Couture, a U.S. apparel design corporation, contracts with Sewco, its wholly owned Country Y subsidiary, to manufacture its clothes. Costs of operating in Country Y are significantly lower than the operating costs in the United States. Although clothes with the Couture label sell for a premium price, the actual production of the clothes does not require significant specialized knowledge that could not be acquired by actual or potential competitors to Sewco at reasonable cost. Thus, Sewco’s functions could be performed by several actual or potential competitors to Sewco in geographic markets that are similar to Country Y. Thus, the fact that production is less costly in Country Y will not, in and of itself, justify additional profits derived from lower operating costs in Country Y inuring to Sewco, because the competitive positions of the other actual or potential producers in similar geographic markets capable of performing the same functions at the same low costs indicate that at arm’s length such profits would not be retained by Sewco ...

The following example illustrates the principles of this paragraph (d)(4)(ii)(C) ...

If an uncontrolled taxpayer operates in a different geographic market than the controlled taxpayer, adjustments may be necessary to account for significant differences in costs attributable to the geographic markets. These adjustments must be based on the effect such differences would have on the consideration charged or paid in the controlled transaction given the relative competitive positions of buyers and sellers in each market. Thus, for example, the fact that the total costs of operating in a controlled manufacturer’s geographic market are less than the total costs of operating in other markets ordinarily justifies higher profits to the manufacturer only if the cost differences would increase the profits of comparable uncontrolled manufacturers operating at arm’s length, given the competitive positions of buyers and sellers in that market ...

Manuco, a wholly-owned foreign subsidiary of P, a U.S. corporation, manufactures products in Country Z for sale to P. No uncontrolled transactions are located that would provide a reliable measure of the arm’s length result under the comparable uncontrolled price method. The district director considers applying the cost plus method or the comparable profits method. Information on uncontrolled taxpayers performing comparable functions under comparable circumstances in the same geographic market is not available. Therefore, adjusted data from uncontrolled manufacturers in other markets may be considered in order to apply the cost plus method. In this case, comparable uncontrolled manufacturers are found in the United States. Accordingly, data from the comparable U.S. uncontrolled manufacturers, as adjusted to account for differences between the United States and Country Z’s geographic market, is used to test the arm’s length price paid by P to Manuco. However, the use of such data may affect the reliability of the results for purposes of the best method rule. See § 1.482-1(c) ...

The following example illustrates this paragraph (d)(4)(ii) ...

Uncontrolled comparables ordinarily should be derived from the geographic market in which the controlled taxpayer operates, because there may be significant differences in economic conditions in different markets. If information from the same market is not available, an uncontrolled comparable derived from a different geographic market may be considered if adjustments are made to account for differences between the two markets. If information permitting adjustments for such differences is not available, then information derived from uncontrolled comparables in the most similar market for which reliable data is available may be used, but the extent of such differences may affect the reliability of the method for purposes of the best method rule. For this purpose, a geographic market is any geographic area in which the economic conditions for the relevant product or service are substantially the same, and may include multiple countries, depending on the economic conditions ...

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Paragraphs 1.130, 1.132 and 6.120 indicate that features of the geographic market in which business operations occur can affect comparability and arm’s length prices. Difficult issues can arise in evaluating differences between geographic markets and in determining appropriate comparability adjustments. Such issues may arise in connection with the consideration of cost savings attributable to operating in a particular market. Such savings are sometimes referred to as location savings. In other situations comparability issues can arise in connection with the consideration of local market advantages or disadvantages that may not be directly related to location savings ...

The geographic market is another economic circumstance that should be identified. The identification of the relevant market is a factual question. For a number of industries, large regional markets encompassing more than one country may prove to be reasonably homogeneous, while for others, differences among domestic markets (or even within domestic markets) are very significant ...

“Yogo Food-Distributor” is a subsidiary in the “Yogo Group” and trades in spices and canned meat and vegetables from the territory of the former Yugoslavia. The main sales markets are Austria and Germany (90%), the remainder being distributed among France, Scandinavia, Great Britain and the Benelux countries. Following an audit the tax authorities issued an assessment of additional taxable income determined by way of a benchmark study into comparable businesses. Yogo Food Distributor was of the opinion that the benchmark-study did not comply with the OECD guidelines in regards of comparability factors and filed a complaint with the Court. Judgement of the Court The contested notices (corporate income tax notices for the years 2010, 2011 and 2012, each dated 13 October 2014) and the preliminary appeal decision (dated 22 September 2017) are annulled pursuant to section 278(1) BAO and the matter is referred back to the tax authority. Excerpt “In order to be able to assess the arm’s length nature of these agreements and the payments made on the basis of these agreements, it is necessary to investigate the following issues: – First, in the sense of a function and risk analysis, it must be determined which assets were used in the context of the complainant’s business activities and which risks it had to bear, in each case in relation to the years in dispute. The contract of 13 December 2002 states that the complainant had “no suppliers/customers or the necessary financial resources”. On the other hand, within the EU, it could provide “warehouse management, logistics, personal customer care, contact with forwarding agents, etc.”. It will “endeavour to explore sales-promoting ideas or identify new products that meet market demand and implement them in agreement with the O-AG”. The O-AG is obliged to “establish the first contact with the customer or to sell the goods on the Western European market”. Financial support is also promised. In payment transactions, the complainant is to act as invoicing party, but all payment flows are to go through O-AG’s accounts. – There are no findings as to which concrete tasks and activities the complainant actually fulfilled or carried out from 2002 onwards and whether the actual circumstances (the conduct of business, the distribution of tasks between the complainant and O-AG, the contracting parties’ powers and possibilities of disposition) still corresponded in the years in dispute to those at the time of the conclusion of the contract in 2002. – With regard to the Supplementary Agreement I-2010 of 26 January 2010, it must be determined which of the economic aspects cited (cost increases in sales, unchanged or reduced sales prices, increased customer bonuses) are suitable to justify a change in the amount of the commission for an individual business year in advance in view of the actual economic relations of the contracting parties (business handling, distribution of tasks, powers and possibilities of disposition) between the complainant and O-AG. – With regard to Supplementary Agreement II-2010 of 26 January 2010, it must be determined which “economic circumstances” justify the granting of a lump-sum support contribution and from which an “increased need for marketing activities and listing expenses” results, this again for a single business year in advance. – With regard to the Supplementary Agreement I-2011 of 29 March 2011, it must be determined, taking into account the results of the functional and risk analysis, to what extent the actual economic circumstances between the complainant and O-AG changed at the time of the conclusion of this agreement compared to those in 2002 (conclusion of the agreement of 13 December 2002). 12.2002), taking into account the wording in the supplementary agreement: “…The complainant thus acts as the successor supplier of Y-Deutschland customers, Y-Deutschland delivers/invoices to the complainant. All expenses/income relating to the change of distribution or the subsequent distribution are for the account/benefit of [the complainant]. O-AG assumes any existing debtor risk at the time of the sales conversion. …” Furthermore, it has to be determined which “imminent additional expenses with regard to marketing activities” are suitable to justify the waiver of the contractually agreed commission “in connection with all sales of the Y-Germany business” and a reduction of the commission (obviously meant – for the remaining sales) for a single business year in advance, this taking into account the complaint’s allegations regarding the take-over of the distribution “of Markte M for the markets Germany, Benelux and France”. In this context, the results of the investigations which led the tax office to qualify these transactions as the “purchase of a distribution area” (preliminary appeal decision) must also be mentioned. – With regard to the Supplementary Agreement I-2012 of 9 January 2012, it must be determined, taking into account the results of the functional and risk analysis, to what extent the “need for increased sales promotion measures” or a product range expansion for an upcoming business period are suitable to justify a lump sum payment of EUR 250,000 from the complainant. Insofar as the tax office, based on the results of the investigation, comes to the conclusion that the contractual agreements concluded by the complainant with O-AG stand up to an arm’s length comparison, findings are to be made, based on corresponding investigations and in compliance with the right to be heard of the parties, as to the extent to which the conclusions on the arm’s length nature of the commission amount, which were apparently drawn from the database studies in the administrative files submitted, are still considered viable, taking into account the results of the functional and risk analysis to be carried out and taking into account the objections of the complainant.” Click here for English translation Click here for other translation ...

The most reliable approach in identifying reliable comparables will be to refer, where possible, to data regarding comparable uncontrolled transactions in the same or comparable geographic market between independent enterprises performing similar functions, assuming similar risks, and using similar assets ...

For example, as government assistance and the specific circumstances of the COVID-19 pandemic may vary across different markets, it may affect the comparables and the arm’s length prices of uncontrolled transactions in different ways.39 For instance, assume Company D, a member of an MNE group, provides manufacturing services and receives a domestic wage subsidy under a job retention programme offered by the government of Country D. Assume further that third party manufacturer Company E in Country E receives a domestic short-time work programme where the hours not worked by employees are directly subsidised. The services provided by Company D and Company E may be similar but the general availability and receipt of government assistance to Company D and Company E may result in a material difference in the arm’s length conditions of the transactions for the period over which the short-time work programme is in place and may not be sufficient to ensure a reliable comparison. In that case, the services provided by Company E would not be comparable for purposes of evaluating and determining the arm’s length price for Company D’s services based on the principles of Chapters II and III of the OECD TPG unless comparability adjustments to take such differences into account can reliably be made, based on an analysis of all of the relevant facts and circumstances of the Other characteristics of the government assistance that might affect comparability, depending on the circumstances, could include, for example, the duration of an assistance program and the relation between the assistance provided and the pandemic-related costs or the lost revenue. 39 Paragraph 1.112 of Chapter I of the OECD TPG on the relevance of differences across markets ...

“Cosmetics Corp” is active in wholesale of medicinal products, cosmetics, perfumery and cleaning products. Following an audit the tax authorities issued an assessment regarding the interest rate on loans granted to the related parties domiciled in Cayman Islands and Luxembourg. An appeal was filed by the company. Judgement of the Tax Court The court partially upheld the assessment. Excerpt “In this sense, it is essential to create a law that contains the guidelines that the OECD has established to guarantee the principle of full competition in transactions carried out between national taxpayers with related companies, for the purpose of applying the technical methods and procedures that they provide; The express reference made by Article 62-A of the TC cannot be considered as a dimension of the principle of relative legal reserve, insofar as there is no full development of the methods or procedures contained therein, nor a reference to an infra-legal rule containing them, but rather a reference that does not have a legal status, i.e. they are not legally binding, but only optional and enunciative to be incorporated into the legal system of each country. Hence, at no time is the legality of the powers of the Directorate General to determine the market price being questioned, since, as has been indicated, the law itself grants it this power, what is being questioned in the present case is the failure of the Directorate General to observe the procedures and forms determined by law to proceed to establish the market price, by using the OECD Guidelines, which, it is reiterated, for the fiscal year audited, did not have a legal status, nor were they binding, since they were not contained in a formal law; Therefore, even if the appellant itself used them, this situation constitutes a choice of the company itself, for the purpose of carrying out an analysis of its transfer prices, but in no way implies that this mechanism is endorsed by law, the Directorate General being obliged to lead or guide the taxpayer in the application of the regulations in force and adjust its operations to the provisions thereof, and if it considered that there was indeed an impediment to determine the market price, it should have documented it and proceeded in accordance with the provisions of the aforementioned legal provisions, which it did not do. Finally, it should be clarified that article 192-A of the Tax Code, cited by the DGII at folios 737 of the administrative file, as grounds that the interest rates applied by the appellant were not agreed at market price, is not applicable to the case at hand, inasmuch as it regulates a legal presumption of obtaining income (income) from interest – which admits proof to the contrary – in all money loan contracts of any nature and denomination, in those cases in which this has not been agreed, which shall be calculated by applying the average active interest rate in force on credits or loans to companies applied by the Financial System and published by the ————— on the total amount of the loan; on the other hand, in the present case, as has been shown above, the determination made by the DGII has been through the application of the transfer prices regulated in article 62-A of the TC, which is completely different from the said presumption; in addition to the fact that, as evidenced in folios 82 to 93 and 309 to 314 of the administrative file, the Revolving Credit Line contracts presented by the appellant, entered into with the companies ————— and — ———— contain the clause “Interest Rate”, in which it is established that the interest rate of each loan will be the market rate agreed by the parties, which was 3% for the first company and 1% for the second, which was effectively verified by the DGII both in the accounting records of the appellant, in the loan amortisation tables, as well as in the referred Transfer Pricing Study, as mentioned above. Consequently, this Court considers that in the present case there has been a violation of the Principles of Legality and Reservation of Law, by virtue of the fact that in the instant case the Directorate General did not follow the procedure established by the legal system in force, and therefore, in issuing the contested act, it acted outside the legally established procedures, and consequently, the decision under appeal, with respect to this point, is not in accordance with the law; it is unnecessary to rule on the other grievances invoked by the appellant in its appeal brief. The aforementioned is in accordance, as pertinent, with precedents issued by this Tribunal with references R1810029TM, of the eleventh hour of September fourth, two thousand and twenty; R1505018TM, of the thirteenth hour and two minutes of May twenty-seventh, two thousand and nineteen; R1511005TM, dated ten o’clock ten minutes past ten on the thirty-first day of August two thousand and eighteen; R1405013T, dated eleven o’clock five minutes past five on the twentieth day of April of the same year; R1405007TM, dated eleven o’clock five minutes past five on the twenty-seventh day of the same month and year; and, R1704001T, dated eleven o’clock five minutes past five on the twenty-ninth day of May of the aforementioned year.” Click here for English translation Click here for other translation ...

Paragraphs 1.110, 1.112 and 6.120 indicate that features of the geographic market in which business operations occur can affect comparability and arm’s length prices. Difficult issues can arise in evaluating differences between geographic markets and in determining appropriate comparability adjustments. Such issues may arise in connection with the consideration of cost savings attributable to operating in a particular market. Such savings are sometimes referred to as location savings. In other situations comparability issues can arise in connection with the consideration of local market advantages or disadvantages that may not be directly related to location savings ...

The geographic market is another economic circumstance that should be identified. The identification of the relevant market is a factual question. For a number of industries, large regional markets encompassing more than one country may prove to be reasonably homogeneous, while for others, differences among domestic markets (or even within domestic markets) are very significant ...