The recent dispute between the Czech Republic tax authorities and Hitachi Astemo Czech s.r.o., resolved by the Regional Court in Brno (Case No. 15 Af 10/2023-128), constitutes a particularly significant ruling on transfer pricing. The focus of the dispute was not on the mechanical application of a valuation method, but on a more profound issue: when an intra-group instruction, even without a formal contract, can constitute a controlled transaction subject to adjustment under the arm’s length principle.
The case forces us to reflect on the precise delimitation of transactions, the consistency between an entity’s functional profile and the risks it assumes, as well as the growing tendency of tax authorities and courts to privilege economic substance over contractual formalism.
The background to the conflict: group instructions with economic impact
The controversy arises from strategic decisions taken within the multinational group to which the Czech subsidiary belonged. As a result of these decisions, the local entity assumed certain costs that had a negative impact on its profitability. The tax authority considered that these costs had not been duly compensated and that, under market conditions, an independent company would not have accepted such an economic burden without adequate consideration.
The taxpayer’s central argument was based on the absence of a specific contract obliging the parent company to compensate the subsidiary. From this perspective, these were business decisions specific to the internal dynamics of a group and not an autonomous controlled transaction.
The court, however, took a different approach. The analysis was not limited to the legal form, but focused on the actual economic effect of the instruction. If an internal decision has concrete financial consequences for a related entity, that reality can be examined under transfer pricing rules, even if there is no explicit contractual agreement structuring the transaction.
The delimitation of the transaction: beyond the contract
One of the most relevant contributions of the ruling is the reaffirmation of the concept of “precise delineation of the transaction.” Within the framework of international standards, the identification of the controlled transaction is not limited to reading the contract. It is essential to analyze the actual conduct of the parties, the functions performed, the assets used, and the risks actually assumed.
In this regard, the court understood that the parent company’s instruction could not be evaluated as a simple internal act without tax consequences. The assumption of costs by the subsidiary constituted a verifiable economic fact. The question, therefore, was not whether there was a formal document, but whether an independent company, acting in comparable circumstances, would have accepted that burden without compensation.
This reasoning is in line with an increasingly established trend in international practice: transfer pricing analysis focuses on the substance and economic rationality of the conduct, not solely on the contractual architecture designed by the group.
Functional profile and economic consistency
The case also requires an examination of the consistency between an entity’s stated functional profile and the risks it actually assumes. If a subsidiary operates under a limited risk model—for example, as a contract manufacturer or provider of routine services—the assumption of extraordinary losses or strategic risks could be inconsistent with its economic characterization.
Under market conditions, an independent company carefully evaluates the financial impact of each decision. Accepting significant costs without a reasonable expectation of recovery or without explicit compensation would hardly be consistent with rational business behavior.
Therefore, the technical analysis must answer an essential question: Is the observed behavior consistent with the functional profile and level of risk that the entity claims to assume? If the answer is no, the tax authority may question the allocation of results and make adjustments to the tax base.
Substance over form: a consolidated trend
The decision of the Regional Court in Brno is not an isolated case. In multiple jurisdictions, tax authorities have expanded the scope of transfer pricing analysis to cover situations where there is no formal contract but there is an economic transfer of value or an implicit reallocation of risks.
This approach implies that internal group policies, centralized strategic decisions, and corporate reorganizations can have significant tax implications. The fact that an instruction emanates from the parent company does not eliminate the need to assess whether the subsidiary was treated in accordance with market conditions.
From a technical perspective, this requires a more rigorous analysis in scenarios such as:
- Operational restructuring with transfer of functions or risks.
- Early termination of intra-group contracts.
- Assumption of losses arising from global strategic decisions.
- Centralization of activities with an impact on local profitability.
In all these cases, the determining factor is economic rationality and consistency with the arm’s length principle.
Practical implications for multinational groups
The Czech precedent offers several relevant lessons for international tax management. First, companies must integrate transfer pricing analysis into the strategic decision-making process. It is not enough to document ex post; it is essential to assess in advance the economic impact and consistency with the functional profile of each entity.
Second, the absence of contractual documentation increases risk. Although substance prevails over form, the existence of clear contracts, contemporary economic analyses, and well-defined internal policies strengthens the defensive position in the event of an audit.
Finally, the case shows that the allocation of losses within a multinational group is a particularly sensitive issue. The tax authority will examine whether the entity bearing the negative impact has the actual capacity to assume the risk and whether it receives compensation commensurate with its functional contribution.
Economic consistency as the basis for defense
The case of Czech Republic vs. Hitachi Astemo Czech s.r.o. confirms that transfer pricing analysis goes beyond the literal wording of contracts: intra-group decisions with a financial impact can be classified as controlled transactions when they generate verifiable economic effects and alter the allocation of risks or results within the group. Economic substance, consistency with the functional profile, and business rationality are now the true pillars of tax examination.
In an environment where authorities are intensifying their scrutiny of the actual conduct of related parties, anticipation and technical consistency are the best defense. Reviewing intra-group policies and validating the correct allocation of risks not only responds to a regulatory requirement, but also to a strategy of financial and reputational protection.
If your organization is facing reorganizations or decisions with cross-border impact, having a company specializing in transfer pricing is key to mitigating contingencies. TPC Group assists multinational groups in the structuring and technical defense of their intragroup policies, ensuring alignment with international standards and strengthening their position in the event of audits.
Source: TPCases