Following an audit the tax authorities concluded that ARGO-HYTOS s.r.o. sold goods (valves, blocks and hydraulic aggregates) to related parties at a price that differed from the prices that would have been agreed between unrelated parties under the same or similar conditions. Furthermore, according to the tax authorities ARGO-HYTOS s.r.o. did not satisfactorily document the difference from those normal prices. An appeal was filed by ARGO-HYTOS s.r.o. with the Regional Court which was dismissed the action by the above-quoted judgment No 30 Af 21/2019-46 (‘the contested judgment’). In the judgement, the Regional Court concluded that ARGO-HYTOS s.r.o. had not satisfactorily demonstrated the difference between the prices agreed between it and the companies of the ARGO-HYTOS group and the prices which would have been agreed between unrelated parties under the same or similar conditions. The Regional Court held that, if the tax authorities wished to justify the reasons for the increase in the applicant’s tax liability, it was incumbent on them to prove that the prices agreed between the applicant and its connected persons differed from those which would have been agreed between independent persons in normal commercial relations under the same or similar conditions. Furthermore, it was its duty to inform the applicant of the difference and to give it time to comment and to substantiate its position. In such a case, the burden of proof would shift to the applicant. In order to fulfil its obligation, the tax authorities would have had to establish the normal price at which independent persons trade in order to compare the price agreed between related parties. The Regional Court did not find merit in the applicant’s objection that the tax authorities had wrongly excluded from the analyses carried out companies which had made a negative operating profit in the period in question. The applicant considered that this procedure was unacceptable, since, in its view, it cannot be assumed that if a comparable entity is negative in one year, it is loss-making in the long term and cannot therefore be regarded as a comparable entity. On this issue, the defendant stated that the excluded loss-making companies could not be considered comparable, since the applicant, as a contract manufacturer, could be considered to perform such functions and bear such risks as to make a reasonable stable profit. Moreover, those companies were not only excluded on the ground of loss-making but also on the ground of non-compliance with other criteria such as NACE code, independence or accounting methods. The Regional Court fully shared that view and therefore found the plea unfounded. On the question of the comparability of the sample of independent companies and the method of calculating the interquartile range, the Regional Court stated that the defendant agreed with the tax authorities which, after assessing the entities included by the applicant in the analysis comparing prices between related and unrelated entities in normal relations under similar or comparable conditions, concluded that none of those companies was comparable to the applicant. Therefore, the tax administration prepared its own SA5 analysis, which included seven companies that could be considered as comparable independent entities. For these companies, the interquartile range of EBIT margin values was found to be between 4,10 % and 8,19 % for the tax years under review, based on data for 2011 and 2013. The Regional Court agreed with this conclusion and thus found the procedure followed by the tax administrator and the defendant to be lawful and factually correct. An appeal was then filed with the Supreme Administrative Court. Judgement of the Court The Supreme Administrative Court ruled in favor of ARGO-HYTOS s.r.o. Excerpts (Unofficial English Translation) “[22] The Supreme Administrative Court did not accept the complainant’s arguments that the law does not provide for the obligation to use a specific database for the analysis of compliance with the arm’s length criterion and that the tax administrator should therefore have respected the fact that the complainant chose the AMADEUS database and taken into account the information available to the complainant when negotiating prices for sales of goods within the ARGO-HYTOS group of related parties, that the tax administrator did not carry out a sufficient qualitative analysis and that it rejected the use of another commercial database. From a tax perspective, it is irrelevant whether or not the complainant had the relevant information to carry out its own internal analysis on the basis of which it set the transfer prices. The fact that the prices negotiated between related parties for the sale of goods or the provision of services differ from the prices normally negotiated between unrelated parties under similar or comparable conditions can be established objectively. It is not a subjective criterion for which the degree of prudence or effort of the taxable person could be taken into account. In other words, if the prices between related parties differ from those between unrelated parties, this is an objective fact, a bare fact which has tax consequences. If the taxpayer has assessed, on the basis of the information available to it, that there is no such difference, even though that assessment is contrary to the facts, then it must bear those tax consequences – it is its responsibility to ensure that it has the relevant information on how to set prices between related parties so that the tax base does not have to be adjusted. The complainant must therefore bear the consequences of having used a database for analysis which did not contain the information necessary to meet the comparability criteria in the relevant period under analysis. [23] The Supreme Administrative Court also did not accept the complainant’s objection regarding the calculation of the weighted average. Indeed, the method used by the complainant, according to which the average operating margin is calculated for all the companies together for each individual year and then averaged over the individual years, may not be more revealing than the method actually used by the tax authorities. The tax authorities are obliged to ascertain the prices at which unrelated persons ...

Amway India is engaged in the business of direct selling of consumer products through multi-level marketing. For FY 2013-2014 Amway paid royalties to a foreign Amway group company. Following an audit, an assessment was issued by the tax authorities where the royalty had been reduced based on a benchmark study resulting in additional taxable income. An appeal was filed by Amway India with the Income Tax Tribunal where the assessment was set aside. An appeal was then filed by the tax authorities with the High Court. In the appeal the tax authorities stated that the Tribunal had failed to appreciate the fact that the royalty payments were excessive considering the Advertisement, Marketing and Promotion (‘AMP’) expenses incurred by Amway India for the benefit of the group’s trademark and brand. According to the tax authorities Amway India created marketing intangibles for the group and should be compensated with a payment from the group rather than having to pay huge royalties. Judgement of the High Court The Court ruled in favor of Amway India. Excerpts “9. A perusal of the above order reveals that the ITAT and CIT (A), both fact finding authorities have concurrently held that the rejection of the two comparables by the TPO is based on conjectures and surmises and thus, deleted the addition made on account of transfer pricing adjustment for transaction related to royalty. Learned Counsel for the appellant concedes that if the rejected two comparables are taken into consideration, the payment made by the assessee to its AEs towards royalty would be at arm’s length and no adjustment would be merited. He also concedes that the said two comparables comply with all the filters prescribed by the TPO. In this view of the matter, we therefore find that the reliance placed by CIT(A) and ITAT on the judgment of this Court in Chrys Capital Investment (supra), was correct. The relevant portion of the said judgment reads as follows, “44. In light of the above findings, this Court concludes as follows: (a) The mere fact that an entity makes high/extremely high profits/losses does not, ipso facto, lead to its exclusion from the list of comparables for the purposes of determination of ALP. In such circumstances, an enquiry under Rule 10B(3) ought to be carried out, to determine as to whether the material differences between the assessee and the said entity can be eliminated. Unless such differences cannot be eliminated, the entity should be included as a comparable. …………………..”    (Emphasis Supplied) 10. In this view of the matter, no substantial questions of law arise for consideration and accordingly, the appeal is dismissed” ...

A similar investigation should be undertaken for potential comparables returning abnormally large profits relative to other potential comparables ...

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

Extreme results might consist of losses or unusually high profits. Extreme results can affect the financial indicators that are looked at in the chosen method (e.g. the gross margin when applying a resale price, or a net profit indicator when applying a transactional net margin method). They can also affect other items, e.g. exceptional items which are below the line but nonetheless may reflect exceptional circumstances. Where one or more of the potential comparables have extreme results, further examination would be needed to understand the reasons for such extreme results. The reason might be a defect in comparability, or exceptional conditions met by an otherwise comparable third party. An extreme result may be excluded on the basis that a previously overlooked significant comparability defect has been brought to light, not on the sole basis that the results arising from the proposed “comparable” merely appear to be very different from the results observed in other proposed “comparables” ...

18 June 2019 the Polish Minister of Finance issued the first explanations on transfer pricing concerning – technical aspects of preparing comparability analyses and transfer pricing documentation. With regard to the technical aspects of preparing comparability analyses, the explanations cover such detailed issues as: data comparability vs. locality feasibility of using internal data feasibility of using bid data the appropriateness of using comparables that are not publicly available (so-called secret comparables) reasonableness of discarding from the comparables sample entities with extreme results (including those with loss) minimum sample size for benchmark data analysis selection of an interval point updating the benchmark data analysis. The second key issue addressed by the explanatory notes is the preparation of descriptions of the consistency of the terms of transactions and other events agreed with related parties with the terms that would be agreed among independent parties. Click here for unofficial English translation ...

A similar investigation should be undertaken for potential comparables returning abnormally large profits relative to other potential comparables ...

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

Extreme results might consist of losses or unusually high profits. Extreme results can affect the financial indicators that are looked at in the chosen method (e.g. the gross margin when applying a resale price, or a net profit indicator when applying a transactional net margin method). They can also affect other items, e.g. exceptional items which are below the line but nonetheless may reflect exceptional circumstances. Where one or more of the potential comparables have extreme results, further examination would be needed to understand the reasons for such extreme results. The reason might be a defect in comparability, or exceptional conditions met by an otherwise comparable third party. An extreme result may be excluded on the basis that a previously overlooked significant comparability defect has been brought to light, not on the sole basis that the results arising from the proposed “comparable” merely appear to be very different from the results observed in other proposed “comparables” ...