A. S.R.L. was issued with a notice of additional taxable income based on an audit of the pricing of the company’s controlled transactions. Among other things, the tax authority had found that the company had claimed to have achieved a profitability rate of 10% on the sale of finished products to the related company B., when in fact this was not the case. If the profitability had been 10%, corporate income tax of RON 3,840,000 would have been paid, but A. S.R.L. only paid RON 188,302 in tax. In the assessment, the tax authority had applied the TNMM using the median of the ROTC indicator for comparable independent companies and, on this basis, determined additional income for the period 2012-2016. An appeal was lodged which went to the High Court. Judgement of the Court The Court dismissed the appeal and found largely in favour of the tax authorities. Excerpt (In English) “As stated in Art. 3.43 of the OECD Guidelines the illustrative list of selection criteria presented in the Guidelines is neither limiting nor prescriptive, as long as the whole process of searching for comparables is transparent and verifiable. The transfer pricing file notes that a number of quantitative and qualitative criteria were also applied to the companies initially selected, so that the expert found that the independent companies considered by the complainant company in determining the interquartile range were comparable in terms of the criteria set out in the OECD Guidelines. The High Court finds that the appellant-respondents did not provide a basis for requiring the introduction of the size criterion in the selection of comparable companies. The Appellants’ argument is that the use of a minimum threshold for these criteria (size criteria) would have been relevant in the identification of independent companies for the comparability sample, but they have not indicated what the legal basis is for such an obligation, in order for the Court of Appeal to find a possible misapplication of the law. The algorithm for selecting comparable companies is entirely an economic, factual algorithm which is within the competence of specialists and the soundness of which can be verified only by the court of first instance, and it is not appropriate for the appeal brought on the basis of grounds of appeal to analyse that aspect. The High Court finds that the Court of First Instance did not misapply the law when it found that the independent companies taken into account by the applicant company in determining the interquartile range were comparable in terms of the criteria set out in the OECD Guidelines, and that the fact that the tax authorities had found that the operating income obtained by F. are lower than those of the Appellant was not sufficient to exclude it from the comparability sample, since the tax authorities did not justify the need to introduce a size criterion for maintaining it in the comparability sample for the period 2012-2016. At the same time, however, since the expert’s verification revealed situations in which A. did not fall within the interquartile range calculated for independent companies with the same functional profile, it was necessary to adjust the company’s income, which was such as to render the claim only partially unlawful. As regards the criticism that the tax inspection authorities found that the company claimed to have achieved a 10% profitability rate from the sale of finished products to the affiliated company B., but in reality this profitability rate did not exist in the financial results of the respondent, the first court took into account the fact that, in the light of the provisions of Articles 3.62 and 3.76 of the OECD Guidelines, the expert identified in the transfer pricing file the choice and justification of the transfer pricing calculation method and the data used, which is as follows: “7.3.2 Application of the cost-plus method to the operating profit/net margin method.” Article 3.62 of the 2010 OECD Guidelines states, “In determining this point, if the range contains relatively equal and highly reliable results, it could be argued that any point in the range satisfies the arm’s length principle. Where comparability flaws remain as discussed in paragraph 3.57, it may be appropriate to use measures of central tendency to determine this point (e.g. median, principal or weighted averages, etc., depending on the specific characteristics of the data set), in order to minimise the risk of error due to remaining unknown or unquantifiable comparability flaws.” Art. 3.76 of the OECD Guidelines states, “To obtain a complete understanding of the facts and circumstances surrounding an audited transaction, it may generally be useful to examine data from both the year under review and previous years. Analysis of such information could reveal facts that may have influenced (or should have influenced) transfer pricing. For example, the use of prior years’ data will show whether the taxpayer’s reported loss on a transaction is part of a history of losses on similar transactions, the result of certain economic conditions in a prior year that resulted in higher costs in the following year, or a reflection of the fact that a product is at the end of its life cycle. Such an analysis can be particularly useful when applying a transactional projection method. See paragraph 1.72 on the usefulness of multi-yearly data in examining loss statements. Multi-year data can improve understanding of long-term arrangements.” Following the analysis of the transfer pricing file and the chapters of the 2010 OECD Guidelines mentioned above, the expert concludes that the multi-year weighted average of the profit indicator determined in the transfer pricing file over the period 2012-2016 for comparable independent companies is a viable calculation option as set out in the OECD Guidelines, but not fully justifiable in this case. As regards the request to the expert to verify whether, in the light of the OECD Guidelines, the adjustment is made to the multi-year average of the range analysed or to the annual median, it was held that, in view of the provisions of Chapters A.7 ...

A Korean subsidiary (“Semicon-sales”) of a foreign group was active in distribution and sales of semiconductors for the automotive and industrial industry. Following an audit, the tax authorities found that the subsidiary had purchased semiconductors from a foreign affiliated company at a higher price than the arm’s length price. An assessment was issued where the the sum of the difference between the arm’s length price and the reported price had been included in the taxable income for FY 2015-2018. Both “Semicon-sales” and the tax authorities had applied the TNMM to find the arm’s length price, but the tax authorities had rejected the comparables selected by “Semicon” and replaced them with others. Not satisfied with the assessment “Semicon-sales” filed an appeal. Judgement of the Court The court remanded the case with an order to exclude from the benchmark comparables where the sales volume is significantly different from that of the “Semicon-sales”. Since the proportion of the taxpayers transactions with large companies is significant, the transaction stage, sales volume, customer, business environment should also be taken into consideration. Click here for English translation Click here for other translation ...

DELSEY España distributes and sells suitcases and other travel accessories of the DESLEY brand on the Spanish market and belongs to the French multinational group of the same name. The Spanish distributor had declared losses for FY 2005-2010 and was subject to a transfer pricing audit for FY 2011 to 2014. Based on the audit, the tax authorities concluded that the losses in FY 2005-2010 was a result of controlled transactions not being priced at arm’s length. The same was concluded for FY 2011 and 2012. The CUP method and RPM method applied by the taxpayer was found to be inappropriate and was replaced with the TNMM by the tax authorities. An appeal was filed by Delsey España S.A. Judgement of the Court The Court dismissed the appeal and upheld the assessment. Click here for English translation Click here for other translation ...

The process followed to identify potential comparables is one of the most critical aspects of the comparability analysis and it should be transparent, systematic and verifiable. In particular, the choice of selection criteria has a significant influence on the outcome of the analysis and should reflect the most meaningful economic characteristics of the transactions compared. Complete elimination of subjective judgments from the selection of comparables would not be feasible, but much can be done to increase objectivity and ensure transparency in the application of subjective judgments. Ensuring transparency of the process may depend on the extent to which the criteria used to select potential comparables are able to be disclosed and the reasons for excluding some of the potential comparables are able to be explained. Increasing objectivity and ensuring transparency of the process may also depend on the extent to which the person reviewing the process (whether taxpayer or tax administration) has access to information regarding the process followed and to the same sources of data. Issues of documentation of the process of identifying comparables are discussed in Chapter V ...

In practice, both quantitative and qualitative criteria are used to include or reject potential comparables. Examples of qualitative criteria are found in product portfolios and business strategies. The most commonly observed quantitative criteria are: Size criteria in terms of Sales, Assets or Number of Employees. The size of the transaction in absolute value or in proportion to the activities of the parties might affect the relative competitive positions of the buyer and seller and therefore comparability. Intangible-related criteria such as ratio of Net Value of Intangibles/Total Net Assets Value, or ratio of Research and Development (R&D)/Sales where available: they may be used for instance to exclude companies with valuable intangibles or significant R&D activities when the tested party does not use valuable intangible assets nor participate in significant R&D activities. Criteria related to the importance of export sales (Foreign Sales/Total Sales), where relevant. Criteria related to inventories in absolute or relative value, where relevant. Other criteria to exclude third parties that are in particular special situations such as start-up companies, bankrupted companies, etc. when such peculiar situations are obviously not appropriate comparisons. The choice and application of selection criteria depends on the facts and circumstances of each particular case and the above list is neither limitative nor prescriptive ...

The tax authorities excluded some of the entities selected by the taxpayer in a benchmark study, as it considered that they did not meet the necessary comparability requirements, and also included some of the excluded entities, as it considered that they were comparable. These modifications to the benchmark resulted in a variation of the arm’s length range, with the margin earned by the taxpayer falling outside the range. The taxpayer argued that the recalculation of market value should be based on a complete new analysis to replace the one provided by the entity. In relation to the rejection of certain comparables, the taxpayer argued that the information used by the tax authorities and consulted on the internet was not available at the time the transfer pricing documentation was prepared. Judgement of the TEAC The TEAC rejected the claim filed by the taxpayer and upheld the assessment of the tax authorities. It is not necessary to carry out a new economic analysis to replace the one provided by the entity, given that the inspection accepts said analysis, and what it limits itself to is correcting the defects present in the same. It is considered reasonable for the inspectorate to apply a rejection criterion based on the number of employees, taking into account that the taxpayer has more than 200 employees on its payroll and that the claimant applied other rejection criteria in order to ensure comparability of the size of the companies. It is understandable that the administration uses the information contained in the websites of the companies selected as comparable at the time of the inspection, it is quoted “as it could not be otherwise”. The TEAC refers to the OECD Guidelines on Transfer Pricing for Multinational Enterprises and Tax Administrations, which stress the importance of verifying the information obtained in the databases. The inspection is justified in making the adjustment to the median because the Administration has revealed  comparability defects in the benchmark provided by the taxpayer in the economic analysis. Click here for English translation Click here for other translation ...

The process followed to identify potential comparables is one of the most critical aspects of the comparability analysis and it should be transparent, systematic and verifiable. In particular, the choice of selection criteria has a significant influence on the outcome of the analysis and should reflect the most meaningful economic characteristics of the transactions compared. Complete elimination of subjective judgments from the selection of comparables would not be feasible, but much can be done to increase objectivity and ensure transparency in the application of subjective judgments. Ensuring transparency of the process may depend on the extent to which the criteria used to select potential comparables are able to be disclosed and the reasons for excluding some of the potential comparables are able to be explained. Increasing objectivity and ensuring transparency of the process may also depend on the extent to which the person reviewing the process (whether taxpayer or tax administration) has access to information regarding the process followed and to the same sources of data. Issues of documentation of the process of identifying comparables are discussed in Chapter V ...

In practice, both quantitative and qualitative criteria are used to include or reject potential comparables. Examples of qualitative criteria are found in product portfolios and business strategies. The most commonly observed quantitative criteria are: Size criteria in terms of Sales, Assets or Number of Employees. The size of the transaction in absolute value or in proportion to the activities of the parties might affect the relative competitive positions of the buyer and seller and therefore comparability. Intangible-related criteria such as ratio of Net Value of Intangibles/Total Net Assets Value, or ratio of Research and Development (R&D)/Sales where available: they may be used for instance to exclude companies with valuable intangibles or significant R&D activities when the tested party does not use valuable intangible assets nor participate in significant R&D activities. Criteria related to the importance of export sales (Foreign Sales/Total Sales), where relevant. Criteria related to inventories in absolute or relative value, where relevant. Other criteria to exclude third parties that are in particular special situations such as start-up companies, bankrupted companies, etc. when such peculiar situations are obviously not appropriate comparisons. The choice and application of selection criteria depends on the facts and circumstances of each particular case and the above list is neither limitative nor prescriptive ...