Ferroli España, S.L.U. is a Spanish manufacturer manufacture of cookers and heaters. In FY 2010 and 2011 the company had various transactions with other companies in the Ferroli Group and reported negative profit margins on these transactions. According to the company this was due to the financial crises in Spain.
Following an audit, the tax authorities issued a notice of assessment where the profit of Ferrolia had been adjusted resulting in additional taxable income. The TNN method had been used and profits were adjusted to the median.
An appeal was filed by Ferroli.
Judgement of the Court
The Court largely ruled in favor of the tax authorities, but according to the Court, an adjustment to the median could only be made where the tax authorities established the existence of comparability defects. Since sufficient proof of such defects had not been established, the adjustment was reduced to the lower quartile (3 % ROS).
Excerpts
“We are therefore within the scope of point 3.61 of the OECD Guidelines, which states: “If the relevant terms of the controlled transaction (e.g. price or margin) are outside the arm’s length range determined by the tax administration, the taxpayer should be given the opportunity to argue how the terms of the controlled transaction satisfy the arm’s length principle, and whether the result falls within the arm’s length range (i.e. that the arm’s length range is different from that determined by the tax administration). If the taxpayer is not able to demonstrate these facts, the tax administration must determine the point within the arm’s length range to which to adjust the condition of the controlled transaction”.”
“Well, the Central Economic-Administrative Court justifies the application of this rule in the following reasoning: “finding ourselves in a situation in which the margin used is out of range, and the reasons have not been accredited, we have to say that we consider it correct to apply the median or central tendency for the determination of the net operating margin between the company’s sales (in this sense, section 3.57 of the OECD Directives”.
In the judgment of this Chamber and Section of 4 February 2021 (ROJ: SAN 416/2021, FJ 2.10), we have summarised the interpretative position on the conditions under which recourse to rule 3. 61 of the OECD Guidelines, as expressed in the judgment of 6 March 2019 (ROJ: SAN 1072/2019), in the following terms: “it is legitimate to resort to what the Guideline calls “measures of central tendency”, but whoever resorts to them has the burden of reasoning and setting out the reasons that lead to their application”.
In the aforementioned judgment of 6 March 2019 (ROJ: SAN 1072/2019, FJ 3), the improper application of the disputed rule by the Tax Administration was reasoned as follows: “In short, it seems to us that, in effect, once it has been determined that the appellant’s ROS in the year under discussion is outside the lowest interquartile range – 2.1% – it is appropriate, in effect, to carry out the corresponding adjustment. But the fact that this occurs does not, without more, allow the median to be applied in the terms provided for in rule 3.62, since the application of that rule is not justified by the fact of being outside the range of full competence, but rather by the existence of “defects in comparability”, which according to the arguments of the TEAC itself were not acceptable in 2008 and, by extension, neither would they be acceptable in relation to 2007″.”
As we can see, the contested decision incurs in the same deficiency of reasoning that we appreciate in the precedent cited above, beyond the differences between the different factual assumptions being tried, as the Central Economic-Administrative Court considers the appeal to the median to be plausible due to the mere existence of a deviation from the range of full competence determined by the Tax Administration. The justification offered by the assessment agreement and which the respondent administration reiterates in its reply, that the margins obtained are too wide, is not sufficient to consider that the burden of reasoning and setting out the reasons that lead to the application of the median in accordance with the provisions of rule 3.61 of the OECD Guidelines, that is to say, due to the persistence of defects of comparability, has been fulfilled. The reasoning offered by the tax authorities that the margins are too wide, having accepted that in 2011 the arm’s length range is within an interquartile range between 3.60 and 6.90 per cent, is not considered sufficiently expressive of the reasons that would support the application of the median in the sense stated above.
The plea on this point is upheld and the application of the lowest point of the arm’s length range determined by the tax authorities (3%) is considered appropriate, with the legal effects inherent in this statement.”
Click here for English translation
Click here for other translation