Skechers USA ITALIA SRL – a company operating in the sector of the marketing of footwear and accessories – challenged a notice of assessment, relating to FY 2004, by which, at the outcome of a tax audit, its business income was adjusted as a result of the ascertained inconsistency of the transfer prices relating to purchases of goods from the parent company (and sole shareholder) resident in Switzerland. The tax authorities had contested the uneconomic nature of the taxpayer company’s operations, given the losses recognised in various financial years, attributing the uneconomic nature to the artificial manipulation of the transfer prices of the purchases of goods and recalculating, consequently, the negative income component constituted by the aforesaid costs pursuant to Article 110, paragraph 7 of the TUIR, with the consequent non-deductibility of the same to the extent exceeding the normal value of the price of the goods in question. Skechers held that the losses did not derive from the costs of the intra-group purchases of the goods, but from the fixed start-up costs, not compensated by an adequate volume of sales, as an effect also of the competitive Italien market. The provincial and later the regional Tax Commission rejected the taxpayer’s appeal. The judge of appeal held that Skechers had not proved that the losses stemmed from the fixed start-up costs, which – moreover – were found only in relation to the Italien company and not in relation to the distribution companies located in other European countries; it then held that it was Skechers’ burden to prove the arm’s length nature of the costs. Skechers then filed an appeal with the Supreme Court. Judgement of the Supreme Court The Supreme Court set aside the decision and remanded the case to the Regional Tax Commission in a different composition. Excerpts “6. The following principle of law should therefore be stated: “on the subject of the determination of business income, the transfer pricing rules set forth in Article 110, paragraph 7, Presidential Decree no. 917 of 22 December 1986. 917 of 22 December 1986 imposes on the tax authorities the burden of proving the existence of transactions between related companies at a price other than the market price, using in this regard the transfer pricing methods described in the OECD Guidelines as soft law rules; once that burden of proof has been discharged, the taxpayer bears the burden of proving that those transactions took place for market values to be considered normal, having regard to the same stage of marketing, time and place where the goods and services were acquired or rendered, having regard – in particular – to the market context in which the taxpayer was operating”. 7. The judgment under appeal, in so far as it burdened the taxpayer company with the proof of the existence and inherent nature of the fixed operating costs, did not comply with the aforesaid principles, both in so far as the burden of proof lies with the Office, and in so far as the burden of proof must relate to the appropriateness of the transfer prices of the purchases of goods, in the market conditions in which the taxpayer company was required to operate, according to one of the criteria indicated in the OECD Guidelines. Nor can the burden of proof be discharged by alleging the mere uneconomicity of management (even if ascribed to the incidence of the aforesaid purchases), since the judge of the merits must verify the use of one of the methods indicated in the aforesaid Guidelines. The merit judge’s assessment must then be carried out in relation to the context in which the taxpayer company was operating at the time of the assessment, during which there had been a high incidence on the typical management of fixed operating costs, due to the start-up phase, which would have required the realisation of higher sales volumes in order to reach the break-even point. 8. The appeal must therefore be upheld and the contested judgment set aside, with reference back to the court a quo, in a different composition, also for the settlement of the costs of the proceedings.” Click here for English translation Click here for other translation ...

Corrugados del Guarco S.A. had declared losses on controlled transactions for FY 2003, 2004 and 2005 as export prices for these transactions had been set below cost and without profit margin, and also different from the price charged for that product to other independent or unrelated companies, in favour of its related company Envases Nicaragüenses S.A. According to the Corrugados del Guarco S.A. the reason why the prices of these controlled transactions had been set low was that unfair competition had made it necessary to use a commercial strategy of selling at preferential prices to the group company in Nicaragua. The tax authorities issued an assessment whereby the prices of the controlled transactions were adjusted in accordance with the arm’s length principle. Furthermore a fine was issued to the company for gross negligence. Judgement of the Supreme Court The Court dismissed the appeal of Corrugados del Guarco S.A. Excerpts from the Judgement “…Finally, and in relation to transfer pricing, on which the plaintiff argues reservation of law, it is necessary to indicate that guideline 20-03, called “Fiscal Treatment of Transfer Pricing, according to Normal Market Value”, issued by the Director General of Taxation on June 10, 2003, refers to the rules of the Organisation for Economic Co-operation and Development (hereinafter OECD), for the setting of prices between related companies. This international organisation is dedicated to contributing to the peaceful and harmonious development of relations between peoples, with an emphasis on collaboration in the global economy. In this regard, the Constitutional Chamber explained the content of the aforementioned body of norms as follows: “The guideline in question is based on the assumption that if these operations have some kind of artificial manipulation, and this is detrimental to the tax authorities, it allows the application of articles 8 and 12 of the Code of Tax Rules and Procedures to establish that certain transactions correspond to a market value as if they had been established between independent persons or entities that compete freely. Although there are different methodologies, to conclude that a price corresponds to a certain reality or not, the problem before the Chamber is an issue closely linked to one that arises for any operator of law that must apply rules that seek to compensate forms of abuse of law or that do not correspond to an economic reality to avoid tax liabilities” (Ruling 2012-4940 of 15 hours 37 minutes of 18 April 2012). The aforementioned court also added, on the constitutionality of the rule “our country does not need to be a member of that body to make use of certain rules or practices that contain a high degree of consensus, especially if, as in the case at hand, articles 15 and 16 of the General Law on Public Administration establish the limits to discretion, even in the absence of a law, which is precisely what is happening in the present case. This Court agrees with the Attorney General’s Office and the Minister of Finance that these are rules with a high degree of subjection to science and technique, as in the case of the general principles of accounting, where a law would not be necessary to reach a technical consensus. In this sense, those methods or techniques make it possible to arrive at a result that is as close to reality as possible, without it being necessary for them to be formally incorporated into the legal system” (ibidem). The above shows that the principle of legal reservation is not violated in the application of OECD transfer pricing methods, such as those analysed here. V.- As a second allegation, it was argued that the financial penalty was imposed without previously following a sanctioning procedure, since it only faced a determinative one.“ ” In the opinion of this Court, the arguments of the appellant also fail to break this aspect of the judgement. The court took for granted that with intent, the plaintiff sold at prices below cost and that she used an agreement with another private individual to defraud the tax authorities, therefore it cannot be indicated in this court that she did not qualify the conduct, establishing that even article 71 of the Code of Tax Rules and Procedures, allows the sanction when it has acted with intent or mere negligence, that is to say, by negligence. The law seeks to ensure that the self-assessments, on which the country’s entire tax system is based, are made seriously and carefully, and therefore penalises fraud and negligence in the self-assessment with 25 percent of what has not been paid to the Treasury. This procedure is necessarily linked to the assessment procedure, where it is defined whether what was declared and paid by the taxpayer is in accordance with the legal system and this is clearly stated by the sentencing body, which also refers that the sanctioning procedure was carried out in the terms established by the said numeral 150 CNPT and that the right of defence was guaranteed by giving the taxpayer a hearing and resolving his appeals.” Click here for English translation Click here for other translation ...

In this case the Slovenian Supreme Court explains that a legal act created by an international organisation can be directly applicable in a Member State only if the Member State has transferred part of its sovereign rights to the organisation, which the Republic of Slovenia has not done by ratifying the OECD Convention. The OECD Guidelines themselves are therefore not directly binding on the Member State, which is already clear from the OECD’s internal acts (Article 18 of the Rules of Procedure of the OECD). It concludes that the mere existence of marketing costs does not mean that they are incurred as a result of the implementation of a business strategy. That link is possible if its substance is demonstrated. It is not possible to determine which costs are causally linked to the implementation of a business strategy if it is not clear what is included in the business strategy in the first place. It is only when an activity can be linked to its implementation costs in a meaningful way that the facts about the level of those costs become legally determinative. It is not possible to refer to the costs of a strategy without demonstrating the content of the strategy.” Click here for English translation Click here for other translation ...

A Russian subsidiary of the Suzuki/Itochu group had been loss making in 2009. Following an audit the tax authority concluded, that the losses incurred by the Russian distributor were due to non-arm’s length transfer pricing within the group and excessive deduction of costs. Decision of the Court The Court decided in favor of the tax authorities and upheld the assessment. “In view of the above, the appeal court considers that the courts’ conclusions that the Inspectorate had not proved that it was impossible to apply the first method for determining the market price and that the Inspectorate had incorrectly applied the resale price method were unfounded.” “In this light, the courts’ conclusions that the Inspectorate incorrectly applied the second method of determining the market price are unfounded.” “In such circumstances, the Inspectorate’s conclusion on the overstatement of the purchase price of vehicles is based on the application of market data and made in compliance with Article 40 of the Tax Code. The courts had no grounds to satisfy the applicant’s claims for the recognition of the Inspectorate’s decision in this part.” “The rest of the judicial acts are lawful and justified. In accordance with Article 252 of the Tax Code recognizes expenses reasonable (economically justified) and documented costs, performed (incurred) by the taxpayer. Herewith, any expenses are considered as expenses on condition that they were incurred for the realization of activities aimed at receiving income.” An appeal filed by Suzuki to the Russian Supreme Court was later dismissed in December 2016. Click here for English Translation ...

L’oreal in India is engaged in manufacturing and distribution of cosmetics and beauty products. In respect of the distribution L’oreal had applied the RPM by benchmarking the gross margin of at 4o.80% against that of comparables at 14.85%. The tax administration rejected the RPM method on the basis that the L’oreal India was consistently incurring losses and the gross margins cannot be relied upon because of product differences in comparables. Accordingly, the tax administration applied Transactional Net Margin Method. L’oreal argued that the years of losses was due to a market penetration strategy in India – not non-arm’s-length pricing of transactions. The comparables had been on the Indian market much longer than L’oreal and had established themselves firmly in the Indian market. The Appellate Tribunal observed that L’oreal India buys products from its parent and sells to unrelated parties without any further processing. According to the OECD TPG, in such a situation, RPM is the most appropriate transfer pricing method. L’oreal India had also produced evidence from its parent that margin earned by the parent on supplies to L’oreal India was 2% to 4% or even less. The tax administration had not disputed these facts. The tax administrations statement, that the parent have earned higher profit, was not based on facts. The Tribunal found that profit earned by the parent was reasonable and hence there was no shifting of profits by L’oreal India to its parent. See also: India vs. Loreal 12 April 2012  and  India vs. Loreal 25 Oct. 2012 ...

The sales company … – (GmbH) was the managing general partner of the plaintiff and defendant, a limited partnership – “Sales KG” – in the years in dispute. The GmbH had a 10/11 share in the capital of “Sales KG”. The limited partner was the Dutchman G. Shareholders of the GmbH with a share of 99% were the … NV (NV) and the … in The Hague (NV L-V). “Sales KG” engaged in wholesale trade in …, which it purchased almost exclusively from NV. It granted its customers rebates, bonuses and discounts in the years in dispute (1962 – 1964). According to the findings of the tax authorities (FA), “Sales KG” had to pay interest on its goods liabilities after 90 days from 1963. It did not charge its customers corresponding interest. The tax authorities increased the profit of “Sales KG” mainly by adding profits allegedly transferred to the Netherlands. In the absence of suitable documentation, the profit shifting was to be estimated at 3% per annum of the purchase of goods from NV. The tax authorities relied on Article 6 of the Agreement between the Federal Republic of Germany and the Kingdom of the Netherlands for the Avoidance of Double Taxation with respect to Taxes on Income and on Capital and Miscellaneous Taxes and for the Settlement of Other Questions in the Field of Taxation of 16 June 1959 – DBA-Netherlands – (BGBl II 1960, 1782, BStBl I 1960, 382), § 217 of the Reich Tax Code (AO) and § 19 No. 6 of the Regulation for the Implementation of the Corporation Tax Act (KStDV). “Sales KG” filed an action against the notices and the Fiscal Court (Finanzgericht, FG) amended the challenged notices and partly reassessed the profits of “Sales KG” and the profit shares of the partners. For the rest, it dismissed the action. The tax authorities lodged an appeal against this decision. Judgement of the Court The Court found that the tax court had correctly refused to increase the profit shares (§ 215.2 AO) of “Sales KG” by the profits allegedly transferred to the NV, as the conditions for a hidden distribution of profits (§ 6.1 sentence 2 of the Corporation Tax Act – KStG -, § 19 no. 6 KStDV) between the GmbH and its shareholder, NV in Holland, were not met. Excerpts “The requirements for a hidden profit distribution between the GmbH and the NV are not fulfilled. Although the FG did not have to decide on this question from its point of view, its findings are sufficient to exclude a hidden profit distribution in the case in dispute. According to the established case law of the Federal Fiscal Court (Bundesfinanzhof, BFH), a hidden profit distribution requires that a corporation grants its shareholders pecuniary advantages and that this benefit has its cause in the corporate relationship. The causality of the corporate relationship is given if the corporation would not grant the advantages to a non-shareholder if it exercised the due care of a prudent and conscientious manager (§ 43, paragraph 1 of the Limited Liability Companies Act) (cf. BFH judgements of 30 July 1975, I R 110/72, BFHE 117, 36, BStBl II 1976, 74, and of 3 February 1977, IV R 122/73, BFHE 121, 327, BStBl II 1977, 346, with further references). N.). The GmbH allegedly benefited the NV by causing it, as managing director and majority shareholder of the KG, to make payments (excessive prices for goods and interest payments) and to waive the passing-on of costs (cf. II 1 a above). Just as a pecuniary advantage can also be granted directly to a third party and indirectly to the shareholder instead of directly to the shareholder, the person directly granting the advantage does not have to be the GmbH itself; it can also be a third party who grants an advantage to the shareholder at the expense of his own profit. This advantage is granted indirectly by the GmbH to the extent that the reduction in profit of the third party affects its own profit (share), provided that the conditions for a hidden profit distribution are otherwise met. In principle, 10/11 of the KG’s loss of profit affects the GmbH’s profit; for the rest, the limited partner G bears the KG’s loss of profit. The Senate does not need to decide whether the possible loss of profits at the limited partnership is only fully attributable to the limited liability company because it alone caused it. In the case in dispute, there is already a lack of the fundamental prerequisite of a benefit which has its cause in the partnership relationship. It is not evident, nor has it been shown by the tax authorities, that the prices for the goods purchased by NV were higher than the usual prices for goods … Similarly, there are no indications that NV would have waived the default interest on the goods and would have partly supported the rebates, discounts and bonuses if it had not been a shareholder in the GmbH …” “If a transaction, in this case e.g. a possible transfer of profits (cf. German Memorandum on the DTA-Netherlands of 16 June 1959 on Article 6, printed in Handbooks on Double Taxation Agreements, Explanatory Notes on the German-Dutch DTA, text part), cannot already be covered under the domestic tax laws, then the direct application of Article 6 of the DTA-Netherlands would amount to an impermissible extension of the tax liability. The BFH rulings on the progression proviso do not contradict this. The progression proviso does not require a domestic statutory provision for its implementation (apart from the consent law pursuant to Article 59, paragraph 2, sentence 1 of the Basic Law – GG), because it does not create a tax liability, but maintains the existing one (BFH ruling of 9 November 1966 I 29/65, BFH ruling of 9 November 1966 I 29/65, BFH ruling of 9 November 1966 I 29/65, BFH ruling of 9 November 1966 I 29/65, BFH ruling of 9 November 1966 I 29/65) ...

Another type of specially low prices which may nevertheless be claimed to be arm’s length prices may be met with where the seller’s object is market penetration. Producers may lower the prices of their goods, even to the extent of temporarily making losses, in order to enter new markets, to increase their share of an existing market, to introduce new products into the market, or to fend off increasing competition etc. One result of this may be to produce a lasting reduction in the normal market price of the relevant goods but in general specially low prices may be expected to be charged for a limited period only, with the specific object of improving the profits of the producer in the long term. Producers may not, however, be alone in this kind of activity; both producing and marketing entities may combine in such an operation, splitting the risk and sharing the profitable outcome, if any, in some way between them. Tax authorities could in principle therefore accept such low prices· charged between associated enterprises as arm’s length prices but only if independent enterprises could be expected to have fixed the prices in the same manner in comparable circumstances ...