The French company Issey Miyake Europe is owned by the Japanese company, Issey Miyake Inc, which is active in the fashion industry.
Following an audit covering the FY 2006 – 2012, the tax authorities issued an assessment of additional income. According to the tax authorities the pricing of controlled transactions was not at arm’s length, resulting in an indirect transfer of profits within the meaning of Article 57 of the General Tax Code.
In order to determine the arm’s length results, the tax authorities applied the transactional net margin method. After searching for comparables on the basis of a database and selecting seven companies for the retail business and nine companies for the wholesale business, and then examining the net operating margins, it adjusted the result to the median. It concluded that Issey Miyake Europe’s results as a wholesaler were within the arm’s length range, but that its results as a retailer were not, with the exception of the financial year ending in 2012, and adopted a rate for this activity corresponding to the median (3,82% for FY 2005, 2.39% for FY 2006, 2.06% for FY 2007, 1.43% for FY 2008, 1.70% for FY 2009, 1.58% for FY 2010 and 2.07% for FY 2011.
Not satisfied with the assessment, Issey Miyake Europe appealed to the Administrative Court, which dismissed the appeal.
Issey Miyake Europe then appealed to the Court of Administrative Appeals.
Judgment of the Court
The Court of Administrative Appeals udheld the decision of the Administrative Court and ruled in favour of the tax authorities.
Excerpts:
“6. In these circumstances, the tax authorities have established that Issey Miyake Inc sells its products to all its subsidiaries worldwide at cost price, to which a margin is added without taking into account the specific nature of local markets, Maintaining the loss-making business in France enabled this company to benefit from a showcase to display and develop the brand’s reputation and to have a commercial outlet in a market with international influence in the luxury goods sector, while Issey Miyake Europe incurred rent expenses that were excessive in relation to its activity with a view to developing the brand. It thus provides evidence that Issey Miyake Europe’s operating result was structurally in deficit for the period under review due to its retail sales activity, as a result of the additional costs incurred by the marketing strategy, which had the effect of having Issey Miyake Inc’s intangible assets valued by its subsidiary.”
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10. Thirdly, it is clear from the investigation, in particular from the terms of the rectification proposal and the response to the taxpayer’s observations, which are not seriously contested, that Issey Miyake Europe, although questioned on this point and even though it was not bound by detailed documentary obligations, did not produce any sufficiently precise evidence during the accounting audit to justify transfer prices, contrary to what it maintains. On the other hand, it submitted a study carried out in June 2015 by Grant Thornton during the taxation procedure, which analysed transactions involving inventories for the period between the financial year ending in 2012 and that ending in 2014 and found, after carrying out an analysis of the functions and risks of Issey Miyake Inc and Issey Miyake Europe alone, the cost-plus method, on the grounds that Issey Miyake Inc also sells wholesale to independent companies in the Asia-Oceania region and that these transactions are similar to those carried out with Issey Miyake Europe. However, this study, which notes that the markets analysed are different and relate to a period other than the period audited, compares the margins achieved by Issey Miyake Inc in its sales to independent distributors with the margins achieved in sales to Issey Miyake Europe, making adjustments to take account of the length of the distribution channel and differences in exchange rate risks, without providing any specific information concerning the products sold, as the study merely refers in general terms to the types of products, the volumes of transactions compared and the contractual stipulations governing these transactions. In these circumstances, the tax authorities were right to reject the method proposed by Issey Miyake Europe.
11. Furthermore, although Issey Miyake Europe contests the principle of the administration’s use of the transactional net margin method, the investigation does not show that the administration had sufficient information, internal to the group, on transfer pricing to enable it to use a method based on transactions, and the applicant does not provide any evidence to support its allegations that the analysis of functions and risks carried out on the basis of its own replies was erroneous. Nor does it provide any evidence in support of its allegations that the method used by the tax authorities would, as a matter of principle, result in over-taxation that did not take commercial factors into account. In these circumstances, Issey Miyake Europe is not entitled to argue that the tax authorities could not have used the transactional net margin method.
12. Fourthly, Issey Miyake Europe maintains that the comparables used by the tax authorities for the retail business are not relevant, since the companies in question are engaged in distribution in the clothing sector and not in the luxury goods sector, which has its own specific requirements, as confirmed by the aesthetics of the windows, the quality of the shops, the locations, the type of staff and the price of the products sold. However, the purpose of the transactional net margin method is to compare the results of controlled transactions with those of third-party companies performing comparable functions and assuming comparable risks, unlike price-based methods, which require the products sold to be similar. In this case, Issey Miyake Europe simply refutes the comparables on the sole grounds that they are not independent French companies distributing luxury ready-to-wear clothing similar to that which it distributes and under the same conditions, whereas the administration, which excluded the companies initially retained whose functions were likely to present substantial differences, such as those performing manufacturing and production functions, appended to the proposed rectification the social and accounting data for the audited financial years of the companies finally retained, all of which specialise in the distribution of clothing and fashion accessories on the national market, and did not simply refer to the description of the business given in the database used. Moreover, Issey Miyake Europe, which does not propose any adjustment relating to the impact of the specific charges that it claims do not contribute to the valuation of the brand, argues that it was not itself able to identify independent French companies distributing luxury ready-to-wear garments similar to those that it distributes. In these circumstances, the tax authorities provide evidence of the relevance of the comparables used.
13. Fifthly, Issey Miyake Europe maintains that the tax authorities were wrong to use the mid-point of the arm’s length interval to make the adjustments at issue, since they had to carry out a detailed study of the situation and the transactions carried out in order to determine the point of the interval to be used. However, it does not refer to any specific circumstances justifying deviation from the mid-point, even though the tax authorities themselves have not noted any such circumstances with regard to the facts and characteristics of Issey Miyake Europe as set out in the proposed adjustment.
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“17. It follows from all the foregoing that Issey Miyake Europe has no grounds for claiming that the Paris Administrative Court wrongly rejected its claim in the judgment under appeal, which is sufficiently reasoned. Its claims for annulment of that judgment and reinstatement of its declared deficits must therefore be rejected.”
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