactions may fall within the scope of VAT, whereas a profit allocation that does not affect the transaction price itself is sometimes considered to fall outside the scope. The distinction is not always clear and depends on a careful factual and contractual analysis.
Are the existing intra-group agreements sufficient to protect against VAT exposure?
Contracts are an essential starting point, but they are not necessarily sufficient on their own. From a VAT perspective, the analysis also examines the economic substance behind the drafting. An agreement drafted for transfer pricing purposes only, without taking VAT implications into account, may not provide an adequate response in an audit.
What is the TNMM and why is it relevant to VAT?
The transactional net margin method – TNMM – is one of the common methods used to price intercompany transactions. The comparison is made at the level of overall profit margins, and therefore year-end adjustments are sometimes made to bring profitability within the target range. The Arcomet case emphasized that such adjustments may be regarded as a supply of services subject to VAT in certain circumstances.
What is the specific customs risk in the context of transfer pricing?
Customs is calculated based on the import price declared at the time of import. An after-the-fact adjustment may require an amendment to the import declaration, with implications including additional customs duties, penalties and interest. In addition, changes in the composition of a product’s added value may undermine eligibility for preferential origin status under free trade agreements – with significant commercial implications.
Can a transfer pricing policy be designed in advance to avoid VAT and customs exposure?
Yes, and this is the right approach. A pricing policy can be designed from the outset to take into account VAT and customs implications as well as income tax. This involves planning the true-up mechanisms and drafting the intra-group agreements in a way that reduces unnecessary exposures – and avoids the need to address issues under pressure after the fact.
What is VIDA and when does it enter into force?
The VAT in the Digital Age (VIDA) package, which is expected to enter into force on 1 July 2030, will create a unified digital reporting system for VAT purposes across the European Union. Transaction data will be transmitted to the tax authorities in near real time, increasing their ability to identify discrepancies between VAT reporting and transfer pricing reporting.
What should a group that has already made pricing adjustments in previous years review?
It should examine whether the adjustments were documented consistently, whether the drafting of the agreements supports the VAT position applied, and whether the required updates were made to customs declarations. A retrospective exposure review makes it possible to address weaknesses in an orderly and controlled manner.
