Maersk Oil and Gas A/S (later TotalEnergies EP Danmark A/S) continued to make operating losses, although the group’s combined oil and gas operations were highly profitable. Following an audit of Maersk Oil, the tax authorities considered that three items did not comply with the arm’s length principle. Maersk Oil incurred all the expenses for preliminary studies of where oil and gas could be found, but the results of these investigations and discoveries were handed over to the newly established subsidiaries free of charge. Licence agreements were signed with Qatar and Algeria for oil extraction. These agreements were entered into with the subsidiaries as contracting parties, but it was Maersk Oil that guaranteed that the subsidiaries could fulfil their obligations and committed to make the required technology and know-how available. Expert assistance (time writing) was provided to the subsidiaries, but these services were remunerated at cost with no profit to Maersk Oil. An assessment was issued where additional taxable income was determined on an aggregated basis as a share of profits from the activities – corresponding to a royalty of approximately 1,7 % of the turnover in the two subsidiaries. In 2018, the Tax Court upheld the decision and Maersk Oil and Gas A/S subsequently appealed to the High Court. In 2022, the High Court held that the subsidiaries in Algeria and Qatar owned the licences for oil extraction, both formally and in fact. In this regard, there was therefore no transaction. Furthermore the explorations studies in question were not completed until the 1990s and Maersk Oil and Gas A/S had not incurred any costs for the subsequent phases of the oil extraction. These studies therefore did not constitute controlled transactions. The Court therefore found no basis for an annual remuneration in the form of royalties or profit shares from the subsidiaries in Algeria and Qatar. On the other hand, the Regional Court found that Maersk Oil and Gas A/S’ so-called performance guarantees for the subsidiaries in Algeria and Qatar were controlled transactions and should therefore be priced at arm’s length. In addition, the Court found that technical and administrative assistance (so-called time writing) to the subsidiaries in Algeria and Qatar at cost was not in line with what could have been obtained if the transactions had been concluded between independent parties. These transactions should therefore also be priced at arm’s length. The High Court referred the cases back to the tax authorities for reconsideration. An appeal was then filed by the tax authorities with the Supreme Court. Judgement of the Supreme Court The Supreme Court decided in favour of the tax authorities and upheld the original assessment. The court stated that the preliminary exploration phases in connection with oil exploration and performance guarantees and the related know-how had an economic value for the subsidiaries, for which an independent party would require ongoing payment in the form of profit share, royalty or the like. They therefore constituted controlled transactions. Furthermore, the court stated that Maersk Oil and Gas A/S’ delivery of timewriting at cost price was outside the scope of what could have been achieved if the agreement had been entered into at arm’s length. Finally, the transactions were considered to be so closely related that they had to be assessed and priced on an aggregated basis and Maersk Oil and Gas A/S had not provided any basis for overturning the tax authorities’ assessment. Click here for English translation Click here for other translation ...

Tiger Flex was a fully fledged footwear manufacturer that was later restructured as a contract manufacturer for the Gucci Group. It had acquired goodwill which was written off for tax purposes, resulting in zero taxable income. The tax authorities disallowed the depreciation deduction. It found that the acquired goodwill had benefited the group as a whole and not just Tiger Flex. Tiger Flex filed an appeal with the Regional Tax Commission. The Regional Tax Commission decided in favour of Tiger Flex. The tax authorities then filed an appeal with the Supreme Court. Judgement of the Supreme Court The Court set aside the decision of the Regional Tax Commission and refered the case back to the Regional Tax Commission in a different composition. Excerpt “It is not disputed that the Tiger and Bartoli factories were profitable assets, endowed with productive and earning capacity. What is disputed, however, is the recorded purchase value which, legally spread over the decade, anaesthetises any contributory capacity, resulting in repeatedly loss-making activities. Hence the various censures on the quantitative, qualitative and inherent deductibility of such costs.” (…) “In the present case, an asset in surplus and capable of producing income was transformed into a loss-making asset with the entry of a depreciation value capable of absorbing its profits; whence the repeated conduct of the loss-making activity legitimised the Office to recover taxation, disallowing a cost that it considered to be to the advantage of the group and not inherent (solely) to Tiger Flex, recalculating it in its amount, with reversal of the burden of proof to the taxpayer who was unable to give a different answer, re-proposing the payment value entered in the balance sheet. On the other hand, the board of appeal imposed the burden of proof of inherence and consistency on the Office, whereas it had long been held that the breach of the precept set forth in Article 2697 of the Civil Code It has long been held that a violation of the precept set forth in Article 2697 of the Italian Civil Code occurs when the judge has attributed the burden of proof to a party other than the one that was burdened by the application of said provision, whereas, where, following an incongruous assessment of the preliminary findings, he erroneously held that the party burdened had discharged such burden, since in this case there is an erroneous assessment of the outcome of the evidence, it can be reviewed in the court of legitimacy only for the defect referred to in Article. 360, no. 5, c.p.c. (Court of Cassation no. 17313 of 2020). And finally, with regard to the assessment of income taxes, the burden of proof of the assumptions of the deductible costs and charges competing in the determination of the business income, including their pertinence and their direct allocation to revenue-producing activities, both under the provisions of Presidential Decree No. 597 of 1973 and Presidential Decree No. 598 of 1973, and Presidential Decree No. 917 of 1986, lies with the taxpayer. Moreover, since the tax authorities’ powers of assessment include the assessment of the appropriateness of the costs and revenues shown in the financial statements and returns, with the denial of the deductibility of a part of a cost that is disproportionate to the revenues or to the object of the business, the burden of proof of the inherent nature of the costs, incumbent on the taxpayer, also relates to the appropriateness of the same (see Court of Cassation V, no. 4554/2010, followed, e plurimis, by no. 10269/2017). The judgment under examination did not comply with this principle, which, finally, in its last paragraph, performs a sort of “resistance test”, i.e. that even if the burden of proof is placed on the taxpayer, it remains undisputed that after a number of years commensurate with the economic effort made, the balance sheet profit was achieved. This is not the profile of the decision, since the Office disputes precisely that for many years there was repeated loss-making conduct, Tiger Flex having taken on burdens not (exclusively) its own, but for the benefit of the entire Gucci group, so that – if ritually distributed – they would have enabled correct profitable conduct, with the consequent discharge of tax burdens.” Click here for English Translation Click here for other translation ...

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 ...

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 ...

FP manufactures product X in Country M and sells it to USSub, which distributes X in the United States. USSub realizes losses with respect to the controlled transactions in each of five consecutive taxable years. In each of the five consecutive years a different uncontrolled comparable realized a loss with respect to comparable transactions equal to or greater than USSub’s loss. Pursuant to paragraph (f)(3)(iii)(C) of this section, the district director examines whether the uncontrolled comparables realized similar losses over a comparable period of time, and finds that each of the five comparables realized losses in only one of the five years, and their average result over the five-year period was a profit. Based on this data, the district director may conclude that the controlled taxpayer’s results are not within the arm’s length range over the five year period, since the economic conditions that resulted in the controlled taxpayer’s loss did not have a comparable effect over a comparable period of time on the uncontrolled comparables ...

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 ...

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 ...

Aisan Industry Czech, s.r.o. is a subsidiary within the Japanese Aisan Industry Group which manufactures various engine components – fuel-pump modules, throttle bodies, carburetors for independent car manufactures such as Renault and Toyota. According to the original transfer pricing documentation the Czech company was classified as a limited risk contract manufacturer within the group, but yet it had suffered operating losses for several years. Following a tax audit an assessment was issued resulting in additional corporate income tax for FY 2011 in the amount of CZK 11 897 090, and on top of that a penalty in the amount of CZK 2 379 418. The assessment resulted from application of arm’s length provisions where the profitability of Aisan Industry Czech, s.r.o. had been determined on the basis of the profitability of comparable companies – TNMM method. An appeal was filed by Aisan Industry Czech, s.r.o. with the Regional Court which – by judgment of 30 October 2019 – dismissed the appeal and confirmed the additional payment order issued by the tax authorities. In its decision the Regional Court concluded that Aisan Industry Czech, s.r.o. should have been compensated for carrying out manufacturing services to the benefit of the multinational Aisan Industry group. The court also concluded that Aisan Industry Czech, s.r.o. was in fact a contract manufacturer – as stated in the original transfer pricing documentation – and not a full-fledged manufacturer as stated in the later “updated” transfer pricing report in which the FAR profile of the company had been significantly altered after receiving the initial assessment. According to the Regional Court, it had been established that the price of the service negotiated between the Aisan Industry Czech, s.r.o. and its parent company Aisan Industry Co., Ltd. was different from the price that would have been negotiated between independent parties under the same commercial conditions. By selling products to related and unrelated parties at prices determined by the group, Aisan Industry Czech, s.r.o. did not even achieve a minimum level of operating profitability. In FY 2011 Aisan Industry Czech, s.r.o. had a negative profit margin of 3,27 %. According to the court Aisan Industry Czech, s.r.o. should have received a remuneration of CZK 61 080 700 from the Aisan group for the manufacturing services, i.e. the difference between the operating margin it would have achieved at at arm’s length, 1,26 % (the minimum of the profit margin of comparable entities), and the profits it had actually achieved -3.27 %. According to the Regional Court, it was not the pricing of the individual products that was relevant, but rather the overall set-up of Aisan Industry Czech, s.r.o.’s operation within the Aisan group as a contract manufacturer bearing disproportionate risks which were not compensated. Therefore it was not appropriate to set a reference price and analyse the individual transactions since the involvement in the group distorted both transactions with related and unrelated parties, as all the prices had been determined by other group entities. An appeal was then filed against the decision of the Regional Court with the Supreme Administrative Court. Judgement of the Supreme Administrative Court The court fully agreed with the decision and conclusions of the Regional Court, which it considered to be correct and well reasoned. Excerpts “In the course of the tax audit, the tax administrator found, on the basis of an analysis of the transfer prices, that the complainant bore risks that were beyond its control and that this fact was not reflected in the pricing policy, which was influenced by the connected persons. The influence of related parties resulted in the complainant selling its products below its operating costs and not being compensated for those losses. ” “Given that the complainant could not influence from whom and for how much it would purchase inputs, nor to whom and for how much it would sell its products (output price), the tax authorities considered the transactions carried out to be controlled, since it was the parent company Aisan JP together with its sister companies ACE and ACA that influenced this, although the risks involved were borne by the complainant.” “As regards the plea that the defendant and the Regional Court erred in law in failing to distinguish between transactions with related parties and those with unrelated parties, that plea is also unfounded. In that regard, it should be noted that the complainant was represented by the companies of the Aisan group, which concluded the transactions to which the complainant was bound. It is clear from the commission agreements that the sister companies ACA and ACE did so in relation to all customers, irrespective of whether they were related or unrelated. The e-mail communications also show the influence of the parent company Aisan JP regarding the final approval of the sale. It is clear from the summary of the functions of the original transfer pricing report that the selection and final approval of material suppliers, setting of delivery terms, price negotiations and negotiation of delivery terms with end customers is without the influence of the complainant. These decisions are made by the parent company Aisan JP and its sister companies ACA and ACE, which also determine the final prices and quantities of products. Although the complainant sells production and purchases materials from unrelated parties, all sales plans are provided by related parties of the Aisan group…..Therefore, in the present case, all transactions carried out by the complainant are considered to be controlled transactions on the basis of a function and risk analysis. The conclusion of both the defendant and the Regional Court that it was not appropriate to analyse individual transactions, since related parties influenced all transactions, is therefore correct.” “The Regional Court and the defendant also correctly stated that the reasons given by the complainant for the negative operating profitability cannot be accepted, also because the complainant did not show negative profitability only in 2011, but it was a long-term trend from 2009 to 2012. For these reasons, the administrative authorities were justified in concluding that the ...

A Danish parent in the Maersk group’s oil and gas segment, Maersk Oil and Gas A/S (Mogas), had operating losses for FY 1986 to 2010, although the combined segment was highly profitable. The reoccurring losses was explained by the tax authorities as being a result of the group’s transfer pricing setup. “Mogas and its subsidiaries and branches are covered by the definition of persons in Article 2(1) of the Tax Act, which concerns group companies and permanent establishments abroad, it being irrelevant whether the subsidiaries and branches form part of local joint ventures. Mogas bears the costs of exploration and studies into the possibility of obtaining mining licences. The expenditure is incurred in the course of the company’s business of exploring for oil and gas deposits. The company is entitled to deduct the costs in accordance with Section 8B(2) of the Danish Income Tax Act. Mogas is responsible for negotiating licences and the terms thereof and for bearing the costs incurred in this connection. If a licence is obtained, subsequent expenditure is borne by a subsidiary or branch thereof, and this company or branch receives all revenue from extraction. Mogas shall ensure that the obligations under the licence right towards the State concerned (or a company established by the State for this purpose) and the contract with the independent joint venture participants are fulfilled by the local Mogas subsidiary or permanent establishment. Mogas has revenues from services provided to the subsidiaries, etc. These services are remunerated at cost. This business model means that Mogas will never make a profit from its operations. It must be assumed that the company would not enter into such a business model with independent parties. It should be noted that dividend income is not considered to be business income.” According to the tax authorities Mogas had provided know-how etc. to the subsidiaries in Algeria and Qatar and had also incurred expenses in years prior to the establishment of these subsidiaries. This constituted controlled transactions covered by the danish arm’s length provisions. Hence an estimated assessment was issued in which the additional income corresponded to a royalty rate of approximately 1,7 % of the turnover in the two subsidiaries. In 2018, the Tax Court upheld the decisions and Mogas subsequently appealed to the regional courts. Judgment of the Regional Court The Regional Court held that the subsidiaries in Algeria and Qatar owned the licences for oil extraction, both formally and in fact. In this regard, there was therefore no transaction. Furthermore the explorations studies in question were not completed until the 1990s and Mogas had not incurred any costs for the subsequent phases of the oil extraction. These studies therefore did not constitute controlled transactions. The Court therefore found no basis for an annual remuneration in the form of royalties or profit shares from the subsidiaries in Algeria and Qatar. On the other hand, the Regional Court found that Mogas’s so-called performance guarantees for the subsidiaries in Algeria and Qatar were controlled transactions and should therefore be priced at arm’s length. In addition, the Court found that technical and administrative assistance (so-called time writing) to the subsidiaries in Algeria and Qatar at cost was not in line with what could have been obtained if the transactions had been concluded between independent parties. These transactions should therefore also be priced at arm’s length. As a result, the Court referred the cases back to the tax authorities for reconsideration. Excerpts “It can be assumed that MOGAS’s profit before financial items and tax in the period 1986-2010 has essentially been negative, including in the income years in question 2006-2008, whereas MOGAS’s profit including financial items, including dividends, in the same period has been positive, and the Regional Court accepts that income from dividends cannot be regarded as business income in the sense that dividends received by MOGAS as owner do not constitute payment for transactions covered by section 2 of the Tax Act. However, the Regional Court considers that the fact that MOGAS’s profit before financial items and tax for the period 1986-2010 has been essentially negative cannot in itself justify allowing the tax authorities to make a discretionary assessment.” “As stated above, the performance guarantees provided by MOGAS and the technical and administrative assistance (timewriting) provided by MOGAS constitute controlled transactions covered by Article 2 of the Tax Code. The performance guarantees, which are provided free of charge to the benefit of the subsidiaries, are not mentioned in the transfer pricing documentation, and the Regional Court considers that this provides grounds for MOGAS’s income relating to the performance guarantees to be assessed on a discretionary basis pursuant to Section 3 B(8) of the Tax Control Act currently in force, cf. Section 5(3).” “Already because MOGAS neither participates in a joint venture nor acts as an operator in relation to oil extraction in Algeria and Qatar, the Court considers that MOGAS’ provision of technical and administrative assistance to the subsidiaries is not comparable to the stated industry practice or MOGAS’ provision of services to DUC, where MOGAS acts as an operator. Against this background, the Regional Court considers that the Ministry of Taxation has established that MOGAS’ provision of technical and administrative assistance (timewriting) to the subsidiaries at cost price is outside the scope of what could have been obtained if the agreement had been concluded between independent parties, cf. tax act Section 2 (1).” Only part of the decision have been published. Click here for English translation Click here for other translation ...

Skechers USA ITALIA SRL – a company operating in the sector of the marketing of footwear and accessories – challenged a notice of assessment, relating to FY 2004, by which, at the outcome of a tax audit, its business income was adjusted as a result of the ascertained inconsistency of the transfer prices relating to purchases of goods from the parent company (and sole shareholder) resident in Switzerland. The tax authorities had contested the uneconomic nature of the taxpayer company’s operations, given the losses recognised in various financial years, attributing the uneconomic nature to the artificial manipulation of the transfer prices of the purchases of goods and recalculating, consequently, the negative income component constituted by the aforesaid costs pursuant to Article 110, paragraph 7 of the TUIR, with the consequent non-deductibility of the same to the extent exceeding the normal value of the price of the goods in question. Skechers held that the losses did not derive from the costs of the intra-group purchases of the goods, but from the fixed start-up costs, not compensated by an adequate volume of sales, as an effect also of the competitive Italien market. The provincial and later the regional Tax Commission rejected the taxpayer’s appeal. The judge of appeal held that Skechers had not proved that the losses stemmed from the fixed start-up costs, which – moreover – were found only in relation to the Italien company and not in relation to the distribution companies located in other European countries; it then held that it was Skechers’ burden to prove the arm’s length nature of the costs. Skechers then filed an appeal with the Supreme Court. Judgement of the Supreme Court The Supreme Court set aside the decision and remanded the case to the Regional Tax Commission in a different composition. Excerpts “6. The following principle of law should therefore be stated: “on the subject of the determination of business income, the transfer pricing rules set forth in Article 110, paragraph 7, Presidential Decree no. 917 of 22 December 1986. 917 of 22 December 1986 imposes on the tax authorities the burden of proving the existence of transactions between related companies at a price other than the market price, using in this regard the transfer pricing methods described in the OECD Guidelines as soft law rules; once that burden of proof has been discharged, the taxpayer bears the burden of proving that those transactions took place for market values to be considered normal, having regard to the same stage of marketing, time and place where the goods and services were acquired or rendered, having regard – in particular – to the market context in which the taxpayer was operating”. 7. The judgment under appeal, in so far as it burdened the taxpayer company with the proof of the existence and inherent nature of the fixed operating costs, did not comply with the aforesaid principles, both in so far as the burden of proof lies with the Office, and in so far as the burden of proof must relate to the appropriateness of the transfer prices of the purchases of goods, in the market conditions in which the taxpayer company was required to operate, according to one of the criteria indicated in the OECD Guidelines. Nor can the burden of proof be discharged by alleging the mere uneconomicity of management (even if ascribed to the incidence of the aforesaid purchases), since the judge of the merits must verify the use of one of the methods indicated in the aforesaid Guidelines. The merit judge’s assessment must then be carried out in relation to the context in which the taxpayer company was operating at the time of the assessment, during which there had been a high incidence on the typical management of fixed operating costs, due to the start-up phase, which would have required the realisation of higher sales volumes in order to reach the break-even point. 8. The appeal must therefore be upheld and the contested judgment set aside, with reference back to the court a quo, in a different composition, also for the settlement of the costs of the proceedings.” Click here for English translation Click here for other translation ...

35. The facts in this example are the same as in Example 9, except that Company S now enters into a three-year royalty-free agreement to market and distribute the watches in the country Y market, with no option to renew. At the end of the three-year period, Company S does not enter into a new contract with Primair. 36. Assume that it is demonstrated that independent enterprises do enter into short-term distribution agreements where they incur marketing and distribution expenses, but only where they stand to earn a reward commensurate with the functions performed, the assets used, and the risks assumed within the time period of the contract. Evidence derived from comparable independent enterprises shows that they do not invest large sums of money in developing marketing and distribution infrastructure where they obtain only a short-term marketing and distribution agreement, with the attendant risk of non-renewal without compensation. The potential short-term nature of the marketing and distribution agreement is such that Company S could not, or may not be able to, benefit from the marketing and distribution expenditure it incurs at its own risk. The same factors mean that Company S’s efforts may well benefit Primair in the future. 37. The risks assumed by Company S are substantially higher than in Example 9 and Company S has not been compensated on an arm’s length basis for bearing these additional risks. In this case, Company S has undertaken market development activities and borne marketing expenditures beyond what comparable independent enterprises with similar rights incur for their own benefit, resulting in significantly lower profit margins for Company S than are made by comparable enterprises. The short term nature of the contract makes it unreasonable to expect that Company S has the opportunity of obtaining appropriate benefits under the contract within the limited term of the agreement with Primair. Under these circumstances, Company S is entitled to compensation for its at risk contribution to the value of the R trademark and trade name during the term of its arrangement with Primair. 38. Such compensation could take the form of direct compensation from Primair to Company S for the anticipated value created through the marketing expenditures and market development functions it has undertaken. Alternatively, such an adjustment could take the form of a reduction in the price paid by Company S to Primair for R watches during Years 1 through 3 ...

30. The facts in this example are the same as in Example 9, except that the market development functions undertaken by Company S in this Example 10 are far more extensive than those undertaken by Company S in Example 9. 31. Where the marketer/distributor actually bears the costs and assumes the risks of its marketing activities, the issue is the extent to which the marketer/distributor can share in the potential benefits from those activities. A thorough comparability analysis identifies several uncontrolled companies engaged in marketing and distribution functions under similar long-term marketing and distribution arrangements. Assume, however, that the level of marketing expense Company S incurred in Years 1 through 5 far exceeds that incurred by the identified comparable independent marketers and distributors. Assume further that the high level of expense incurred by Company S reflects its performance of additional or more intensive functions than those performed by the potential comparables and that Primair and Company S expect those additional functions to generate higher margins or increased sales volume for the products. Given the extent of the market development activities undertaken by Company S, it is evident that Company S has made a larger functional contribution to development of the market and the marketing intangibles and has assumed significantly greater costs and assumed greater risks than the identified potentially comparable independent enterprises (and substantially higher costs and risks than in Example 9). There is also evidence to support the conclusion that the profits realised by Company S are significantly lower than the profit margins of the identified potentially comparable independent marketers and distributors during the corresponding years of similar long-term marketing and distribution agreements. 32. As in Example 9, Company S bears the costs and associated risks of its marketing activities under a long-term contract of exclusive marketing and distribution rights for the R watches, and therefore expects to have an opportunity to benefit (or suffer a loss) from the marketing and distribution activities it undertakes. However, in this case Company S has performed functions and borne marketing expenditures beyond what independent enterprises in potentially comparable transactions with similar rights incur for their own benefit, resulting in significantly lower profit margins for Company S than are made by such enterprises. 33. Based on these facts, it is evident that by performing functions and incurring marketing expenditure substantially in excess of the levels of function and expenditure of independent marketer/distributors in comparable transactions, Company S has not been adequately compensated by the margins it earns on the resale of R watches. Under such circumstances it would be appropriate for the country Y tax administration to propose a transfer pricing adjustment based on compensating Company S for the marketing activities performed (taking account of the risks assumed and the expenditure incurred) on a basis that is consistent with what independent enterprises would have earned in comparable transactions. Depending on the facts and circumstances reflected in a detailed comparability analysis, such an adjustment could be based on: Reducing the price paid by Company S for the R brand watches purchased from Primair. Such an adjustment could be based on applying a resale price method or transactional net margin method using available data about profits made by comparable marketers and distributors with a comparable level of marketing and distribution expenditure if such comparables can be identified. An alternative approach might apply a residual profit split method that would split the relevant profits from sales of R branded watches in country Y by first giving Company S and Primair a basic return for the functions they perform and then splitting the residual profit on a basis that takes into account the relative contributions of both Company S and Primair to the generation of income and the value of the R trademark and trade name. Directly compensating Company S for the excess marketing expenditure it has incurred over and above that incurred by comparable independent enterprises including an appropriate profit element for the functions and risks reflected by those expenditures. 34. In this example, the proposed adjustment is based on Company S’s having performed functions, assumed risks, and incurred costs that contributed to the development of the marketing intangibles for which it was not adequately compensated under its arrangement with Primair. If the arrangements between Company S and Primair were such that Company S could expect to obtain an arm’s length return on its additional investment during the remaining term of the distribution agreement, a different outcome could be appropriate ...

Generally speaking, a loss-making uncontrolled transaction should trigger further investigation in order to establish whether or not it can be a comparable. Circumstances in which loss-making transactions/ enterprises should be excluded from the list of comparables include cases where losses do not reflect normal business conditions, and where the losses incurred by third parties reflect a level of risks that is not comparable to the one assumed by the taxpayer in its controlled transactions. Loss-making comparables that satisfy the comparability analysis should not however be rejected on the sole basis that they suffer losses ...

An independent enterprise would not continue loss-generating activities unless it had reasonable expectations of future profits. See paragraphs 1.149-1.151. Simple or low risk functions in particular are not expected to generate losses for a long period of time. This does not mean however that loss-making transactions can never be comparable. In general, all relevant information should be used and there should not be any overriding rule on the inclusion or exclusion of loss-making comparables. Indeed, it is the facts and circumstances surrounding the company in question that should determine its status as a comparable, not its financial result ...

Another example where a taxpayer’s transactions may be combined is related to portfolio approaches. A portfolio approach is a business strategy consisting of a taxpayer bundling certain transactions for the purpose of earning an appropriate return across the portfolio rather than necessarily on any single product within the portfolio. For instance, some products may be marketed by a taxpayer with a low profit or even at a loss, because they create a demand for other products and/or related services of the same taxpayer that are then sold or provided with high profits (e.g. equipment and captive aftermarket consumables, such as vending coffee machines and coffee capsules, or printers and cartridges). Similar approaches can be observed in various industries. Portfolio approaches are an example of a business strategy that may need to be taken into account in the comparability analysis and when examining the reliability of comparables. See paragraphs 1.134-1.138 on business strategies. However, as discussed in paragraphs 1.149-1.151, these considerations will not explain continued overall losses or poor performance over time. Moreover, in order to be acceptable, portfolio approaches must be reasonably targeted as they should not be used to apply a transfer pricing method at the taxpayer’s company-wide level in those cases where different transactions have different economic logic and should be segmented. See paragraphs 2.84-2.85. Finally, the above comments should not be misread as implying that it would be acceptable for one entity within an MNE group to have a below arm’s length return in order to provide benefits to another entity of the MNE group, see in particular paragraph 1.150 ...

A factor to consider in analysing losses is that business strategies may differ from MNE group to MNE group due to a variety of historic, economic, and cultural reasons. Recurring losses for a reasonable period may be justified in some cases by a business strategy to set especially low prices to achieve market penetration. For example, a producer may lower the prices of its goods, even to the extent of temporarily incurring losses, in order to enter new markets, to increase its share of an existing market, to introduce new products or services, or to discourage potential competitors. However, especially low prices should be expected for a limited period only, with the specific object of improving profits in the longer term. If the pricing strategy continues beyond a reasonable period, a transfer pricing adjustment may be appropriate, particularly where comparable data over several years show that the losses have been incurred for a period longer than that affecting comparable independent enterprises. Further, tax administrations should not accept especially low prices (e.g. pricing at marginal cost in a situation of underemployed production capacities) as arm’s length prices unless independent enterprises could be expected to have determined prices in a comparable manner ...

The fact that there is an enterprise making losses that is doing business with profitable members of its MNE group may suggest to the taxpayers or tax administrations that the transfer pricing should be examined. The loss enterprise may not be receiving adequate compensation from the MNE group of which it is a part in relation to the benefits derived from its activities. For example, an MNE group may need to produce a full range of products and/or services in order to remain competitive and realize an overall profit, but some of the individual product lines may regularly lose revenue. One member of the MNE group might realize consistent losses because it produces all the loss-making products while other members produce the profit-making products. An independent enterprise would perform such a service only if it were compensated by an adequate service charge. Therefore, one way to approach this type of transfer pricing problem would be to deem the loss enterprise to receive the same type of service charge that an independent enterprise would receive under the arm’s length principle ...

When an associated enterprise consistently realizes losses while the MNE group as a whole is profitable, the facts could trigger some special scrutiny of transfer pricing issues. Of course, associated enterprises, like independent enterprises, can sustain genuine losses, whether due to heavy start-up costs, unfavourable economic conditions, inefficiencies, or other legitimate business reasons. However, an independent enterprise would not be prepared to tolerate losses that continue indefinitely. An independent enterprise that experiences recurring losses will eventually cease to undertake business on such terms. In contrast, an associated enterprise that realizes losses may remain in business if the business is beneficial to the MNE group as a whole ...

An additional consideration is whether there is a plausible expectation that following the business strategy will produce a return sufficient to justify its costs within a period of time that would be acceptable in an arm’s length arrangement. It is recognised that a business strategy such as market penetration may fail, and the failure does not of itself allow the strategy to be ignored for transfer pricing purposes. However, if such an expected outcome was implausible at the time of the transaction, or if the business strategy is unsuccessful but nonetheless is continued beyond what an independent enterprise would accept, the arm’s length nature of the business strategy may be doubtful and may warrant a transfer pricing adjustment. In determining what period of time an independent enterprise would accept, tax administrations may wish to consider evidence of the commercial strategies evident in the country in which the business strategy is being pursued. In the end, however, the most important consideration is whether the strategy in question could plausibly be expected to prove profitable within the foreseeable future (while recognising that the strategy might fail), and that a party operating at arm’s length would have been prepared to sacrifice profitability for a similar period under such economic circumstances and competitive conditions ...

Timing issues can pose particular problems for tax administrations when evaluating whether a taxpayer is following a business strategy that distinguishes it from potential comparables. Some business strategies, such as those involving market penetration or expansion of market share, involve reductions in the taxpayer’s current profits in anticipation of increased future profits. If in the future those increased profits fail to materialise because the purported business strategy was not actually followed by the taxpayer, the appropriate transfer pricing outcome would likely require a transfer pricing adjustment. However legal constraints may prevent re-examination of earlier tax years by the tax administrations. At least in part for this reason, tax administrations may wish to subject the issue of business strategies to particular scrutiny ...

Business strategies also could include market penetration schemes. A taxpayer seeking to penetrate a market or to increase its market share might temporarily charge a price for its product that is lower than the price charged for otherwise comparable products in the same market. Furthermore, a taxpayer seeking to enter a new market or expand (or defend) its market share might temporarily incur higher costs (e.g. due to start-up costs or increased marketing efforts) and hence achieve lower profit levels than other taxpayers operating in the same market ...

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 ...

The Danish tax authorities had issued a discretionary assessment of the taxable income of Tetra Pak Processing Systems A/S due to inadequate transfer pricing documentation and continuous losses. Judgement of the Supreme Court The Supreme Court found that the TP documentation provided by the company did not comply to the required standards. The TP documentation did state how prices between Tetra Pak and the sales companies had been determined and did not contain a comparability analysis, as required under the current § 3 B, para. 5 of the Tax Control Act and section 6 of the Danish administrative ordinance regarding transfer pricing documentation. Against this background, the Supreme Court found that the TP documentation was deficient to such an extent that it had to be equated with missing documentation. The Supreme Court agreed that Tetra Pak’s taxable income for FY 2005-2009 could be determined on a discretionary basis. According to the Supreme Court Tetra Pak had not proved that the tax authorities’ discretionary assessments were based on an incorrect or deficient basis, or that the assessment had led to a clearly unreasonable result. Hence, there was no basis for setting aside the assessment. The Supreme Court therefore upheld the prior High Court’s decision. In the decision reference is made to OECD 2010 Transfer Pricing Guidelines Importance of Transfer Pricing documentation and comparability analysis: Para 1.6, 2.22, 2.23, 2.78, 3.1, 3.22 and 5.17 Choice of tested party: Para 3.18 Exceptional and extraordinary costs and calculation of net profit indicator/profit level indicator: Para 2.80 Click here for translation ...

A fully fledged Norwegian distributor in the H group was restructured and converted into a Limited risk distributor. The tax authorities issued an assessment where the income of the Norwegian distributor was adjusted to the median in a benchmark study prepared by the tax authorities, based on the “Transactional Net Margin Method” (TNMM method). Decision of the Tax Board In a majority decision, the Tax Board determined that the case should be send back to the tax administration for further processing. Excerpt “…The majority agrees with the tax office that deficits over time may give reason to investigate whether the intra-group prices are set on market terms. However, the case is not sufficiently informed for the tribunal to take a final position on this. In order to determine whether the income has been reduced as a result of incorrect pricing of intra-group transactions and debits, it is necessary to analyze the agreed prices and contract terms. A comparability analysis will be needed, cf. OECD TPG Chapter III, including especially OECD TPG Section 3.4. to be able to determine whether the intra-group prices have been at arm’s length. When analysing the controlled transactions and identifying possible comparable uncontrolled transactions, reference must be made to the comparability factors as instructed in OECD TPG section 1.36. A functional analysis must be performed to identify which party to the contractual relationship is to form the basis for the choice of pricing method in accordance with OECD TPG clause 3.4, step 3, as well as a market analysis to identify how this may affect the price in the controlled transactions. See OECD TPG Section 3.7, step 2. In the majority’s view, the tax office is closest to making the necessary analyzes and assessments of the above matters. The majority therefore believes that the decision should be revoked and sent back to the tax office for possible new processing, cf. the Tax Administration Act § 13-7 (3).” Click here for translation ...

PT Nanindah Mutiara Shipyard Ltd reported losses for FY 2013. The tax authorities issued an assessment where the income of the company was increased by a substantial amount referring to applicable transfer pricing regulations. Nanindah Mutiara Shipyard Ltd filed a complaint with the Tax Court, but the Tax Court upheld the assessment. An application for judicial review was then filed with the Supreme Court. Judgement of the Supreme Court The Supreme Court ruled in favor of Nanindah Mutiara Shipyard Ltd. The Tax Court had erred in assessing facts, data, evidence and application of the law. The decision of the Tax Court was canceled and the petition for judicial review was granted. Losses reported by Nanindah Mutiara Shipyard Ltd were not due to non-arm’s length pricing, but rather exceptional circumstances that occurred at the local company in the years following 2010. Excerpts: ” … a. that the reasons for the Petitioner’s petition for judicial review in the a quo case are positive corrections to Business Circulation amounting to Rp45,920,139,538.00; which the Panel of Judges of the Tax Court maintains can be justified, because after examining and re-examining the arguments put forward in the Memorandum of Review by the Petitioner for Judicial Review in connection with the Counter Memorandum of Review, it can invalidate the facts and weaken the evidence revealed in the trial. as well as legal considerations of the Tax Court Panel of Judges, because in the a quo case in the form of substances that have been examined, decided and tried by the Tax Court Judges there are errors in assessing facts, data, evidence and application of the law as well as real mistakes in it, so that the Supreme Court of Justice canceled the a quo Tax Court decision and tried again with the legal considerations below, because in casu it is related to the evidentiary value that prioritizes the principle of material truth and based on the principle of substance over the form which has fulfilled the Ne Bis Vexari Rule principle as which has required that all administrative actions must be based on applicable laws and regulations. Whereas therefore the object of the dispute is in the form of a positive correction of Business Circulation amounting to Rp.45,920,139,538.00;which have been considered based on facts, evidence and application of the law and decided with the conclusion that the Panel of Judges maintains that there are factual errors and legal errors, so that the Supreme Court of Justice overturned the a quo decision and retrial with the consideration that due to in casu, the relationship with a special relationship, there are indications that the indicator of the current level of profit of the Appellant for the Review Applicant for the 2013 Fiscal Year which is below the normal profit range of similar companies, is not due to the existence of transfer pricing or pricing for transactions between parties that have a special relationship, but due to the impact of riots, causing extraordinary costs and companies not operating at full capacity. Thus, the Transfer Pricing Documentation of the present Appellant for the Review of the Appellant for the 2013 Fiscal Year, thus causing the loss suffered by the current Appellant of the Appeal for the Review of the 2013 Fiscal Year is the effect of extraordinary events in 2010 namely riots. at the shipyard in one of the companies belonging to the business group which is located adjacent to the shipyard of the present Appellant of the Applicant for Judicial Review. Besides that, The Panel of Supreme Court Justices is of the opinion that the decrease in income received by the Appellant now, the Petitioner for Review for the Fiscal Year after the riots, is due to the decline in new shipbuilding projects and the cancellation of orders that have caused ongoing shipbuilding projects to be neglected. decisive factors include the decline in new shipbuilding projects. Whereas on the basis of a state of chaos, it is considered as an extraordinary situation (force majeure) or a state of coercion (overmacht) which will directly result in the assessment of legal obligations on the fulfillment of tax obligations not being in the expected level of position, b. whereas therefore, the reasons for the Petitioner’s application for judicial review can be justified and sufficiently based on law because the arguments submitted are decisive opinions and therefore deserve to be granted and because there is a decision of the Tax Court which clearly contradicts the prevailing laws and regulations. applies as stipulated in Article 91 letter e of Law Number 14 of 2002 concerning the Tax Court and related laws, so that the accrued tax is recalculated into overpayment of Rp3,818,166,381.00; with the following details: …based on the above considerations, according to the Supreme Court, there are sufficient reasons to grant the petition for review;” Click here for translation ...

In all circumstances it will be necessary to consider the specific facts and circumstances when determining whether a so-called “limited-risk” entity could incur losses at arm’s length. This is reflected in the OECD TPG which states that “simple or low risk functions in particular are not expected to generate losses for a long period of time”,22 and therefore holds open the possibility that simple or low risk functions may incur losses in the short-run. In particular, when examining the specific facts and circumstances, the analysis should be informed by the accurate delineation of the transaction and the performance of a robust comparability analysis. For example, where the losses incurred by third parties reflect a level of risks that is not comparable to the one assumed by the taxpayer in its controlled transaction then such a comparable should be excluded from the list of comparables (see paragraph 3.65 of the OECD TPG). 22  Paragraph 3.64 of Chapter III of the OECD TPG ...

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 ...

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

The question in this case was whether royalty payments from a loss making Danish subsidiary Adecco A/S (H1 A/S in the decision) to its Swiss parent company Adecco SA (G1 SA in the decision – an international provider of temporary and permanent employment services active throughout the entire range of sectors in Europe, the Americas, the Middle East and Asia – for use of trademarks and trade names, knowhow, international network intangibles, and business concept were deductible expenses for tax purposes or not. In  2013, the Danish tax authorities (SKAT) had amended Adecco A/S’s taxable income for the years 2006-2009 by a total of DKK 82 million. Adecco A/S submitted that the company’s royalty payments were operating expenses deductible under section 6 (a) of the State Tax Act and that it was entitled to tax deductions for royalty payments of 1.5% of the company’s turnover in the first half of 2006 and 2% up to and including 2009, as these prices were in line with what would have been agreed if the transactions had been concluded between independent parties and thus compliant  with the requirement in section 2 of the Tax Assessment Act (- the arm’s length principle). In particular, Adecco A/S claimed that the company had lifted its burden of proof that the basic conditions for deductions pursuant to section 6 (a) of the State Tax Act were met, and the royalty payments thus deductible to the extent claimed. According to section 6 (a) of the State Tax Act expenses incurred during the year to acquire, secure and maintain income are deductible for tax purposes. There must be a direct and immediate link between the expenditure incurred and the acquisition of income. The company hereby stated that it was not disputed that the costs were actually incurred and that it was evident that the royalty payment was in the nature of operating costs, since the company received significant economic value for the payments. The High Court ruled in favor of the Danish tax authorities and concluded as follows: “Despite the fact that, as mentioned above, there is evidence to suggest that H1 A/S’s payment of royalties for the use of the H1 A/S trademark is a deductible operating expense, the national court finds, in particular, that H1 A/S operates in a national Danish market, where price is by far the most important competitive parameter, that the company has for a very long period largely only deficit, that it is an agreement on payment to the company’s ultimate parent company – which must be assumed to have its own purpose of being represented on the Danish market – and that royalty payments must be regarded as a standard condition determined by G1 SA independent of the market in which the Danish company is working, as well as the information on the marketing costs incurred in the Danish company and in the Swiss company compared with the failure to respond to the relevant provocations that H1 A/S has not lifted the burden of proof that the payments of royalties to the group-affiliated company G1 SA, constitutes a deductible operating expense, cf. section 6 (a) of the State Tax Act. 4.5 and par. 4.6, the national court finds that the company’s royalty payment cannot otherwise be regarded as a deductible operating expense.” Adecco appealed the decision to the Supreme Court. The Supreme Court overturned the decision of the High Court and ruled in favor of Adecco. The Supreme Court held that the royalty payments had the nature of deductible operating costs. The Supreme Court also found that Adecco A/S’s transfer pricing documentation for the income years in question was not insufficient to such an extent that it could be considered equal to lack of documentation. The company’s income could therefore not be determined on a discretionary basis by the tax authorities. Finally, the Supreme Court did not consider that a royalty rate of 2% was not at arm’s length, or that Adecco A/S’s marketing in Denmark of the Adecco brand provided a basis for deducting in the royalty payment a compensation for a marketing of the global brand. Click here for translation ...

SAS RKS, a French subsidiary of the Swedish SKF group, was engaged in manufacturing of bearings. RKS had, with the exception of 2008, had a negative results since 2005. Following an audit for FY 2009 and 2010, the French tax administration by application of the TNMM method, determined that SAS RKS should have a net profit margin of 2.33% in 2009 and 2.62% in 2010. The tax assessment was brought to the Montreuil Administrative Court, and in April 2018 a judgement in favor of the company was issued. This judgement was appealed by the tax authorities to the CAA. The CAA overturned the judgment of the Administrative Court and found in favor of the tax authorities. “The administration has qualified as hidden income the profits mentioned in the preceding paragraphs, transferred by the company RKF to the business units of the SKF group, established abroad. While the applicant does not dispute that the reduction in its prices may constitute income distributed in a concealed manner, it submits that the administration has not adduced evidence of an intention to grant and receive a benefit without consideration. However, it follows from the above that RKS has sold its products at a loss since 2005 and that its purchasers have benefited, during the same period, from transfer prices decided each month by the Swedish parent company AB SFK in order to guarantee them a gross margin of 3 %, irrespective of the cost price of these products to their supplier. Under these conditions, which are unrelated to the formation and negotiation of prices in normal commercial relations, the intention to grant and receive a benefit is established.“ Click here for translation ...

At issue was the question of whether the Danish tax authorities had been entitled to make a discretionary assessment of the taxable income of Icemachine Manufacturer A/S due to inadequate transfer pricing documentation and continuous losses. And if such a discretionary assessment was justified, the question of whether the company had lifted the burden of proof that the tax authorities’ estimates had been clearly unreasonable. The Court ruled that the transfer pricing documentation provided by the company was so inadequate that it did not provide the tax authorities with a sufficient basis for determining whether the arm’s length principle had been followed. The tax authorities had therefore been entitled to make a discretionary assessment of the taxable income. For that purpose the Court found that the tax authorities had been justified in using the TNM method with the Danish company as the tested party, since sufficiently reliable information on the sales companies in the group had not been provided. Click here for translation (Part I) Click here for translation (Part II) ...

A Oy had operated as the marketing and sales company of an international group in Finland. With the exception of 2008, the company’s operations had been unprofitable in 2003-2011, while at the same time the Group’s operations had been profitable overall. A Oy had purchased the products from the contract manufacturers belonging to the group. The method used in the Group’s transfer pricing documentation for product purchases had been characterized as a modified cost-plus / profit margin method (TNMM). The tested parties were contract manufacturers belonging to the group, for whom four comparable independent companies had been found in a search of the Amadeus database. According to the documentation, the EBITDA target margin for the Group’s contract manufacturers was set at two percent. When submitting A Oy’s tax return for 2010, the tax Office had considered, on the basis of the OECD’s 2010 Transfer Pricing Guidelines (paragraphs 1.70 – 1.72), that in independent business transactions the sales company would have received a  compensating adjustment or other equivalent credit as an adjustment. In addition, the tax office had considered that the analysis of the manufacturing companies had not made it possible to assess A Oy’s situation with sufficient reliability in relation to the long-term losses of A Oy’s operations. For this reason, the tax office had used A Oy as a test party when it had determined the company’s arm’s length profit level. Based on its report, the tax office had made an increase in the amount of taxable income reported by the company for the tax year 2010 and 2007-2009. The Supreme Administrative Court held that the loss of the group company did not in itself indicate that the company were to receive a service fee or other consideration from other group companies who could be considered to have benefited from the activities of the loss-making sales company. When determining the market conditionality of a loss-making group company’s transfer prices using the cost-plus or transaction margin method, the OECD transfer pricing guidelines require that a company for which reliable data can be found for the most closely comparable transactions be tested. Taking into account the activities performed by A Oy on the one hand and the contract manufacturers belonging to the A group on the other hand, the risks borne by them and their assets, A Oy should not have been chosen as the tested party. The contract manufacturers belonging to the group should have been selected as the companies to be tested, as had been done in the transfer price documentation of the A group. It had not been alleged in the case that A Oy’s transfer pricing had not been carried out in accordance with the transfer pricing documentation prepared by the Group or that the independent companies referred to in the Group’s transfer pricing documentation were not comparable. Therefore, and because A Oy had presented business reasons for its losses, the Supreme Administrative Court annulled the tax adjustments. Click here for translation ...

Aisan Industry Czech, s.r.o. is a subsidiary within the Japanese Aisan Industry Group which manufactures various engine components – fuel-pump modules, throttle bodies, carburetors for independent car manufactures such as Renault and Toyota. According to the original transfer pricing documentation the Czech company was classified as a limited risk contract manufacturer within the group, but yet it had suffered operating losses for several years. Following a tax audit an assessment was issued resulting in additional corporate income tax for FY 2011 in the amount of CZK 11 897 090, and on top of that a penalty in the amount of CZK 2 379 418. The assessment resulted from application of arm’s length provisions where the profitability of Aisan Industry Czech, s.r.o. had been determined on the basis of the profitability of comparable companies – TNMM method. An appeal was filed by Aisan Industry Czech, s.r.o. with the Regional Court. Judgement of the Regional Court The court dismissed the appeal and upheld the assessment of the tax authorities. In its decision the Regional Court concluded that Aisan Industry Czech, s.r.o. should have been compensated for carrying out manufacturing services to the benefit of the multinational Aisan Industry group. The court also concluded that Aisan Industry Czech, s.r.o. was in fact a contract manufacturer – as stated in the original transfer pricing documentation – and not a full-fledged manufacturer as stated in the later “updated” transfer pricing report in which the FAR profile of the company had been significantly altered after receiving the initial assessment. According to the Regional Court, it had been established that the price of the service negotiated between the Aisan Industry Czech, s.r.o. and its parent company Aisan Industry Co., Ltd. was different from the price that would have been negotiated between independent parties under the same commercial conditions. By selling products to related and unrelated parties at prices determined by the group, Aisan Industry Czech, s.r.o. did not even achieve a minimum level of operating profitability. In FY 2011 Aisan Industry Czech, s.r.o. had a negative profit margin of 3,27 %. According to the court Aisan Industry Czech, s.r.o. should have received a remuneration of CZK 61 080 700 from the Aisan group for the manufacturing services, i.e. the difference between the operating margin it would have achieved at at arm’s length, 1,26 % (the minimum of the profit margin of comparable entities), and the profits it had actually achieved -3.27 %. According to the Regional Court, it was not the pricing of the individual products that was relevant, but rather the overall set-up of Aisan Industry Czech, s.r.o.’s operation within the Aisan group as a contract manufacturer bearing disproportionate risks which were not compensated. Therefore it was not appropriate to set a reference price and analyse the individual transactions since the involvement in the group distorted both transactions with related and unrelated parties, as all the prices had been determined by other group entities. Click here for English Translation Click here for other translation ...

The question in this case was whether royalty payments from a loss making Danish subsidiary Adecco A/S (H1 A/S in the decision) to its Swiss parent company Adecco SA (G1 SA in the decision – an international provider of temporary and permanent employment services active throughout the entire range of sectors in Europe, the Americas, the Middle East and Asia – for use of trademarks and trade names, knowhow, international network intangibles, and business concept were deductible expenses for tax purposes or not. In  2013, the Danish tax authorities (SKAT) had amended Adecco A/S’s taxable income for the years 2006-2009 by a total of DKK 82 million. “Section 2 of the Tax Assessment Act. Paragraph 1 states that, when calculating the taxable income, group affiliates must apply prices and terms for commercial or economic transactions in accordance with what could have been agreed if the transactions had been concluded between independent parties. SKAT does not consider it in accordance with section 2 of the Tax Assessment Act that during the period 2006 to 2009, H1 A/S had to pay royalty to G1 SA for the right to use trademark, “know-how intangibles” and “ international network intangibles ”. An independent third party, in accordance with OECD Guidelines 6.14, would not have agreed on payment of royalties in a situation where there is a clear discrepancy between the payment and the value of licensee’s business. During the period 2006 to 2009, H1 A/S did not make a profit from the use of the licensed intangible assets. Furthermore, an independent third party would not have accepted an increase in the royalty rate in 2006, where the circumstances and market conditions in Denmark meant that higher profits could not be generated. H1 A/S has also incurred considerable sales and marketing costs at its own expense and risk. Sales and marketing costs may be considered extraordinary because the costs are considered to be disproportionate to expected future earnings. This assessment takes into account the licensing agreement, which states in Article 8.2 that the termination period is only 3 months, and Article 8.6, which states that H1 A/S will not receive compensation for goodwill built up during the contract period if the contract is terminated. H1 A/S has built and maintained the brand as well as built up “brand value” on the Danish market. The company has contributed to value of intangible assets that they do not own. In SKAT’s opinion, an independent third party would not incur such expenses without some form of compensation or reduction in the royalty payment, cf. OECD Guidelines 6.36 – 6.38. If H1 A/S was not associated with the trademark owners, H1 A/S would, in SKAT’s opinion, have considered other alternatives such as terminating, renegotiating or entering into more profitable licensing agreements, cf. OECD Guidelines 1.34-1.35. A renegotiation is precisely a possibility in this situation, as Article 8.2 of the license agreement states that the agreement for both parties can be terminated at three months’ notice. The control of the group has resulted in H1 A/S maintaining unfavorable agreements, not negotiating better terms and not seeking better alternatives. In addition, SKAT finds that the continuing losses realized by the company are also due to the Group’s interest in being represented on the Danish market. In order for the Group to service the global customers that are essential to the Group’s strategy, it is important to be represented in Denmark in order to be able to offer contracts in all the countries where the customer has branches. Such a safeguard of the Group’s interest would require an independent third party to be paid, and the company must therefore also be remunerated accordingly, especially when the proportion of global customers in Denmark is significantly lower than in the other Nordic countries.“ Adecco A/S submitted that the company’s royalty payments were operating expenses deductible under section 6 (a) of the State Tax Act and that it was entitled to tax deductions for royalty payments of 1.5% of the company’s turnover in the first half of 2006 and 2% up to and including 2009, as these prices were in line with what would have been agreed if the transactions had been concluded between independent parties and thus compliant  with the requirement in section 2 of the Tax Assessment Act (- the arm’s length principle) . In particular, Adecco A/S claimed that the company had lifted its burden of proof that the basic conditions for deductions pursuant to section 6 (a) of the State Tax Act were met, and the royalty payments thus deductible to the extent claimed. According to section 6 (a) of the State Tax Act expenses incurred during the year to acquire, secure and maintain income are deductible for tax purposes. There must be a direct and immediate link between the expenditure incurred and the acquisition of income. The company hereby stated that it was not disputed that the costs were actually incurred and that it was evident that the royalty payment was in the nature of operating costs, since the company received significant economic value for the payments. The High Court ruled in favor of the Danish tax authorities and concluded as follows: “Despite the fact that, as mentioned above, there is evidence to suggest that H1 A/S’s payment of royalties for the use of the H1 A/S trademark is a deductible operating expense, the national court finds, in particular, that H1 A/S operates in a national Danish market, where price is by far the most important competitive parameter, that the company has for a very long period largely only deficit, that it is an agreement on payment to the company’s ultimate parent company – which must be assumed to have its own purpose of being represented on the Danish market – and that royalty payments must be regarded as a standard condition determined by G1 SA independent of the market in which the Danish company is working, as well as the information on the marketing costs incurred in the Danish company and in the Swiss company compared with the failure to respond to ...

The Swedish Branch of Yazaki Europe Ltd had been heavily lossmaking for more than five years. The Branch only had a limited number of customers in Sweden and where it acted as a simple information exchange provider. The branch had limited risks, as all risk related to R&D functions were located outside Sweden. Excerpt from the Judgement of the Court “…the District Court finds that the branch has had limited opportunities to influence the costs of the products, the choice of suppliers and service providers regarding the development of the products in the projects run in collaboration with the Swedish customers, and price to the customer. Furthermore, the branch has been referred to make purchases in the currencies that result from the group structure. The branch states that…the work done by the branch has been of such scope and importance that significant people functions are to be considered in the branch for virtually all risks that can be associated with production and development. – the sale of the goods and services sold from the branch. The branch also states that the branch’s Branch Manager was the CEO and certified part of the Electronics & Instrumentation Business Unit (EIBU), a collaboration between various business units within YEL. The branch relies on a statement from expert Roberto Bernales Soriano. …The job descriptions, agreements and protocols, as well as the investigation in general, do not, in the opinion of the Administrative Court, support any decisive decision in the branch or that the head office’s role should have been limited to such passive decision-making as is discussed in the expert opinion cited by the branch. The investigation does not therefore support that it is in the branch that most of the risks and assets associated with the production for the sale in the branch have been handled. Deloitte’s functional analysis and benchmarking study as well as other studies were conducted in 2015, ie. in retrospect. …The Court of Appeal considers that the value of the functional analysis and the new benchmarking study as well as other studies is limited. … the District Court considers that the branch was primarily responsible for sales to Swedish customers, have been collectors and intermediaries of information to and from customers and other units. The TP documentation and other investigations show that the branch has not borne the risks posed by the branch. In view of the activities carried out in the branch, the limited functions that existed in the branch and the limited risks borne by the branch, there is clear support for the notion that the branch has been a service provider, which should have reported a stable profit during the years that is now in question and not such a risk-bearing entity as the branch thinks. It is clear from the investigation that the losses were incurred as a result of the day-to-day sales operations in the branch and not because the branch has taken such risks as an entrepreneur takes. Thus, it is clear that the reported profit does not reflect the financial result the branch would have had if it had been an independent company. … In order to be able to estimate the result in this case, a discretionary assessment must be made. …The Swedish Tax Agency has taken into account the existing investigation and made relevant comparisons. In the light of what is stated in the TP documentation on the Group’s remuneration levels for the production units , for management and for design and development services, the profit assessed by the Swedish Tax Agency – the margin of 2 per cent for the branch in the current year, is considered prudently estimated.“ Click here for translation ...

The Swedish branch of Technology Partners International Europe Ltd. was loss-making. The branch had no significant people functions but only two employees performing low value-added services. From the Judgement of the Court of Appeal “The distribution of revenue and costs between a British company and its Swedish branch is regulated for the current tax years in Article 7 of the 1983 double taxation agreement with the United Kingdom. Further guidance on the application of this issue can be obtained in the 2008 OECD report on profit allocation. A two-step test according to the so-called functional separate entity approach, as described in the administrative law, must be done. The Court of Appeal agrees, in light of the information provided by the branch during the Swedish Tax Agency’s investigation and because the Nordic manager cannot be linked to the branch, in the administrative court’s assessment that the branch has in the current years lacked so-called significant people functions. Nor has the branch had any function which has meant financially significant activities or areas of responsibility. It is therefore a so-called low risk service provider vis-à-vis the head office. The Swedish Tax Agency has used the net margin method to determine the arm’s length level in the distribution of income. The work has been based on the costs to be attributed to the branch and used a profit margin of 5% on the basis that the branch may in any case be considered to provide so-called low value adding services. The branch has referred to ongoing restructuring work in the Nordic organization in the Group, market and business strategic aspects as well as the assessment made in the Group’s internal pricing policy. However, the Tax Agency may be deemed to have shown that the branch’s income and expenses must be determined in accordance with the appealed decisions. What the branch has presented does not change this assessment. The appeal must therefore be rejected in this part.” Click here for translation ...

A Swiss company provided administration and other services to trusts. According to the company a related party in the Seychelles handled the daily business and received remuneration in accordance with an intra-group service agreement. Due to the service fees paid the Swiss company reported losses. Following an audit the tax administration issued an assessment where the fees paid to the related company in the Seychelles had been determined using the cost plus (5%) method. Judgement of the Supreme Court The court dismissed the appeal of A. SA and upheld the assessment of the tax authorities. The Court confirmed that the Seychelles company only performed routine functions without assumption of any significant risk. The cost plus 5% remuneration was therefore confirmed. Excerpts “4.6. According to the OECD Committee on Fiscal Affairs, by referring to the conditions that would prevail between independent enterprises for comparable transactions (i.e. for “comparable open market transactions”) in making the profit adjustment, the arm’s length principle takes the approach of treating the members of a multinational group as separate entities. In doing so, the focus is on the nature of the transactions between the members of the multinational group and whether the terms and conditions of those controlled transactions differ from those that would be obtained for comparable transactions in the open market. This analysis is referred to as “comparability analysis” (OECD Guidelines 2010, § 1.6). The OECD Committee on Fiscal Affairs clarifies that the application of the arm’s length principle is generally based on a comparison of the terms of a transaction between associated enterprises and those of a transaction between independent enterprises. For such a comparison to be meaningful, the economic characteristics of the situations considered must be sufficiently comparable (OECD Guidelines 2010, § 1.33). Five characteristics or “comparability factors” may be important in assessing comparability: the characteristics of the goods or services transferred, the functions performed by the parties (taking into account the assets deployed and the risks assumed), the contractual terms, the economic circumstances of the parties, and the industrial and business strategies pursued by the parties (OECD Guidelines 2010, § 1.36). In the context of a benchmarking exercise, the examination of these five factors is inherently twofold, as it involves analysing the factors that affect the taxpayer’s controlled transactions and those that affect comparable transactions in the open market (OECD Guidelines 2010, § 1.38). In the absence of comparable transactions, the arm’s length price is determined by other methods, such as the cost plus method. This method consists in particular in determining the costs incurred by the company providing the service, to which an appropriate margin is added so as to obtain an appropriate profit taking into account the functions performed and the market conditions (judgment 2C_11/2018 of 10 December 2018, para. 7.4). ” “The appellant does not dispute that, with the exception of the 2011 business year, which showed an accounting profit of CHF 155,319, it made losses during the years 2008 to 2012 and declared zero taxable profits, taking into account the losses carried forward, for all tax periods. It also did not dispute that the customers had no contact with the subsidiary, which had only one customer, the parent company, that the parent company bore all the marketing and canvassing costs, as well as the entire salary of the director, that the contracts were concluded solely between the parent company and the customer, that the people working for the subsidiary were less qualified than those working for the parent company, that the staff of the subsidiary performed purely executory tasks ordered by the parent company, and finally that the risks with regard to the customer were borne by the parent company. The asymmetry between the appellant’s successive losses and the totality of its tasks and expenses, while the subsidiary provided only low-value-added services, was a sufficient indication that the price of the services provided by the subsidiary was disproportionate (see OECD Principles 2010, § 1.70). In these circumstances, the previous court could rightly consider that the burden of proof was reversed and that it was up to the appellant to show that the cost of the services in question was commercially justified. The claim that the rules on the allocation of the burden of proof had been violated was rejected. 6.2. The appellant complains in vain that the previous instance confirmed the application of the cost-plus method instead of the comparable market transaction method. It fails to see that the latter method, as explained above (see recital 4.6), requires a twofold examination, since it involves analysing the five comparability factors, including the functions performed by the parties (taking into account the assets used and the risks assumed), which have an impact both on the taxpayer’s controlled transactions and on comparable transactions on the open market. In the present case, the previous instance rightly found that the respondent authority had analysed the relationship between the appellant and the subsidiary, the content of the service contract of 6 February 2009, the functions performed by the appellant, in particular marketing and prospecting, and the allocation of commercial risks, whereas the appellant, wrongly arguing that the comparability analysis had been wrongly defined, in particular with regard to the company’s cost structure (see The appellant, wrongly arguing that the comparability analysis was incorrectly defined, in particular with regard to the company’s cost structure (cf. appeal memorandum, p. 5), confined itself to providing extracts from pages found on the internet setting out the prices charged by its competitors. However, it appears, as the previous court rightly held, that these documents do not make it possible to ascertain that the transactions in question are indeed free market transactions comparable to those carried out between the appellant and its subsidiary as described by the respondent authority. The appellant, who bears the burden of proof (see recital 6.1 above), has therefore failed to demonstrate that the prices charged by its subsidiary were commercially justified, having regard to comparable transactions on the free market. It follows that the previous ...

The Italian company J.T.G.P spa, a subsidiary in a multinational pharma group ALPHA J, had recorded operating losses for fiscal years 1997 to 2013, where, at a consolidated level, the group had showed positive results. According to the Italian tax authorities, the reason why the Italian company was still in operation was due to the fact that the group had an interest in keeping an international profile, and to that end the Italian company performed marketing activities benefiting the Group. An assessment was issued where the taxable income of the Italian company was added compensation for inter-company marketing services carried out by the Italian company on behalf of the group. The company argued that the pharmaceutical market and the governmental policy on the prices of medicines in Italy was the reason for the losses. In support of this claim the company submitted broad documentary evidence during the audit. Judgement of the regional Court The Court held in favor of the taxpayer. According to the Court, the company had demonstrated that the reasons for the losses were not the result of improper transfer pricing policies, but rather local market conditions – drug prices, etc. Furthermore, the court found that no conclusive evidence had been provided by the tax authorities to support the existence of “hidden” marketing services performed by the Italian company to the benefit of the group. Excerpt “The existence of losses has been demonstrated by the taxpayer where the type of products marketed and the specificity of the Italian pharmaceutical market, which is stationary as a result of the forced reduction in the prices of reimbursable drugs and the regulation of price increases for C-range products and the difficulty of competing with larger groups, have been highlighted. In addition, the company does not operate in the field of generic products but deals exclusively with general practitioners and specialists and distributes its products through a network of pharmaceutical wholesalers who, in turn, serve pharmacies throughout the country and is subject to government policies regarding the pricing of pharmaceutical products. In any event, it should be noted that, from a statutory point of view, the company had achieved positive results in 2013 and in subsequent years in terms of net income, as shown by the financial statements for the years ended 31 December 2013, 31 December 2014, 31 December 2015 and 31 December 2016 on file, nor did the Office prove that the services had resulted in an advantage for the group, having limited itself to presumptions.“ Click here for English translation Click here for other translation ...

In this case Nestlé Zambia had reported continuous losses for more than five years. Following an Transfer Pricing audit covering years 2010 – 2014, the tax administration  issued an assessment whereby profits were adjusted to ZMW 56,579,048 resulting in additional taxes of ZMW13,860,103 plus penalties and other levies. The assessment was based on Nestlé Zambia being characterised as a limited risk distributor instead of a full fledged dristributor. Nestlé  Zambia held that the tax administrations characterisation of the entity as a limited risk distributor was incorrect and that the assessment had not been performed in accordance with the arm’s length principle.  The Tribunal ruled in favor of Nestlé, except for it’s position on the characterisation of the entity as a limited risk distributor (ground four cf. the excerp below). “The summary of our findings is  that  there  was  basis  for  initiating  a  transfer pricing audit in this case because as has been stated in  Paragraph  1.129  of  the OECD Guidelines that, “When an associated enterprise consistently realises losses while the Multinational enterprise group as a whole is profitable, the facts could trigger some special scrutiny of transfer pricing issues.”  We opine that the Appellant being in continuous loss making position,  triggered  an  enquiry  into  transfer  pricing  issues but the manner in  which  the  Respondent  went  about  the  enquiry  was wrong. There could be transfer pricing issues that require  scrutiny  particularly  in light of  the  testimony  from  AWl  that  the  Appellant  is  continuously  making losses while it’s related parties are making profits. The Appellant succeeds in Grounds One, Two, Three, Five and Six but fails in Ground Four. The net effect is therefore that the assessment by the Respondent that the Appellant was liable to pay a sum of ZMW13,860,103.00 was wrongly arrived at. This is so because the said assessment was based on inaccurate transfer pricing results emanating from use of an inappropriate transfer pricing method, disproportionate comparables and an unjustified add back of unrealized exchange losses. By reason of the foregoing, the assessment by the Respondent is accordingly and hereby set aside.” ...

The Finnish tax authorities had made a transfer pricing adjustment to a Finnish marketing and sales subsidiary with continuous losses. The tax authorities had identified a “hidden” services transaction between the Finnish subsidiary and an unidentified foreign group company. The Administrative Court ruled in favor of the tax authorities. The adjustment was not considered by the Court as a recharacterisation. Reference was made to TPG 2010, paragraphs 1.34, 1.42 to 1.49, 1.64, 1.65 and 1.70 to 1.72. Click here for translation ...

The issue in this case was whether tax administration could tax a “non-existent income” through the “deeming provisions” of s 98 of Zimbabwe’s Income Tax Act. A lease agreement and a separate logistical agreement had been entered by CRS Ltd and a related South African company, for the lease of its mechanical trucks, trailers and tankers for a fixed rental. The tax payer contended that the rentals in the agreements were fair and reasonable. The tax administration contended that they were outrageously low so as to constitute under invoicing and tax avoidance. The court ruled in favor of the tax administration. Excerps from the Judgement: “Where any transaction, operation or scheme (including a transaction, operation or scheme involving the alienation of property) has been entered into or carried out, which has the effect of avoiding or postponing liability for any tax or of reducing the amount of such liability, and which in the opinion of the Commissioner, having regard to the circumstances under which the transaction, operation or scheme was entered into or carried out- (a) was entered into or carried out by means or in a manner which would not normally be employed in the entering into or carrying out of a transaction, operation or scheme of the nature of the transaction, operation or scheme in question; or (b) has created rights or obligations which would not nonnally be created between persons dealing at arm’s length under a transaction, operation or scheme of the nature of the transaction, operation or scheme in question; and the Commissioner is of the opinion that the avoidance or postponement of such liability or the reduction of the amount of such liability was the sole purpose or one of the main purposes of the transaction, operation or scheme, the Commissioner shall determine the liability for any tax and the amount thereof as if the transaction, operation or scheme had not been entered into or carried out, or in such manner as in the circumstances of the case he considers appropriate for the prevention or diminution of such avoidance, postponement or reduction.” “Accordingly, I agree with Mr Bhebhe that the agreements had the stipulated effect of avoiding or reducing the appellant’s liability for income tax. The circumstances prevailing at the time the agreement was entered into or carried out In the hyperinflationary era, the appellant averred that it could not secure local contracts that would enable it to fully utilize all its assets. The local currency Jost value at an alarming rate. The pricing of transport services became a nightmare. The income derived from transport services could not sustain the local operations. It was faced with the spectre of liquidation and staff retrenchments. The effect of which was that its loyal and skilled manpower mainly consisting of approximately 110 drivers would lose their only source of livelihood for themselves and their families while the company mechanical horses and trailers would deteriorate through disuse. The appellant could not access the foreign currency required to purchase spare parts and fuel necessary to keep the local operations running.” “It is a notorious fact of commercial life that related parties enter into contractual amngements. I did not discern any abnormalities in the nature of the agreements nor in the identities of the signatories. There was however an admixture of the normal and abnormal in the manner in which the agreements were carried out. For starters, the appellant overemphasized the indisputable uniqueness of the manner in which the agreements were carried out. In the letter of 24 October 2013 at p 50.1 para 11 the external accountants for the appellant wrote that “the appellant’s position is unique in the transport regime of Zimbabwe and there is no other haulier which provides a similar service.” The same point was repeated in the letter of 6 December 2013 at p 45.1 in para 1.2 where the same accountants indicated that they “were unaware of any Zimbabwean company which operates in the same unique situation as the appellant.” “In assessing the information availed to the Commissioner by the appellant and to this Court by both the appellant and the Commissioner, I am satisfied the agreements were carried out in a manner which would not normally be employed in such transactions. In the light of the formulation of Trollip JA in Hicklin v Secretary for Inland Revenue, supra, it appears to me that the two parties were not acting at arm’s length.” “It was clear that each party derived tangible benefits from the agreements. The related party had the right to lease the equipment and the obligation to pay rentals and maintain the equipment. The appellant received a fixed rental. The obligation to meet the maintenance and running expenses was unique and abnonnal. The fixed rentals which negated the cost plus mark-up principle was abnormal and would not have been concluded by parties dealing at arm’s length.” “It seems trite to me that the purpose of a private company is to make a profit. The appellant is not a non-profit making organisation. The appellant was content with the untenable situation in which it made and continues to make losses without any prospects of ever making a profit. It seems to me that the fixed rental was deliberately designed to ensure that the appellant would remain viable enough to survive liquidation and costly retrenchments and at the same avoid or reduce its income tax liability.” “I am satisfied that the avoidance or reduction of income tax liability was one of the main purposes of the agreement (s).” “In my view, the transactions undertaken by the appellant fell into the all-embracing provisions of s 98. The respondent correctly invoked this provision in assessing the appellant to income tax in each of the four tax years in question.” “The appellant strongly argued against the alteration of the contract of lease concluded between the related parties by the respondent. While Mr Bhebhe conceded that the respondent did not have the legal authority to alter the contract of the related parties ...

35. The facts in this example are the same as in Example 9, except that Company S now enters into a three-year royalty-free agreement to market and distribute the watches in the country Y market, with no option to renew. At the end of the three-year period, Company S does not enter into a new contract with Primair. 36. Assume that it is demonstrated that independent enterprises do enter into short-term distribution agreements where they incur marketing and distribution expenses, but only where they stand to earn a reward commensurate with the functions performed, the assets used, and the risks assumed within the time period of the contract. Evidence derived from comparable independent enterprises shows that they do not invest large sums of money in developing marketing and distribution infrastructure where they obtain only a short-term marketing and distribution agreement, with the attendant risk of non-renewal without compensation. The potential short-term nature of the marketing and distribution agreement is such that Company S could not, or may not be able to, benefit from the marketing and distribution expenditure it incurs at its own risk. The same factors mean that Company S’s efforts may well benefit Primair in the future. 37. The risks assumed by Company S are substantially higher than in Example 9 and Company S has not been compensated on an arm’s length basis for bearing these additional risks. In this case, Company S has undertaken market development activities and borne marketing expenditures beyond what comparable independent enterprises with similar rights incur for their own benefit, resulting in significantly lower profit margins for Company S than are made by comparable enterprises. The short term nature of the contract makes it unreasonable to expect that Company S has the opportunity of obtaining appropriate benefits under the contract within the limited term of the agreement with Primair. Under these circumstances, Company S is entitled to compensation for its at risk contribution to the value of the R trademark and trade name during the term of its arrangement with Primair. 38. Such compensation could take the form of direct compensation from Primair to Company S for the anticipated value created through the marketing expenditures and market development functions it has undertaken. Alternatively, such an adjustment could take the form of a reduction in the price paid by Company S to Primair for R watches during Years 1 through 3 ...

30. The facts in this example are the same as in Example 9, except that the market development functions undertaken by Company S in this Example 10 are far more extensive than those undertaken by Company S in Example 9. 31. Where the marketer/distributor actually bears the costs and assumes the risks of its marketing activities, the issue is the extent to which the marketer/distributor can share in the potential benefits from those activities. A thorough comparability analysis identifies several uncontrolled companies engaged in marketing and distribution functions under similar long-term marketing and distribution arrangements. Assume, however, that the level of marketing expense Company S incurred in Years 1 through 5 far exceeds that incurred by the identified comparable independent marketers and distributors. Assume further that the high level of expense incurred by Company S reflects its performance of additional or more intensive functions than those performed by the potential comparables and that Primair and Company S expect those additional functions to generate higher margins or increased sales volume for the products. Given the extent of the market development activities undertaken by Company S, it is evident that Company S has made a larger functional contribution to development of the market and the marketing intangibles and has assumed significantly greater costs and assumed greater risks than the identified potentially comparable independent enterprises (and substantially higher costs and risks than in Example 9). There is also evidence to support the conclusion that the profits realised by Company S are significantly lower than the profit margins of the identified potentially comparable independent marketers and distributors during the corresponding years of similar long-term marketing and distribution agreements. 32. As in Example 9, Company S bears the costs and associated risks of its marketing activities under a long-term contract of exclusive marketing and distribution rights for the R watches, and therefore expects to have an opportunity to benefit (or suffer a loss) from the marketing and distribution activities it undertakes. However, in this case Company S has performed functions and borne marketing expenditures beyond what independent enterprises in potentially comparable transactions with similar rights incur for their own benefit, resulting in significantly lower profit margins for Company S than are made by such enterprises. 33. Based on these facts, it is evident that by performing functions and incurring marketing expenditure substantially in excess of the levels of function and expenditure of independent marketer/distributors in comparable transactions, Company S has not been adequately compensated by the margins it earns on the resale of R watches. Under such circumstances it would be appropriate for the country Y tax administration to propose a transfer pricing adjustment based on compensating Company S for the marketing activities performed (taking account of the risks assumed and the expenditure incurred) on a basis that is consistent with what independent enterprises would have earned in comparable transactions. Depending on the facts and circumstances reflected in a detailed comparability analysis, such an adjustment could be based on: Reducing the price paid by Company S for the R brand watches purchased from Primair. Such an adjustment could be based on applying a resale price method or transactional net margin method using available data about profits made by comparable marketers and distributors with a comparable level of marketing and distribution expenditure if such comparables can be identified. An alternative approach might apply a residual profit split method that would split the combined profits from sales of R branded watches in country Y by first giving Company S and Primair a basic return for the functions they perform and then splitting the residual profit on a basis that takes into account the relative contributions of both Company S and Primair to the generation of income and the value of the R trademark and trade name. Directly compensating Company S for the excess marketing expenditure it has incurred over and above that incurred by comparable independent enterprises including an appropriate profit element for the functions and risks reflected by those expenditures. 34. In this example, the proposed adjustment is based on Company S’s having performed functions, assumed risks, and incurred costs that contributed to the development of the marketing intangibles for which it was not adequately compensated under its arrangement with Primair. If the arrangements between Company S and Primair were such that Company S could expect to obtain an arm’s length return on its additional investment during the remaining term of the distribution agreement, a different outcome could be appropriate ...

Generally speaking, a loss-making uncontrolled transaction should trigger further investigation in order to establish whether or not it can be a comparable. Circumstances in which loss-making transactions/ enterprises should be excluded from the list of comparables include cases where losses do not reflect normal business conditions, and where the losses incurred by third parties reflect a level of risks that is not comparable to the one assumed by the taxpayer in its controlled transactions. Loss-making comparables that satisfy the comparability analysis should not however be rejected on the sole basis that they suffer losses ...

An independent enterprise would not continue loss-generating activities unless it had reasonable expectations of future profits. See paragraphs 1.129-1.131. Simple or low risk functions in particular are not expected to generate losses for a long period of time. This does not mean however that loss-making transactions can never be comparable. In general, all relevant information should be used and there should not be any overriding rule on the inclusion or exclusion of loss-making comparables. Indeed, it is the facts and circumstances surrounding the company in question that should determine its status as a comparable, not its financial result ...

Another example where a taxpayer’s transactions may be combined is related to portfolio approaches. A portfolio approach is a business strategy consisting of a taxpayer bundling certain transactions for the purpose of earning an appropriate return across the portfolio rather than necessarily on any single product within the portfolio. For instance, some products may be marketed by a taxpayer with a low profit or even at a loss, because they create a demand for other products and/or related services of the same taxpayer that are then sold or provided with high profits (e.g. equipment and captive aftermarket consumables, such as vending coffee machines and coffee capsules, or printers and cartridges). Similar approaches can be observed in various industries. Portfolio approaches are an example of a business strategy that may need to be taken into account in the comparability analysis and when examining the reliability of comparables. See paragraphs 1.114-1.118 on business strategies. However, as discussed in paragraphs 1.129-1.131, these considerations will not explain continued overall losses or poor performance over time. Moreover, in order to be acceptable, portfolio approaches must be reasonably targeted as they should not be used to apply a transfer pricing method at the taxpayer’s company-wide level in those cases where different transactions have different economic logic and should be segmented. See paragraphs 2.84-2.85. Finally, the above comments should not be misread as implying that it would be acceptable for one entity within an MNE group to have a below arm’s length return in order to provide benefits to another entity of the MNE group, see in particular paragraph 1.130 ...

A factor to consider in analysing losses is that business strategies may differ from MNE group to MNE group due to a variety of historic, economic, and cultural reasons. Recurring losses for a reasonable period may be justified in some cases by a business strategy to set especially low prices to achieve market penetration. For example, a producer may lower the prices of its goods, even to the extent of temporarily incurring losses, in order to enter new markets, to increase its share of an existing market, to introduce new products or services, or to discourage potential competitors. However, especially low prices should be expected for a limited period only, with the specific object of improving profits in the longer term. If the pricing strategy continues beyond a reasonable period, a transfer pricing adjustment may be appropriate, particularly where comparable data over several years show that the losses have been incurred for a period longer than that affecting comparable independent enterprises. Further, tax administrations should not accept especially low prices (e.g. pricing at marginal cost in a situation of underemployed production capacities) as arm’s length prices unless independent enterprises could be expected to have determined prices in a comparable manner ...

The fact that there is an enterprise making losses that is doing business with profitable members of its MNE group may suggest to the taxpayers or tax administrations that the transfer pricing should be examined. The loss enterprise may not be receiving adequate compensation from the MNE group of which it is a part in relation to the benefits derived from its activities. For example, an MNE group may need to produce a full range of products and/or services in order to remain competitive and realize an overall profit, but some of the individual product lines may regularly lose revenue. One member of the MNE group might realize consistent losses because it produces all the loss-making products while other members produce the profit-making products. An independent enterprise would perform such a service only if it were compensated by an adequate service charge. Therefore, one way to approach this type of transfer pricing problem would be to deem the loss enterprise to receive the same type of service charge that an independent enterprise would receive under the arm’s length principle ...

When an associated enterprise consistently realizes losses while the MNE group as a whole is profitable, the facts could trigger some special scrutiny of transfer pricing issues. Of course, associated enterprises, like independent enterprises, can sustain genuine losses, whether due to heavy start-up costs, unfavourable economic conditions, inefficiencies, or other legitimate business reasons. However, an independent enterprise would not be prepared to tolerate losses that continue indefinitely. An independent enterprise that experiences recurring losses will eventually cease to undertake business on such terms. In contrast, an associated enterprise that realizes losses may remain in business if the business is beneficial to the MNE group as a whole ...

An additional consideration is whether there is a plausible expectation that following the business strategy will produce a return sufficient to justify its costs within a period of time that would be acceptable in an arm’s length arrangement. It is recognised that a business strategy such as market penetration may fail, and the failure does not of itself allow the strategy to be ignored for transfer pricing purposes. However, if such an expected outcome was implausible at the time of the transaction, or if the business strategy is unsuccessful but nonetheless is continued beyond what an independent enterprise would accept, the arm’s length nature of the business strategy may be doubtful and may warrant a transfer pricing adjustment. In determining what period of time an independent enterprise would accept, tax administrations may wish to consider evidence of the commercial strategies evident in the country in which the business strategy is being pursued. In the end, however, the most important consideration is whether the strategy in question could plausibly be expected to prove profitable within the foreseeable future (while recognising that the strategy might fail), and that a party operating at arm’s length would have been prepared to sacrifice profitability for a similar period under such economic circumstances and competitive conditions ...

Timing issues can pose particular problems for tax administrations when evaluating whether a taxpayer is following a business strategy that distinguishes it from potential comparables. Some business strategies, such as those involving market penetration or expansion of market share, involve reductions in the taxpayer’s current profits in anticipation of increased future profits. If in the future those increased profits fail to materialise because the purported business strategy was not actually followed by the taxpayer, the appropriate transfer pricing outcome would likely require a transfer pricing adjustment. However legal constraints may prevent re-examination of earlier tax years by the tax administrations. At least in part for this reason, tax administrations may wish to subject the issue of business strategies to particular scrutiny ...

Business strategies also could include market penetration schemes. A taxpayer seeking to penetrate a market or to increase its market share might temporarily charge a price for its product that is lower than the price charged for otherwise comparable products in the same market. Furthermore, a taxpayer seeking to enter a new market or expand (or defend) its market share might temporarily incur higher costs (e.g. due to start-up costs or increased marketing efforts) and hence achieve lower profit levels than other taxpayers operating in the same market ...

Herbalife International India is a subsidiary of HLI Inc., USA. It is engaged in the business of dealing in weight management, food and dietary supplements and personal care products. The return of income for the assessment year 2006-07 was filed declaring Nil income. The Indian company had paid royalties and management fees to its US parent and sought to justify the consideration paid to be at arm’s length. In the transfer pricing documentation the Transactional Net Margin Method (TNMM) had been selected as the most appropriate method for the purpose of bench marking the transactions. The case was selected for scrutiny by the tax authorities and following an audit, deductions for administrative services were denied and royalty payments were reduced. Disagreeing with the assessment Herbalife filed an appeal. Decision of the Income Tax Appellate Tribunal The Tax Appellate Tribunal dismissed the appeal of Herbalife and upheld the tax assessment. Excerpts “The appellant had not filed any additional evidences to prove the administrative services/technical knowhow are actually received by the appellant and thus the assessee company had failed to discharge this onus of proving this aspect. Therefore, even as per the provisions of Indian Evidence Act, the presumption can be drawn that the assessee has no evidence to prove this aspect. Therefore, the AO/TPO was justified in adopting the ALP in respect of payment of administrative services and royalty at Nil. Thus, the grounds of appeal in ground Nos. 2 to 7 are dismissed. In respect of the other grounds of appeal, since we held that there was no proof of receipt of administrative services as well as technical knowhow which is used in the process of manufacturing activity, the question of bundling of transaction or aggregating all other transactions does not arise.” “Thus all the grounds of appeal relating to the royalty and administrative services have been dismissed. Then the only ground of appeal that survives is ground IT(TP)A No.1406/Bang/2010 IT(TP)A No.924/Bang/2012 relating to uphold of disallowance on account of doubtful advance written off of Rs.1,20,16,395/-. The brief facts surrounding this addition are as under:” ...

A Russian subsidiary of the Suzuki/Itochu group had been loss making in 2009. Following an audit the tax authority concluded, that the losses incurred by the Russian distributor were due to non-arm’s length transfer pricing within the group and excessive deduction of costs. Decision of the Court The Court decided in favor of the tax authorities and upheld the assessment. “In view of the above, the appeal court considers that the courts’ conclusions that the Inspectorate had not proved that it was impossible to apply the first method for determining the market price and that the Inspectorate had incorrectly applied the resale price method were unfounded.” “In this light, the courts’ conclusions that the Inspectorate incorrectly applied the second method of determining the market price are unfounded.” “In such circumstances, the Inspectorate’s conclusion on the overstatement of the purchase price of vehicles is based on the application of market data and made in compliance with Article 40 of the Tax Code. The courts had no grounds to satisfy the applicant’s claims for the recognition of the Inspectorate’s decision in this part.” “The rest of the judicial acts are lawful and justified. In accordance with Article 252 of the Tax Code recognizes expenses reasonable (economically justified) and documented costs, performed (incurred) by the taxpayer. Herewith, any expenses are considered as expenses on condition that they were incurred for the realization of activities aimed at receiving income.” An appeal filed by Suzuki to the Russian Supreme Court was later dismissed in December 2016. Click here for English Translation ...

L’oreal in India is engaged in manufacturing and distribution of cosmetics and beauty products. In respect of the distribution L’oreal had applied the RPM by benchmarking the gross margin of at 4o.80% against that of comparables at 14.85%. The tax administration rejected the RPM method on the basis that the L’oreal India was consistently incurring losses and the gross margins cannot be relied upon because of product differences in comparables. Accordingly, the tax administration applied Transactional Net Margin Method. L’oreal argued that the years of losses was due to a market penetration strategy in India – not non-arm’s-length pricing of transactions. The comparables had been on the Indian market much longer than L’oreal and had established themselves firmly in the Indian market. The Appellate Tribunal observed that L’oreal India buys products from its parent and sells to unrelated parties without any further processing. According to the OECD TPG, in such a situation, RPM is the most appropriate transfer pricing method. L’oreal India had also produced evidence from its parent that margin earned by the parent on supplies to L’oreal India was 2% to 4% or even less. The tax administration had not disputed these facts. The tax administrations statement, that the parent have earned higher profit, was not based on facts. The Tribunal found that profit earned by the parent was reasonable and hence there was no shifting of profits by L’oreal India to its parent. See also: India vs. Loreal 12 April 2012  and  India vs. Loreal 25 Oct. 2012 ...

A Russian subsidiary of the car manufacturer group HYUNDAI had been claiming losses on a reoccurring basis. Following an audit the tax authority concluded, that the losses incurred by the Russian distributor were mainly due to non-arm’s length transfer pricing within the group of companies and issued an assessment for FY 2009 – 2010 in the amount of 857 741 779 rubles. The assessment was partially  upheld by the Arbitration Court and then appealed to the Supreme Court. Decision of the Russian Supreme Court The Supreme Court dismissed the appeal lodged by HYUNDAI. “In checking the calculation of the market price of the goods, the court, having assessed whether the data given in the calculation of the market price for the acquisition of the vehicles corresponded to the data contained in the primary documents, came to the conclusion that the calculation presented by the inspectorate was justified. The court considered that the tax authority had made the calculation on the basis of the particular characteristics and sale of each particular car (according to the VIN). Under such circumstances, the court concluded that the taxpayer overstated the amount of costs to reduce income from sales for 2009 in the amount of 136 475 133 rubles, for 2010 – in the amount of 500 997 837 rubles. The cassation appeal contains no arguments related to the episode involving application of thin capitalization rules to interest on bank loans. In studying the arguments contained in the complaint, it was established that they were reduced to a review of the factual circumstances of the case established by the courts and could not be the subject of the Judicial Board of the Supreme Court of the Russian Federation, which in virtue of paragraph 1 of Part 7 of Art. 291.6 of the Arbitration Procedural Code of the Russian Federation with authority to review the circumstances established by the courts of lower instances. The courts have not committed any violations of the rules of substantive law or of the requirements of procedural law, which entail unconditional cancellation of the judicial acts.“ Click here for English Translation ...

A Russian subsidiary of the Mazda Motors Group had been claiming losses. Following an audit the tax authorities concluded that losses for FY 2009, was due to overstatement of the purchase prices of Mazda cars. An assessment was issued where the pricing was determined using the Resale Price Method, resulting in additional income of 1,362,172,034 rubles. The Arbitration Court held in favor of the tax authorities and this decision was upheld by the Arbitration Court of Appeal. The decision was then appealed to the Supreme Court. The Supreme Court denied the appeal and upheld the decision of the Arbitration Court. Click here for English Translation ...

A Russian subsidiary of the car manufacturer group HYUNDAI had been claiming losses in fiscal years 2008 and 2009. In the opinion of the tax authority, losses incurred by the Russian distributor were mainly due to non-arm’s length transfer pricing within the group of companies. Decision of the Russian Arbitration Court According to the court, the applied transfer pricing method is not applicable in the present case. A comparison with wholesalers in the Russian automotive market cannot be made, it said. The reason for this is the common sales strategy of automotive groups in Russia. Almost all non-Russian manufacturers distribute their automobiles through affiliated wholesale companies, which in turn purchase the vehicles from affiliated companies abroad. The only exceptions in this context are currently companies such as Volkswagen or BMW, which operate their own production facilities in Russia. Therefore, a reliable identification of comparable business transactions with regard to independent Russian importers is not possible. The second conclusion of the court refers to the negative market development caused by the financial crisis in 2008/2009. Accordingly, the economic development alone does not constitute a sufficient reason for the recognition of losses of a distribution company. With this assessment, the courts followed the opinion of the competent tax authorities in characterizing the local HYUNDAI sales companies as routine companies. A Russian sales company with a low risk level is generally entitled to a stable, positive remuneration. In this respect, the Russian Arbitration Court supported the view of the tax authorities that a local sales company would also not have to bear the losses caused by the financial crisis. In the opinion of the tax authorities as well as the court, the affiliated business partner abroad should have borne the losses instead of the Russian HYUNDAI company. The Court also stated that agreed contractual clauses that provide for increased costs for advertising and marketing without offering a correspondingly higher added value for the sales companies do not comply with the arm’s length principle. Click here for English Translation ...

A Russian subsidiary of the Mazda Motors Group had been claiming losses. In the opinion of the tax authority, the losses incurred by the Russian distributor were mainly due to non-arm’s length transfer pricing within the group of companies. An assessment was issued where the pricing had been determined using the Resale Price Method. Decision of the Russian Arbitration Court “Having evaluated the arguments of the parties and the evidence presented in the case, taking into account the provisions of Art. 71 APC RF, the appeal court considers the conclusions of the court of first instance as motivated, consistent with the circumstances of the case and the requirements of the law.In the presence of these circumstances, the claims claimed by the company were rightly rejected by the court of first instance.Thus, the decision of the court is legal and justified, corresponds to the materials of the case and the current legislation, in connection with which it is not subject to cancellation. href=”https://tpguidelines.com/wp-content/uploads/Russia-vs-Mazda-Motor-Rus-Ltd-2014.htm”>Click here for English Translation ...

Quark Systems Pvt. is engaged in providing customer support services on behalf of the Quark Group. TNMM had been applied as the most appropriate method for determining arm’s length income. In an audit, the tax administration rejected one of the companies selected as a comparable on the basis that it was in a start-up and had losses for consecutive years. Quark Systems argued that once functional comparability is established, the comparable should not be rejected on grounds such as start-up phase. Quark also argued for rejection of a high-margin comparable on the basis that the company had significant controlled transactions. The Appellate Tribunal upheld the need for a proper functional analysis of the tested party and the comparables in determination of ALP and objected to the selection of comparables merely on the basis of business classification provided in the database. The case was returned to the tax administration ...

In the case of Panasonic Indonesia the tax authorities had disallowed deductions for services and royalties paid for by the local company to the Panasonic Corporation Japan. The tax authorities held that Panasonic Indonesia did not received the purported services and that the company should not pay royalty due to its status as a contracting manufacturer. Judgement of the Tax Court The Court decided predominantly in favour of the tax authorities. The court found that Panasonic Indonesia had been unable to prove that actual ‘services’ had been received for an amount equal to 3% of net sales of all product manufactured and 1% of net sales for technical assistance and brand fees. Furthermore it was notet that Panasonic Indonesia reported consistent losses. Click here for translation ...

The Bundesfinanzhof confirmed that losses incurred by a simpel distribution entity over a longer period of time trigger a rebuttable presumption in Germany that transfer prices have not been at arm’s length. A German company, Loss Distributor GmbH, imported goods from their Swiss sister company S-AG and had made continious losses over a period of time. The tax authorities found that the purchase prices paid to the S-AG had increased since 1989 and that the German company could not fully pass on the increased purchase price to its customers. Since at the same time the price of the Swiss franc had fallen since 1989, the purchase prices paid to the S-AG in the years of the dispute had been inflated and currency gains had been transferred to Switzerland in this way. A tax assessment was therefor issued. The German company appeal the assessment to the Bundesfinanzhof. The Federal Tax Court ruled in favor of the tax authorities. Click here for English translation Click here for other translation ...

A German GmbH distributed clothing for its Italian parent. The German tax authorities issued a tax assessment based on hidden profit distribution from the German GmbH in favor of its Italien parent as a result of excessive purchase prices, which led to high and continuous losses in Germany. The tax authorities determined the arm’s length price based on purchase prices, which the German GmbH had paid to external suppliers. However, these purchases accounted for only 5% of the turnover. The German Tax Court affirmed in substance a vGA (hidden profit distribution) as the tax authorities had provided no proff of deviation from arm’s length prices. If a hidden profit distribution is to be accepted, the profit shall be increased by the difference between the actually agreed price and the price agreed by independent contractual parties under similar circumstances – the arm’s length price. Where a range of arm’s length prices is produced, there are no legal basis for adjustment to the median value. The assessment must instead be based on the best value for the taxpayer. Distributors incurring losses for more than three years: The Senate understands its ruling in BFHE 170, 550, BStBl II 1993, 457 to say that whenever a distribution company sells products of an affiliate company and suffers significant losses for more than three years, a rebuttable presumption is triggered that the agreed transfer price has not been at arm’s length. The assumption of a rebuttable presumption means that the taxpayer can explain and prove why the actually agreed transfer price is nevertheless appropriate. This applies if the articles purchased exceeds 95% of the total turnover. The taxpayer may, For example, explain why the actual development is either due to mismanagement or other reasons that were not foreseen and, above all, that timely adaptation measures have been taken. Losses can be accepted over a period of more than three years if the corresponding proof is provided. It may be necessary to extend the period within which profit must be achieved. If proof is not provided and the taxpayer does not take any adaptive measures, a reasonable profit can be estimated and spread over the years. Click here for English translation Click here for other translation ...

(a) It has to be recognised that a member of an MNE may, like any independent enterprise, sustain genuine losses whether from mismanagement, from unfavourable economic conditions either in its particular market, or more generally, etc. It follows therefore that if losses are made by a member of an MNE it is not necessarily because the transfer prices of the relevant goods are artificially fixed to produce that result. (b) There are other circumstances too in which tax authorities could find losses acceptable – particularly what may be called ” start-up ” losses or ” market penetration ” losses which would, of their nature, be expected to be sustained only during a short period – see paragraph 43 below. (c) Where it is claimed that losses have been sustained over a comparatively short period in such circumstances, tax authorities should not therefore have much difficulty in accepting that they are genuine. (d) Where, however, a multinational enterprise consistently makes losses over a period of several years in a particular country it might seem appropriate to regard the losses as artificial since an independent enterprise which consistently made losses would eventually go out of business. However, it is necessary to bear in mind that an MNE may legitimately hesitate for a long time to wind up the operations of a loss-making member of the group in a particular country if there are strong political or social pressures in that country to persuade them to continue these operations, or even if the capital which the MNE had invested in that enterprise was considerable in amount and there was some prospect of eventually making the enterprise profitable again. It is not to be assumed therefore . that sustained losses are necessarily artificial. But they could certainly be a feature which deserved close examination. (e) A rather special case of the loss-making enterprise within an MNE would be exemplified by the situation (mentioned in paragraph 41) in which a group of companies produces a range of pro ducts, some of which would be profitable to produce on an arm’s length basis and some not but all of which are needed in order that the group should make a profit overall and a member of the group in one country produces only the loss-making products in the range while the profit-making products are made elsewhere. An independent enterprise could not operate if it could only make losses by selling at an arm’s length price and it would be appropriate in these circumstances to regard the loss-making member of the MNE as producing not for its own benefit but for the benefit of other members of the group and thus as performing a service for which it should be paid an adequate fee. (f) In all the above cases, satisfactory evidence needs to be received from the enterprise ...

It cannot be envisaged that over a long period an independent enterprise can continue to remain in business and make losses and this has to be taken into account in the attitude of the tax authorities towards associated enterprises which make losses over long periods. It may be recognised that in an arm’s length situation start-up losses may occur, or that, due to a weak market, a profitless situation may last for a relatively long period of time in the anticipation of future compensating profits. Nevertheless, if losses are consistently made over a period in an associated enterprise, the tax authorities will have to address themselves to the question whether these losses are not being made with a view to transferring taxable profits to an associate in another country, or in the financial interest of the group as a whole rather than the associated enterprise in question. This will normally require a closer examination of the whole operations of the group. This examination may well show that the decision to keep going a loss making business has been dictated by constraining political or social reasons; when evidence of such reasons is given, a profit adjustment may or may not be justified ...