If there are differences between the tested party and an uncontrolled comparable that would materially affect the profits determined under the relevant profit level indicator, adjustments should be made according to the comparability provisions of § 1.482-1(d)(2). In some cases, the assets of an uncontrolled comparable may need to be adjusted to achieve greater comparability between the tested party and the uncontrolled comparable. In such cases, the uncontrolled comparable’s operating income attributable to those assets must also be adjusted before computing a profit level indicator in order to reflect the income and expense attributable to the adjusted assets. In certain cases it may also be appropriate to adjust the operating profit of the tested party and comparable parties. For example, where there are material differences in accounts payable among the comparable parties and the tested party, it will generally be appropriate to adjust the operating profit of each party by increasing it to reflect an imputed interest charge on each party’s accounts payable. As another example, it may be appropriate to adjust the operating profit of a party to account for material differences in the utilization of or accounting for stock-based compensation (as defined by § 1.482-7(d)(3)(i)) among the tested party and comparable parties ...

Other factors listed in § 1.482-1(d)(3) also may be particularly relevant under the comparable profits method. Because operating profit usually is less sensitive than gross profit to product differences, reliability under the comparable profits method is not as dependent on product similarity as the resale price or cost plus method. However, the reliability of profitability measures based on operating profit may be adversely affected by factors that have less effect on results under the comparable uncontrolled price, resale price, and cost plus methods. For example, operating profit may be affected by varying cost structures (as reflected, for example, in the age of plant and equipment), differences in business experience (such as whether the business is in a start-up phase or is mature), or differences in management efficiency (as indicated, for example, by objective evidence such as expanding or contracting sales or executive compensation over time). Accordingly, if material differences in these factors are identified based on objective evidence, the reliability of the analysis may be affected ...

GlaxoSmithKline Costa Rica S.A. manufactures pharma products which is sold to both independent customers in the region and to group companies abroad. For FY 2004 and 2005 pricing of the controlled transactions had been determined based on the TNMM method using return on total costs (ROTC) as PLI. GSK said the range of return on total costs “for the comparable independent companies ranges from 4.7 per cent to 14.5 per cent, with a median of 9.6 per cent. GSK CR obtained an average ROTC of 50.6 percent during fiscal years 2004 and 2005, which was not below the range identified for comparable independent companies. Accordingly, the transfer prices used by GSK CR in its controlled transactions did not distort GSK CR’s profitability and satisfied the arm’s length principle set out in the OECD Guidelines. In 2009 the tax authorities issued an assessment for FY 2004 and 2005 based on the internal CUP method. “…between the transactions under study, namely sales to related and unrelated customers, there is complete similarity in terms of the characteristics of the product that is addressed to both types of customers, it is the same product, i.e. with identical characteristics…” “the taxpayer GSK sells at different prices with its related companies, taking into account the following branded products: Andrews, SB Analgesics, Oxy, Panadol Concept (RT) and Phillips Mom. It found that some products were sold at 34% of the price to an independent. Thus during the period 2004 it found that products such as Sal Andrews Cja X 50’s, code 200041010 was sold to independents at ¢1,366.57 and to affiliated companies at ¢468.68. The average profit margin over standard cost for products sold to independent customers was 285.33% and for affiliates it was 28.22%.” Applying the internal CUP method resulted in an adjustment of taxable profits in an amount of ¢394,638,821.00. Not content with the tax assessment an appeal was filed by GlaxoSmithKline with the tax court. The appeal was dismissed in 2013 and later in 2019 by the Court of appeal. An appeal was then filed with the Supreme Court. Judgement of the Supreme Court The Court dismissed the appeal of GlaxoSmithKline and upheld the assessment of the tax authorities. Excerpts from the Judgement “The principle of economic reality, provided for in precepts 8 and 12 of the CNPT, essentially allows the Tax Administration to depart from the forms adopted by the taxpayer to unravel the true tax scope of the contract, in order to avoid tax evasion and thus determine what the business between the parties really consisted of. In the case under study, several aspects can be extracted from the evidence in the case file and referred to above. Firstly, the application of the CUP method is not outside the scope of administrative discretion based on due technical discretion, in proper compliance with paragraphs 15 and 16 of the LGAP. Discretion allows the Administration to determine the best technical criterion to be used. It is a detailed study in which the comparison of the same products is reflected. Secondly, the PwC reports show the possibility of using other methods to determine the actual transfer pricing situation. Indeed, PwC’s work is very comprehensive and justified on each of the points it raises. It is clear to this House that these documents were prepared by experts with extensive knowledge of the subject. Thirdly, the expert opinion is not a study that helps to solve the conflict, as it is basically dedicated to indicate whether the system used by the TA complies or not with the Guidelines, in order to deduce that the best work was that of PwC. However, as has been seen, as explained throughout this judgment, it is not in dispute whether the TA had to apply the Guidelines as they are established; with the obligation to follow each of the guidelines set out therein. The shortcomings that this Chamber detects in the evidence provided by GSK, lies in the fact that the study carried out by the expert PwC, takes into account variables, which do not appear in the file and which the TA did not have, specifically those private reports adduce preponderant factors that influence and directly affect the sale price and analyse elements such as: sales volumes, brands, economic conditions of each country, price controls established in some regions, names under which the products are sold, specifications of the respective packaging, geographic issues, development and market size; which from their point of view make the products incomparable. However, as the auditor indicates, when he carried out his study and asked GSK directly for information on the elements that could influence the prices of related companies with respect to independent companies, in which a clear difference was noted, the taxpayer’s response was that the only factor that affected prices was advertising. This response was given even though the taxpayer was aware that a transfer pricing study was being carried out on the company. PwC’s work goes beyond this statement made by the taxpayer during the audit process, and that is why, even if they are complete and technical studies, they are elaborated with completely different parameters than those available to the TA, as expressly indicated by the plaintiff. None of the elements referred to were arguments made by the taxpayer when the study was carried out. Likewise, it is unacceptable the position used by the plaintiff that when GSK responded to the auditor that “other” elements were also part of the aspects that varied the transfer prices with the related parties, it was the TA’s obligation to find out what those “other” elements consisted of; it is up to the taxpayer to provide all the required information. Thus, it is not possible to affirm that the work carried out by the TA was deficient, unreliable or incomplete; since, all things being equal, it has not been possible to disprove that this study is erroneous or unreliable, in such a way that, in the present case, it is not evident that the ...

Because of the importance of the underlying assumptions and valuation parameters, taxpayers and tax administrations making use of valuation techniques in determining arm’s length prices for transferred intangibles should explicitly set out each of the relevant assumptions made in creating the valuation model, should describe the basis for selecting valuation parameters, and should be prepared to defend the reasonableness of such assumptions and valuation parameters. Moreover, it is a good practice for taxpayers relying on valuation techniques to present as part of their transfer pricing documentation some sensitivity analysis reflecting the consequential change in estimated intangible value produced by the model when alternative assumptions and parameters are adopted ...

The reliability of the intangible value produced using a valuation model is particularly sensitive to the reliability of the underlying assumptions and estimates on which it is based and on the due diligence and judgment exercised in confirming assumptions and in estimating valuation parameters ...

When applying valuation techniques, including valuation techniques based on projected cash flows, it is important to recognise that the estimates of value based on such techniques can be volatile. Small changes in one or another of the assumptions underlying the valuation model or in one or more of the valuation parameters can lead to large differences in the intangible value the model produces. A small percentage change in the discount rate, a small percentage change in the growth rates assumed in producing financial projections, or a small change in the assumptions regarding the useful life of the intangible can each have a profound effect on the ultimate valuation. Moreover, this volatility is often compounded when changes are made simultaneously to two or more valuation assumptions or parameters ...