Following an audit of Beta Healthcare International Limited, a Kenyan subsidiary in the Aspen Healthcare Group, the tax authorities issued a notice of additional taxable income relating to controlled transactions, in which they had determined the arm’s length price for controlled transactions using the CUP method instead of the TNM-method as applied by the company. Beta Healthcare International Limited appealed to the Tax Appeals Tribunal, arguing that the tax authorities had failed in its characterisation of the company, failed to consider the comparability factors of the transactions and misapplied the transfer pricing guidelines. Decision of the Tax Appeals Tribunal The Tribunal dismissed the appeal and ruled in favour of the tax authorities. Excerpts “(…) 134. The Tribunal reviewed the parties’ pleadings and established that the Appellant attached the disputed information to its pleadings. However, the Respondent, both in its pleadings and orally at the hearing, urged that the information was never provided to it. Further, while the Appellant stated that it submitted the disputed information on 8th March, 2022, the Tribunal did not sight any document to confirm this averment. 135. In regard to selection of an appropriate Transfer Pricing method, Paragraph 2.1 of the OECD Guidelines provides that the selection of the transfer pricing method should consider the following; a. the respective strengths and weaknesses of the OECD recognised methods; b. the appropriateness of the method considered in view of the nature of the controlled transaction, determined through a functional analysis; c. the availability of reliable information (on uncontrolled comparables) needed to apply the selected method and/or other methods; and d. the degree of comparability between controlled and uncontrolled transactions, including the reliability of comparability adjustments that may be needed to eliminate material differences between them. 136. Additionally, Paragraph 3.20 of the OECD Guidelines states that, “ In order to select and apply the most appropriate transfer pricing method to the circumstances of the case, information is needed on the comparability factors in relation to the controlled transaction under review and in particular on the functions, assets and risks of all the parties to the controlled transaction, including the foreign associated enterprise(s).” 137. Paragraph 1.35 and 1.36 of the OECD Guidelines state as follows regarding comparable factors for the establishment of an appropriate Transfer Pricing method: “ 1.35. …Before making comparisons with uncontrolled transactions, it is therefore vital to identify the economically relevant characteristics of the commercial or financial relations as expressed in the controlled transaction. 1.36 The economically relevant characteristics or comparability factors that need to be identified in the commercial or financial relations between the associated enterprises in order to accurately delineate the actual transaction can be broadly categorised as follows: i. The contractual terms of the transaction; ii. The functions performed by each of the parties to the transaction, taking into account assets used and risks assumed, including how those functions relate to the wider generation of value by the MNE group to which the parties belong, the circumstances surrounding the transaction, and industry practices; iii. The characteristics of property transferred, or services provided; iv. The economic circumstances of the parties and of the market in which the parties operate; and v. The business strategies pursued by the parties.” 138. The Tribunal further notes that Paragraph 2.20 of the OECD Guidelines provides as follows in regard to application of the CUP method of Transfer Pricing: “ For the CUP method to be reliably applied to commodity transactions, the economically relevant characteristics of the controlled transaction and the uncontrolled transactions or the uncontrolled arrangements represented by the quoted price need to be comparable. For commodities, the economically relevant characteristics include, among others, the physical features and quality of the commodity; the contractual terms of the controlled transaction, such as volumes traded, period of the arrangements, the timing and terms of delivery, transportation, insurance, and foreign currency terms. For some commodities, certain economically relevant characteristics (e.g. prompt delivery) may lead to a premium or a discount. If the quoted price is used as a reference for determining the arm’s length price or price range, the standardised contracts which stipulate specifications on the basis of which commodities are traded on the exchange and which result in a quoted price for the commodity may be relevant. Where there are differences between the conditions of the controlled transaction and the conditions of the uncontrolled transactions or the conditions determining the quoted price for the commodity that materially affect the price of the commodity transactions being examined, reasonably accurate adjustments should be made to ensure that the economically relevant characteristics of the transactions are comparable. Contributions made in the form of functions performed, assets used and risks assumed by other entities in the supply chain should be compensated in accordance with the guidance provided in these Guidelines.” (Emphasis ours) 139. Separately, Paragraph 2.64 of the OECD Guidelines provide as follows regarding the application of the TNMM method: “ The transactional net margin method examines the net profit relative to an appropriate base (e.g. costs, sales, assets) that a taxpayer realises from a controlled transaction (or transactions that are appropriate to aggregate under the principles of paragraphs 3.9 -3.12). Thus, a transactional net margin method operates in a manner similar to the cost plus and resale price methods. This similarity means that in order to be applied reliably, the transactional net margin method must be applied in a manner consistent with the manner in which the resale price or cost plus method is applied. This means in particular that the net profit indicator of the taxpayer from the controlled transaction (or transactions that are appropriate to aggregate under the principles of paragraphs 3.9 -3.12) should ideally be established by reference to the net profit indicator that the same taxpayer earns in comparable uncontrolled transactions, i.e. by reference to “internal comparables” (see paragraphs 3.27-3.28). Where this is not possible, the net margin that would have been earned in comparable transactions by an independent enterprise (“external comparables”) may serve as a guide (see paragraphs 3.29-3.35) ...

RKS, whose business consists of the manufacture of very large custom bearings for the civil and military industries, is controlled by the Swedish SKF group through (SAS) SKF Holding France. RKS was subject to a tax audit for FY 2009 and 2010, at the end of which the tax authorities took the view that the results reported by SAS RKS (losses since 2005) had not been determined in accordance with the arm’s length principle. It therefore increased SAS RKS’s results from 2006 to 2010 to the median net margin observed in a benchmark of eight comparable companies, equal to 4.17% in 2006, 4.32% in 2007, 3.38% in 2008, 2.33% in 2009 and 2.62% in 2010. SAS SKF France Holding applied to the Administrative Court for a discharge, and in judgment no. 1608939 of April 23, 2018, the Montreuil Administrative Court upheld the claim. In ruling no. 18VE02849 of June 22, 2020, the Versailles Administrative Court of Appeal upheld the appeal lodged by the the authorities against this ruling. By decision no. 443133 of October 4, 2021, the Conseil d’Etat, hearing an appeal lodged by SAS SKF France Holding, set aside the decision of the Versailles Administrative Court of Appeal and referred the case back to it. Judgement of the Administrative Court of Appeal In accordance with the guidance provided in the decision of the Conseil d’Etat, the Administrative Court of Appeal ruled in favor of SKF Holding and annulled the assessment of the additional taxable income. Excerpts in English “6. In addition, as mentioned above, the tax authorities have found that SAS RKS has had a negative net margin since 2005, with the exception of 2008. It then carried out a functional analysis of SAS RKS’s intra-group relations, taking the view that SAS RKS performed only limited production functions, and that it was therefore not likely to receive negative remuneration in view of the risks associated with this role. Lastly, it applied a “transactional net margin method” (MTMN), comparing SAS RKS’s ratio of net margin to sales for the operations in question with that of eight companies operating at arm’s length in similar fields. In doing so, it noted that the company’s net margin ratio was -19.32% in 2006, -6.44% in 2007, 1.41% in 2008, -10.46% in 2009 and -21.87% in 2010, compared with 4.17% in 2006, 4.32% in 2007, 3.38% in 2008, 2.33% in 2009 and 2.62% in 2010 for the median of the companies compared. In view of these factors, and as stated in the Conseil d’Etat’s decision of October 4, 2021, in the absence of any criticism of the comparables used by the tax authorities, the latter have established a presumption of profit transfer for the transactions in question, up to the difference between the amount of revenue recorded and that which would have resulted from the application of the average net margin rate of the panel of comparable companies. 7. However, SKF Holding France maintains that its subsidiary SAS RKS in fact assumes a more important functional role than that of a simple production unit within the SKF group, which meant that it had to assume higher development and commercial risks, which materialized in 2009 and 2010 and led to significant operating losses. 8. It is clear from the investigation that SAS RKS, founded in 1932 and acquired by the SKF group in 1965, has long-standing technical expertise and manufactures very specific products, often made-to-measure, for civil and military engineering, whose clientele, made up exclusively of professionals, is in fact limited to around fifteen companies, thus requiring no sales prospecting expenditure on the part of the distributing companies. In addition, SAS RKS owns all the tangible assets required for production, bears the risks associated with production, such as product quality defects, organizes the transport and logistics of its products at its own expense, and bears the inventory risk, as recognized by the French tax authorities when they accepted the principle of a provision for inventory depreciation during the audit. While it is common ground that the intangible assets, including patents, required for this production are held by AB SKF in Sweden, it is nevertheless clear from the investigation that SAS RKS carried out research and development work during the period under review, that it participated, through its parent company SKF Holding France, in an agreement to share research and development costs organized at group level, and that it therefore benefited free of charge from all the intangible assets thus held by the Swedish parent company. Furthermore, while it is common ground that the Swedish parent company periodically sends SAS RKS a schedule of margins to be applied to production costs, depending on the country of invoicing. This schedule is intended to guarantee a margin of 3% for the distribution companies, it is clear from the investigation that SAS RKS is free to determine its own production costs, known as “standard production costs”, which serve as the basis for negotiations with the end customer, carried out jointly with the distribution companies. It also emerges from the investigation, and in particular from the results of computer processing carried out by the tax authorities, that this scale, while applied in the majority of intra-group transactions, is not systematically applied. Furthermore, the company, which bears the exchange rate risk, maintains, without being contradicted, that it can freely refuse to contract with a customer if the final price negotiated does not suit it. On the other hand, it appears from the investigation that the distributing companies are limited to managing sales in practical terms, for example by drawing up contracts and invoices, and to assisting end customers in their negotiations with SAS RKS. As a result, SAS RKS enjoys relative autonomy within the Group, and assumes a high level of risk due to its production activities. Furthermore, it is clear from the investigation that the standard production cost defined by SAS RKS, which serves as the basis for the final price agreed with the customer, is determined at a very early ...