FP, a foreign manufacturer, sells Product to USSub, its U.S. subsidiary, which in turn sells Product to its domestic affiliate Sister. Sister sells Product to unrelated buyers. In this case, the applicable resale price is the price at which Sister sells Product in uncontrolled transactions. The determination of the appropriate gross profit margin for the sale from FP to USSub will take into account the functions performed by USSub and Sister, as well as other relevant factors described in § 1.482-1(d)(3) ...

If there are material differences between the controlled and uncontrolled transactions that would affect the gross profit margin, adjustments should be made to the gross profit margin earned with respect to the uncontrolled transaction according to the comparability provisions of § 1.482-1(d)(2). For this purpose, consideration of operating expenses associated with functions performed and risks assumed may be necessary, because differences in functions performed are often reflected in operating expenses. If there are differences in functions performed, however, the effect on gross profit of such differences is not necessarily equal to the differences in the amount of related operating expenses. Specific examples of the factors that may be particularly relevant to this method include – (1) Inventory levels and turnover rates, and corresponding risks, including any price protection programs offered by the manufacturer; (2) Contractual terms (e.g., scope and terms of warranties provided, sales or purchase volume, credit terms, transport terms); (3) Sales, marketing, advertising programs and services, (including promotional programs, rebates, and co-op advertising); (4) The level of the market (e.g., wholesale, retail, etc.); and (5) Foreign currency risks ...

Comparability under this method is less dependent on close physical similarity between the products transferred than under the comparable uncontrolled price method. For example, distributors of a wide variety of consumer durables might perform comparable distribution functions without regard to the specific durable goods distributed. Substantial differences in the products may, however, indicate significant functional differences between the controlled and uncontrolled taxpayers. Thus, it ordinarily would be expected that the controlled and uncontrolled transactions would involve the distribution of products of the same general type (e.g., consumer electronics). Furthermore, significant differences in the value of the distributed goods due, for example, to the value of a trademark, may also affect the reliability of the comparison. Finally, the reliability of profit measures based on gross profit may be adversely affected by factors that have less effect on prices. For example, gross profit may be affected by a variety of other factors, including cost structures (as reflected, for example, in the age of plant and equipment), business experience (such as whether the business is in a start-up phase or is mature), or management efficiency (as indicated, for example, by expanding or contracting sales or executive compensation over time). Accordingly, if material differences in these factors are identified based on objective evidence, the reliability of the analysis may be affected ...

The degree of comparability between an uncontrolled transaction and a controlled transaction is determined by applying the comparability provisions of § 1.482-1(d). A reseller’s gross profit provides compensation for the performance of resale functions related to the product or products under review, including an operating profit in return for the reseller’s investment of capital and the assumption of risks. Therefore, although all of the factors described in § 1.482-1(d)(3) must be considered, comparability under this method is particularly dependent on similarity of functions performed, risks borne, and contractual terms, or adjustments to account for the effects of any such differences. If possible, appropriate gross profit margins should be derived from comparable uncontrolled purchases and resales of the reseller involved in the controlled sale, because similar characteristics are more likely to be found among different resales of property made by the same reseller than among sales made by other resellers. In the absence of comparable uncontrolled transactions involving the same reseller, an appropriate gross profit margin may be derived from comparable uncontrolled transactions of other resellers ...

Kenya Fluospar Company Ltd (KFC) had been issued an assessment related to VAT and transfer pricing – leasing of mining equipment, mining services and management services. The assessment was later set aside by the Tax Tribunal and an appeal was then filed by the tax authorities with the High Court THE JUDGEMENT The High Court dismissed the appeal of the tax authorities and decided in favour of KFC. Excerpts “B. Whether the Commissioner was right in the using Transactional Nett Margin Method (TNMM) instead of Split Profit Method (SPM) in determining how to share the income tax between KFC EPZ. 48. Rule 7 thus gives the various methods of choice, one of them being the profit split method. In this regard also, Rule 8(2) provides as follows – 8(2). A person shall apply the method most appropriate for his enterprise, having regard to the nature of the transaction, or class of related persons or function performed by such persons in relation to the transaction. 49. In my view, it follows from the above provisions that the choice of the most favourable tax assessment method is that of the tax payer and not the Commissioners. In this regard, I agree with the reasoning in the case of Unilever Kenya Ltd – vs – The Commissioner of Income Tax [2005]eKLR wherein it was held that the tax payer is entitled to choose the most favourable method to their advantage as far liability to tax is concerned. 50. I however, agree that the Commissioner can intervene where there is evidence of fraud or evasion of taxes. The Commissioner can also intervene and re-asses income tax of a taxpayer and raise additional assessments – see Pilli Management Consultants Ltd – vs – Commissioner of Income Tax – Mombasa HC Misc. Application No.525 of 2016. 51. The main issue that has arisen herein is that instead of addressing the objection raised using the selected profit margin method, the Commissioner changed to the Transactional Nett Margin Method without indicating the law that confers on the Commissioner the power to change the method. 52. Even in this appeal the Commissioner has not pointed the section of the law that gives it the right to change the choice method elected by the taxpayer. The Commissioner maintains that it has general power to change the method because they found new intangible assets of KFC. 53. First of all, there is no evidence that the mining and prospecting licences were new assets not known in the profit split method. Secondly, even if they were new intangible assets, the Commissioner would have to back his change of method with the law, which they have not. I thus find that the Commissioner had no legal power to change to a new method of Transaction Nett Margin method. The Commissioner could only use the Profit Split method chosen by the tax payer. The Commissioner was thus right in using the Transactional Nett Margin Method.” “C. Whether the alleged non benchmarked management services offered to KFC by a related non – resident company (KCMC) do in fact exist, and if so what value could be attributed to the same. 54. It is not in dispute that KFC entered into a management consultancy agreement with Kestrel Capital Management Limited (KCMC), such services to be provided upon requests. The Commissioner contends that no such management consultancy services were provided as no requests were made by KFC to KCMC for such services. KFC on the other hand maintains that they were provided with such management consultancy services by KCMC through meetings and other interactions on financial, investment and human resources matters, and relied on minutes of meetings held which were not disputed by the Commissioner. 55. In my view though indeed there is no evidence that any formal written requests for such management consultancy services was produced by KFC, there was evidence of interactions and meetings held. Such interactions and meetings between KFC and KCMC in my view were adequate proof of consultancy services provided. An adviser is an adviser and the final decision will still have to be made by the principal. If an adviser and a principal hold meetings and discuss items on the operations and management of the business affairs of the principal, in my view, that is adequate to satisfy the provision of consultancy services by the consultant. The fact that members of one corporate institution are the same in another corporate institution does not make a difference in law. As for the value to be attributed to the professional services provided, that will go according to the respective contract, and this court is not suited to determine the same with the facts placed before it.” “63. Consequently, and for the above reasons, I find that both appeals have no merits. I thus dismiss Appeal No. 2 of 2018 and No.3 of 2018 herein. Each of the parties will bear their respective costs of appeal.” Click here for other translation Kenya vs KFC ITA_3_&_2_of_2018__ Feb 2020 ...

“H-S Goods S.A.” was active in wholesale trade of heating and sanitary goods. The main supplier of the products was a related company from Germany, and the cusomers/recipients of the goods were both unrelated domestic companies and foreign related companies (in Latvia and Ukraine). Approximately 30 % of sales were to related parties. Sales prices for the controlled transactions, were determined based on the purchase prices from the supplier. “H-S Goods S.A.” argued that transactions with the related parties were not sale of goods, but rather provision of warehousing services on behalf of the related German supplier. For these services “H-S Goods S.A.” received a 5% margin. The tax authorities found that the activities and the fact that legal title to the goods was transferred to “H-S Goods S.A.”, meant that the transaction was in fact distribution of goods. Furthermore, the margins obtained by “H-S Goods S.A.” from sale of goods to unrelated customers was considerably higher than the 5% margins obtained from sales to related parties. A complaint was filed by “H-S Goods S.A.” with the Administrative Court which was unsuccessful. According to 2011 decision from the Administrative Court , the tax authorities had proven that the margin on goods sold to unrelated customers was considerably higher than the margin obtained from sales to related parties. The court also agreed that the activities of “H-S Goods S.A.” could not be considered warehousing services. An appeal was then filed by “H-S Goods S.A.” with the Supreme Administrative Court. Judgement of the Court The Court upheld the decision of the court of first instance. Excerpts “The Supreme Administrative Court held as follows: 7. the cassation appeal has no justified grounds. Pursuant to Article 174 of the P.p.s.a., a cassation appeal may be based on the following grounds: (1) infringement of substantive law through its misinterpretation or misapplication; (2) infringement of procedural provisions, if this infringement could have had a significant impact on the outcome of the case. The Supreme Administrative Court, in connection with Article 183 § 1 of the P.p.s.a., considers the case within the limits of the cassation appeal, taking into account ex officio only the invalidity of the proceedings. Binding of the Court to the grounds of the cassation complaint requires that they are correctly specified in the complaint itself. This means that it is necessary to cite the specific provisions of law which the court has violated, to substantiate the allegation of their violation and, if a violation of procedural law is alleged, to demonstrate additionally that this violation could have had a significant impact on the outcome of the case. As regards substantive law, it is necessary to demonstrate what the misinterpretation or misapplication by the court of first instance consisted of and what the correct interpretation or application of the substantive law provision should have been. Similarly, in the case of an infringement of procedural law, it is necessary to indicate the provisions of that law infringed by the court, what the infringement of those provisions consisted in and why that infringement could have had a significant impact on the outcome of the case. When the cassation appeal alleges both a violation of substantive law and a violation of procedural law, the last-mentioned allegation is examined first. Only after it has been determined that the state of facts adopted by the court in the appealed judgment is correct or has not been effectively challenged, may one move on to control the process of subsumption of the given state of facts under the provision of substantive law applied in the case. (cf. the judgment of the Supreme Administrative Court of 19 February 2008, II FSK 1787/06, unpublished). In the present case, the appellant only raises allegations of infringement of procedural provisions, since the content of the plea I named as the allegation of violation of substantive law in fact indicates only circumstances of procedural nature, such as: “erroneous assumption by the Court of First Instance that the most appropriate method of estimating income in transactions with related parties is the transaction margin method”. Meanwhile, a possible incorrect legal assessment of the factual state does not constitute a violation of substantive law and, as such, cannot constitute a cassation ground within the meaning of Article 174(1) of the A.P.S.A. An assessment of the legitimacy of the application of substantive law, i.e. Article 11(3) of the A.P.D.O.P. in conjunction with § 4(4), § 11(1) and (2) and § 12(1) and (2) of the Ordinance may only be made on the basis of correctly established facts. Incorrect application of the law consists of the so-called error in subsumption, which is expressed in the fact that the facts established in the case were erroneously deemed to correspond to the hypothetical state provided for by the legal norm, or that the established facts were erroneously not “drawn” under the hypothesis of a specific legal norm. Thus, the application of the substantive law is the correct reference of the substantive law norm to the established state of facts, i.e. the correct confrontation of the circumstances of the state of facts with the hypothesis of the legal norm and the submission of this state of facts to a legal assessment on the basis of the content of this norm. Hence, the defects raised by the author of the cassation complaint may be challenged only under the second ground of the cassation complaint – Article 174(2) of the Code of Civil Procedure.” “Allegation II, point 1 is not justified. Contrary to the arguments of the appellant, the court of first instance, following the guidelines contained in the judgment of the Supreme Administrative Court of 1 March 2011, correctly determined the nature of the transaction between the taxpayer and related entities. In particular, it referred to the amount of the established 5% margin, indicating at the same time that the margin imposed on goods intended for sale on the Polish market was on average 6 times higher than the established compensatory margin.” Click here for ...

“H-S Goods S.A.” was active in wholesale trade of heating and sanitary goods. The main supplier of the products was a related company from Germany, and the cusomers/recipients of the goods were both unrelated domestic companies and foreign related companies (in Latvia and Ukraine). Approximately 30 % of sales were to related parties. Sales prices for the controlled transactions, were determined based on the purchase prices from the supplier. “H-S Goods S.A.” argued that transactions with the related parties were not sale of goods, but rather provision of warehousing services on behalf of the related German supplier. For these services “H-S Goods S.A.” received a 5% margin. The tax authorities found that the activities and the fact that legal title to the goods was transferred to “H-S Goods S.A.”, meant that the transaction was in fact distribution of goods. Furthermore, the margins obtained by “H-S Goods S.A.” from sale of goods to unrelated customers was considerably higher than the 5% margins obtained from sales to related parties. A complaint was filed by “H-S Goods S.A.” with the Administrative Court. Judgement of the Court The Court dismissed the complaint. According to the court, the tax authorities had proved that the margin on goods sold to unrelated customers was considerably higher than the margin obtained from sales to related parties. The court also agreed that the activities of “H-S Goods S.A.” could not be considered warehousing services. Click here for English translation Click here for other translation I SA_Kr 716_11 - Wyrok WSA w Krakowie z 2011-07-05 ...