A. S.R.L. was issued with a notice of additional taxable income based on an audit of the pricing of the company’s controlled transactions. Among other things, the tax authority had found that the company had claimed to have achieved a profitability rate of 10% on the sale of finished products to the related company B., when in fact this was not the case. If the profitability had been 10%, corporate income tax of RON 3,840,000 would have been paid, but A. S.R.L. only paid RON 188,302 in tax. In the assessment, the tax authority had applied the TNMM using the median of the ROTC indicator for comparable independent companies and, on this basis, determined additional income for the period 2012-2016. An appeal was lodged which went to the High Court. Judgement of the Court The Court dismissed the appeal and found largely in favour of the tax authorities. Excerpt (In English) “As stated in Art. 3.43 of the OECD Guidelines the illustrative list of selection criteria presented in the Guidelines is neither limiting nor prescriptive, as long as the whole process of searching for comparables is transparent and verifiable. The transfer pricing file notes that a number of quantitative and qualitative criteria were also applied to the companies initially selected, so that the expert found that the independent companies considered by the complainant company in determining the interquartile range were comparable in terms of the criteria set out in the OECD Guidelines. The High Court finds that the appellant-respondents did not provide a basis for requiring the introduction of the size criterion in the selection of comparable companies. The Appellants’ argument is that the use of a minimum threshold for these criteria (size criteria) would have been relevant in the identification of independent companies for the comparability sample, but they have not indicated what the legal basis is for such an obligation, in order for the Court of Appeal to find a possible misapplication of the law. The algorithm for selecting comparable companies is entirely an economic, factual algorithm which is within the competence of specialists and the soundness of which can be verified only by the court of first instance, and it is not appropriate for the appeal brought on the basis of grounds of appeal to analyse that aspect. The High Court finds that the Court of First Instance did not misapply the law when it found that the independent companies taken into account by the applicant company in determining the interquartile range were comparable in terms of the criteria set out in the OECD Guidelines, and that the fact that the tax authorities had found that the operating income obtained by F. are lower than those of the Appellant was not sufficient to exclude it from the comparability sample, since the tax authorities did not justify the need to introduce a size criterion for maintaining it in the comparability sample for the period 2012-2016. At the same time, however, since the expert’s verification revealed situations in which A. did not fall within the interquartile range calculated for independent companies with the same functional profile, it was necessary to adjust the company’s income, which was such as to render the claim only partially unlawful. As regards the criticism that the tax inspection authorities found that the company claimed to have achieved a 10% profitability rate from the sale of finished products to the affiliated company B., but in reality this profitability rate did not exist in the financial results of the respondent, the first court took into account the fact that, in the light of the provisions of Articles 3.62 and 3.76 of the OECD Guidelines, the expert identified in the transfer pricing file the choice and justification of the transfer pricing calculation method and the data used, which is as follows: “7.3.2 Application of the cost-plus method to the operating profit/net margin method.” Article 3.62 of the 2010 OECD Guidelines states, “In determining this point, if the range contains relatively equal and highly reliable results, it could be argued that any point in the range satisfies the arm’s length principle. Where comparability flaws remain as discussed in paragraph 3.57, it may be appropriate to use measures of central tendency to determine this point (e.g. median, principal or weighted averages, etc., depending on the specific characteristics of the data set), in order to minimise the risk of error due to remaining unknown or unquantifiable comparability flaws.” Art. 3.76 of the OECD Guidelines states, “To obtain a complete understanding of the facts and circumstances surrounding an audited transaction, it may generally be useful to examine data from both the year under review and previous years. Analysis of such information could reveal facts that may have influenced (or should have influenced) transfer pricing. For example, the use of prior years’ data will show whether the taxpayer’s reported loss on a transaction is part of a history of losses on similar transactions, the result of certain economic conditions in a prior year that resulted in higher costs in the following year, or a reflection of the fact that a product is at the end of its life cycle. Such an analysis can be particularly useful when applying a transactional projection method. See paragraph 1.72 on the usefulness of multi-yearly data in examining loss statements. Multi-year data can improve understanding of long-term arrangements.” Following the analysis of the transfer pricing file and the chapters of the 2010 OECD Guidelines mentioned above, the expert concludes that the multi-year weighted average of the profit indicator determined in the transfer pricing file over the period 2012-2016 for comparable independent companies is a viable calculation option as set out in the OECD Guidelines, but not fully justifiable in this case. As regards the request to the expert to verify whether, in the light of the OECD Guidelines, the adjustment is made to the multi-year average of the range analysed or to the annual median, it was held that, in view of the provisions of Chapters A.7 ...

On 24 May 2022, the Italian Tax Agency (Agenzia delle Entrate) released CIRCULAR NO. 16/E containing operational instructions on issues relating to application of the arm’s length range. The circular – which is based on the OECD transfer Pricing Guidelines, guidance on benchmark studies issued by the Joint Transfer Pricing Forum, and relevant Italian case laws – provides operational instructions regarding the correct interpretation of the notion of “arm’s length range”, as also specified in Article 6 of the Decree of 14 May 2018, when applying the provisions set forth in Article 110, paragraph 7, of the Consolidated Income Tax Act or of the provisions contained in the Double Taxation Treaties entered into by Italy in accordance with Article 9 of the OECD Model Convention. The operational instructions concludes as follows the correct application of the most appropriate transfer pricing method may, instead of a single value, lead to a range of values all complying with the arm’s length principle; in such cases, the full range of values within the arm’s length range may be used if all the transactions identified in the range are equally comparable; if, on the other hand, some of the transactions within the range show defects of comparability that cannot be reliably identified or quantified and, therefore adjusted, the use of ‘statistical tools’ (in order to strengthen their reliability) and a value within the narrow range is preferable. Recourse, on the other hand, to a value as central as possible within the range (also in order to minimise the risk of error due to the presence of such defects) must be limited to cases in which the range does not include values characterised by a sufficient degree of comparability even to consider reliable any point within the narrow range by means of statistical tools and must, in any case, be specifically justified; Therefore, it will be the responsibility of the Offices to resort to the “full range” for the purpose of identifying the arm’s length range only in those cases in which a perfect comparability of all the observations of the set with the “tested party” can be discerned. In conclusion, in recalling once again that according to the OECD Guidelines the identification of a set of values could be symptomatic of the fact that the application of the arm’s length principle allows in certain circumstances to reach only an approximation of the conditions that would have been established between independent enterprises, it is recommended that the adjustments involving the identification of the point that best satisfies the arm’s length principle within the range be argued in detail. Click here for English translation Click here for other translation ...

In this case “A. Median S.R.L.” had appealed a decision of the court of first instance where the income had been determined to the median value. According to the company the median is not the only value corresponding to the market value, when both the lower limit and the upper limit of the range of comparison in turn reflect the market value of the goods or services supplied. The provisions of Article 2.7 of the Guidelines were relied on in that regard. “…the assessment must be made in a manner which does not contravene Article 2.7 of the OECD Guidelines, that is to say, does not lead to overtaxation. However, given that the court of first instance assumed that the only value which may be taken into account in determining the transfer price is the median value, any other value within the margin established is excluded, which is contrary to the Tax Code and the OECD Guidelines.” The Tax authorities requested that the appeal be dismissed as unfounded. In its grounds, it states that the provisions of the Code do not reveal the priority applicability of the rules set out in the OECD Guidelines, but highlight the fact that, depending on the circumstances of the case, the relevant guidelines which the Guidelines develop are taken into account. The Guide is a practical tool and its incorporation into national legislation has been left to the discretion of the States. Although Romania is not a member of the OECD, there has been concern to align with international standards in this area. However, it should be borne in mind that the provisions of the Guide can only be invoked domestically if they are incorporated into national legislation. Judgement of Court The Court dismissed the appeal of “A. Median S.R.L.” and decided in favor of the tax authorities. “Having analysed the documents and the case-file and the judgment under appeal in the light of the grounds for annulment, the High Court finds that the appeal brought by the applicant A. S.R.L. is unfounded….” Excerpts (Unofficial English translation) “The Court of First Instance correctly held that the provisions of the Order, which state that the adjustment/estimation of transfer prices is to take place at the median value of the comparison range, fully correspond to the provisions of the Tax Code. Compliance with the market price in transactions between related persons is verified on the basis of the transfer pricing file and involves an analysis under conditions of comparability of controlled transactions in relation to uncontrolled ones, using the most appropriate method among those provided for in Article 11(1)(b) of the Code. (2) of the Tax Code. The result of the analysis is reflected in a range of values/range of values with relatively equal relevance. If the prices used in the relationship between the affiliates fall within this range, the provisions of the Tax Code relating to the adjustment do not apply. Adjustment occurs when the prices used by the affiliates do not fall within the range of comparison and that adjustment, as provided for in the rule challenged by the applicant, takes place at the median value of the range of comparison. The appellant-claimant submits that any value of the comparison range, that is to say not only the median value but also the lower quartile as well as the upper quartile of the comparison range, corresponds to the market value, so that the norming of the adjustment to the median value is unlawful. The High Court finds that the claims of the appellant-appellant are unfounded since the median value of the comparison range best corresponds to the requirement to reflect market value. The appellant criticises, in fact, the failure of the secondary legislature to adopt the rule of adjustment to any value of the comparison range which would be more favourable to the affiliated person concerned by the transfer pricing verification. That does not, however, constitute, in relation to the higher-ranking legislative framework, a criticism of the unlawfulness of the lower-ranking rules under challenge. Transfer pricing is not an exact science, as the OECD Guidelines also point out. There is flexibility in terms of the methods used for comparison, and in terms of assessing the results by reference to a range of values rather than a fixed point. However, when verified prices fall outside the range of comparison, the manner of adjustment to reflect market value is within the discretion of the secondary legislator. And the solution chosen by the secondary judge – adjusting to the median value of the comparison range – is the one that best meets the imperative of reflecting market value and the imperative of uniform and equal application of the tax law. The exercise of this role by the national tax administration is also recognised by the OECD Guidelines, paragraphs 3.61 and 3.62. Moreover, the very recommendations in the OECD Guidelines referred to above are to the effect that the point within the range at which the adjustment takes place should be the median value if there are some comparability flaws which cannot be identified and/or quantified. The applicant’s references to paragraph 2.7 of the OECD Guidelines were correctly dismissed by the court. Those provisions contain recommendations applicable at the stage of carrying out the comparability analysis, which ends with the establishment of the comparability range. Paragraph 2.7 refers to profit-based methods of comparison and not to the adjustment operation. As such, not only at the level of the legality analysis, but not even at the level of argument, the reference to point 2.7 of the Guidelines is irrelevant and does not support the appellant-claimant’s contention that the choice of the median adjustment solution could lead to overtaxation.” “Referring to paragraphs 3.57 and 3.62 of the OECD Guidelines, the appellant submits that the central tendency of the market is not a point, but a range, namely the range of comparison, from the lower quartile to the upper quartile, and that the Guidelines leave the possibility of adjustment to any ...