“Fertilizer B.V.” is part of a Norwegian group that produces, sells and distributes fertiliser (products). “Fertilizer B.V.” is the parent company of a several subsidiaries, including the intermediate holding company [C] BV and the production company [D] BV. The case before the Dutch Supreme Court involves two points of dispute: (i) is a factually highly effective hedge sufficient for mandatory connected valuation of USD receivables and payables? (ii) is the transfer prices according to the supply and distribution agreements between [D] and a Swiss group company (AG) at arm’s length? (i) Factual hedge of receivables and payables “Fertilizer B.V.” had receivables, forward foreign exchange contracts and liabilities in USD at the end of 2012 and 2013. It values those receivables and payables at acquisition price or lower value in use. It recognised currency gains as soon as they were realised and currency losses as soon as a receivable was valued lower or a debt higher. The court has measured dollar debts and forward contracts coherently, but not dollar debts against dollar receivables from a Brazilian subsidiary arising from corporate financing. The Court of Appeal does not consider a highly effective currency hedge (actual correlation) in itself sufficient for coherent valuation; in its view, this also requires a business policy connection between opposite currency positions, such as an intent of hedging or a business relationship between receivable and debt. The Secretary of State believes that the reality principle means that in the case of an actual 100% correlation, debts and receivables in the same currency should be measured coherently. With all the disputed receivables and payables being denominated in USD, the currency hedge is very effective, so they should be measured coherently. A-G Wattel believes that the reality of a highly effective currency hedge is that no foreign exchange risk is incurred as long as and to the extent that the hedge exists and that, therefore, the reality principle to that extent compels coherent valuation, irrespective of whether the entrepreneur intended hedging and irrespective of the existence or non-existence of prudential link between receivable and debt in the same currency. This, in his view, is in line with the case law on coherent valuation he has reproduced. He considers the cassation appeal of the State Secretary in both cases well-founded. (ii) Transfer pricing [D] produces fertiliser products and sells them to affiliated sales organisations. Transfer prices are based on the Transfer Pricing Master File (TP Master File) that says fully fledged producers like [D] are rewarded according to the comparable uncontrolled price (CUP). In 2008, it was decided to invest €400m by [D] in a plant, which was commissioned in early September 2011, enabling [D] to produce 39% more urea and fertiliser products (the surplus) than before. On 14 September 2011, following the commissioning of the new plant, [D] and AG entered into a Supply Agreement and a Distribution Agreement. AG is “related” to the interested party and to [D] within the meaning of Section 8 Vpb. Those agreements provide that AG buys the surplus for cost plus 5%, for five years, with tacit renewal. On that basis, [D] invoices 39% of its production at cost plus 5% to AG every month and remits the rest of its profit on the surplus to AG. According to the Inspector, this results in a monthly improper profit shift from [D] in the Netherlands to AG in Switzerland. The court did not find it plausible that a fully fledged profitable producer like [D] would cede its existing and proven excess profit capacity – which was only improved by the new plant – on a large part of its production to a third party in the market. The party making that claim will have to provide a business explanation for the fact that the agreements leave only 5% margin to the group’s proven much more profitable ‘best performing’ entrepreneur which continued to perform all the functions it was performing before, except (on paper) 39% production risk control, and for the fact that [D]’s substantial residual profit was henceforth transferred by it on a monthly basis to an affiliated acquirer of 39% production risk, with no significance to [D]’s original 61% production and no significance to the core functions required for [D]’s 39% surplus production. According to A-G Wattel, the Court of Appeal thus did not divide the burden of proof unreasonably or contrary to due process. Those who make remarkable contentions contrary to their own previous and 61% still held positions and contrary to their own TP Master File will have to provide an explanation. ‘The Court’s judgment implies, in the absence of sufficient explanation by the interested party, substantially (i) that a company that is unmistakably the most complex entity cannot be changed into a routine margin producer by mere contracting for an arbitrary percentage (39%) of its capacity while at the same time remaining fully fledged entrepreneur for the identical 61% remaining production and for the 39% surplus also effectively keeping everything as it was, and (ii) that neither can a Swiss group company which is not introduced to [D]’s production (processes), logistics, distribution and administration, and which is thus unmistakably the least complex entity, be turned into the true entrepreneur that [D] is by a mere contract for the same arbitrary percentage (39%) and also remains for that 39%, the less so as that contract is incompatible with the group’s TP Master File. Since, according to the Court, an unaffiliated entrepreneur would never agree to such a contract and, therefore, such contracts, according to it, are not concluded between unaffiliated parties, arm’s-length terms are difficult to conceive: no arm’s-length terms can be conceived for a non-existent transaction, so the situation without the said agreements must be assumed. A-G Wattel considers these judgments correct insofar as they are legal, factual and not incomprehensible. He therefore does not find incomprehensible the Court of Appeal’s conclusion that, for tax purposes, the situation without the two agreements should be assumed, which are not thereby disregarded, but ...

42. The facts in this example are the same as those set out in Example 10 with the following additions: At the end of Year 3, Primair stops manufacturing watches and contracts with a third party to manufacture them on its behalf. As a result, Company S will import unbranded watches directly from the manufacturer and undertake secondary processing to apply the R name and logo and package the watches before sale to the final customer. It will then sell and distribute the watches in the manner described in Example 10. As a consequence, at the beginning of Year 4, Primair and Company S renegotiate their earlier agreement and enter into a new long term licensing agreement. The new agreement, to start at the beginning of Year 4, is for five years, with Company S having an option for a further five years. Under the new agreement, Company S is granted the exclusive right within country Y to process, market and distribute watches bearing the R trademark in consideration for its agreement to pay a royalty to Primair based on the gross sales of all such watches. Company S receives no compensation from Primair in respect of the renegotiation of the original marketing and distribution agreement. It is assumed for purposes of this example that the purchase price Company S pays for the watches from the beginning of Year 4 is arm’s length and that no consideration with respect to the R name is embedded in that price. 43. In connection with a tax audit conducted by country Y tax administrations in Year 6, it is determined, based on a proper functional analysis, that the level of marketing expenses Company S incurred during Years 1 through 3 far exceeded those incurred by independent marketers and distributors with similar long term marketing and distribution agreements. It is also determined that the level and intensity of marketing activity undertaken by Company S exceeded that of independent marketers and distributors, and that the relatively greater activity has been successful in expanding volumes and/or increasing the Primair group’s overall margins from sales in country Y. Given the extent of the market development activities undertaken by Company S, including its strategic control over such activities, it is evident from the comparability and functional analysis that Company S has assumed significantly greater costs and assumed greater risks than comparable independent enterprises. There is also evidence that the individual entity profit margins realised by Company S are significantly lower than the profit margins of comparable independent marketers and distributors during the corresponding years of similar long-term marketing and distribution arrangements. 44. The country Y audit also identifies that in Years 4 and 5, Company S bears the costs and associated risks of its marketing activities under the new long-term licensing arrangement with Primair, and because of the long-term nature of the agreement, Company S may have an opportunity to benefit (or suffer a loss) from its activities. However, Company S has undertaken market development activities and incurred marketing expenditure far beyond what comparable independent licensees with similar long-term licensing agreements undertake and incur for their own benefit, resulting in significantly lower anticipated profit margins for Company S than those of comparable enterprises. 45. Based on these facts, Company S should be compensated with an additional return for the market development functions it performs, the assets it uses and the risks it assumes. For Years 1 through 3, the possible bases for such an adjustment would be as described in Example 10. For Years 4 and 5 the bases for an adjustment would be similar, except that the adjustment could reduce the royalty payments from Company S to Primair, rather than the purchase price of the watches. Depending on the facts and circumstances, consideration could also be given to whether Company S should have received compensation in connection with the renegotiation of the arrangement at the end of Year 3 in accordance with the guidance in Part II of Chapter IX ...

39. The facts in this example are the same as in Example 9 with the following additions: By the end of Year 3, the R brand is successfully established in the country Y market and Primair and Company S renegotiate their earlier agreement and enter into a new long-term licensing agreement. The new agreement, which is to commence at the beginning of Year 4, is for five years with Company S having an option for a further five years. Under this agreement, Company S agrees to pay a royalty to Primair based on the gross sales of all watches bearing the R trademark. In all other respects, the new agreement has the same terms and conditions as in the previous arrangement between the parties. There is no adjustment made to the price payable by Company S for the branded watches as a result of the introduction of the royalty. Company S’s sales of R brand watches in Years 4 and 5 are consistent with earlier budget forecasts. However, the introduction of the royalty from the beginning of year 4 results in Company S’s profit margins declining substantially. 40. Assume that there is no evidence that independent marketers/distributors of similar branded products have agreed to pay royalties under similar arrangements. Company S’s level of marketing expenditure and activity, from Year 4 on, is consistent with that of independent enterprises. 41. For transfer pricing purposes, it would not generally be expected that a royalty would be paid in arm’s length transactions where a marketing and distribution entity obtains no rights for transfer pricing purposes in trademarks and similar intangibles other than the right to use such intangibles in distributing a branded product supplied by the entity entitled to the income derived from exploiting such intangibles. Furthermore, the royalty causes Company S’s profit margins to be consistently lower than those of independent enterprises with comparable functions performed, assets used and risks assumed during the corresponding years of similar long-term marketing and distribution arrangements. Accordingly, a transfer pricing adjustment disallowing the royalties paid would be appropriate based on the facts of this example ...

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

20. Primair, a resident of country X, manufactures watches which are marketed in many countries around the world under the R trademark and trade name. Primair is the registered owner of the R trademark and trade name. The R name is widely known in countries where the watches are sold and has obtained considerable economic value in those markets through the efforts of Primair. R watches have never been marketed in country Y, however, and the R name is not known in the country Y market. 21. In Year 1, Primair decides to enter the country Y market and incorporates a wholly owned subsidiary in country Y, Company S, to act as its distributor in country Y. At the same time, Primair enters into a long-term royalty-free marketing and distribution agreement with Company S. Under the agreement, Company S is granted the exclusive right to market and distribute watches bearing the R trademark and using the R trade name in country Y for a period of five years, with an option for a further five years. Company S obtains no other rights relating to the R trademark and trade name from Primair, and in particular is prohibited from re-exporting watches bearing the R trademark and trade name. The sole activity of Company S is marketing and distributing watches bearing the R trademark and trade name. It is assumed that the R watches are not part of a portfolio of products distributed by Company S in country Y. Company S undertakes no secondary processing, as it imports packaged watches into country Y ready for sale to the final customer. 22. Under the contract between Primair and Company S, Company S purchases the watches from Primair in country Y currency, takes title to the branded watches and performs the distribution function in country Y, incurs the associated carrying costs (e.g. inventory and receivables financing), and assumes the corresponding risks (e.g. inventory, credit and financing risks). Under the contract between Primair and Company S, Company S is required to act as a marketing agent to assist in developing the market for R watches in country Y. Company S consults with Primair in developing the country Y marketing strategy for R watches. Primair develops the overall marketing plan based largely on its experience in other countries, it develops and approves the marketing budgets, and it makes final decisions regarding advertising designs, product positioning and core advertising messages. Company S consults on local market issues related to advertising, assists in executing the marketing strategy under Primair’s direction, and provides evaluations of the effectiveness of various elements of the marketing strategy. As compensation for providing these marketing support activities, Company S receives from Primair a service fee based on the level of marketing expenditure it incurs and including an appropriate profit element. 23. Assume for the purpose of this example that, based upon a thorough comparability analysis, including a detailed functional analysis, it is possible to conclude that the price Company S pays Primair for the R watches should be analysed separately from the compensation Company S receives for the marketing it undertakes on behalf of Primair. Assume further that based upon identified comparable transactions, the price paid for the watches is arm’s length and that this price enables Company S to earn an arm’s length level of compensation from selling the watches for the distribution function it performs, the assets it uses and the risks it assumes. 24. In Years 1 to 3, Company S embarks on a strategy that is consistent with its agreement with Primair to develop the country Y market for R watches. In the process, Company S incurs marketing expenses. Consistent with the contract, Company S is reimbursed by Primair for the marketing expenses it incurs, and is paid a mark-up on those expenses. By the end of Year 2, the R trademark and trade name have become well established in country Y. The compensation derived by Company S for the marketing activities it performed on behalf of Primair is determined to be arm’s length, based upon comparison to that paid to independent advertising and marketing agents identified and determined to be comparable as part of the comparability analysis. 25. Under these circumstances, Primair is entitled to retain any income derived from exploiting the R trademark and trade name in the country Y market that exceeds the arm’s length compensation to Company S for its functions and no transfer pricing adjustment is warranted under the circumstances ...

B Restructuring LDA was a distributor within the E group. During FY 2014-2016 a number of manufacturing entities within the group terminated distribution agreements with B Restructuring LDA and subsequently entered into new Distribution Agreements, under similar terms, with another company of the group C. These events were directed by the Group’s parent company, E. The tax authorities was of the opinion, that if these transaction had been carried out in a free market, B would have received compensation for the loss of intangible assets – the customer portfolio and the business and market knowledge (know-how) inherent to the functions performed by B. In other words, these assets had been transferred from B to C. The tax authorities performed a valuation of the intangibles and issued an assessment of additional taxable income resulting from the transaction. E Group disagreed with the assessment as, according to the group, there had been no transaktion between the B and C. Furthermore the group held that there was no transaction or disposal of intangibles, as B could not sell what did not belong to it, namely the client portfolio, which had been, almost in its entirety, raised by the Group, prior to its use by B. Result reached in the arbitration tribunal The Tribunal set aside the assessment of additional income in respect of transfer of intangibles. Excerpts “…The Tax Authorities, anchored in the positions of the OECD, states in the RIT that: “From this perspective, the acceptance by B… of a distribution contract, on which the entirety of its activity depends, containing clauses that (i) harm its individual interest (Clause 11, which provides that the parties waive the right to claim damages in connection with the execution or termination of the contract) […] is a decision that differs from the rationality of pursuing self-interest that would exist in an independent company ” Indeed, the position that independent entities, when transacting with each other, would require consideration for the transfer of assets is understandable. However, it is also true that § 6.13 of the OECD Guidelines underlines that within a Group there are special relationships, with rules specific to the Group, which should not be automatically called into question for failure to respect the arm’s length principle, particularly in transactions involving intangibles. In this context, the RIT is totally silent, and should not be, on the value of the Group’s contribution to B… customers, as based on the evidence, in particular in the logic of application of the excess earnings method (and respective elements contributing to the assets under appraisal). In a transaction between independent parties, the selling party, having previously obtained such a right or intangible asset, certainly through the payment of a consideration, what it would gain is the value arising from its specific contribution, and not the total value of the asset, since a substantial part of it was not developed by it . In the present case, the profit of B… would have to be deducted the value contributed by the group for the portfolio of clients reallocated to C… . If a compensation for the reallocation of B…’s intangibles was accepted, it would also have to be analysed how it would be shared among the Group’s entities that contributed to the generation of the reallocated intangibles. In light of all the foregoing, it can be concluded that the tax acts of assessment of the CIT and the compensatory interest inherent thereto are vitiated by an error in the assumptions and can therefore be annulled on the grounds of substantive defects, by virtue of the AT’s failure to observe the legal criteria of the method for determining the comparable market price (PCM) or other alternative method. Specifically: a. The allegedly comparable price was obtained by the AT from the data of a controlled transaction, and not from a transaction between independent parties – which is not admissible under Article 63 of the IRC Code, Ministerial Order 1446-C/2001 and the OECD Guidelines that enshrine the guidelines to be followed for this purpose; b. The evaluation method used was the discounted cash-flow method, which has as general postulate that the value of an asset (or company) is based on the cash flows that it will release, updated (present value) to the moment when the transaction of that asset (or company) takes place. However, inconsistently, despite invoking that method, the AT did not rely on a projection of cash flows for a multi-year period, basing itself on the profits (and not, as stated, cash flows) of a given year – 2014 (and not, as stated, on a multi-year basis); c. Relevant comparability factors were not taken into account, such as, in the present case, the fact that the “profit” of B… should be deducted the value contributed by the Group for the portfolio of clients reallocated to C…”. Also with regard to the choice of method, in the words of the TCA Sul, in its Judgment of 25 January 2018, rendered in Case No. 06660/13 (available in http://www.dgsi.pt): “Transfer prices, as we have already stated, must be determined in accordance with the arm’s length principle (Pursuant to article 2 of Ordinance no. 1446-C/2001, the arm’s length principle is applicable (i) to controlled transactions between an IRS or IRC taxpayer and a non-resident entity; (ii) to transactions carried out between a non-resident entity and its permanent establishment, including those carried out between a permanent establishment in Portuguese territory and other permanent establishments of the same entity located outside this territory; (iii) controlled transactions carried out between entities resident in Portuguese territory subject to IRS or IRC. And by virtue of Article 58(10) of the CIRC and Article 23 of the above-mentioned Ministerial Order, the arm’s length principle is also applicable to the situations provided for therein. Maybe for this reason, the legislator consecrated an open clause regarding the methods to be adopted to determine the transfer prices (see the wording of paragraph b) of article 4 of Ministerial Order no. 1446-C/2001, of 21st March) ...

ZERAIM IBERICA SA, a Spanish subsidiary in the Swiss Syngenta Group (that produces seeds and agrochemicals), had first been issued a tax assessment relating to fiscal years 2006 and 2007 and later another assessment for FY 2008 and 2009 related to the arm’s length price of seeds acquired from Zeraim Gedera (Israel) and thus the profitability of the distribution activities in Spain. The company held that new evidence – an advance pricing agreement (APA) between France and Switzerland – demonstrated that the comparability analysis carried out by the Spanish tax authorities suffered from significant deficiencies and resulted in at totally irrational result, intending to allocate a net operating result or net margin of 32.79% in fiscal year 2008 and 30.81% in 2009 to ZERAIM IBERICA SA when the profitability of distribution companies in the sector had average net margins of 1.59%. The tax authorities on there side argued that the best method for pricing the transactions was the Resale Price Method and further argued that the companies in the benchmark study provided by the taxpayer were not comparable. The authorities also pointed to the fact that ZERAIM IBERICA SA prior to entering the distribution agreement had a gross margin of around 40%, and now after entering the agreement would have a net margin of only 1.5%. The Court held in favor of the tax authorities due to (1) lack of explanation to the shift in profitability of ZERAIM IBERICA SA before and after entering the distribution agreement and (2) lack in comparability between the companies selected for the benchmark study and the Spanish distributor and (3) the transactional net margin method presented by the taxpayer in accordance with Spanish regulations is subordinated to the direct methods (resale price minus etc.). Click here for English translation Click here for other translation ...

Samsung Electronics Baltic Ltd, is a subsidiary of Samsung Electronics Co. Ltd, which was established at the end of 2007. On 1 January 2008, Samsung Electronics Baltic and Samsung Electronics Co. Ltd entered into Distribution Agreement, under which Samsung Electronics Baltic was appointed as the distributor in the Baltic States of the products manufactured by Samsung Electronics Co. Ltd and its subsidiaries (‘the Distribution Agreement’). In 2008 and 2009, Samsung Electronics Baltic carried out business activities in the territory of Latvia, Lithuania and Estonia distributing the goods received from Samsung Electronics Co. Ltd under the Distribution Agreement. Samsung Electronics Baltic also provided warranty services for the goods sold by engaging service providers for that purpose, namely merchants who carried out repairs of the goods (‘Repair Services’). On 2 January 2008, Samsung Electronics Baltic concluded a Warranty Assumption Agreement (‘the Warranty Assumption Agreement’) with its sister company, Samsung Electronics Overseas B.V. (‘Dutch Samsung’), which was the distributor of Samsung Electronics Co. Ltd’s products in the Baltic States before the Applicant. Under the agreement, Samsung Electronics Baltic undertook to provide product warranty services for products sold by Dutch Samsung in the Baltic markets in 2005, 2006 and 2007, and Dutch Samsung undertook to pay Samsung Electronics Baltic a lump sum of USD 4 369 550 to fulfil the assumed warranty obligations. In order to fulfil its obligations under this contract, Samsung Electronics Baltic engaged the services of Repair Service Providers. Pursuant to the Distribution Agreement and the Marketing Fund Agreement (‘the Marketing Fund Agreement’) concluded on 1 January 2008 between Samsung Electronics Baltic and Samsung Electronics Co. Ltd, Samsung Electronics Baltic also performed marketing functions for the Samsung Group in 2008. In particular, Samsung Electronics Baltic engaged marketing agencies as marketing service providers in accordance with the marketing strategy set out by Samsung Electronics Co. Ltd. Samsung Electronics Baltic paid the service fees indicated in the invoices issued by these agencies and subsequently invoiced Samsung Electronics Co. Ltd (or other related companies) for the same amount. The State Revenue Service (hereinafter – the Service) audited Samsung Electronics Baltic for value added tax for the period from January 2008 to October 2009 and for corporate income tax for 2008. The administrative procedure before the authority was concluded by the decision of the Revenue Service of 15 February 2011 (hereinafter – the appealed decision), by which the value added tax, the related penalty and late payment fines were calculated for additional payment to the budget, the value added tax to be refunded from the budget and the related penalty were reduced, and the corporate income tax and the related late payment fines and penalties were calculated for additional payment to the budget by the applicant. As regards value added tax, the contested decision states that in 2008 and 2009 Samsung Electronics Baltic deducted as input tax in its value added tax returns the amounts of tax indicated in the invoices issued to Samsung Electronics Baltic by the Repair Service. According to the Authority, Samsung Electronics Baltic was not entitled to do so, since the transactions in question were not aimed at the pursuit of Samsung Electronics Baltic’s economic activity (transactions subject to value added tax). The Revenue Service considers that Samsung Electronics Baltic used the transactions in question to secure its warranty service obligations towards Samsung Electronics Co. Ltd and Samsung Netherlands, whereas, in the Revenue Service’s view, these relationships are not to be regarded as transactions subject to value added tax but as cost compensation transactions which are not subject to value added tax. As regards corporation tax, the contested decision states that Samsung Electronics Baltic, in performing the group’s marketing functions, has acted as an intermediary which undertakes to provide the related companies with the services of subcontractors (marketing agencies). The Authority found that since Samsung Electronics Baltic passed on the services received from the unrelated parties – the marketing agencies – to Samsung Electronics Co. Ltd and other related undertakings without a mark-up, it follows that Samsung Electronics Baltic provided services to the related undertakings below the market price, since an unrelated undertaking would have added a mark-up to such intermediation services in order to make a profit. Consequently, there are grounds for adjusting Samsung Electronics Baltic’s corporation taxable income by the difference between the value of the services reported by Samsung Electronics Baltic and the market value of the services as calculated by the Revenue Service. The method of adding up costs should be used to determine the market value of the services provided. Taking into account the information available in the Amadeus database, it is estimated that the operating cost or profit margin for unrelated undertakings ranges between 1,7 % and 4,05 %. Consequently, the market value of the services provided by Samsung Electronics Baltic to its affiliates was determined by applying the profit margin of 1,7 % to the sum of the value of the services received from the marketing agencies and Samsung Electronics Baltic’s agency costs as determined in the audit. In follows from the judgement that – If the arm’s length price is not applied and the goods or services are sold at a price below the arm’s length price, the taxable income for corporation tax purposes must be revised upwards by that part of the difference. The legislator has accepted that the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, which summarise the best practices in transfer pricing of OECD Member States, complement the explanation of the market price methods in the legislation and provide guidance to help calculate the market price as accurately as possible. Consequently, the application of market price methodologies should take into account and use, to the extent possible, the guidance provided in those guidelines. Determining the nature of the service provided is a prerequisite for application of the cost markup method. The essence of the cost markup method is the application of a mark-up to the costs incurred by the service provider in providing the service which is ...

42. The facts in this example are the same as those set out in Example 10 with the following additions: At the end of Year 3, Primair stops manufacturing watches and contracts with a third party to manufacture them on its behalf. As a result, Company S will import unbranded watches directly from the manufacturer and undertake secondary processing to apply the R name and logo and package the watches before sale to the final customer. It will then sell and distribute the watches in the manner described in Example 10. As a consequence, at the beginning of Year 4, Primair and Company S renegotiate their earlier agreement and enter into a new long term licensing agreement. The new agreement, to start at the beginning of Year 4, is for five years, with Company S having an option for a further five years. Under the new agreement, Company S is granted the exclusive right within country Y to process, market and distribute watches bearing the R trademark in consideration for its agreement to pay a royalty to Primair based on the gross sales of all such watches. Company S receives no compensation from Primair in respect of the renegotiation of the original marketing and distribution agreement. It is assumed for purposes of this example that the purchase price Company S pays for the watches from the beginning of Year 4 is arm’s length and that no consideration with respect to the R name is embedded in that price. 43. In connection with a tax audit conducted by country Y tax administrations in Year 6, it is determined, based on a proper functional analysis, that the level of marketing expenses Company S incurred during Years 1 through 3 far exceeded those incurred by independent marketers and distributors with similar long term marketing and distribution agreements. It is also determined that the level and intensity of marketing activity undertaken by Company S exceeded that of independent marketers and distributors, and that the relatively greater activity has been successful in expanding volumes and/or increasing the Primair group’s overall margins from sales in country Y. Given the extent of the market development activities undertaken by Company S, including its strategic control over such activities, it is evident from the comparability and functional analysis that Company S has assumed significantly greater costs and assumed greater risks than comparable independent enterprises. There is also evidence that the individual entity profit margins realised by Company S are significantly lower than the profit margins of comparable independent marketers and distributors during the corresponding years of similar long-term marketing and distribution arrangements. 44. The country Y audit also identifies that in Years 4 and 5, Company S bears the costs and associated risks of its marketing activities under the new long-term licensing arrangement with Primair, and because of the long-term nature of the agreement, Company S may have an opportunity to benefit (or suffer a loss) from its activities. However, Company S has undertaken market development activities and incurred marketing expenditure far beyond what comparable independent licensees with similar long-term licensing agreements undertake and incur for their own benefit, resulting in significantly lower anticipated profit margins for Company S than those of comparable enterprises. 45. Based on these facts, Company S should be compensated with an additional return for the market development functions it performs, the assets it uses and the risks it assumes. For Years 1 through 3, the possible bases for such an adjustment would be as described in Example 10. For Years 4 and 5 the bases for an adjustment would be similar, except that the adjustment could reduce the royalty payments from Company S to Primair, rather than the purchase price of the watches. Depending on the facts and circumstances, consideration could also be given to whether Company S should have received compensation in connection with the renegotiation of the arrangement at the end of Year 3 in accordance with the guidance in Part II of Chapter IX ...

39. The facts in this example are the same as in Example 9 with the following additions: By the end of Year 3, the R brand is successfully established in the country Y market and Primair and Company S renegotiate their earlier agreement and enter into a new long-term licensing agreement. The new agreement, which is to commence at the beginning of Year 4, is for five years with Company S having an option for a further five years. Under this agreement, Company S agrees to pay a royalty to Primair based on the gross sales of all watches bearing the R trademark. In all other respects, the new agreement has the same terms and conditions as in the previous arrangement between the parties. There is no adjustment made to the price payable by Company S for the branded watches as a result of the introduction of the royalty. Company S’s sales of R brand watches in Years 4 and 5 are consistent with earlier budget forecasts. However, the introduction of the royalty from the beginning of year 4 results in Company S’s profit margins declining substantially. 40. Assume that there is no evidence that independent marketers/distributors of similar branded products have agreed to pay royalties under similar arrangements. Company S’s level of marketing expenditure and activity, from Year 4 on, is consistent with that of independent enterprises. 41. For transfer pricing purposes, it would not generally be expected that a royalty would be paid in arm’s length transactions where a marketing and distribution entity obtains no rights for transfer pricing purposes in trademarks and similar intangibles other than the right to use such intangibles in distributing a branded product supplied by the entity entitled to the income derived from exploiting such intangibles. Furthermore, the royalty causes Company S’s profit margins to be consistently lower than those of independent enterprises with comparable functions performed, assets used and risks assumed during the corresponding years of similar long-term marketing and distribution arrangements. Accordingly, a transfer pricing adjustment disallowing the royalties paid would be appropriate based on the facts of this example ...

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

20. Primair, a resident of country X, manufactures watches which are marketed in many countries around the world under the R trademark and trade name. Primair is the registered owner of the R trademark and trade name. The R name is widely known in countries where the watches are sold and has obtained considerable economic value in those markets through the efforts of Primair. R watches have never been marketed in country Y, however, and the R name is not known in the country Y market. 21. In Year 1, Primair decides to enter the country Y market and incorporates a wholly owned subsidiary in country Y, Company S, to act as its distributor in country Y. At the same time, Primair enters into a long-term royalty-free marketing and distribution agreement with Company S. Under the agreement, Company S is granted the exclusive right to market and distribute watches bearing the R trademark and using the R trade name in country Y for a period of five years, with an option for a further five years. Company S obtains no other rights relating to the R trademark and trade name from Primair, and in particular is prohibited from re-exporting watches bearing the R trademark and trade name. The sole activity of Company S is marketing and distributing watches bearing the R trademark and trade name. It is assumed that the R watches are not part of a portfolio of products distributed by Company S in country Y. Company S undertakes no secondary processing, as it imports packaged watches into country Y ready for sale to the final customer. 22. Under the contract between Primair and Company S, Company S purchases the watches from Primair in country Y currency, takes title to the branded watches and performs the distribution function in country Y, incurs the associated carrying costs (e.g. inventory and receivables financing), and assumes the corresponding risks (e.g. inventory, credit and financing risks). Under the contract between Primair and Company S, Company S is required to act as a marketing agent to assist in developing the market for R watches in country Y. Company S consults with Primair in developing the country Y marketing strategy for R watches. Primair develops the overall marketing plan based largely on its experience in other countries, it develops and approves the marketing budgets, and it makes final decisions regarding advertising designs, product positioning and core advertising messages. Company S consults on local market issues related to advertising, assists in executing the marketing strategy under Primair’s direction, and provides evaluations of the effectiveness of various elements of the marketing strategy. As compensation for providing these marketing support activities, Company S receives from Primair a service fee based on the level of marketing expenditure it incurs and including an appropriate profit element. 23. Assume for the purpose of this example that, based upon a thorough comparability analysis, including a detailed functional analysis, it is possible to conclude that the price Company S pays Primair for the R watches should be analysed separately from the compensation Company S receives for the marketing it undertakes on behalf of Primair. Assume further that based upon identified comparable transactions, the price paid for the watches is arm’s length and that this price enables Company S to earn an arm’s length level of compensation from selling the watches for the distribution function it performs, the assets it uses and the risks it assumes. 24. In Years 1 to 3, Company S embarks on a strategy that is consistent with its agreement with Primair to develop the country Y market for R watches. In the process, Company S incurs marketing expenses. Consistent with the contract, Company S is reimbursed by Primair for the marketing expenses it incurs, and is paid a mark-up on those expenses. By the end of Year 2, the R trademark and trade name have become well established in country Y. The compensation derived by Company S for the marketing activities it performed on behalf of Primair is determined to be arm’s length, based upon comparison to that paid to independent advertising and marketing agents identified and determined to be comparable as part of the comparability analysis. 25. Under these circumstances, Primair is entitled to retain any income derived from exploiting the R trademark and trade name in the country Y market that exceeds the arm’s length compensation to Company S for its functions and no transfer pricing adjustment is warranted under the circumstances ...

Nordea Nordic Baltic AB was the manager of funds and a central distributor in Sweden of certain funds registered in Luxembourg. The company entered into a new distribution agreement that replaced two previous agreements. According to this new agreement, the remuneration to the company was lower than under the previous agreement. The company considered that the compensation under the old agreements had been too high which therefore compensated for (set-off) the lower compensation received according to the new agreement. The Court of Appeal stated that the set-off principle must be applied with caution. A basic precondition should be that these are transactions that have arisen within the framework of the same contractual relationship. It did not matter if the company was overcompensated by another party to the agreement. Any overcompensation in previous years from the same contracting party could also not be taken into account as it was the result of a different pricing strategy within the framework of another contract. For internal set-offs to be considered they must be related to transactions between the same contracting parties and covered by the same pricing strategy within the same agreement. Click here for translation ...

A Danish production company terminated a 10-year license and distribution agreement with a group distribution company one year prior to expiry of the agreement. The distribution agreement was transferred to another group company and the new distribution company agreed as a successor in interest to pay a “termination fee” to the former distribution company. However, the termination fee was paid by the Danish production company and the amount was depreciated in the tax-return. The Danish company claimed that it was a transfer pricing case and argued that the tax administration could only adjust agreed prices and conditions of the agreement if the requirements for making a transfer pricing correction were met. The Supreme Court stated that the general principles of tax law in the State Tax Act §§ 4-6 also applies to the related companies. Hence, the question was whether the termination fee was held for “acquiring, securing and maintaining the applicant’s income”, cf. the state tax act § 6. The Supreme Court found that payment of the termination fee did not have a sufficient connection to the Danish company’s income acquisition for the payment to be tax deductible. The applicant was therefore not entitled to tax depreciation of the payment. The Supreme Court ruled in favor of the Danish tax administration. Click here for translation ...