Unfair trading is often referred to as the cause of crisis in various sectors, holding down small and medium enterprises. In practice, unfair trading is sometimes improperly confused with predatory pricing or distortion of competition. Unfair trading may also trigger serious tax implications.
The Commerce Act: Unfair Trading
Selling below competitors’ prices is not forbidden per se. Lower prices can encourage competition and, of course, benefit consumers.
However, under Croatia’s Commerce Act, selling below cost plus VAT is considered unfair trading. Exceptions include when goods are sold close to their expiration date, are being withdrawn from assortment, or are sold as part of an ultimate sale when closing the store or as part of a company’s bankruptcy and liquidation, along with other fair reasons for selling below cost that do not result in the prevention, limitation, or distortion of competition. What constitutes a “fair” reason is decided by the audit authorities, so one may question the equal treatment of all market participants.
The Commerce Act also refers to “competition,” so unfair trading matters are sometimes mistakenly brought before the Competition Agency. Ultimately, however, breaches of the Commerce Act fall within the inspectorate of the Ministry of Finance, and do not fall within the authority of the Competition Agency.
The Competition Act: Predatory Prices
Predatory prices, which are used to abuse an undertaking’s dominant position on the market, consist of selling products temporarily below their cost to squeeze-out a competitor or prevent it entry to the market, only to raise them afterwards.
For the Competition Agency to determine that an infringement of the Competition Act has occurred, the allegedly-predatory pricing strategy must include an undertaking’s dominant market position and market power strong enough to act independently of competitors and consumers.
Damage Claims
Indemnity claims for damages due to unfair trading or a competitor’s abuse of its dominant position should be addressed to the Court.
Tax Implications of Unfair Trading
Unfair trading is investigated and punished by the Ministry of Finance inspectorate. Practice has shown that its control may also take the form of significant transfer-pricing (tax) assessments.
Transfer pricing generally refers to prices and conditions of transactions within multinational groups, which should be in line with market prices and conditions. This is primarily a tax problem because of the risk that a multinational group may use transfer prices to decrease its tax base in one jurisdiction or to move profit from one jurisdiction to another.
Since trading in a multinational group is regulated by an internal pricing policy, whether a company is part of a group is one of the factors considered when analyzing potentially unfair trading. This may require further analysis of transfer prices applied in group transactions, resulting in additional tax assessments. In short, if the inspectors determine that trading was unfair and that prices applied in related party transactions are not in line with the arm’s length principle, they will adjust the undertaking’s tax base. This is usually done by increasing the tax base on the conclusion that the costs of goods/services were too high and/or that the selling prices were too low.
Transfer pricing analysis and conclusions of unfair trading may also result in adjustments to prices in non-related party transactions. If, for example, inspectors find that an undertaking operates at a net margin lower than the average competitors’ net margin and conclude that this is because of intra-group transactions preceding the transaction with unrelated parties, they may adjust the undertaking’s tax base to bring it into line with the level of its competitors.
These sanctions usually ignore other reasons for selling goods below cost (including VAT), such as enhancing entry to the market or selling “accessory” articles to improve sales of the main product, although, as such reasons do not in any way prevent, limit, or distort competition, they do not represent unfair trading.
In practice, undertakings that continuously make losses and have tax losses carried forward are likely to be subject to unfair trading control and transfer prices analysis.
Once in the authorities’ cross-hairs, undertakings may expect to face long and uncertain administrative procedures. Tax matters are finally resolved by Administrative courts, where procedures regularly last between three and four years. The levied tax obligations are generally payable before the court procedure – i.e., based on the final tax resolution.
To conclude, unfair trading is a threat to market and consumer trust and undertakings which are judged to be trading unfairly expose themselves to significant fines and tax audits. The rules on unfair trading should therefore be taken seriously and companies should review prevention measures carefully and regularly.
By Tamara Jelic Kazic, Partner, and Marija Zrno, Attorney-at-Law, CMS Zagreb
This Article was originally published in Issue 4.11 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.