Terex Italia s.r.l. is a manufacturer of heavy machinery and sold these products to a related distributor in the UK. The remuneration of the distributor had been determined based on application of the TNM-method. Following an audit for FY 2009 and 2010 the tax authorities served Terex a notice of assessment where adjustments was made to the taxable income in respect of a transfer pricing transaction, and in particular contesting the issuance of a credit note, in favour of the English company GENIE UK with the description “sales prices adjustment” recorded in the accounts as a reversal of revenue, in that, according to the Office, as a result of the adjustment made by the note, Terex would have made sales below cost to the English company, carrying out a clearly uneconomic transaction. In the same note, the non-deductibility of costs for transactions with blacklisted countries was contested. Terex lodged appeals against the assessments, but the Provincial Tax Commission upheld them only “in respect of the purchases from Hong Kong”, implicitly rejecting them in respect of the purchases made in Switzerland and explicitly rejecting them in respect of the disputed credit notes. An appeal was later rejected by the Regional Tax Commission. An appeal was then filed by Terex with the Supreme Court. In this appeal Terex stated that “The CTR, for the purposes of identifying the ‘normal value’ of the intra-group transactions relating to the relations with the English company GENIE UK, wrongly disallowed the applicability of the TNMM method (of the ‘net margin’), used by the taxpayer for the years 2009 and 2010 and presupposed the issuance of the contested credit notes and the relative reduction of the declared income, on the other hand, the Office considered that the CUP method (of the ‘price comparison’), used by the tax authorities in the findings relating to the same tax years, was applicable, with the consequent emergence of a higher taxable income, compared to that declared. The same Administration, on the other hand, with reference to the intra-group relations with the same company, located in the tax years 2007 and 2008 and subject to control without censure in the same audit, had not denied the applicability of the TNMM method, used by the taxpayer, which in such cases had led to the issuance of debit notes, with the relative increase in declared income.” Judgement of the Court The Supreme Court upheld part of the judgement (black listed costs) and refered part of it (Transfer pricing method and “sales prices adjustment”) back to the Regional Tax Commission for reconsideration. Excerpts in English 5.1. In particular, with regard to the method applicable for the purpose of determining the “normal value”, it has been clarified, with specific reference to the one referred to as the “TNMM”, that “On the subject of the determination of business income, the regulations set forth in Article 110, paragraph 7, of Presidential Decree no. 917 of 1986, aimed at repressing the economic phenomenon of “transfer pricing”, i.e. the shifting of taxable income following transactions between companies belonging to the same group and subject to different national regulations, requires the determination of weighted transfer prices for similar transactions carried out by companies competing on the market, for which purpose it is possible to use the method developed by the OECD which is based on the determination of the net margin of the transaction (so-called “TNMM”), which is based on the determination of the net margin of the transaction. “TNMM”), provided that the period of investigation is selected, the comparable companies are identified, the appropriate accounting adjustments are made to the financial statements of the tested party, due account is taken of the differences between the tested party and the comparable companies in terms of risks assumed or functions performed, and a reliable indicator of the level of profitability is assumed.” (Cass. 17/05/2022, no. 15668; the principle was shared by, among others, Cass. 12/09/2022, nos. 26695, 26696, 26697 and 26698; Cass. 28/04/2023, no. 11252).” “The adoption of the TNMM is particularly reliable when the functional analysis shows the existence of a party (tested party or tested party) to the controlled transaction that performs simpler functions and assumes less risk than the other party to the transaction (para. 2.64 et seq. OECD). In analogy to the RPM (Resale Price Method) or CPM (Cost Plus Method), it focuses on the profitability of the tested party in the controlled transaction, whereas it differs from it in that it operates at the level of net margins and not gross margins.” “Indeed, according to the OECD Guidelines (OECD, Guidelínes,1995), ‘The selection of a transfer pricing method is always aimed at finding the most appropriate method for a particular case. For this purpose, the following should be taken into account in the selection process: the respective advantages and disadvantages of the methods recognised by the OECD; the consistency of the method considered with the nature of the controlled transaction, as determined in particular through functional analysis; the availability of reliable information (especially on independent comparables) necessary for the application of the selected method and/or the other methods; the degree of comparability between controlled transactions and transactions between independent companies, including the reliability of comparability adjustments that are necessary to eliminate significant differences between them. No method can be used in all eventualities and it is not necessary to demonstrate the non-applicability of a given method to the circumstances of the particular case. Ministerial Circular No. 42 of 12 December 1981 also pointed out that the appropriateness of a transfer pricing method is assessed on a case-by-case basis.” “5.6. The importance that the TNMM has assumed in practice, as the most widely used means of determining transfer prices, has made it the subject of interest of the Eu Joint Transfer Pricing Forum (JTPF) body, set up by the European Commission, which, in 2019, drew up a document (EU JOINT TRANSFER PRICING FORUM, DOC: JTPF/002/2019/EN, SECTION 2), in which it describes its essential characteristics, among which, substantially tracing the ...

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 ...

Tomas Bodero S.A. added a 4% fee when re-invoicing goods purchased from unrelated manufacturers to its Panamanian subsidiary. The transfer pricing documentation stated that “this fee (4%) is very similar to the fee that brokers in the sector usually charge for brokering imports of goods, so it can be concluded that a market price is charged for the services that the parent company provides to the subsidiary”. Following an audit, the tax authorities issued a tax assessment which, among other adjustments to the taxable income, also adjusted the fee received from the subsidiary. The arm’s length fee for the service provided was set at approximately 26% of the purchase price. Appeals were filed by Tomas Bodero S.A. which ended up in the High Court. Judgement of the Court In regards of procurement fee, the Court ruled in favor of Tomas Bodero A.S. Excerpts “….the method used by the Inspectorate to calculate the transfer prices is sufficiently justified; the internal comparable method is the method which, in general and a priori, provides a greater degree of accuracy and legal certainty given that it is obtained from the prices established by the interested party. However, regardless of the objections raised by the appellant regarding the sampling used by the Inspectorate – limited to a single month of the financial year and including a single Latin American client – and the possible discrepancies as regards the correct identification of the goods, the fact is that the tax authorities have not at any time called into question the specific business/financial intermediation and management model developed between the Spanish parent company and the Panamanian subsidiary. …the Inspectorate [does not] question the fact that the goods are at no time at the physical disposal of the parent company, since the supplier’s dispatch is made directly in Latin America. …we must understand that the (higher) price compared by the Inspectorate, in addition to the commercial margin of the resale itself, includes the cost of intermediation of the independent agent, which is not the case with the (lower) price re-invoiced by the parent company to its filial, which acts as a commercial intermediary with the retailers in Latin America. In fact, in the only invoice compared by the Inspectorate issued directly by the plaintiff to a Latin American customer -FacVen/9758, dated 5 January 2015- the filial TB LATAM is listed as “agent”, whereas, as we said, in the invoices issued by the appellant to its filial the legend “re-invoicing” appears. In other words, we cannot consider logical or reasonable the criterion of the Inspectorate that the price invoiced by the appellant to retailers for resales with agent intermediation is comparable to the price re-invoiced directly by the parent company to its filial in an operation of mere financial intermediation and management -without the intervention of a commercial agent, a task carried out by the filial itself-, all of which leads us to annul the regularisation for this concept. Click here for English Translation Click here for other translation Spain vs Tomas Bodero SA 11 july 2023 STSJ_CL_3218_2023 BW ...

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 ...

SAS Weg France is owned by the Spanish company Weg Iberia, which in turn is wholly owned by the head company of the Weg Equipamentos Electricos SA group, based in Brazil. At the end of an audit covering the financial years 2010, 2011 and 2012, the tax authorities noted that SAS Weg France, which had not provided any documentation justifying the transfer pricing policy within the group, paid its suppliers, who were members of the group, within a maximum of 30 days of shipment of the goods, whereas delivery times averaged two months from Brazil and three months from China, and that its customers paid its invoices between 45 and 90 days after invoicing. According to the tax authorities SAS Weg France thus performed a gratuitous financial function which constituted an indirect transfer of profits within the meaning of Article 57 of the General Tax Code. The tax authorities adjusted the company’s operating profit to the median of a benchmark study of fourteen comparable companies. As a result, the tax authorities reduced the losses declared by SAS Weg France for the financial year 2009, made it liable for additional corporate tax contributions for the financial years 2011 and 2012 and subjected the amounts transferred abroad to withholding tax. These taxes were subject to a 10% surcharge for failure to file a tax return pursuant to Article 1728 of the French General Tax Code. SAS Weg France was also fined for failing to provide transfer pricing documentation as required by the French General Tax Code. Dissatisfied with the assessment, SAS Weg France appealed to the Administrative Court, which dismissed the appeal in 2021. SAS Weg France then appealed against the decision of the Administrative Court to the Court of Administrative Appeals. Judgment of the Court The Appeals Court overturned the decision of the Administrative Court and ruled in favour of SAS Weg France. Excerpts: “4. In order to consider that the service provided by Weg France constituted an unjustified advantage that was not part of normal commercial management for the benefit of the group’s suppliers, the department compared the net margin rate of SAS Weg France, calculated after elimination of financial charges, with that of independent companies that did not have a specific financial function. The tax authorities selected a sample of fourteen independent companies that had adopted the same NAF code as SAS Weg France, i.e. wholesale of electrical equipment and wholesale of miscellaneous industrial supplies and equipment, with sales in excess of €5 million for 2010 and 2011 and whose sales amounted to less than 90% of sales, and that were positioned as wholesalers/dealers. 5. Weg France maintains, without being challenged on this point either at first instance or on appeal, that the products it distributes are intended solely for the industrial sector, whereas the sample of comparable companies used by the tax authorities includes companies that sell to individuals and companies that distribute household equipment, In this respect, the differences in margins noted by the department can be explained by the difference in situation between it and nine of the companies on the panel. In addition, the applicant company argued that, although five of the companies on the panel selected by the authorities could be considered comparable, their operating margins appeared to be consistent with the margins it had itself achieved during the period under review. In the absence of any challenge by the tax authorities to the arguments put forward by the applicant company in support of its plea, the tax authorities cannot be regarded as establishing the existence of a practice falling within the scope of Article 57 of the General Tax Code. It follows that Weg France is entitled to argue that the tax authorities were wrong to call into question the loss carried forward for 2009, to reinstate the sums considered as profit transfers in its taxable income for the financial years 2011 and 2012 and to consider that the benefits granted to the companies in the group constituted distributed income within the meaning of c. of Article 111 of the French General Tax Code subject to withholding tax.” Click here for English translation Click here for other translation France vs Weg France 25 May 2023 Case No 21LY03690 ...

Dart Sudamericana S.A. (now Dart Sudamericana SRL) imported so-called EPS T601 pellets from related party abroad for use in its manufacturing activities. The controlled transactions had been priced using the CUP method. Following an audit the tax authorities made a transfer pricing adjustment where it had applied the transactional net margin method (TNMM). According to the tax authorities, the price paid for the pellets in the controlled transaction was higher than the arm’s length price. The adjustment resulted in an assessment of additional taxable income. Not satisfied with the assessment Dart Sudamericana filed a complaint. Tax Court Ruling The court upheld the assessment issued by the tax authorities and dismissed Dart Sudamericana’s appeal. Excerpts “In short, the appellant merely tried to prove the similarity of the product in order to carry out the price comparison, which is not sufficient for a proper study of the comparability of the transactions. At the risk of being reiterative, the transactions should be analysed, not only the products being traded. Therefore, the tax authority is right – as stated above – in its challenge to the application of the Comparable Price Method between Independent Parties – CUP or Uncontrolled Price – as a method of price analysis for the importation of EPS pellets and the application – entirely in accordance with the position taken by the appellant in the 2003 period – of the Transactional Net Margin Method for the 2004 tax period. “ “…In this regard, and as the Tax Court rightly pointed out, the OECD Committee on Fiscal Affairs has stated in its report that multi-year data are useful for providing information about the relevant business cycles and product life cycles of comparables. Differences in the business cycle or product cycle may have a substantial effect on transfer pricing conditions that must be assessed to determine comparability. Accordingly, in order to gain a full understanding of the facts and circumstances surrounding a controlled transaction, it may be useful to examine data for both the year under review and prior years. This type of analysis may be particularly useful when using one of the profit-based methods, as is the case here. The facts and circumstances of the particular case will determine whether differences in economic circumstances significantly influence the price, and whether reasonably accurate adjustments can be made to eliminate the effects of such differences” (Vid. CNACAF, Sala I, “Volkswagen Argentina S.A.”, 26/12/2019. The emphasis is my own). In this context, it is noted first of all that it is not clear from the appeals made, both in administrative proceedings and before this Court, that the use of multi-annual data was due to differences in the economic cycle of the industry under test. Likewise, it has not been proven that the economic situation the country went through in 2001 and 2002 existed in the countries of the companies used for the comparability study. The experts say nothing in their reports on the issue, limiting themselves to stating that national legislation does not prevent the use of multi-annual data, which – as mentioned above – is not in dispute. Therefore, and considering that the inclusion of data from 2001 and 2002 would inevitably increase the differences in comparability with companies abroad, I consider that the tax authority is right.” Click here for English Translation Click here for other translation EXPTE-N°35.050-I ...

The tax authority, based on the results of an audit, found that the prices in controlled export transactions of goods, carried out between “LK Ukraine Group” and related parties, did not comply with the arm’s length principle, i.e. the selling prices of the goods were lower than the minimum values of the arm’s length range. Disagreeing with this conclusion, “LK Ukraine Group” stated that the the method applied by the tax authority during the audit of prices in controlled transactions was unlawful and inappropriate due to the lack of information on all possible costs. At the request of the supervisory authority, “LK Ukraine Group” provided evidence that when determining the prices of goods, the group was guided by information based on monitoring, in particular, prices on the Euronext exchange, namely, the average selling prices of agricultural products on the terms of delivery EXW-port, which refuted the assertion of the authority that the controlled transactions did not comply with the arm’s length principle. The District Administrative Court dismissed the claim in a decision upheld by the Administrative Court of Appeal. The courts of previous instances concluded that, based on the Tax Code of Ukraine, the tax authority had calculated the median of the range to determine the price in a controlled transaction, which is consistent with the arm’s length principle. Judgement of the Supreme Court The Supreme Court also dismissed the appeal of “LK Ukraine Group” and upheld the challenged court decisions. If the audit of controlled transactions on export of “rapeseed” goods establishes that prices in controlled transactions on export of goods of the commodity carried out by the taxpayer (taking into account the adjustment for the cost of transshipment of goods on board the vessel) are less than the minimum values of price intervals (ranges), i.e., do not comply with the arm’s length principle and the selling prices are lower than the price range, the terms of such transactions differ from the terms and conditions applied between unrelated parties in comparable uncontrolled transactions. Click here for English translation Click here for other translation TPcase - Ukrain 23 March 2023 ...

SAS Sames Kremlin marketed its products abroad through subsidiaries or independent agents, depending on the territory. In Argentina, Brazil, India, Portugal and Russia it sold its products through subsidiaries under either a buy/sell distributor agreement or a commissionaire agreement. In Iran, Turkey and South Korea it sold the goods through independent agents to whom it paid a commission. The tax authorities considered that the commission paid to the independent agents was a CUP and determined the commission paid to the subsidiaries on that basis. The remuneration of the subsidiaries in excess of the commission (margin) paid to the independent agents was considered to be a transfer of profits abroad. SAS Sames Kremlin appealed against the assessment, arguing that the subsidiaries performed much more important functions than independent agents and that there were also significant geographical differences. The Administrative Court rejected the appeal and the case was then brought before the Administrative Court of Appeal. Judgement of the Court The Court upheld the decision of the Administrative Court and dismissed SAS Sames Kremlin’s appeal. Excerpt: “4. In order to justify the higher amount of remuneration paid to the subsidiaries of the group headed by SAS Sames Kremlin, compared with the amount paid to independent local intermediaries, SAS Sames Kremlin argued that the geographical markets in which the subsidiaries operated were fundamentally different from those in which the third-party sales agents operated, since they were highly strategic insofar as they were home to large car manufacturers, while the other markets were anecdotal. The subsidiaries responded to major invitations to tender, whereas the local sales agents were involved only in the supply of spare parts and small equipment, and the subsidiaries provided additional marketing, after-sales service, on-site assembly and testing of equipment, and assistance with the collection of debts, as evidenced by the significant human resources at their disposal. 5. Although the turnover achieved in Iran, Turkey and South Korea was generally lower than that achieved through the subsidiaries, it does not appear from the investigation that the characteristics of these markets justify the differences in the remuneration paid to the subsidiaries and to the independent intermediaries, since the turnover achieved by the subsidiaries is not systematically higher than the turnover achieved through independent sales agents. Even supposing that the composition of turnover achieved through independent sales agents is different from that achieved through subsidiaries, the latter including more sales of large equipment through tenders and fewer sales of spare parts and small equipment, which is not apparent from the investigation in the case of certain subsidiaries, it is common ground that the remuneration of independent sales agents does not take account of the nature of the products and equipment sold, since it is invariably set at 20% of turnover, and that the remuneration paid to subsidiaries is, irrespective of the nature of the products, equivalent to the amount of the discount they would have received if they had acted as a buyer-reseller. Finally, it is not apparent from the documents in the files that the services provided by the independent intermediaries are significantly less substantial than the services provided by the subsidiaries in their intermediation activity alone. The mere fact that the subsidiaries have greater material and human resources is not sufficient to presume, in the absence of documents in the file to that effect, that those resources were used in the context of the latter activity. It follows that, contrary to what is maintained, it does not follow from the investigation that the differences in remuneration between subsidiaries and intermediary agents can be explained by the different situation of those suppliers. Although the applicant company argues that the commissions paid to the subsidiaries take account of the margin which they would have made on a purchase/resale of the same product, such an argument is not such as to justify the abovementioned differences in remuneration between the economic agents belonging to the group and those outside it, since they are involved in the same intermediary activity, which is different from the purchase/resale activity. The various doctrines referred to, which are not expressly invoked on the basis of the provisions of Article L. 80 A of the Book of Tax Procedures, do not interpret the tax law differently from the above. 6. It follows that the tax authorities must be regarded as establishing, under the conditions referred to in point 3, the existence of an advantage, and were entitled to reintegrate it into the results of the French company, as the latter did not justify that this advantage would have had at least equivalent counterparts for it.” Click here for English translation Click here for other translation CAA de PARIS, 2ème chambre, 01_03_2023, 21PA06439 ...

SA Exel Industries marketed its products abroad through subsidiaries or independent agents, depending on the territory. In Brazil, India, Argentina, Russia and Portugal it sold its products through subsidiaries under either a buy/sell distributor agreement or a commissionaire agreement. In Iran, Turkey and South Korea it sold through independent agents to whom it paid a commission. The tax authorities considered that the commission paid to the independent agents was a CUP and determined the commission paid to the subsidiaries on that basis. The remuneration of the subsidiaries in excess of the commission (margin) paid to the independent agents was considered to be a transfer of profits abroad. SA Exel Industries appealed against this assessment, arguing that the subsidiaries performed much more important functions than independent agents. It also argued that there were significant market differences, since the subsidiaries operated in highly strategic markets where the major car manufacturers were dominant, while the other markets in which the independent agents operated were anecdotal. The Administrative Court dismissed the appeal and the case was then brought to the Administrative Court of Appeal. Judgement of the Court The Court upheld the decision of the Administrative Court and dismissed SA Exel Industries’ appeal. Excerpt “4. In order to justify the higher amount of remuneration paid to the subsidiaries of the group it heads, compared with the amount paid to independent local intermediaries, SA Exel Industries argues that the geographical markets in which the subsidiaries operated are fundamentally different from those in which the third-party sales agents operated, since they are highly strategic in that they are home to large car manufacturers, whereas the other markets are anecdotal, The subsidiaries responded to major invitations to tender, whereas the local sales agents were involved only in the supply of spare parts and small equipment, and the subsidiaries provided additional marketing, after-sales service, on-site assembly and testing of equipment, and assistance with the collection of debts, as evidenced by the significant human resources at their disposal. 5. Although the turnover achieved in Iran, Turkey and South Korea was generally lower than that achieved through the subsidiaries, it does not appear from the investigation that the characteristics of these markets justify the differences in the remuneration paid to the subsidiaries and to the independent intermediaries, since the turnover achieved by the subsidiaries is not systematically higher than the turnover achieved through independent sales agents. Even supposing that the composition of turnover achieved through independent sales agents is different from that achieved through subsidiaries, the latter including more sales of large equipment through tenders and fewer sales of spare parts and small equipment, which is not apparent from the investigation in the case of certain subsidiaries, it is common ground that the remuneration of independent sales agents does not take account of the nature of the products and equipment sold, since it is invariably set at 20% of turnover, and that the remuneration paid to subsidiaries is, irrespective of the nature of the products, equivalent to the amount of the discount they would have received if they had acted as a buyer-reseller. Finally, it is not apparent from the documents in the files that the services provided by the independent intermediaries are significantly less substantial than the services provided by the subsidiaries in their intermediation activity alone. The mere fact that the subsidiaries have greater material and human resources is not sufficient to presume, in the absence of documents in the file to that effect, that those resources were used in the context of the latter activity. It follows that, contrary to what is maintained, it does not follow from the investigation that the differences in remuneration between subsidiaries and intermediary agents can be explained by the different situation of those suppliers. Although the applicant company argues that the commissions paid to the subsidiaries take account of the margin which they would have made on a purchase/resale of the same product, such an argument is not such as to justify the abovementioned differences in remuneration between the economic agents belonging to the group and those outside it, since they are involved in the same intermediary activity, which is different from the purchase/resale activity. The various doctrines referred to, which are not expressly invoked on the basis of the provisions of Article L. 80 A of the Book of Tax Procedures, do not interpret the tax law differently from the above. 6. It follows that the tax authorities must be regarded as establishing, under the conditions referred to in point 3, the existence of an advantage, and were entitled to reintegrate it into the results of the French company, as the latter did not justify that this advantage would have had at least equivalent counterparts for it.” Click here for English translation Click here for other translation CAA de PARIS, 2ème chambre, 01_03_2023, 21PA06438 ...

“Gas-Trader KtF” – a subsidiary in the E.ON group – had entered into loan agreements with other group companies and the related parties had determined the interest rate by application of the CUP method using the Thomson Reuters LoanConnector database. Comparable transactions was extracted from the database by searching for credit rating, type of debtor party, date of loan, maturity, transactions with completed status, and spread/provision fee. An audit was conducted by the tax authorities for FY 2012-2013 and the interest rate determined by the group was found to be incompliant with the arm’s length principle. The tax authorities applied the same method as Gas-Trader but added further search criteria in the selection of comparable transactions – credit purpose and insurance coverage. This resulted in a different range and an assessment of additional taxable income was issued. An appeal was filed by Gas-Trader KtF with the National Tax and Customs Board of Appeal where a judgement in favor of the tax authorities was issued. Then an appeal was then filed with the courts where the decision was annulled and the Board of Appeal ordered to initiate new proceedings. During these proceedings, an expert opinion was obtained which was in favor of Gas-Trader. However following objections from the tax authorities, the Board of Appeal dismissed the expert opinion and decided predominantly in favor of the tax authorities. An appeal was then filed with Supreme Administrative Court. Judgement of the Court The Supreme Administrative Court set aside the decision and issued a judgement in favor of Gas-Trader. In its judgment, the Court states “[26] A large amount of data is needed to determine the transfer price. However, the available information may be incomplete, difficult to interpret, difficult to obtain for reasons of confidentiality, or may not exist at all, or the relevant independent enterprise itself may be missing. In the practical application of the arm’s length principle, the objective is always to determine an acceptable estimate of arm’s length profit based on reliable data. The ‘estimated’ nature of the transfer price means that it is never an exact tax act, but requires both the taxpayer and the tax authorities to subsequently take evidence that is clearly identifiable and realistic. The Curia has stated in its judgment Kfv.I.35.550/2018/12 that the question of transfer pricing can be a technical question or a purely legal question depending on the underlying facts. In the case at hand, the defendant transformed the decision into a question of law by basing its decision not on an examination of the transfer pricing method, but on a different classification of the underlying legal relationship from that of the plaintiff in that case. In the present case, the Curia adds that, in the event of a substantive examination of the transfer pricing method by the tax authorities, the applicant may also submit a request for evidence on a technical point in the course of the judicial review. [27] Among the methods of transfer pricing, both the Directives and the Tao [Corporate Tax and Dividend Tax] Law recognise the method of comparative independent prices. Pursuant to Section 18(2)(a) of the Tao Law, the arm’s length price is to be determined by one of the following methods: the arm’s length price method, whereby the arm’s length price is the price that independent parties would apply for the sale of a comparable asset or service in an economically comparable market. The problem in applying this method is the identification of the ‘economically comparable market’, which is ultimately achieved by applying the correction/constraint criteria within the scope of the method. Indeed, an independent transaction can only be compared with a controlled transaction using the method of comparable independent prices if one of the following two conditions is met: (a) none of the differences, if any, between the transactions to be compared or between the undertakings entering into those transactions can materially affect the free market price, or (b) relatively accurate adjustments can be made to eliminate the distortive effect of such differences. Therefore, where distorting differences exist between controlled and unrelated transactions, adjustments should be made to at least broadly eliminate price influencing factors and enhance comparability. Each of the narrowing methods should be assessed for their relative accuracy and only those adjustments should be made that are likely to improve comparability. [28] In the case at bar, it is a fact that the defendant did not make a finding with respect to the plaintiff’s records that the plaintiff had developed what it considered to be an appropriate transfer price, that the defendant agreed to the use of the comparative independent pricing method. The court’s remedy resulted from a difference in the criteria considered by the parties to eliminate the distorting effect of the differences. It may also be noted that in the decision of the Court of Appeal ordering a new trial in the main proceedings, the defendant excluded the application of the interquartile range correction criterion of narrowing the range around the midpoint. [29] Defendant used the data extracted by the plaintiff from the LoanConnector database to verify the transfer pricing. In its procedure, it considered the relevant aspects of the Directives to be relevant, according to the review request: in the expected audit practice, tax auditors should be flexible in their approach, take into account the business considerations of taxpayers and start their analysis from the perspective of the pricing method chosen by the taxpayer. If the taxpayer’s screening strategy is reproducible and the screening steps are suitable to produce a suitable sample for the transaction under consideration, the tax administration will use the taxpayer’s database screening as a basis. If, for any reason, the tax administration disputes the screening steps, it will attempt to make the necessary adjustments based on the taxpayer’s research to ensure that the results calculated from the improved sample are consistent with the market price principle. As a starting point, the tax administration does not therefore seek to determine the price or range of prices applicable to ...

The degree of comparability between the controlled and uncontrolled taxpayers is determined by applying the comparability provisions of § 1.482-1(d). The comparable profit split compares the division of operating profits among the controlled taxpayers to the division of operating profits among uncontrolled taxpayers engaged in similar activities under similar circumstances. Although all of the factors described in § 1.482-1(d)(3) must be considered, comparability under this method is particularly dependent on the considerations described under the comparable profits method in § 1.482-5(c)(2) or § 1.482-9(f)(2)(iii) because this method is based on a comparison of the operating profit of the controlled and uncontrolled taxpayers. In addition, because the contractual terms of the relationship among the participants in the relevant business activity will be a principal determinant of the allocation of functions and risks among them, comparability under this method also depends particularly on the degree of similarity of the contractual terms of the controlled and uncontrolled taxpayers. Finally, the comparable profit split may not be used if the combined operating profit (as a percentage of the combined assets) of the uncontrolled comparables varies significantly from that earned by the controlled taxpayers ...

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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 ...

An operating profit represents a return for the investment of resources and assumption of risks. Therefore, although all of the factors described in § 1.482-1(d)(3) must be considered, comparability under this method is particularly dependent on resources employed and risks assumed. Moreover, because resources and risks usually are directly related to functions performed, it is also important to consider functions performed in determining the degree of comparability between the tested party and an uncontrolled taxpayer. The degree of functional comparability required to obtain a reliable result under the comparable profits method, however, is generally less than that required under the resale price or cost plus methods. For example, because differences in functions performed often are reflected in operating expenses, taxpayers performing different functions may have very different gross profit margins but earn similar levels of operating profit ...

If there are material differences between the controlled and uncontrolled transactions that would affect the gross profit markup, adjustments should be made to the gross profit markup earned in the comparable uncontrolled transaction according to the provisions of § 1.482-1(d)(2). For this purpose, consideration of the operating expenses associated with the 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) The complexity of manufacturing or assembly; (2) Manufacturing, production, and process engineering; (3) Procurement, purchasing, and inventory control activities; (4) Testing functions; (5) Selling, general, and administrative expenses; (6) Foreign currency risks; and (7) Contractual terms (e.g., scope and terms of warranties provided, sales or purchase volume, credit terms, transport terms) ...

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

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

USP, a United States manufacturer of farm machinery, sells its products to FSub, its wholly-owned distributor in Country Y. USP, operating at nearly full capacity, sells 95% of its inventory to FSub. To make use of its excess capacity, and also to establish a comparable uncontrolled price for its transfer price to FSub, USP increases its production to full capacity. USP sells its excess inventory to Compco, an unrelated foreign distributor in Country X. Country X has approximately the same economic conditions as that of Country Y. Because one of the principal purposes of selling to Compco was to establish an arm’s length price for its controlled transactions with FSub, USP’s sale to Compco cannot be used as an uncontrolled comparable to determine USP’s arm’s length result from its controlled transaction ...

Not in the ordinary course of business. USP, a United States manufacturer of computer software, sells its products to FSub, its foreign distributor in country X. Compco, a United States competitor of USP, also sells its products in X through unrelated distributors. However, in the year under review, Compco is forced into bankruptcy, and Compco liquidates its inventory by selling all of its products to unrelated distributors in X for a liquidation price. Because the sale of its entire inventory was not a sale in the ordinary course of business, Compco’s sale cannot be used as an uncontrolled comparable to determine USP’s arm’s length result from its controlled transaction ...

The following examples illustrate the principle of this paragraph (d)(4)(iii) ...

Transactions ordinarily will not constitute reliable measures of an arm’s length result for purposes of this section if – (1) They are not made in the ordinary course of business; or (2) One of the principal purposes of the uncontrolled transaction was to establish an arm’s length result with respect to the controlled transaction ...

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Couture, a U.S. apparel design corporation, contracts with Sewco, its wholly owned Country Y subsidiary, to manufacture its clothes. Costs of operating in Country Y are significantly lower than the operating costs in the United States. Although clothes with the Couture label sell for a premium price, the actual production of the clothes does not require significant specialized knowledge that could not be acquired by actual or potential competitors to Sewco at reasonable cost. Thus, Sewco’s functions could be performed by several actual or potential competitors to Sewco in geographic markets that are similar to Country Y. Thus, the fact that production is less costly in Country Y will not, in and of itself, justify additional profits derived from lower operating costs in Country Y inuring to Sewco, because the competitive positions of the other actual or potential producers in similar geographic markets capable of performing the same functions at the same low costs indicate that at arm’s length such profits would not be retained by Sewco ...

The following example illustrates the principles of this paragraph (d)(4)(ii)(C) ...

If an uncontrolled taxpayer operates in a different geographic market than the controlled taxpayer, adjustments may be necessary to account for significant differences in costs attributable to the geographic markets. These adjustments must be based on the effect such differences would have on the consideration charged or paid in the controlled transaction given the relative competitive positions of buyers and sellers in each market. Thus, for example, the fact that the total costs of operating in a controlled manufacturer’s geographic market are less than the total costs of operating in other markets ordinarily justifies higher profits to the manufacturer only if the cost differences would increase the profits of comparable uncontrolled manufacturers operating at arm’s length, given the competitive positions of buyers and sellers in that market ...

Manuco, a wholly-owned foreign subsidiary of P, a U.S. corporation, manufactures products in Country Z for sale to P. No uncontrolled transactions are located that would provide a reliable measure of the arm’s length result under the comparable uncontrolled price method. The district director considers applying the cost plus method or the comparable profits method. Information on uncontrolled taxpayers performing comparable functions under comparable circumstances in the same geographic market is not available. Therefore, adjusted data from uncontrolled manufacturers in other markets may be considered in order to apply the cost plus method. In this case, comparable uncontrolled manufacturers are found in the United States. Accordingly, data from the comparable U.S. uncontrolled manufacturers, as adjusted to account for differences between the United States and Country Z’s geographic market, is used to test the arm’s length price paid by P to Manuco. However, the use of such data may affect the reliability of the results for purposes of the best method rule. See § 1.482-1(c) ...

The following example illustrates this paragraph (d)(4)(ii) ...

Uncontrolled comparables ordinarily should be derived from the geographic market in which the controlled taxpayer operates, because there may be significant differences in economic conditions in different markets. If information from the same market is not available, an uncontrolled comparable derived from a different geographic market may be considered if adjustments are made to account for differences between the two markets. If information permitting adjustments for such differences is not available, then information derived from uncontrolled comparables in the most similar market for which reliable data is available may be used, but the extent of such differences may affect the reliability of the method for purposes of the best method rule. For this purpose, a geographic market is any geographic area in which the economic conditions for the relevant product or service are substantially the same, and may include multiple countries, depending on the economic conditions ...

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In certain circumstances, taxpayers may adopt strategies to enter new markets or to increase a product’s share of an existing market (market share strategy). Such a strategy would be reflected by temporarily increased market development expenses or resale prices that are temporarily lower than the prices charged for comparable products in the same market. Whether or not the strategy is reflected in the transfer price depends on which party to the controlled transaction bears the costs of the pricing strategy. In any case, the effect of a market share strategy on a controlled transaction will be taken into account only if it can be shown that an uncontrolled taxpayer engaged in a comparable strategy under comparable circumstances for a comparable period of time, and the taxpayer provides documentation that substantiates the following – (A) The costs incurred to implement the market share strategy are borne by the controlled taxpayer that would obtain the future profits that result from the strategy, and there is a reasonable likelihood that the strategy will result in future profits that reflect an appropriate return in relation to the costs incurred to implement it; (B) The market share strategy is pursued only for a period of time that is reasonable, taking into consideration the industry and product in question; and (C) The market share strategy, the related costs and expected returns, and any agreement between the controlled taxpayers to share the related costs, were established before the strategy was implemented ...

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Evaluating the degree of comparability between controlled and uncontrolled transactions requires a comparison of the property or services transferred in the transactions. This comparison may include any intangible property that is embedded in tangible property or services being transferred (embedded intangibles). The comparability of the embedded intangibles will be analyzed using the factors listed in § 1.482-4(c)(2)(iii)(B)(1) (comparable intangible property). The relevance of product comparability in evaluating the relative reliability of the results will depend on the method applied. For guidance concerning the specific comparability considerations applicable to transfers of tangible and intangible property and performance of services, see §§ 1.482-3 through 1.482-6 and § 1.482-9; see also §§ 1.482-3(f), 1.482-4(f)(4), and 1.482-9(m), dealing with the coordination of intangible and tangible property and performance of services rules ...

Determining the degree of comparability between controlled and uncontrolled transactions requires a comparison of the significant economic conditions that could affect the prices that would be charged or paid, or the profit that would be earned in each of the transactions. These factors include – (A) The similarity of geographic markets; (B) The relative size of each market, and the extent of the overall economic development in each market; (C) The level of the market (e.g., wholesale, retail, etc.); (D) The relevant market shares for the products, properties, or services transferred or provided; (E) The location-specific costs of the factors of production and distribution; (F) The extent of competition in each market with regard to the property or services under review; (G) The economic condition of the particular industry, including whether the market is in contraction or expansion; and (H) The alternatives realistically available to the buyer and seller ...

USSub is the wholly-owned U.S. subsidiary of FP, a foreign manufacturer. USSub acts as a distributor of goods manufactured by FP. FP and USSub execute an agreement providing that FP will bear any ordinary product liability costs arising from defects in the goods manufactured by FP. In practice, however, when ordinary product liability claims are sustained against USSub and FP, USSub pays the resulting damages. Therefore, the district director disregards the contractual arrangement regarding product liability costs between FP and USSub, and treats the risk as having been assumed by USSub ...

S, a Country X corporation, manufactures small motors that it sells to P, its U.S. parent. P incorporates the motors into various products and sells those products to uncontrolled customers in the United States. The contract price for the motors is expressed in U.S. dollars, effectively allocating the currency risk for these transactions to S for any currency fluctuations between the time the contract is signed and payment is made. As long as S has adequate financial capacity to bear this currency risk (including by hedging all or part of the risk) and the conduct of S and P is consistent with the terms of the contract (i.e., the contract price is not adjusted to reflect exchange rate movements), the agreement of the parties to allocate the exchange risk to S will be respected ...

The facts are the same as in Example 1, except that in Year 1 FD had only $100,000 in total capital, including loans. In subsequent years USM makes no additional contributions to the capital of FD, and FD is unable to obtain any capital through loans from an unrelated party. Nonetheless, USM continues to sell 20,000 widgets annually to FD under the terms of the contract, and USM extends credit to FD to enable it to finance the purchase. FD does not have the financial capacity in Years 1, 2 and 3 to finance the purchase of the widgets given that it could not sell most of the widgets it purchased during those years. Thus, notwithstanding the terms of the contract, USM and not FD assumed the market risk that a substantial portion of the widgets could not be sold, since in that event FD would not be able to pay USM for all of the widgets it purchased ...

FD, the wholly-owned foreign distributor of USM, a U.S. manufacturer, buys widgets from USM under a written contract. Widgets are a generic electronic appliance. Under the terms of the contract, FD must buy and take title to 20,000 widgets for each of the five years of the contract at a price of $10 per widget. The widgets will be sold under FD’s label, and FD must finance any marketing strategies to promote sales in the foreign market. There are no rebate or buy back provisions. FD has adequate financial capacity to fund its obligations under the contract under any circumstances that could reasonably be expected to arise. In Years 1, 2 and 3, FD sold only 10,000 widgets at a price of $11 per unit. In Year 4, FD sold its entire inventory of widgets at a price of $25 per unit. Since the contractual terms allocating market risk were agreed to before the outcome of such risk was known or reasonably knowable, FD had the financial capacity to bear the market risk that it would be unable to sell all of the widgets it purchased currently, and its conduct was consistent over time, FD will be deemed to bear the risk ...

The following examples illustrate this paragraph (d)(3)(iii) ...

In general, the determination of which controlled taxpayer bears a particular risk will be made in accordance with the provisions of § 1.482-1(d)(3)(ii)(B) (Identifying contractual terms). Thus, the allocation of risks specified or implied by the taxpayer’s contractual terms will generally be respected if it is consistent with the economic substance of the transaction. An allocation of risk between controlled taxpayers after the outcome of such risk is known or reasonably knowable lacks economic substance. In considering the economic substance of the transaction, the following facts are relevant – (1) Whether the pattern of the controlled taxpayer’s conduct over time is consistent with the purported allocation of risk between the controlled taxpayers; or where the pattern is changed, whether the relevant contractual arrangements have been modified accordingly; (2) Whether a controlled taxpayer has the financial capacity to fund losses that might be expected to occur as the result of the assumption of a risk, or whether, at arm’s length, another party to the controlled transaction would ultimately suffer the consequences of such losses; and (3) The extent to which each controlled taxpayer exercises managerial or operational control over the business activities that directly influence the amount of income or loss realized. In arm’s length dealings, parties ordinarily bear a greater share of those risks over which they have relatively more control ...

Determining the degree of comparability between controlled and uncontrolled transactions requires a comparison of the significant risks that could affect the prices that would be charged or paid, or the profit that would be earned, in the two transactions. Relevant risks to consider include – (1) Market risks, including fluctuations in cost, demand, pricing, and inventory levels; (2) Risks associated with the success or failure of research and development activities; (3) Financial risks, including fluctuations in foreign currency rates of exchange and interest rates; (4) Credit and collection risks; (5) Product liability risks; and (6) General business risks related to the ownership of property, plant, and equipment ...

Contractual terms imputed from economic substance. (i) Company X is a member of a controlled group that has been in operation in the pharmaceutical sector for many years. In years 1 through 4, Company X undertakes research and development activities. As a result of those activities, Company X developed a compound that may be more effective than existing medications in the treatment of certain conditions. (ii) Company Y is acquired in year 4 by the controlled group that includes Company X. Once Company Y is acquired, Company X makes available to Company Y a large amount of technical data concerning the new compound, which Company Y uses to register patent rights with respect to the compound in several jurisdictions, making Company Y the legal owner of such patents. Company Y then enters into licensing agreements with group members that afford Company Y 100% of the premium return attributable to use of the intangible property by its subsidiaries. (iii) In determining whether an allocation is appropriate in year 4, the Commissioner may consider the economic substance of the arrangements between Company X and Company Y, and the parties’ course of conduct throughout their relationship. Based on this analysis, the Commissioner determines that it is unlikely that an uncontrolled taxpayer operating at arm’s length would make available the results of its research and development or perform services that resulted in transfer of valuable know how to another party unless it received contemporaneous compensation or otherwise had a reasonable anticipation of receiving a future benefit from those activities. In this case, Company X’s undertaking the research and development activities and then providing technical data and know-how to Company Y in year 4 is inconsistent with the registration and subsequent exploitation of the patent by Company Y. Therefore, the Commissioner may impute one or more agreements between Company X and Company Y consistent with the economic substance of their course of conduct, which would afford Company X an appropriate portion of the premium return from the patent rights. For example, the Commissioner may impute a separate services agreement that affords Company X contingent-payment compensation for its services in year 4 for the benefit of Company Y, consisting of making available to Company Y technical data, know-how, and other fruits of research and development conducted in previous years. These services benefited Company Y by giving rise to and contributing to the value of the patent rights that were ultimately registered by Company Y. In the alternative, the Commissioner may impute a transfer of patentable intangible property rights from Company X to Company Y immediately preceding the registration of patent rights by Company Y. The taxpayer may present additional facts that could indicate which of these or other alternative agreements best reflects the economic substance of the underlying transactions, consistent with the parties’ course of conduct in the particular case ...

Non-arm’s length compensation. (i) The facts are the same as in paragraph (i) of Example 4. As in Example 4, assume that, after adjustments are made to improve the reliability of the comparison for any material differences relating to marketing activities, manufacturing or marketing intangible property, and other comparability factors, the royalties paid by independent licensees would provide the most reliable measure of the arm’s length royalty owed by USSub to FP, apart from the additional facts described in paragraph (ii) of this Example 5. (ii) In years 1 through 4, USSub performs certain incremental marketing activities with respect to the AA trademark athletic gear, in addition to the activities required under the terms of the basic license agreement, that are also incremental as compared with those activities observed in the comparables. At the start of year 1, FP enters into a separate services agreement with USSub, which states that FP will compensate USSub quarterly, in an amount equal to specified costs plus X%, for these incremental marketing functions. Further, these written agreements reflect the intent of the parties that USSub receive such compensation from FP throughout the term of the agreement, without regard to the success or failure of the promotional activities. During years 1 through 4, USSub performs marketing activities pursuant to the separate services agreement and in each year USSub receives the specified compensation from FP on a cost of services plus basis. (iii) In evaluating year 4, the Commissioner performs an analysis of independent parties that perform promotional activities comparable to those performed by USSub and that receive separately-stated compensation on a current basis without contingency. The Commissioner determines that the magnitude of the specified cost plus X% is outside the arm’s length range in each of years 1 through 4. Based on an evaluation of all the facts and circumstances, the Commissioner makes an allocation to require payment of compensation to USSub for the promotional activities performed in year 4, based on the median of the interquartile range of the arm’s length markups charged by the uncontrolled comparables described in paragraph (e)(3) of this section. (iv) Given that based on facts and circumstances, the terms agreed by the controlled parties were that FP would bear all risks associated with the promotional activities performed by USSub to promote the AA trademark product in the United States market, and given that the parties’ conduct during the years examined was consistent with this allocation of risk, the fact that the cost of services plus markup on USSub’s services was outside the arm’s length range does not, without more, support imputation of additional contractual terms based on alternative views of the economic substance of the transaction, such as terms indicating that USSub, rather than FP, bore the risk associated with these activities ...

Contractual terms imputed from economic substance. (i) FP, a foreign producer of athletic gear, is the registered holder of the AA trademark in the United States and in other countries worldwide. In year 1, FP enters into a licensing agreement that affords its newly organized United States subsidiary, USSub, exclusive rights to certain manufacturing and marketing intangible property (including the AA trademark) for purposes of manufacturing and marketing athletic gear in the United States under the AA trademark. The contractual terms of this agreement obligate USSub to pay FP a royalty based on sales, and also obligate both FP and USSub to undertake without separate compensation specified types and levels of marketing activities. Unrelated foreign businesses license independent United States businesses to manufacture and market athletic gear in the United States, using trademarks owned by the unrelated foreign businesses. The contractual terms of these uncontrolled transactions require the licensees to pay royalties based on sales of the merchandise, and obligate the licensors and licensees to undertake without separate compensation specified types and levels of marketing activities. In years 1 through 6, USSub manufactures and sells athletic gear under the AA trademark in the United States. Assume that, after adjustments are made to improve the reliability of the comparison for any material differences relating to marketing activities, manufacturing or marketing intangible property, and other comparability factors, the royalties paid by independent licensees would provide the most reliable measure of the arm’s length royalty owed by USSub to FP, apart from the additional facts in paragraph (ii) of this Example 4. (ii) In years 1 through 6, USSub performs incremental marketing activities with respect to the AA trademark athletic gear, in addition to the activities required under the terms of the license agreement with FP, that are also incremental as compared to those observed in the comparables. FP does not directly or indirectly compensate USSub for performing these incremental activities during years 1 through 6. By year 7, AA trademark athletic gear generates a premium return in the United States, as compared to similar athletic gear marketed by independent licensees. In year 7, USSub and FP enter into a separate services agreement under which FP agrees to compensate USSub on a cost basis for the incremental marketing activities that USSub performed during years 1 through 6, and to compensate USSub on a cost basis for any incremental marketing activities it may perform in year 7 and subsequent years. In addition, the parties revise the license agreement executed in year 1, and increase the royalty to a level that attributes to FP substantially all the premium return from sales of the AA trademark athletic gear in the United States. (iii) In determining whether an allocation of income is appropriate in year 7, the Commissioner may consider the economic substance of the arrangements between USSub and FP and the parties’ course of conduct throughout their relationship. Based on this analysis, the Commissioner determines that it is unlikely that, ex ante, an uncontrolled taxpayer operating at arm’s length would engage in the incremental marketing activities to develop or enhance intangible property owned by another party unless it received contemporaneous compensation or otherwise had a reasonable anticipation of a future benefit. In this case, USSub’s undertaking the incremental marketing activities in years 1 through 6 is a course of conduct that is inconsistent with the parties’ adoption in year 7 of contractual terms by which FP compensates USSub on a cost basis for the incremental marketing activities that it performed. Therefore, the Commissioner may impute one or more agreements between USSub and FP, consistent with the economic substance of their course of conduct, which would afford USSub an appropriate portion of the premium return from the AA trademark athletic gear. For example, the Commissioner may impute a separate services agreement that affords USSub contingent-payment compensation for the incremental activities it performed during years 1 through 6, which benefited FP by contributing to the value of the trademark owned by FP. In the alternative, the Commissioner may impute a long-term, exclusive United States license agreement that allows USSub to benefit from the incremental activities. As another alternative, the Commissioner may require FP to compensate USSub for terminating USSub’s imputed long-term United States license agreement, a license that USSub made more valuable at its own expense and risk. The taxpayer may present additional facts that could indicate which of these or other alternative agreements best reflects the economic substance of the underlying transactions, consistent with the parties’ course of conduct in this particular case ...

Contractual terms imputed from economic substance. (i) FP, a foreign producer of wristwatches, is the registered holder of the YY trademark in the United States and in other countries worldwide. In year 1, FP enters the United States market by selling YY wristwatches to its newly organized United States subsidiary, USSub, for distribution in the United States market. USSub pays FP a fixed price per wristwatch. USSub and FP undertake, without separate compensation, marketing activities to establish the YY trademark in the United States market. Unrelated foreign producers of trademarked wristwatches and their authorized United States distributors respectively undertake similar marketing activities in independent arrangements involving distribution of trademarked wristwatches in the United States market. In years 1 through 6, USSub markets and sells YY wristwatches in the United States. Further, in years 1 through 6, USSub undertakes incremental marketing activities in addition to the activities similar to those observed in the independent distribution transactions in the United States market. FP does not directly or indirectly compensate USSub for performing these incremental activities during years 1 through 6. Assume that, aside from these incremental activities, and after any adjustments are made to improve the reliability of the comparison, the price paid per wristwatch by the independent, authorized distributors of wristwatches would provide the most reliable measure of the arm’s length price paid per YY wristwatch by USSub. (ii) By year 7, the wristwatches with the YY trademark generate a premium return in the United States market, as compared to wristwatches marketed by the independent distributors. In year 7, substantially all the premium return from the YY trademark in the United States market is attributed to FP, for example through an increase in the price paid per watch by USSub, or by some other means. (iii) In determining whether an allocation of income is appropriate in year 7, the Commissioner may consider the economic substance of the arrangements between USSub and FP, and the parties’ course of conduct throughout their relationship. Based on this analysis, the Commissioner determines that it is unlikely that, ex ante, an uncontrolled taxpayer operating at arm’s length would engage in the incremental marketing activities to develop or enhance intangible property owned by another party unless it received contemporaneous compensation or otherwise had a reasonable anticipation of receiving a future benefit from those activities. In this case, USSub’s undertaking the incremental marketing activities in years 1 through 6 is a course of conduct that is inconsistent with the parties’ attribution to FP in year 7 of substantially all the premium return from the enhanced YY trademark in the United States market. Therefore, the Commissioner may impute one or more agreements between USSub and FP, consistent with the economic substance of their course of conduct, which would afford USSub an appropriate portion of the premium return from the YY trademark wristwatches. For example, the Commissioner may impute a separate services agreement that affords USSub contingent-payment compensation for its incremental marketing activities in years 1 through 6, which benefited FP by contributing to the value of the trademark owned by FP. In the alternative, the Commissioner may impute a long-term, exclusive agreement to exploit the YY trademark in the United States that allows USSub to benefit from the incremental marketing activities it performed. As another alternative, the Commissioner may require FP to compensate USSub for terminating USSub’s imputed long-term, exclusive agreement to exploit the YY trademark in the United States, an agreement that USSub made more valuable at its own expense and risk. The taxpayer may present additional facts that could indicate which of these or other alternative agreements best reflects the economic substance of the underlying transactions, consistent with the parties’ course of conduct in the particular case ...

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 ...

Differences in volume. USP, a United States agricultural exporter, regularly buys transportation services from FSub, its foreign subsidiary, to ship its products from the United States to overseas markets. Although FSub occasionally provides transportation services to URA, an unrelated domestic corporation, URA accounts for only 10% of the gross revenues of FSub, and the remaining 90% of FSub’s gross revenues are attributable to FSub’s transactions with USP. In determining the degree of comparability between FSub’s uncontrolled transaction with URA and its controlled transaction with USP, the difference in volumes involved in the two transactions and the regularity with which these services are provided must be taken into account if such difference would have a material effect on the price charged. Inability to make reliable adjustments for these differences would affect the reliability of the results derived from the uncontrolled transaction as a measure of the arm’s length result ...

The following examples illustrate this paragraph (d)(3)(ii) ...

In the absence of a written agreement, the district director may impute a contractual agreement between the controlled taxpayers consistent with the economic substance of the transaction. In determining the economic substance of the transaction, greatest weight will be given to the actual conduct of the parties and their respective legal rights (see, for example, § 1.482-4(f)(3) (Ownership of intangible property)). For example, if, without a written agreement, a controlled taxpayer operates at full capacity and regularly sells all of its output to another member of its controlled group, the district director may impute a purchasing contract from the course of conduct of the controlled taxpayers, and determine that the producer bears little risk that the buyer will fail to purchase its full output. Further, if an established industry convention or usage of trade assigns a risk or resolves an issue, that convention or usage will be followed if the conduct of the taxpayers is consistent with it. See UCC 1-205. For example, unless otherwise agreed, payment generally is due at the time and place at which the buyer is to receive goods. See UCC 2-310 ...

The contractual terms, including the consequent allocation of risks, that are agreed to in writing before the transactions are entered into will be respected if such terms are consistent with the economic substance of the underlying transactions. In evaluating economic substance, greatest weight will be given to the actual conduct of the parties, and the respective legal rights of the parties (see, for example, § 1.482-4(f)(3) (Ownership of intangible property)). If the contractual terms are inconsistent with the economic substance of the underlying transaction, the district director may disregard such terms and impute terms that are consistent with the economic substance of the transaction ...

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Determining the degree of comparability between the controlled and uncontrolled transactions requires a comparison of the significant contractual terms that could affect the results of the two transactions. These terms include – (1) The form of consideration charged or paid; (2) Sales or purchase volume; (3) The scope and terms of warranties provided; (4) Rights to updates, revisions or modifications; (5) The duration of relevant license, contract or other agreements, and termination or renegotiation rights; (6) Collateral transactions or ongoing business relationships between the buyer and the seller, including arrangements for the provision of ancillary or subsidiary services; and (7) Extension of credit and payment terms. Thus, for example, if the time for payment of the amount charged in a controlled transaction differs from the time for payment of the amount charged in an uncontrolled transaction, an adjustment to reflect the difference in payment terms should be made if such difference would have a material effect on price. Such comparability adjustment is required even if no interest would be allocated or imputed under § 1.482-2(a) or other applicable provisions of the Internal Revenue Code or regulations ...

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Determining the degree of comparability between controlled and uncontrolled transactions requires a comparison of the functions performed, and associated resources employed, by the taxpayers in each transaction. This comparison is based on a functional analysis that identifies and compares the economically significant activities undertaken, or to be undertaken, by the taxpayers in both controlled and uncontrolled transactions. A functional analysis should also include consideration of the resources that are employed, or to be employed, in conjunction with the activities undertaken, including consideration of the type of assets used, such as plant and equipment, or the use of valuable intangibles. A functional analysis is not a pricing method and does not itself determine the arm’s length result for the controlled transaction under review. Functions that may need to be accounted for in determining the comparability of two transactions include – (A) Research and development; (B) Product design and engineering; (C) Manufacturing, production and process engineering; (D) Product fabrication, extraction, and assembly; (E) Purchasing and materials management; (F) Marketing and distribution functions, including inventory management, warranty administration, and advertising activities; (G) Transportation and warehousing; and (H) Managerial, legal, accounting and finance, credit and collection, training, and personnel management services ...

The comparability factors listed in § 1.482-1(d)(1) are discussed in this section. Each of these factors must be considered in determining the degree of comparability between transactions or taxpayers and the extent to which comparability adjustments may be necessary. In addition, in certain cases involving special circumstances, the rules under paragraph (d)(4) of this section must be considered ...

Whether a controlled transaction produces an arm’s length result is generally evaluated by comparing the results of that transaction to results realized by uncontrolled taxpayers engaged in comparable transactions under comparable circumstances. For this purpose, the comparability of transactions and circumstances must be evaluated considering all factors that could affect prices or profits in arm’s length dealings (comparability factors). While a specific comparability factor may be of particular importance in applying a method, each method requires analysis of all of the factors that affect comparability under that method. Such factors include the following – (i) Functions; (ii) Contractual terms; (iii) Risks; (iv) Economic conditions; and (v) Property or services ...

In 2009 the BlackRock Group acquired Barclays Global Investors for a total sum of $13,5bn. The price was paid in part by shares ($6.9bn) and in part by cash ($6.6bn). The cash payment was paid by BlackRock Holdco 5 LLC – a US Delaware Company tax resident in the UK – but funded by the parent company by issuing $4bn loan notes to the LLC. In the years following the acquisition Blackrock Holdco 5 LLC claimed tax deductions in the UK for interest payments on the intra-group loans. Following an audit in the UK the tax authorities disallowed the interest deductions. The tax authorities held that the transaction would not have happened between independent parties. They also found that the loans were entered into for an unallowable tax avoidance purpose. A UK taxpayer can be denied a deduction for interest where a loan has an unallowable purpose i.e, where a tax advantage is the company’s main purpose for entering into the loan relationship (section 441 of the Corporation Tax Act 2009). If there is such an unallowable purpose, the company may not bring into account for that period ….so much of any debit in respect of that relationship as is attributable to the unallowable purpose. An appeal was filed by the BlackRock Group. In November 2020 the First Tier Tribunal found that an independent lender acting at arm’s length would have made loans to LLC5 in the same amount and on the same terms as to interest as were actually made by LLC4 (the “Transfer Pricing Issue”). The FTT further found that the Loans had both a commercial purpose and a tax advantage purpose but that it would be just and reasonable to apportion all the debits to the commercial purpose and so they were fully deductible by LLC5 (the “Unallowable Purpose Issue”). An appeal was then filed with the Upper Tribunal by the tax authorities. Judgement of the Upper Tribunal The Upper Tribunal found that the First Tier Tribunal had erred in law and therefore allowed HMRC’s appeal on both the transfer pricing issue and the unallowable purpose issue. The First Tier Tribunal’s Decision was set aside and the tax authorities amendments to LLC5’s tax returns were confirmed. Transfer Pricing “The actual provision of the loans from LLC4 to LLC5 differed from any arm’s length provision in that the loans would not have been made as between independent enterprises. The actual provision conferred a potential advantage in relation to United Kingdom taxation. The profits and losses of LLC5, including the allowing of debits for the interest and other expenses payable on the Loans, are to be calculated for tax purposes as if the arm’s length provision had been made or imposed instead of the actual provision. In this case, no arm’s length loan for $4 billion would have been made in the form that LLC4 made to LLC5 and hence HMRC’s amendments to the relevant returns should be upheld and confirmed.” Unallowable Purpose “The FTT did not err in finding that LLC5 had both a commercial purpose and an unallowable tax advantage main purpose in entering into the Loans. However, it was wrong to decide that the just and reasonable apportionment was solely to the commercial purpose. But for the tax advantage purpose there would have been no commercial purpose to the Loans and all the relevant facts and circumstances lead inexorably to the conclusion that the loan relationship debits should be wholly attributed to the unallowable tax purpose and so disallowed.” HMRC_v_Blackrock_Holdco_LLC5_UT-2021-000022_-_final_decision_ ...

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 ...

The French company Issey Miyake Europe is owned by the Japanese company, Issey Miyake Inc, which is active in the fashion industry. Following an audit covering the FY 2006 – 2012, the tax authorities issued an assessment of additional income. According to the tax authorities the pricing of controlled transactions was not at arm’s length, resulting in an indirect transfer of profits within the meaning of Article 57 of the General Tax Code. In order to determine the arm’s length results, the tax authorities applied the transactional net margin method. After searching for comparables on the basis of a database and selecting seven companies for the retail business and nine companies for the wholesale business, and then examining the net operating margins, it adjusted the result to the median. It concluded that Issey Miyake Europe’s results as a wholesaler were within the arm’s length range, but that its results as a retailer were not, with the exception of the financial year ending in 2012, and adopted a rate for this activity corresponding to the median (3,82% for FY 2005, 2.39% for FY 2006, 2.06% for FY 2007, 1.43% for FY 2008, 1.70% for FY 2009, 1.58% for FY 2010 and 2.07% for FY 2011. Not satisfied with the assessment, Issey Miyake Europe appealed to the Administrative Court, which dismissed the appeal. Issey Miyake Europe then appealed to the Court of Administrative Appeals. Judgment of the Court The Court of Administrative Appeals udheld the decision of the Administrative Court and ruled in favour of the tax authorities. Excerpts: “6. In these circumstances, the tax authorities have established that Issey Miyake Inc sells its products to all its subsidiaries worldwide at cost price, to which a margin is added without taking into account the specific nature of local markets, Maintaining the loss-making business in France enabled this company to benefit from a showcase to display and develop the brand’s reputation and to have a commercial outlet in a market with international influence in the luxury goods sector, while Issey Miyake Europe incurred rent expenses that were excessive in relation to its activity with a view to developing the brand. It thus provides evidence that Issey Miyake Europe’s operating result was structurally in deficit for the period under review due to its retail sales activity, as a result of the additional costs incurred by the marketing strategy, which had the effect of having Issey Miyake Inc’s intangible assets valued by its subsidiary.” (…) 10. Thirdly, it is clear from the investigation, in particular from the terms of the rectification proposal and the response to the taxpayer’s observations, which are not seriously contested, that Issey Miyake Europe, although questioned on this point and even though it was not bound by detailed documentary obligations, did not produce any sufficiently precise evidence during the accounting audit to justify transfer prices, contrary to what it maintains. On the other hand, it submitted a study carried out in June 2015 by Grant Thornton during the taxation procedure, which analysed transactions involving inventories for the period between the financial year ending in 2012 and that ending in 2014 and found, after carrying out an analysis of the functions and risks of Issey Miyake Inc and Issey Miyake Europe alone, the cost-plus method, on the grounds that Issey Miyake Inc also sells wholesale to independent companies in the Asia-Oceania region and that these transactions are similar to those carried out with Issey Miyake Europe. However, this study, which notes that the markets analysed are different and relate to a period other than the period audited, compares the margins achieved by Issey Miyake Inc in its sales to independent distributors with the margins achieved in sales to Issey Miyake Europe, making adjustments to take account of the length of the distribution channel and differences in exchange rate risks, without providing any specific information concerning the products sold, as the study merely refers in general terms to the types of products, the volumes of transactions compared and the contractual stipulations governing these transactions. In these circumstances, the tax authorities were right to reject the method proposed by Issey Miyake Europe. 11. Furthermore, although Issey Miyake Europe contests the principle of the administration’s use of the transactional net margin method, the investigation does not show that the administration had sufficient information, internal to the group, on transfer pricing to enable it to use a method based on transactions, and the applicant does not provide any evidence to support its allegations that the analysis of functions and risks carried out on the basis of its own replies was erroneous. Nor does it provide any evidence in support of its allegations that the method used by the tax authorities would, as a matter of principle, result in over-taxation that did not take commercial factors into account. In these circumstances, Issey Miyake Europe is not entitled to argue that the tax authorities could not have used the transactional net margin method. 12. Fourthly, Issey Miyake Europe maintains that the comparables used by the tax authorities for the retail business are not relevant, since the companies in question are engaged in distribution in the clothing sector and not in the luxury goods sector, which has its own specific requirements, as confirmed by the aesthetics of the windows, the quality of the shops, the locations, the type of staff and the price of the products sold. However, the purpose of the transactional net margin method is to compare the results of controlled transactions with those of third-party companies performing comparable functions and assuming comparable risks, unlike price-based methods, which require the products sold to be similar. In this case, Issey Miyake Europe simply refutes the comparables on the sole grounds that they are not independent French companies distributing luxury ready-to-wear clothing similar to that which it distributes and under the same conditions, whereas the administration, which excluded the companies initially retained whose functions were likely to present substantial differences, such as those performing manufacturing and production functions, appended ...

A Polish company, “Shopping Centre Lender sp.k.”, had been granted three intra group loans in FY 2013 for a maximum amount of EUR 2 million, EUR 115 million and EUR 43.5 million. The interest rate on the loans had been set at 9%. The tax authorities found that the 9% interest rate was higher than the arm’s length rate, and issued an assessment where the interest rate had been lowered to 3.667%, resulting in lower interest expenses and thus additional taxable income. “Shopping Centre Lender sp.k.” filed an appeal with the Administrative Court claiming that the procedure for estimating income – determining the arm’s length interest rate – had not been conducted correctly by the tax authority. In a judgement issued in May 2019 (no. III SA/Wa 1777/18) the Administrative Court issued a judgement in favour of the company. An appeal was then filed by the tax authorities with the Supreme Administrative Court. Judgement of the Supreme Administrative Court The Supreme Administrative Court upheld the decision of the Administrative Court and dismissed the appeal of the tax authorities. Excerpts “In the opinion of the Supreme Administrative Court, the Court of First Instance made a proper assessment of the case submitted to its review. In the justification of the contested judgment, it presented the legal basis for the decision and its explanation, and within this framework it diagnosed the infringements committed by the authority and assessed their impact on the results of the case. It did so in a clear manner which makes it possible to review the grounds on which it was based. The conclusions formulated, as well as the objections to the proceedings conducted and the content of the decision concluding them, were presented in a reliable and comprehensive manner, in mutual confrontation of the state of the case, applicable legal norms and case-law. It indicated which provisions had been violated, which allegations of the complaint it considered justified and why. In the present case, the essence of the dispute essentially boiled down to determining whether the interest rate (9% p.a.) of the three loans concluded in 2013 for a maximum amount of EUR 2 million, EUR 115 million and EUR 43.5 million (in respect of which the total balance of liabilities as at 30 September 2014 amounted to almost PLN 623 million), which were granted to the Applicant by a related entity, was in line with market conditions, i.e. whether independent, rational entities would have agreed on an interest rate of that amount under comparable conditions. More generally, however, the issue in the case oscillated around so-called transfer pricing and generally – in view of the arguments now raised by the parties – boiled down to an assessment of whether, in fact, the procedure for estimating income [art. 11 of the AOP] had been conducted correctly, as the authority argued, or, as the Appellant and the Court argued, in breach of the provisions of the Act and the Ordinance.” “Referring in turn to the individual problems diagnosed by the WSA, it should be pointed out that this Court, taking into account the disposition arising from the content of Article 11(1) of the A.p.d.o.p., rightly emphasised that its application (in order to determine the income of a given entity and the tax due) requires a prior analysis of comparability. In order to determine what conditions would be set between independent entities, it is necessary to determine what transactions concluded by independent entities are comparable to the transaction assessed from the point of view of Article 11(1) of the A.l.t.d.o.p., which requires a prior comparability analysis. Such an analysis is always conducted, as it serves the purpose of determining whether the prerequisite for estimating income (and the tax due) under Article 11(1) of the A.l.t.c. has been fulfilled. This conclusion is also confirmed by the above-mentioned § 6(1) of the Ordinance, The comparability analysis precedes the assessment, regardless of the method of assessment that would ultimately be applied. On the other hand, § 21 of the Ordinance (Chapter 5) indicates how to estimate income in the case of the specific benefits specified therein (loan or credit). One must agree with the Court of First Instance that the application of Article 11(1) of the A.P.C. requires a prior comparability analysis in respect of the loans in question. A properly conducted comparability analysis should consist of the steps listed in § 6(4) of the Ordinance and establish the relevant comparability factors (§ 21(3) of the Ordinance, which uses the term “relevant circumstances relating to a particular case”) arising from § 6(3) and § 21(3) of the Ordinance.” “The point is that it is not a matter of carrying out any comparability analysis, but rather one consisting precisely of the steps listed in § 6(4) of the Ordinance and establishing the relevant comparability factors arising from § 6(3) and § 21(3) of the Ordinance. As the Court of First Instance aptly pointed out, § 6(4) lists the consecutive stages comprising the comparability analysis, of which the first two in particular include – a general analysis of information concerning the taxpayer and its economic environment (stage one) and an analysis of the terms and conditions established or imposed between related parties, in particular on the basis of the functions they perform, the assets involved and the risks incurred, as a result of which economically relevant factors in the circumstances of the case under review should be identified (stage two). In the realities of this case, the Court of First Instance correctly held that the authority, in its decision issued pursuant to Article 11(1) of the A.p.d.o.p. – taking into account the aforementioned provisions of the Ordinance – in carrying out the comparability analysis was obliged to carry out the individual stages and identify the relevant comparability factors, and this should have been appropriately reflected in the wording of the decision. And although one has to agree with the authority that the Regulation does not indicate the necessity of drawing up the analysis in the ...

Poltova GZK is a Ukrainian subsidiary of the Ferrexpo group – the world’s third largest exporter of iron ore pellets. In FY 2015 the iron ore mined in Ukraine by Poltava GZK was sold to other companies in the group – Ferrexpo Middle East FZE, and the transfer prices for the ore was determined by application of the CUP method using Platts quotations. However, according to the tax authorities Poltava GZK used Platts quotations for pellets with a lower iron content when pricing the higher quality pellets, resulting in non arm’s length prices for the controlled transactions and lower profits in the Ukraine subsidiary. The tax authorities also found that Poltava GZK had overestimated the cost of freight – in the case of actual transportation of pellets by ships of different classes (“Panamax”, “Capesize”), the adjustment of the delivery conditions was carried out only at the maximum rate. On that basis an assessment was issued. Not satisfied with the assessment an appel was filed Poltova GZK, and in 2019 the Administrative Court and later the Court of Appeal set aside the assessment of the tax authorities. An appeal was then filed by the tax authorities with the Supreme Court. Judgement of the Supreme Court The Supreme Court partially annulled the decision of the Administrative Court and Court of Appeal and ruled predominantly in favor of the tax authorities approving the position that the transfer prices of the iron ore pellets did not correspond to the arm’s length price. The Court confirmed the validity of the tax assessment and the legality of the issued tax notice-decision regarding the reduction of the negative taxable income in an amount of 1.3 billion hryvnias (~$35 millions).  The Court confirmed that the taxpayer did not take into account the actual properties of the products specified in the Quality Certificates, namely: the content of impurities (silicon dioxide) and the moisture level when pricing the controlled transactions. The court confirmed that the constant fluctuation of prices on the market of iron ore pellets is not a basis for comparing prices in CU with the average indicator in comparable operations for a certain period (month) without constructing a price range. Also, the taxpayer had overestimated the cost of freight. Click here for English translation Click here for other translation Ukrain vs PrJSC Supreme Administrative Court case no 440-1053-19 ...

C. spółka z o.o. is part of a larger group and mainly (95%) sells products (metal containers) and related services to related parties. According to its transfer pricing documentation the “cost-plus” method had been used to determine the prices of products sold to related parties. The company was audited for FY 2016. According to the tax authorities, the company did not provide enough evidence to support the cost-plus method. The tax authority instead used the transactional net profit method to estimate the company’s income for the year 2016, taking into account factors such as characteristics of goods or services, functional analysis, contractual conditions, economic conditions, and economic strategy by comparing the company’s performance with similar companies over a 3 year period by using EBIT margin. As a result, the authority adjusted the company’s loss and established income based on a EBIT margin of 3.66%, resulting in additional taxable income of PLN 1,803,592.08. Judgement of the Administrative Court The Court found that the TNMM was the most appropriate method to determine the company’s income in 2016, and that the comparability analysis was carried out in accordance with the regulations and data available to the authority. However, the tax authorities have wrongly determined the income of the complainant, by referencing to its entire activity, despite the fact that 5% of the transactions are not subject to regulation under Article 11(1)-(3) of the A.p.d.o.p. Because of this, the court repealed the decision of the first-instance authority and stated that when re-examining the case, the authority should take into account the position expressed in the court’s decision. Excerpt from the judgement regarding adjustments where the result is within the inter quartile range “It is also necessary to share the Applicant’s position regarding the use of the median average, well, the authority of first instance, which was accepted by the Appellate Body, stressed on page 151 of the issued decision that the statistical analysis conducted by it used positional measures, as the comparative analysis is an approximation of the prices used in transactions between unrelated parties. In order to determine the range of prices, statistical tools in the form of quartiles (…) were used to analyse the results, the analysis carried out assuming that the appropriate range of results is the interquartile area (first quartile, median, third quartile). Hence, according to the authority, in practice, the most common assumption is that the market values are those that fall between the value of the lower quartile and the upper quartile of the sample population. The inter-quartile range is used to define the rules generally applicable in the market. It should be noted here that the inter-quartile area for 2016, ranges from 1.61% to 3.89%, so since the market value of the EBIT(2) operating margin is already the value of the bottom quartile of 1.61%, and the estimation made is to determine the margin obtained in comparable transactions by independent entities – §18 of the MF Regulation (and such market transactions are already at the level of the bottom quartile), there is no legal basis for determining the market values of EBIT(2) using the arithmetic average of the median operating margin.” Click here for English Translation Click here for other translation I SA_Go 103_22 - Wyrok WSA w Gorzowie Wlkp. z 2022-06-09 ...

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 ...

ConocoPhillips Skandinavia AS (COPSAS) is a wholly owned subsidiary of the Norwegian branch of ConocoPhillips Norway, which is registered in Delaware, USA. ConocoPhillips Norway, which does not conduct special taxable business, is a wholly owned company in the ConocoPhillips Group. The group’s headquarters are in Houston, Texas, USA. The question at issue was whether the interest rate on a loan had been set too high, thus resulting in a reduction of the taxable income of COPSAS. In May 2013, COPSAS entered into a loan agreement with the related company ConocoPhillips Norway Funding Ltd (COPN Funding). The loan had a limit of NOK 20 billion and a term of 5 years. The agreed interest rate was NIBOR 6M + 1.25%. NIBOR 6M is a current interest rate (benchmark interest rate), while 1.25% is a fixed interest rate – the so-called «interest margin». The interest margin of 1.25% corresponds to 125 so-called basis points (bp). The loan facility was primarily established to finance investments in two fields on the Norwegian continental shelf, where the company is the operator. From previous years, the company has had several long-term loans in USD and NOK with an interest margin of 37.5 bp above a reference interest rate of either LIBOR or NIBOR. The loans have previously been rolled out and renewed for five years at a time. The interest margin of 37.5 bp was fixed. With effect from 27 October 2015, the loans in USD were combined into one loan in NOK. The interest margin of 37.5 bp was continued. The company’s loan of May 2013 did not replace any previous loans. The fixed interest margin of 1.25% on the company’s borrowing limit of May 2013 had been based on an interest rate analysis prepared by PwC in connection with the borrowing (“Intercompany interest rate analysis”, hereinafter the “interest rate analysis”) on 3 May 2013. On 8 March 2019, the Oil Tax Office issued a decision where the interest rate of the May 2013-loan was set at NIBOR 6M + 75 bp. This led to the following conclusion: «The determinations for the income years 2013-2017 are changed accordingly by ConocoPhillips Skandinavia AS’ interest expenses on interest-bearing debt being reduced by the following amounts: Income year 2013: NOK 27,875,000 Income year 2014: NOK 52,487,500 Income year 2015: NOK 70,972,223 Income year 2016: NOK 71,909,445 Income year 2017: NOK 63,777,778 » The Court of Appeal notes that when basis points are discussed in the following, reference is made to basis points beyond 6 months NIBOR, unless otherwise specified. The reason for this is that the borrowing rate is agreed as NIBOR 6M + 125 bp. COPSAS filed a lawsuit with the District Court where the decision issued by the tax authorities was upheld. COPSAS then filed an appeal with the Court of Appeal. Judgement of the Court of Appeal The Court dismissed the appeal and decided in favour of the Norwegian tax authorities. Excerpts “The Court of Appeal further points out that COPSAS has on average used around half the borrowing limit, and that the borrowing limit of NOK 20 billion was mostly used to borrow NOK 14 billion. Although it was not clear at the time of entering into the agreement how large a part of the loan framework was to be used, there is much to suggest that if it had been a loan between independent parties, COPSAS would not have taken out a loan of NOK 20 billion and paid for flexibility , when it has been shown that only a limited part of the borrowing limit was used. The Court of Appeal also points out that the loan agreement contains a clause on interest rate adjustment if COPSAS changes its “credit standing” during the term. This means that the agreement allows the interest rate to be adjusted if the loan is drawn up in full, and this can thus also reduce the value of the opportunity to use the entire loan framework. The question then is whether it should be adjusted for swap, ie currency risk. The experts, Hoddevik and Steen, explained why it is appropriate for companies operating on the Norwegian continental shelf to also borrow money in Norwegian kroner. There will be an extra risk if the companies borrow in dollars, when other income and expenses, including tax, are calculated in kroner. At the same time, a loan of the magnitude relevant in this case must be raised in the international dollar market. The Norwegian bond market is too small for it to be relevant to borrow such amounts in the Norwegian bond market. If COPSAS had borrowed in the market, they would therefore have had to take out a loan in dollars and pay a premium for the loan to be converted to Norwegian kroner. The various interest rate indices referred to do not take swap into account, but are based on loans taken out in the same currency in which they are to be repaid. The Court of Appeal points out that no consideration has been agreed for this component either, and that it can indicate that the parties have considered that no swap costs should be calculated. One view is that for the lender, COPN Funding, the exchange risk can go both ways, ie that it is basically coincidental whether there is a gain or a loss by the lender operating in the dollar market, while lending in kroner. When it is an intra-group loan, there is no basis for calculating consideration for swap as losses and gains are within the group. As emphasized by the State, compensation for counterparty risk is then not relevant. The Court of Appeal refers here to LG-2016-92595, the Hess judgment, The Court of Appeal considers that when the loan has been raised in Norwegian kroner and is to be repaid in Norwegian kroner, no adjustments shall be made as if the loan had been agreed in dollars, which would then be paid out and repaid in Norwegian kroner. In the same way ...

GlaxoSmithKline Costa Rica S.A. manufactures pharma products which is sold to both independent customers in the region and to group companies abroad. For FY 2004 and 2005 pricing of the controlled transactions had been determined based on the TNMM method using return on total costs (ROTC) as PLI. GSK said the range of return on total costs “for the comparable independent companies ranges from 4.7 per cent to 14.5 per cent, with a median of 9.6 per cent. GSK CR obtained an average ROTC of 50.6 percent during fiscal years 2004 and 2005, which was not below the range identified for comparable independent companies. Accordingly, the transfer prices used by GSK CR in its controlled transactions did not distort GSK CR’s profitability and satisfied the arm’s length principle set out in the OECD Guidelines. In 2009 the tax authorities issued an assessment for FY 2004 and 2005 based on the internal CUP method. “…between the transactions under study, namely sales to related and unrelated customers, there is complete similarity in terms of the characteristics of the product that is addressed to both types of customers, it is the same product, i.e. with identical characteristics…” “the taxpayer GSK sells at different prices with its related companies, taking into account the following branded products: Andrews, SB Analgesics, Oxy, Panadol Concept (RT) and Phillips Mom. It found that some products were sold at 34% of the price to an independent. Thus during the period 2004 it found that products such as Sal Andrews Cja X 50’s, code 200041010 was sold to independents at ¢1,366.57 and to affiliated companies at ¢468.68. The average profit margin over standard cost for products sold to independent customers was 285.33% and for affiliates it was 28.22%.” Applying the internal CUP method resulted in an adjustment of taxable profits in an amount of ¢394,638,821.00. Not content with the tax assessment an appeal was filed by GlaxoSmithKline with the tax court. The appeal was dismissed in 2013 and later in 2019 by the Court of appeal. An appeal was then filed with the Supreme Court. Judgement of the Supreme Court The Court dismissed the appeal of GlaxoSmithKline and upheld the assessment of the tax authorities. Excerpts from the Judgement “The principle of economic reality, provided for in precepts 8 and 12 of the CNPT, essentially allows the Tax Administration to depart from the forms adopted by the taxpayer to unravel the true tax scope of the contract, in order to avoid tax evasion and thus determine what the business between the parties really consisted of. In the case under study, several aspects can be extracted from the evidence in the case file and referred to above. Firstly, the application of the CUP method is not outside the scope of administrative discretion based on due technical discretion, in proper compliance with paragraphs 15 and 16 of the LGAP. Discretion allows the Administration to determine the best technical criterion to be used. It is a detailed study in which the comparison of the same products is reflected. Secondly, the PwC reports show the possibility of using other methods to determine the actual transfer pricing situation. Indeed, PwC’s work is very comprehensive and justified on each of the points it raises. It is clear to this House that these documents were prepared by experts with extensive knowledge of the subject. Thirdly, the expert opinion is not a study that helps to solve the conflict, as it is basically dedicated to indicate whether the system used by the TA complies or not with the Guidelines, in order to deduce that the best work was that of PwC. However, as has been seen, as explained throughout this judgment, it is not in dispute whether the TA had to apply the Guidelines as they are established; with the obligation to follow each of the guidelines set out therein. The shortcomings that this Chamber detects in the evidence provided by GSK, lies in the fact that the study carried out by the expert PwC, takes into account variables, which do not appear in the file and which the TA did not have, specifically those private reports adduce preponderant factors that influence and directly affect the sale price and analyse elements such as: sales volumes, brands, economic conditions of each country, price controls established in some regions, names under which the products are sold, specifications of the respective packaging, geographic issues, development and market size; which from their point of view make the products incomparable. However, as the auditor indicates, when he carried out his study and asked GSK directly for information on the elements that could influence the prices of related companies with respect to independent companies, in which a clear difference was noted, the taxpayer’s response was that the only factor that affected prices was advertising. This response was given even though the taxpayer was aware that a transfer pricing study was being carried out on the company. PwC’s work goes beyond this statement made by the taxpayer during the audit process, and that is why, even if they are complete and technical studies, they are elaborated with completely different parameters than those available to the TA, as expressly indicated by the plaintiff. None of the elements referred to were arguments made by the taxpayer when the study was carried out. Likewise, it is unacceptable the position used by the plaintiff that when GSK responded to the auditor that “other” elements were also part of the aspects that varied the transfer prices with the related parties, it was the TA’s obligation to find out what those “other” elements consisted of; it is up to the taxpayer to provide all the required information. Thus, it is not possible to affirm that the work carried out by the TA was deficient, unreliable or incomplete; since, all things being equal, it has not been possible to disprove that this study is erroneous or unreliable, in such a way that, in the present case, it is not evident that the ...

The widespread existence of markets for borrowing and lending money and the frequency of such transactions between independent borrowers and lenders, coupled with the widespread availability of information and analysis of loan markets may make it easier to apply the CUP method to financial transactions than may be the case for other types of transactions. Information available often includes details on the characteristics of the loan and the credit rating of the borrower or the rating of the specific issuance. Characteristics which will usually increase the risk for the lender, such as long maturity dates, absence of security, subordination, or application of the loan to a risky project, will tend to increase the interest rate. Characteristics which limit the lender’s risk, such as strong collateral, a high quality guarantee, or restrictions on future behaviour of the borrower, will tend to result in a lower interest rate ...

There may be special circumstances, such as in the case of start-up entities, or those that have recently been part of a merger, that may have an impact on the credit rating of a group entity. These special situations should be taken into consideration ...

As a credit rating depends on a combination of quantitative and qualitative factors, there is still likely to be some variance in creditworthiness between borrowers with the same credit rating. In addition, when making comparisons between borrowers using the kind of financial metrics typically seen as important to lenders, such as debt-earnings or debt-equity ratios, it is important to note that the same financial metrics will not necessarily result in the same credit rating if there are other differences between the rated parties. For example, it may require stronger financial metrics to obtain a given rating in some industries than to obtain the same rating for a borrower in other industries. More intrinsically risky industries and those with less stable revenue streams tend to require better financial ratios in order to obtain the same rating ...

Business strategies must also be examined in accurately delineating the actual financial transaction and in determining comparability for transfer pricing purposes since different business strategies can have a significant effect on the terms and conditions which would be agreed between independent enterprises ...

Currency differences are another potentially important factor. Economic factors such as growth rate, inflation rate, and the volatility of exchange rates, mean that otherwise similar financial instruments issued in different currencies may have different prices. Moreover, prices for financial instruments in the same currency may vary across financial markets or countries due to regulations such as interest rate controls, exchange rate controls, foreign exchange restrictions and other legal and practical restrictions on financial market access ...

Macroeconomic trends such as central bank lending rates or interbank reference rates, and financial market events like a credit crisis, can affect prices. In this regard, the precise timing of the issue of a financial instrument in the primary market or the selection of comparable data in the secondary market can therefore be very significant in terms of comparability. For instance, it is not likely that multiple year data on loan issuances will provide useful comparables. The opposite is more likely to be true, i.e. that the closer in timing a comparable loan issuance is to the issuance of the tested transaction, the less the likelihood of different economic factors prevailing, notwithstanding that particular events can cause rapid changes in lending markets ...

In some circumstances group synergies contribute to the level of income earned by an MNE group. Such group synergies can take many different forms including streamlined management, elimination of costly duplication of effort, integrated systems, purchasing or borrowing power, etc. Such features may have an effect on the determination of arm’s length conditions for controlled transactions and should be addressed for transfer pricing purposes as comparability factors. As they are not owned or controlled by an enterprise, they are not intangibles within the meaning of Section A. 1. See Section D.8 of Chapter I for a discussion of the transfer pricing treatment of group synergies ...

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 ...

Prices are likely to be affected by differences in products, and gross margins are likely to be affected by differences in functions, but net profit indicators are less adversely affected by such differences. As with the resale price and cost plus methods that the transactional net margin method resembles, this does not mean that a mere similarity of functions between two enterprises will necessarily lead to reliable comparisons. Assuming similar functions can be isolated from among the wide range of functions that enterprises may exercise, in order to apply the method, the net profit indicators related to such functions may still not be automatically comparable where, for instance, the enterprises concerned carry on those functions in different economic sectors or markets with different levels of profitability. When the comparable uncontrolled transactions being used are those of an independent enterprise, a high degree of similarity is required in a number of aspects of the associated enterprise and the independent enterprise involved in the transactions in order for the controlled transactions to be comparable; there are various factors other than products and functions that can significantly influence net profit indicators ...

Another practical strength of the transactional net margin method is that, as with any one-sided method, it is necessary to examine a financial indicator for only one of the associated enterprises (the “tested” party). Similarly, it is often not necessary to state the books and records of all participants in the business activity on a common basis or to allocate costs for all participants as is the case with the transactional profit split method. This can be practically advantageous when one of the parties to the transaction is complex and has many interrelated activities or when it is difficult to obtain reliable information about one of the parties. However, a comparability (including functional) analysis must always be performed in order to appropriately characterise the transaction between the parties and choose the most appropriate transfer pricing method, and this analysis generally necessitates that some information on the five comparability factors in relation to the controlled transaction be collected on both the tested and the non-tested parties. See paragraphs 3.20-3.23 ...

For the CUP method to be reliably applied to commodity transactions, the economically relevant characteristics of the controlled transaction and the uncontrolled transactions or the uncontrolled arrangements represented by the quoted price need to be comparable. For commodities, the economically relevant characteristics include, among others, the physical features and quality of the commodity; the contractual terms of the controlled transaction, such as volumes traded, period of the arrangements, the timing and terms of delivery, transportation, insurance, and foreign currency terms. For some commodities, certain economically relevant characteristics (e.g. prompt delivery) may lead to a premium or a discount. If the quoted price is used as a reference for determining the arm’s length price or price range, the standardised contracts which stipulate specifications on the basis of which commodities are traded on the exchange and which result in a quoted price for the commodity may be relevant. Where there are differences between the conditions of the controlled transaction and the conditions of the uncontrolled transactions or the conditions determining the quoted price for the commodity that materially affect the price of the commodity transactions being examined, reasonably accurate adjustments should be made to ensure that the economically relevant characteristics of the transactions are comparable. Contributions made in the form of functions performed, assets used and risks assumed by other entities in the supply chain should be compensated in accordance with the guidance provided in these Guidelines ...

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 ...

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 following example illustrates the concept of determining the actual transaction where a transaction has not been identified by the MNE. In reviewing the commercial or financial relations between Company P and its subsidiary companies, it is observed that those subsidiaries receive services from an independent party engaged by Company P. Company P pays for the services, the subsidiaries do not reimburse Company P directly or indirectly through the pricing of another transaction and there is no service agreement in place between Company P and the subsidiaries. The conclusion is that, in addition to a provision of services by the independent party to the subsidiaries, there are commercial or financial relations between Company P and the subsidiaries, which transfer potential value from Company P to the subsidiaries. The analysis would need to determine the nature of those commercial or financial relations from the economically relevant characteristics in order to determine the terms and conditions of the identified transaction ...

Where no written terms exist, the actual transaction would need to be deduced from the evidence of actual conduct provided by identifying the economically relevant characteristics of the transaction. In some circumstances the actual outcome of commercial or financial relations may not have been identified as a transaction by the MNE, but nevertheless may result in a transfer of material value, the terms of which would need to be deduced from the conduct of the parties. For example, technical assistance may have been granted, synergies may have been created through deliberate concerted action (as discussed in Section D.8), or know-how may have been provided through seconded employees or otherwise. These relations may not have been recognised by the MNE, may not be reflected in the pricing of other connected transactions, may not have been formalised in written contracts, and may not appear as entries in the accounting systems. Where the transaction has not been formalised, all aspects would need to be deduced from available evidence of the conduct of the parties, including what functions are actually performed, what assets are actually used, and what risks are actually assumed by each of the parties ...

The following example illustrates the concept of differences between written contractual terms and conduct of the parties, with the result that the actual conduct of the parties delineates the transaction. Company S is a wholly-owned subsidiary of Company P. The parties have entered into a written contract pursuant to which Company P licenses intellectual property to Company S for use in Company S’s business; Company S agrees to compensate Company P for the licence with a royalty. Evidence provided by other economically relevant characteristics, and in particular the functions performed, establishes that Company P performs negotiations with third-party customers to achieve sales for Company S, provides regular technical services support to Company S so that Company S can deliver contracted sales to its customers, and regularly provides staff to enable Company S to fulfil customer contracts. A majority of customers insist on including Company P as joint contracting party along with Company S, although fee income under the contract is payable to Company S. The analysis of the commercial or financial relations indicates that Company S is not capable of providing the contracted services to customers without significant support from Company P, and is not developing its own capability. Under the contract, Company P has given a licence to Company S, but in fact controls the business risk and output of Company S such that it has not transferred risk and function consistent with a licensing arrangement, and acts not as the licensor but the principal. The identification of the actual transaction between Company P and Company S should not be defined solely by the terms of the written contract. Instead, the actual transaction should be determined from the conduct of the parties, leading to the conclusion that the actual functions performed, assets used, and risks assumed by the parties are not consistent with the written licence agreement ...

Where there is doubt as to what transaction was agreed between the associated enterprises, it is necessary to take into account all the relevant evidence from the economically relevant characteristics of the transaction. In doing so one must bear in mind that the terms of the transaction between the enterprises may change over time. Where there has been a change in the terms of a transaction, the circumstances surrounding the change should be examined to determine whether the change indicates that the original transaction has been replaced through a new transaction with effect from the date of the change, or whether the change reflects the intentions of the parties in the original transaction. Particular care should be exercised where it appears that any changes may have been triggered by knowledge of emerging outcomes from the transaction. Changes made in the purported assumption of a risk when risk outcomes are known do not involve an assumption of risk since there is no longer any risk, as discussed in paragraph 1.78 ...

In transactions between independent enterprises, the divergence of interests between the parties ensures (i) that contractual terms are concluded that reflect the interests of both of the parties, (ii) that the parties will ordinarily seek to hold each other to the terms of the contract, and (iii) that contractual terms will be ignored or modified after the fact generally only if it is in the interests of both parties. The same divergence of interests may not exist in the case of associated enterprises or any such divergences may be managed in ways facilitated by the control relationship and not solely or mainly through contractual agreements. It is, therefore, particularly important in considering the commercial or financial relations between associated enterprises to examine whether the arrangements reflected in the actual conduct of the parties substantially conform to the terms of any written contract, or whether the associated enterprises’ actual conduct indicates that the contractual terms have not been followed, do not reflect a complete picture of the transactions, have been incorrectly characterised or labelled by the enterprises, or are a sham. Where conduct is not fully consistent with economically significant contractual terms, further analysis is required to identify the actual transaction. Where there are material differences between contractual terms and the conduct of the associated enterprises in their relations with one another, the functions they actually perform, the assets they actually use, and the risks they actually assume, considered in the context of the contractual terms, should ultimately determine the factual substance and accurately delineate the actual transaction ...

If the characteristics of the transaction that are economically relevant are inconsistent with the written contract between the associated enterprises, the actual transaction should generally be delineated for purposes of the transfer pricing analysis in accordance with the characteristics of the transaction reflected in the conduct of the parties ...

The following example illustrates the concept of clarifying and supplementing the written contractual terms based on the identification of the actual commercial or financial relations. Company P is the parent company of an MNE group situated in Country P. Company S, situated in Country S, is a wholly-owned subsidiary of Company P and acts as an agent for Company P’s branded products in the Country S market. The agency contract between Company P and Company S is silent about any marketing and advertising activities in Country S that the parties should perform. Analysis of other economically relevant characteristics and in particular the functions performed, determines that Company S launched an intensive media campaign in Country S in order to develop brand awareness. This campaign represents a significant investment for Company S. Based on evidence provided by the conduct of the parties, it could be concluded that the written contract may not reflect the full extent of the commercial or financial relations between the parties. Accordingly, the analysis should not be limited by the terms recorded in the written contract, but further evidence should be sought as to the conduct of the parties, including as to the basis upon which Company S undertook the media campaign ...

However, the written contracts alone are unlikely to provide all the information necessary to perform a transfer pricing analysis, or to provide information regarding the relevant contractual terms in sufficient detail. Further information will be required by taking into consideration evidence of the commercial or financial relations provided by the economically relevant characteristics in the other four categories (see paragraph 1.36): the functions performed by each of the parties to the transaction, taking into account assets used and risks assumed, together with the characteristics of property transferred or services provided, the economic circumstances of the parties and of the market in which the parties operate, and the business strategies pursued by the parties. Taken together, the analysis of economically relevant characteristics in all five categories provides evidence of the actual conduct of the associated enterprises. The evidence may clarify aspects of the written contractual arrangements by providing useful and consistent information. If the contract neither explicitly nor implicitly (taking into account applicable principles of contract interpretation) addresses characteristics of the transaction that are economically relevant, then any information provided by the contract should be supplemented for purposes of the transfer pricing analysis by the evidence provided by identifying those characteristics ...

A transaction is the consequence or expression of the commercial or financial relations between the parties. The controlled transactions may have been formalised in written contracts which may reflect the intention of the parties at the time the contract was concluded in relation to aspects of the transaction covered by the contract, including in typical cases the division of responsibilities, obligations and rights, assumption of identified risks, and pricing arrangements. Where a transaction has been formalised by the associated enterprises through written contractual agreements, those agreements provide the starting point for delineating the transaction between them and how the responsibilities, risks, and anticipated outcomes arising from their interaction were intended to be divided at the time of entering into the contract. The terms of a transaction may also be found in communications between the parties other than a written contract ...

For a discussion of the relevance of these factors for the application of particular pricing methods, see the consideration of those methods in Chapter II ...

All methods that apply the arm’s length principle can be tied to the concept that independent enterprises consider the options realistically available to them and in comparing one option to another they consider any differences between the options that would significantly affect their value. For instance, before purchasing a product at a given price, independent enterprises normally would be expected to consider whether they could buy an equivalent product on otherwise comparable terms and conditions but at a lower price from another party. Therefore, as discussed in Chapter II, Part II, the comparable uncontrolled price method compares a controlled transaction to similar uncontrolled transactions to provide a direct estimate of the price the parties would have agreed to had they resorted directly to a market alternative to the controlled transaction. However, the method becomes a less reliable substitute for arm’s length transactions if not all the characteristics of these uncontrolled transactions that significantly affect the price charged between independent enterprises are comparable. Similarly, the resale price and cost plus methods compare the gross profit margin earned in the controlled transaction to gross profit margins earned in similar uncontrolled transactions. The comparison provides an estimate of the gross profit margin one of the parties could have earned had it performed the same functions for independent enterprises and therefore provides an estimate of the payment that party would have demanded, and the other party would have been willing to pay, at arm’s length for performing those functions. Other methods, as discussed in Chapter II, Part III, are based on comparisons of net profit indicators (such as profit margins) between independent and associated enterprises as a means to estimate the profits that one or each of the associated enterprises could have earned had they dealt solely with independent enterprises, and therefore the payment those enterprises would have demanded at arm’s length to compensate them for using their resources in the controlled transaction. Where there are differences between the situations being compared that could materially affect the comparison, comparability adjustments must be made, where possible, to improve the reliability of the comparison. Therefore, in no event can unadjusted industry average returns themselves establish arm’s length prices ...

The second phase in which economically relevant characteristics or comparability factors are used in a transfer pricing analysis relates to the process set out in Chapter III of making comparisons between the controlled transactions and uncontrolled transactions in order to determine an arm’s length price for the controlled transaction. To make such comparisons, taxpayers and tax administrations need first to have identified the economically relevant characteristics of the controlled transaction. As set out in Chapter III, differences in economically relevant characteristics between the controlled and uncontrolled arrangements need to be taken into account when establishing whether there is comparability between the situations being compared and what adjustments may be necessary to achieve comparability ...

Independent enterprises, when evaluating the terms of a potential transaction, will compare the transaction to the other options realistically available to them, and they will only enter into the transaction if they see no alternative that offers a clearly more attractive opportunity to meet their commercial objectives. In other words, independent enterprises would only enter into a transaction if it is not expected to make them worse off than their next best option. For example, one enterprise is unlikely to accept a price offered for its product by an independent commercial enterprise if it knows that other potential customers are willing to pay more under similar conditions, or are willing to pay the same under more beneficial conditions. Independent enterprises will generally take into account any economically relevant differences between the options realistically available to them (such as differences in the level of risk) when valuing those options. Therefore, identifying the economically relevant characteristics of the transaction is essential in accurately delineating the controlled transaction and in revealing the range of characteristics taken into account by the parties to the transaction in reaching the conclusion that there is no clearly more attractive opportunity realistically available to meet their commercial objectives than the transaction adopted. In making such an assessment, it may be necessary or useful to assess the transaction in the context of a broader arrangement of transactions, since assessment of the options realistically available to third parties is not necessarily limited to the single transaction, but may take into account a broader arrangement of economically related transactions ...

Economically relevant characteristics or comparability factors are used in two separate but related phases in a transfer pricing analysis. The first phase relates to the process of accurately delineating the controlled transaction for the purposes of this chapter, and involves establishing the characteristics of the transaction, including its terms, the functions performed, assets used, and risks assumed by the associated enterprises, the nature of the products transferred or services provided, and the circumstances of the associated enterprises, in accordance with the categories set out in the previous paragraph. The extent to which any one of the characteristics categorised above is economically relevant in a particular transaction depends on the extent to which it would be taken into account by independent enterprises when evaluating the terms of the same transaction were it to occur between them ...

The economically relevant characteristics or comparability factors that need to be identified in the commercial or financial relations between the associated enterprises in order to accurately delineate the actual transaction can be broadly categorised as follows: The contractual terms of the transaction (D.1.1). The functions performed by each of the parties to the transaction, taking into account assets used and risks assumed, including how those functions relate to the wider generation of value by the MNE group to which the parties belong, the circumstances surrounding the transaction, and industry practices (D.1.2). The characteristics of property transferred or services provided (D.1.3). The economic circumstances of the parties and of the market in which the parties operate (D.1.4). The business strategies pursued by the parties (D.1.5). This information about the economically relevant characteristics of the actual transaction should be included as part of the local file as described in Chapter V in support of a taxpayer’s analysis of its transfer pricing ...

Apex Tool Holding France acquired all the shares of Cooper Industrie France, which has since become Apex Tool France. This transaction was financed by a ten-year vendor loan at a rate of 6%. This claim on Apex Tool Holding France was transferred on the same day by the seller to the parent company of this company, which is the head of a global group specialising in tool manufacturing and thus, from that date, the creditor of its subsidiary. Apex Tool Holding France reintegrated the fraction of interest relating to this intra-group loan exceeding the average annual effective rate charged by credit institutions for variable-rate loans granted to companies into its income for the years 2011 to 2013. Apex considered that an interest rate of 6 % was in line with that which it could have obtained from independent financial institutions or organisations under similar conditions. The analysis was set aside by the tax authorities and an assessment was issued where the deduction of interest had been reduced. Apex filed an appeal with the Administrative Court of Appeal. The Court found in favor of the tax authorities in a decision issued in March 2020. An appeal was then filed by Apex with the Supreme Court. Judgement of the Court The Supreme Court set aside the decision of the Court of Appeal and issued a decision in favor of Apex Tool Group. Excerpts (Unofficial English translation) “3. It is clear from the documents in the file submitted to the trial judges that in order to establish that the rate of 6% at which ATFH1 had paid the loan granted to it by its parent company, which was higher than the rate provided for in the first paragraph of 3° of 1 of Article 39 of the General Tax Code, was not higher than the rate that this company would have obtained from an independent financial institution, the applicant company relied on an initial study drawn up by its counsel. In the absence of previous loans obtained by ATFH1 in 2010, this study first determined the credit rating of the intra-group loan in dispute according to the methodology published by the rating agency Moody’s for the analysis of industrial companies, which took into account the company’s profile, in particular with regard to market data, its size, its profitability, the leverage effect and its financial policy. The rating was set at “BB+”. The study then compared ATHF’s interest rate of 6% with the rates of bond issues over the same period with comparable credit ratings, using data available in the Bloomberg database. The company also relied on an additional study that analysed the arm’s length rate in a sample of bank loans to companies in the non-financial sector with credit ratings ranging from ‘BBB-‘ to ‘BB’. 4. Firstly, in holding that the credit rating assigned to the intra-group loan granted to ATFH1 by the first study in accordance with the methodology set out in point 3 did not reflect the intrinsic situation of that company on the grounds that it had been determined by taking into account the aggregate financial statements of the group that ATHF1 formed with its subsidiaries and sub-subsidiaries whereas, as stated in point 2, for the application of the provisions of Articles 39 and 212 of the General Tax Code, the profile of the borrowing company must in principle be assessed in the light of the financial and economic situation of the group that this company forms with its subsidiaries, the Court erred in law. 5. Secondly, it is clear from the documents in the file submitted to the court that the sample of comparable companies used in the supplementary study, the relevance of which had not been contested by the administration, concerned companies in the non-financial sector such as ATFH1 and which had obtained credit ratings ranging from “BBB-” to “BB”, i.e. one notch above and below the “BB+” credit rating determined for the loan in question in the first study. In dismissing this additional study on the sole ground that the companies in the sample belonged to heterogeneous sectors of activity and that, consequently, it was not established that, for a banker, they would have presented the same level of risk as that of ATFH1, whereas the credit rating systems developed by the rating agencies aim to compare the credit risks of the rated companies after taking into account, in particular, their sector of activity, the Court erred in law. “ Click here for English translation Click here for other translation Conseil d'État, 9ème - 10ème chambres réunies, 29_12_2021, 441357 ...

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 ...

The Mahou (SAN MIGUEL) S.A Group is active in brewing and sale of beers. Penibética de cervezas y bebidas SL and Andaluza de cervezas y bebidas SL are wholly owned by Cervezas Alhambra SL, which again is owned by MAHOU (SAN MIGUEL) S.A. The main activity of Cervezas Alhambra SL is the distribution and marketing under its own brands of the beer produced by its subsidiaries; that of Penibética de Cervezas y Bebidas SL is the production of beers which, without its own brand, are mainly distributed and marketed by Alhambra and the core activity of Andaluza de Cervezas y Bebidas S.L. is the manufacture of beers which, without its own brand, are distributed and marketed by Alhambra. In 2014, the tax authorities issued two tax assessments to the group: one in relation to FY 2008 and 2009, in the amount of €12,303,526.50 an another in relation to FY 2010, 2011, in the amount of €4,951,701.39. Among the issues raised in these assessments was transfer pricing. The CUP method used by the company was rejected by the tax authorities who instead applied the TNMM method. The tax authorities considered that the pricing of the sales made by Penibética de Cervezas y Bebidas S.L and Andaluza de Cervezas y Bebidas S.L to Cervezas Alhambra SL had been below market price, which could be due to fiscal reasons as the higher taxable income in Cervezas Alhambra SL could be offset by losses from previous years. Dissatisfied with the tax assessment Mahou S.A. filed a complaint which resulted in a decision in favour of the tax authorities. This decision was then appealed to the Audiencia Nacional. Judgement of the Court The National Court dismissed the appeal of Mahou in regards of transfer pricing and upheld the assessment of the tax authorities. Excerpts “As mentioned above, Cervezas Alhambra SL had significant BINs pending offsetting; they were generated in 1996 and subsequent years and at the start of the verification period amounted to 47,485,324.63 euros. And in the years 2010 and 2011 the declared tax bases of Cervezas Alhambra SL amounted to 8,953,184.43 euros and 8,213,717.51 euros. Tax Group 612/09, in which the related parties are taxed, has made the following offsets of tax losses from Cervezas Alhambra SL in years prior to its inclusion in the consolidated group: 2,884,427.23 euros (year of generation: 1996) 6,068,757.20 euros (year of generation. 1997) 2011: 6,781,618.18 euros (year of generation: 1997). Well, in the settlement, as a result of applying the TNMM to the transactions between related parties, the declared operating results are readjusted, increasing the results and bases declared by Penibética de Cervezas y Bebidas SL and Andaluza de Cervezas y Bebidas S.L in 2010 by €1,314,040 and €1,556,860 respectively, and correspondingly reducing the operating result and taxable base of Cervezas Alhambra SL in 2010 by €2,870,900. And here the problem lies in determining which is the (most appropriate) method for establishing the price of related-party transactions. Of the methods regulated in Article 16.4 TRLIS, the dichotomous positions in conflict here are, on the one hand, the CUP method, maintained by the appellant, and, on the other, the TNMM method applied by the Inspectorate. First of all, in the financial year prior to 2010, the TNMM was used to determine the transfer prices between related parties, although it is fair to recognise that in that year the transactions between Cervezas Alhambra and its subsidiaries were not included, since the fiscal group 612/09 had its first financial year in 2010. Be that as it may, Mahou, S.A. provided the Inspectorate with a series of transfer pricing reports of the companies of the group prior to the financial year 2010 carried out by Ernst & Young (manufacture of Cervezas Alhambra S.L. by Mahou S.A. and with San Miguel, Penibética de Cervezas y Bebidas S.L. with San Miguel, Cervezas Anaga S.A. with Mahou and San Miguel, purchase of Mahou branded beers and other brands manufactured by San Miguel and Cervezas Anaga and sale of beers manufactured by Mahou under the San Miguel brand to San Miguel and purchase of own branded beers manufactured by related entities and other brands manufactured by San Miguel and Cervezas Anaga and sale of own branded beers to related entities and sale of Mahou branded goods manufactured by Mahou S. A.) and in all of them the sale of Mahou branded goods manufactured by Mahou S. A. to San Miguel and sale of Mahou branded goods to San Miguel and sale of Mahou branded goods manufactured by San Miguel and Cervezas Anaga S.A. to San Miguel. A.) and in all of them the TNMM was used as it was considered the most appropriate to assess whether the brewing activities are in line with the arm’s length principle, using as an indicator of profitability the operating margin on total costs, selecting the brewing companies as the tested party. As regards the comparables used, Alhambra and Penibética use the AMADEUS and SABI databases, selecting five comparable European brewing companies, using data for 2006, 2007 and 2008. Well, even hypothetically admitting that the use of the TNMM in previous years cannot condition the valuation of the transactions between Cervezas Alhambra and its subsidiaries because in those years they were not included and therefore were not analysed in the reports, we must agree with the Inspectorate that with the information available this is the methodology that allows the transfer prices of brewing operations to be assessed, while the use of the CUP method is unacceptable. In fact, in the report A-02 (in section A.3.d) as well as in the non-conformity report (3.3 d/) and in section 4 of the pricing report of the operations of Penibética, Andaluza and Alhambra, the reasons for opting for this method are sufficiently justified, having used to select the comparable samples those that meet the requirements of activity and independence in accordance with the OECD guidelines obtained from the internationally accredited AMADEUS database. At the same time, the Inspectorate rejects the CUP method in ...

“Construction Service S.A.” is active in Design, Repair and Construction of buildings. During the FY 2011-2013 it paid for services – management services and construction services – rendered from related parties. Following an audit the tax authorities issued an assessment where payments for these services had been adjusted by reference to the arm’s length principle. According to the authorities the benchmark studies in the company’s transfer pricing documentation suffered from comparability defects and moreover it had not been sufficiently demonstrated that the services had been effectively provided. The tax authorities pointed out that since the company is not considered comparable to the taxpayer, the interquartile range would be from 5.15% to 8.30% with a median of 5.70%; therefore, the taxpayer’s operating margin of 4.07% is outside the interquartile range. Not satisfied with the adjustment “Construction Service S.A.” filed an appeal with the Tax Court Judgement of the Tax Court The court ruled in favour of “construction S.A” and revoked the decision of the tax authorities. Excerpts “Without prejudice to the foregoing, we must clarify that the adjustments to the financial information must use, precisely, the financial information, which leads us to disagree with the decision of the taxpayer’s expert to use the information from the income tax return for the calculation of the operating margin, knowing that there are quantitative and qualitative differences with respect to the financial information (page 565 of the Court’s file), and even with the information contained in the transfer pricing studies, which makes his answers to questions 1 and 2 less reliable, since the information used to determine the interquartile range is based on financial information (not tax information) of the comparables.” “In this regard, this Court considers that although the OECD Transfer Pricing Guidelines indicate in the section entitled “Multi-year data” of the Comparability Analysis Section, in paragraphs 3.75 to 3. 79, the possibility of using data relating to several years for the profitability analysis or multi-year data, the Tax Administration, used information from 2010 to 2012 of comparable companies since the appellant itself indicated in the 2012 Transfer Pricing Study, the total transactions carried out with its related parties abroad, taking into account that it was in this period, in which the transactions were carried out, according to the global financial information of the audited Financial Statements as of 31 December 2012 by , therefore the operating margin that should be adjusted to the median of free competition, the costs of the operations with related parties of ———— to the year 2012, but we agree with the Tax Administration that the additional liquidation for the Income Tax is the one declared for the fiscal period 2013, since it was in that period due to the opted method where the total gross income, costs and expenses were allocated, which includes as already mentioned the adjustment of the operating margin (See fs. 221 to 244 of Volume 1 of the DGI’s file). Therefore, it is not possible for the taxpayer, at this stage, to point out that the Tax Administration should have used the information from the periods of the companies selected as comparable, in accordance with the Transfer Pricing guidelines, taking into consideration the income tax return for the 2013 tax period, which includes the 3 years of operations of the work, i.e. from 2011 to 2013 (instead of 2010-2012), and which yields a profitability indicator or operating margin according to ————, (even though the company ——————– has been rejected, and maintaining those that the DGI did accept), of 4. 58%, a median of 4.67% and 7.85%, which, in its opinion, would place it within the range of compliance with the arm’s length principle. Similarly, we consider it important to point out that in the same way that the taxpayer cannot claim to use its aggregated financial information, ignoring the analysis made in its transfer pricing report submitted in the 2012 period, neither is it correct for the tax authorities to make an adjustment to the taxpayer’s segmented financial information (2012), and use, for the purposes of the additional assessment, the taxpayer’s accumulated income tax return, corresponding to the entire project. It is essential that any adjustment to the taxpayer’s financial/tax information is made in a congruent manner, i.e. taking into account the accumulated activity and not in a partial manner.” “preceding paragraphs and on the OECD’s guidelines in points 1.42, 1.52, 1.53, 1.55, 1.57 and 1.59 of Chapter I, which deals with the Arm’s Length Principle of the Transfer Pricing Guidelines.” “In this sense, this Court has stated in Resolution n.° TAT-RF-002 of 10 January 2020, regarding the possible manipulation of comparables known by the Anglo-Saxon expression “cherry picking”, in the following terms: “just as the criteria for discarding must be applied uniformly by the taxpayer, they must also be applied uniformly by the Tax Administration, regardless of whether the results of the analysis are in favour of or against the Treasury (The three companies challenged by the Tax Administration were those that presented the lowest operating margins: 1. 00%; -0.03% and -23.64% respectively), concluding that “it is incongruous to object to comparables that are in similar circumstances with others that have been accepted, i.e. that have a reasonable level of comparability with the examined party”.” “By virtue of the allegations made by both parties, we consider from the procedural evidence in the file that the process followed to identify potential comparables by both parties has been systematic and verifiable; however, we agree with the taxpayer that the companies selected by them are comparable with ————, and comply with the Principle of Full Competition, therefore, they should be taken into account within the interquartile range, since we consider that the elements of the comparability analysis, indicated by the DGI, are not compromised. In view of the above, as we do not agree with the objection made to this comparable company by the Tax Administration, and as the taxpayer is within the range of full competence, this Court must revoke Resolution no. 201-3306 of ...

P.T. Sanken Indonesia Ltd. – an Indonesian subsidiary of Sanken Electric Co., Ltd. Japan – paid royalties to its Japanese parent for use of IP. The royalty payment was calculated based on external sales and therefore did not include sales of products to group companies. The royalty payments were deducted for tax purposes. Following an audit, the tax authorities issued an assessment where deductions for the royalty payments were denied. According to the authorities the license agreement had not been registrered in Indonesia. Furthermore, the royalty payment was found not to have been determined in accordance with the arm’s length principle. P.T. Sanken issued a complaint over the decision with the Tax Court, where the assessment later was set aside. This decision was then appealed to the Supreme Court by the tax authorities. Judgement of the Supreme Court The Supreme Court dismissed the appeal of the tax authorities and upheld the decision of the Tax Court. The OECD Transfer Pricing Guidelines states that to test the existence of transactions to royalty payments on intangible between related parties, four tests/considerations must be performed: a) Willing to pay test (Par 6.14); b) Economic benefit test (Par 6.15); c) Product life cycle considerations (Par 1.50); d) Identify contractual and arrangement for transfer of IP (Par 6.16-6.19 ); To obtain a comparison that is reliable the level of comparability between the transactions must be determined. The degree of comparability must be measured accurately and precisely because it would be “the core” in the accuracy of the results of the selected method . Although the characteristics of products and the provision in the contract on the sale to related parties and independent was comparable, it was not sufficient to justify the conditions of the transactions are  sufficiently comparable; Based on the OECD Guidelines there are five factors of comparability, namely : ( i ) the terms and conditions in the contract ; (ii) FAR analysis ( function , asset and risk ); (iii) the product or service being transacted ; (iv) business strategy ; and (v) economic situation ; In the application of the arm’s length principle, the OECD TP Guidenline provide guidance as follows: 6.23 “In establishing arm’s length pricing in the case of a sale or license of intangible property, it is possible to use the CUP method where the same owner has transferred or licensed comparable intangible property under comparable circumstances to independent enterprises. The amount of consideration charged in comparable trnsaction between independent enterprises in the same industry can also be guide, where this information is available, and a range of pricing may be Appropriate. “That the provisions mentioned in the above , the Panel of Judges Court believes that the payment of royalties can be financed due to meet the requirements that have been set out in the OECD TP Guidenline and have a relationship with 3M ( Getting , Charge and Maintain ) income and therefore on the correction compa ( now Applicant Review Back) in the case a quo not be maintained because it is not in accordance with the provisions of regulatory legislation which applies as stipulated in Article 29, the following explanation of Article 29 paragraph (2) Paragraph Third Act Provisions General and Tata How Taxation in conjunction with Article 4 paragraph (1), Article 6 paragraph (1) and Article 9 paragraph (1) and Article 18 paragraph (3) of Law – Income Tax Law in conjunction with Article 69 paragraph (1) letter e and Article 78 of the Tax Court Law ; Click here for translation putusan_5291_b_pk_pjk_2020 Dec 2021 ...

Furniture S.A is engaged in the production and sale of furniture and had established a US subsidiary to market and sell furniture overseas. The pricing of the controlled transactions with the US subsidiary had been based on a resale price method, which resulted in prices amounting to 70% of the list price for the products. The Portuguese tax authority issued an assessment for FY 2015 and 2016, where the pricing of the controlled transaction had been adjusted in accordance with the price list resulting in additional taxable profits. Result reached in the arbitration tribunal. The Tribunal set aside the additional assessment of income in respect of the transfer pricing adjustment. Excerpts “…In the contract concluded with E… the Claimant safeguarded direct sales to large customers (with volume to fill a given number of containers). In practice, despite this safeguard, it is apparent from the evidence produced that the only major customer in the US since then has been E… and, in particular, no business was conducted with any major US customer in the years 2015 and 2016. Therefore, it is not possible to identify, as there is no internal comparable in the transactions carried out by the Claimant with unrelated entities in the US market. In fact, the comparable used by the Tax and Customs Authority are the list prices of direct (end) customers of the Claimant, in relation to which the comparability factors required for the application of the transfer pricing regime are not demonstrated, namely the comparable market price method used by the Tax and Customs Authority. In fact, to compare commercial transactions carried out with wholesalers (on the one hand) with transactions carried out with retailers and direct addressees (on the other hand), is to compare substantially different realities, since the intervention of wholesalers in the marketing circuit necessarily implies that prices are charged that ensure them a profit margin, which does not occur in sales made directly to retailers. Indeed, it is unsustainable, from an economic point of view, that, in purchases from the Plaintiff for subsequent resale to retailers, an independent wholesale intermediary would accept a price that would not allow it to remunerate itself with a margin (aimed at covering its costs plus a remuneration). Therefore, it cannot be considered proven that the price that would be charged between the Claimant and E…, if the latter were an independent wholesaler, would be the price charged by the Claimant with retailers. On the other hand, the quantities sold by the Claimant to E… are different (much higher) than those sold to other direct customers of the Claimant in the US market and the quantity of goods sold is one of the factors “likely to influence the price of the transactions” expressly provided for in paragraph a) of no. 5 of Ordinance no. 1446-C/2001. Furthermore, the conditions under which marketing is carried out are also different, as none of the operations carried out with direct retail customers were subject to the conditions agreed in the contract entered into between the Claimant and E… and “the contractual terms and conditions that define, explicitly or implicitly, the manner in which responsibilities, risks and profits are shared between the parties involved in the operation”, are comparability factors that sub-paragraph b) of article 5 of Ordinance 1446-C/2001 requires to be weighed. In this context, it must be taken into account that the deferral of payment allowed to a wholly owned entity does not imply bearing an economic risk similar to that inherent to transactions with independent entities. In this context, as there are unique characteristics in the transactions of the Claimant with E…, the lack of adequacy of the comparable market price method is evident, as it “requires the highest degree of comparability with incidence both on the object and other terms and conditions of the transaction and on the functional analysis of the intervening entities” (article 6, no. 1, of Ministerial Order no. 1446-C/2001). This lack of appropriateness of the comparable market price method is confirmed by paragraph a) of no. 2 of the same article 6 of Ministerial Order 1446-C/2001, from which it follows that, as regards the use of internal comparables, this method cannot be used when there is no “transaction of the same nature having as its object an identical or similar service or product, in like quantity or value, and under substantially identical terms and conditions, with an independent entity in the same or similar markets”. Lastly, it should be emphasised that, as tax arbitration proceedings are an alternative to judicial review proceedings (Article 124(2) of Law 3-B/2010 of 28 April 2010), they are, like the latter, a procedural means of mere legality which aims to eliminate the effects produced by illegal acts, annulling them or declaring their nullity or non-existence [Articles 2 of the RJAT and 99 of the RJAT]. Therefore, the acts must be assessed as they were performed. Therefore, it is not in question to assess whether the application by the Claimant of the transfer pricing regime (for example, in relation to the use of the Minimum Resale Price Method provided for in article 7 of Ministerial Order no. 1446-C/2001) was correct or not, but to determine whether the corrections made by the Tax and Customs Authority have legal support. In the case at issue, the corrections are illegal due to an error in the choice of the comparable market price method and its application to a situation in which the legal requirements for its application are not met. Therefore, it must be concluded that the corrections made by the Portuguese Tax and Customs Authority based on the transfer pricing system are vitiated by error on the assumptions of law. This error justifies the annulment of the corrections, under the terms of article 163, no. 1, of the Administrative Procedure Code, applicable subsidiarily under the terms of article 2, paragraph c), of the LGT. The request for arbitral award regarding these corrections being granted, the knowledge of the remaining defects imputed to ...

Furniture S.A is engaged in the production and sale of furniture and had established a US subsidiary to market and sell furniture overseas. The pricing of the controlled transactions with the US subsidiary had been based on a resale price method, which resulted in prices amounting to 70% of the list price for the products. The Portuguese tax authority issued an assessment, where the pricing of the controlled transaction had been adjusted in accordance with the price list resulting in additional taxable profits. Result reached in the arbitration tribunal. The Tribunal set aside the additional assessment of income in respect of the transfer pricing adjustment. Excerpts “… The application of the principle of comparability must be based on an individual analysis of the transactions, with a view to comparing the conditions practiced in a transaction between related entities and those practiced between independent entities. As it results from the matter of fact given as settled, the creation by the Claimant of a subsidiary based in the United States of America was determined by the bankruptcy of its main US customer and had the purpose of maintaining and boosting the commercial relationship with that market and minimizing the costs of local transportation, storage and packaging of the products sold to retailers and the agency of local intermediaries. The contract for the supply of products and goods entered into between the Claimant and the subsidiary sets out precise rules regarding the commercial relationship established between the parties and the charges that each of the contracting parties assumes in relation to the marketing of the furniture manufactured by the Claimant (clauses five and six). The same contract expressly contemplates the possibility of the direct sale of the products and goods to other customers residing in the United States of America without prior authorisation of the subsidiary (clause four). In this context, the invoicing of the supplies made to the subsidiary for 70% of the price list practiced in the sales directly made by the Applicant in the North American market constitutes a reasonable profit margin, which is intended not only to remunerate the activity of reselling the products, but also to compensate the marketing costs incurred by the counterparty and to which it is contractually bound. It is not possible to consider, under this condition, that the Claimant violates the arm’s length by stipulating, in relation to its subsidiary, a lower price than that practiced in direct sales, when it is certain that the comparison established by the Tax Authority is made with the direct clients of the Claimant without considering the comparability factors between the tied and the non-tied operations, namely with regard to the contractual terms and conditions that define how responsibilities, risks, and profits are shared between the parties involved in any of those operations. Therefore, regardless of the most appropriate method for determining transfer prices, the tax correction, in this regard, proves to be illegal due to the incorrect interpretation and application of the transfer pricing regime by the Claimant.” Click here for English translation. Click here for other translation P14_2021-T - 2021-11-23 ...

Following a tax audit of controlled transactions in 2013 and 2015 for the sale of goods to foreign related parties, the tax authorities concluded that Totland had understated the price of the goods sold and thus its taxable income. On that basis an assessment of additional income tax was issued. Totland disagreed with the assessment and filed an appeal. Totland stated that the dates of the price information used by the tax authorities differed from the date of the controlled transactions in question, and furthermore that those uncontrolled transactions were carried out on different terms. Totland had based the pricing of the controlled transactions on stock exchange prices and noted that the tax authorities in the assessment had violated the requirements of the Tax Code of Ukraine by applying stock exchange prices established a decade before the controlled transactions were carried out. The District Court dismissed Totland’s claim and upheld the assessment. Later the Court of Appeal overturned the decision of the District Court and decided in favor of Totland. The Court  of Appeal concluded that the uncontrolled transactions on which the pricing and assessment had been based were not comparable with the controlled transactions. An appeal was then filed by the tax authorities with the Supreme Court. Judgement of the Court The Supreme Court dismissed the tax authorities appeal and upheld the decision of the Court of Appeal. According to the Resolution of the Cabinet of Ministers of Ukraine dated 08 September 2016 No. 616 “On Approval of the List of Exchange Traded Goods and World Commodity Exchanges for determining the compliance of the terms of controlled transactions with the arm’s length principle”, the compliance of the terms with the arm’s length principle is determined by the CUP method. The components of this method are: use of the price range for stock exchange quoted goods; consideration of the volume of the controlled transaction, payment and delivery terms; consideration of the quality characteristics of the goods and the costs of their transportation. The provisions of sub-clause 39.2.1.3 of clause 39.2 of Article 39 of the Tax Code of Ukraine are special for controlled transactions on export and/or import of goods that have a stock exchange quotation and are included in the list approved by the said resolution. Sources of information on stock exchange quotations, criteria for comparability of controlled and uncontrolled transactions are determined in accordance with subparagraphs 39.5.3.1, 39.2.2 of Article 39 of the Tax Code of Ukraine. In the judgement the Supreme Court refers to its prior ruling in case No. 804/5360/17, where the Supreme Court, applying the provisions of the above subparagraphs of Article 39 of the Tax Code of Ukraine, concluded that the tax authority in determining the price range for controlled transactions of commodities must verify the reliability of the information sources used; the terms of uncontrolled transactions with the terms of controlled transactions; the compliance of the prices selected for comparison in comparable uncontrolled transactions with the terms of controlled transactions. Click here for English translation Click here for other translation Ukrain 580-2610-19 ORG ...

“Yogo Food-Distributor” is a subsidiary in the “Yogo Group” and trades in spices and canned meat and vegetables from the territory of the former Yugoslavia. The main sales markets are Austria and Germany (90%), the remainder being distributed among France, Scandinavia, Great Britain and the Benelux countries. Following an audit the tax authorities issued an assessment of additional taxable income determined by way of a benchmark study into comparable businesses. Yogo Food Distributor was of the opinion that the benchmark-study did not comply with the OECD guidelines in regards of comparability factors and filed a complaint with the Court. Judgement of the Court The contested notices (corporate income tax notices for the years 2010, 2011 and 2012, each dated 13 October 2014) and the preliminary appeal decision (dated 22 September 2017) are annulled pursuant to section 278(1) BAO and the matter is referred back to the tax authority. Excerpt “In order to be able to assess the arm’s length nature of these agreements and the payments made on the basis of these agreements, it is necessary to investigate the following issues: – First, in the sense of a function and risk analysis, it must be determined which assets were used in the context of the complainant’s business activities and which risks it had to bear, in each case in relation to the years in dispute. The contract of 13 December 2002 states that the complainant had “no suppliers/customers or the necessary financial resources”. On the other hand, within the EU, it could provide “warehouse management, logistics, personal customer care, contact with forwarding agents, etc.”. It will “endeavour to explore sales-promoting ideas or identify new products that meet market demand and implement them in agreement with the O-AG”. The O-AG is obliged to “establish the first contact with the customer or to sell the goods on the Western European market”. Financial support is also promised. In payment transactions, the complainant is to act as invoicing party, but all payment flows are to go through O-AG’s accounts. – There are no findings as to which concrete tasks and activities the complainant actually fulfilled or carried out from 2002 onwards and whether the actual circumstances (the conduct of business, the distribution of tasks between the complainant and O-AG, the contracting parties’ powers and possibilities of disposition) still corresponded in the years in dispute to those at the time of the conclusion of the contract in 2002. – With regard to the Supplementary Agreement I-2010 of 26 January 2010, it must be determined which of the economic aspects cited (cost increases in sales, unchanged or reduced sales prices, increased customer bonuses) are suitable to justify a change in the amount of the commission for an individual business year in advance in view of the actual economic relations of the contracting parties (business handling, distribution of tasks, powers and possibilities of disposition) between the complainant and O-AG. – With regard to Supplementary Agreement II-2010 of 26 January 2010, it must be determined which “economic circumstances” justify the granting of a lump-sum support contribution and from which an “increased need for marketing activities and listing expenses” results, this again for a single business year in advance. – With regard to the Supplementary Agreement I-2011 of 29 March 2011, it must be determined, taking into account the results of the functional and risk analysis, to what extent the actual economic circumstances between the complainant and O-AG changed at the time of the conclusion of this agreement compared to those in 2002 (conclusion of the agreement of 13 December 2002). 12.2002), taking into account the wording in the supplementary agreement: “…The complainant thus acts as the successor supplier of Y-Deutschland customers, Y-Deutschland delivers/invoices to the complainant. All expenses/income relating to the change of distribution or the subsequent distribution are for the account/benefit of [the complainant]. O-AG assumes any existing debtor risk at the time of the sales conversion. …” Furthermore, it has to be determined which “imminent additional expenses with regard to marketing activities” are suitable to justify the waiver of the contractually agreed commission “in connection with all sales of the Y-Germany business” and a reduction of the commission (obviously meant – for the remaining sales) for a single business year in advance, this taking into account the complaint’s allegations regarding the take-over of the distribution “of Markte M for the markets Germany, Benelux and France”. In this context, the results of the investigations which led the tax office to qualify these transactions as the “purchase of a distribution area” (preliminary appeal decision) must also be mentioned. – With regard to the Supplementary Agreement I-2012 of 9 January 2012, it must be determined, taking into account the results of the functional and risk analysis, to what extent the “need for increased sales promotion measures” or a product range expansion for an upcoming business period are suitable to justify a lump sum payment of EUR 250,000 from the complainant. Insofar as the tax office, based on the results of the investigation, comes to the conclusion that the contractual agreements concluded by the complainant with O-AG stand up to an arm’s length comparison, findings are to be made, based on corresponding investigations and in compliance with the right to be heard of the parties, as to the extent to which the conclusions on the arm’s length nature of the commission amount, which were apparently drawn from the database studies in the administrative files submitted, are still considered viable, taking into account the results of the functional and risk analysis to be carried out and taking into account the objections of the complainant.” Click here for English translation Click here for other translation Austria GZ RV-3100163-2018 ...

A foreign group had transferred funds to a branch in Peru and claimed that the transfer was a capital contribution – and not a loan. Following an audit the tax authorities issued an assessment, where the funds were considered a loan and withholding taxes on the determined interest payments was lifted. An appeal was filed by the group. Judgement of the Tax Court The Tax Court set aside the assessment and decided in favour of the group. Excerpts ” In this regard, the table presented shows that four of the elements considered by the law were taken into account, which were duly substantiated. Thus, with regard to the amounts of the transfers at the beginning and end of the year, it can be seen that these were between $570 million and $780 million, while the comparable operations presented amounts of between $100 million and $1 billion. In relation to the term or amortisation period, in the case of the operation under analysis, it was determined that since it was not paid during the 2013 financial year, the term of the comparables should not be less than one year; therefore, in the case of the comparables, terms ranging from 3 to 5 years were identified. Regarding the start date of the comparable loans, it was considered that the subscription date should be at least two years, considering that, according to the information available, the transfer of funds from the parent company started in that period and it was assessed that they should be in force throughout 2013. With regard to the guarantees, it was concluded that the comparable operations are secured loans, while those analysed are not, which suggests that the Administration is acting conservatively, as the loans received from the related party under their current conditions (without guarantee) would imply the application of a higher interest rate than those selected as comparable. From the evaluation carried out, it can be seen that the Administration carried out the analysis of some of the characteristics applicable to the case in question, as considered in article 11O of the Income Tax Law Regulations; However, it is noted that it has not taken into account some other elements of the operation that are relevant in order to establish a comparable financial transaction and that may have an impact on the setting of the interest rate to be charged, such as the solvency of the debtor and the risk rating, elements considered by paragraph d) of article 32-A of the Income Tax Law and paragraph a) of numeral 1 of article 110 of the regulations of the aforementioned law. In this regard, it has not been proven that the Administration had carried out a correct comparability analysis for the transaction subject to assessment, i.e. a due comparison of the transaction under examination with a transaction carried out between independent parties under the same or similar conditions, in accordance with the provisions of article 32-A, paragraph d) of the Income Tax Law and article 110 of the regulations of the aforementioned law, in order to establish the market value of the interest rate agreed between the appellant and its related party in the 2013 financial year. That in accordance with the foregoing, the aforementioned objection is not duly substantiated, and therefore, it should be lifted; and consequently, the appealed decision should be revoked and the contested determination should be annulled. ” Click here for English translation Click here for other translation 2021_1_05569 ...

A foreign group had transferred funds to one of its branches, Perupetro, in Peru and claimed that the transfer was a capital contribution – and not a loan. Following an audit the tax authorities issued an assessment, where the funds transferred were considered a loan and withholding taxes on the interest payments had been lifted. An appeal was filed by Perupetro. Perupetro held that the transfers of funds made by its non-domiciled parent company in its favour in the financial year 2014 constitute assigned capital (capital contributions) and not loans as considered by the Administration. It pointed out that the tax authorities has not followed the procedure established by the Income Tax Law and the OECD Guidelines to delineate the operation observed, a situation that would have allowed it to note that it does not qualify as a loan. Perupetro further claimed that the tax authorities had not carried out a correct comparability analysis for the transaction subject to assessment, i.e. a proper comparison of the transaction under examination with a transaction carried out between independent parties under the same or similar conditions, in accordance with the provisions of paragraph d) of article 32-A of the Income Tax Law and article 110 of the regulations of the aforementioned law, in order to establish the market value of the interest rate agreed between the appellant and its related party in the 2014 financial year. Judgement of the Tax Court The Tax Court sets aside the assessment and decided in favour of Perupetro. Excerpts ” From the evaluation carried out, it can be seen that the Administration carried out the analysis of some of the characteristics applicable to the case in question, as considered in article 110 of the Income Tax Law Regulations; However, it is noted that it has not taken into account some other elements of the operation that are relevant in order to establish a comparable financial transaction and that may have an impact on the setting of the interest rate to be charged, such as the solvency of the debtor and the risk rating, elements considered by paragraph d) of article 32-A of the Income Tax Law and paragraph a) of numeral 1 of article 110 of the regulations of the aforementioned law. In this regard, it has not been proven that the Administration had carried out a correct comparability analysis for the transaction subject to assessment, i.e. a proper comparison of the transaction under examination with a transaction carried out between independent parties under the same or similar conditions, in accordance with the provisions of paragraph d) of article 32-A of the Income Tax Law and article 110 of the regulations of the aforementioned law, in order to establish the market value of the interest rate agreed between the appellant and its related party in the 2014 financial year. That in accordance with the foregoing, the objection of the Administration is not duly substantiated, and it is therefore appropriate to lift it and, consequently, revoke the appealed ruling and annul the contested determination ruling.” Click here for English Translation Click here for other translation 2021_1_05562 ...

Following an audit of Oracle Technology Systems (Kenya) Limited, a distributor of Oracle products in Kenya, the tax authority issued an assessment for FY2015-2017 relating to controlled transactions. In assessing the income, the tax authority had used a CUP method instead of the TNMM. Dissatisfied with the assessment, Oracle Technology Systems (Kenya) Limited appealed to the Tax Appeals Tribunal on the basis that the return on its related party transactions was at arm’s length and did not require adjustment. Judgement of Tax Appeals Tribunal The Tribunal referred the case back to the tax authority for an appropriate reassessment. Excerpts “The question that arises is which method was the most suitable one. The OECD TP Guidelines state that the preferred method is CUP. But this only applies where there are appropriate comparables. Internal comparables are of course always preferred where they are reliable or can be reliably adjusted. From our understanding, the TP Policy implied that the reason internal comparables could not be used was due to differences in the functions of the independent distributors as compared with those of the Appellant. 127. We however note that during the hearing and in its submissions, the Appellant went out of its way to show that its functions are routine and not much different from those carried out by other distributors. The Appellant for example states in Paragraph 76 of its Statement of Facts as follows:- ‘The Appellant would like to note that the IT industry itself is a very competitive market and that the Appellant’s functional profile is not different from other value-added distributors in the same competitive market … ”  128. Similarly, the expert witness Dr Neighbour stated in his review of the Appellant’s role as a distributor as thus:- “In my experience, these are standard functions that would be expected of a typical distributor, i.e one that provides some local sales and marketing activity to support the sales as well as provision of customer support and services in respect of the distributed products … “ 129. The arguments offered by the Appellant seem to imply its functions are no different from any other distributor. This seems to contradict what its TP Policy suggests that the reasons it could not use the internal comparables was because the functions carried out by the Appellant and the  independent distributors were different and could not be reliably adjusted. 130. If indeed as the Appellant and its expert witness suggests its functions are routine and much in line with those of other distributors in the industry, we are at a loss as to why the internal comparables could not be used, and where such internal comparables were available why the CUP method which as both parties have admitted is the preferred method could not be used. (…) 132. It is unclear to the Tribunal both from the Appellant’s and the Respondent’s arguments and the documentation made available whether the Appellant is indeed a routine distributor as it averred during the hearing or if the services it offers are distinct as stated in the TP Policy. 133. Accordingly, we are of the view that the matter ought to be referred back to the Respondent to carry out a proper audit and in particular a functional analysis to determine what the exact functions of the Appellant are and if these are fundamentally different from those of independent distributors. Only then is it possible to determine the proper method to be applied.” ”Oracle_Systems_Limited_(Kenya_Branch)_v…Taxes-_TAT_149_of_2019_[2021”] ...

The French tax authorities had issued an assessment to SARL Elie Saab France in which they asserted that the French subsidiary had not been sufficiently remunerated for additional expenses and contributions to the value of the SARL Elie Saab trademark. The Supreme Administrative Court upheld the decision of the tax authorities. “It is clear from the statements in the judgment under appeal that the company Elie Saab France is responsible for the management, manufacture and distribution for the Elie Saab group of the top-of-the-range daywear line, distributes “Elie Saab” brand accessories for all the group’s entities, as well as the distribution in France and for European customers of the haute couture line, and sells, in its Paris boutique and to boutiques distributing the brand worldwide, a line of evening wear and accessories developed by the group’s Lebanese subsidiary. In addition, Elie Saab France has a showroom in the Paris boutique to present the brand’s haute couture creations, for which it pays the rent and the property fittings as well as the staff costs. Finally, it is responsible for organising the fashion shows of the “Elie Saab” brand for the haute couture and ready-to-wear collections, and is in charge of the brand’s communication and promotional campaigns. Considering that the French company, which has been largely loss-making since its first financial year ended in 2002, was incurring expenses for the benefit of the group as a whole and not for its own activity, the tax authorities reinstated, on the basis of Article 57 of the General Tax Code, in the taxable results of the financial years ended from 2007 to 2010 the amount of expenses related to the promotion of the “Elie Saab” brand and the organisation of fashion shows that had not been re-invoiced to the Lebanese parent company, a margin of 5% for those expenses that had been re-invoiced at cost price, as well as the personnel expenses of the press department.” “Firstly, by rejecting the argument of Elie Saab France that the payment by it of the disputed promotional and communication expenses, which had not been incurred solely to enhance the value of the Elie Saab brand, which was the property of its Lebanese parent company, but also for the exercise of its own activity, in particular in its capacity as the group’s profit centre for the “accessories” activity and as the person responsible for the high-end daytime ready-to-wear line, the court implicitly but necessarily ruled, in a sufficiently reasoned decision and without committing an error of law, that the tax authorities had established the assumption of responsibility by the French company for expenses incumbent on its foreign parent company and, consequently, the existence of a practice falling within the provisions of Article 57 of the General Tax Code.” “Secondly, in holding that Elie Saab France had not established the existence of consideration likely to counter the presumption of transfer of profits to the Lebanese holding company, arguing on the one hand that its parent company had not re-invoiced expenses that it had incurred for the benefit of the group’s entities, such as expenses relating to the provision of services to the group’s employees, The court did not err in law or distort the documents in the file by arguing, on the one hand, that the parent company did not re-invoice expenses that it had incurred for the benefit of the group’s entities, such as expenses related to the provision of support services, to the contract with the Fashion TV channel and to the remuneration of the two co-managers of the parent company and of the group’s creator, and, on the other hand, that the parent company did not invoice a trademark fee.” “It follows from the foregoing that Elie Saab France has no grounds for seeking the annulment of the judgment which it is challenging. Its claims under Article L. 761-1 of the Code of Administrative Justice can only be rejected.” Click here for English Translation Click here for other translation France vs SARL Elie Saab France June 2021 Conseil d'État Case No 433985FR ...

A Korean subsidiary in the “Semiconductor-group” was active in distribution and sales services. At issue was which transfer pricing method was the most appropriate for determining the arm’s length remuneration for these activities in FY 2013. Judgement of the Court The Court dismissed the claims of the company and upheld the decision of the tax authorities. Excerpt “However, the following circumstances that can be comprehensively acknowledged in the foregoing evidence and description in Evidence A No. 21, namely, (1) OECD Transfer Price Taxation Guidelines 2.101 stipulate that in order for a Gross Margin Ratio to be applied, a taxpayer shall not perform other important functions (manufacturing functions, etc.) that must be compensated using other transfer price methods or financial indicators in a related transaction, which are very sensitive to cost classification, such as operating expenses and other expenses, and thus may cause problems of comparability and irrelevant costs; and (2) Charles H. Berry, which devised the Gross Margin Method of the Transactional Net Margin Method, stated in the paper “Berry Ratios” that, in a case where a company performs other functions in addition to simple sales activities, the distinction between the cost of sales and the cost of operations is unclear and thus the gross margin ratio of sales can be artificially changed, and thus the Gross Margin Method of the Transactional Net Margin Method may not be applied. (3) Although the Plaintiff may perform a service installation and guarantee business, part sales business, in light of the above laws, it is difficult to apply the gross profit margin method among the transactional net margin methods to the Plaintiff’s sales support service transactions (even if the gross profit margin method among the Transactional Net Margin Methods can be applied, as the Plaintiff claims, the following circumstances that can comprehensively acknowledge the purpose of the entire pleadings in each of the descriptions of A Nos. 18 and 19, that is, (1), the codes of 508 companies extracted by the Plaintiff according to the industrial classification codes of the Korean Standard Industrial Classification are “46539: Other industrial machinery and equipment wholesale business, 46592: Medical, Precision and Scientific Equipment wholesale business, 46594: Machinery and equipment for electricity, wholesale business, 46599, and other wholesale business,” (1) In the case of the Plaintiff’s direct comparison of the technical support services and the wholesale business of the Plaintiff, which can be directly determined by the method (1) Four comparable companies were selected, and the difference in the degree of holding inventory assets, trade receivables, and purchase obligations was adjusted for comparability. Considering the characteristics of the Plaintiff in which inventory assets, trade receivables, and purchase obligations do not exist, it is difficult to deem that such adjustment is an ordinary net profit margin that can be generally accepted. Therefore, we do not accept the Plaintiff’s allegation in this part.” Click here for English translation Click here for other translation Korea 270521 ...

31 March 2021 the Polish Ministry of Finance published tax explanations on transfer pricing No. 3 regarding the CUP method The explanations covers: the rationale for using the comparable uncontrolled price method, variants of the comparable uncontrolled price method, comparison of the comparable uncontrolled price method with other methods, typical areas of application of the comparable uncontrolled price method, difficulties in applying the comparable uncontrolled price method, example of using the comparable uncontrolled price method. Click here for unofficial English translation Poland Tax Exp 3 CUP objasnienia-podatkowe-w-zakresie-cen-transferowych-z-31-marca-2021-r-nr-3-mpcn ...

In this ruling Bondo Tea Estates Ltd. challenged an adjustment made by the tax authorities to the price at which green leaf tea was supplied by the applicant to Kijura Tea Company Limited, a related party. The ruling also concerns disallowance of an assessed loss of Shs. 220,985,115. Bondo Tea Estates Ltd. is an out grower of tea which it supplies to an associated company, Kijura Tea Company Limited. In 2018, the tax authorities conducted an audit for FY 2016/2017 which purportedly revealed that the company had under declared its sales (price of 320 compared to range of 500-700) and that it had unreconciled retained earnings and current liabilities. On that basis the tax authorities adjusted the price of the related party transactions and issued an assessment of Shs. 544,409,110 of which Shs. 174,409,650 was principal income tax, Shs. 348,819,302 penalty and Shs. 20,929,158 interest. Bondo Tea Estates Ltd. did not agree with the assessment and filed an appeal with the Tax Appeals Tribunal where the following issues were set down for determination. Whether there was under-declaration of sales by the applicant to the respondent for the financial year ending 31stMarch 2017? Whether the average price adjustment by the respondent is in conformity with the law? Whether there was loss incurred by the applicant for the year ending 31stMarch, 2017 which was not recognized by the respondent? What remedies are available to the parties? Judgement of the Tax Appeals Tribunal The tribunal allowed the appeal of Bondo Tea Estates Ltd. and set aside the assessment issued by the tax authorities in regards of transfer pricing. Excerpt “The question the Tribunal has to ask itself, was the price set by the applicant and its associate, Kijura Tea Company limited, one that could be considered as one between unrelated parties?   In order to understand whether the applicant’s price to Kijura Tea Company was at arm’s length one has to ask how was the price set? The minutes of a tea stakeholders meeting of 7th January 2015 at Toro Club, Fort Portal, exhibit A5 show that it was attended by representatives of all the major green leaf buyers, namely; Mpanga Growers Tea Factory, Kijura Tea Company, Mabale Growers Tea Factory, Rusekere Growers Tea Factory and others. The meeting agreed to reduce the price of green leaf from the current Shs. 350 per kg to Shs, 280 per kg with effect from 16th January 2016 due to the fall in prices at the auction market. The meeting also reduced transport cost from Shs. 100 to Shs. 80 per kg of green leaf. The meeting resolved that stakeholders using the services of transporters should ensure that the prices offered to farmers did not exceed Shs. 280 per kg. By April 2016, 14 months after the price was fixed by the tea factories, the applicant was selling Shs. 320 per kilogram, an increment of Shs. 40. The price of the applicant was above the price set by the different stakeholders. It would have been a different matter if the price was below that set by the stakeholders. One cannot say the applicant’s price to Kijura Tea Company was not at arm’s length.   Further the applicant contended that its price did not include transport charges which varied from where the out growers came from. The applicant contended that the respondent did not state whether the Shs. 500 per kilogram paid to out growers included transport costs. The field report the respondent conducted was on 12th September 2018. The income tax period in issue is April 2016 to March 2017. The prices of tea is not static. One cannot use the price of tea in September 2018 to ascertain the price from April 2016 to March 2017. The prices at the auction market in September 2018 may have increased.  The said inspection report is not signed. Furthermore it does not disclose which unrelated companies and their officials the respondent interacted with. No sale invoices of unrelated companies are attached. Further, the interview was not representative of the local green leaf market, only five out growers were interviewed. The minutes of the stakeholders show that there are more than 5 tea factories in the Toro tea growing region which rely on hundreds of individual out growers for their supply of green leaf. The respondent’s representatives ought to have interviewed out growers selling green leaf to Kijura Tea Company to establish what price they were charging. The representatives only interviewed out growers selling their green leaf to Rusekere Growers Tea Company, McLeod Russell Uganda Limited and Mabale Growers Tea Factory Limited. This would enable establish if the differences between the applicant’s sale price and that of other out growers were not due to distortions arising from factors like transport costs or the quality of green leaf. The report does not state the locations of fields of the five to determine the distance between their fields and the tea factories. The report does not show whether the out growers incurred additional expenses such as transport. The respondent’s failure to take these factors into account substantially affect the credibility of the field inspection report. From the evidence before us, we have failed to find sufficient justification for the adjustment by the respondent of the applicant’s sales price. We accordingly find that there was no under-declaration by the applicant of its sales of green leaf to Kijura Tea Company limited for the financial year 2016/2017. We also find that the average price adjustment by the respondent was, for the above reasons, not in conformity with the law.” Click here for other translation Uganda vs Kijura Tea Company Limited ITAT Case no 65 of 2018 ...

Transactions had taken place between Vibac S.p.A. and related foreign group companies related to use of trademarks and royalty/license payments. It was up to the Vibac S.p.A. to demonstrate that the remuneration received from related companies for use of the trademark of the products had been at arm’s length. According to the company the royalty had been set at a low price to ensure that the foreign subsidiaries were more competitive. An upward adjustment was issued by the tax authorities rejecting the taxpayer’s argument that the below market royalty was explained by the need to enable its foreign subsidiary to penetrate more effectively the US market. The tax authorities argued that such a strategy could only be justifiable in a limited period. The tax authorities determined the arm’s length royalty payment by application of the Resale Price Method (RPM). However, due to the uniqueness of the asset transferred, which hardly allows the identification of comparable transactions, the same circular, while not excluding that in some cases one of the basic criteria adopted for the transfer of tangible goods (comparison, resale or increased cost) may be applied, points out that it should not be overlooked that a licence agreement depends essentially on the forecasts of the result that may be achieved by the licensee in the territory to which the right of exploitation refers and that it is, therefore, necessary to develop subsidiary valuation methods, always inspired by the principle of the arm’s length price, i.e. the price that would have been agreed upon between independent undertakings. With regard to the determination of the fee concerning the use of intangible assets, the circular notes that it is greatly affected by the specific characteristics of the economic sector to which the intangible right refers and that, in general, it is commensurate with the turnover of the licensee, so that the reference to these indices is a valid initial data for the assessment of the “normal value”. Vibac S.p.A. did not approve of the assessment an brought the case to court. The court of first instance held in favour of the tax authorities. This decision was then appealed to Corte di Cassazione. Judgement of the Court The Italien Corte di Cassazione upheld the decision of the court of first instance and dismissed the appeal of Vibac S.p.A. Excerpts: Indeed, the rationale of the abovementioned domestic tax legislation is to be found in the safeguarding of the principle of free competition, as set out in Article 9 of the OECD Model Convention, which is to be interpreted in the light of the specific features of tax law on tax arbitrage. In fact, the rationale of the domestic tax rules referred to above is to be found in the safeguarding of the principle of free competition, set out in Article 9 of the OECD Model Convention, which provides for the possibility of taxing profits arising from intra-group transactions that have been governed by conditions different from those that would have been agreed between independent companies in comparable transactions carried out on the free market; it is therefore necessary to verify the economic substance of the transaction and to compare it with similar transactions carried out, in comparable circumstances, in free market conditions between independent parties and to assess its compliance with these (Court of Cassation no. 5645 of 2020, id. no. 9615 of 2019; id. 27018 of 2017). Thus, company policy, taken in itself, is not a necessary and sufficient cause of justification for derogating from the normal value rule. Since the normal value of a transaction is a function of the economic characteristics of the transaction, the transaction from which the normal value is to be derived will concern (a) goods and services of the same kind, (b) at the same marketing stage, (c) at the same time and (d) in the same market where the goods or services were acquired. In order to achieve the highest possible degree of comparability, the second part of Article 9 TUIR states that “for the determination of normal value”, reference should be made, “as far as possible, to the price lists or tariffs of the person who supplied the goods or services”. The presence of varied intra-group commercial transactions fully captures the estimative meaning of Article 9, as well as the OECD model. The adoption of the Resale Price Method is advocated, not only by Circular 22.9.1980 (No. 32/9/2267), but also and above all by the 1995 OECD Report. Click here for English translation Click here for other translation Corte di Cassazione 1232-2021 ...

The economically relevant characteristics of the accurately delineated controlled transaction will help in determining the potential effect of the receipt of government assistance on the pricing of the controlled transaction, if any. For instance, some of the aspects to consider in analysing the impact, if any, of the receipt of government assistance on the price of a controlled transaction include the availability, purpose, duration and other conditions imposed by the government in granting the assistance; the allocation of the economically significant risks; and the level of competition and demand within the relevant markets. In addition, as indicated in paragraph 1.34 of the OECD TPG, the identification of these economically relevant characteristics would require a broad evaluation of how the MNE group responds to the receipt of government assistance ...

For example, assume that geographic comparability is deemed as the most relevant comparability factor given the nature of the effects of COVID-19 in a particular market. In these circumstances, in order to obtain reliable data from a particular market it may potentially be necessary to relax other comparability criteria, and then refine the sample ...

Sté Paule Ka Holding, was set up as part of a leveraged buy-out (LBO) operation to finance the acquisition of the Paule Ka group, and in 2011 it acquired the entire capital of the group a price of 42 million euros. The acquisition was financed by issuing convertible bonds carrying an interest rate of 8%. The French tax authorities issued an assessment where deductions for certain payments related to the acquisition and part of the interest payments on the bonds were disallowed. Decision from the Administrative court of appeal The Court found in favor of the company in regards to the payment related to the acquisition and in favor of the tax administration in regards to the partially disallowed deduction of interest payments. “It follows from the foregoing that the elements invoked by the administration do not provide proof that the expenditure of EUR 390,227 correctly entered in the accounts was not incurred in the interest of the company Paule Ka Holding. The latter is thus entitled to argue that the administration was wrong to refuse to deduct it in respect of the financial year ended in 2012 and, consequently, to request the reduction of the tax bases and the discharge of the corresponding taxes, including the penalties for deliberate failure to comply as provided for in a) of Article 1729 of the General Tax Code, applied by the administration to this head of rectification.” “...These bonds have a term of ten years, bear interest at a rate of 8%, have a principal amount that is repayable in full at maturity, are not accompanied by any guarantee or security, bear capitalised interest and are convertible at maturity at the rate of one new share with a value of one euro for every 10 OCAs granted. Paule Ka Holding recognised interest on bonds of EUR 2 083 490 for the year ended 2012 and EUR 2 574 298 for the year ended 2013 as an expense. The department questioned the amount of these deductions for the interest paid on the bonds subscribed by Black Tie Luxco by applying the legal interest rate provided for in Article 39(1)(3) of the General Tax Code, i.e. 3.64% and 3.10% for the said financial years. Deductions for the difference in the calculated interest in the amount of EUR 1,092,601 for the financial year ending in 2012 and EUR 908,667 for the financial year ending in 2013 were disallowed. To justify the rate applied to the above-mentioned compulsory loans, Paule Ka Holding produced a study drawn up by the firm Dauge et associés on 30 September 2015. This firm carried out a credit rating of the company, based on an analysis of its financial structure with regard to its balance sheet situation, based on two criteria, the Banque de France rating of the borrower, based on the criteria of earning capacity, financial autonomy The Banque de France rating of the borrower, based on the criteria of earning capacity, financial autonomy, solvency and liquidity, and the estimate of the credit risk of the OCAs issued using the Standard and Poor’s analysis grid, on the basis of the group’s consolidated business plan, to conclude that the rating is estimated at BB-, corresponding to a satisfactory business risk profile and an aggressive financial risk. Based on this rating, it then estimated the credit margin applicable to the OCAs based on the European Commission’s recommendations for estimating reference and discount rates, with margin levels based on credit rating categories. The firm concluded from these elements that the interest rate of 8% seemed appropriate given the profile of the borrower and the characteristics of the bonds issued. However, the study produced consists of generalities and the data presented in it is not documented. Indeed, the mere reference to a credit rating does not imply that all the companies concerned by this rating have identical repayment capacities, taking into account all the quantitative and qualitative factors specific to each company. Furthermore, it does not appear from this study that the internal rating of Paule Ka Holding, as described, takes sufficient account of the company’s own characteristics, in particular the state of its accounts, its competitive positioning and the quality of its managers and employees. This internal rating does not take into account the possibility of the company receiving external assistance in the event of difficulties in honouring its commitments. Under these conditions, this study is insufficient to justify the rate applied to the bonds in dispute. In addition, Paule Ka Holding has provided examples of companies that took out bonds in the context of LBO transactions for acquisitions dated from May 2011 to June 2012 at rates varying between 7 and 12%, which, according to the company, show that the rate of 8% was a market rate compared with those applied by other companies of comparable size and for loans of the same nature. However, the investigation shows that the bonds presented for comparison have either a shorter duration than those in dispute or are not convertible into shares. Their amount is very different from that issued by Paule Ka Holding, some of which are also associated with “senior” debts. Moreover, the issuing companies, of very different sizes, carry out their activities in different fields from that of Paule Ka Holding, a takeover structure of a group in the high-end ready-to-wear sector. There is nothing to show the conditions under which the loans presented for comparison purposes were established. Under these conditions, since the comparability of the economic conditions has not been demonstrated, the terms of comparison proposed by Paule Ka Holding do not justify the rate applied to the bond loans in dispute. It follows from the foregoing that Paule Ka Holding does not justify the rate it could have obtained from independent financial institutions or organisations for a loan granted under similar conditions with regard to the yield on bond loans from undertakings in comparable economic conditions, for loans constituting a realistic alternative to an intra-group loan, taking into account its own characteristics, in particular its risk profile. It does not therefore ...

P.T. Sanken Indonesia Ltd. – an Indonesian subsidiary of Sanken Electric Co., Ltd. Japan – paid royalties to its Japanese parent for use of IP. The royalty payment was calculated based on external sales and therefore did not include sales of products to group companies. The royalty payments were deducted for tax purposes. Following an audit, the tax authorities issued an assessment where deductions for the royalty payments were denied. According to the authorities the license agreement had not been registrered in Indonesia. Furthermore, the royalty payment was found not to have been determined in accordance with the arm’s length principle. P.T. Sanken issued a complaint over the decision with the Tax Court, where the assessment later was set aside. This decision was then appealed to the Supreme Court by the tax authorities. Judgement of the Supreme Court The Supreme Court dismissed the appeal of the tax authorities and upheld the decision of the Tax Court. The OECD Transfer Pricing Guidelines states that to test the existence of transactions to royalty payments on intangible between related parties, four tests/considerations must be performed: a) Willing to pay test (Par 6.14); b) Economic benefit test (Par 6.15); c) Product life cycle considerations (Par 1.50); d) Identify contractual and arrangement for transfer of IP (Par 6.16-6.19 ); To obtain a comparison that is reliable the level of comparability between the transactions must be determined. The degree of comparability must be measured accurately and precisely because it would be “the core” in the accuracy of the results of the selected method . Although the characteristics of products and the provision in the contract on the sale to related parties and independent was comparable, it was not sufficient to justify the conditions of the transactions are  sufficiently comparable; Based on the OECD Guidelines there are five factors of comparability, namely : ( i ) the terms and conditions in the contract ; (ii) FAR analysis ( function , asset and risk ); (iii) the product or service being transacted ; (iv) business strategy ; and (v) economic situation ; In the application of the arm’s length principle, the OECD TP Guidenline provide guidance as follows: 6.23 “In establishing arm’s length pricing in the case of a sale or license of intangible property, it is possible to use the CUP method where the same owner has transferred or licensed comparable intangible property under comparable circumstances to independent enterprises. The amount of consideration charged in comparable trnsaction between independent enterprises in the same industry can also be guide, where this information is available, and a range of pricing may be Appropriate. “That the provisions mentioned in the above , the Panel of Judges Court believes that the payment of royalties can be financed due to meet the requirements that have been set out in the OECD TP Guidenline and have a relationship with 3M ( Getting , Charge and Maintain ) income and therefore on the correction compa ( now Applicant Review Back) in the case a quo not be maintained because it is not in accordance with the provisions of regulatory legislation which applies as stipulated in Article 29, the following explanation of Article 29 paragraph (2) Paragraph Third Act Provisions General and Tata How Taxation in conjunction with Article 4 paragraph (1), Article 6 paragraph (1) and Article 9 paragraph (1) and Article 18 paragraph (3) of Law – Income Tax Law in conjunction with Article 69 paragraph (1) letter e and Article 78 of the Tax Court Law ; Click here for translation putusan_5291_b_pk_pjk_2020_20210918 ...

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. The Administrative Court decided in favour of Ferragamo and dismissed the assessment. According to the Court the tax administration has not demonstrated the existence of an advantage granted by Ferragamo France to Salvatore Ferragamo SPA, nor the amount of this advantage. Judgement of the Conseil d’Etat The Conseil d’Etat overturned the decision of the Administrative Court 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.” Click here for English Translation Click here for other translation Fr vs IT fash ...

ST Microelectronics Pvt. Ltd. is a subsidiary of ST Microelectronics Pte. Ltd. which in turn is a wholly owned subsidiary of ST Microelectronics NV, Netherlands. ST Microelectronics Pvt. Ltd. is into the business of Integrated Circuit Design, CAD Tools and software development for its overseas group concerns. It also provides marketing support services to a group company and software development services related to design implementation and maintenance with respect to Integrated Circuits as required by guidelines/instructions. During the year under assessment, the taxpayer entered into various transactions with its Associated Enterprises. In order to benchmark its international transactions qua provision of software development services and qua provision of marketing support services ST Microelectronics used Transactional Net Margin Method (TNMM) with Operating Profit/Operating Cost as the Profit Level Indicator (PLI) being the Most Appropriate Method (MAM), computed its own margin at 11.11% as against weighted average arithmetic mean margin of 19 comparables at 11.31% and found its international transactions at arm’s length. The Transfer Pricing Officer by applying qualitative and quantitative filters finally selected 13 comparables and computed their margin at 23.20% and thereby computed the adjustment of Rs.38,30,91,011/-. The taxpayer carried the matter before the Disputes Resolution Panel by way of filing objections who has excluded one comparable and included another comparable in the final list which resulted in a margin of 21.53%. On that basis the adjustment was revised to Rs.33,01,81,949/-. ST Microelectronics filed an appeal with the Income Tax Tribunal. Judgement of the Tribunal The Tribunal allowed the appeal filed by ST Microelectronics. Click here for other translation India vs ST Microelectronics Pvt. Ltd September 2020 Delhi tax tribunal ITA No 6169-Del-2012 ...

“G Pharma Ltd” is a distributor of generic and specialised pharmaceutical products purchased exclusively from affiliated suppliers. It has no significant intangible assets nor does it assume any significant risks. However for 17 consecutive years it has had losses. Following an audit, the tax authorities issued an assessment, where the income of G Pharma Ltd was determined by application of the Transactional Net Margin Method (TNMM). According to the tax authorities a limited risk distributor such as G Pharma Ltd would be expected to be compensated with a small, guaranteed, positive profitability. G Pharma Ltd disagreed with the assessment and filed an appeal. Judgement of the Court The court dismissed the appeal of G Pharma Ltd and upheld the assessment issued by the tax authorities. Excerpts “First, the reasons for the rejection of the final comparable sample of two companies were set out in detail and then the reasons for using the net profit margin as an appropriate indicator of profitability for the chosen method of documenting intra-group transactions were documented in a clear and substantiated manner, citing the relevant OECD guidelines, in order to establish whether or not the principle of equidistance was respected. Subsequently, since the claim concerning the inclusion of the company ……………………. in the final sample of comparable companies was accepted, the calculations of the arm’s length thresholds were provided in order to assess whether or not the arm’s length principle was respected. Following the above, the method of calculation of the resulting difference due to the non-respect of the arm’s length principle in the intra-group invoicing of the applicant’s transactions with the related companies of the group was analysed. Consequently, the applicant’s claims in respect of the first plea in law of the application are not upheld and are rejected as unfounded in law and in substance. Because the applicant itself, as documented in detail in the documentation file, arrived at the above method of documentation, which it nevertheless applied on incorrect bases. The choice of the gross profit margin as an appropriate indicator of profitability is incorrect as it is not provided for in the OECD guidelines” “based on the above, it would be expected that it would be compensated with a small, guaranteed, positive profitability. Instead, the picture it presents over time is one of a company with consistently disproportionately high losses from inception to the present day beyond any notion of business sense or contrary to normal commercial transactions, which demonstrates the need to adjust its intragroup pricing given the fact that all of its purchases and a significant portion of its operating expenses are intragroup transactions. Since the applicant’s claim that ‘in calculating the adjustment to its operating profitability, due to non-compliance with the arm’s length principle, account should also be taken of the adjustments to the tax adjustment already made by the accounting differences declared by the company’ cannot be accepted and is rejected, since this is a comparison between dissimilar figures, that is to say, a comparison between the applicant’s tax result and the accounting results of comparable companies in the sample. Because the applicant’s claim that, ‘any adjustment to its operating profitability should be based on the 1st quartile value and not that of the median’, is not accepted and is rejected, as, when assessing the operating profile, the applicant performs additional functions beyond a mere reseller and in particular than the comparable companies in the final sample as it has a disproportionately high cost of operating expenses to gross income compared to the comparable companies. Moreover, none of the comparable undertakings in the final sample is representative of the industry as they all have similar gross revenues to the applicant and therefore similar market share in the pharmaceutical industry. The choice of the median is the most appropriate because it eliminates possible comparability deficits (differences in factors and circumstances) that may exist between the applicant and the undertakings in the sample. Because the tax audit has come to the clear and well-founded conclusion that the pricing policy pursued by the applicant with its related undertakings does not comply with the arm’s length principle and is outside the acceptable limits. Since it follows from the foregoing that the contested income tax assessment measure was lawfully adopted, the applicant’s claims to the contrary must be rejected as unfounded.” Click here for English translation Click here for other translation ΔΕΔ 1582-2020 ...

The activity of Spółka A sp. z o.o. included salmon breeding, processing, smoking and sale and distribution of the finished products. The company operated within Group A with head quarter in the Netherlands. By decision of 27 May 2019, the tax authorities determined that the operating expenses determined by transactions with related parties were inflated by PLN 29,613,156.00. The authorities did not accept calculations presented by the Company, as there were no reliable accounting records regarding the amount of costs incurred. Furthermore, the authorities held that the cost plus method, which should guarantee profit on the transaction in the Company, had been applied incorrect. The dispute before the administrative Court boils down to assessing whether the court of first instance, in compliance with the provisions in force, reversed the decision of the authorities in its entirety and referred the case back for reconsideration due to the deficiencies found in the evidentiary proceedings, making it necessary to conduct the proceedings in a significant part. “As indicated by the Supreme Administrative Court in its judgment of 20 June 2018 in case II FSK 1665/16, the regulation contained in Art. 11 of the LLD is a special regulation and its purpose is to protect the interests of the State Treasury against such activities of taxpayers which consist in applying prices deviating from market prices in controlled transactions in order to achieve a favourable tax result for themselves. Therefore, the rationale for the application of Article 11 of the ACT is not only the fact of occurrence of the relationship referred to in paragraphs 1 and 4, but the use of those relationships to change the level of taxation (tax avoidance). The regulation contained in Article 11 of the CFRA is based on the assumption that all transactions should comply with market conditions, i.e. conditions which would be agreed upon by independent entities in the same or in a similar situation. However, the mere fact of economic relations referred to in Article 11 of the CFR may not in itself give rise to negative tax consequences for related entities. However, the use of such relationships to change the level of taxation contrary to the statutory obligation is of tax significance. Using the position of affiliated entities for such purpose finds a tax sanction, which is the estimation of income. However, this sanction cannot be applied without proving that the related party position is used to shift income (profits) in order to reduce taxation. The findings in this respect should have the characteristics of a clear, logical conclusion from the evidence gathered. “…The estimation of prices applied in transactions between taxpayers and related parties cannot be made solely by simply transferring the price or margin from a transaction between independent parties – without assessing the comparability of the terms of those transactions. The tax authority, based on comparative data, should therefore primarily demonstrate the reliability of the transactions (entities) compared, and thus also refer to the economic functions and strategies applied by operators, also in the context of assessing the importance of these factors for the possibility of comparison.” “…in the opinion of the Court, the Director of the Chamber rightly revoked the decision of the tax authorities of 27 May 2019 due to failure to observe the obligation to analyse the possibility of applying the so-called traditional methods of estimating the income of a Party, indicated in the Regulation, and failure to justify the reasons why the Body decided that those methods could not be applied in this case. The First Instance Authority did not justify that the most appropriate pricing method in the case should be the transactional net margin method.” Click here for translation Poland vs Sp zoo July 2020 ...

A Greek MNE Group, “Agri Ltd”, was active and specialised in wholesale trade of agricultural machinery, parts and tools. In 2012 a German company was established by the group to distribute products in the Central European region. The pricing of the goods sold by Agri Ltd. to the German distributor was determined by testing the income of Agri Ltd using a TNMM. Following an audit the tax authorities issued a revised tax assessment, where the pricing of the inter-company transactions had instead been determined by applying a traditional cost plus method where the German subsidiary was the tested party. The resulting assessment was appealed by Agri Ltd. Judgement of the Court The court dismissed the appeal of Argri Ltd. “Since the tax audit, documented and clearly concluded that the cost plus margin method should have been chosen for the sales of the applicant to its subsidiary, the findings of the audit, as recorded in the 18.12.2019 Partial Income Tax Audit Report, are considered valid, acceptable and fully justified. Since it is clear from the above that the impugned income tax adjustment order was lawfully issued, the applicant’s contentions to the contrary are rejected as unfounded.” Click here for English translation Click here for other translation ΔΕΔ Α 1514-2020 ...

East African Breweries International Ltd (applicant) is a wholly owned subsidiary of East African Breweries Limited, and is incorporated in Kenya. East African Breweries International Ltd was involved in developing the markets of the companies in countries that did not have manufacturing operations. The company did not carry out marketing services in Uganda but was marketing Ugandan products outside Uganda. After sourcing customers, they pay to the applicant. A portion is remitted to Uganda Breweries Limited and East African Breweries International Ltd then adds a markup on the products obtained from Uganda Breweries Limited sold to customers in other countries. East African Breweries International Ltd would pay a markup of 7.5 % to Uganda Breweries and then sell the items at a markup of 70 to 90%. In July 2015 the tax authorities (respondent) audited Uganda Breweries Limited, also a subsidiary of East African Breweries Limited, and found information relating to transactions with the East African Breweries International Ltd for the period May 2008 to June 2015. The tax authorities issued an assessment of income tax of Shs. 9,780,243,983 for the period June 2009 to June 2015 on the ground that East African Breweries International Ltd was resident in Uganda for tax purposes. An appeal was filed by East African Breweries International Ltd where the agreed issues were: 1. Whether the applicant is a taxable person in Uganda under the Income Tax Act? 2. Whether the applicant obtained income from Uganda for the period in issue? 3. What remedies are available to the parties? Judgement of the Tax Appeals Tribunal The tribunal dismissed the appeal of East African Breweries International Ltd and upheld the assessment issued by the tax authorities. Excerpt “From the invoices and dispatch notes tendered in as exhibits, it was not clear who the exporter of the goods was. There was no explanation why the names of the parties were crossed out and replaced with others in some of the invoices and dispatch notes. While the applicant did not have an office or presence in Uganda it was exporting goods. In the absence of satisfactory explanations, the Tribunal would not fault the Commissioner’s powers to re-characterize transactions where there is a tax avoidance scheme. The arrangement may not only be a tax avoidance scheme but also one where the form does not reflect the substance. The markup the applicant was paying Uganda Breweries was extraordinarily low compared to what the applicant was obtaining from its sale to third partied. Once again in the absence of good reasons, the form does not reflect the substance. If the Commissioner re-characterized such transactions, the Tribunal will not fault him or her. The Commissioner cannot be said to have acted grossly irrationally for the Tribunal to set aside the decision. The Tribunal notes that the activities of the group companies were overlapping. It is not clear whether they were actually sharing TIN, premises and staff. The witness who came to testify on behalf of the applicant was from East African Breweries Limited. Despite the applicant selling goods to many countries it does not have an employee or officer to testify on its behalf. The markup of the sale of the goods by Uganda Breweries Limited to the applicant was far lower than that between the applicant and the final consumers in Sudan, Congo and Rwanda. While Uganda Breweries Limited was charging the applicant a markup of 7.5% the applicant was charging its customers 70 to 90%. This is part of a transfer pricing arrangement where the companies are dealing with each other not at arm’s length. The arm’s length principle requires inter-company transactions to conform to a level that would have applied had the transactions taking place between unrelated parties, all other factors remaining the same. Under. S. 90 of the Income Tax Act, in any transaction between associates, the commissioner may distribute, apportion or allocate income, deductions between the associates as is necessary to reflect the income realized by the taxpayer in an arm’s length transaction. An associate is defined in S. 3 of the Income Tax Act. In making any adjustments the commissioner may determine the source of income and the nature of any payment or loss. The transfer pricing arrangement originated in Uganda. The Commissioner apportion taxes according to the income received by the applicant. In Unilever Kenya Limited v CIT Income Tax Appeal No. 753/2003 (High Court of Kenya) Unilever Kenya Limited (UKL) and Unilever Uganda Limited (UUL) were both subsidiaries of Unilever PLC, a UK multinational group. Pursuant to a contract, UKL manufactured goods on behalf of and supplied them to UUL, at a price lower than UKL charged to unrelated parties in its domestic and export sales for identical goods. The Commissioner raised an assessment against UKL in respect of sales made by UKL to UUL on the basis that UKL’s sale to UUL were not at arm’s length prices. In that matter it was held that in the absence of guidelines under Kenya law, the taxpayer was entitled to apply OECD transfer pricing guidelines. In this application, the issue is not about which rules to apply. What the Tribunal can note is that the Commissioner has powers to apportion income on an intergroup company and issue an assessment. In this case the Commissioner chose the applicant over Uganda Breweries Limited. The Tribunal feels that the Commissioner was acting within his discretion and was justified to do so. Taking all the above into consideration, the Tribunal finds that the applicant did not discharge the burden placed on it to prove the respondent ought to have made the decision differently. Click here for other translation 10178_EABLi_Vs_URA (1) ...

A intercompany loan had been granted within the Apex Tool group at an interest rate of 6 percent and to demonstrate the arm’s length nature of the interest rate the borrowing company provided a comparability analyses. The analysis was set aside by the tax authorities and an assessment was issued where the deduction of interest had been reduced. Apex then filed an appeal with the Administrative Court of Appeal. Judgement of the Court The Court dismissed the analyses provided by Apex and upheld the assessment of the tax authorities. Excerpts (Unofficial English translation) “9. The investigation shows that the credit rating assigned to the loan in question by Baker and McKenzie, after several adjustments, was not based on the intrinsic situation of ATHF1, particularly with regard to its lending activity and its development prospects. On the contrary, it was allocated on the basis of the aggregate financial statements of the sub-group it formed with four of its subsidiaries and sub-subsidiaries, only one of which, in any event, carried out the industrial activity that Apex Tool Group claims was the only relevant basis for comparison, in the absence of a basis for holding companies other than investment companies and conglomerates. Furthermore, although it is not excluded that the arm’s length rates can be evaluated by taking into account the yield of bond loans, this is only on condition, even supposing that the loan taken out constitutes a realistic alternative to an intra-group loan, that the companies serving as references are in comparable economic conditions. In the case in point, this condition cannot be considered to have been met for the companies in the Baker and McKenzie sample, for which it is only argued, firstly, that they have credit ratings close to that attributed to the ATHF1 loan and, secondly, that they had recourse to the bond market for transactions of the same duration and maturity. Lastly, although the additional study produced by Apex Tool Group shows arm’s length rates close to those obtained by ATHF1 from its parent company, it has not been established that the so-called comparable companies in the study sample, belonging to heterogeneous sectors of activity, would have presented the same level of risk for a banker as that which ATHF1 faced at the same time. Under these conditions, Apex Tool Group, which did not submit to the judge any offer of a loan from a banking establishment, does not provide the proof that ATHF1 was entitled to deduct the interest on the disputed loan up to the rate of 6% that it had actually paid.” “10. Under the terms of 1. of II of Article 212 of the General Tax Code: “When the amount of interest paid by a company to all directly or indirectly related companies within the meaning of Article 39(12) and deductible in accordance with I simultaneously exceeds the following three limits in respect of the same financial year: / a) The product corresponding to the amount of the said interest multiplied by the ratio existing between one and a half times the amount of the equity capital, assessed at the choice of the company at the opening or at the closing of the financial year and the average amount of the sums left or made available by all of the companies directly or indirectly linked within the meaning of Article 12 of Article 39 during the course of the financial year, b) 25% of the current result before tax previously increased by the said interest, the depreciation taken into account for the determination of this same result and the share of leasing rentals taken into account for the determination of the sale price of the asset at the end of the contract, /c) The amount of interest paid to this company by companies directly or indirectly linked within the meaning of Article 12 of Article 39, / the fraction of interest exceeding the highest of these limits cannot be deducted in respect of this financial year, unless this fraction is less than 150,000 . / However, this fraction of interest which is not immediately deductible may be deducted in respect of the following financial year up to the amount of the difference calculated in respect of that financial year between the limit mentioned in b and the amount of interest allowed for deduction under I. The balance not deducted at the end of this financial year is deductible in respect of subsequent financial years under the same conditions, subject to a discount of 5% applied at the beginning of each of these financial years. 11. Since ATHF1 was unable to benefit from the deductibility of the financial expenses arising from the loan taken out on 4 July 2010 beyond the rates of 3.91% and 3.39% set for the financial years ending in 2011 and 2012 respectively, it was not eligible for the extension of the deductibility limits set by II of Article 212 of the General Tax Code. Consequently, Apex Tool Group’s request that the calculation of ATHF1’s thin capitalisation interest be adjusted so that the balance of its interest subsequently carried forward at 31 December 2013 is increased from EUR 1,435,512 to EUR 2,401,651 can only be rejected. 12. It follows from all the foregoing that Apex Tool Group SAS is not entitled to argue that the Administrative Court of Melun wrongly rejected the remainder of its claim. Consequently, its claims for the application of Article L 761-1 of the Code of Administrative Justice can only be rejected.” Click here for English translation Click here for other translation CAA de PARIS, 7ème chambre, 10_03_2020, 18PA00608 ...

The tax authorities of the Czech Republic issued an assessment of additional income taxes and penalties for FY 2010 and 2011, because AZETKO s.r.o. according to the tax authorities did not receive an arm’s length remuneration for administration and operation of a website and e-shop on behalf on a related party, Quantus Consulting s.r.o. AZETKO disagreed with the assessment and brought the case to court. The regional court ruled in favor of AZETKO, but the tax administration appealed the decision to the Supreme Administrative Court. Judgement of the Supreme Court The Supreme Court found the tax administrations change in pricing method under the appeal of the case unsubstantiated. The tax administration had originally applied the CUP method, but in the appeal proceedings instead used the net margin transaction method (TNMM). On that basis, the appeal was dismissed by the Court. The conditions for application of the transfer pricing provisions in Section 23(7) of the Czech Income Tax Act was summarised by the Court as follows If it is proved that the parties are related persons within the meaning of Section 23(7) of the Income Tax Act, it is for the tax administrator to prove that the prices agreed between these persons differ from the prices that would have been agreed between independent persons in normal business relations under the same or similar conditions. Therefore, the principle that in tax proceedings it is the tax subject who bears the burden of allegations in relation to its tax liability and the burden of proof in relation to these allegations does not apply (cf. The tax administrator must therefore carry out a comparison in which it must establish both the price agreed between the related parties and the normal price (compared with the average price, the so-called reference price) at which independent persons trade in a comparable commodity. A necessary (but not sufficient) condition for the adjustment of the tax base under Section 23(7) of the Income Tax Act is the existence of a price difference. In order to establish the ‘normal’ nature of the price, the administrator must be able to bear the burden of proof in relation to all relevant aspects. The tax authorities can, and usually will, determine the normal price by comparing the prices actually obtained for the same or similar commodity between genuine independent operators. However, it may determine it, in particular because of the absence or unavailability of data on such prices, only as a hypothetical estimate based on logical and rational reasoning and economic experience. On the issue of business strategy the court provided the following insights “According to the above-mentioned guidelines, a business strategy is understood as an attempt to penetrate a new market, where prices can be significantly distorted by higher costs of introducing a product to the market while applying a lower final selling price of this product, but it can also be different circumstances. In assessing this factor, the SAC agrees with the regional court that the administrative authorities assessed the business strategy only for the applicant, namely that it is an established company with an established business program. However, for the companies being compared, they did not assess this factor, and the influence of this question on the assessment of the present case cannot be ruled out without further ado.” Click here for translation 0341_5Afs_1700047_20190920095602_20191008114014_prevedeno ...

A Polish subsidiary in a German Group had taken out a significant inter-company loan resulting in a significantly reduced income due to interest deductions. At issue was application of the Polish arm’s length provisions and the arm’s length nature of the interest rate on the loan. The tax authorities had issued an assessment where the interest rate on the loans had been adjusted and the taxable income increased. On that basis, a complaint was filed by the company to the Administrative Court. The administrative court rejected the complaint and ruled in favor of the tax authorities. An appeal was then brought before the Supreme Administrative Court. The Supreme Administrative Court rejected the appeal, although it did not share some of the conclusions and statements of the Court of first instance. The key issue in the case was to determine is whether the provisions of Art. 11 (Containing the Polish arm’s length provisions), allowing the authority to determine the income of the Company and the tax due without taking into account the conditions arising from existing relationships, including capital applies. Art. 11 paragraph 1 and paragraph 4. allows for the this provision to apply if three cumulative conditions are met: 1) the existence of connections between the parties referred to in art. 11 paragraph 1 points 1-3 or in para. 4 item 1 or 2 update; 2) the impact of these connections resulting in conditions that differ from those that would be agreed between independent entities; 3) the taxpayer’s failure to recognize income or income lower than would be expected if the above mentioned connections had not been there. The Supreme Administrative Court agreed that these cumulative conditions are met. The authority has made estimates of income on the basis of § 21 paragraph. 1 and 2 cited above. Regulation in the light of which it rules, if the taxpayer to provide an entity affiliated with the taxpayer loan ( credit ) or will receive such a loan ( credit ), regardless of their purpose and destiny, or also give or receive in any form of warranty or guarantee, the price of the market for this service are the interest or commission or other form of remuneration, which agreeing on for such a service, provided on comparable terms , entities independent ( paragraph. 1). The arm’s length interest rate is determined on the basis of the interest, that the entity would have to pay an independent party for obtaining a loan ( loans ) for the same period in comparable circumstances. However, according to the Supreme Administrative Court the inter group loan agreement differs from the typical loan agreements concluded by banks. The applicant does not conduct an economic activity identical to that of banks; With regard to the nature of the transaction applicant suffered much less risk of insolvency of a counter party, than borne by the bank in relation to the borrowers; The Company had a much greater possibility of controlling the situation of the financial and solvency of the counter party in the course of the duration of the contract than the bank in case of a contract of credit; The applicant does not bear the costs of verifying the ability of credit counter party and had the opportunity to immediately recover the funds provided in the framework of the agreement, which differ from the conditions defined by the parties of the contract of credit, concluded with the bank; The applicant does not incur other costs associated with granting and service the loan , which usually bear the banks; The applicant functioning in the group ‘s capital, implemented assumptions and tasks of economic different from those, which are the essence of the activities of entities operating on the market of services financial. Since comparable transactions between unrelated entities could not be established during the period under consideration, the CUP method was not applicable to the disputed contract. The Supreme Administrative Court states that the judgment under appeal meets the requirements provided for in art. 141 § 4 and fully enables its instance control, despite some shortcomings. The tax authority, while re- examining the case, is not bound within the meaning of the legal assessment contained in the fragment of the justification of the Administrative Court questioned by the Supreme Administrative Court. Instead, the legal assessment contained in this judgment is binding. Considering the, the Supreme Administrative Court dismissed complaint. Click here for translation Poland II FSK 1808-17 - Wyrok ...

A Polish company, “Shopping Centre Lender sp.k.”, had been granted three intra group loans in FY 2013 for EUR 2 million, EUR 115 million and EUR 43.5 million. The interest rate on the loans had been set at 9%. The tax authorities found that the 9% interest rate was higher than the arm’s length rate and carried out its own analysis on the basis of the comparative data from 66 transactions. In addition, data posted on the internet on the website of the National Bank of Poland was consulted. The summary showed that in the aforementioned period, the average interest rates applied by Polish financial institutions for loans granted to enterprises in EUR ranged from 2.4% to 3.6%. Furthermore, by letters in April 2017 the tax authorities requested information from domestic financial institutions regarding the interest rates and commission rates for loans granted to commercial companies in the period from June 2013 to September 2014. The information received showed that the interest rates applied by the banks were set as the sum of: the EURIBOR base rate (usually three months) and the bank’s margin. Between June 2013 and September 2014, interest rates varied and ranged from 0.515% to 6.50%. On the basis of the information received an assessment was issued where the interest rate on the three inter group loans had been lowered from 9% to 3.667% resulting in lower interest expenses and thus additional taxable income. Shopping Centre Lender sp.k. filed an appeal with the Administrative Court claiming that the procedure for estimating income – determining the arm’s length interest rate – had not been followed correctly by the tax authority. Judgement of the Administrative Court The Administrative Court issued a judgement in favour of Shopping Centre Lender sp.k. The Court found that the tax authorities procedure for estimating income had been in breach of the provisions of the Act and the Ordinance on transfer pricing adjustments. Click here for English Translation Click here for other translation Poland vs A Lender May 2019 AC ...

According to Amphenol Interconnect the TNMM was the most appropriate method for determining the arm’s length price in respect of exports and import of goods from the related parties. And since the net profit margin of Amphenol was comparable to the net profit margin of the comparable companies, the transactions were at arm’s length. The tax authorities disagreed and issued an assessment for FY 2012-2013 where the controlled transactions had instead been priced using the CUP method. Judgement of the Tribunal The Tribunal decided in favor of Amphenol. Excerpt “The Hon’ble High Court after analyzing the issues at length has held that CUP method would not be the most appropriate method in view of various adjustments, which would have to be made due to differences in FAR, in order to arrive at the arm’s length price of finished goods. The Hon’ble High Court notes that the Tribunal had taken into account the fact that for overwhelming majority of exports to associated enterprises, the TPO has accepted the TNMM method for arriving at the arm’s length price and hence, there was no reason why for balance of export of finished goods, TNMM method should not be applied. Similar direction was also given in respect of imports of finished goods, which were sold to third parties and the associated enterprises and by applying FAR analysis, it was held that where the finished goods were customized goods and the geographical differences, volume differences, timing differences, risk differences and functional differences were there, then CUP method would not be the most appropriate method to determine arm’s length price. The TNMM method was held to be most appropriate method. Further, the Hon’ble High Court has applied similar reasoning while deciding appeal of assessee relating to assessment year 2005-06 in ITA No.1388/2015, vide judgment dated 18.04.2018 and the appeal of Revenue has been dismissed. In the totality of the above said facts and circumstances, where the issue stands covered by the order of jurisdictional High Court in the case of assessee itself, there is no merit in the orders of authorities below in making aforesaid transfer pricing adjustment in the hands of assessee both with respect to exports to associated enterprises and with respect to imports from associated enterprises. It may be pointed out that majority of transactions have been accepted to be at arm’s length price by the TPO by applying TNMM method, only in respect of few transactions, the TPO had applied CUP method. There is no merit in the order of TPO in this regard and reversing the final order passed by Assessing Officer, we allow the claim of assessee and direct the Assessing Officer to delete the transfer pricing adjustment made in the hands of assessee. The grounds of appeal No.2 and 3 are thus, allowed. The grounds of appeal No.4 to 6 are academic as pointed out by the learned Authorized Representative for the assessee and the same are dismissed.” India vs Amphenol Interconnect India May 2019 Tax Tribunal ...

CCompany A was active in the management and administration of trusts and companies; related advice and services. A held 99% of the shares in E, a Seychelles-based company. This subsidiary acted as a sub-contractor for company registrations and corporate affairs in the Seychelles. A and E had entered into a service contract dated 6 February 2009 under which the subsidiary provided these services to A. Following an audit, tax assessments were issued for the tax years 2009 – 2012, in which the tax authorities (AFC-GE) had attributed a percentage of 5% of E’s expenses as the maximum allowable remuneration for the activities of the subsidiary. The remainder was added back to A’s taxable income. An administrative appeal was lodged against these tax assessments, but the appeal was later dismissed in 2016. A then appealed to the Administrative Court (TPAI), which, by judgment of 18 December 2017, upheld A’s appeal and annulled the assessments and fines. The tax authorities appealed to the Court of Justice. Judgment of the Court The Court of Justice overturned the decision of the Administrative Court and ruled in favour of the tax authorities. Excerpt “6. a. Implementation of the arm’s length principle presupposes identification of the market value of the asset transferred or the service rendered. Where there is an open market, the prices on that market are decisive and allow for an effective comparison with the prices applied between associated companies (ATF 140 II 88 recital 4.2 and the references cited therein). b. If there is no free market allowing an effective comparison, then the method of comparison with a comparable transaction (or comparable price method) should be used, which consists of making a comparison with the price applied between third parties in a transaction with the same characteristics, i.e. taking into account all the decisive circumstances (BGE 140 II 88 recital 4.2; 138 II 57 recital 2.2; Federal Court ruling 2C_674/2015 of 26 October 2017 recital 7.2). This method corresponds to the comparable open market price method presented in the OECD principles (n. 2.13 et seq.). For this method to be applicable, the transaction with a third party or between third parties must be similar to the transaction under review, i.e. it must have been entered into in circumstances comparable to those of the transaction under review. However, the notion of “comparable transaction” is not easy to define. The relevance of the comparison with transactions concluded with third parties presupposes that the determining economic circumstances of these transactions are similar to those of the transaction under review (OECD principles, n. 1.33 et seq.). The comparability of transactions is determined according to their nature and in the light of all the circumstances of the particular case. If the relevant economic conditions differ from those of the transaction under review, adjustments must be made to eliminate the effects of these differences (OECD principles, 1.33 et seq.). However, it cannot be entirely ruled out that a comparable transaction would not have been concluded at the market price, since the formation of the price may be influenced by several factors, such as market conditions, contractual terms (for example, the existence of secondary services, the quantity of goods sold, payment terms), the commercial strategy pursued by the third-party purchaser or the economic functions of the parties. Nevertheless, the price charged in a comparable transaction is presumed to correspond to the market price; in the event of a dispute, the burden of proof to the contrary lies with the company (Federal Court ruling 2C_1082/2013 of 14 January 2015, para. 5.2 and the references cited). c. In the absence of a comparable transaction, the arm’s length price is determined using other methods, such as the cost plus method. This method consists in determining the costs incurred by the company providing the service, to which an appropriate margin is added in order to obtain an appropriate profit taking into account the functions performed and the market conditions (ATF 140 II 88 rec. 4.2 p. 94; judgment of the Federal Court 2C_11/2018 of 10 December 2018 recital 7.4). d. A concealed distribution of profits also presupposes that the unusual nature of the benefit was recognisable by the company’s governing bodies. This condition is presumed to have been met if the disproportion was clearly recognisable. In this respect, reference should be made to the case law and doctrine developed in private law concerning the imputation of knowledge of the corporate bodies to the legal person, which holds that this imputation does not apply in an absolute manner, but that it must only come into play for what is known to the body that is at least seized of the matter, or else when the information acquired by one body has not been passed on to another body, due to a defect in the organisation of the company (Federal Court ruling 2C_1082/2013 cited above, rec. 6.1 and references cited). 7. It is up to the taxing authority to establish the facts on which the tax claim is based or which increase it, whereas the taxpayer must allege and prove the facts which eliminate or reduce this claim, these rules also applying to proceedings before the appeal authorities (ATF 140 II 248 recital 3.5). In tax reminder and fine proceedings, the tax authority must prove that the assessment is incomplete (Federal Court ruling 2C_342/2017 of 12 April 2018, recital 4.1). In the area of services that can be valued in money, the tax authorities must prove that the company has provided a service and that it has not received any consideration or has received insufficient consideration. If the evidence gathered by the tax authorities provides sufficient indications of the existence of such a disproportion, it is then up to the taxpayer to establish the accuracy of his allegations to the contrary (ATF 138 II 57 rec. 7.1 p. 66; Federal Court ruling 2C_814/2017 cited above, para. 8.1.3). Moreover, once a fact is considered to be established, the question of the burden of proof no longer arises ...

In this case there were family, capital and personal ties between the Blueberry Factory and its shareholders, and the terms and conditions of the Company’s transactions with its shareholders (purchase of blueberry fruit) had not been at arm’s length. The higher prices paid by the Blueberry Farm benefited the shareholders (suppliers), who thus generated higher income from their agricultural activities, not subject to income tax. The company generated only losses in the years 2011 – 2013. According to the Polish tax authorities, the Blueberry Farm purchased blueberry fruit at excessive prices and thus overstated its tax-deductible expenses by PLN 347,845.48. The excessive prices (relative to market prices) increased the income of its shareholders (agricultural producers), whose income was not subject to personal income tax as being derived from agricultural activities. The tax authorities applied the provisions of Art. 11.1, Par. 2.2 of the Corporate Income Tax Act of February 15th 1992, as the gross margin earned by the Blueberry Factory on sales of blueberries (2.56%) did not cover the costs of consumption of materials and energy, third party services, depreciation and other costs, which resulted in a loss for 2012. (PLN 218,838.03), and losses for 2011 and 2013. The application of excessive fruit purchase prices from the Company’s shareholders (4 persons running fruit farms and 1 farm owner), with family, personal and capital ties, also resulted in the Blueberry Factory taking out 6 loans from it’s shareholders for the total amount of PLN 877,697.70. in 2012. The average gross margin of the Blueberry Factory when selling goods (blueberries) in 2012 was 2.2%. Meanwhile, unrelated entities, selected in the course of the proceedings, which were involved in the purchase and sale of blueberries, having the relevant certificates necessary to sell fruit abroad, had gross margins ranging from 3.5% to 21.87%. The tax authorities held that the average gross margin in comparable transactions was 11.35% and PLN 2.27 per kilogram. The tax authorities determined the Blueberry Factory’s corporate income tax liability for 2012 at PLN 22,114, instead of the declared loss (PLN 218,838.03). The Court of first instance agreed with the tax authorities that there were capital, personal and family ties between these entities. In the opinion of the court, all the conditions referred to in Art. 11.1 of the Polish Act on Public Offering, which authorises the determination of the income and tax payable by way of estimation, had been fulfilled. The Court also considered the pricing method used by the authorities – resale prices – to be appropriate. The comparability analysis took into account both the type and quality of fruit traded (the fact of holding certificates). The average margin applied by independent entities was calculated. In estimating the cost of blueberry fruit purchased by the Company, favourable assumptions were made, as the basis for the estimation was the margins applied by entities (fruit producer groups) which purchased blueberry fruit, holding only the G-certificate and applying the lowest margins among the surveyed entities. The comparability analysis also took into account, among others, such factors as the certificates held, type of recipients of the goods (domestic and foreign), type of entity, production process, technologies used, type and time of transactions. The Court also deemed it appropriate that DUKS issued a provision under Art. 179.1 of the Polish Corporate Governance Act, which excluded information on entities conducting business competitive to the Company. The Blueberry Factory filed a complaint against the decision. The Supreme Administrative Court considered that the appeal was justified and therefore had to be granted. The gist of the dispute in the case at hand is to assess whether, in fact, the procedure for estimating income [Article 11 of the Act] was carried out correctly, as claimed by the authority and accepted by the Court of First Instance, or, as the applicant argues in cassation – with a breach of the provisions of the Act and the Regulation – which is linked to the authority’s analysis of the comparability of transactions. “All this allows us to conclude that, although the OECD Transfer Pricing Guidelines do not contain standards of generally applicable law (Article 87(1) of the Polish Constitution), when interpreting the provisions governing the prerequisites for the use of transfer pricing and the general conditions for determining income by means of estimation (Article 11(1) to (3) of the Act), the indications of those guidelines should be taken into account as a kind of “set of good practices” and a point of reference for choosing the right interpretative direction.” “In the light of the above, contrary to what the WSA suggested, the aforementioned guidelines will be relevant to the assessment of the assessment method used by the authority and, in particular, of its implementation.” The Court of first instance did not sufficiently consider the proceedings conducted by the authorities – in particular with regard to the comparability analysis. It was principally assumed that the Company’s business model was the basis for its market strategy – which in its opinion was to generate losses in order to maximise profits of its shareholders. At the same time, despite arguments consistently raised by a party in the course of proceedings, the court did not address issues regarding comparability factors. First of all, the key issue in this case, namely that the party has the status of an agricultural producer group. This, in turn, raises other relevant issues: – the specific nature of the entity, the principles and essence of the group’s operation, the scope of the objectives it should pursue, the strategy of producer groups – the use of aid measures, the issue and importance of the Recognition Plan, the issue of the group’s market strategy during the recognition period. The Supreme Administrative Court referred the case back to the Court of first instance for reconsideration. Poland II FSK 1665-16 en Poland II FSK 1665-16 ...

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 1.33-1.118. 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 ...

Prices are likely to be affected by differences in products, and gross margins are likely to be affected by differences in functions, but net profit indicators are less adversely affected by such differences. As with the resale price and cost plus methods that the transactional net margin method resembles, this does not mean that a mere similarity of functions between two enterprises will necessarily lead to reliable comparisons. Assuming similar functions can be isolated from among the wide range of functions that enterprises may exercise, in order to apply the method, the net profit indicators related to such functions may still not be automatically comparable where, for instance, the enterprises concerned carry on those functions in different economic sectors or markets with different levels of profitability. When the comparable uncontrolled transactions being used are those of an independent enterprise, a high degree of similarity is required in a number of aspects of the associated enterprise and the independent enterprise involved in the transactions in order for the controlled transactions to be comparable; there are various factors other than products and functions that can significantly influence net profit indicators ...

Another practical strength of the transactional net margin method is that, as with any one-sided method, it is necessary to examine a financial indicator for only one of the associated enterprises (the “tested” party). Similarly, it is often not necessary to state the books and records of all participants in the business activity on a common basis or to allocate costs for all participants as is the case with the transactional profit split method. This can be practically advantageous when one of the parties to the transaction is complex and has many interrelated activities or when it is difficult to obtain reliable information about one of the parties. However, a comparability (including functional) analysis must always be performed in order to appropriately characterise the transaction between the parties and choose the most appropriate transfer pricing method, and this analysis generally necessitates that some information on the five comparability factors in relation to the controlled transaction be collected on both the tested and the non-tested parties. See paragraphs 3.20-3.23 ...

For the CUP method to be reliably applied to commodity transactions, the economically relevant characteristics of the controlled transaction and the uncontrolled transactions or the uncontrolled arrangements represented by the quoted price need to be comparable. For commodities, the economically relevant characteristics include, among others, the physical features and quality of the commodity; the contractual terms of the controlled transaction, such as volumes traded, period of the arrangements, the timing and terms of delivery, transportation, insurance, and foreign currency terms. For some commodities, certain economically relevant characteristics (e.g. prompt delivery) may lead to a premium or a discount. If the quoted price is used as a reference for determining the arm’s length price or price range, the standardised contracts which stipulate specifications on the basis of which commodities are traded on the exchange and which result in a quoted price for the commodity may be relevant. Where there are differences between the conditions of the controlled transaction and the conditions of the uncontrolled transactions or the conditions determining the quoted price for the commodity that materially affect the price of the commodity transactions being examined, reasonably accurate adjustments should be made to ensure that the economically relevant characteristics of the transactions are comparable. Contributions made in the form of functions performed, assets used and risks assumed by other entities in the supply chain should be compensated in accordance with the guidance provided in these Guidelines ...

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 ...

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 following example illustrates the concept of determining the actual transaction where a transaction has not been identified by the MNE. In reviewing the commercial or financial relations between Company P and its subsidiary companies, it is observed that those subsidiaries receive services from an independent party engaged by Company P. Company P pays for the services, the subsidiaries do not reimburse Company P directly or indirectly through the pricing of another transaction and there is no service agreement in place between Company P and the subsidiaries. The conclusion is that, in addition to a provision of services by the independent party to the subsidiaries, there are commercial or financial relations between Company P and the subsidiaries, which transfer potential value from Company P to the subsidiaries. The analysis would need to determine the nature of those commercial or financial relations from the economically relevant characteristics in order to determine the terms and conditions of the identified transaction ...

Where no written terms exist, the actual transaction would need to be deduced from the evidence of actual conduct provided by identifying the economically relevant characteristics of the transaction. In some circumstances the actual outcome of commercial or financial relations may not have been identified as a transaction by the MNE, but nevertheless may result in a transfer of material value, the terms of which would need to be deduced from the conduct of the parties. For example, technical assistance may have been granted, synergies may have been created through deliberate concerted action (as discussed in Section D.8), or know-how may have been provided through seconded employees or otherwise. These relations may not have been recognised by the MNE, may not be reflected in the pricing of other connected transactions, may not have been formalised in written contracts, and may not appear as entries in the accounting systems. Where the transaction has not been formalised, all aspects would need to be deduced from available evidence of the conduct of the parties, including what functions are actually performed, what assets are actually used, and what risks are actually assumed by each of the parties ...

The following example illustrates the concept of differences between written contractual terms and conduct of the parties, with the result that the actual conduct of the parties delineates the transaction. Company S is a wholly-owned subsidiary of Company P. The parties have entered into a written contract pursuant to which Company P licenses intellectual property to Company S for use in Company S’s business; Company S agrees to compensate Company P for the licence with a royalty. Evidence provided by other economically relevant characteristics, and in particular the functions performed, establishes that Company P performs negotiations with third-party customers to achieve sales for Company S, provides regular technical services support to Company S so that Company S can deliver contracted sales to its customers, and regularly provides staff to enable Company S to fulfil customer contracts. A majority of customers insist on including Company P as joint contracting party along with Company S, although fee income under the contract is payable to Company S. The analysis of the commercial or financial relations indicates that Company S is not capable of providing the contracted services to customers without significant support from Company P, and is not developing its own capability. Under the contract, Company P has given a licence to Company S, but in fact controls the business risk and output of Company S such that it has not transferred risk and function consistent with a licensing arrangement, and acts not as the licensor but the principal. The identification of the actual transaction between Company P and Company S should not be defined solely by the terms of the written contract. Instead, the actual transaction should be determined from the conduct of the parties, leading to the conclusion that the actual functions performed, assets used, and risks assumed by the parties are not consistent with the written licence agreement ...

Where there is doubt as to what transaction was agreed between the associated enterprises, it is necessary to take into account all the relevant evidence from the economically relevant characteristics of the transaction. In doing so one must bear in mind that the terms of the transaction between the enterprises may change over time. Where there has been a change in the terms of a transaction, the circumstances surrounding the change should be examined to determine whether the change indicates that the original transaction has been replaced through a new transaction with effect from the date of the change, or whether the change reflects the intentions of the parties in the original transaction. Particular care should be exercised where it appears that any changes may have been triggered by knowledge of emerging outcomes from the transaction. Changes made in the purported assumption of a risk when risk outcomes are known do not involve an assumption of risk since there is no longer any risk, as discussed in paragraph 1.78 ...

In transactions between independent enterprises, the divergence of interests between the parties ensures (i) that contractual terms are concluded that reflect the interests of both of the parties, (ii) that the parties will ordinarily seek to hold each other to the terms of the contract, and (iii) that contractual terms will be ignored or modified after the fact generally only if it is in the interests of both parties. The same divergence of interests may not exist in the case of associated enterprises or any such divergences may be managed in ways facilitated by the control relationship and not solely or mainly through contractual agreements. It is, therefore, particularly important in considering the commercial or financial relations between associated enterprises to examine whether the arrangements reflected in the actual conduct of the parties substantially conform to the terms of any written contract, or whether the associated enterprises’ actual conduct indicates that the contractual terms have not been followed, do not reflect a complete picture of the transactions, have been incorrectly characterised or labelled by the enterprises, or are a sham. Where conduct is not fully consistent with economically significant contractual terms, further analysis is required to identify the actual transaction. Where there are material differences between contractual terms and the conduct of the associated enterprises in their relations with one another, the functions they actually perform, the assets they actually use, and the risks they actually assume, considered in the context of the contractual terms, should ultimately determine the factual substance and accurately delineate the actual transaction ...

If the characteristics of the transaction that are economically relevant are inconsistent with the written contract between the associated enterprises, the actual transaction should generally be delineated for purposes of the transfer pricing analysis in accordance with the characteristics of the transaction reflected in the conduct of the parties ...

The following example illustrates the concept of clarifying and supplementing the written contractual terms based on the identification of the actual commercial or financial relations. Company P is the parent company of an MNE group situated in Country P. Company S, situated in Country S, is a wholly-owned subsidiary of Company P and acts as an agent for Company P’s branded products in the Country S market. The agency contract between Company P and Company S is silent about any marketing and advertising activities in Country S that the parties should perform. Analysis of other economically relevant characteristics and in particular the functions performed, determines that Company S launched an intensive media campaign in Country S in order to develop brand awareness. This campaign represents a significant investment for Company S. Based on evidence provided by the conduct of the parties, it could be concluded that the written contract may not reflect the full extent of the commercial or financial relations between the parties. Accordingly, the analysis should not be limited by the terms recorded in the written contract, but further evidence should be sought as to the conduct of the parties, including as to the basis upon which Company S undertook the media campaign ...

However, the written contracts alone are unlikely to provide all the information necessary to perform a transfer pricing analysis, or to provide information regarding the relevant contractual terms in sufficient detail. Further information will be required by taking into consideration evidence of the commercial or financial relations provided by the economically relevant characteristics in the other four categories (see paragraph 1.36): the functions performed by each of the parties to the transaction, taking into account assets used and risks assumed, together with the characteristics of property transferred or services provided, the economic circumstances of the parties and of the market in which the parties operate, and the business strategies pursued by the parties. Taken together, the analysis of economically relevant characteristics in all five categories provides evidence of the actual conduct of the associated enterprises. The evidence may clarify aspects of the written contractual arrangements by providing useful and consistent information. If the contract neither explicitly nor implicitly (taking into account applicable principles of contract interpretation) addresses characteristics of the transaction that are economically relevant, then any information provided by the contract should be supplemented for purposes of the transfer pricing analysis by the evidence provided by identifying those characteristics ...

A transaction is the consequence or expression of the commercial or financial relations between the parties. The controlled transactions may have been formalised in written contracts which may reflect the intention of the parties at the time the contract was concluded in relation to aspects of the transaction covered by the contract, including in typical cases the division of responsibilities, obligations and rights, assumption of identified risks, and pricing arrangements. Where a transaction has been formalised by the associated enterprises through written contractual agreements, those agreements provide the starting point for delineating the transaction between them and how the responsibilities, risks, and anticipated outcomes arising from their interaction were intended to be divided at the time of entering into the contract. The terms of a transaction may also be found in communications between the parties other than a written contract ...

For a discussion of the relevance of these factors for the application of particular pricing methods, see the consideration of those methods in Chapter II ...

All methods that apply the arm’s length principle can be tied to the concept that independent enterprises consider the options realistically available to them and in comparing one option to another they consider any differences between the options that would significantly affect their value. For instance, before purchasing a product at a given price, independent enterprises normally would be expected to consider whether they could buy an equivalent product on otherwise comparable terms and conditions but at a lower price from another party. Therefore, as discussed in Chapter II, Part II, the comparable uncontrolled price method compares a controlled transaction to similar uncontrolled transactions to provide a direct estimate of the price the parties would have agreed to had they resorted directly to a market alternative to the controlled transaction. However, the method becomes a less reliable substitute for arm’s length transactions if not all the characteristics of these uncontrolled transactions that significantly affect the price charged between independent enterprises are comparable. Similarly, the resale price and cost plus methods compare the gross profit margin earned in the controlled transaction to gross profit margins earned in similar uncontrolled transactions. The comparison provides an estimate of the gross profit margin one of the parties could have earned had it performed the same functions for independent enterprises and therefore provides an estimate of the payment that party would have demanded, and the other party would have been willing to pay, at arm’s length for performing those functions. Other methods, as discussed in Chapter II, Part III, are based on comparisons of net profit indicators (such as profit margins) between independent and associated enterprises as a means to estimate the profits that one or each of the associated enterprises could have earned had they dealt solely with independent enterprises, and therefore the payment those enterprises would have demanded at arm’s length to compensate them for using their resources in the controlled transaction. Where there are differences between the situations being compared that could materially affect the comparison, comparability adjustments must be made, where possible, to improve the reliability of the comparison. Therefore, in no event can unadjusted industry average returns themselves establish arm’s length prices ...

The second phase in which economically relevant characteristics or comparability factors are used in a transfer pricing analysis relates to the process set out in Chapter III of making comparisons between the controlled transactions and uncontrolled transactions in order to determine an arm’s length price for the controlled transaction. To make such comparisons, taxpayers and tax administrations need first to have identified the economically relevant characteristics of the controlled transaction. As set out in Chapter III, differences in economically relevant characteristics between the controlled and uncontrolled arrangements need to be taken into account when establishing whether there is comparability between the situations being compared and what adjustments may be necessary to achieve comparability ...

Independent enterprises, when evaluating the terms of a potential transaction, will compare the transaction to the other options realistically available to them, and they will only enter into the transaction if they see no alternative that offers a clearly more attractive opportunity to meet their commercial objectives. In other words, independent enterprises would only enter into a transaction if it is not expected to make them worse off than their next best option. For example, one enterprise is unlikely to accept a price offered for its product by an independent commercial enterprise if it knows that other potential customers are willing to pay more under similar conditions, or are willing to pay the same under more beneficial conditions. Independent enterprises will generally take into account any economically relevant differences between the options realistically available to them (such as differences in the level of risk) when valuing those options. Therefore, identifying the economically relevant characteristics of the transaction is essential in accurately delineating the controlled transaction and in revealing the range of characteristics taken into account by the parties to the transaction in reaching the conclusion that there is no clearly more attractive opportunity realistically available to meet their commercial objectives than the transaction adopted. In making such an assessment, it may be necessary or useful to assess the transaction in the context of a broader arrangement of transactions, since assessment of the options realistically available to third parties is not necessarily limited to the single transaction, but may take into account a broader arrangement of economically related transactions ...

Economically relevant characteristics or comparability factors are used in two separate but related phases in a transfer pricing analysis. The first phase relates to the process of accurately delineating the controlled transaction for the purposes of this chapter, and involves establishing the characteristics of the transaction, including its terms, the functions performed, assets used, and risks assumed by the associated enterprises, the nature of the products transferred or services provided, and the circumstances of the associated enterprises, in accordance with the categories set out in the previous paragraph. The extent to which any one of the characteristics categorised above is economically relevant in a particular transaction depends on the extent to which it would be taken into account by independent enterprises when evaluating the terms of the same transaction were it to occur between them ...

The economically relevant characteristics or comparability factors that need to be identified in the commercial or financial relations between the associated enterprises in order to accurately delineate the actual transaction can be broadly categorised as follows: The contractual terms of the transaction (D.1.1). The functions performed by each of the parties to the transaction, taking into account assets used and risks assumed, including how those functions relate to the wider generation of value by the MNE group to which the parties belong, the circumstances surrounding the transaction, and industry practices (D.1.2). The characteristics of property transferred or services provided (D.1.3). The economic circumstances of the parties and of the market in which the parties operate (D.1.4). The business strategies pursued by the parties (D.1.5). This information about the economically relevant characteristics of the actual transaction should be included as part of the local file as described in Chapter V in support of a taxpayer’s analysis of its transfer pricing ...

Following an audit the tax authorities issued an assessment, where the interest rate on a loan had been changed based on application of transfer pricing rules. An appeal was filed by “Holding S.A.” arguing that the transfer pricing rules do not apply to the loan operations observed, since there has not been a lower payment of income tax as required by paragraph a) of article 32-A of the aforementioned tax law, This is also not verified by having obtained losses in the years 2000 to 2005, since being a holding company and only receiving income from dividends, such losses cannot be carried forward, in addition to the fact that the only effect of the objection formulated is to reduce the loss and not to determine a higher tax payable. Judgement of the Tax Court The Tax Court sets aside the assessment and decided in favour Holding S.A. Excerpts “In this sense, it has not been proven that the Administration had carried out a due comparison of the same or similar transactions in order to correctly establish the market value of the transactions analysed in application of the transfer pricing rules, specifically, in accordance with the provisions of paragraph d) of article 32°-A of the Income Tax Law. Consequently, the objection raised by the Administration should be lifted, and the appealed decision should be revoked and the contested resolutions of determination should be annulled, as well as the fines applied. Click here for English Translation Click here for other translation Peru 2017_1_05608 ...

P.T. Sanken Electric Indonesia Ltd. – an Indonesian subsidiary of Sanken Electric Co., Ltd. Japan – paid royalties to its Japanese parent for use of IP. The royalty payment was calculated based on external sales and therefore did not include sales of products to group companies. The royalty payments were deducted for tax purposes. The tax authorities denied the deduction as the license agreement had not been registrered in Indonesia. Furthermore, the royalty payment was not found to have been determined in accordance with the arm’s length principle. P.T. Sanken Electric Indonesia Ltd appealed the decision of the Tax Court. Judgement of the Tax Court The tax court set aside the assessment and decided in favor of taxpayer. Click here for translation Indonesia PUT 68357-PP-MIA-15-2016 ...

Loan agreements were entered into between Cotton Naturals (I) Pvt. and a US subsidiary on 13th April, 2002, 7th May, 2003 and then on 8th September, 2003. The rate of interest had been fixed at 4% per annum on the principal sum. The CUP method had been applied to determine the rate. The tax authorities held that the arm’s length interest rate should instead be set at 14% p.a. Following an objection to the assessment, at partial relief was granted in the form of a reduction of the rate to 12,20%. An appeal was filed by Cotton Naturals with the Tax Appellate Tribunal Cotton Naturals (I) Pvt. Ltd. where in February 2013 the assessment was set aside. An appeal was then filed with the High Court by the tax authorities. Decision of the High Court The High Court decided in favor of Cotton Naturals (I) Pvt. Ltd. and set aside the tax assessment. Excerpts “Transfer pricing determination is not primarily undertaken to re-write the character and nature of the transaction, though this is permissible under two exceptions. Chapter X and Transfer Pricing rules do not permit the Revenue authorities to step into the shoes of the assessee and decide whether or not a transaction should have been entered. It is for the assessed to take  commercial decisions and decide how to conduct and carry on its business. Actual business transactions that are legitimate cannot be restructured.” “Transfer pricing is a mechanism to undo an attempt to shift profits and correct any under or over payment in a controlled transaction by ascertaining the fair purpose is to ascertain whether the transfer price is the same price which would have been agreed and paid for by unrelated enterprises transacting with each other, if the price is determined by market forces. The first step in this exercise is to ascertain the international transaction, which in the present case is payment of interest on the money lent. The next step is to ascertain the functions performed under the international transaction by the respective AEs. Thereafter, the comparables have to be selected by undertaking a comparability analysis. The comparability analysis should ensure that the functions performed by the comparables match with the functions being performed by the AE to whom payment is made for the services rendered. These aspects have been elucidated in detail in Sony India Ltd. (supra) by referring to the OECD Guidelines as well as United Nations Practical Manual of Transfer Pricing for Developing Countries.” “The finding of the TPO that for this reason the interest rate should be computed at 14% per annum i.e. the average yield on unrated bonds for Financial Years (FY, for short) 2006-07, has to be rejected.” “We have no hesitation in holding that the interest rate should be the market determined interest rate applicable to the currency concerned in which the loan has to be repaid. Interest rates should not be computed on the basis of interest payable on the currency or legal tender of the place or the country of residence of either party. Interest rates applicable to loans and deposits in the national currency of the borrower or the lender would vary and are dependent upon the fiscal policy of the Central bank, mandate of the Government and several other parameters. Interest rates payable on currency specific loans/ deposits are significantly universal and globally applicable. The currency in which the loan is to be re-paid normally determines the rate of return on the money lent, i.e. the rate of interest.” “In the light of the aforesaid discussion, the substantial question of law mentioned above has to be answered against the appellant i.e. the Revenue and in favour of the respondent-assessee. The appeal is accordingly disposed of. There will be no order as to costs.” India vs cotton naturals - fin trans case no 233-2014 BW ...

In this case the court accepted the tax authorities’ procedure for determining the arm’s length price for advertising services, whereby the tax authorities took into account conditions such as the size of the advertising space, the type of event, the duration of the advertising, etc., when comparing controlled and uncontrolled transactions The appeal of JN Trans was dismissed by the court. Click here for English Translation Click here for other translation Czech Case No 9 Afs 92-2013 ...

At issue in the case of SK Group Indonesia was sale of lube base oil to SK Energy International (Singapore). The transfer price had been determined by the group using the Transactional Net Margin Method (TNMM). An adjustment was issued by tax authorities claiming that the controlled transactions had been underpriced. This was concluded based on the comparable Uncontrolled Price method (CUP). Judgement of the Tax Court The Court decided in favour of SK Group. According to the court the tax authorities had not been able to sufficiently prove that the CUP method was a more appropriate method. Click here for translation putusan_put-56237_pp_m.iib_15_2014_20210530 ...

Distribuidora Salvadorena de Petroleo S.A. DE C.V. (DSP), is active in “the wholesale and retail marketing of oil, derivatives, gas, lubricants, additives and energy in general. Following an audit the tax authorities issued an assessment regarding sale of oil. According to the authorities the prices determined by DSP for oil sold to a related party – Nejapa Power Company L.L.C. – had not been at arm’s length. An appeal was filed by the DSP. Judgement of the Supreme Court The court set aside the assessment and decided in favour of DSP. “The method of estimated, indexed or presumptive base is constructed through the use of indications, its application becomes indispensable when the Tax Administration does not have the direct means to provide it with certain data, the failure to file returns or those filed by the taxpayers do not allow the knowledge of the data necessary for the complete estimation of the taxable bases or income, or when the taxpayers themselves offer resistance, excuses or refusals in the face of the audit action ordered against them, or substantially fail to comply with their accounting obligations, or when the background information provided lacks probative value. etc. In the above cases, although not the only ones, the Tax Administration is empowered to proceed to determine the tax on the basis of an estimated or indicative basis known as “presumptive basis”, using for this purpose the verification of indications, otherwise the Treasury would be circumvented by tax evaders. The important thing is that in the application of this method, the tax office must gather a series of facts or circumstances in which their normal link or connection with those foreseen by the Law as the material budget of the tax, allow it to infer in the investigated case the existence and amount of the obligation. The purpose of the Law is to establish the real value of the transaction, at no time to establish non-existent income, therefore, by attempting to create non-existent income by applying a legal provision referring to market prices, which constitute an element of the index base, it creates an inaccuracy, since it is not in line with reality. Hence, the actions of the Directorate General of Internal Taxes are unlawful, since it unjustifiably applied the method of the estimated, indexed or presumed base for the unofficial tax assessment made on the plaintiff company, which according to the parameters established by the tax legislation was not the corresponding one.” “In accordance with the foregoing considerations, this Chamber concludes that the actions of the Directorate General of Internal Taxes are illegal, having used both the mixed base and the estimated, indexed or presumed base for the liquidation of the Income Tax of the company”. Click here for English translation Click here for other translation El Salvador vs OIL 386-2010 ORG ...

A Turkeys Pharma Company carried out drug production, import and sales operations, and had purchased different active ingredients from foreign group companies. Following an audit the tax office found that the prices paid by the Pharma Company for six ingredients had been above the market price resulting in a hidden distribution of profits. A price study was performed for similar active ingredients suggesting price deviations ranging from 167 – 975 % Table 2: Price deviation from market price Theophylline 167.26%ibuprofen 478.34%Fluoxetine 975.15%Hyoscine-N-Butilbrüm 150.13%Povidone Iodine 176.83%metamizolesodi 260.05% An assessment was issued where the cost of the ingredients – and thus taxable income of the Pharma company – was adjusted based on the price paid for similar active ingredients between unrelated parties. The Pharma Company disagreed with the assessment and brought the case before the tax court. The Tax Court issued a decision in favor of the Pharma company. In a study from the Turkish Pharmaceutical Association it was stated that active ingredients could have different prices due to reasons such as using original methods, impurities, crystal structure and polymorphism, mesh size, batch size, certificate differences etc. Based on this study the Tax Court found, that although it had been determined that the Pharma Company had purchased active ingredients at higher prices compared to other companies, there was no clear information about the characteristics of the active substance, production factors, or other factors that will cause price differentiation. This decision was appealed by the tax authorities. The Court of Appeal approved of the decision issued by the tax court and dismissed the appeal. Click here for translation Turkey 2009-2352-k-2011-7637-t-20-12-2011 ...