Eaton is an Ohio corporation with a global presence. It manufactures a wide range of electrical and industrial products. During the relevant period—2005 and 2006—Eaton had its foreign subsidiaries in Puerto Rico and the Dominican Republic manufacture certain products which Eaton then sold to its other affiliates and third-party customers. In 2002, Eaton applied for an APA related to these transactions. In 2004 the IRS and Eaton entered into the first APA which covered tax years 2001 through 2005. And in 2006 a second APA was entered which covered tax years 2006 through 2010. A few years after entering in to the APAs, Eaton reviewed its records and caught some inadvertent calculation errors. After letting the IRS know, Eaton corrected the mistakes. But the IRS thought that Eaton’s mistakes were serious enough to warrant its unilateral cancellation of the APAs for tax years 2005 and 2006. And after cancelling the APAs, the IRS handed Eaton a notice claiming a deficiency of tens of millions of dollars. Eaton filed a petition in the Tax Court, challenging the deficiency notice and the IRS’s cancellation of the APAs. The Tax Court sided with Eaton on the major issues, concluding that the IRS had wrongfully cancelled the APAs. However, the Tax Court also concluded that Eaton’s self-corrections didn’t constitute § 482 adjustments, and denied relief from double taxation. It reasoned that relief under Revenue Procedure 99-32 applies to § 482 adjustments only. An appeal was filed by the tax authorities – and a cross appeal by Eaton – with the Sixth Circuit (US Court of Appeal). Judgement of the Court The Court sided with Eaton on all issues presented, including Eaton’s claim for relief form double taxation. The Court held that (1) the IRS had the burden of proving that there were grounds to cancel the APAs under generally applicable contract-law principles and failed to meet that burden, and (2) the IRS could not impose IRC Section 6662 penalties on Eaton Corporation’s self-reported adjustments, and (3) that Eaton was eligible to claim relief from double taxation ...

A situation where Berry ratios can prove useful is for intermediary activities where a taxpayer purchases goods from an associated enterprise and on-sells them to other associated enterprises. In such cases, the resale price method may not be applicable given the absence of uncontrolled sales, and a cost plus method that would provide for a mark-up on the cost of goods sold might not be applicable either where the cost of goods sold consists in controlled purchases. By contrast, operating expenses in the case of an intermediary may be reasonably independent from transfer pricing formulation, unless they are materially affected by controlled transaction costs such as head office charges, rental fees or royalties paid to an associated enterprise, so that, depending on the facts and circumstances of the case, a Berry ratio may be an appropriate indicator, subject to the comments above ...

The selection of the appropriate financial indicator depends on the facts and circumstances of the case, see paragraph 2.82. Concerns have been expressed that Berry ratios are sometimes used in cases where they are not appropriate without the caution that is necessary in the selection and determination of any transfer pricing method and financial indicator. See paragraph 2.98 in relation to the use of cost-based indicators in general. One common difficulty in the determination of Berry ratios is that they are very sensitive to classification of costs as operating expenses or not, and therefore can pose comparability issues. In addition, the issues raised at paragraphs 2.99-2.100 above in relation to pass-through costs equally arise in the application of Berry ratios. In order for a Berry ratio to be appropriate to test the remuneration of a controlled transaction (e.g. consisting in the distribution of products), it is necessary that: The value of the functions performed in the controlled transaction (taking account of assets used and risks assumed) is proportional to the operating expenses, The value of the functions performed in the controlled transaction (taking account of assets used and risks assumed) is not materially affected by the value of the products distributed, i.e. it is not proportional to sales, and The taxpayer does not perform, in the controlled transactions, any other significant function (e.g. manufacturing function) that should be remunerated using another method or financial indicator ...

“Berry ratios” are defined as ratios of gross profit to operating expenses. Interest and extraneous income are generally excluded from the gross profit determination; depreciation and amortisation may or may not be included in the operating expenses, depending in particular on the possible uncertainties they can create in relation to valuation and comparability ...

Sabic India Pvt Ltd was primarily engaged in providing marketing support services to facilitate the selling of fertilizers and chemicals in India on behalf of the Sabic Group holding company. The Indian company did not hold any title to inventories and all products sold were directly invoiced to the holding companies of the taxpayer. To determine the arm’s length remuneration for marketing support services Sabic India Pvt Ltd found that the TNMM was the most appropriate method The tax authorities disagreed and instead held that the CUP method was more appropriate. On that basis an assessment was issued. Judgement of the Tax Appellate Tribunal The Tribunal decided in favor of Sabic India Pvt Ltd and set aside the tax assessment. The Tribunal held that the TNMM cannot be discarded without any valid justification as the method was widely accepted by the Indian revenue since 2009. The Tribunal concluded that the tax authorities were not able to provide any justification for its decision that the methodology was not suitable. Excerpt “Considering the facts of the case in hand in totality in the light of the judicial decisions mentioned here in above we are of the considered view that the lower authorities should have accepted TNMM as the most appropriate method on the business profile qua the international transaction of the assessee as was accepted in A.Y.2009-10 to 2014-15. We accordingly direct the AO/ TPO to delete the TP adjustment of Rs.361320620/- appeal filed by the assessee is accordingly allowed.” Click here for other translation ...

A Korean subsidiary in the “Semiconductor-group” was active in distribution and sales services. At issue was which transfer pricing method was the most appropriate for determining the arm’s length remuneration for these activities in FY 2013. Judgement of the Court The Court dismissed the claims of the company and upheld the decision of the tax authorities. Excerpt “However, the following circumstances that can be comprehensively acknowledged in the foregoing evidence and description in Evidence A No. 21, namely, (1) OECD Transfer Price Taxation Guidelines 2.101 stipulate that in order for a Gross Margin Ratio to be applied, a taxpayer shall not perform other important functions (manufacturing functions, etc.) that must be compensated using other transfer price methods or financial indicators in a related transaction, which are very sensitive to cost classification, such as operating expenses and other expenses, and thus may cause problems of comparability and irrelevant costs; and (2) Charles H. Berry, which devised the Gross Margin Method of the Transactional Net Margin Method, stated in the paper “Berry Ratios” that, in a case where a company performs other functions in addition to simple sales activities, the distinction between the cost of sales and the cost of operations is unclear and thus the gross margin ratio of sales can be artificially changed, and thus the Gross Margin Method of the Transactional Net Margin Method may not be applied. (3) Although the Plaintiff may perform a service installation and guarantee business, part sales business, in light of the above laws, it is difficult to apply the gross profit margin method among the transactional net margin methods to the Plaintiff’s sales support service transactions (even if the gross profit margin method among the Transactional Net Margin Methods can be applied, as the Plaintiff claims, the following circumstances that can comprehensively acknowledge the purpose of the entire pleadings in each of the descriptions of A Nos. 18 and 19, that is, (1), the codes of 508 companies extracted by the Plaintiff according to the industrial classification codes of the Korean Standard Industrial Classification are “46539: Other industrial machinery and equipment wholesale business, 46592: Medical, Precision and Scientific Equipment wholesale business, 46594: Machinery and equipment for electricity, wholesale business, 46599, and other wholesale business,” (1) In the case of the Plaintiff’s direct comparison of the technical support services and the wholesale business of the Plaintiff, which can be directly determined by the method (1) Four comparable companies were selected, and the difference in the degree of holding inventory assets, trade receivables, and purchase obligations was adjusted for comparability. Considering the characteristics of the Plaintiff in which inventory assets, trade receivables, and purchase obligations do not exist, it is difficult to deem that such adjustment is an ordinary net profit margin that can be generally accepted. Therefore, we do not accept the Plaintiff’s allegation in this part.” Click here for English translation Click here for other translation ...

A situation where Berry ratios can prove useful is for intermediary activities where a taxpayer purchases goods from an associated enterprise and on-sells them to other associated enterprises. In such cases, the resale price method may not be applicable given the absence of uncontrolled sales, and a cost plus method that would provide for a mark-up on the cost of goods sold might not be applicable either where the cost of goods sold consists in controlled purchases. By contrast, operating expenses in the case of an intermediary may be reasonably independent from transfer pricing formulation, unless they are materially affected by controlled transaction costs such as head office charges, rental fees or royalties paid to an associated enterprise, so that, depending on the facts and circumstances of the case, a Berry ratio may be an appropriate indicator, subject to the comments above ...

The selection of the appropriate financial indicator depends on the facts and circumstances of the case, see paragraph 2.82. Concerns have been expressed that Berry ratios are sometimes used in cases where they are not appropriate without the caution that is necessary in the selection and determination of any transfer pricing method and financial indicator. See paragraph 2.98 in relation to the use of cost-based indicators in general. One common difficulty in the determination of Berry ratios is that they are very sensitive to classification of costs as operating expenses or not, and therefore can pose comparability issues. In addition, the issues raised at paragraphs 2.99-2.100 above in relation to pass-through costs equally arise in the application of Berry ratios. In order for a Berry ratio to be appropriate to test the remuneration of a controlled transaction (e.g. consisting in the distribution of products), it is necessary that: The value of the functions performed in the controlled transaction (taking account of assets used and risks assumed) is proportional to the operating expenses, The value of the functions performed in the controlled transaction (taking account of assets used and risks assumed) is not materially affected by the value of the products distributed, i.e. it is not proportional to sales, and The taxpayer does not perform, in the controlled transactions, any other significant function (e.g. manufacturing function) that should be remunerated using another method or financial indicator ...

“Berry ratios” are defined as ratios of gross profit to operating expenses. Interest and extraneous income are generally excluded from the gross profit determination; depreciation and amortisation may or may not be included in the operating expenses, depending in particular on the possible uncertainties they can create in relation to valuation and comparability ...

Mitsui & Co., an Indian subsidiary in a Japanese multinational trading group, was involved in trade support activities which it performed to the benefit of the Japanese parent. The Indian subsidiary provided business support services for a wide range of products. These controlled transactions were benchmarked by the application of the TNMM using Berry Ratio as the PLI. The Indian tax authorities contested the transfer pricing approach. Judgement of the Income Tax Appelant Tribunal The Indian tax court ruled in favor of Mitsui. According to the Court, the Indian subsidiary did not bear any risk related to possession of goods, nor did it bear financial risk, or warranty risk ...

Hallmark Marketing Corporation was the exclusive wholesale distributor of Hallmark products in the US and had been granted a royalty-free licence to use the Hallmark trademark in the territory. Hallmark Marketing Corporation was characterised as a routine distributor and its income was determined using the TNMM method with Berry Ratio as the PLI. The New York Division of Taxation disagreed with the use of the Berry Ratio because Hallmark Marketing Corporation also performed manufacturing activities, brand protection functions and owned non-rutine intangible assets. Judgement of the Tax Appeals Commission The Tax Appeals Commission ruled in favour of Hallmark Marketing Corporation. According to the Commission, Hallmark Marketing Corporation was a limited-risk distributor and did not provide any valuable services or non-routine intangibles ...