Universal Pictures International Spain SL is a distributor of films on the Spanish Market. It distributes films both from related parties (Universal Pictures) and from unrelated parties. Following an audit, the Spanish tax authorities issued an assessment where the remuneration received for distribution of films from related parties had been compared to the remuneration received from distribution of films from unrelated parties and where the pricing of the controlled transactions had been adjusted accordingly . Not satisfied with the assessment of additional income a complaint was filed by Universal Pictures International Spain SL. Judgement of the Court The Court predominantly held in favor of Universal Pictures International Spain SL. The distribution activities performed in regards of films from related parties were limited risk whereas the activities performed in regards of distribution of films from unrelated parties were fully fledged. Hence the pricing of the controlled and uncontrolled transactions was not comparable. However, the comparables in the benchmark analysis on which Universal Pictures International Spain SL had based the pricing of controlled transactions was not all considered sufficiently comparable by the court and on that basis the case was referred back for reconsideration. Click here for English translation Click here for other translation ...

When considering the risks assumed by a party to a controlled transaction, tax administrations should carefully consider the commercial rationale for any purported change in the risks assumed by a party before and after the outbreak of COVID-19 (and taking into consideration the accurate delineation of such purported change). In particular, concerns may arise where before the outbreak of COVID-19 a taxpayer argues that a “limited-risk” distributor did not assume any marketplace risk and hence was only entitled to a low return, but after the outbreak argues that the same distributor assumes some marketplace risk (for example, due to changes in risk management functions) and hence should be allocated In this scenario, consideration should be given to re-examining whether prior to the outbreak of COVID-19 the “limited-risk” distributor genuinely did not assume any marketplace risk, whether after the outbreak the “limited risk” distributor did not actually assume any marketplace risk, and/or whether the assumption of this risk following the outbreak of COVID-19 is a result of a business restructuring. If a prior risk allocation is recognised under an accurate delineation, in order for a reallocation of that risk to be recognised under a subsequent updated accurate delineation, such new risk allocation must be supported by an analysis of all the facts and circumstances and relevant evidence should be obtained and documented to substantiate the position. In this respect, the guidance in Chapter IX of the OECD TPG may be relevant. In general, consideration should be given to whether a taxpayer is taking inconsistent positions pre- and post- pandemic and, if so, whether either position is consistent with the accurate delineation of the transaction ...

In determining whether or not a “limited-risk” entity may incur losses, the risks assumed by an entity will be particularly important. This reflects the fact that at arm’s length, the allocation of risks between the parties to an arrangement affects how profits or losses resulting from the transaction are allocated.23 For example, where there is a significant decline in demand due to COVID-19, a “limited-risk” distributor (classified as such, for example, based on limited inventory ownership – such as through the use of “flash title” and drop-shipping – and therefore limited risk of inventory obsolescence) that assumes some marketplace risk (based on the accurate delineation of the transaction) may at arm’s length earn a loss associated with the playing out of this risk. The extent of the loss that may be earned at arm’s length will be determined by the conditions and the economically relevant characteristics of the accurately delineated transaction compared to those of comparable uncontrolled transactions, including application of the most appropriate transfer pricing method and following the guidance in Chapter II of this note and Chapters II and III of the OECD TPG. In the example provided in this paragraph, the TNMM or potentially the resale- minus method depending on the more detailed facts and circumstances, might be used as the most appropriate method to test the arm’s length nature of the return, and third party comparable distributors might in these circumstances earn a loss, which may, for example, arise if the decline in demand means that the value of sales is insufficient to cover local fixed costs. It should be noted that the comparables chosen should be suitable in light of the accurate delineation of the transaction, in particular with reference to the risks assumed by each of the counterparties to the transaction. However, it will not be appropriate for a “limited-risk” distributor that does not assume any marketplace risk or another specific risk to bear a portion of the loss associated with the playing out of that risk. For instance, a “limited risk” distributor that does not assume credit risk should not bear losses derived from the playing out of the credit risk. For this reason, when determining whether an entity operating under limited risk arrangements can sustain losses the guidance in Chapter I of the OECD TPG, particularly as it relates to the analysis of risks in commercial or financial relations,24 will be particularly relevant. 23 Paragraph 1.58 of Chapter I of the OECD TPG. 24  Paragraphs 1.56 -1.106 of Chapter I of the OECD TPG ...

In all circumstances it will be necessary to consider the specific facts and circumstances when determining whether a so-called “limited-risk” entity could incur losses at arm’s length. This is reflected in the OECD TPG which states that “simple or low risk functions in particular are not expected to generate losses for a long period of time”,22 and therefore holds open the possibility that simple or low risk functions may incur losses in the short-run. In particular, when examining the specific facts and circumstances, the analysis should be informed by the accurate delineation of the transaction and the performance of a robust comparability analysis. For example, 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 transaction then such a comparable should be excluded from the list of comparables (see paragraph 3.65 of the OECD TPG). 22  Paragraph 3.64 of Chapter III of the OECD TPG ...

When performing transfer pricing analyses, the activities performed by an entity may lead it to be characterised as “limited-risk” where it has a relatively lower level of functions and risks. 20 Though the term “limited-risk” is commonly used, since the term is not defined in the OECD TPG, the functions performed, assets used and risks assumed by “limited-risk” entities vary, and therefore it is not possible to establish a general rule that entities so-described should or should not incur losses. It should also be noted that neither the mere labelling of activities as “limited-risk” nor the fact that an entity receives a fixed remuneration means by itself that an entity operates on a limited risk basis in a controlled transaction.21 Further, no supposition should be made regarding the most appropriate transfer pricing method to apply in any set of circumstances without first undertaking a full and accurate delineation of the transaction, which then will help inform the choice of method made when performing the appropriate comparability analysis. 20 Paragraph 9.2 of Chapter IX of the OECD TPG. 21  Paragraph 1.81 of Chapter I of the OECD TPG ...

First, it is important to emphasise that the allocation of risks between the parties to an arrangement affects how profits or losses resulting from the transaction are allocated at arm’s length through the pricing of the transaction.18 Hence, the existing guidance on the analysis of risks in commercial or financial relations will be particularly relevant for determining how losses are allocated between associated parties. 18 Paragraph 1.58 of Chapter I of the OECD TPG ...

During the COVID-19 pandemic, many MNE groups have incurred losses due to a decrease in demand, inability to obtain or supply products or services or as a result of exceptional, non-recurring operating costs.17 The allocation of losses between associated entities can give rise to dispute and hence is an issue that requires consideration given the probable increase in the frequency and magnitude of losses in the current economic environment. When considering the issue of losses and the allocation of COVID-19 specific costs, three issues warrant specific discussion. 17 For example, this might include expenditure on personal protective equipment, on IT infrastructure required to implement a “test and trace” system, measures to reconfigure office space to implement physical distancing requirements, or on other health-related safety equipment ...

The activity of Spółka A sp. z o.o. included salmon breeding, processing, smoking and sale and distribution of the finished products. The company operated within Group A with head quarter in the Netherlands. By decision of 27 May 2019, the tax authorities determined that the operating expenses determined by transactions with related parties were inflated by PLN 29,613,156.00. The authorities did not accept calculations presented by the Company, as there were no reliable accounting records regarding the amount of costs incurred. Furthermore, the authorities held that the cost plus method, which should guarantee profit on the transaction in the Company, had been applied incorrect. The dispute before the administrative Court boils down to assessing whether the court of first instance, in compliance with the provisions in force, reversed the decision of the authorities in its entirety and referred the case back for reconsideration due to the deficiencies found in the evidentiary proceedings, making it necessary to conduct the proceedings in a significant part. “As indicated by the Supreme Administrative Court in its judgment of 20 June 2018 in case II FSK 1665/16, the regulation contained in Art. 11 of the LLD is a special regulation and its purpose is to protect the interests of the State Treasury against such activities of taxpayers which consist in applying prices deviating from market prices in controlled transactions in order to achieve a favourable tax result for themselves. Therefore, the rationale for the application of Article 11 of the ACT is not only the fact of occurrence of the relationship referred to in paragraphs 1 and 4, but the use of those relationships to change the level of taxation (tax avoidance). The regulation contained in Article 11 of the CFRA is based on the assumption that all transactions should comply with market conditions, i.e. conditions which would be agreed upon by independent entities in the same or in a similar situation. However, the mere fact of economic relations referred to in Article 11 of the CFR may not in itself give rise to negative tax consequences for related entities. However, the use of such relationships to change the level of taxation contrary to the statutory obligation is of tax significance. Using the position of affiliated entities for such purpose finds a tax sanction, which is the estimation of income. However, this sanction cannot be applied without proving that the related party position is used to shift income (profits) in order to reduce taxation. The findings in this respect should have the characteristics of a clear, logical conclusion from the evidence gathered. “…The estimation of prices applied in transactions between taxpayers and related parties cannot be made solely by simply transferring the price or margin from a transaction between independent parties – without assessing the comparability of the terms of those transactions. The tax authority, based on comparative data, should therefore primarily demonstrate the reliability of the transactions (entities) compared, and thus also refer to the economic functions and strategies applied by operators, also in the context of assessing the importance of these factors for the possibility of comparison.” “…in the opinion of the Court, the Director of the Chamber rightly revoked the decision of the tax authorities of 27 May 2019 due to failure to observe the obligation to analyse the possibility of applying the so-called traditional methods of estimating the income of a Party, indicated in the Regulation, and failure to justify the reasons why the Body decided that those methods could not be applied in this case. The First Instance Authority did not justify that the most appropriate pricing method in the case should be the transactional net margin method.” Click here for translation ...

SAS RKS, a French subsidiary of the Swedish SKF group, was engaged in manufacturing of bearings. RKS had, with the exception of 2008, had a negative results since 2005. Following an audit for FY 2009 and 2010, the French tax administration by application of the TNMM method, determined that SAS RKS should have a net profit margin of 2.33% in 2009 and 2.62% in 2010. The tax assessment was brought to the Montreuil Administrative Court, and in April 2018 a judgement in favor of the company was issued. This judgement was appealed by the tax authorities to the CAA. The CAA overturned the judgment of the Administrative Court and found in favor of the tax authorities. “The administration has qualified as hidden income the profits mentioned in the preceding paragraphs, transferred by the company RKF to the business units of the SKF group, established abroad. While the applicant does not dispute that the reduction in its prices may constitute income distributed in a concealed manner, it submits that the administration has not adduced evidence of an intention to grant and receive a benefit without consideration. However, it follows from the above that RKS has sold its products at a loss since 2005 and that its purchasers have benefited, during the same period, from transfer prices decided each month by the Swedish parent company AB SFK in order to guarantee them a gross margin of 3 %, irrespective of the cost price of these products to their supplier. Under these conditions, which are unrelated to the formation and negotiation of prices in normal commercial relations, the intention to grant and receive a benefit is established.“ Click here for translation ...