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

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