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 ITA-Tiger-Flex-1-2023-25517 and 2023-25524-and-2023-25528 ...

Due to the economic situation of automotive suppliers in Germany in 2006, “Cutting Tech GMBH” established a subsidiary (CB) in Bosnien-Herzegovina which going forward functioned as a contract manufacturer. CB did not develop the products itself, but manufactured them according to specifications provided by “Cutting Tech GMBH”. The majority of “Cutting Tech GMBH”‘s sales articles were subject to multi-stage production, which could include various combinations of production processes. In particular, “Cutting Tech GMBH” was no longer competitive in the labour-intensive manufacturing processes (cut-off grinding, turning, milling) due to the high wage level in Germany. Good contribution margins from the high-tech processes (adiabatic cutting, double face grinding) increasingly had to subsidise the losses of the labour-intensive processes. Individual production stages, however, could not be outsourced to external producers for reasons of certification and secrecy. In addition, if the production had been outsourced, there would have been a great danger that a third company would have siphoned off “Cutting Tech GMBH”‘s know-how and then taken over the business with “Cutting Tech GMBH”‘s customer. This could have led to large losses in turnover for “Cutting Tech GMBH”. Furthermore, some of the labour-intensive work also had to cover one or more finishing stages of the high-tech processes, so that this business was also at risk if it was outsourced. For these reasons, the decision was made to outsource the labour-intensive production processes to Bosnia-Herzegovina in order to become profitable again and to remain competitive in the future. There, there were German-speaking staff with the necessary expertise, low customs duties and a low exchange rate risk. CB functioned as a contract manufacturer with the processes of production, quality assurance and a small administrative unit. Cost advantages existed not only in personnel costs, but also in electricity costs. CB prevented the plaintiff’s good earnings from the high-tech processes in Germany from having to continue to be used to subsidise the low-tech processes. “Cutting Tech GMBH” supplied CB with the material needed for production. The deliveries were processed as sales of materials. “Cutting Tech GMBH” received as purchase prices its cost prices without offsetting profit mark-ups or handling fees/commissions. The material was purchased and supplied to CB by “Cutting Tech GMBH”, which was able to obtain more favourable purchase prices than CB due to the quantities it purchased. The work commissioned by “Cutting Tech GMBH” was carried out by CB with the purchased material and its personnel. CB then sold the products to “Cutting Tech GMBH”. In part, they were delivered directly by CB to the end customers, in part the products were further processed by “Cutting Tech GMBH” or by third-party companies. “Cutting Tech GMBH” determined the transfer prices for the products it purchased using a “contribution margin calculation”. Until 2012, “Cutting Tech GMBH” purchased all products manufactured by CB in Bosnia and Herzegovina. From 2013 onwards, CB generated its own sales with the external company P. This was a former customer of “Cutting Tech GMBH”. Since “Cutting Tech GMBH” could not offer competitive prices to the customer P in the case of production in Germany, CB took over the latter’s orders and supplied P with the products it manufactured in accordance with the contracts concluded. CB did not have its own distribution in the years in dispute. The tax audit of FY 2011 – 2013 The auditor assumed that the transfer of functions and risks to CB in 2007/2008 basically fulfilled the facts of a transfer of functions. However, since only a routine function had been transferred, “Cutting Tech GMBH” had rightly carried out the transfer of functions without paying any special remuneration. Due to CB’s limited exposure to risks, the auditor considered that the cost-plus method should be used for transfer pricing. In adjusting the transfer prices, the auditor assumed a mark-up rate of 12%. The material invoiced by “Cutting Tech GMBH” and the scrap proceeds was not included in the cost basis used in the assessment. For 2013, the auditor took into account that the customer P had agreed contracts exclusively with CB and reduced the costs by the costs of the products sold to P. Furthermore, the auditor took the legal view that the entire audit period should be considered uniformly. Therefore, it was appropriate to deduct an amount of €64,897 in 2011, which had been calculated in favour of “Cutting Tech GMBH” in 2010 and not taken into account in the tax assessment notices, in order to correct the error. The auditor did not consider it justified to determine the transfer prices for “Cutting Tech GMBH”‘s purchases of goods by means of a so-called contribution margin calculation. Based on the functional and risk analysis, the auditor concluded that CB was a contract manufacturer. On the grounds that this profit of CB was remuneration for a routine function, the auditor refrained from recognising a vGA because of the transfer of client P from the applicant to CB. However, he stated that according to arm’s length royalty rates, values between 1% and 3% could be recognised as royalty “according to general practical experience.” “Cutting Tech GMBH” filed an appeal against the assessment in 2015 and in November 2019 the Tax Court parcially allowed the appeal of “Cutting Tech GMBH” and adjusted the assessment issued by the tax authorities. An appeal and cross appeal against the decision of the Tax Court was then filed with the Federal Tax Court (BFH). Judgement of the BFH The Federal Tax Court overturned the decision of the Tax Court and referred the case back to the Tax Court for another hearing and decision. “The appeals of the plaintiff and the FA are well-founded. They lead to the previous decision being set aside and the matter being referred back to the Fiscal Court for a different hearing and decision (§ 126 Para. 3 Sentence 1 No. 2 FGO). The arm’s length comparison carried out by the lower court to determine the transfer prices for the acquisition of processed products from C by the Plaintiff is not free of legal ...

ERT Automotive Bohemia s.r.o. is active in the automotive industry. From 1 January 2013 to 30 November 2013, it provided the manufacture and repair of upholstery products for the automotive industry for its ‘sister’ company, Reiner Lasertec GmbH, established in Germany (both companies were owned at the time by the parent company Notos Beteiligungen GmbH, also established in Germany). ERT Automotive Bohemia s.r.o. provided ‘wage labour’ for Reiner Lasertec at a price of EUR 0,15 per minute of work. In December 2013, ERT Automotive Bohemia s.r.o. changed this business model. It no longer simply processed materials for Reiner Lasertec, but instead took over its former role. It was thus responsible for the production of the entire specific automotive part, which it then supplied as an independent manufacturer and final supplier. The Tax Office suspected that ERT Automotive Bohemia s.r.o. had supplied services to a related party from January to November 2013 at a lower price than would have been agreed between independent parties pursuant to section 23(7) of the Income Tax Act. Following a tax audit, it therefore assessed ERT Automotive Bohemia s.r.o. by way of an additional assessment for corporate income tax for FY 2013. ERT Automotive Bohemia s.r.o. criticised the tax authorities for ‘comparing incomparables’ – that is to say, for comparing the activities and costs as a subcontractor and of Reiner Lasertec as the final supplier. However, Reiner Lasertec, as the final supplier, was, unlike ERT Automotive Bohemia s.r.o., in charge of, for example, negotiations with customers. ERT Automotive Bohemia s.r.o. also pointed out that, according to the tax authorities’ calculations, as a mere manufacturer, it should be making unprecedented profits (for that position in the production chain) in terms of wages. ERT Automotive Bohemia s.r.o. succeeded in an appeal to the Regional Court, which referred the case back for further proceedings. According to the Regional Court, the tax authorities did not bear the burden of proof or the burden of proof as regards the determination of the reference price and the difference between the agreed price and the reference price. Nor did they deal with the argument that the agreed price for the services provided to Reiner Lasertec covered all its costs as well as a reasonable profit. They did not take sufficient account of the fact that ERT Automotive Bohemia s.r.o. acted as a subcontractor in the controlled transaction, whereas in the independent transaction it was already acting as an independent manufacturer. Judgement of the Supreme Administrative Court The Supreme Administrative Court upheld the decision of the Regional Court and ruled in favour of ERT Automotive Bohemia s.r.o. Excerpts “[15] However, the tax authorities suspected that until November 2013 the applicant had provided its services ‘below cost’. The tax authorities first intended to adjust the applicant’s tax base by approximately CZK 7,5 million, based on the reference price determined by the TNMM (net margin method). However, he subsequently (also following the applicant’s objections) proceeded to establish a new reference price using the CUP (comparable independent prices) method. In determining the second reference price, the administrator compared the original transaction between the applicant and Rainer Lasertec (or the provision of services by the applicant from January to November 2013) with the subsequent transaction between the applicant and Boshoku Automotive. He then attempted to ‘clean up’ the independent transaction with Boshoku Automotive so as to compare only comparable activities, i.e. the part of the production that the applicant was also providing before December 2013 (the essential part of the dispute being whether the complainant succeeded in doing so). And it concluded that the applicant had indeed provided its services to Reiner Lasertec until November 2013 ‘below cost’, i.e. at a lower price than would have been agreed under similar conditions between independent persons…” “[21] First of all, the selection of the independent transactions with which the tax authority wants to compare the controlled transaction is already under scrutiny: ‘the selection of independent transactions and, if they are not fully comparable, the appropriate method of their adjustment must be made on the basis of objective, fair and reviewable criteria’ (8 Afs 80/2007). When determining the reference price, the tax authorities must primarily base themselves on existing independent transactions which are at least at their core comparable to the controlled transaction.” “[29] At the most general level, the SAC recognises that a transaction which is broader in scope than the controlled transaction and which incorporates the subject matter of the controlled transaction (i.e., for example, the present independent transaction) may also serve as an independent transaction in determining the reference price. As the SAC has already stated above, the range of transactions that can be used for comparison is wide (cf. paragraph [21]). After all, the SAC has even gone so far in the past as to allow the tax authorities to use a transaction between related parties as an independent transaction, but with a price determined by an expert opinion (cf. cases 1 Afs 143/2017, cited above, paragraph 26, and 3 Afs 105/2017, paragraph 22). [30] However, even such an independent transaction must be comparable, at least in substance, to a controlled transaction. It must at least be eligible for subsequent correction. What comparability means, at least at its core, is of course to be determined on a case-by-case basis. In general, however, the subject matter of the controlled transaction must form an essential part of the wider arm’s length transaction – so that the arm’s length price is agreed with respect to it. If the subject matter of the controlled transaction were only a marginal, insignificant part of the wider arm’s length transaction, it would become unworkable. Similarly, it is important that the position of the parties to the broader arm’s length transaction, in particular that corresponding to the position of the taxpayer in the controlled transaction, should not differ substantially. It is only if these conditions are met that the adjustment of the arm’s length transaction will make any sense – otherwise the tax authorities would ...

ESAB CZ was a contract manufacturer for ESAB Europe. The contract set ESAB CZ’s target profit margin for 2014 and 2015 at between 2,5 % and 3,5 %, with an adjustment to 3 % if the actual profit margin achieved was outside that range. Those values were determined on the basis of a benchmarking analysis which produced a minimum profit margin of 0,41 % and an interquartile range of profit margins between 2,14 % and 5,17 %. The benchmarking analysis were not disputed, but the tax authorities held that the cost base on which the markup was calculated should have included annual amortisations/depreciations. ESAB CZ disagreed and filed a complaint with the Regional Court. Judgement of the Court The court ruled in favour of the tax authorities. Excerpts “51. Furthermore, it should be emphasised that the applicant has not demonstrated that the asset allowance does not relate to the applicant’s contract manufacturing and has not demonstrated that it relates to any other activity, failing to identify any other specific activity relating to the allowance and the income generated from it. Nor is any such thing apparent from the applicant’s accounts, where the write-down of the impairment is booked in the area of contract manufacturing for a ‘related party’. The tax authorities and, consequently, the defendant, therefore, reached the lawful conclusion that the cost item of the asset impairment charge in the tax years under review was related to the applicant’s contract manufacturing activities and that there was therefore no objective reason for excluding it from the cost base when calculating the profitability indicator. The applicant did not incur any real expenditure either on the valuation difference or on the assets as such. It merely took over the assets from its predecessor and included the depreciation of the remaining assets in the calculation of its profitability, so that it acquired assets for which it would have had to pay the purchase price if it had bought them. There is no doubt that those assets generate income for the applicant and that, if sold, their residual value will be an expense and the sale itself will generate income. Therefore, the applicant’s argument that the amortisation of the valuation difference does not constitute, by its very nature, a real cost incurred in the transaction under assessment and is an exceptional item caused by the conversion carried out cannot be upheld. 52. The Regional Court agrees with the defendant’s views and considers it beyond doubt that the depreciation relates to the revaluation of assets whose transfer resulted from the project and was the substance of the spin-off and those assets are related to the contractual production. Thus, the revaluation of the assets was the result of the project and the difference in the revaluation of the assets and the subsequent depreciation of the revaluation of those assets could not have been influenced by the applicant. Nor did it determine its position as a manufacturer or that this activity was its only source of profit. The defendant’s view that the consequences of decisions taken by another company in the group cannot be passed on to the applicant and thereby reduce its profits by those items excluded from the cost base is lawful. In those circumstances, the costs in the form of depreciation on the difference in the revaluation of assets should be included in the calculation of the applicant’s profitability because of the relationship of that depreciation to assets related to the applicant’s production activities.” (…) “…The TNMM method was chosen as the profitability indicator and the net operating cost margin (NCPM) as the indicator. The resulting interquartile range, which the applicant considered to be market normal and to which it referred, was set between 2,14 % and 5,17 %. This analysis was accepted and relied upon by the tax authority, which concluded that the data obtained in the comparative analysis were sufficiently reliable and that the difference between the negotiated price and the normal price within the meaning of Article 23(7) of the ITA was demonstrated by the tax authority…. (…) 57. As is apparent from the foregoing, the defendant assumed that the sufficiently large sample of 56 comparable companies identified included companies with revalued assets. In the present case, the Benchmarking Analysis took into account a multi-year sample (2013 to 2015) of data on independent companies. The independent companies reflect the development of the market, whereby they register their assets in both historical and real valuation, acquire new technologies or technically upgrade their assets, etc. The defendant thus concludes that the data obtained in the Benchmarking Study is sufficiently reliable and that the difference between the agreed price and the normal price within the meaning of Art. § The tax administration fulfilled its burden of proof with regard to all the relevant facts (there is no dispute as to the proof of the transaction between the related parties) and by the Call for Evidence it shifted the burden of proof to the claimant, who did not satisfactorily prove the price difference in relation to the item of the write-down of the valuation difference, although it had sufficient time to do so. 58. The Regional Court agrees with the defendant’s conclusions thus expressed. The defendant has commented in detail on the comparative analysis submitted by the applicant and has given proper reasons why it considers it sufficiently reliable. The defendant has also dealt properly with the question of why it is necessary to determine a value at the mid-point between two extreme values in order to guarantee the best possible comparability, when it is appropriate to base the value on a mean trend in order to eliminate outliers or inaccuracies. The Regional Court was therefore unable to uphold the applicant’s plea that the defendant acted unlawfully by applying a profit margin at the level of the bottom quartile rather than at the level of the minimum resulting from the comparative analysis, that minimum being only 0.41 %. The applicant supports that argument by citing ...

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 ...

38. Company A is the parent company of M Group, an MNE group engaged in the manufacturing and distribution of electronic devices. Company A has the exclusive right to sell the devices in all territories. 39. Company A decides to subcontract the manufacturing of the electronic devices to Company B, another member of M Group. Under the terms of the contract, Company B will follow the directions of Company A to produce the devices. Company B will source and supply the materials necessary to produce the different parts of the final products. A key component in the manufacturing process is sourced from Company A. Company B sells the finished goods to Company A, which in turn will market and distribute the product to unrelated customers. 40. To perform the manufacturing activities, Company B has invested in machinery and tooling that is specifically adapted to the production of the electronic devices sold by M Group. Company B has no other customer than Company A so its entire output is acquired by Company A. 41. The accurately delineated transaction shows that Company B does not make any unique and valuable contributions in relation to the controlled transactions and the business of M Group. Furthermore, the risks assumed by Company B are not economically significant for the business operations of the group. While the operations of Company B are integrated to some degree with those of Company A and are dependent upon Company A, arm’s length compensation for the contributions of Company B can be reliably benchmarked by reference to comparable uncontrolled transactions and the application of a one-sided transfer pricing method or methods. Under these circumstances, the transactional profit split method is unlikely to be the most appropriate method ...

In such an example, given that the relocated activity is a highly competitive one, it is likely that the enterprise in Country A has the option realistically available to it to use either the affiliate in Country B or a third party manufacturer. As a consequence, it should be possible to find comparables data to determine the conditions in which a third party would be willing at arm’s length to manufacture the clothes for the enterprise. In such a situation, a contract manufacturer at arm’s length would generally be attributed very little, if any, part of the location savings. Doing otherwise would put the associated manufacturer in a situation different from the situation of an independent manufacturer, and would be contrary to the arm’s length principle ...

Another example of an activity that may involve intra-group services is manufacturing or assembly operations. The activities can take a variety of forms including what is commonly referred to as contract manufacturing. In some cases of contract manufacturing the producer may operate under extensive instruction from the counterparty about what to produce, in what quantity and of what quality. In some cases, raw materials or components may be made available to the producer by the counterparty. The production company may be assured that its entire output will be purchased, assuming quality requirements are met. In such a case the production company could be considered as performing a low-risk service to the counterparty, and the cost plus method could be the most appropriate transfer pricing method, subject to the principles in Chapter II ...

It may also be the case that the acquiring business will leverage the existing position of the acquired business to expand the business of the acquirer in the territory of operation of the acquired business by causing the acquired business to use the acquirer’s branding. In that case, consideration should be given to whether the acquirer should make a payment to or otherwise compensate the acquired business for the functions performed, risks assumed, and assets used (including its market position) in connection with expanded use of the acquirer’s name ...

Where an existing successful business is acquired by another successful business and the acquired business begins to use a name, trademark or other branding indicative of the acquiring business, there should be no automatic assumption that a payment should be made in respect of such use. If there is a reasonable expectation of financial benefit to the acquired company from using the acquiring company’s branding, then the amount of any payment should be informed by the level of that anticipated benefit ...

In determining the amount of payment with respect to a group name, it is important to consider the amount of the financial benefit to the user of the name attributable to use of that name, the costs and benefits associated with other alternatives, and the relative contributions to the value of the name made by the legal owner, and the entity using the name in the form of functions performed, assets used and risks assumed. Careful consideration should be given to the functions performed, assets used, and risks assumed by the user of the name in creating or enhancing the value of the name in its jurisdiction. Factors that would be important in a licence of the name to an independent enterprise under comparable circumstances applying the principles of Chapters I – III should be taken into account ...

Where one member of the group is the owner of a trademark or other intangible for the group name, and where use of the name provides a financial benefit to members of the group other than the member legally owning such intangible, it is reasonable to conclude that a payment for use would have been made in arm’s length transactions. Similarly, such payments may be appropriate where a group member owns goodwill in respect of the business represented by an unregistered trademark, use of that trademark by another party would constitute misrepresentation, and the use of the trademark provides a clear financial benefit to a group member other than that owning the goodwill and unregistered trademark ...

Questions often arise regarding the arm’s length compensation for the use of group names, trade names and similar intangibles. Resolution of such questions should be based on the principles of this Section B and on the commercial and legal factors involved. As a general rule, no payment should be recognised for transfer pricing purposes for simple recognition of group membership or the use of the group name merely to reflect the fact of group membership. See paragraph 7.12 ...

The principles set out in this section similarly apply in situations where a member of an MNE group provides manufacturing services that may lead to process or product improvements on behalf of an associated enterprise that will assume legal ownership of such process or product improvements. Examples 14 to 17 in the Annex I to Chapter VI illustrate in greater detail the application of this Section B in the context of research and development arrangements ...

Company C in country D is a 100% subsidiary of company E, located in country F. In comparison with country F, wages are very low in country D. At the expense and risk of company E, television sets are assembled by company C. All the necessary components, know-how, etc. are provided by company E. The purchase of the assembled product is guaranteed by company E in case the television sets fail to meet a certain quality standard. After the quality check, the television sets are brought – at the expense and risk of company E – to distribution centres company E has in several countries. The function of company C can be described as a purely contract manufacturing function. The risks company C could bear are eventual differences in the agreed quality and quantity. The basis for applying the cost plus method will be formed by all the costs connected to the assembling activities ...

In the circumstances of Example 2 in paragraph 1.84, the significant risks associated with generating a return from the manufacturing activities are controlled by Company A, and the upside and downside consequences of those risks should therefore be allocated to Company A. Company B controls the risk that it fails to competently deliver services, and its remuneration should take into account that risk, as well as its funding costs for the acquisition of the manufacturing plant. Since the risks in relation to the capacity utilisation of the asset are controlled by Company A, Company A should be allocated the risk of under-utilisation. This means that the financial consequences related to the materialisation of that risk including failure to cover fixed costs, write-downs, or closure costs should be allocated to Company A ...

Company B manufactures products for Company A. Under step 1 capacity utilisation risk and supply chain risk have been identified as economically significant in this transaction, and under step 2 it has been established that under the contract Company A assumes these risks. The functional analysis under step 3 provides evidence that Company B built and equipped its plant to Company A’s specifications, that products are manufactured to technical requirements and designs provided by Company A, that volume levels are determined by Company A, and that Company A runs the supply chain, including the procurement of components and raw materials. Company A also performs regular quality checks of the manufacturing process. Company B builds the plant, employs and trains competent manufacturing personnel, and determines production scheduling based on volume levels determined by Company A. Although Company B has incurred fixed costs, it has no ability to manage the risk associated with the recovery of those costs through determining the production units over which the fixed costs are spread, since Company A determines volumes. Company A also determines significant costs relating to components and raw materials and the security of supply. The evaluation of the evidence concludes that Company B performs manufacturing services. Significant risks associated with generating a return from the manufacturing activities are controlled by Company A. Company B controls the risk that it fails to competently deliver services. Each company has the financial capacity to assume its respective risks ...

Amgen, in a note to its financial statement for the quarterly period ended June 30, 2021, disclosed that it has been issued tax assessments of approximately $3.6b plus interest for tax years 2010, 2011 and 2012 by the IRS. Proposed adjustments for FY 2013, 2014 and 2015 has also been issued.  The dispute relates to the allocation of profits between Amgen group entities in the United States and the U.S. territory of Puerto Rico. According to the note, Amgen has filed a petition in the U.S. Tax Court to contest the assessments. 4. Income taxes The effective tax rates for the three and six months ended June 30, 2021, were 16.8% and 12.6%, respectively, compared with 11.2% and 10.4%, respectively, for the corresponding periods of the prior year. The increase in our effective tax rate for the three and six months ended June 30, 2021, was primarily due to the non-deductible IPR&D expense arising from the acquisition of Five Prime. The effective tax rates differ from the federal statutory rate primarily as a result of foreign earnings from the Company’s operations conducted in Puerto Rico, a territory of the United States that is treated as a foreign jurisdiction for U.S. tax purposes, that are subject to a tax incentive grant through 2035. In addition, the Company’s operations conducted in Singapore are subject to a tax incentive grant through 2034. These earnings are also subject to U.S. tax at a reduced rate of 10.5%. The U.S. territory of Puerto Rico imposes an excise tax on the gross intercompany purchase price of goods and services from our manufacturer in Puerto Rico. The rate of 4% is effective through December 31, 2027. We account for the excise tax as a manufacturing cost that is capitalized in inventory and expensed in cost of sales when the related products are sold. For U.S. income tax purposes, the excise tax results in foreign tax credits that are generally recognized in our provision for income taxes when the excise tax is incurred. One or more of our legal entities file income tax returns in the U.S. federal jurisdiction, various U.S. state jurisdictions and certain foreign jurisdictions. Our income tax returns are routinely examined by tax authorities in those jurisdictions. Significant disputes may arise with tax authorities involving issues regarding the timing and amount of deductions, the use of tax credits and allocations of income and expenses among various tax jurisdictions because of differing interpretations of tax laws, regulations and relevant facts. In 2017, we received a Revenue Agent Report (RAR) and a modified RAR from the Internal Revenue Service (IRS) for the years 2010, 2011 and 2012 proposing significant adjustments that primarily relate to the allocation of profits between certain of our entities in the United States and the U.S. territory of Puerto Rico. We disagreed with the proposed adjustments and calculations and pursued a resolution with the IRS administrative appeals office. As previously reported, we were unable to reach resolution with the IRS appeals office. In July 2021, we filed a petition in the U.S. Tax Court to contest two duplicate Statutory Notices of Deficiency (Notices) for 2010, 2011 and 2012 that we received in May and July 2021. The duplicate Notices seek to increase our U.S. taxable income by an amount that would result in additional federal tax of approximately $3.6 billion, plus interest. Any additional tax that could be imposed would be reduced by up to approximately $900 million of repatriation tax previously accrued on our foreign earnings. In any event, we firmly believe that the IRS’s positions in the Notices are without merit and we will vigorously contest the Notices through the judicial process. In addition, in 2020, we received an RAR and a modified RAR from the IRS for the years 2013, 2014 and 2015 also proposing significant adjustments that primarily relate to the allocation of profits between certain of our entities in the United States and the U.S. territory of Puerto Rico, similar to those proposed for the years 2010, 2011 and 2012. We disagree with the proposed adjustments and calculations and are pursuing resolution with the IRS administrative appeals office. We are currently under examination by the IRS for the years 2016, 2017 and 2018. We are also currently under examination by a number of other state and foreign tax jurisdictions. Final resolution of these complex matters is not likely within the next 12 months. We believe our accrual for income tax liabilities is appropriate based on past experience, interpretations of tax law, application of the tax law to our facts and judgments about potential actions by tax authorities; however, due to the complexity of the provision for income taxes and uncertain resolution of these matters, the ultimate outcome of any tax matters may result in payments substantially greater than amounts accrued and could have a material adverse impact on our condensed consolidated financial statements. We are no longer subject to U.S. federal income tax examinations for the years ended on or before December 31, 2009. During the three and six months ended June 30, 2021, the gross amounts of our unrecognized tax benefits (UTBs) increased $50 million and $110 million, respectively, as a result of tax positions taken during the current year. Substantially all of the UTBs as of June 30, 2021, if recognized, would affect our effective tax rate ...

“Tobacco S.A.” is the parent company of a group active in the tobacco industry. C. SA is a subsidiary of the group and operates as a toll manufacturer (Toller) on behalf of another subsidiary, B S.A. For the manufacturing services provided C S.A receives a “toll fee” from B S.A. According to the manufacturing service agreement the toll fee is calculated, based on Toller’s production costs plus and the capital invested by Toller in the production. Following an audit the tax authorities issued an additional assessment of corporate income tax and compensatory interest, relating to FY 2009, in the amount of EUR 1,395,039.79. The tax authorities considered that i) to correct the value of the production costs of the year 2009, in the amount corresponding to the deduction of the income with the “Write Off” of several credit balances of third parties over the company, since these deductions were not provided for in the contract; ii) to correct the value of the return on invested capital [which in the contract and also in the sentence is designated by the acronym ROCE] because the rules of the contract for its determination were not respected, which resulted in a lower remuneration by C. S.A. and in a cost saving by its contractual counterpart, leading to a result that is not compatible with the arm’s length principle. An appeal was filed against the assessment, but the tax tribunal of Lisbon dismissed the appeal and upheld the assessment. An appeal was then filed with the Supreme Administrative Court. Tobacco S.A. claimed that it did not in any way breach the contract for the provision of production services as it applied the POC rules when calculating the toll fee. Thus, it must be concluded that the correction made by the Tax Authority and confirmed by the Court of Appeal and which is claimed to be exclusively based on the incorrect interpretation of the contract by the Appellant is illegal due to the violation of the law. Moreover, according to Tobacco S.A, the tax authorities made an error on the assumptions, since it corrected the calculation of the value of the return on invested capital based on different rules from those which, in its interpretation, result from the contract. The appellant had made the calculations according to the statutory accounts (POC accounts), in compliance with the provisions of Annex B to the contract, and the Tax Authorities decided to correct those values by applying the values contained in Annexes C and D (US GAAP accounting classifications), which, according to the appellant, have the sole function of “allowing uniform intra-group reporting, essentially of a management nature”. “(…) as to the corrections to the ROCE, in the amount of €2,965,761.08, the appellant claims that, by disregarding the POC accounts and considering the US GAAP accounts, the Tax Authorities followed an understanding that does not prove to be correct and is distant from that provided for in the agreements entered into. Judgement of the Supreme Administrative Court The Supreme Administrative Court dismissed the case, as it considered to lack jurisdiction in regards to a judgment on the factual matter. The case was therefore officially transferred to the South Administrative Central Court. Excerpt “… Therefore, the Supreme Administrative Court is reserved the role of a review court, with intervention only in cases where the matter of fact in dispute in the case is stabilised and only the law remains under discussion. In order to assess the competence of the Supreme Administrative Court on the grounds of hierarchy, it is necessary to consider, in principle, only the content of the conclusions of the appeal statements (since these define the object and delimit the scope of the appeal – cf. It is necessary, in principle, to look only at the content of the conclusions of the appeal statement (since the object and scope of the appeal are defined by those conclusions – see Article 635 of the CPC) and check whether, in the light of those conclusions, the questions in dispute are resolved exclusively by applying and interpreting legal norms or whether, on the contrary, consideration of them implies the need to settle questions of fact (either because the appellant maintains that the facts presented as proved in the judgment have not been proved, or because he disagrees with the conclusions of fact to be drawn from them, or, still, because he invokes facts which have not been presented as proved and which are not, in the abstract, irrelevant for the judgment of the case). But not only this, it may also be necessary to compare the conclusions with the very substance of the allegations in the appeal, in particular to check whether they expressly contradict the facts on which the decision is based. And if the appellant raises any issue of fact, the appeal will no longer be based exclusively on points of law, and the competence of the Central Administrative Court will be defined from the outset, regardless of the possibility that this Court may eventually conclude that the disagreement on the factual issue is irrelevant for the decision of the appeal. However, the problem, in this case, of the correct interpretation of the contractual clauses on the basis of which the accounts (the accounting system) that are to serve as the basis for the calculation of the taxable amount are defined, is still a matter of fact. Although it is accepted that it may be qualified as a mixed matter (of fact and law), as it involves, on the one hand, the interpretation of the will of the contractual parties in determining the accounts that they intended to use in the calculation of the taxable amount for the purposes of taxation in Portugal of C……… (factual judgment) and, on the other hand, the normative interpretation of the contractual and legal clauses that define the arm’s length principle in the scope of legal transactions between persons that are in a special relationship with each other (transfer pricing), the truth is ...

A-Contract Manufacturer LDA is an entity residing in Portugal, whose main activity is contract manufacturing of coffee machines and irons, as well as spare parts, tools etc. on behalf of its German parent B A.G. Following an audit, the tax authorities found that the results of A-Contract Manufacturer LDA had not been at arm’s length. An assessment of additional income was issued where the adjustment had been determined based on a benchmark study and use of statistical tools – interquartile range and median. Not satisfied with the assessment A-Contract Manufacturer LDA brought the case to the CAAD, a Portuguese arbitration tribunal. Decision of CAAD The CAAD decided in favour of the tax authorities and upheld the assessment. Excerpt “In sum, regarding the first claim of the Claimant that the arm’s length principle was violated, it appears that the Defendant did nothing more than, in compliance with the duty imposed by art. In short, as to the first claim of violation of the arm’s length principle, it appears that the Claimant, in compliance with the duty imposed by article 3 of Ministerial Order no. 1446-C/2001, of 21 December, and in the exercise of a margin of technical discretion resulting from that precept, carried out calculations that are fully based on the OECD guidelines, after concluding that “the operating result generated [by the Claimant] was lower than it would have been had those transactions been carried out between independent entities” (point 1.4 of the RIT). The mere invocation of its nature as a “contract manufacturer” is not a reason to preclude the application of the arm’s length principle to the special relations between the Claimant and the corporate Group of which it forms part, and even less to conceive any exceptional regime vis-à-vis the rule of application of the OECD Guidelines and the national rules that define those guidelines. As to the Claimant’s second allegation that the arm’s length principle was violated, consisting in the argument that the median value used by the Defendant was highly inflated, this is a mere divergence of quantifications and calculations between the Claimant and the Defendant, and not a doubt that, as the Claimant claims, could lead to the application of art. 100 of the CPPT – since the conclusions of the RIT do not show any such doubt, besides the fact that there is no evidence of any error in the calculations made by the AT that led to the results shown in the RIT. Moreover – and this is the most relevant point – even with lower medians and interquartile ranges such as those proposed by the Claimant, the margins presented by the Claimant are well below these medians, and outside these ranges, with all the consequences that we have seen must result.” Click here for English translation. Click here for other translation Portugal P808_2019-T - 2020-12-21 ...

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

“Beltart Manufacturing” is a Bulgarian toll-manufacturer of of clothing accessories – trouser belts etc. – and is a member of the German Beltart Group. The remuneration for the manufactoring services provided to the group for 2013 and 2014 had been lower than for previous years. According to the company this was due to changes to the contractual and economic conditions and discounts. Following an audit the tax authorities came to the conclusion that the remuneration for 2013 and 2014 should be increased to the same level as for the previous years.  According to the tax authorities, the additional income had been determined by application of the CUP method. An appeal was filed by Beltart Manufacturing with the Administrative court, where the assessment was set aside. According to the court the tax authority had  not analyzed the economic situation for the period 2011 and 2012, and then for 2013 and 2014 in order to determine that the company’s profits. Since the tax authority has compared the remuneration of the services for a period different from the period under review, it could not be held that the same are identical for both the periods. The fact that there is no comparable market data makes it impossible to verify whether the terms of the transaction correspond to the terms of a comparable transaction between unrelated parties. In the absence of comparable date, there is no way to justify a deviation in the terms of the transaction. An appeal was then filed by the tax authorities with the Supreme Administrative Court. Judgement of the Supreme Administrative Court The Supreme Administrative Court set aside the decision of the Administrative Court and remanded the case for further considerations. Excerpts “…On the merits, the applicant submits the following opinion: The allegations of the Director of the ‘ODOP Directorate’ – Varna that there are substantial breaches of the rules of court procedure in the annulment of the judgment are well-founded. The objection of the applicant that the evidence submitted was credited unilaterally by the court and was not discussed in totality with all the other evidence available in the case is also considered as justified. It is reasonably submitted that the provision of Article 116(4) of the Code of Civil Procedure has not been complied with. The market price was correctly determined by the revenue authorities in this case, whereas the conclusions to the contrary of the Administrative Court-Varna are incorrect and unlawful. In the part rejecting the appeal, the judgment under appeal was correctly rendered in compliance with the rules of court procedure and in correct application of the substantive law. For that reason, the cassation appeal lodged by Beltart Ltd is unfounded and the judgment in that part must be upheld” “The absence of a market analogue to determine the ‘market price’ cannot be the sole ground for annulment of the revision act. The Board of Appeal, as a court of substance, has to assess whether the company’s financial result has been correctly increased. That assessment also relates to the determination of the ‘market price’ of the service and the existence of a deviation therefrom. Ordinance No. H-9 of 14 August 2006 on the procedure and methods for the application of methods for determining market prices provides for several methods for determining the “market price” within the meaning of § 1, item 8 of the State Tax Code. Since in the present case, according to the first instance Chamber, the “market price” was incorrectly determined by the method of comparable uncontrolled prices and the method of increased value by the revenue authorities, the market value of the service should have been determined in the judicial phase of the proceedings in order to make an assessment as to the absence or not of tax evasion. The expert evidence heard is incomplete in that it shows that the market price of the service in the course of the audit proceedings was not actually determined by the comparable uncontrolled prices method and the incremental value method as alleged by the revenue authorities. However, the expert also did not determine the market price according to any of the methods of Regulation No H-9/2006. In the course of the court proceedings, no “market price” of the invoiced services within the meaning of §1, item 8 of the RA of the Tax Code was established. It was the court’s duty to determine the market price and to assess whether, in view of that price, an evasion of taxation under Article 15 and Article 16 of the Income Tax Act had been established which justified the increase in the company’s financial accounting result. This has not been done and in paragraph 1 of the decision it is formally held that in the absence of a basis for comparison the RA is unlawful” “Although part of the reasoning of the judgment is correct, the judgment must be set aside in its entirety on the basis of the substantive breaches of the rules of court. The restatement of the company’s financial result relates to the determination of the taxable amount for 2013 and 2014, which must be carried out on the retrial of the case, taking into account all the prerequisites for the increase in the SFR set out in the audit certificate. In order to correctly establish the tax base on which to determine the corporate tax liabilities of the audited entity for 2013 and 2014, the court should clarify the issues of the “market price” of the service provided, determine whether there is an evasion of taxation within the meaning of Articles 15 and 16 of the Income Tax Act; assess whether for any of the years the company is making a loss and, accordingly, determine the amount of advance payments for the period and any interest thereon under Article 89 of the Income Tax Act. Lastly, having determined the tax base, it should, after hearing an expert opinion, determine the interest payable on the unpaid public debts under Article 175(1) of the Tax Code.” ...

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 KHO2020-34 ...

PK manufacturing Ltd was a contract manufacturer of cabins for excavators for the Japanese parent and paid royalties for use of IP owned by the parent. Following an audit, the tax authorities issued an assessment where deductions for royalty payments were disallowed due to lack of documentation for ownership to Intellectual Property by the Japanese parent. Furthermore, the tax authorities did not see any economic benefit for the contract manufacturer in paying the royalties, as it had been continuously loss making. The Company disagreed and brought the case to court. The Court of Appeal ruled in favor of the tax authorities. Existence and ownership to the Intellectual Property in question had not been sufficiently documented by the Japanese parent company. The Supreme Court dismissed the request for review filed by PK Co. Ltd. Click here for translation putusan_366_b_pk_pjk_2020_20200908cl ...

A Polish subsidiary performed manufacturing on a limited risk basis (a so-called contract manufacturer) on behalf of the group parent and should be remunerated based on the functions performed. During the year, sales of products are made at constant registration prices based on the standard cost. It is only after the end of the year and the summary of costs and revenues of operations that the applicant is able to determine her own profit level to a fixed level at the level of operating profit. In view of the above, the parties apply a mechanism for determining profitability, including the correction of mutual settlements. The necessary adjustment of profitability to a certain level can take place only after an annual summary of costs and revenues of operations, with detailed data on the applicant’s actual profitability only available at the end of the year or even afterwards. Given that the operating result obtained by the applicant is subject to verification and correction at the end of a given financial year, in practice it is possible that the correcting invoice ( or other document confirming the reasons for the correction ), which respectively increases or decreases the value of remuneration for sold goods or services a) will be issued after the end of the year, or b) will be issued during the ( last day ) of the financial year. Against the background, the company asked whether the year end adjustments should be taken into account for the accounting period in which those adjustment-invoices or documents were issued? In the company´s opinion, the current provisions clearly indicate that adjustments to revenues or tax deductible costs should be made in the accounting period in which the corrective invoice was issued or received or – in the absence of an invoice – another document confirming the reasons for the correction. Only in the event that the correction is caused by a calculation error or other obvious mistake, should the correction be made in the accounting period in which the original income or tax deductible expenses were recorded. The tax authorities considered the position presented by the applicant to be incorrect. As a rule, the moment when the revenue related to business activity arose shall be considered the date of “delivery”. Decision of the Administrative Court The court notes that the applicant applies the profitability adjustment mechanism to a certain level. Under international tax law, the concept of compensating adjustments has developed, which should be understood as a correction by which the taxpayer himself adjusts the price ( income ) in transactions with related entities to a level that in his opinion corresponds to market value, even if the price differs from the amount, which was actually settled between the related parties. In the court’s view, the essence of the mechanism of adjusting the profitability presented by the applicant to the previously assumed level does not manifest itself in the fact that the price of specific , individualized products sold earlier is changed. As a result of its application, the applicant’s profitability level is equalized to the level assumed in advance. The purpose of the correction is not to modify the prices at which specific, individual transactions were carried out during the tax year. Given the specifics of the profitability adjustment described by the applicant, the court concludes that this adjustment should be considered as a new event resulting from an agreement stating that the applicant, in connection with the business activity, should achieve the assumed level of profitability appropriate for the subsidiaries function in the group. The event giving rise to the margin to the previously assumed amount is not due in any way to the incorrect recognition of the amount of revenue previously achieved by the applicant. In this situation, according to the court, the authority did not correctly answer the question aimed at determining the moment at which revenue adjustment should have been made. However, the authority correctly stated that in the facts presented in the application there are no grounds to reduce the value of previously recognized revenues. The authority also correctly stated that the payment received by the applicant would constitute revenue from the moment they were received. Click here for translation I SA-Po 800-19 - Wyrok WSA w Poznaniu Contract Manufacturing ...

Due to the economic situation of automotive suppliers in Germany in 2006, “Cutting Tech GMBH” established a subsidiary (CB) in Bosnien-Herzegovina which going forward functioned as a contract manufacturer. CB did not develop the products itself, but manufactured them according to specifications provided by “Cutting Tech GMBH”. The majority of “Cutting Tech GMBH”‘s sales articles were subject to multi-stage production, which could include various combinations of production processes. In particular, “Cutting Tech GMBH” was no longer competitive in the labour-intensive manufacturing processes (cut-off grinding, turning, milling) due to the high wage level in Germany. Good contribution margins from the high-tech processes (adiabatic cutting, double face grinding) increasingly had to subsidise the losses of the labour-intensive processes. Individual production stages, however, could not be outsourced to external producers for reasons of certification and secrecy. In addition, if the production had been outsourced, there would have been a great danger that a third company would have siphoned off “Cutting Tech GMBH”‘s know-how and then taken over the business with “Cutting Tech GMBH”‘s customer. This could have led to large losses in turnover for “Cutting Tech GMBH”. Furthermore, some of the labour-intensive work also had to cover one or more finishing stages of the high-tech processes, so that this business was also at risk if it was outsourced. For these reasons, the decision was made to outsource the labour-intensive production processes to Bosnia-Herzegovina in order to become profitable again and to remain competitive in the future. There, there were German-speaking staff with the necessary expertise, low customs duties and a low exchange rate risk. CB functioned as a contract manufacturer with the processes of production, quality assurance and a small administrative unit. Cost advantages existed not only in personnel costs, but also in electricity costs. CB prevented the plaintiff’s good earnings from the high-tech processes in Germany from having to continue to be used to subsidise the low-tech processes. “Cutting Tech GMBH” supplied CB with the material needed for production. The deliveries were processed as sales of materials. “Cutting Tech GMBH” received as purchase prices its cost prices without offsetting profit mark-ups or handling fees/commissions. The material was purchased and supplied to CB by “Cutting Tech GMBH”, which was able to obtain more favourable purchase prices than CB due to the quantities it purchased. The work commissioned by “Cutting Tech GMBH” was carried out by CB with the purchased material and its personnel. CB then sold the products to “Cutting Tech GMBH”. In part, they were delivered directly by CB to the end customers, in part the products were further processed by “Cutting Tech GMBH” or by third-party companies. “Cutting Tech GMBH” determined the transfer prices for the products it purchased using a “contribution margin calculation”. Until 2012, “Cutting Tech GMBH” purchased all products manufactured by CB in Bosnia and Herzegovina. From 2013 onwards, CB generated its own sales with the external company P. This was a former customer of “Cutting Tech GMBH”. Since “Cutting Tech GMBH” could not offer competitive prices to the customer P in the case of production in Germany, CB took over the latter’s orders and supplied P with the products it manufactured in accordance with the contracts concluded. CB did not have its own distribution in the years in dispute. The tax audit of FY 2011 – 2013 The auditor assumed that the transfer of functions and risks to the CB in 2007/2008 basically fulfilled the facts of a transfer of functions. However, since only a routine function had been transferred, “Cutting Tech GMBH” had rightly carried out the transfer of functions without paying any special remuneration. Due to CB’s limited exposure to risks, the auditor considered that the cost-plus method should be used for transfer pricing. In adjusting the transfer prices, the auditor assumed a mark-up rate of 12%. The material invoiced by “Cutting Tech GMBH” and the scrap proceeds was not included in the cost basis used in the assessment. For 2013, the auditor took into account that the customer P had agreed contracts exclusively with CB and reduced the costs by the costs of the products sold to P. Furthermore, the auditor took the legal view that the entire audit period should be considered uniformly. Therefore, it was appropriate to deduct an amount of €64,897 in 2011, which had been calculated in favour of “Cutting Tech GMBH” in 2010 and not taken into account in the tax assessment notices, in order to correct the error. The auditor did not consider it justified to determine the transfer prices for “Cutting Tech GMBH”‘s purchases of goods by means of a so-called contribution margin calculation. Based on the functional and risk analysis, the auditor concluded that CB was a contract manufacturer. On the grounds that this profit of CB was remuneration for a routine function, the auditor refrained from recognising a vGA because of the transfer of client P from the applicant to CB. However, he stated that according to arm’s length royalty rates, values between 1% and 3% could be recognised as royalty “according to general practical experience.” “Cutting Tech GMBH” filed an appeal against the assessment in 2015. Judgement of the Fiscal Court The Fiscal Court adjusted the assessment issued by the tax authorities and thus parcially allowed the appeal of “Cutting Tech GMBH”. Excerpts “In the case at issue, the decisive cause for the plaintiff losing the customer P is not to be seen in the transfer of business to CB. The applicant lost the customer because it could not offer him competitive prices. The takeover of the business with P by CB is thus not the cause of the loss of the customer. The plaintiff’s factual submission is undisputed in this respect and is confirmed by the small profit that CB made from the business according to the calculations of the foreign auditor.” “The FA was correct to add € … to the taxable income in the year 2013 due to the supply of materials to CB for the processing of its business with ...

Due to the economic situation of automotive suppliers in Germany in 2006, “Cutting Tech GMBH” established a subsidiary (CB) in Bosnien-Herzegovina which going forward functioned as a contract manufacturer. CB did not develop the products itself, but manufactured them according to specifications provided by “Cutting Tech GMBH”. The majority of “Cutting Tech GMBH”‘s sales articles were subject to multi-stage production, which could include various combinations of production processes. In particular, “Cutting Tech GMBH” was no longer competitive in the labour-intensive manufacturing processes (cut-off grinding, turning, milling) due to the high wage level in Germany. Good contribution margins from the high-tech processes (adiabatic cutting, double face grinding) increasingly had to subsidise the losses of the labour-intensive processes. Individual production stages, however, could not be outsourced to external producers for reasons of certification and secrecy. In addition, if the production had been outsourced, there would have been a great danger that a third company would have siphoned off “Cutting Tech GMBH”‘s know-how and then taken over the business with “Cutting Tech GMBH”‘s customer. This could have led to large losses in turnover for “Cutting Tech GMBH”. Furthermore, some of the labour-intensive work also had to cover one or more finishing stages of the high-tech processes, so that this business was also at risk if it was outsourced. For these reasons, the decision was made to outsource the labour-intensive production processes to Bosnia-Herzegovina in order to become profitable again and to remain competitive in the future. There, there were German-speaking staff with the necessary expertise, low customs duties and a low exchange rate risk. CB functioned as a contract manufacturer with the processes of production, quality assurance and a small administrative unit. Cost advantages existed not only in personnel costs, but also in electricity costs. CB prevented the plaintiff’s good earnings from the high-tech processes in Germany from having to continue to be used to subsidise the low-tech processes. “Cutting Tech GMBH” supplied CB with the material needed for production. The deliveries were processed as sales of materials. “Cutting Tech GMBH” received as purchase prices its cost prices without offsetting profit mark-ups or handling fees/commissions. The material was purchased and supplied to CB by “Cutting Tech GMBH”, which was able to obtain more favourable purchase prices than CB due to the quantities it purchased. The work commissioned by “Cutting Tech GMBH” was carried out by CB with the purchased material and its personnel. CB then sold the products to “Cutting Tech GMBH”. In part, they were delivered directly by CB to the end customers, in part the products were further processed by “Cutting Tech GMBH” or by third-party companies. “Cutting Tech GMBH” determined the transfer prices for the products it purchased using a “contribution margin calculation”. Until 2012, “Cutting Tech GMBH” purchased all products manufactured by CB in Bosnia and Herzegovina. From 2013 onwards, CB generated its own sales with the external company P. This was a former customer of “Cutting Tech GMBH”. Since “Cutting Tech GMBH” could not offer competitive prices to the customer P in the case of production in Germany, CB took over the latter’s orders and supplied P with the products it manufactured in accordance with the contracts concluded. CB did not have its own distribution in the years in dispute. The tax audit of FY 2011 – 2013 The auditor assumed that the transfer of functions and risks to the CB in 2007/2008 basically fulfilled the facts of a transfer of functions. However, since only a routine function had been transferred, “Cutting Tech GMBH” had rightly carried out the transfer of functions without paying any special remuneration. Due to CB’s limited exposure to risks, the auditor considered that the cost-plus method should be used for transfer pricing. In adjusting the transfer prices, the auditor assumed a mark-up rate of 12%. The material invoiced by “Cutting Tech GMBH” and the scrap proceeds was not included in the cost basis used in the assessment. For 2013, the auditor took into account that the customer P had agreed contracts exclusively with CB and reduced the costs by the costs of the products sold to P. Furthermore, the auditor took the legal view that the entire audit period should be considered uniformly. Therefore, it was appropriate to deduct an amount of €64,897 in 2011, which had been calculated in favour of “Cutting Tech GMBH” in 2010 and not taken into account in the tax assessment notices, in order to correct the error. The auditor did not consider it justified to determine the transfer prices for “Cutting Tech GMBH”‘s purchases of goods by means of a so-called contribution margin calculation. Based on the functional and risk analysis, the auditor concluded that CB was a contract manufacturer. On the grounds that this profit of CB was remuneration for a routine function, the auditor refrained from recognising a vGA because of the transfer of client P from the applicant to CB. However, he stated that according to arm’s length royalty rates, values between 1% and 3% could be recognised as royalty “according to general practical experience.” “Cutting Tech GMBH” filed an appeal against the assessment in 2015. Judgement of the Fiscal Court The Fiscal Court adjusted the assessment issued by the tax authorities and thus parcially allowed the appeal of “Cutting Tech GMBH”. Excerpts “In the case at issue, the decisive cause for the plaintiff losing the customer P is not to be seen in the transfer of business to CB. The applicant lost the customer because it could not offer him competitive prices. The takeover of the business with P by CB is thus not the cause of the loss of the customer. The plaintiff’s factual submission is undisputed in this respect and is confirmed by the small profit that CB made from the business according to the calculations of the foreign auditor.” “The FA was correct to add € … to the taxable income in the year 2013 due to the supply of materials to CB for the processing of its business with ...

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 15Af_105_2015_29 ...

The question in the case was whether Cytec Norway KS (now Allnex Norway A/S) had paid an arm’s length price for an intra-group transfer of intangible assets in 2010. Cytec Norway KS had set the price for the accquired intangibles at NOK 210 million and calculated tax depreciations on that basis. The Norwegian tax authorities found that no intangibles had actually been transferred. The tax Appeals Committee determined that intangibles had been transferred but only at a total value of NOK 45 million. The Court of appeal upheld the dicision of the Tax Appeals Committee, where the price for tax purposes was estimated at NOK 44.9 million. Click here for translation Norway vs Cytec 19 March 2019, Borgarting Lagmannsrett Case No 2017-90184 ...

PK manufacturing Ltd was a contract manufacturer of cabins for excavators for the Japanese parent and paid royalties for use of IP owned by the parent. Following an audit, the tax authorities issued an assessment where deductions for royalty payments were disallowed due to lack of documentation for ownership to Intellectual Property by the Japanese parent. Furthermore, the tax authorities did not see any economic benefit for the contract manufacturer in paying the royalties, as it had been continuously loss making. The Company disagreed and brought the case to court. The Court of Appeal ruled in favor of the tax authorities. Existence and ownership to the Intellectual Property in question had not been sufficiently documented by the Japanese parent company. Part 1 – Click here for translation Part 2 – Click here for translation Putusan Nomor ...

Intracom Taiwan had deducted losses on intra-group receivables and management fees in its taxable income. These deductions had been partially denied by the Taiwanese tax administration due to lack of documentation and economic substance. Intracom brought the case to court. The Supreme Administrative court dismissed Intracom’s appeal and upheld the assessment. On the issue of deduction for bad debt the court states:“The Appellee’s request for such documents was in accordance with the law. However, the Appellant was unable to produce documents that met the statutory requirements, and from this point of view, the Appellee’s refusal to allow the recognition of the doubtful accounts could not be considered an error.(3) The appellant’s argument that the tax authorities should accept the recognition of doubtful debts as long as the appellant obtains the documentary evidence of the “foreign office certification” which proves the objective fact that “the debtor of the receivable has gone into liquidation” is clearly inconsistent with Article 94 of the R.O.C.“ On the issue of management fee the court states:“Under the aforesaid objective circumstance that “the authenticity and necessity of this management fee expenditure is highly doubtful” Click here for English Translation 最高行政法院107年判字第691號判決 ...

A ruling was issued by the Italian Revenue Service on the following question on the VAT treatment of Transfer Pricing adjustments. “Alfa represents that it is part of a multinational Group (hereinafter, the “Group”). The Group is implementing a new integrated development plan, aimed at the joint creation of products and platforms necessary for the production and marketing of goods under brand X. The legal and economic ownership of the X trademark and of the relevant know-how belongs to the non-EU company Beta, which acts as “Principal” and assumes all risks connected to the production and marketing of the goods, granting the trademark and the know-how free of charge to the subsidiaries engaged in the production and marketing of the X goods. The plaintiff entered into an intra-group agreement (the ‘Agreement’) with Beta, whereby Beta undertakes to act as contract assembler for the purpose of manufacturing X products, putting its own equipment at the disposal of Gamma (a company incorporated under Italian law which acts as a contract manufacturer). In particular, Alfa has contractually assumed the task of coordinating all production factors relating to the production of the goods, as well as those relating to the marketing of the same, through the Group’s distribution network, and the task of managing logistics and quality control activities, in the interests of Beta. The X goods, produced by the company Gamma, are therefore purchased by the company Alfa at a price in line with the policy adopted by the Group in terms of transfer prices, consistent with the criterion of free competition (the so-called “Arm’s length”). Subsequently, they are marketed, through Beta, in the North American and Rest of the World markets and, through Delta, in the European, Middle Eastern and African markets (the so-called EMEA market). In this regard, the questioning Company points out that also the sales made by it to Beta and Delta take place at a price in line with the Group’s policy in terms of transfer prices, consistently with the criterion of free competition. In accordance with the transfer pricing model followed by the Group, the Agreement provides that, if the actual profits recorded by the respondent company in a given year falls outside the interquartile range of reference, specific adjustments must be made in order to comply with the above-mentioned arm’s length criterion. As a result of this, Beta undertakes to recognise, where necessary, the payment of a contribution in favour of Alfa whenever the latter incurs operating losses, such as those resulting from the activities carried out and from the considerable costs incurred for the purchase of equipment used in the production cycle. In light of the above, the Company asks to know whether or not the contribution possibly recognised by Beta in favour of the latter, in case of a difference between the profit realised by the latter and the profit determined according to the arm’s length criterion, can be considered relevant for VAT purposes pursuant to Article 3 of Presidential Decree No. 633 of 1972.” Tax Ruling of the Italian Revenue Agency ” … In order for transfer pricing adjustments to affect the determination of the taxable amount for VAT, by increasing or decreasing the consideration for the sale of the goods or the provision of the service, it is therefore necessary that: (a) there must be consideration, i.e., a monetary or in-kind adjustment for such an adjustment; (b) the supply of goods or services to which the consideration relates is identified; (c) there is a direct link between the supplies of goods or services and the consideration. As pointed out by the European Commission itself in the aforementioned document no. 923, “while the principle of free competition must generally be observed in all intra-group transactions, on the basis of the transfer pricing rules applied for the purposes of direct taxation, the scope of the principle of free competition laid down by the VAT Directive seems much more circumscribed. In fact, such a rule is susceptible to optional application by Member States and can only be applied for the purpose of preventing tax evasion and avoidance under well-defined circumstances” (see paragraph 3.1.1). Such circumstances are specifically identified by Article 80 of Directive 2006/112/EC – implemented in Italy by Article 13, third paragraph, of Presidential Decree No. 633 of 1972 – as an exception to the general criteria for determining the VAT taxable amount set forth in Article 73 of the Directive. In this respect, according to the case-law of the EU Court of Justice, “the conditions for the application of the latter article [Article 80 of Directive 2006/112/EC] are mandatory and national legislation may not provide, on the basis of that provision, that the taxable amount is to be equal to the open market value in cases other than those listed in that provision” (see the judgment of 8 May 2013, in case C-142/12, and the judgment of 26 April 2012, in cases C-621/10 and C-129/11). This orientation is, moreover, confirmed by the most recent case law of the Supreme Court of Cassation, according to which “transfer pricing is based on the concept of normal market value pursuant to Presidential Decree no. 917 of 22 December 1986, Article 9 and Article 76, paragraph 5 (now 110, paragraph 7) (…) and responds to the need for a fair division of profits in the various countries where multinational groups operate. For VAT, on the other hand, the consideration actually received is a pivotal element of the mechanism for applying the tax, based on the principle of neutrality of the tax (which would be violated if the taxable base were calculated as an amount per hypothesis higher than the consideration received: a principle that has always been derived from the EU directives (most recently made explicit in Article 73 of Directive 112/2006/Cee) and implemented in Italy by Presidential Decree No. 633, Article 13 of 26 October 1972″ (Judgment No. 2240 of 2018). On the basis of these principles, with reference to the present case, the Agreement between ...

38. Company A is the parent company of M Group, an MNE group engaged in the manufacturing and distribution of electronic devices. Company A has the exclusive right to sell the devices in all territories. 39. Company A decides to subcontract the manufacturing of the electronic devices to Company B, another member of M Group. Under the terms of the contract, Company B will follow the directions of Company A to produce the devices. Company B will source and supply the materials necessary to produce the different parts of the final products. A key component in the manufacturing process is sourced from Company A. Company B sells the finished goods to Company A, which in turn will market and distribute the product to unrelated customers. 40. To perform the manufacturing activities, Company B has invested in machinery and tooling that is specifically adapted to the production of the electronic devices sold by M Group. Company B has no other customer than Company A so its entire output is acquired by Company A. 41. The accurately delineated transaction shows that Company B does not make any unique and valuable contributions in relation to the controlled transactions and the business of M Group. Furthermore, the risks assumed by Company B are not economically significant for the business operations of the group. While the operations of Company B are integrated to some degree with those of Company A and are dependent upon Company A, arm’s length compensation for the contributions of Company B can be reliably benchmarked by reference to comparable uncontrolled transactions and the application of a one-sided transfer pricing method or methods. Under these circumstances, the transactional profit split method is unlikely to be the most appropriate method ...

A Danish HQ acquired goods from an affiliated contract manufacturing company. The Danish tax authorities issued an adjustment of the prices based on the Danish arm’s length provisions contained in section 2 of the Tax Assessment Act. Decision of the Tax tribunal The Tax Tribunal found that the tax authorities had proved that the company’s method for pricing the controlled transactions contained too many uncertainties. The Tax Tribunal further found that the method applied by the tax authorities was in accordance with the OECD Transfer Pricing Guidelines, as the contract manufacturing activities could be equated with a service. Finally, the Tax Tribunal did not find that the pricing of controlled transactions of goods or services could be based on a return on capital employed (ROCE). Pricing of controlled transactions of goods or services was to be based on a comparability analysis of similar transactions between independent companies, cf. OECD Transfer Pricing Guidelines 2010, p. 1.33 and 1.38. Click here for translation DK SKM2018-173-LSR ...

In such an example, given that the relocated activity is a highly competitive one, it is likely that the enterprise in Country A has the option realistically available to it to use either the affiliate in Country B or a third party manufacturer. As a consequence, it should be possible to find comparables data to determine the conditions in which a third party would be willing at arm’s length to manufacture the clothes for the enterprise. In such a situation, a contract manufacturer at arm’s length would generally be attributed very little, if any, part of the location savings. Doing otherwise would put the associated manufacturer in a situation different from the situation of an independent manufacturer, and would be contrary to the arm’s length principle ...

Another example of an activity that may involve intra-group services is manufacturing or assembly operations. The activities can take a variety of forms including what is commonly referred to as contract manufacturing. In some cases of contract manufacturing the producer may operate under extensive instruction from the counterparty about what to produce, in what quantity and of what quality. In some cases, raw materials or components may be made available to the producer by the counterparty. The production company may be assured that its entire output will be purchased, assuming quality requirements are met. In such a case the production company could be considered as performing a low-risk service to the counterparty, and the cost plus method could be the most appropriate transfer pricing method, subject to the principles in Chapter II ...

It may also be the case that the acquiring business will leverage the existing position of the acquired business to expand the business of the acquirer in the territory of operation of the acquired business by causing the acquired business to use the acquirer’s branding. In that case, consideration should be given to whether the acquirer should make a payment to or otherwise compensate the acquired business for the functions performed, risks assumed, and assets used (including its market position) in connection with expanded use of the acquirer’s name ...

Where an existing successful business is acquired by another successful business and the acquired business begins to use a name, trademark or other branding indicative of the acquiring business, there should be no automatic assumption that a payment should be made in respect of such use. If there is a reasonable expectation of financial benefit to the acquired company from using the acquiring company’s branding, then the amount of any payment should be informed by the level of that anticipated benefit ...

In determining the amount of payment with respect to a group name, it is important to consider the amount of the financial benefit to the user of the name attributable to use of that name, the costs and benefits associated with other alternatives, and the relative contributions to the value of the name made by the legal owner, and the entity using the name in the form of functions performed, assets used and risks assumed. Careful consideration should be given to the functions performed, assets used, and risks assumed by the user of the name in creating or enhancing the value of the name in its jurisdiction. Factors that would be important in a licence of the name to an independent enterprise under comparable circumstances applying the principles of Chapters I – III should be taken into account ...

Where one member of the group is the owner of a trademark or other intangible for the group name, and where use of the name provides a financial benefit to members of the group other than the member legally owning such intangible, it is reasonable to conclude that a payment for use would have been made in arm’s length transactions. Similarly, such payments may be appropriate where a group member owns goodwill in respect of the business represented by an unregistered trademark, use of that trademark by another party would constitute misrepresentation, and the use of the trademark provides a clear financial benefit to a group member other than that owning the goodwill and unregistered trademark ...

Questions often arise regarding the arm’s length compensation for the use of group names, trade names and similar intangibles. Resolution of such questions should be based on the principles of this Section B and on the commercial and legal factors involved. As a general rule, no payment should be recognised for transfer pricing purposes for simple recognition of group membership or the use of the group name merely to reflect the fact of group membership. See paragraph 7.12 ...

The principles set out in this section similarly apply in situations where a member of an MNE group provides manufacturing services that may lead to process or product improvements on behalf of an associated enterprise that will assume legal ownership of such process or product improvements. Examples 14 to 17 in the Annex to Chapter VI illustrate in greater detail the application of this Section B in the context of research and development arrangements ...

Company C in country D is a 100% subsidiary of company E, located in country F. In comparison with country F, wages are very low in country D. At the expense and risk of company E, television sets are assembled by company C. All the necessary components, know-how, etc. are provided by company E. The purchase of the assembled product is guaranteed by company E in case the television sets fail to meet a certain quality standard. After the quality check, the television sets are brought – at the expense and risk of company E – to distribution centres company E has in several countries. The function of company C can be described as a purely contract manufacturing function. The risks company C could bear are eventual differences in the agreed quality and quantity. The basis for applying the cost plus method will be formed by all the costs connected to the assembling activities ...

In the circumstances of Example 2 in paragraph 1.84, the significant risks associated with generating a return from the manufacturing activities are controlled by Company A, and the upside and downside consequences of those risks should therefore be allocated to Company A. Company B controls the risk that it fails to competently deliver services, and its remuneration should take into account that risk, as well as its funding costs for the acquisition of the manufacturing plant. Since the risks in relation to the capacity utilisation of the asset are controlled by Company A, Company A should be allocated the risk of under-utilisation. This means that the financial consequences related to the materialisation of that risk including failure to cover fixed costs, write-downs, or closure costs should be allocated to Company A ...

Company B manufactures products for Company A. Under step 1 capacity utilisation risk and supply chain risk have been identified as economically significant in this transaction, and under step 2 it has been established that under the contract Company A assumes these risks. The functional analysis under step 3 provides evidence that Company B built and equipped its plant to Company A’s specifications, that products are manufactured to technical requirements and designs provided by Company A, that volume levels are determined by Company A, and that Company A runs the supply chain, including the procurement of components and raw materials. Company A also performs regular quality checks of the manufacturing process. Company B builds the plant, employs and trains competent manufacturing personnel, and determines production scheduling based on volume levels determined by Company A. Although Company B has incurred fixed costs, it has no ability to manage the risk associated with the recovery of those costs through determining the production units over which the fixed costs are spread, since Company A determines volumes. Company A also determines significant costs relating to components and raw materials and the security of supply. The evaluation of the evidence concludes that Company B performs manufacturing services. Significant risks associated with generating a return from the manufacturing activities are controlled by Company A. Company B controls the risk that it fails to competently deliver services. Each company has the financial capacity to assume its respective risks ...

The Spanish Tax administration made an income adjustment of Citresa (a Spanish subsidiary of the Schweeps Group) Corporate Income Tax for FY 2003, 2004, 2005 and 2006, resulting in a tax liability of €38.6 millon. Citresa entered into a franchise agreement and a contract manufacturing agreement with Schweppes International Limited (a related party resident in the Netherlands). The transactions between the related parties were not found to be in accordance with the arm’s length principle. In the parent company, CITRESA, the taxable income declared for the years 2003 to 2005 was increased as a result of an adjustment of market prices relating to the supply of certain fruit and other components by Citresa to Schweppes International Limited. In the subsidiary, SCHWEPPES, S.A. (SSA), the taxable income declared for the years 2003 to 2006 was increased as a result of adjustment of market prices relating to the supply of concentrates and extracts by the entity Schweppes International Limited, resident in Holland, to SSA. The taxpayer had used the CUP method to verify the arm’s length nature of the transaction while the Spanish Tax administration – due to lack of comparable transactions – found it more appropriate to use the transactional net margin method (TNMM). Prior to 1 December 2006, the Spanish Corporate Income Tax Act (CIT) established three methods of pricing related transactions (the “Comparable Uncontrolled Price Method”, the “Cost Plus Method” and the “Resale Price Method”) and if none were applicable it established the application of the “Transactional Profit Split Method”. Thus, the “Transactional Net Margin Method” was not included at the time the market value of related transactions was established. However, as the Tax Treaty between Spain and the Netherlands was applicable, the Spanish Tax Authorities considered that the OECD Transfer Pricing Guidelines could be directly applicable. Consequently, as the “Transactional Net Margin Method” was envisaged in the above-mentioned Guidelines, the Spanish Tax Authorities understood that this method could be used as a valid pricing method. The case ended up in Court where Citresa argued that the assessment was in breach of EU rules on freedom of establishment and that the TNM method had been applied by the authorities without any legal basis in Spain for the years in question. Judgement of the Court In regards to the claimed violation of the principle of freedom of establishment cf. TFEU article 49, the Court stated: “….the mere purposes of argument, that there can be no doubt as to the conformity with European Union Law of the regime of related-party transactions in Spain, in the terms in which this infringement is proposed to us, which is what is strictly speaking being postulated in cassation for the first time, it being sufficient to support this assertion to record some elementary considerations, such as that the censure is projected indiscriminately on the whole of the law (that is to say, on the legal regime of related-party transactions), which is to say, on the legal regime of related-party transactions, on the legal regime of related-party transactions regulated by Article 16 of Law 43/1995, of 27 December 1995, on Corporate Income Tax, and then Article 16 of Royal Legislative Decree 4/2004, of 5 March 2004, which approves the revised text of the Law on Corporate Income Tax – TRLIS), while, at the same time and in open contradiction, it advocates the application of the precept to resolve the case, thus starting from its compliance with European Union Law.” In regards to application of the transactional net margin method, the Court stated: “…tax years cover the period from January 2003 to February 2006. Article 16.3 of Law 43/1995, in the wording applicable to the case, and the same provision of the TRLIS, in its original version, established the following: “In order to determine the normal market value, the tax authorities shall apply the following methods: Market price of the good or service in question or of others of similar characteristics, making, in this case, the necessary corrections to obtain equivalence, as well as to consider the particularities of the transaction. The following shall be applicable on a supplementary basis: The sale price of goods and services calculated by increasing the acquisition value or production cost of the goods and services by the margin normally obtained by the taxable person in comparable transactions entered into with independent persons or entities or by the margin normally obtained by companies operating in the same sector in comparable transactions entered into with independent persons or entities. Resale price of goods and services established by the purchaser, reduced by the margin normally obtained by the aforementioned purchaser in comparable transactions arranged with independent persons or entities or by the margin normally obtained by companies operating in the same sector in comparable transactions arranged with independent persons or entities, considering, where applicable, the costs incurred by the aforementioned purchaser in order to transform the aforementioned goods and services. Where none of the above methods are applicable, the price derived from the distribution of the joint result of the transaction in question shall be applied, taking into account the risks assumed, the assets involved and the functions performed by the related parties”. This hierarchical list exhausts the possible methods available to the administration for establishing the market value of the transactions to which it has been applied. It consists of four methods: one of them, which we can call direct or primary, that of the market price of the good or service in question (art. 16.3.a) LIS); two others that the law itself declares to be supplementary, that of the increase in acquisition value and that of the resale price (art. 16.3.b) of the legal text itself); and finally, as a residual or supplementary second degree method, that of the distribution of the joint result of the operation in question (art. 16.3.c) LIS). These obviously do not include the valuation method used by the tax inspectorate in this case, that of the net margin of all transactions, introduced ex novo by Law 36/2006, of 29 November, on measures for the ...

In this case “Indonesia Ltd” paid royalties for use of IP owned by the Japanese parent. Following an audit, the tax authorities issued an assessment where the royalty payments were disallowed. Judgement of the Court The Court ruled in favour of the taxpayer. According to the court “Indonesia Ltd” had been able to prove that services had actually been rendered. Click here for translation Putusan Pengadilan Pajak Nomor Put70118-PP-M-IA-15-2016y ...

In this case the Italien tax administration concluded that transactions between an Italien company an a German sister company had been priced lower than the “normal value” of similar transactions. Judgement of the Supreme Court The Supreme Court ruled partly in favor of the GE Transportation Systems S.p.A. and partly in favour of the tax authorities. The case was remanded to the lower court for further considerations. In relation to intercompany transactions the court found that GE Transportation Systems S.p.A. had only limited risk and that the German company owned the intellectual property. In relation to transactions with independent companies, GE Transportation Systems S.p.A. assumed the risks of the transaction and had the rights to manufacture and sell the products. These differences justified different price and led to the transactions not being comparable. The Court concluded that the limited risk – contract manufacturing – transactions with the German parent could not be compared with the full-fledged manufacturing activities. In regards to the limited risk transactions, the court also stated that the Italien contract manufacturer is in a weaker bargaining position compared to a full-fledged manufacturer that owns the relevant intangibles. Excerpt “Since the case cannot be decided on the merits, it must be referred to the Regional Administrative Court of Tuscany in another composition, which will re-examine the accepted grounds and, therefore, in accordance with the above-mentioned principles, will decide on the merits and settle the costs of the present proceedings.” Click here for English translation Click here for other translation Italy Supreme-Court-23-December-2014-No.-27296 ...

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 putusan_put.45162_pp_m.xv_15_2013_20210530 ...

SC Enviro Agro India is a manufacturer of household insecticides and pesticides and had entered into a technology license agreement with a related party – SCCL Japan – and it also purchases the requirement of intermediates from the said company only.  In the years in question, it has purchased intermediates and sold the products to the entities that approved by the SCCL. One of the company to whom most of the products were sold was SCI, a 100% subsidiary of SCCL. In the transfer pricing report SC Enviro Agro India stated that the arrangement with SCCL and SCI was in the nature of contract manufacturing. Following an audit, the tax authorities accepted the price paid/received as arm’s length price for purchase of insecticides and pesticides, intermediates from SCCL and sale of insecticides and pesticides to SCI. But in regards of the royalty payment of 5% to SCCL as per the technology license agreement, the authorities were of the opinion that since the purchase and sales are only from/to associate concerns and not to anybody else, there is no commercial exploitation of technical knowhow. SC Enviro Agro India was nothing but contract manufacturing and as such there was no basis for payment of royalty. Accordingly, deductions for royalty payments were disallowed in assessment year 2003-04 and assessment year 2004-05.  SC Enviro Agro India submitted that it has not paid royalty on entire sales price, but only on the value addition made to the intermediates purchased from the principal company, therefore, no royalty was paid on purchase cost of the raw material and only on the value addition. Furthermore, details of sales made to outside parties i.e. third parties was submitted so as to counter the observations that it has sold only to the related parties. On that basis the tax authorities allowed royalty payment on the sales made to third parties and reduced the assessment. An appeal was filed by SC Enviro Agro India in which it stated that since it had obtained technical knowhow from SCCL, 5% royalty on the entire value addition made should have been allowed rather than restricting to sales made to third parties. SC Enviro Agro India also stated that it was not a contract manufacturer. It was also further stated that since royalty was paid at 5%, it could not be disallow since it was within the safe harbor range of (+)/(-) 5% Judgement of the Court The Court decided in favour of SC Enviro Agro India and dismissed the assessment issued by the tax authorities. Excerpts “…Till assessment year 2003-04 there was no dispute with reference to the payment of royalty and even in the original assessment completed the royalty was allowed as eligible expenditure in the order under section 143(3). In assessment year 2004-05 this issue for the first time was examined by the TPO on the basis of the TP report of assessee wherein assessee submitted that the arrangement is in the nature of contract manufacturers in the FAR analysis. Since this was admitted by assessee, the TPO without examining the nature of agreement or the manufacturing activity of assessee or any other incidental factor came to a conclusion that since assessee admitted to be a contract manufacturer, there is no need to pay any royalty. In his order the TPO also mentions that assessee was not making any sales to outside parties, the fact of which is not correct. On the basis of his observations, he arrived at the royalty arm’s length price at Nil.” “The TPO has to examine whether the price paid or amount paid was at arm’s length or not under the provisions of Transfer Pricing and its rules. The rule does not authorize the TPO to disallow any expenditure on the ground that it was not necessary or prudent for assessee to have incurred the same. On that principle alone, we cannot approve the order of the TPO as it not only considered the facts wrongly but also exceeded the jurisdiction available to the TPO in examining the arm’s length price on a transaction.” “Even though admittedly assessee mentioned in the TP report that the arrangement is in the nature of contract manufacturing, the facts indicates otherwise. The royalty was paid as per the agreement on the value-added price to the SCCL for providing the license and technical knowhow. This payment is independent of whether assessee is full fledged manufacturer or a contract manufacturer or a toll manufacturer and the nature of manufacturing activity cannot have any bearing on the payment of royalty. “ “Since we do not find any reason to restrict the royalty to Nil, we are not in a position to approve the order of the CIT (A) on this issue. Without going into the nitty-gritty of determining whether assessee is a contract manufacturer or a full-fledged manufacturer, since royalty is paid for allowing assessee in utilizing the technical knowhow and the license for manufacturing activity, we are of the opinion that the payment of royalty is wholly and exclusively for the purpose of business. In view of this, we allow assessee’s ground and direct AO to allow the royalty as claimed.” ITA Nos 2057 & 2058-Mum-2009 ORG ...

Prior to a business restructuring in 1999, the Spanish subsidiary, Roche Vitaminas S.A., was a full-fledged distributor, involved in manufacturing, importing, and selling the pharmaceutical products in the Spanish and Portuguese markets. In 1999 the Spanish subsidiary and the Swiss parent, Roche Vitamins Europe Ltd., entered into a manufacturing agreement and a distribution agreement. Under the manufacturing agreement, the Spanish subsidiary manufactured products  according to directions and using formulas, know-how, patents, and trademarks from the Swiss parent. These manufacturing activities were remunerated at cost plus 3.3 percent. Under the distribution (agency) agreement, the Spanish subsidiary would “represent, protect and promote” the products. These activities were remunerated at 2 percent of sales. The Spanish subsidiary was now characterized as a contract manufacturer and commission agent and the taxable profits in Spain were much lower than before the business restructuring. The Spanish tax authorities argued that the activities constituted a PE in Spain according to article 5 of DTT between Spain and Switzerland. Therefore, part of the profits should be allocated to the Spanish subsidiary in accordance with article 7 of the DTT. Supreme Court Judgement The Supreme Court held that the restructured Spanish entity created a PE of Roche Vitamins Europe Ltd. in Switzerland. The profits attributed to the PE included not only the manufacturing profits but also profits from the distribution activity performed on behalf of Roche Vitamins Europe Ltd. in Switzerland. Excerpts “The administration is therefore correct in stating that the applicant company operated in Spain by means of a permanent establishment…” “In short, what is laid down in these two paragraphs 1 and 2 of Article 7 of the Spanish-Swiss Convention (in summary form) is that: (a) If a taxpayer acts in a State, of which he is not a resident, through a permanent establishment, then the profits of that taxpayer may be taxed in that State, but only to the extent that such profits are attributable to the said re-establishment. (b) This means that only the profit that the non-resident would have made in that State if he had had a full presence (as a resident), through a separate and distinct company, will be taxable in that State; but, of course, only in respect of the activity carried out by that establishment. The Audiencia Nacional, contrary to this reading of Article 7, establishes that if a non-resident company has a permanent establishment, then it must be taxed in the State in which that establishment is located for all the activities carried out in the territory of that State, even if they are not carried out through the permanent establishment. Contrary to this, and by application of the only possible interpretation of Article 7(1) and (2) (already explained and in accordance with the criteria of the OECD Tax Committee, as we shall see below), a permanent establishment should only be taxed in the State in which it is located on the profit derived from the activity carried out through the permanent establishment.” “…the sales figure must include all sales made by the permanent establishment. We consider that it is established in the file, contrary to the appellant’s submissions, that those sales must include those made to Portuguese customers, since they were made as a result of the promotional and marketing activities of Roche Vitaminas SA and are therefore attributable to it. It is also common ground that the expenses referred to by the appellant have been taken into account, as is stated in the official document dated 12 July 2002. For the rest, we refer to what was established in the settlement agreement dated 23 April 2003, as well as to the full arguments contained in the judgment under appeal.” Click here for english translation Click here for other translation Spain-vs-Roche-Januar-2014-Supreme-Court-case-nr.-1626-2008 ...

In this case royalty payments from Sona Okegawa Precision Forgings Ltd. – a contract manufacturer in India – had been disallowed by the tax authorities. The tax authorities “had analyzed this transaction and observed that assessee manufactured the goods and sold those goods to the AE. These goods are specific goods which have been produced for the associate enterprises. The technology has been received from the AE for producing these goods, therefore, the assessee has to be construed as a contract manufacturer for these products. The payment of royalty in the case of a contract manufacturer to the AE is not justified as per OECD guidelines.” Judgement The appeal of the tax authorities was dismissed “…The first aspect is whether the royalty paid by the assessee @ 3% is excessive and not computed at arm’s length price. We find that the assessee has placed on record copy of the letter dated 30.4.1993 written by the RBI, Exchange Control Department to M/s. Sona Steering System Ltd. wherein royalty @ 3% on domestic sales subject to taxes for a period of five years was allowed to be paid. There are similar other correspondence which have been placed on the paper book. Similarly, on page 51 of the paper book, a press note issued in 2003 issued by the Government of India, Ministry of Commerce & Industries, Department of Industrial Policy and Promotion has been placed. In this press release, royalty payment at 8% on export and 5% on domestic sales has been referred as a reasonable payment for processing the cases for approval. Thus, learned TPO failed to bring any material on the record which can suggests that payment of royalty @ 3% was excessive, one and not at arm’s length price. The other aspect is whether assessee has made the sales to the A.E at arm’s length price or not? This issue has not been considered by the learned TPO in detail. He was unable to collect any material indicating that sales price charges by the assessee was not at arm’s length. In a way, he accepted that sales made by the assessee to Assessing Officer are on arm’s length. Learned First Appellate Authority has considered this aspect also in the finding extracted above. Learned TPO further not brought any material indicating the fact that assessee is a contract manufacturer. He only draws inference in this regard. In assessment year 2004-05, ITAT has considered this aspect and has upheld the order of the Learned CIT(Appeals) deleting such addition. Thus, after taking into consideration the facts and circumstances and the findings of the Learned CIT(Appeals) extracted supra, we do not find any merit in this appeal. It is dismissed.” India vs Sona Okegawa Precision Forgings 2011 ...

Fulford India Ltd. imported active pharmaceutical ingredients (APIs) from related group companies and sold them in India. The TNM method was used for determening transfer prices. The tax administration found the CUP method to be the most appropriate. Fulford India argued that the CUP method requires stringent comparability and any differences which could materially affect the price in the open market should be taken into consideration. In the pharmaceutical world, APIs whith similar properties may still be different in relation to quality, efficiancy, impurities etc. Therefore, the two products cannot be compared. In court, it was further explained that Fulford also performed secondary manufacturing functions, converting the APIs into formulations. Hence, Fulford could be descriped as a value added distributor. The Court concluded that the selection of the best method should be based on functional analysis and the characterisation of the transactions and the entities. The fact that Fulford had secondary manufacturing activities had not previously been explained to the tax authorities. Accordingly, the case was returned to tax administration for a revised assessment. Fulford_(I)_Ltd,_Mumbai_vs_Assessee ...

A Spanish subsidiary of a UK Group (Borex), which imported, processed and sold the materials to third parties, was transformed into a a contract manufacturer. The Spanish subsidiary signed two separate contracts with the UK parent – one for warehousing and the provision of services and the other in respect of an sales agency. Under the first contract, the minerals purchased by the parent would be stored and processed by the subsidiary, which would also provide other relevant services. Under the second contract, the Spanish subsidiary would promote sales of the minerals in Spain, but, as the prices and conditions were fixed by the UK parent, the subsidiary would only send orders to the parent, which according to the contract was not bound to accept them. The subsidiary could not accept orders in the name of the parent or receive payment. The tax authorities argued that there was a high degree of overlapping between the activities carried out by the parent and the subsidiary. According to the tax authorities warehousing, service and promotion of sales activities could not be considered separately, and as the activities were not of a preparatory or auxiliary nature there was a PE in Spain . The National Court concluded that, article 5(3) of the Spain-UK Tax Treaty (article 5(4) of the OECD Model) did not apply, as the activities in the subsidiary could not be considered in isolation. The activities were to be considered part of a chain that completed an economic cycle in Spain. Click here for English translation Click here for other translation Spain-vs-Borex-February-2011-National-Court-case-nr.-80-2008 ...