Following an audit of Oracle Technology Systems (Kenya) Limited, a distributor of Oracle products in Kenya, the tax authority issued an assessment for FY2015-2017 relating to controlled transactions. In assessing the income, the tax authority had used a CUP method instead of the TNMM. Dissatisfied with the assessment, Oracle Technology Systems (Kenya) Limited appealed to the Tax Appeals Tribunal on the basis that the return on its related party transactions was at arm’s length and did not require adjustment. Judgement of Tax Appeals Tribunal The Tribunal referred the case back to the tax authority for an appropriate reassessment. Excerpts “The question that arises is which method was the most suitable one. The OECD TP Guidelines state that the preferred method is CUP. But this only applies where there are appropriate comparables. Internal comparables are of course always preferred where they are reliable or can be reliably adjusted. From our understanding, the TP Policy implied that the reason internal comparables could not be used was due to differences in the functions of the independent distributors as compared with those of the Appellant. 127. We however note that during the hearing and in its submissions, the Appellant went out of its way to show that its functions are routine and not much different from those carried out by other distributors. The Appellant for example states in Paragraph 76 of its Statement of Facts as follows:- ‘The Appellant would like to note that the IT industry itself is a very competitive market and that the Appellant’s functional profile is not different from other value-added distributors in the same competitive market … ”  128. Similarly, the expert witness Dr Neighbour stated in his review of the Appellant’s role as a distributor as thus:- “In my experience, these are standard functions that would be expected of a typical distributor, i.e one that provides some local sales and marketing activity to support the sales as well as provision of customer support and services in respect of the distributed products … “ 129. The arguments offered by the Appellant seem to imply its functions are no different from any other distributor. This seems to contradict what its TP Policy suggests that the reasons it could not use the internal comparables was because the functions carried out by the Appellant and the  independent distributors were different and could not be reliably adjusted. 130. If indeed as the Appellant and its expert witness suggests its functions are routine and much in line with those of other distributors in the industry, we are at a loss as to why the internal comparables could not be used, and where such internal comparables were available why the CUP method which as both parties have admitted is the preferred method could not be used. (…) 132. It is unclear to the Tribunal both from the Appellant’s and the Respondent’s arguments and the documentation made available whether the Appellant is indeed a routine distributor as it averred during the hearing or if the services it offers are distinct as stated in the TP Policy. 133. Accordingly, we are of the view that the matter ought to be referred back to the Respondent to carry out a proper audit and in particular a functional analysis to determine what the exact functions of the Appellant are and if these are fundamentally different from those of independent distributors. Only then is it possible to determine the proper method to be applied.” ”] ...

The starting point for scrutinising transfer prices would frequently be the appearance of a discrepancy between the profits returned by an associated enterprise and those which might be expected to be made by comparable enterprises in the uncontrolled situation. Since the assessment of an arm’s length price depends very often on careful judgement and the resolution of many, perhaps conflicting, considerations by negotiation between the tax authorities and the enterprise concerned, it follows that if the prices actually paid can be substantiated by acceptable evidence as being arm’s length prices there would be no justification for seeking to make merely minor or marginal adjustments to them for tax purposes. Similarly a tax authority should hesitate to disturb without good reason a pricing arrangement reasonably and consistently operated between associated enterprises if it is also reasonably and consistently operated in comparable dealings with independent parties. Moreover, as a general principle, tax authorities should base their search for an arm’s length price on actual transactions and should not substitute hypothetical transactions for them, thus seeming to substitute their own commercial judgement for that of the enterprise at the time when the transactions were concluded (though there may be some circumstances where the form of transaction has effectively to be ignored – see paragraphs 23 and 24) ...