XZ España SA, a Spanish subsidiary of a multinational consumer goods group, underwent a corporate income tax audit for the 2015–17 financial years. The controlled transactions included intra-group loans, participation in cross-border and domestic cash pooling arrangements, and the provision of contract manufacturing services to related entities. For manufacturing activities, the group applied the TNMM with EBIT over total costs as the profit level indicator, supported by a benchmarking study.
While the tax authorities accepted the method and profit indicator used for manufacturing services, they rejected part of the comparable set used by the taxpayer and recalculated the interquartile range. Based on this, they concluded that the taxpayer’s profitability fell outside the arm’s length range and adjusted the margin to the median. Adjustments were also made in relation to intra-group loans and cash pooling. These included the use of the group credit rating, the rejection of country risk adjustments, the substitution of Euribor with Eonia, and the requirement for symmetrical remuneration of creditor and debtor positions.
XZ España SA challenged the assessment relating to manufacturing services, arguing that the automatic adjustment to the median for these services was unjustified as the tax authorities had not identified any ongoing comparability defects after refining the comparable set. The taxpayer relied on OECD Guidelines paragraphs 3.61 and 3.62, as well as Spanish case law, to argue that any adjustment should be made to the lower quartile in the absence of proven comparability defects. The taxpayer also contested the transfer pricing adjustments relating to intra-group financing and cash pooling.
Judgment
The court upheld the transfer pricing adjustments relating to intra-group loans and cash pooling in full. However, it partially upheld XZ España SA’s claim in relation to manufacturing services. The court held that, while the tax authorities were entitled to revise the comparable set and determine a new interquartile range, they had not justified the existence of persistent comparability defects that would warrant the use of a measure of central tendency/median. In the absence of such justification, the court ruled that the adjustment could not be made to the median, but instead to the lower quartile of the range.
Excerpt in English
“It is clear that the arguments presented on pages 103 and 104 of the statement of disagreement, and those expressed on pages 80 and 81 of the settlement agreement, do not justify the existence of comparability defects that, in accordance with paragraph 3.62 of the OECD Guidelines, would advise the use of the median to determine the point in the range that would satisfy the arm’s length principle.
On the other hand, in the analysis, by the Inspection, of the allegations made by the entity, which are subject to partial estimation, a “new interquartile range” is determined -page 88 of the settlement agreement- indicating that its main consequence “is that the result of the taxpayer in the years subject to verification would continue to be outside the range and it would be necessary to make an adjustment of said results to the median of the new interquartile range” .
And it is established -page 90 of the settlement agreement- that “partially accepting the claim of the entity with regard to the exclusion of entities dedicated exclusively to the manufacture of water and other beverages, we will recalculate, with the new margins, the adjustment to be made with respect to the 2015 and 2016 financial years, as the new study yields, with respect to 2017, the same median as that used in the actuary’s proposal” .
Nor is there any justification, in the arguments included in the settlement agreement when examining allegations made by the taxpayer, for the existence of comparability defects that would advise the use of the median.
Therefore, the partial assessment of the claim made is appropriate, and the adjustment should be made to the lower quartile of the range obtained by the Inspection instead of to the median.”
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