SAS Sames Kremlin marketed its products abroad through subsidiaries or independent agents, depending on the territory. In Argentina, Brazil, India, Portugal and Russia it sold its products through subsidiaries under either a buy/sell distributor agreement or a commissionaire agreement. In Iran, Turkey and South Korea it sold the goods through independent agents to whom it paid a commission. The tax authorities considered that the commission paid to the independent agents was a CUP and determined the commission paid to the subsidiaries on that basis. The remuneration of the subsidiaries in excess of the commission (margin) paid to the independent agents was considered to be a transfer of profits abroad. SAS Sames Kremlin appealed against the assessment, arguing that the subsidiaries performed much more important functions than independent agents and that there were also significant geographical differences. The Administrative Court rejected the appeal and the case was then brought before the Administrative Court of Appeal. Judgement of the Court The Court upheld the decision of the Administrative Court and dismissed SAS Sames Kremlin’s appeal. Excerpt: “4. In order to justify the higher amount of remuneration paid to the subsidiaries of the group headed by SAS Sames Kremlin, compared with the amount paid to independent local intermediaries, SAS Sames Kremlin argued that the geographical markets in which the subsidiaries operated were fundamentally different from those in which the third-party sales agents operated, since they were highly strategic insofar as they were home to large car manufacturers, while the other markets were anecdotal. The subsidiaries responded to major invitations to tender, whereas the local sales agents were involved only in the supply of spare parts and small equipment, and the subsidiaries provided additional marketing, after-sales service, on-site assembly and testing of equipment, and assistance with the collection of debts, as evidenced by the significant human resources at their disposal. 5. Although the turnover achieved in Iran, Turkey and South Korea was generally lower than that achieved through the subsidiaries, it does not appear from the investigation that the characteristics of these markets justify the differences in the remuneration paid to the subsidiaries and to the independent intermediaries, since the turnover achieved by the subsidiaries is not systematically higher than the turnover achieved through independent sales agents. Even supposing that the composition of turnover achieved through independent sales agents is different from that achieved through subsidiaries, the latter including more sales of large equipment through tenders and fewer sales of spare parts and small equipment, which is not apparent from the investigation in the case of certain subsidiaries, it is common ground that the remuneration of independent sales agents does not take account of the nature of the products and equipment sold, since it is invariably set at 20% of turnover, and that the remuneration paid to subsidiaries is, irrespective of the nature of the products, equivalent to the amount of the discount they would have received if they had acted as a buyer-reseller. Finally, it is not apparent from the documents in the files that the services provided by the independent intermediaries are significantly less substantial than the services provided by the subsidiaries in their intermediation activity alone. The mere fact that the subsidiaries have greater material and human resources is not sufficient to presume, in the absence of documents in the file to that effect, that those resources were used in the context of the latter activity. It follows that, contrary to what is maintained, it does not follow from the investigation that the differences in remuneration between subsidiaries and intermediary agents can be explained by the different situation of those suppliers. Although the applicant company argues that the commissions paid to the subsidiaries take account of the margin which they would have made on a purchase/resale of the same product, such an argument is not such as to justify the abovementioned differences in remuneration between the economic agents belonging to the group and those outside it, since they are involved in the same intermediary activity, which is different from the purchase/resale activity. The various doctrines referred to, which are not expressly invoked on the basis of the provisions of Article L. 80 A of the Book of Tax Procedures, do not interpret the tax law differently from the above. 6. It follows that the tax authorities must be regarded as establishing, under the conditions referred to in point 3, the existence of an advantage, and were entitled to reintegrate it into the results of the French company, as the latter did not justify that this advantage would have had at least equivalent counterparts for it.” Click here for English translation Click here for other translation ...

SA Exel Industries marketed its products abroad through subsidiaries or independent agents, depending on the territory. In Brazil, India, Argentina, Russia and Portugal it sold its products through subsidiaries under either a buy/sell distributor agreement or a commissionaire agreement. In Iran, Turkey and South Korea it sold through independent agents to whom it paid a commission. The tax authorities considered that the commission paid to the independent agents was a CUP and determined the commission paid to the subsidiaries on that basis. The remuneration of the subsidiaries in excess of the commission (margin) paid to the independent agents was considered to be a transfer of profits abroad. SA Exel Industries appealed against this assessment, arguing that the subsidiaries performed much more important functions than independent agents. It also argued that there were significant market differences, since the subsidiaries operated in highly strategic markets where the major car manufacturers were dominant, while the other markets in which the independent agents operated were anecdotal. The Administrative Court dismissed the appeal and the case was then brought to the Administrative Court of Appeal. Judgement of the Court The Court upheld the decision of the Administrative Court and dismissed SA Exel Industries’ appeal. Excerpt “4. In order to justify the higher amount of remuneration paid to the subsidiaries of the group it heads, compared with the amount paid to independent local intermediaries, SA Exel Industries argues that the geographical markets in which the subsidiaries operated are fundamentally different from those in which the third-party sales agents operated, since they are highly strategic in that they are home to large car manufacturers, whereas the other markets are anecdotal, The subsidiaries responded to major invitations to tender, whereas the local sales agents were involved only in the supply of spare parts and small equipment, and the subsidiaries provided additional marketing, after-sales service, on-site assembly and testing of equipment, and assistance with the collection of debts, as evidenced by the significant human resources at their disposal. 5. Although the turnover achieved in Iran, Turkey and South Korea was generally lower than that achieved through the subsidiaries, it does not appear from the investigation that the characteristics of these markets justify the differences in the remuneration paid to the subsidiaries and to the independent intermediaries, since the turnover achieved by the subsidiaries is not systematically higher than the turnover achieved through independent sales agents. Even supposing that the composition of turnover achieved through independent sales agents is different from that achieved through subsidiaries, the latter including more sales of large equipment through tenders and fewer sales of spare parts and small equipment, which is not apparent from the investigation in the case of certain subsidiaries, it is common ground that the remuneration of independent sales agents does not take account of the nature of the products and equipment sold, since it is invariably set at 20% of turnover, and that the remuneration paid to subsidiaries is, irrespective of the nature of the products, equivalent to the amount of the discount they would have received if they had acted as a buyer-reseller. Finally, it is not apparent from the documents in the files that the services provided by the independent intermediaries are significantly less substantial than the services provided by the subsidiaries in their intermediation activity alone. The mere fact that the subsidiaries have greater material and human resources is not sufficient to presume, in the absence of documents in the file to that effect, that those resources were used in the context of the latter activity. It follows that, contrary to what is maintained, it does not follow from the investigation that the differences in remuneration between subsidiaries and intermediary agents can be explained by the different situation of those suppliers. Although the applicant company argues that the commissions paid to the subsidiaries take account of the margin which they would have made on a purchase/resale of the same product, such an argument is not such as to justify the abovementioned differences in remuneration between the economic agents belonging to the group and those outside it, since they are involved in the same intermediary activity, which is different from the purchase/resale activity. The various doctrines referred to, which are not expressly invoked on the basis of the provisions of Article L. 80 A of the Book of Tax Procedures, do not interpret the tax law differently from the above. 6. It follows that the tax authorities must be regarded as establishing, under the conditions referred to in point 3, the existence of an advantage, and were entitled to reintegrate it into the results of the French company, as the latter did not justify that this advantage would have had at least equivalent counterparts for it.” Click here for English translation Click here for other translation ...

The facts are the same as in Example 5, except that Product X is branded with a valuable trademark that is owned by P. A, B, and C distribute unbranded competing products, while D and E distribute products branded with other trademarks. D and E do not own any rights in the trademarks under which their products are sold. The value of the products that A, B, and C sold are not similar to the value of the products sold by S. The value of products sold by D and E, however, is similar to that of Product X. Although close product similarity is not as important for a reliable application of the resale price method as for the comparable uncontrolled price method, significant differences in the value of the products involved in the controlled and uncontrolled transactions may affect the reliability of the results. In addition, because in this case it is difficult to determine the effect the trademark will have on price or profits, reliable adjustments for the differences cannot be made. Because D and E have a higher level of comparability than A, B, and C with respect to S, pursuant to § 1.482-1(e)(2)(ii), only D and E may be included in an arm’s length range ...

The facts are the same as Example 5, except that sufficient data is not available to determine whether any of the uncontrolled distributors provide warranties or to determine the payment terms of the contracts. Because differences in these contractual terms could materially affect price or profits, the inability to determine whether these differences exist between the controlled and uncontrolled transactions diminishes the reliability of the results of the uncontrolled comparables. However, the reliability of the results may be enhanced by the application of a statistical method when establishing an arm’s length range pursuant to § 1.482-1(e)(2)(iii)(B) ...

(i) USP, a U.S. corporation, manufactures Product X, an unbranded widget, and sells it to FSub, its wholly owned foreign subsidiary. FSub acts as a distributor of Product X in country M, and sells it to uncontrolled parties in that country. Uncontrolled distributors A, B, C, D, and E distribute competing products of approximately similar value in country M. All such products are unbranded. (ii) Relatively complete data is available regarding the functions performed and risks borne by the uncontrolled distributors and the contractual terms under which they operate in the uncontrolled transactions. In addition, data is available to ensure accounting consistency between all of the uncontrolled distributors and FSub. Because the available data is sufficiently complete and accurate to conclude that it is likely that all material differences between the controlled and uncontrolled transactions have been identified, such differences have a definite and reasonably ascertainable effect, and reliable adjustments are made to account for such differences, the results of each of the uncontrolled distributors may be used to establish an arm’s length range pursuant to § 1.482-1(e)(2)(iii)(A) ...

USSub, a U.S. corporation, is the exclusive distributor of widgets for its foreign parent. To determine whether the gross profit margin of 25% earned by USSub is an arm’s length result, the district director considers applying the resale price method. There are several uncontrolled distributors that perform similar functions under similar circumstances in uncontrolled transactions. However, the uncontrolled distributors treat certain costs such as discounts and insurance as cost of goods sold, while USSub treats such costs as operating expenses. In such cases, accounting reclassifications, pursuant to § 1.482-3(c)(3)(iii)(B), must be made to ensure consistent treatment of such material items. Inability to make such accounting reclassifications will decrease the reliability of the results of the uncontrolled transactions ...

FP, a foreign manufacturer, sells Product to USSub, its U.S. subsidiary, which in turn sells Product to its domestic affiliate Sister. Sister sells Product to unrelated buyers. In this case, the applicable resale price is the price at which Sister sells Product in uncontrolled transactions. The determination of the appropriate gross profit margin for the sale from FP to USSub will take into account the functions performed by USSub and Sister, as well as other relevant factors described in § 1.482-1(d)(3) ...

(i) S, a U.S. corporation, is the exclusive distributor for FP, its foreign parent. There are no changes in the beginning and ending inventory for the year under review. S’s total reported cost of goods sold is $800, consisting of $600 for property purchased from FP and $200 of other costs of goods sold incurred to unrelated parties. S’s applicable resale price and reported gross profit are as follows: Applicable resale price $1000 Cost of goods sold: Cost of purchases from FP 600 Costs incurred to unrelated parties 200 Reported gross profit 200 (ii) The district director determines that the appropriate gross profit margin is 25%. Therefore, S’s appropriate gross profit is $250 (i.e., 25% of the applicable resale price of $1000). Because S is incurring costs of sales to unrelated parties, an arm’s length price for property purchased from FP must be determined under a two-step process. First, the appropriate gross profit ($250) is subtracted from the applicable resale price ($1000). The resulting amount ($750) is then reduced by the costs of sales incurred to unrelated parties ($200). Therefore, an arm’s length price for S’s cost of sales of FP’s product in this case equals $550 (i.e., $750 minus $200) ...

A controlled taxpayer sells property to another member of its controlled group that resells the property in uncontrolled sales. There are no changes in the beginning and ending inventory for the year under review. Information regarding an uncontrolled comparable is sufficiently complete to conclude that it is likely that all material differences between the controlled and uncontrolled transactions have been identified and adjusted for. If the applicable resale price of the property involved in the controlled sale is $100 and the appropriate gross profit margin is 20%, then an arm’s length result of the controlled sale is a price of $80 ($100 minus (20% × $100)) ...

The degree of consistency in accounting practices between the controlled transaction and the uncontrolled comparables that materially affect the gross profit margin affects the reliability of the result. Thus, for example, if differences in inventory and other cost accounting practices would materially affect the gross profit margin, the ability to make reliable adjustments for such differences would affect the reliability of the results. Further, the controlled transaction and the uncontrolled comparable should be consistent in the reporting of items (such as discounts, returns and allowances, rebates, transportation costs, insurance, and packaging) between cost of goods sold and operating expenses ...

The reliability of the results derived from the resale price method is affected by the completeness and accuracy of the data used and the reliability of the assumptions made to apply this method. See § 1.482-1(c) (Best method rule) ...

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If there are material differences between the controlled and uncontrolled transactions that would affect the gross profit margin, adjustments should be made to the gross profit margin earned with respect to the uncontrolled transaction according to the comparability provisions of § 1.482-1(d)(2). For this purpose, consideration of operating expenses associated with functions performed and risks assumed may be necessary, because differences in functions performed are often reflected in operating expenses. If there are differences in functions performed, however, the effect on gross profit of such differences is not necessarily equal to the differences in the amount of related operating expenses. Specific examples of the factors that may be particularly relevant to this method include – (1) Inventory levels and turnover rates, and corresponding risks, including any price protection programs offered by the manufacturer; (2) Contractual terms (e.g., scope and terms of warranties provided, sales or purchase volume, credit terms, transport terms); (3) Sales, marketing, advertising programs and services, (including promotional programs, rebates, and co-op advertising); (4) The level of the market (e.g., wholesale, retail, etc.); and (5) Foreign currency risks ...

Comparability under this method is less dependent on close physical similarity between the products transferred than under the comparable uncontrolled price method. For example, distributors of a wide variety of consumer durables might perform comparable distribution functions without regard to the specific durable goods distributed. Substantial differences in the products may, however, indicate significant functional differences between the controlled and uncontrolled taxpayers. Thus, it ordinarily would be expected that the controlled and uncontrolled transactions would involve the distribution of products of the same general type (e.g., consumer electronics). Furthermore, significant differences in the value of the distributed goods due, for example, to the value of a trademark, may also affect the reliability of the comparison. Finally, the reliability of profit measures based on gross profit may be adversely affected by factors that have less effect on prices. For example, gross profit may be affected by a variety of other factors, including cost structures (as reflected, for example, in the age of plant and equipment), business experience (such as whether the business is in a start-up phase or is mature), or management efficiency (as indicated, for example, by expanding or contracting sales or executive compensation over time). Accordingly, if material differences in these factors are identified based on objective evidence, the reliability of the analysis may be affected ...

The degree of comparability between an uncontrolled transaction and a controlled transaction is determined by applying the comparability provisions of § 1.482-1(d). A reseller’s gross profit provides compensation for the performance of resale functions related to the product or products under review, including an operating profit in return for the reseller’s investment of capital and the assumption of risks. Therefore, although all of the factors described in § 1.482-1(d)(3) must be considered, comparability under this method is particularly dependent on similarity of functions performed, risks borne, and contractual terms, or adjustments to account for the effects of any such differences. If possible, appropriate gross profit margins should be derived from comparable uncontrolled purchases and resales of the reseller involved in the controlled sale, because similar characteristics are more likely to be found among different resales of property made by the same reseller than among sales made by other resellers. In the absence of comparable uncontrolled transactions involving the same reseller, an appropriate gross profit margin may be derived from comparable uncontrolled transactions of other resellers ...

Whether results derived from applications of this method are the most reliable measure of the arm’s length result must be determined using the factors described under the best method rule in § 1.482-1(c). The application of these factors under the resale price method is discussed in paragraphs (c)(3) (ii) and (iii) of this section ...

See § 1.482-1(e)(2) for determination of the arm’s length range ...

The appropriate gross profit is computed by multiplying the applicable resale price by the gross profit margin (expressed as a percentage of total revenue derived from sales) earned in comparable uncontrolled transactions ...

The applicable resale price is equal to either the resale price of the particular item of property involved or the price at which contemporaneous resales of the same property are made. If the property purchased in the controlled sale is resold to one or more related parties in a series of controlled sales before being resold in an uncontrolled sale, the applicable resale price is the price at which the property is resold to an uncontrolled party, or the price at which contemporaneous resales of the same property are made. In such case, the determination of the appropriate gross profit will take into account the functions of all members of the group participating in the series of controlled sales and final uncontrolled resales, as well as any other relevant factors described in § 1.482-1(d)(3) ...

The resale price method measures an arm’s length price by subtracting the appropriate gross profit from the applicable resale price for the property involved in the controlled transaction under review ...

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The resale price method evaluates whether the amount charged in a controlled transaction is arm’s length by reference to the gross profit margin realized in comparable uncontrolled transactions. The resale price method measures the value of functions performed, and is ordinarily used in cases involving the purchase and resale of tangible property in which the reseller has not added substantial value to the tangible goods by physically altering the goods before resale. For this purpose, packaging, repackaging, labelling, or minor assembly do not ordinarily constitute physical alteration. Further the resale price method is not ordinarily used in cases where the controlled taxpayer uses its intangible property to add substantial value to the tangible goods ...

PriceSmart Inc (PSMT) operates a retail chain including approximately 25 department stores in the Caribbean and Central America. PSMT’s local branch had recognised losses in their profit tax returns for the years 2001 to 2006. In 2009, the tax authorities audited the tax returns for the years 2002 to 2006. At issue was the definition and interpretation of the various functions of the interested party and the risks incurred. In particular, the dispute concerned transfer pricing typologies, and whether the local branch could be characterised as a ‘Limited Risk Distributor’ or as a ‘Buy-Sell Distributor’ with a ‘proprietary’ risk in respect of, inter alia, accounts receivable, stock and currency. The tax authorities characterised the local branch as a ‘Limited Distributor’ as it was not the local branch but PSMT Inc. that determined the marketing strategy, mix of products. The branch hasd virtually no decision-making influence in this, because its tasks and activities are determined by functions and employees of PSMT outside Aruba and the decision-making power of branch was limited to simple operational activities. In view of these observations an assesment was issued where a ‘cost-plus’ method of 3% of the costs was applied to calculate the arm’s length profit. After receiving The Council’s preliminary assessment a settlement was reached between the parties according to which losses for 2000 and 2001 were accepted and for the following years a net operating margin of 1.5% (return on sales) were to be applied. Click here for translation ...

At issue was the existence of a basis for taking into account the deductibility of the costs of services, the costs related to the repurchase and destruction of products and the tax deductibility of royalty expenses charged between related parties. Judgment of the Court The Administrative Court concluded that “Buy/Sell Distributor” had failed to prove that the disputed services charged to it were actually supplied and necessary for it. As regards the costs relating to the redemption and destruction of the products, it held that “Buy/Sell Distributor” was not obliged to bear those costs in view of the functions it performed within the multinational company’s system and the risks it bore. The Court also held that there was no basis for treating the royalty payment as a tax deductible expense. Click here for English translation Click here for other translation ...