Following a tax audit the tax authority conducted a on-site inspection of PJSC Odesa Port Plant on the completeness of tax calculation in respect of controlled transactions on the export of mineral fertilisers to non-resident companies Ameropa AG (Switzerland), “Koch Fertilizer Trading SARL (Switzerland), Nitora Commodities (Malta) Ltd (Malta), Nitora Commodities AG (Switzerland), Trammo AG (Switzerland), Trammo DMCC (United Arab Emirates), NF Trading AG (Switzerland) for FY 2013 and 2014, as well as business transactions on import of natural gas in gaseous form from a non-resident company Ostchem Holding Limited (Republic of Cyprus) for FY 2013. Based on the results of the inspection, an assessment of additional taxable income was issued. The assessment was based on the following considerations of the tax authority: – it is impossible to use the “net profit” method to confirm the compliance of prices in PJSC Odesa Port Plant’s controlled transactions for the export of mineral fertilisers in 2013 and 2014, since the “comparable uncontrolled price” method should have been used to determine the price in the said controlled transactions. The position of the tax authority is based on the fact that the application of the “net profit” method for determining the price does not allow to objectively determine the relevance of the price of the controlled transaction due to the lack of consideration of the impact of global trends in the nitrogen fertiliser market; information on derivative data available in officially recognised sources of information may be considered sufficient to determine the market price range (range of exchange prices) and calculate the level of arm’s length prices; in the presence of a market price range (range of exchange prices), – PJSC Odesa Port Plant’s transactions with Ostchem Holding Limited for the purchase of natural gas are controlled and PJSC Odesa Port Plant used the method of comparable uncontrolled price in determining the price in controlled transactions for the import of natural gas. However, PJSC Odesa Port Plant is a related party of PJSC Sumykhimprom, therefore, comparing the price in the controlled transaction with the prices in transactions that are also recognised as controlled. – it is not possible to use the “comparable uncontrolled price” method and it is appropriate to use the “net profit” method for natural gas import transactions, since no official source of information contains information on comparable uncontrolled transactions; it is not possible to adjust for the price of natural gas transportation from the European hub to the territory of Ukraine to ensure the proper level of comparability of the price in controlled transactions, and therefore the tax authority to find comparable transactions to apply the “net profit” method. It was found that the contract holder, Ostchem Holding Limited, did not perform any functions that could have influenced the increase in the sale price of natural gas. In the course of the audit, the Amadeus database was used to select independent companies that are comparable to Ostchem Holding Limited in terms of activities within the controlled natural gas import transaction. The sample included, in the tax authority’s opinion, independent companies with comparable activities and a similar functional profile to Ostchem Holding Limited. As a result of the search for comparable companies, 3 companies were selected, which, in the tax authority’s opinion, are fully comparable to Ostchem Holding Limited with key financial indicators for 2013. Based on the results of the analysis of the financial indicators of the comparable companies and the calculation of the range of profitability indicators, the tax authority found that the minimum value of the net profitability range for the comparable year 2013 was 0.04%, and the maximum value of the net profitability range was 1.51%. Thus, the net profitability of the controlled transaction with Ostchem Holding Limited exceeds the maximum value of the market range of net profitability of comparable companies by 30.34%. PJSC Odesa Port Plant disagreed with the tax assessment and filed an appeal. The district court upheld the appeal and dismissed the tax assessment. Subsequently, the Court of Appeal upheld the decision of the District Court and ruled in favour of PJSC Odesa Port Plant. The tax authority then appealed to the Supreme Court, which sent the case back to the Court of Appeal, which in the new trail upheld the tax authority’s assessment. This decision was then appealed to the Supreme Court – again – because, according to PJSC Odesa Port Plant, the Court of Appeal did not follow the instructions and conclusions of the Supreme Court in the course of the new procedure. Judgement of the Court The Supreme Court found that the violations of procedural and substantive law had been committed by the courts of first instance and appeal, and the failure to take into account the relevant correct conclusions of the Supreme Court, give grounds for sending the case for a new trial. In the new trail, it is necessary to take into account the above, to comprehensively and fully clarify all the factual circumstances of the case, verifying them with appropriate and admissible evidence, and to make a reasoned and lawful court decision with appropriate legal justification in terms of accepting or rejecting the arguments of the parties to the case. Excerpt in English “Subparagraphs 39.2.2.8 – 39.2.2.9 of paragraph 39.2.2 of Article 39.2.2 of the TC of Ukraine stipulate that, when determining the comparability of commercial and/or financial terms of comparable transactions with the terms of the controlled transaction, the characteristics of the markets for goods (works, services) where such transactions are conducted are analysed. At the same time, differences in the characteristics of such markets should not significantly affect the commercial and/or financial terms of the transactions conducted there, or such differences should be taken into account when making the appropriate adjustment. In determining the comparability of the characteristics of markets for goods (works, services), the following factors are taken into account: geographical location of markets and their volumes; the presence of competition in the markets, the relative competitiveness of sellers and buyers in the market; the ...

Banana S.A. sold bananas to related parties abroad. These transactions were priced using the TNMM method and the result of the benchmark analysis was an interquartile range of ROTC from 0.71% to 11.09%. However, Banana S.A. had continuous losses and for 2016 its return on total costs (ROTC) was -1.83%. To this end, an “adjustment” was made by adding “unearned income” related to storm damage to the actual results, which increased the company’s ROTC from -1.83% to 3.57%. The tax authorities disagreed with both the transfer pricing method used and the “adjustment” made to the results. An assessment of additional taxable income in an amount of B/.20,646,930,51. was issued, where the CUP method (based on quoted commodity prices for bananas) had been applied. Judgement of the Court The Court agreed with the tax authorities that the “adjustment” for “unearned income” was not allowed. “….In this sense, we agree with the Tax Administration when questioning the adjustment made by the taxpayer, attending to the reality exposed by the itself in the appeal , explaining that —————– produces different types of bananas according to their characteristics which are direct consequence of the position of the banana in the bunch, so that in the scenario of having lost an approximate of 700,000 boxes due to climatic events, it is impossible to claim that the total of boxes lost would have had a cost of USD 8.30, already that this would represent that the lost bunches, only had bananas extra quality, so that of according to the taxpayer’s own explanations is impossible. …. Based on the above, we can conclude that the taxpayer did not disclose the weather event that affected its plantations in the audited income statement for the period 2016, nor in its audited financial statements, since at the information financial that is uses to make the adjustments of comparability,such events were not reported since there is no financial information that validates their existence and therefore they are rejected.” However, as regards the transfer pricing method, the Court agreed with the taxpayer that although the product was the same, other comparability factors were not. On this basis, the assessment of the additional taxable income was changed by the court to the result previously determined by the tax authorities using the TNMM, without taking into account the adjustment for unearned profits. “….Tax Administration undermined the conclusions and results presented in the Transfer Pricing Study of ———————- for the year 2016, which were established using the Transactional Net Margin Method (TNMM), by not accepting that the taxpayer’s income and margin, which would have been higher had the weather events that caused losses not occurred, notwithstanding, the taxpayer emphasises that the Tax Administration accepted all the comparables used in the Transfer Pricing Study. In this regard, the taxpayer adds that had the weather events that caused the loss of 719,531 boxes of bananas not occurred, the company’s margins would have been within the inter-quartile ranges of the comparables selected for the Transfer Pricing Study, and secondly, being weather events of an exceptional nature. In this regard, the appellant adds that by using the Transactional Net Margin Method (TNMM), it is possible to adjust the company’s revenues and costs in order to show what the margin would have been………………………. .The operating margin of —————— was -1.83% in 2016, due to the damages caused by the weather events, which, had they not occurred, the adjusted margin would have been 3.57%. Since the Directorate General Revenue did not accept this argument, it concluded that since the appellant’s margin is not within the inter-quartile range, which is 0.71%, up to 11.09%, it then proceeded to adjust the operating profit margin of ——————, to the value of the —————- of the operating margins of the comparable companies selected for the Transfer Pricing Study, which is 4.83% and in order to achieve this profit margin, it proceeded to increase the appellant’s revenues in the amount of B/.6,747,901.75.” Click here for English Translation Click here for other translation Panama resoluciones_2023_08_08_Exp-068-2020 ...

“Electric Component Manufacturing KtF” is a Hungarian subsidiary of a global group that distributes electronic components in more than 150 countries worldwide. The tax authorities had conducted a comprehensive tax audit of the Hungarian company for the period from 1 October 2016 to 30 September 2017, which resulted in an assessment of additional taxable income. The transfer pricing issues identified by the tax authorities were the remuneration received by the Hungarian company for its manufacturing activities and excessive interest payments to a group company in Luxembourg. Judgement of the Supreme Court The Supreme Court set aside the judgment of the Court of Appeal and ordered the court to conduct new proceedings and issue a new decision. In its decision, the Court of Appeal had relied on an expert opinion, which the Supreme Court found to to be questionable, because there were serious doubt as to its correctness. Therefore, according to the order issued by the Supreme Court, the Court of Appeal may not undertake a professional assessment of the expert opinion that goes beyond the interpretation of the applicable legislation, nor may it review the expert opinion in the new proceedings in the absence of expertise. Excerpt “[58] In relation to the adjustment of the profit level indicator for manufacturing activities, the expert found that comparable companies do not charge taxes such as the local business tax and the innovation levy as an expense to operating profit, the amount of which distorts comparability, this is a clearly identifiable difference in the cost structure of the company under investigation and the comparable companies, so an adjustment should be made in accordance with the OECD guidelines and the Transfer Pricing Regulation, because the statistical application of the interquartile range restriction cannot be used to increase comparability. However, the Court of First Instance held that it was not disputed that, even if the interquartile range as a statistical method was used, it might be necessary to apply individual adjustments, but that the applicant had not provided the audit with a detailed analysis of the justification for the adjustment and had not provided any documentary evidence in the course of the two administrative proceedings to show how the adjustment applied served to increase comparability. However, the application for review relied on the contradictory nature of the reasoning in this respect, since, while the Court of First Instance criticised the lack of documentation to support the adjustment {Ist judgment, paragraph 34}, it shared the expert’s view that this would indeed require an investment of time and energy which taxpayers could not reasonably be expected to make {Ist judgment, paragraph 35}. [59] On the other hand, the judgment at first instance explained that the applicant had only carried out research in the course of the administrative proceedings into whether the countries of the undertakings used as comparators had a similar type of tax burden to the Hungarian local business tax, and the expert had referred in his expert opinion to the fact that the applicant had only identified this one difference when carrying out the comparative analysis, but, if a detailed analysis is carried out, each difference can be individually identified and quantified and it is for this reason that the OECD guidelines also allow a range of results to be taken into account, because it reduces the differences between the business characteristics of the associated enterprises and the independent companies involved in comparable transactions and also takes account of differences which occur in different commercial and financial circumstances. Thus, the expert did not share the expert’s view that, while the narrowing to the interquartile range includes differences that are not quantifiable or clearly identifiable, individual adjustments should always be applied in the case of clearly identifiable and quantifiable significant differences. Thus, the trial court took a contrary view to the expert on this issue. [60] Nor did the Court of First Instance share the expert’s view in relation to the interest rate on the intercompany loan granted to the applicant by its affiliate and did not accept the expert’s finding that the MNB’s interest rate statistics were an averaging of the credit spreads of the debtor parties involved in the financing transactions, on an aggregated basis and, consequently, the use of the MNB interest rate statistics is not in itself capable of supporting or refuting the arm’s length principle of the interest rate applied in intra-group lending transactions, whether long or short-term. Nor did it accept the method used and described by the applicant in the comparability field, since it did not consider that the applicant should have used an international database to look for comparative data, since comparability was questionable. Furthermore, it considered irrelevant the expert’s reference to the fact that the average loan interest rates in Hungary in 2016 were strongly influenced by the low interest rates on subsidised loans to businesses and criticised the fact that the expert did not consider it necessary to examine the applicant’s current account loans under the cash-pool scheme. [61] It can thus be concluded that the Court of First Instance, in its judgment, did not accept the reasoning of the private expert’s opinion and made professionally different findings from those of the expert on both substantive points. [62] The opinion of the appointed expert is questionable if a) it is incomplete or does not contain the mandatory elements of the opinion required by law, b) it is vague, c) it contradicts itself or the data in the case, or d) there is otherwise a strong doubt as to its correctness [Art. 316 (1) of the Civil Code]. The private expert’s opinion is questionable if a) the case specified in paragraph (1) is present [Art. 316 (2) a) of the Civil Code]. Section 316 of the Private Expert Act specifies and indicates precisely in which cases the expert’s opinion is to be considered as a matter of concern. Thus, the expert’s opinion is of concern if it is incomplete, vague, contradictory or otherwise doubtful. The latter case ...

The tax authorities issued a transfer pricing adjustment of USD 1.4 million for FY2013, claiming that the remuneration of “Tech Distributor S.A.” had not been determined in accordance with the arm’s length principle. According to the tax authorities, there were inconsistencies between the amounts of controlled transactions reported in the transfer pricing documentation and the income tax return. The tax authorities also found that “Tech Distributor S.A.” had incorrectly included “other income” in the calculation of its operating margin for the purposes of applying the Transactional Net Margin Method (TNMM). Finally, some of the companies selected as comparables were rejected and “comparability adjustments” were also disregarded. After making these adjustments to the benchmark analysis, the profit margin of “Tech Distributor S.A.” was outside the interquartile range and therefore the profit was adjusted to the median. “Tech Distributor S.A. appealed to the Tax Tribunal. Decision of the Tax Tribunal The Tribunal dismissed the appeal and upheld the assessment of the tax authorities. According to the Tribunal, ‘other income’ should not be included in the calculation of the operating margin. The court also upheld the tax authorities’ rejection of some of the comparables and agreed that the comparability adjustments made by the company were incorrect. Click here for English translation Click here for other translation Panama TAT-RF-006 ...

Yazaki Bulgaria Ltd is active in the automotive industry and is part of the Japanese Yazaki Group. It had used the transactional net margin method (TNMM) to demonstrate that prices for the sale of products to related parties were at arm’s length. Following an audit, the tax authorities found that the company’s profit was outside the arm’s length range and issued an assessment of additional income for FY2014-2016. According to the tax authorities, Yazaki Bulgaria Ltd had not included all its costs when calculating its profit margin. Administrative Court Judgement The Administrative Court annulled the tax authority’s assessment and ruled in favour of Yazaki Bulgaria Ltd. Excerpt “It is undisputed in this case that the adjustments made by the appellant for comparability with the amounts of additional labour costs in individual years are as follows: For 2014, the reported operating loss of £2,192,845.67 was adjusted upwards to a net profit of £4,837,402.79 as a result of the elimination for comparability purposes of costs of £7,030,248. 46 leva; before adjustments a net profit margin of -1.02% is calculated and after adjustments the net profit margin indicator is +2.34% and falls above the lower quartile value which is 2.27; For 2015 – the reported net profit from operations of £4,086,310.44 has been adjusted upwards to a net profit of £11,832,352.26 as a result of eliminating for comparability purposes expenses of £7,746,041. 82 leva; before adjustments, the net profit margin is calculated at 1.43% and after adjustments, the net profit margin indicator is 4.26% and falls above the lower quartile value of 1.68%; for 2016 – the reported net profit from operations of £1,259,468.30 has been adjusted upwards to a net profit of £6,815,444.19 as a result of eliminating for comparability purposes expenses of £5,555,975. 89; Before adjustments, the net profit margin is calculated at 0.46% and after adjustments, the net profit margin indicator is 2.56% and falls above the lower quartile value which is 2.22% . In summary of the foregoing, the court finds that after the audited entity’s elimination of net profit comparability expenses, Y.B.’s net profit margin indicator falls within the interquartile range, and therefore, the conclusion that the company’s net profit margin indicator is below market values is not warranted. The adjustments made were to eliminate the effect of additional staff and training costs which affected the auditee’s net profit margin and, in the Court’s view, were consistent with the purpose of Article 4 N-9 of 14.08.2006 – to achieve a result that would have been achieved in an ordinary commercial or financial relationship between independent persons under comparable conditions. The additional costs have been recognized by the tax administration as actually incurred and are part of the costs taken into account in the declared financial result of the company. There is no basis for transformation of the financial result of the company, as done by the audit on the basis of Art, Article 16 and Article 78 of the Income Tax Act, since the net profit of the company falls within the market values when adjustments are made for comparability, i.e. there is no conduct on the part of the audited entity aimed at tax evasion. For the reasons set out above, the Court considers that the appeal should be upheld by annulling the contested revision act.” Click here for English Translation Click here for other translation Bulgaria vs YAZAKI BULGARIA LTD SAC No 22-2022 ...

Like the methods described in §§ 1.482-3, 1.482-4, 1.482-5, and 1.482-9, the comparable profit split relies exclusively on external market benchmarks. As indicated in § 1.482-1(c)(2)(i), as the degree of comparability between the controlled and uncontrolled transactions increases, the relative weight accorded the analysis under this method will increase. In addition, the reliability of the analysis under this method may be enhanced by the fact that all parties to the controlled transaction are evaluated under the comparable profit split. However, the reliability of the results of an analysis based on information from all parties to a transaction is affected by the reliability of the data and the assumptions pertaining to each party to the controlled transaction. Thus, if the data and assumptions are significantly more reliable with respect to one of the parties than with respect to the others, a different method, focusing solely on the results of that party, may yield more reliable results ...

The reliability of the results derived from the comparable profit split is affected by the quality of the data and assumptions used to apply this method. In particular, the following factors must be considered – (1) The reliability of the allocation of costs, income, and assets between the relevant business activity and the participants’ other activities will affect the accuracy of the determination of combined operating profit and its allocation among the participants. If it is not possible to allocate costs, income, and assets directly based on factual relationships, a reasonable allocation formula may be used. To the extent direct allocations are not made, the reliability of the results derived from the application of this method is reduced relative to the results of a method that requires fewer allocations of costs, income, and assets. Similarly, the reliability of the results derived from the application of this method is affected by the extent to which it is possible to apply the method to the parties’ financial data that is related solely to the controlled transactions. For example, if the relevant business activity is the assembly of components purchased from both controlled and uncontrolled suppliers, it may not be possible to apply the method solely to financial data related to the controlled transactions. In such a case, the reliability of the results derived from the application of this method will be reduced. (2) The degree of consistency between the controlled and uncontrolled taxpayers in accounting practices that materially affect the items that determine the amount and allocation of operating profit affects the reliability of the result. Thus, for example, if differences in inventory and other cost accounting practices would materially affect operating profit, the ability to make reliable adjustments for such differences would affect the reliability of the results. Further, accounting consistency among the participants in the controlled transaction is required to ensure that the items determining the amount and allocation of operating profit are measured on a consistent basis ...

If there are differences between the controlled and uncontrolled taxpayers that would materially affect the division of operating profit, adjustments must be made according to the provisions of § 1.482-1(d)(2) ...

Adjusting operating profit for differences in accounts payable. (i) USD is the U.S. subsidiary of a foreign corporation. USD purchases goods from its foreign parent and sells them in the U.S. market. For purposes of applying the comparable profits method, 10 uncontrolled distributors that are similar to USD have been identified. (ii) There are significant differences in the level of accounts payable among the uncontrolled distributors and USD. To adjust for these differences, the district director increases the operating profit of the uncontrolled distributors and USD to reflect interest expense imputed to the accounts payable. The imputed interest expense for each company is calculated by multiplying the company’s accounts payable by an interest rate appropriate for its short-term debt ...

Adjusting operating assets and operating profit for differences in accounts receivable. (i) USM is a U.S. company that manufactures parts for industrial equipment and sells them to its foreign parent corporation. For purposes of applying the comparable profits method, 15 uncontrolled manufacturers that are similar to USM have been identified. (ii) USM has a significantly lower level of accounts receivable than the uncontrolled manufacturers. Since the rate of return on capital employed is to be used as the profit level indicator, both operating assets and operating profits must be adjusted to account for this difference. Each uncontrolled comparable’s operating assets is reduced by the amount (relative to sales) by which they exceed USM’s accounts receivable. Each uncontrolled comparable’s operating profit is adjusted by deducting imputed interest income on the excess accounts receivable. This imputed interest income is calculated by multiplying the uncontrolled comparable’s excess accounts receivable by an interest rate appropriate for short-term debt ...

If there are differences between the tested party and an uncontrolled comparable that would materially affect the profits determined under the relevant profit level indicator, adjustments should be made according to the comparability provisions of § 1.482-1(d)(2). In some cases, the assets of an uncontrolled comparable may need to be adjusted to achieve greater comparability between the tested party and the uncontrolled comparable. In such cases, the uncontrolled comparable’s operating income attributable to those assets must also be adjusted before computing a profit level indicator in order to reflect the income and expense attributable to the adjusted assets. In certain cases it may also be appropriate to adjust the operating profit of the tested party and comparable parties. For example, where there are material differences in accounts payable among the comparable parties and the tested party, it will generally be appropriate to adjust the operating profit of each party by increasing it to reflect an imputed interest charge on each party’s accounts payable. As another example, it may be appropriate to adjust the operating profit of a party to account for material differences in the utilization of or accounting for stock-based compensation (as defined by § 1.482-7(d)(3)(i)) among the tested party and comparable parties ...

Other factors listed in § 1.482-1(d)(3) also may be particularly relevant under the comparable profits method. Because operating profit usually is less sensitive than gross profit to product differences, reliability under the comparable profits method is not as dependent on product similarity as the resale price or cost plus method. However, the reliability of profitability measures based on operating profit may be adversely affected by factors that have less effect on results under the comparable uncontrolled price, resale price, and cost plus methods. For example, operating profit may be affected by varying cost structures (as reflected, for example, in the age of plant and equipment), differences in business experience (such as whether the business is in a start-up phase or is mature), or differences in management efficiency (as indicated, for example, by objective evidence such as 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 tested party’s operating profit must first be adjusted to reflect all other allocations under section 482, other than adjustments pursuant to this section ...

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 ...

If there are differences between the controlled and uncontrolled transactions that would affect price, adjustments should be made to the price of the uncontrolled transaction according to the comparability provisions of § 1.482-1(d)(2). Specific examples of the factors that may be particularly relevant to this method include – (1) Quality of the product; (2) Contractual terms (e.g., scope and terms of warranties provided, sales or purchase volume, credit terms, transport terms); (3) Level of the market (i.e., wholesale, retail, etc.); (4) Geographic market in which the transaction takes place; (5) Date of the transaction; (6) Intangible property associated with the sale; (7) Foreign currency risks; and (8) Alternatives realistically available to the buyer and seller ...

The degree of comparability between controlled and uncontrolled transactions is determined by applying the provisions of § 1.482-1(d). Although all of the factors described in § 1.482-1(d)(3) must be considered, similarity of products generally will have the greatest effect on comparability under this method. In addition, because even minor differences in contractual terms or economic conditions could materially affect the amount charged in an uncontrolled transaction, comparability under this method depends on close similarity with respect to these factors, or adjustments to account for any differences. The results derived from applying the comparable uncontrolled price method generally will be the most direct and reliable measure of an arm’s length price for the controlled transaction if an uncontrolled transaction has no differences with the controlled transaction that would affect the price, or if there are only minor differences that have a definite and reasonably ascertainable effect on price and for which appropriate adjustments are made. If such adjustments cannot be made, or if there are more than minor differences between the controlled and uncontrolled transactions, the comparable uncontrolled price method may be used, but the reliability of the results as a measure of the arm’s length price will be reduced. Further, if there are material product differences for which reliable adjustments cannot be made, this method ordinarily will not provide a reliable measure of an arm’s length result ...

Reliability of adjustment for differences in volume. (i) FS manufactures product XX and sells that product to its parent corporation, P. FS also sells product XX to uncontrolled taxpayers at a price of $100 per unit. Except for the volume of each transaction, the sales to P and to uncontrolled taxpayers take place under substantially the same economic conditions and contractual terms. In uncontrolled transactions, FS offers a 2% discount for quantities of 20 per order, and a 5% discount for quantities of 100 per order. If P purchases product XX in quantities of 60 per order, in the absence of other reliable information, it may reasonably be concluded that the arm’s length price to P would be $100, less a discount of 3.5%. (ii) If P purchases product XX in quantities of 1,000 per order, a reliable estimate of the appropriate volume discount must be based on proper economic or statistical analysis, not necessarily a linear extrapolation from the 2% and 5% catalog discounts applicable to sales of 20 and 100 units, respectively ...

In order to be considered comparable to a controlled transaction, an uncontrolled transaction need not be identical to the controlled transaction, but must be sufficiently similar that it provides a reliable measure of an arm’s length result. If there are material differences between the controlled and uncontrolled transactions, adjustments must be made if the effect of such differences on prices or profits can be ascertained with sufficient accuracy to improve the reliability of the results. For purposes of this section, a material difference is one that would materially affect the measure of an arm’s length result under the method being applied. If adjustments for material differences cannot be made, the uncontrolled transaction may be used as a measure of an arm’s length result, but the reliability of the analysis will be reduced. Generally, such adjustments must be made to the results of the uncontrolled comparable and must be based on commercial practices, economic principles, or statistical analyses. The extent and reliability of any adjustments will affect the relative reliability of the analysis. See § 1.482-1(c)(1) (Best method rule). In any event, unadjusted industry average returns themselves cannot establish arm’s length results ...

Ferragamo France, which was set up in 1992 and is wholly owned by the Dutch company Ferragamo International BV, which in turn is owned by the Italian company Salvatore Ferragamo Spa, carries on the business of retailing shoes, leather goods and luxury accessories and distributes, in shops in France, products under the ‘Salvatore Ferragamo’ brand, which is owned by the Italian parent company. An assessment had been issued to Ferragamo France in which the French tax authorities asserted that the French subsidiary had not been sufficiently remunerated for additional expenses and contributions to the value of the Ferragamo trademark. The French subsidiary had been remunerated on a gross margin basis, but had incurred losses in previous years and had indirect cost exceeding those of the selected comparable companies. In 2017 the Administrative Court decided in favour of Ferragamo and dismissed the assessment issued by the tax authorities. According to the Court the tax administration had not demonstrated the existence of an advantage granted by Ferragamo France to the Italien parent, Salvatore Ferragamo SPA, nor the amount of this advantage. This decision was later upheld by the Administrative Court of Appeal. An appel was then filed by the tax authorities with the Supreme Court. The Supreme Court (Conseil d’Etat) overturned the decision and remanded the case back to the Administrative Court of Appeal for further considerations. “In ruling that the administration did not establish the existence of an advantage granted to the Italian company on the grounds that the French company’s results for the financial years ending from 2010 to 2015 had been profitable without any change in the company’s transfer pricing policy, whereas it had noted that the exposure of additional charges of wages and rents in comparison with independent companies was intended to increase, in a strategic market in the luxury sector, the value of the Italian brand which did not yet have the same notoriety as its direct competitors, the administrative court of appeal erred in law. Moreover, although it emerged from the documents in the file submitted to the trial judges that the tax authorities had established the existence of a practice falling within the provisions of Article 57 of the General Tax Code, by showing that the remuneration granted by the Italian company was not sufficient to cover the additional expenses which contributed to the value of the Salvatore Ferragamo trade mark incurred by the French subsidiary and by arguing that the latter had been continuously loss-making since at least 1996 until 2009, the court distorted the facts and documents in the file. By dismissing, under these conditions, the existence of an indirect transfer of profits to be reintegrated into its taxable income when the company did not establish, by merely claiming a profitable situation between 2010 and 2015, that it had received a consideration for the advantage in question, the court incorrectly qualified the facts of the case.” Judgement of the Administrative Court of Appeal The Administrative Court of Appeal issued a final decision in June 2022 in which the 2017 decision of the Paris Administrative Court was annulled and the tax assessment issued by the tax authorities reinstated. “Firstly, Ferragamo France argued that the companies included in the above-mentioned panel were not comparable, since most of their activities were carried out in the provinces, whereas its activity was concentrated in international tourist areas, mainly in Paris, and their workforce was less than ten employees, whereas it employed 68 people, that they are mere distributors whereas it also manages a network of boutiques and concessions in department stores, and that some of them own their premises whereas it rents its premises for amounts much higher than the rents in the provinces, the relationship between external charges and turnover thus being irrelevant. However, most of the comparables selected by the administration, which operate as multi-brand distributors in the luxury ready-to-wear sector, were proposed by Ferragamo France itself. Moreover, the company does not indicate the adjustments that should be made to the various ratios of salary and external costs used to obtain a result that it considers more satisfactory, even though it has been established that additional costs in the area of salaries and property constitute an advantage granted to Salvatore Ferragamo Spa. Furthermore, apart from the fact that it has not been established that some of the companies on the panel own their premises, Ferragamo France does not allege that excluding the companies in question from the calculation of the ratios would result in a reduction in the amount of the adjustments. Lastly, as regards the insufficient consideration of the management of a network of department stores’ boutiques and concessions, Ferragamo France does not provide any specific information in support of its allegations, whereas the comparison made by the administration is intended to assess the normality of the remuneration of its retail activity.” … It follows from all of the above that the Minister of the Economy, Finance and Recovery is entitled to argue that it was wrong for the Administrative Court of Paris, in the judgment under appeal, to discharge, in terms of duties and increases, the supplementary corporate tax assessment to which Ferragamo France was subject in respect of the financial year ended in 2010, of the withholding tax charged to it for 2009 and 2010 and of the supplementary minimum business tax and business value added contribution charged to it for 2009 and 2010 respectively. This judgment must therefore be annulled and the aforementioned taxes, in duties and increases, must be remitted to Ferragamo France.” Click here for English Translation Click here for other translation France vs Ferragamo CAA de PARIS, 2ème chambre, 30_06_2022, 20PA03601 ...

A Korean subsidiary (“Semicon-sales”) of a foreign group was active in distribution and sales of semiconductors for the automotive and industrial industry. Following an audit, the tax authorities found that the subsidiary had purchased semiconductors from a foreign affiliated company at a higher price than the arm’s length price. An assessment was issued where the the sum of the difference between the arm’s length price and the reported price had been included in the taxable income for FY 2015-2018. Both “Semicon-sales” and the tax authorities had applied the TNMM to find the arm’s length price, but the tax authorities had rejected the comparables selected by “Semicon” and replaced them with others. Not satisfied with the assessment “Semicon-sales” filed an appeal. Judgement of the Court The court remanded the case with an order to exclude from the benchmark comparables where the sales volume is significantly different from that of the “Semicon-sales”. Since the proportion of the taxpayers transactions with large companies is significant, the transaction stage, sales volume, customer, business environment should also be taken into consideration. Click here for English translation Click here for other translation Korea vs Corp 2022-06-09 인쇄 - 국세법령정보시스템 ...

Example of a Working Capital Adjustment See Chapter III, Section A.6 of these Guidelines for general guidance on comparability adjustments. The assumptions about arm’s length arrangements in the following examples are intended for illustrative purposes only and should not be taken as prescribing adjustments and arm’s length arrangements in actual cases of particular industries. While they seek to demonstrate the principles of the sections of the Guidelines to which they refer, those principles must be applied in each case according to the specific facts and circumstances of that case. This example is provided for illustration purposes as it represents one way, but not necessarily the only way, in which such an adjustment can be calculated. Furthermore, the comments below relate to the application of a transactional net margin method in the situations where, given the facts and circumstances of the case and in particular the comparability (including functional) analysis of the transaction and the review of the information available on uncontrolled comparables, such a method is found to be the most appropriate method to be used. Introduction  This simple example shows how to make an adjustment in recognition of differences in levels of working capital between a tested party (TestCo) and a comparable (CompCo). See paragraphs 3.47-3.54 of these Guidelines for general guidance on comparability adjustments. Working capital adjustments may be warranted when applying the transactional net margin method. In practice they are usually found when applying a transactional net margin method, although they might also be applicable in cost plus or resale price methods. Working capital adjustments should only be considered when the reliability of the comparables will be improved and reasonably accurate adjustments can be made. They should not be automatically made and would not be automatically accepted by tax administrations. Why make a working capital adjustment? In a competitive environment, money has a time value. If a company provided, say, 60 days trade terms for payment of accounts, the price of the goods should equate to the price for immediate payment plus 60 days of interest on the immediate payment price. By carrying high accounts receivable a company is allowing its customers a relatively long period to pay their accounts. It would need to borrow money to fund the credit terms and/or suffer a reduction in the amount of cash surplus which it would otherwise have available to invest. In a competitive environment, the price should therefore include an element to reflect these payment terms and compensate for the timing The opposite applies to higher levels of accounts payable. By carrying high accounts payable, a company is benefitting from a relatively long period to pay its suppliers. It would need to borrow less money to fund its purchases and/or benefit from an increase in the amount of cash surplus available to invest. In a competitive environment, the cost of goods sold should include an element to reflect these payment terms and compensate for the timing A company with high levels of inventory would similarly need to either borrow to fund the purchase or reduce the amount of cash surplus which the company is able to invest. Note that the interest rate might be affected by the funding structure (e.g. where the purchase of inventory is partly funded by equity) or by the risk associated with holding specific types of Making a working capital adjustment is an attempt to adjust for the differences in time value of money between the tested party and potential comparables with an assumption that the difference should be reflected in profits. The underlying reasoning is that: A company will need funding to cover the time gap between the time it invests money (i.e. pays money to supplier) and the time it collects the investment (i.e. collects money from customers) This time gap is calculated as: the period needed to sell inventories to customers + (plus) the period needed to collect money from customers – (less) the period granted to pay debts to supplyers The process of calculating working capital adjustments: a)Identify differences in the levels of working capital. Generally trade receivables, inventory and trade payables are the three accounts considered. The transactional net margin method is applied relative to an appropriate base, for example costs, sales or assets (see paragraph 2.64 of the Guidelines). If the appropriate base is sales, for example, then any differences in working capital levels should be measured relative to sales. Calculate a value for differences in levels of working capital between the tested party and the comparable relative to the appropriate base and reflecting the time value of money by use of an appropriate interest Adjust the result to reflect differences in levels of working capital. The following example adjusts the comparable’s result to reflect the tested party’s levels of working capital. Alternative calculations are to adjust the tested party’s results to reflect the comparables levels of working capital or to adjust both the tested party and the comparable’s results to reflect “zero” working A practical example of calculating working capital adjustments:  6. The following calculation is hypothetical. It is only to demonstrate how a working capital adjustment can be TestCo Year 1 Year 2 Year 3 Year 4 Year 5 Sales $179.5m $182.5m $187m $195m $198m Earnings Before Interest & Tax (EBIT) $1.5m $1.83m $2.43m $2.54m $1.78m EBIT/Sales (%) 0.8% 1% 1.3% 1.3% 0.9% Working Capital (at end of year)1 Trade Receivables (R) $30m $32m $33m $35m $37m Inventories (I) $36m $36m $38m $40m $45m Trade Payables (P) $20m $21m $26m $23m $24m Receivables (R) + Inventory (I) – Payables (P) $46m $47m $45m $52m $58m (R + I – P) / Sales 25.6% 25.8% 24.1% 26.7% 29.3% CompCo Year 1 Year 2 Year 3 Year 4 Year 5 Sales $120.4m $121.2m $121.8m $126.3m $130.2m Earnings Before Interest & Tax (EBIT) $1.59m $3.59m $3.15m $4.18m $6.44m EBIT/Sales (%) 1.32% 2.96% 2.59% 3.31% 4.95% Working Capital (at end of year)1 Trade Receivables (R) $17m $18m $20m $22m $23m Inventory (I) $18m $20m $26m $24m $25m Trade Payables (P) $11m ...

The application of the CUP method to a transaction involving a captive insurance may encounter practical difficulties to determine the need for and quantification of comparability adjustments. In particular, account should be taken of potential differences between the controlled and uncontrolled transactions that may affect the reliability of the comparables. Those differences may refer, for instance, to situations where the functional analysis indicates that a captive insurance performs less functions than a commercial insurer (e.g. a captive insurance that only insures internal risks within the MNE group may not need to perform distribution and sales functions). Similarly, differences between the captive insurance and the potential comparables in business volume or in the level of capital between the captive insurance and unrelated parties may require comparability adjustments (see paragraph 10.221) ...

The reliability of economic models’ outcomes depends upon the parameters factored into the specific model and the underlying assumptions adopted. In evaluating the reliability of economic models as an approach to pricing intra-group loans it is important to note that economic models’ outcomes do not represent actual transactions between independent parties and that, therefore, comparability adjustments would be likely required. However, in situations where reliable comparable uncontrolled transactions cannot be identified, economic models may represent tools that can be usefully applied in identifying an arm’s length price for intra-group loans, subject to the same constraints regarding market conditions discussed in paragraph 10.98 ...

Whereas it is unlikely that an MNE group’s average interest rate paid on its external debt meets the comparability requirements to be considered as an internal CUP, it may be possible to identify potential comparable loans within the borrower’s or its MNE group’s financing with an independent lender as the counterparty. As with external CUPs, it may be necessary to make appropriate adjustments to improve comparability. See Example 1 at 1.164 – 1.166 ...

Arm’s length interest rates can also be based on the return of realistic alternative transactions with comparable economic characteristics. Depending on the facts and circumstances, realistic alternatives to intra-group loans could be, for instance, bond issuances, loans which are uncontrolled transactions, deposits, convertible debentures, commercial papers, etc. In the evaluation of those alternatives as potential comparables it is important to bear in mind that, based on facts and circumstances, comparability adjustments may be required to eliminate the material effects of differences between the controlled intra-group loan and the selected alternative in terms of, for instance, liquidity, maturity, existence of collateral or currency ...

In an ideal scenario, a comparability analysis would enable the identification of financial transactions between independent parties which match the tested transaction in all respects. With the many variables involved, it is more likely that potential comparables will differ from the tested transaction. Where differences exist between the tested transaction and any proposed comparable, it will be necessary to consider whether such differences will have a material impact on the price. If so, it may be possible, where appropriate, to make comparability adjustments to improve the reliability of a comparable. This is more likely to be achievable where the adjustment is based on a quantitative factor and there is good quality data easily available (e.g. on currency differences) than, for instance, in trying to compare loans to borrowers with qualitative differences or where data is not so readily available (e.g. borrowers with different business strategies) ...

There are cases where comparables (including internal comparables) are available, subject to possible comparability adjustments being performed. One example of a possible application of the CUP method would be the case where an enterprise that used to transact independently with the MNE group is acquired, and the acquisition is followed by a restructuring of the now controlled transactions. Subject to a review of the five economically relevant characteristics or comparability factors and of the possible effect of the controlled and uncontrolled transactions taking place at different times, it might be the case that the conditions of the pre-acquisition uncontrolled transactions provide a CUP for the post-acquisition controlled transactions. Even where the conditions of the transactions are restructured, it might still be possible, depending on the facts and circumstances of the case, to adjust for the transfer of functions, assets and/or risks that occurred upon the restructuring. For instance, a comparability adjustment might be performed to account for the fact that a different party assumes bad debt risk ...

It should also be recognised that comparability adjustments for factors other than differences in the nature of the intangibles used may be required in matters involving the use of intangibles in connection with a controlled sale of goods or services. In particular, comparability adjustments may be required for matters such as differences in markets, locational advantages, business strategies, assembled workforce, corporate synergies and other similar factors. While such factors may not be intangibles as that term is described in Section A. 1 of this chapter, they can nevertheless have important effects on arm’s length prices in matters involving the use of intangibles ...

Where the need to make comparability adjustments arises because of differences in the intangibles used by the tested party in a controlled transaction and the intangibles used by a party to a potentially comparable uncontrolled transaction, difficult factual questions can arise in quantifying reliable comparability adjustments. These issues require thorough consideration of the relevant facts and circumstances and of the available data regarding the impact of the intangibles on prices and profits. Where the impact on price of a difference in the nature of the intangibles used is clearly material, but not subject to accurate estimation, it may be necessary to utilise a different transfer pricing method that is less dependent on identification of reliable comparables ...

The principles of paragraphs 3.47 to 3.54 relating to comparability adjustments apply with respect to transactions involving the transfer of intangibles or rights in intangibles. It is important to note that differences between intangibles can have significant economic consequences that may be difficult to adjust for in a reliable manner. Particularly in situations where amounts attributable to comparability adjustments represent a large percentage of the compensation for the intangible, there may be reason to believe, depending on the specific facts, that the computation of the adjustment is not reliable and that the intangibles being compared are in fact not sufficiently comparable to support a valid transfer pricing analysis. If reliable comparability adjustments are not possible, it may be necessary to select a transfer pricing method that is less dependent on the identification of comparable intangibles or comparable transactions ...

Ensuring the needed level of transparency of comparability adjustments may depend upon the availability of an explanation of any adjustments performed, the reasons for the adjustments being considered appropriate, how they were calculated, how they changed the results for each comparable and how the adjustment improves comparability. Issues regarding documentation of comparability adjustments are discussed in Chapter V ...

It is not appropriate to view some comparability adjustments, such as for differences in levels of working capital, as “routine” and uncontroversial, and to view certain other adjustments, such as for country risk, as more subjective and therefore subject to additional requirements of proof and reliability. The only adjustments that should be made are those that are expected to improve comparability ...

It is not always the case that adjustments are warranted. For instance, an adjustment for differences in accounts receivable may not be particularly useful if major differences in accounting standards were also present that could not be resolved. Likewise, sophisticated adjustments are sometimes applied to create the false impression that the outcome of the comparables search is “scientific”, reliable and accurate ...

It bears emphasis that comparability adjustments are only appropriate for differences that will have a material effect on the comparison. Some differences will invariably exist between the taxpayer’s controlled transactions and the third party comparables. A comparison may be appropriate despite an unadjusted difference, provided that the difference does not have a material effect on the reliability of the comparison. On the other hand, the need to perform numerous or substantial adjustments to key comparability factors may indicate that the third party transactions are in fact not sufficiently comparable ...

Comparability adjustments should be considered if (and only if) they are expected to increase the reliability of the results. Relevant considerations in this regard include the materiality of the difference for which an adjustment is being considered, the quality of the data subject to adjustment, the purpose of the adjustment and the reliability of the approach used to make the adjustment ...

An example of a working capital adjustment designed to reflect differing levels of accounts receivable, accounts payable and inventory is provided in the Annex to Chapter III. The fact that such adjustments are found in practice does not mean that they should be performed on a routine or mandatory basis. Rather, the improvement to comparability should be shown when proposing these types of adjustments (as for any type of adjustment). Further, a significantly different level of relative working capital between the controlled and uncontrolled parties may result in further investigation of the comparability characteristics of the potential comparable ...

Examples of comparability adjustments include adjustments for accounting consistency designed to eliminate differences that may arise from differing accounting practices between the controlled and uncontrolled transactions; segmentation of financial data to eliminate significant non- comparable transactions; adjustments for differences in capital, functions, assets, risks ...

The need to adjust comparables and the requirement for accuracy and reliability are pointed out in these Guidelines on several occasions, both for the general application of the arm’s length principle and more specifically in the context of each method. To be comparable means that none of the differences (if any) between the situations being compared could materially affect the condition being examined in the methodology or that reasonably accurate adjustments can be made to eliminate the effect of any such differences. Whether comparability adjustments should be performed (and if so, what adjustments should be performed) in a particular case is a matter of judgment that should be evaluated in light of the discussion of costs and compliance burden at Section C ...

On the other hand, internal comparables are not always more reliable and it is not the case that any transaction between a taxpayer and an independent party can be regarded as a reliable comparable for controlled transactions carried on by the same taxpayer. Internal comparables where they exist must satisfy the five comparability factors in the same way as external comparables, see paragraphs 1.33-1.138. Guidance on comparability adjustments also applies to internal comparables, see paragraphs 3.47-3.54. Assume for instance that a taxpayer manufactures a particular product, sells a significant volume thereof to its foreign associated retailer and a marginal volume of the same product to an independent party. In such a case, the difference in volumes is likely to materially affect the comparability of the two transactions. If it is not possible to make a reasonably accurate adjustment to eliminate the effects of such difference, the transaction between the taxpayer and its independent customer is unlikely to be a reliable comparable ...

The facts are the same as in paragraph 2.42. However, the amount of the warranty expenses incurred by Distributor A proves impossible to ascertain so that it is not possible to reliably adjust the gross profit of A to make the gross profit margin properly comparable with that of B. However, if there are no other material functional differences between A and B and the net profit of A relative to its sales is known, it might be possible to apply the transactional net margin method to B by comparing the margin relative to A’s sales to net profits with the margin calculated on the same basis for B ...

The selection of the denominator should be consistent with the comparability (including functional) analysis of the controlled transaction, and in particular it should reflect the allocation of risks between the parties (provided said allocation of risks is arm’s length, see Section D.1.2.1 in Chapter I). For instance, capital-intensive activities such as certain manufacturing activities may involve significant investment risk, even in those cases where the operational risks (such as market risks or inventory risks) might be limited. Where a transactional net margin method is applied to such cases, the investment-related risks are reflected in the net profit indicator if the latter is a return on investment (e.g. return on assets or return on capital employed). Such indicator might need to be adjusted (or a different net profit indicator selected) depending on what party to the controlled transaction bears that risk, as well as on the degree of differences in risk that may be found in the taxpayer’s controlled transaction and in comparables. See paragraphs 3.47-3.54 for a discussion of comparability adjustments ...

In those cases where there is a correlation between the credit terms and the sales prices, it could be appropriate to reflect interest income in respect of short-term working capital within the calculation of the net profit indicator and/or to proceed with a working capital adjustment, see paragraphs 3.47-3.54. An example would be where a large retail business benefits from long credit terms with its suppliers and from short credit terms with its customers, thus making it possible to derive excess cash that in turn may make it possible to have lower sales prices to customers than if such advantageous credit terms were not available ...

In applying the transactional net margin method, the selection of the most appropriate net profit indicator should follow the guidance at paragraphs 2.2 and 2.8 in relation to the selection of the most appropriate method to the circumstances of the case. It should take account of the respective strengths and weaknesses of the various possible indicators; the appropriateness of the indicator considered in view of the nature of the controlled transaction, determined in particular through a functional analysis; the availability of reliable information (in particular on uncontrolled comparables) needed to apply the transactional net margin method based on that indicator; and the degree of comparability between controlled and uncontrolled transactions, including the reliability of comparability adjustments that may be needed to eliminate differences between them, when applying the transactional net margin method based on that indicator. These factors are discussed below in relation to both the determination of the net profit and its weighting ...

Another important aspect of comparability is measurement consistency. The net profit indicators must be measured consistently between the associated enterprise and the independent enterprise. In addition, there may be differences in the treatment across enterprises of operating expenses and non-operating expenses affecting the net profits such as depreciation and reserves or provisions that would need to be accounted for in order to achieve reliable comparability ...

The transactional net margin method may afford a practical solution to otherwise insoluble transfer pricing problems if it is used sensibly and with appropriate adjustments to account for differences of the type referred to above. The transactional net margin method should not be used unless the net profit indicators are determined from uncontrolled transactions of the same taxpayer in comparable circumstances or, where the comparable uncontrolled transactions are those of an independent enterprise, the differences between the associated enterprises and the independent enterprises that have a material effect on the net profit indicator being used are adequately taken into account. Many countries are concerned that the safeguards established for the traditional transaction methods may be overlooked in applying the transactional net margin method. Thus where differences in the characteristics of the enterprises being compared have a material effect on the net profit indicators being used, it would not be appropriate to apply the transactional net margin method without making adjustments for such differences. The extent and reliability of those adjustments will affect the relative reliability of the analysis under the transactional net margin method. See discussion of comparability adjustments at paragraphs 3.47-3.54 ...

A is a domestic manufacturer of timing mechanisms for mass- market clocks. A sells this product to its foreign subsidiary B. A earns a 5% gross profit mark up with respect to its manufacturing operation. X, Y, and Z are independent domestic manufacturers of timing mechanisms for mass- market watches. X, Y, and Z sell to independent foreign purchasers. X, Y, and Z earn gross profit mark ups with respect to their manufacturing operations that range from 3% to 5%. A accounts for supervisory, general, and administrative costs as operating expenses, and thus these costs are not reflected in cost of goods sold. The gross profit mark ups of X, Y, and Z, however, reflect supervisory, general, and administrative costs as part of costs of goods sold. Therefore, the gross profit mark ups of X, Y, and Z must be adjusted to provide accounting consistency ...

Another important aspect of comparability is accounting consistency. Where the accounting practices differ in the controlled transaction and the uncontrolled transaction, appropriate adjustments should be made to the data used to ensure that the same type of costs are used in each case to ensure consistency. The gross profit mark ups must be measured consistently between the associated enterprise and the independent enterprise. In addition, there may be differences across enterprises in the treatment of costs that affect gross profit mark ups that would need to be accounted for in order to achieve reliable comparability. In some cases it may be necessary to take into account certain operating expenses in order to achieve consistency and comparability; in these circumstances the cost plus method starts to approach a net rather than gross profit analysis. To the extent that the analysis takes into account operating expenses, its reliability may be adversely affected for the reasons set forth in paragraphs 2.70 – 2.73. Thus, the safeguards described in paragraphs 2.74 – 2.81 may be relevant in assessing the reliability of such analyses ...

The CUP method is a particularly reliable method where an independent enterprise sells the same product as is sold between two associated enterprises. For example, an independent enterprise sells unbranded Colombian coffee beans of a similar type, quality, and quantity as those sold between two associated enterprises, assuming that the controlled and uncontrolled transactions occur at about the same time, at the same stage in the production/distribution chain, and under similar conditions. If the only available uncontrolled transaction involved unbranded Brazilian coffee beans, it would be appropriate to inquire whether the difference in the coffee beans has a material effect on the price. For example, it could be asked whether the source of coffee beans commands a premium or requires a discount generally in the open market. Such information may be obtainable from commodity markets or may be deduced from dealer prices. If this difference does have a material effect on price, some adjustments would be appropriate. If a reasonably accurate adjustment cannot be made, the reliability of the CUP method would be reduced, and it might be necessary to select another less direct method instead ...

In considering whether controlled and uncontrolled transactions are comparable, regard should be had to the effect on price of broader business functions other than just product comparability (i.e. factors relevant to determining comparability under Chapter I). Where differences exist between the controlled and uncontrolled transactions or between the enterprises undertaking those transactions, it may be difficult to determine reasonably accurate adjustments to eliminate the effect on price. The difficulties that arise in attempting to make reasonably accurate adjustments should not routinely preclude the possible application of the CUP method. Practical considerations dictate a more flexible approach to enable the CUP method to be used and to be supplemented as necessary by other appropriate methods, all of which should be evaluated according to their relative accuracy. Every effort should be made to adjust the data so that it may be used appropriately in a CUP method. As for any method, the relative reliability of the CUP method is affected by the degree of accuracy with which adjustments can be made to achieve comparability ...

It may be difficult to find a transaction between independent enterprises that is similar enough to a controlled transaction such that no differences have a material effect on price. For example, a minor difference in the property transferred in the controlled and uncontrolled transactions could materially affect the price even though the nature of the business activities undertaken may be sufficiently similar to generate the same overall profit margin. When this is the case, some adjustments will be appropriate. As discussed below in paragraph 2.17, the extent and reliability of such adjustments will affect the relative reliability of the analysis under the CUP method ...

Comparability adjustments may be warranted to account for group synergies ...

Comparability issues, and the need for comparability adjustments, can also arise because of the existence of MNE group synergies. In some circumstances, MNE groups and the associated enterprises that comprise such groups may benefit from interactions or synergies amongst group members that would not generally be available to similarly situated independent enterprises. Such group synergies can arise, for example, as a result of combined purchasing power or economies of scale, combined and integrated computer and communication systems, integrated management, elimination of duplication, increased borrowing capacity, and numerous similar factors. Such group synergies are often favourable to the group as a whole and therefore may heighten the aggregate profits earned by group members, depending on whether expected cost savings are, in fact, realised, and on competitive conditions. In other circumstances such synergies may be negative, as when the size and scope of corporate operations create bureaucratic barriers not faced by smaller and more nimble enterprises, or when one portion of the business is forced to work with computer or communication systems that are not the most efficient for its business because of group wide standards established by the MNE group ...

Some businesses are successful in assembling a uniquely qualified or experienced cadre of employees. The existence of such an employee group may affect the arm’s length price for services provided by the employee group or the efficiency with which services are provided or goods produced by the enterprise. Such factors should ordinarily be taken into account in a transfer pricing comparability analysis. Where it is possible to determine the benefits or detriments of a unique assembled workforce vis-à- vis the workforce of enterprises engaging in potentially comparable transactions, comparability adjustments may be made to reflect the impact of the assembled workforce on arm’s length prices for goods or services ...

The need for comparability adjustments related to features of the local market in cases where reasonably reliable local market comparables cannot be identified may arise in several different contexts. In some circumstances, market advantages or disadvantages may affect arm’s length prices of goods transferred or services provided between associated enterprises ...

In situations where reasonably reliable local market comparables cannot be identified, the determination of appropriate comparability adjustments for features of the local market should consider all of the relevant facts and circumstances. As with location savings, in each case where reliable local market comparables cannot be identified, it is necessary to consider (i) whether a market advantage or disadvantage exists, (ii) the amount of any increase or decrease in revenues, costs or profits, vis-à-vis those of identified comparables from other markets, that are attributable to the local market advantage or disadvantage, (iii) the degree to which benefits or burdens of local market features are passed on to independent customers or suppliers, and (iv) where benefits or burdens attributable to local market features exist and are not fully passed on to independent customers or suppliers, the manner in which independent enterprises operating under similar circumstances would allocate such net benefits or burdens between them ...

Features of the local market in which business operations occur may affect the arm’s length price with respect to transactions between associated enterprises. While some such features may give rise to location savings, others may give rise to comparability concerns not directly related to such savings. For example, the comparability and functional analysis conducted in connection with a particular matter may suggest that the relevant characteristics of the geographic market in which products are manufactured or sold, the purchasing power and product preferences of households in that market, whether the market is expanding or contracting, the degree of competition in the market and other similar factors affect prices and margins that can be realised in the market. Similarly, the comparability and functional analysis conducted in connection with a particular matter may suggest that the relative availability of local country infrastructure, the relative availability of a pool of trained or educated workers, proximity to profitable markets, and similar features in a geographic market where business operations occur create market advantages or disadvantages that should be taken into account. Appropriate comparability adjustments should be made to account for such factors where reliable adjustments that will improve comparability can be identified ...

At issue in the case of „RĪGAS DZIRNAVNIEKS” was if the interest rates charged on loans between related parties were at arm’s length. Judgement of the Court of Appeals The Court remanded the case to the Regional Court for a new hearing. Excerpts “As already indicated above, paragraphs 84, 91 and 92.3.1 and 92.3.2 of Regulation No 556 deal with the need for adjustments and mathematical calculations when significant differences in the comparable data and their material effects are established. The need for adjustments is also underlined in point 1.35 of the Guidelines. Guidance on how differences between comparables are to be addressed is provided, inter alia, in paragraph 3.57 of the Guidelines. It may be the case that, although every effort is made to exclude items with a lower level of comparability, the result is a series of figures for which it is considered that, given the process used to select the comparables and the information available on the limitations of the comparables, certain comparability defects remain which cannot be identified and/or quantified and are therefore not corrected for. In such cases, if the range includes a large number of observations, a statistical tool that takes into account the central tendency to narrow the range (e.g. to an interquartile range or other percentiles) could help to improve the reliability of the analysis. Thus, the Guidelines consider those cases where the analysis ends with a series of numbers. In such cases, various statistical tools should be used to narrow the range as much as possible. Reading these legal provisions in their context, it is clear that, although Regulation No 556 does not explain how adjustments and mathematical calculations are to be made, it is clear that, according to these legal provisions, the consistency of the transaction price with the price range indicated in the database used for a given type of product is not sufficient in itself to recognise the conformity of the price to be verified with the market price. The above-mentioned provisions of paragraphs 84, 91 and 92 of Regulation No 556 set out a number of relevant factors for the comparability of transactions. This means that for each transaction carried out with a related company, a detailed comparison should be made with the data used, indicating similar and dissimilar circumstances and adjusting the data where necessary. Consequently, the fact that the interest rates applied in the transactions between the applicant and its related companies fall within the range of interest rates used by the District Court does not, in itself, give rise to a finding beyond reasonable doubt that the applicant’s transaction prices are in line with market prices and that no corresponding adjustments are necessary. Moreover, the Regional Court merely referred to the first paragraph of Article 6(4) of the Law on Corporation Tax, which governed the adjustment of taxable income for interest payments during the audit period. However, the Regional Court has not explained whether that provision is also applicable in the present case. Nor has the Revenue Service, in its cassation appeal, put forward any arguments concerning the application and applicability of that provision to the dispute in the present case. Therefore, when examining the merits of the case, if it is concluded that the use of the statistical data compiled by the Bank of Latvia requires an adjustment, it must also be ascertained whether appropriate adjustments are not to be made in accordance with the procedure laid down in the first paragraph of Section 6.4 of the Law on Corporate Income Tax.” Click here for English translation Click here for other translation SKA-103-2021 ...

This case deals with the choice of transfer pricing method. Following an audit, an upwards adjustment of the taxable income was issued by the tax authorities. The adjustment was based on application of the cost plus method instead of the CUP method as had been chosen by the company. The company disagreed with the assessment and filed an appeal with the tax court. Judgement of the Tax Court The Tax Court allowed the appeal and set aside the assessment of the tax authorities due to lack of statement of reasons for choosing another transfer pricing method. Excerpt “Because the provisions of Article 17 §§§1,2 of the Code of Administrative Procedure (Law 2690/1999) entitled ‘Reasons’ set out the following: “1. The individual administrative act must contain a statement of reasons, which must include a statement of the existence of the legal requirements for its issuance. 2. The statement of reasons must be clear, specific, adequate and must be apparent from the information on the file, unless it is expressly provided by law that it must be contained in the body of the act’. It follows from the combination of the above provisions that the audit report, which constitutes the statement of reasons for the act imposing the tax, must be clear, specific and sufficient. The purpose of the statement of reasons is to enable both the taxpayer and the Court of Justice to verify whether the administrative act was adopted for the benefit of the taxpayer and whether it complies with or is in conformity with the rules of law which define the framework of legality (cf. Epaminondas Spiliotopoulos, Administrative Law Manual, § 5.Reasons for the administrative act). According to case law, the complete vagueness of the Audit Report is equivalent to its non-existence (see CoE 565/2008, 2054/1995). Because, as is clear from the relevant Audit Report (pp. 48-49), in this particular case, the audit rejected the method of the comparable uncontrolled price (CUP), without indicating whether it was possible to maintain this method but with reasonable adjustments. Since in view of the above, the Final Income Tax Adjustment Act No. …………./2020 of the Head of the C.E.M.E.P., for the tax year 2014 is held to be formally defective and therefore void.” Click here for English translation Click here for other translation Greece 2021-3495 ...

“TP Packaging” is mainly engaged in the marketing of packaging materials, which in 2013 required a number of goods and services provided by its related companies. The transfer pricing analysis of the controlled transactions was carried out with “TP Packaging” as the tested party. The transactional net margin method (TNMM) was applied using the profitability indicator ROS (return on sales) and external comparables (eleven comparables). “TP Packaging”‘s financial information for the years 2011 to 2013 was used but certain adjustments had been made to the 2013 financial results. The results showed that “TP Packaging”‘s profitability in 2013 was within the interquartile range. The tax authorities agreed with the study presented in the transfer pricing analysis. However, they did not accept the use of multi-year financial information (years 2011 to 2013) and the adjustments made to the financial results. As a result, “TP Packaging”‘s profitability in 2013 was now below the interquartile range. A transfer pricing adjustment was therefore made to the median, which resulted in an assessment of additional taxable income. Not satisfied with the assessment, “TP Packaging” appealed to the Tax Court. Decision of the Tax Court The Court upheld the assessment issued by the tax authorities and dismissed the appeal of “TP Packaging”. Excerpts “It should be reiterated that the purpose of the accounting adjustment referred to by the appellant was to prepare and present its financial statements in accordance with the IFRS accounting standard, this not having been an aspect taken into account in the search for and selection of comparable companies, given that independent companies were identified as such which adopted in some cases a different accounting standard (US GAAP) and in others the same accounting standard (IFRS), it is therefore not apparent that the exclusion of the accounting adjustment referred to by the appellant helped to improve comparability with the abovementioned companies, the argument that the comparable companies did not make an accounting adjustment to their financial information is not a valid reason, since, as mentioned above, the exclusion of that accounting adjustment would mean that the appellant’s financial information would no longer be shown in accordance with IFRS, which would be justified in the transfer pricing analysis if it were intended to bring the appellant’s accounting standard, as the party under analysis, into line with the accounting standards used by the independent third parties selected as comparable, which has not been verified in the present case. On the other hand, the transfer pricing analysis under the application of the TNM method performed by the submitted study, as well as the analysis performed by the Administration, used the financial information of the Appellant’s complete financial statements as the examined part, i.e. both parties considered it appropriate for the comparability analysis not to segment the Appellant’s financial information (which excludes income and expenses not related to the related transactions under examination)”, Therefore, the Appellant’s claim that the accounting adjustment for the adoption of IFRS relates to other transactions (machine leases) and that its exclusion for the transfer pricing analysis would therefore improve comparability with the independent companies selected as comparables is not supportable. From the foregoing, it is established that the relevance of the comparability adjustment proposed by the appellant (exclusion of the accounting adjustment for the adoption of IFRS) for the purposes of the transfer pricing analysis is not substantiated, and therefore the rejection by the Administration of said adjustment is in accordance with the law.” Click here for English Translation Click here for other translation Peru 06526-1-2021 ...

Finally, when applying a one-sided method such as the resale price method, the cost plus method, or the TNMM, the accounting treatment of the government assistance in both the tested party and any comparable may need to be specifically identified, especially when the tested party and the comparables apply different accounting standards. For example, the government assistance may be deducted from the costs under the relevant accounting standard, or it may be presented separately. In addition, the accounting treatment of government subsidies under different accounting standards may impact different levels of profitability (e.g. gross profit, operating profit, net profit, etc.) or might even be accounted for in the “other comprehensive income” statement, only being recycled into the “profit or loss statement” of the entity over time. Where accounting treatments of the same type of assistance differ between the tested party and the comparable, a comparability adjustment may be required. In addition, divergences in the accounting treatment of government assistance could point to a difference in the type of government support provided – e.g. the accounting treatment of a conditional loan differs from that of an outright grant. Such a difference could affect comparability and might be more difficult to adjust for than a simple accounting difference ...

Third, adjustments for accounting consistency may be required to improve comparability. Adjustments for accounting consistency are designed to eliminate the effect of differing accounting practices between the controlled and uncontrolled transactions and should be considered if and only if they are expected to increase the reliability of the results of a comparability analysis.32 In some cases, if exceptional costs arising from COVID-19 may be accounted for as either operating or non-operating items by different taxpayers in different transactions, then comparability adjustments may be In other cases there can be differences in whether the COVID-19 related costs are taken into account above or below the gross profit line. For instance, the recognition of the purchase of PPE as an operating cost by the tested party and as a cost of goods sold by a comparable may have a significant impact when computing a profit level indicator based on gross profit and may require a comparability adjustment. 32 Paragraph 3.48 and 3.50 of Chapter III of the OECD TPG ...

This aspect is also relevant in performing the comparability analysis. For instance, assume government intervention forces a taxpayer to close its distribution facilities for three months. In undertaking a benchmark analysis, care should be taken in verifying that comparable enterprises have faced similar restrictions or conditions. Otherwise, it might be necessary to adjust the period over which the comparison is performed (e.g. excluding the economic data corresponding to the three months where the taxpayer was unable to operate). Taxpayers and tax administrations should determine on a case-by-case basis the extent to which these adjustments are necessary in circumstances where the potential differences may not have a material impact on the comparability. In this respect, the guidance in paragraphs 3.50 to 3.52 of the OECD TPG is relevant ...

The unprecedented change in the economic environment following the outbreak of COVID-19 creates unique challenges for performing comparability analysis. The pandemic may have a significant impact on the pricing of some transactions between independent enterprises and may reduce the reliance that can be placed on historical data when performing comparability analyses. This may require taxpayers and tax administrations to consider practical approaches that can be adopted to address information deficiencies, such as comparability adjustments. Such practical approaches regarding the performance of comparability analyses should be consistent with the transfer pricing policy of the taxpayer over time ...

In this case, a Romanian manufacturer and distributor (A. SA) in the Electrolux group (C) had been loss making while the group as a whole had been profitable. The tax authorities issued an assessment, where the profit of A. SA had been determined based on a comparison to the profitability of independent traders in households appliances. When calculating the profit margin of A. SA certain adjustments was made to the costs – depreciations, extraordinary costs etc. When comparing A. SA’s net profit to financial results with those of the group to which it belongs, it emerged that, during the period under review, the applicant was loss-making while C. made a profit. With reference to paragraphs 1.70 and 1.71 of the OECD Transfer Pricing Guidelines, when an affiliated company consistently makes a loss while the group as a whole is profitable, the data may call for a special analysis of the transfer pricing elements, as this loss-making company may not receive an adequate reward from the group of which it is part and with which it does business for the benefits derived from its activities. An analysis of the way in which the prices at which the applicant’s products are sold to other companies in C. are determined shows that those prices are imposed by the group, and that there is a uniform group policy of remunerating the manufacturing companies within the group and those carrying out distribution activities. According to the document called “Framework Documentation 2013”, Annex 28 of the transfer pricing file, transfer prices are established on the basis of budgeted estimated costs, comprising direct material cost, direct labour cost and direct manufacturing costs, as well as indirect manufacturing costs and processing costs, plus a margin of 2.5%. Compared to this mark-up, the mark-up applied to B.’s direct and indirect production costs was between 27.04% and 34.87% over the period 2008-2013, as shown in B.’s public financial statements. It is true that B. is an entrepreneur whose activity involves several functions and risks, which may lead to higher mark-ups or higher losses, but it is worth noting that the mark-up applied to the cost of goods sold by B. is 11-14 times higher than that established for A. S.A.. During the entire period subject to tax inspection, the applicant incurred losses, while C. made a profit. In the years 2010, 2011 and 2013, with a turnover of more than 400.000.000 RON, the applicant always recorded a net loss. According to the tax authorities the court of first instance erred in finding that the comparison between the operating cost margin of 2.50% established by the transfer pricing policy for the applicant’s household appliance manufacturing activities and B.’s gross cost margin was erroneous, given that the applicant failed to identify the source of the cost of goods sold values used for the calculation of B.’s gross cost margin, according to RIF p. 5. A comparative analysis of the applicant’s sales invoices for household appliances to C. on the one hand and to independent companies on the other found that, for identical products, in similar quantities, at similar times of the year, the applicant sold to independent companies, under conditions presumed to be competitive and negotiated, at unit prices at least 25% higher than the prices at which it sold the same products to group companies. Judgement of Supreme Court The Court referred the case back to the lower court, within the limits of the cassation, for the completion of the evidence, in compliance with the rulings given on the questions of law in this decision. Excerpt “The Court of First Instance held that the defendant authorities had estimated the income which the applicant should have obtained from transactions with related persons by taking into account the median value of the interquartile range, relying on the provisions of Article 2(2)(b) of the EC Treaty. (2) and (3) of Annex 1 to OPANAF No 222/2008. These provisions, which concern both the comparison and the adjustment, stipulate, with regard to the first issue, that the maximum and minimum segments of the comparison interval are extreme results which will not be used in the comparison margin. They were held by the court to unduly restrict the range of comparison since neither Article 11 of the Tax Code, to the application of which the Order is given, nor the Methodological Norms for the application of the Tax Code provide for the exclusion of the upper and lower quartiles from the range of comparison. Citing paragraph 2.7 of Chapter II, Part I of the OECD Guidelines, which it held to be of superior legal force to FINANCE Ordinance No 222/2008, the court concluded that, in order to consider that the prices charged in transactions with related persons comply with the arm’s length principle, it is sufficient that the taxpayer’s net margin falls within the interquartile range of comparison, without eliminating the extremes. The High Court finds that there is no argument to exclude from the application of the provisions of OPANAF No 222/2008 relating to the preparation of the transfer pricing file and, in particular, the provisions cited above, which exclude extreme results from the comparison margin. The Order is a regulatory act and applies in addition to the provisions of Article 11(11) of Regulation (EC) No 1073/2004. (2) of the Tax Code and Art. 79 para. (2) of O.G. no. 92/2003 on the Fiscal Procedure Code. The higher rules do not regulate the comparison method or the adjustment method, which were left within the scope of the secondary rules. On the other hand, the provisions of the Guidelines cited by the Court of First Instance do not support the thesis that such extreme results are not excluded, since they refer to the choice of the most appropriate method for analysing transfer prices between related persons, and not to the comparability analysis referred to in Chapter III, Section A.7, which allows the use of a comparison range and the exclusion of extremes (paragraph 3.63). Moreover, the comparison ...

What “Vehicles Distributor” seeks to achieve in the present case is an attempt to adjust (reduce) the transaction price retrospectively by reference to a new transfer price, and not to claim repayment of the customs duty overpaid as a result of an incorrect customs value in the customs declarations upon release for free circulation. The customs declarations at issue were lodged as regular declarations and customs duties were levied on the value of the goods determined therein. It is not, therefore, the case that the value indicated in the declarations was arbitrary or fictitious or that the price at the time of sale of the goods could not be determined. Nor is there any basis in the facts for the applicant’s allegation that the goods were released for free circulation on the basis of the provisional value of the goods. Click here for English translation Click here for other translation UPRS_Sodba_III_U_208_2018-12-24.09.2020 ...

Results in a Danish company engaged in distribution of pharmaceuticals were significantly below the arm’s length range of net profit according to the benchmark study, but by disregarding annual goodwill amortization of DKK 57.1 million, the results were within the arm’s length range. The goodwill being amortized in Pharma Distributor A A/S had been determined under a prior acquisition of the company, and later – due to a merger with the acquiring danish company – booked in Pharma Distributor A A/S. The main question in the case was whether Pharma Distributor A A/S were entitled to disregard the goodwill amortization in the comparability analysis. The national tax court had ruled in favor of the company, but the national court reached the opposite result. Thus, the National Court found that the goodwill in question had to be regarded as an operating asset, and therefore the depreciation had to be regarded as operating expenses when calculating the net profit (EBIT margin). In 2017 the Danish tax tribunal found in favor of Pharma Distributor A A/S However, The Danish National Court found that the controlled transactions had not been priced in accordance with the arm’s length principle in section 2 (2) of the Tax Assessment Act. 1, and that the tax authorities was therefore basically justified in assessing the income of Pharma Distributor A A/S. But there was no basis for adjustment for the income year 2010, where the EBIT margin of the company (including goodwill amortization) was within the interquartile range of the benchmark. The National Court further found that Pharma Distributor A A/S had not demonstrated that the companies whose results were included in the benchmark possessed goodwill that was simply not capitalized and which corresponded approximately to the value of the goodwill in Pharma Distributor A A/S. Therefore, the National Court did not find that adjusting for goodwill amortization in the comparability analysis, would make the comparison more correct. Pharma Distributor A A/S also claimed that special commercial conditions (increased price competition, restructuring , etc.) and not incorrect pricing had led to lower earnings. The Court found that such conditions had not been demonstrated by the company. On this basis, the National Court found that the tax authorities was entitled to make the assessment of additional income in FY 2006-2009, but not for FY 2010. The court found that, when adjusting the taxable income, an individual estimate must be made for each year, based on what income the defendants could be assumed to have obtained if they had acted in in accordance with the arm’s length principle. The court referred the case for re-assessment of the taxable income for FY 2006-2009. Click here for translation SKM2020-105-olrn ...

In an ideal scenario, a comparability analysis would enable the identification of financial transactions between independent parties which match the tested transaction in all respects. With the many variables involved, it is more likely that potential comparables will differ from the tested transaction. Where differences exist between the tested transaction and any proposed comparable, it will be necessary to consider whether such differences will have a material impact on the price. If so, it may be possible, where appropriate, to make comparability adjustments to improve the reliability of a comparable. This is more likely to be achievable where the adjustment is based on a quantitative factor and there is good quality data easily available (e.g. on currency differences) than, for instance, in trying to compare loans to borrowers with qualitative differences or where data is not so readily available (e.g. borrowers with different business strategies) ...

The case of Volkswagen Argentina S.A. revolves around benchmarking and comparability adjustments. In the transfer pricing analysis Volkswagen adjusts the results of the tested party (local entity) for extraordinary losses due to local economic conditions. The Federal Court of Appeals supports the adjustment to the results of the tested party and also the approach of averaging out the results of the tested party over a period of three year. Click here for English Translation ARGVW dec 2019 ...

In 2014, RIF Trading House sourced and bought agricultural products in Russia – wheat, barley, corn and peas. These products were then exported to a trader in the UAE, which turned out to be related to RIF Trading House. However, RIF Trading House had not provide information on the relationship, nor the required transfer pricing documentation on the controlled transactions. Following an audit, the Russian Federal Tax Service came to the conclusion that the export prices had been lowered in the supply of products to the trader in UAE. The Russian Federal Tax Service independently conducted a transfer pricing analysis – functional analysis, analyzed the market, commodity exchange prices (Platts, ICAR) etc., and then issued a tax assessment where combinations of pricing methods and adjustments had been applied to determine the pricing of the controlled transactions and thus the income of RIF Trading House. Disagreeing with the assessment RIF Trading House brought the case to Court. The court ruled in favor of the tax authorities. Click here for translation A40-241020-2018_20190417_Reshenija_i_postanovlenija ...

Example of a Working Capital Adjustment See Chapter III, Section A.6 of these Guidelines for general guidance on comparability adjustments. The assumptions about arm’s length arrangements in the following examples are intended for illustrative purposes only and should not be taken as prescribing adjustments and arm’s length arrangements in actual cases of particular industries. While they seek to demonstrate the principles of the sections of the Guidelines to which they refer, those principles must be applied in each case according to the specific facts and circumstances of that case. This example is provided for illustration purposes as it represents one way, but not necessarily the only way, in which such an adjustment can be calculated. Furthermore, the comments below relate to the application of a transactional net margin method in the situations where, given the facts and circumstances of the case and in particular the comparability (including functional) analysis of the transaction and the review of the information available on uncontrolled comparables, such a method is found to be the most appropriate method to be used. Introduction  This simple example shows how to make an adjustment in recognition of differences in levels of working capital between a tested party (TestCo) and a comparable (CompCo). See paragraphs 3.47-3.54 of these Guidelines for general guidance on comparability adjustments. Working capital adjustments may be warranted when applying the transactional net margin method. In practice they are usually found when applying a transactional net margin method, although they might also be applicable in cost plus or resale price methods. Working capital adjustments should only be considered when the reliability of the comparables will be improved and reasonably accurate adjustments can be made. They should not be automatically made and would not be automatically accepted by tax administrations. Why make a working capital adjustment? In a competitive environment, money has a time value. If a company provided, say, 60 days trade terms for payment of accounts, the price of the goods should equate to the price for immediate payment plus 60 days of interest on the immediate payment price. By carrying high accounts receivable a company is allowing its customers a relatively long period to pay their accounts. It would need to borrow money to fund the credit terms and/or suffer a reduction in the amount of cash surplus which it would otherwise have available to invest. In a competitive environment, the price should therefore include an element to reflect these payment terms and compensate for the timing The opposite applies to higher levels of accounts payable. By carrying high accounts payable, a company is benefitting from a relatively long period to pay its suppliers. It would need to borrow less money to fund its purchases and/or benefit from an increase in the amount of cash surplus available to invest. In a competitive environment, the cost of goods sold should include an element to reflect these payment terms and compensate for the timing A company with high levels of inventory would similarly need to either borrow to fund the purchase or reduce the amount of cash surplus which the company is able to invest. Note that the interest rate might be affected by the funding structure (e.g. where the purchase of inventory is partly funded by equity) or by the risk associated with holding specific types of Making a working capital adjustment is an attempt to adjust for the differences in time value of money between the tested party and potential comparables with an assumption that the difference should be reflected in profits. The underlying reasoning is that: A company will need funding to cover the time gap between the time it invests money (i.e. pays money to supplier) and the time it collects the investment (i.e. collects money from customers) This time gap is calculated as: the period needed to sell inventories to customers + (plus) the period needed to collect money from customers – (less) the period granted to pay debts to supplyers The process of calculating working capital adjustments: a)Identify differences in the levels of working capital. Generally trade receivables, inventory and trade payables are the three accounts considered. The transactional net margin method is applied relative to an appropriate base, for example costs, sales or assets (see paragraph 2.64 of the Guidelines). If the appropriate base is sales, for example, then any differences in working capital levels should be measured relative to sales. Calculate a value for differences in levels of working capital between the tested party and the comparable relative to the appropriate base and reflecting the time value of money by use of an appropriate interest Adjust the result to reflect differences in levels of working capital. The following example adjusts the comparable’s result to reflect the tested party’s levels of working capital. Alternative calculations are to adjust the tested party’s results to reflect the comparables levels of working capital or to adjust both the tested party and the comparable’s results to reflect “zero” working A practical example of calculating working capital adjustments:  6. The following calculation is hypothetical. It is only to demonstrate how a working capital adjustment can be TestCo Year 1 Year 2 Year 3 Year 4 Year 5 Sales $179.5m $182.5m $187m $195m $198m Earnings Before Interest & Tax (EBIT) $1.5m $1.83m $2.43m $2.54m $1.78m EBIT/Sales (%) 0.8% 1% 1.3% 1.3% 0.9% Working Capital (at end of year)1 Trade Receivables (R) $30m $32m $33m $35m $37m Inventories (I) $36m $36m $38m $40m $45m Trade Payables (P) $20m $21m $26m $23m $24m Receivables (R) + Inventory (I) – Payables (P) $46m $47m $45m $52m $58m (R + I – P) / Sales 25.6% 25.8% 24.1% 26.7% 29.3% CompCo Year 1 Year 2 Year 3 Year 4 Year 5 Sales $120.4m $121.2m $121.8m $126.3m $130.2m Earnings Before Interest & Tax (EBIT) $1.59m $3.59m $3.15m $4.18m $6.44m EBIT/Sales (%) 1.32% 2.96% 2.59% 3.31% 4.95% Working Capital (at end of year)1 Trade Receivables (R) $17m $18m $20m $22m $23m Inventory (I) $18m $20m $26m $24m $25m Trade Payables (P) $11m ...

There are cases where comparables (including internal comparables) are available, subject to possible comparability adjustments being performed. One example of a possible application of the CUP method would be the case where an enterprise that used to transact independently with the MNE group is acquired, and the acquisition is followed by a restructuring of the now controlled transactions. Subject to a review of the five economically relevant characteristics or comparability factors and of the possible effect of the controlled and uncontrolled transactions taking place at different times, it might be the case that the conditions of the pre-acquisition uncontrolled transactions provide a CUP for the post-acquisition controlled transactions. Even where the conditions of the transactions are restructured, it might still be possible, depending on the facts and circumstances of the case, to adjust for the transfer of functions, assets and/or risks that occurred upon the restructuring. For instance, a comparability adjustment might be performed to account for the fact that a different party assumes bad debt risk ...

It should also be recognised that comparability adjustments for factors other than differences in the nature of the intangibles used may be required in matters involving the use of intangibles in connection with a controlled sale of goods or services. In particular, comparability adjustments may be required for matters such as differences in markets, locational advantages, business strategies, assembled workforce, corporate synergies and other similar factors. While such factors may not be intangibles as that term is described in Section A. 1 of this chapter, they can nevertheless have important effects on arm’s length prices in matters involving the use of intangibles ...

Where the need to make comparability adjustments arises because of differences in the intangibles used by the tested party in a controlled transaction and the intangibles used by a party to a potentially comparable uncontrolled transaction, difficult factual questions can arise in quantifying reliable comparability adjustments. These issues require thorough consideration of the relevant facts and circumstances and of the available data regarding the impact of the intangibles on prices and profits. Where the impact on price of a difference in the nature of the intangibles used is clearly material, but not subject to accurate estimation, it may be necessary to utilise a different transfer pricing method that is less dependent on identification of reliable comparables ...

The principles of paragraphs 3.47 to 3.54 relating to comparability adjustments apply with respect to transactions involving the transfer of intangibles or rights in intangibles. It is important to note that differences between intangibles can have significant economic consequences that may be difficult to adjust for in a reliable manner. Particularly in situations where amounts attributable to comparability adjustments represent a large percentage of the compensation for the intangible, there may be reason to believe, depending on the specific facts, that the computation of the adjustment is not reliable and that the intangibles being compared are in fact not sufficiently comparable to support a valid transfer pricing analysis. If reliable comparability adjustments are not possible, it may be necessary to select a transfer pricing method that is less dependent on the identification of comparable intangibles or comparable transactions ...

Ensuring the needed level of transparency of comparability adjustments may depend upon the availability of an explanation of any adjustments performed, the reasons for the adjustments being considered appropriate, how they were calculated, how they changed the results for each comparable and how the adjustment improves comparability. Issues regarding documentation of comparability adjustments are discussed in Chapter V ...

It is not appropriate to view some comparability adjustments, such as for differences in levels of working capital, as “routine” and uncontroversial, and to view certain other adjustments, such as for country risk, as more subjective and therefore subject to additional requirements of proof and reliability. The only adjustments that should be made are those that are expected to improve comparability ...

It is not always the case that adjustments are warranted. For instance, an adjustment for differences in accounts receivable may not be particularly useful if major differences in accounting standards were also present that could not be resolved. Likewise, sophisticated adjustments are sometimes applied to create the false impression that the outcome of the comparables search is “scientific”, reliable and accurate ...

It bears emphasis that comparability adjustments are only appropriate for differences that will have a material effect on the comparison. Some differences will invariably exist between the taxpayer’s controlled transactions and the third party comparables. A comparison may be appropriate despite an unadjusted difference, provided that the difference does not have a material effect on the reliability of the comparison. On the other hand, the need to perform numerous or substantial adjustments to key comparability factors may indicate that the third party transactions are in fact not sufficiently comparable ...

Comparability adjustments should be considered if (and only if) they are expected to increase the reliability of the results. Relevant considerations in this regard include the materiality of the difference for which an adjustment is being considered, the quality of the data subject to adjustment, the purpose of the adjustment and the reliability of the approach used to make the adjustment ...

An example of a working capital adjustment designed to reflect differing levels of accounts receivable, accounts payable and inventory is provided in the Annex to Chapter III. The fact that such adjustments are found in practice does not mean that they should be performed on a routine or mandatory basis. Rather, the improvement to comparability should be shown when proposing these types of adjustments (as for any type of adjustment). Further, a significantly different level of relative working capital between the controlled and uncontrolled parties may result in further investigation of the comparability characteristics of the potential comparable ...

Examples of comparability adjustments include adjustments for accounting consistency designed to eliminate differences that may arise from differing accounting practices between the controlled and uncontrolled transactions; segmentation of financial data to eliminate significant non- comparable transactions; adjustments for differences in capital, functions, assets, risks ...

The need to adjust comparables and the requirement for accuracy and reliability are pointed out in these Guidelines on several occasions, both for the general application of the arm’s length principle and more specifically in the context of each method. To be comparable means that none of the differences (if any) between the situations being compared could materially affect the condition being examined in the methodology or that reasonably accurate adjustments can be made to eliminate the effect of any such differences. Whether comparability adjustments should be performed (and if so, what adjustments should be performed) in a particular case is a matter of judgment that should be evaluated in light of the discussion of costs and compliance burden at Section C ...

The facts are the same as in paragraph 2.42. However, the amount of the warranty expenses incurred by Distributor A proves impossible to ascertain so that it is not possible to reliably adjust the gross profit of A to make the gross profit margin properly comparable with that of B. However, if there are no other material functional differences between A and B and the net profit of A relative to its sales is known, it might be possible to apply the transactional net margin method to B by comparing the margin relative to A’s sales to net profits with the margin calculated on the same basis for B ...

The selection of the denominator should be consistent with the comparability (including functional) analysis of the controlled transaction, and in particular it should reflect the allocation of risks between the parties (provided said allocation of risks is arm’s length, see Section D.1.2.1 in Chapter I). For instance, capital-intensive activities such as certain manufacturing activities may involve significant investment risk, even in those cases where the operational risks (such as market risks or inventory risks) might be limited. Where a transactional net margin method is applied to such cases, the investment-related risks are reflected in the net profit indicator if the latter is a return on investment (e.g. return on assets or return on capital employed). Such indicator might need to be adjusted (or a different net profit indicator selected) depending on what party to the controlled transaction bears that risk, as well as on the degree of differences in risk that may be found in the taxpayer’s controlled transaction and in comparables. See paragraphs 3.47-3.54 for a discussion of comparability adjustments ...

In those cases where there is a correlation between the credit terms and the sales prices, it could be appropriate to reflect interest income in respect of short-term working capital within the calculation of the net profit indicator and/or to proceed with a working capital adjustment, see paragraphs 3.47-3.54. An example would be where a large retail business benefits from long credit terms with its suppliers and from short credit terms with its customers, thus making it possible to derive excess cash that in turn may make it possible to have lower sales prices to customers than if such advantageous credit terms were not available ...

In applying the transactional net margin method, the selection of the most appropriate net profit indicator should follow the guidance at paragraphs 2.2 and 2.8 in relation to the selection of the most appropriate method to the circumstances of the case. It should take account of the respective strengths and weaknesses of the various possible indicators; the appropriateness of the indicator considered in view of the nature of the controlled transaction, determined in particular through a functional analysis; the availability of reliable information (in particular on uncontrolled comparables) needed to apply the transactional net margin method based on that indicator; and the degree of comparability between controlled and uncontrolled transactions, including the reliability of comparability adjustments that may be needed to eliminate differences between them, when applying the transactional net margin method based on that indicator. These factors are discussed below in relation to both the determination of the net profit and its weighting ...

Another important aspect of comparability is measurement consistency. The net profit indicators must be measured consistently between the associated enterprise and the independent enterprise. In addition, there may be differences in the treatment across enterprises of operating expenses and non-operating expenses affecting the net profits such as depreciation and reserves or provisions that would need to be accounted for in order to achieve reliable comparability ...

The transactional net margin method may afford a practical solution to otherwise insoluble transfer pricing problems if it is used sensibly and with appropriate adjustments to account for differences of the type referred to above. The transactional net margin method should not be used unless the net profit indicators are determined from uncontrolled transactions of the same taxpayer in comparable circumstances or, where the comparable uncontrolled transactions are those of an independent enterprise, the differences between the associated enterprises and the independent enterprises that have a material effect on the net profit indicator being used are adequately taken into account. Many countries are concerned that the safeguards established for the traditional transaction methods may be overlooked in applying the transactional net margin method. Thus where differences in the characteristics of the enterprises being compared have a material effect on the net profit indicators being used, it would not be appropriate to apply the transactional net margin method without making adjustments for such differences. The extent and reliability of those adjustments will affect the relative reliability of the analysis under the transactional net margin method. See discussion of comparability adjustments at paragraphs 3.47-3.54 ...

A is a domestic manufacturer of timing mechanisms for mass- market clocks. A sells this product to its foreign subsidiary B. A earns a 5% gross profit mark up with respect to its manufacturing operation. X, Y, and Z are independent domestic manufacturers of timing mechanisms for mass- market watches. X, Y, and Z sell to independent foreign purchasers. X, Y, and Z earn gross profit mark ups with respect to their manufacturing operations that range from 3% to 5%. A accounts for supervisory, general, and administrative costs as operating expenses, and thus these costs are not reflected in cost of goods sold. The gross profit mark ups of X, Y, and Z, however, reflect supervisory, general, and administrative costs as part of costs of goods sold. Therefore, the gross profit mark ups of X, Y, and Z must be adjusted to provide accounting consistency ...

Another important aspect of comparability is accounting consistency. Where the accounting practices differ in the controlled transaction and the uncontrolled transaction, appropriate adjustments should be made to the data used to ensure that the same type of costs are used in each case to ensure consistency. The gross profit mark ups must be measured consistently between the associated enterprise and the independent enterprise. In addition, there may be differences across enterprises in the treatment of costs that affect gross profit mark ups that would need to be accounted for in order to achieve reliable comparability. In some cases it may be necessary to take into account certain operating expenses in order to achieve consistency and comparability; in these circumstances the cost plus method starts to approach a net rather than gross profit analysis. To the extent that the analysis takes into account operating expenses, its reliability may be adversely affected for the reasons set forth in paragraphs 2.70 – 2.73. Thus, the safeguards described in paragraphs 2.74 – 2.81 may be relevant in assessing the reliability of such analyses ...

The CUP method is a particularly reliable method where an independent enterprise sells the same product as is sold between two associated enterprises. For example, an independent enterprise sells unbranded Colombian coffee beans of a similar type, quality, and quantity as those sold between two associated enterprises, assuming that the controlled and uncontrolled transactions occur at about the same time, at the same stage in the production/distribution chain, and under similar conditions. If the only available uncontrolled transaction involved unbranded Brazilian coffee beans, it would be appropriate to inquire whether the difference in the coffee beans has a material effect on the price. For example, it could be asked whether the source of coffee beans commands a premium or requires a discount generally in the open market. Such information may be obtainable from commodity markets or may be deduced from dealer prices. If this difference does have a material effect on price, some adjustments would be appropriate. If a reasonably accurate adjustment cannot be made, the reliability of the CUP method would be reduced, and it might be necessary to select another less direct method instead ...

In considering whether controlled and uncontrolled transactions are comparable, regard should be had to the effect on price of broader business functions other than just product comparability (i.e. factors relevant to determining comparability under Chapter I). Where differences exist between the controlled and uncontrolled transactions or between the enterprises undertaking those transactions, it may be difficult to determine reasonably accurate adjustments to eliminate the effect on price. The difficulties that arise in attempting to make reasonably accurate adjustments should not routinely preclude the possible application of the CUP method. Practical considerations dictate a more flexible approach to enable the CUP method to be used and to be supplemented as necessary by other appropriate methods, all of which should be evaluated according to their relative accuracy. Every effort should be made to adjust the data so that it may be used appropriately in a CUP method. As for any method, the relative reliability of the CUP method is affected by the degree of accuracy with which adjustments can be made to achieve comparability ...

It may be difficult to find a transaction between independent enterprises that is similar enough to a controlled transaction such that no differences have a material effect on price. For example, a minor difference in the property transferred in the controlled and uncontrolled transactions could materially affect the price even though the nature of the business activities undertaken may be sufficiently similar to generate the same overall profit margin. When this is the case, some adjustments will be appropriate. As discussed below in paragraph 2.17, the extent and reliability of such adjustments will affect the relative reliability of the analysis under the CUP method ...

Comparability adjustments may be warranted to account for group synergies ...

Comparability issues, and the need for comparability adjustments, can also arise because of the existence of MNE group synergies. In some circumstances, MNE groups and the associated enterprises that comprise such groups may benefit from interactions or synergies amongst group members that would not generally be available to similarly situated independent enterprises. Such group synergies can arise, for example, as a result of combined purchasing power or economies of scale, combined and integrated computer and communication systems, integrated management, elimination of duplication, increased borrowing capacity, and numerous similar factors. Such group synergies are often favourable to the group as a whole and therefore may heighten the aggregate profits earned by group members, depending on whether expected cost savings are, in fact, realised, and on competitive conditions. In other circumstances such synergies may be negative, as when the size and scope of corporate operations create bureaucratic barriers not faced by smaller and more nimble enterprises, or when one portion of the business is forced to work with computer or communication systems that are not the most efficient for its business because of group wide standards established by the MNE group ...

Some businesses are successful in assembling a uniquely qualified or experienced cadre of employees. The existence of such an employee group may affect the arm’s length price for services provided by the employee group or the efficiency with which services are provided or goods produced by the enterprise. Such factors should ordinarily be taken into account in a transfer pricing comparability analysis. Where it is possible to determine the benefits or detriments of a unique assembled workforce vis-à- vis the workforce of enterprises engaging in potentially comparable transactions, comparability adjustments may be made to reflect the impact of the assembled workforce on arm’s length prices for goods or services ...

The need for comparability adjustments related to features of the local market in cases where reasonably reliable local market comparables cannot be identified may arise in several different contexts. In some circumstances, market advantages or disadvantages may affect arm’s length prices of goods transferred or services provided between associated enterprises ...

In situations where reasonably reliable local market comparables cannot be identified, the determination of appropriate comparability adjustments for features of the local market should consider all of the relevant facts and circumstances. As with location savings, in each case where reliable local market comparables cannot be identified, it is necessary to consider (i) whether a market advantage or disadvantage exists, (ii) the amount of any increase or decrease in revenues, costs or profits, vis-à-vis those of identified comparables from other markets, that are attributable to the local market advantage or disadvantage, (iii) the degree to which benefits or burdens of local market features are passed on to independent customers or suppliers, and (iv) where benefits or burdens attributable to local market features exist and are not fully passed on to independent customers or suppliers, the manner in which independent enterprises operating under similar circumstances would allocate such net benefits or burdens between them ...

Features of the local market in which business operations occur may affect the arm’s length price with respect to transactions between associated enterprises. While some such features may give rise to location savings, others may give rise to comparability concerns not directly related to such savings. For example, the comparability and functional analysis conducted in connection with a particular matter may suggest that the relevant characteristics of the geographic market in which products are manufactured or sold, the purchasing power and product preferences of households in that market, whether the market is expanding or contracting, the degree of competition in the market and other similar factors affect prices and margins that can be realised in the market. Similarly, the comparability and functional analysis conducted in connection with a particular matter may suggest that the relative availability of local country infrastructure, the relative availability of a pool of trained or educated workers, proximity to profitable markets, and similar features in a geographic market where business operations occur create market advantages or disadvantages that should be taken into account. Appropriate comparability adjustments should be made to account for such factors where reliable adjustments that will improve comparability can be identified ...

The Platform for Collaboration on Tax (IMF, OECD, UN and the WBG) has published a toolkit for addressing difficulties in accessing comparables Data for Transfer Pricing Analyses. The Toolkit Includes a supplementary report on addressing the information gaps on prices of Minerals Sold in an intermediate form. PUBLIC-toolkit-on-comparability-and-mineral-pricing ...

A Japanese company entered into a transaction with a foreing group company to import English-language learning materials into Japan. The learning materials were then resold to Japanese customers. The Japanese tax authority found that the resale price method should be used for setting the arm’s-length price for the transaction. The arm’s-length price for the controlled transaction was the price at which the Japanese company resold the English-language learning materials to customers, minus a normal profit margin multiplied by the price. The “normal profit margin” in this case was found to be the weighted average ratio of gross margin to the total revenue for multiple transactions, where unrelated parties imported the same as the English-language learning materials, or goods of a similar sort, and then resold them to customers. The tax authority held that unrelated parties importing and selling learning materials should be considered comparable transactions, and appropriate adjustments could be made to account for difference. However, an important difference between the tested transactions and the comparables found by the tax authorities, was that a famous cartoon character featured in the learning materials in the controlled transaction, while the characters used for the comparable materials were not known to the public. The court held that, under the resale price method, the arm’s-length price was calculated based on the “normal profit margin” in similar transactions. The method is based on the comparability of the functions performed by the seller, focusing on the fact that the profit margin relating to the resale transaction has a close relation to the functions performed and risks assumed by the seller, rather than the type of inventory assets relating to the transaction. Therefore, it is important to ensure that no significant differences exists between the comparable transactions and tested transaction, in terms of the functions performed or risks assumed by the seller. When selecting comparable transaction, it is necessary to identify differences which may effect profit margins and if such differences is identified make appropriate adjustments. If the difference cannot be adjusted for the selected comparable transaction should be rejected. It was determined that the functions performed by the respective sellers in each transaction were not substantially different because both transactions were door-to-door sales by sales representatives, learning materials were developed and produced by respective suppliers, and the seller did not perform the manufacturing function. However, as the method and content of advertising and the compensation of sales representatives differed between these transactions, the differences in functions performed by the sellers, affecting the calculation of the normal profit margin, were deemed objectively obvious. Intangibles used in a transaction may impact various factors like sales price of inventory assets, gross revenue, advertisement expenses, sales expenses, negotiations with a seller and royalties. It is was difficult to measure the impact of these factors on the gross profit margins and therefore make an appropriate adjustment. The comparable transactions selected by the tax authority were rejected by the court as inappropriate, and the court ruled in the taxpayer’s favour. Click here for English Translation DIS13005 ...

Ensuring the needed level of transparency of comparability adjustments may depend upon the availability of an explanation of any adjustments performed, the reasons for the adjustments being considered appropriate, how they were calculated, how they changed the results for each comparable and how the adjustment improves comparability. Issues regarding documentation of comparability adjustments are discussed in Chapter V ...

It is not appropriate to view some comparability adjustments, such as for differences in levels of working capital, as “routine” and uncontroversial, and to view certain other adjustments, such as for country risk, as more subjective and therefore subject to additional requirements of proof and reliability. The only adjustments that should be made are those that are expected to improve comparability ...

It is not always the case that adjustments are warranted. For instance, an adjustment for differences in accounts receivable may not be particularly useful if major differences in accounting standards were also present that could not be resolved. Likewise, sophisticated adjustments are sometimes applied to create the false impression that the outcome of the comparables search is “scientific”, reliable and accurate ...

It bears emphasis that comparability adjustments are only appropriate for differences that will have a material effect on the comparison. Some differences will invariably exist between the taxpayer’s controlled transactions and the third party comparables. A comparison may be appropriate despite an unadjusted difference, provided that the difference does not have a material effect on the reliability of the comparison. On the other hand, the need to perform numerous or substantial adjustments to key comparability factors may indicate that the third party transactions are in fact not sufficiently comparable ...

Comparability adjustments should be considered if (and only if) they are expected to increase the reliability of the results. Relevant considerations in this regard include the materiality of the difference for which an adjustment is being considered, the quality of the data subject to adjustment, the purpose of the adjustment and the reliability of the approach used to make the adjustment ...

An example of a working capital adjustment designed to reflect differing levels of accounts receivable, accounts payable and inventory is provided in the Annex to Chapter III. The fact that such adjustments are found in practice does not mean that they should be performed on a routine or mandatory basis. Rather, the improvement to comparability should be shown when proposing these types of adjustments (as for any type of adjustment). Further, a significantly different level of relative working capital between the controlled and uncontrolled parties may result in further investigation of the comparability characteristics of the potential comparable ...

Examples of comparability adjustments include adjustments for accounting consistency designed to eliminate differences that may arise from differing accounting practices between the controlled and uncontrolled transactions; segmentation of financial data to eliminate significant non- comparable transactions; adjustments for differences in capital, functions, assets, risks ...

The need to adjust comparables and the requirement for accuracy and reliability are pointed out in these Guidelines on several occasions, both for the general application of the arm’s length principle and more specifically in the context of each method. As noted at paragraph 1.33, to be comparable means that none of the differences (if any) between the situations being compared could materially affect the condition being examined in the methodology or that reasonably accurate adjustments can be made to eliminate the effect of any such differences. Whether comparability adjustments should be performed (and if so, what adjustments should be performed) in a particular case is a matter of judgment that should be evaluated in light of the discussion of costs and compliance burden at Section C ...

A Korean pharma corporation produced and sold finished pharmaceuticals. Active ingredients were imported from foreign related parties in the United States and Ireland. The Korean pharma corporation produced and sold the original finished products by importing the five original patented raw materials that had expired from the patent period in each business period from December 1, 2001 to November 30. The tax authorities calculated the normal price of the original raw materials by a comparable third party pricing method. As for the specific methodology, the median price of imported generic raw materials for other domestic pharmaceutical companies was calculated by multiplying the ratio between the original product and the medical insurance price of the drug (generic finished product) produced by the domestic generic raw material by other domestic pharmaceutical companies. After calculating the normal price of the raw materials, the difference between the original price of the original raw materials and the difference between the original price and the normal price of the raw materials was included in the income. The tax authorities filed a law suit against the company for the disposition of a corporate tax levy, which had the following points:there are significant differences between generic drugs (or their raw materials) and original drugs (or their raw materials) in terms of customer loyalty,was not a market price reflecting the difference in quality but a government regulation price, which is an indicator of finished products, andwas not correlated with the import price of raw materials, so it was pointed out that it was inappropriate as an index to adjust for significant difference. Judgement of the Supreme Court “Generic raw materials in this case have the same composition and molecular structure as the original raw materials of the case and their efficacy, ie biological efficacy, do not seem to be much different, so the rest of the generic raw materials It would be possible to derive reasonable normal prices through such adjustments to the import prices of generic raw materials in this case. The medical insurance drug price does not include the consideration of the market value of the drug and its raw materials in the decision process, and furthermore, it is not considered whether the raw material of the drug is original or generic. And the upper limit is also determined by the number of items listed on the same ingredient formulation and the upper limit of the listed ingredients. Therefore, the price of the original finished product in the case of the health insurance drug price and the price of the generic drug It is hard to say that the adjustment method that utilizes the difference between drug prices can not be a way to rationally eliminate differences in consumer loyalty etc. that have a significant impact on the import price of generic raw materials in this case.” The Supreme Court concluded that if the original drug (or raw material) and generic drug (or raw material) are different in terms of customer loyalty, sales method and cost structure, and if the difference can be reasonably adjusted, it was possible to derive a reasonable normal price. The problem was whether rational adjustments could be applied to take into account the difference in price between the original drug and the generic drugThe Supreme Court held that such an adjustment could not be made, at that the assessment issued by the tax authorities was illegal. Click here for English translation Korean TP case 2007두13913 ...

In Korea the tax authorities usually regarded domestic transactions as better comparables and there were only few cases where transfer pricing had been applied based on foreign transactions. In this case, the Korean Supreme Court confirms that international transactions can be used as comparables for the pricing of domestic transaktions. Click here for English Translation 99두3423 ...

In the early 2000s the IRS issued a “APA study guide” where guidance is provided in relation to various practical issues in the area of transfer pricing. The study guide is part of a large collection of IRS practices and statistics from working with MAP and APA that can be accessed via this link. IRS - apa_study_guide 1999 ...