Following an audit of Beta Healthcare International Limited, a Kenyan subsidiary in the Aspen Healthcare Group, the tax authorities issued a notice of additional taxable income relating to controlled transactions, in which they had determined the arm’s length price for controlled transactions using the CUP method instead of the TNM-method as applied by the company. Beta Healthcare International Limited appealed to the Tax Appeals Tribunal, arguing that the tax authorities had failed in its characterisation of the company, failed to consider the comparability factors of the transactions and misapplied the transfer pricing guidelines. Decision of the Tax Appeals Tribunal The Tribunal dismissed the appeal and ruled in favour of the tax authorities. Excerpts “(…) 134. The Tribunal reviewed the parties’ pleadings and established that the Appellant attached the disputed information to its pleadings. However, the Respondent, both in its pleadings and orally at the hearing, urged that the information was never provided to it. Further, while the Appellant stated that it submitted the disputed information on 8th March, 2022, the Tribunal did not sight any document to confirm this averment. 135. In regard to selection of an appropriate Transfer Pricing method, Paragraph 2.1 of the OECD Guidelines provides that the selection of the transfer pricing method should consider the following; a. the respective strengths and weaknesses of the OECD recognised methods; b. the appropriateness of the method considered in view of the nature of the controlled transaction, determined through a functional analysis; c. the availability of reliable information (on uncontrolled comparables) needed to apply the selected method and/or other methods; and d. the degree of comparability between controlled and uncontrolled transactions, including the reliability of comparability adjustments that may be needed to eliminate material differences between them. 136. Additionally, Paragraph 3.20 of the OECD Guidelines states that, “ In order to select and apply the most appropriate transfer pricing method to the circumstances of the case, information is needed on the comparability factors in relation to the controlled transaction under review and in particular on the functions, assets and risks of all the parties to the controlled transaction, including the foreign associated enterprise(s).” 137. Paragraph 1.35 and 1.36 of the OECD Guidelines state as follows regarding comparable factors for the establishment of an appropriate Transfer Pricing method: “ 1.35. …Before making comparisons with uncontrolled transactions, it is therefore vital to identify the economically relevant characteristics of the commercial or financial relations as expressed in the controlled transaction. 1.36 The economically relevant characteristics or comparability factors that need to be identified in the commercial or financial relations between the associated enterprises in order to accurately delineate the actual transaction can be broadly categorised as follows: i. The contractual terms of the transaction; ii. The functions performed by each of the parties to the transaction, taking into account assets used and risks assumed, including how those functions relate to the wider generation of value by the MNE group to which the parties belong, the circumstances surrounding the transaction, and industry practices; iii. The characteristics of property transferred, or services provided; iv. The economic circumstances of the parties and of the market in which the parties operate; and v. The business strategies pursued by the parties.” 138. The Tribunal further notes that Paragraph 2.20 of the OECD Guidelines provides as follows in regard to application of the CUP method of Transfer Pricing: “ For the CUP method to be reliably applied to commodity transactions, the economically relevant characteristics of the controlled transaction and the uncontrolled transactions or the uncontrolled arrangements represented by the quoted price need to be comparable. For commodities, the economically relevant characteristics include, among others, the physical features and quality of the commodity; the contractual terms of the controlled transaction, such as volumes traded, period of the arrangements, the timing and terms of delivery, transportation, insurance, and foreign currency terms. For some commodities, certain economically relevant characteristics (e.g. prompt delivery) may lead to a premium or a discount. If the quoted price is used as a reference for determining the arm’s length price or price range, the standardised contracts which stipulate specifications on the basis of which commodities are traded on the exchange and which result in a quoted price for the commodity may be relevant. Where there are differences between the conditions of the controlled transaction and the conditions of the uncontrolled transactions or the conditions determining the quoted price for the commodity that materially affect the price of the commodity transactions being examined, reasonably accurate adjustments should be made to ensure that the economically relevant characteristics of the transactions are comparable. Contributions made in the form of functions performed, assets used and risks assumed by other entities in the supply chain should be compensated in accordance with the guidance provided in these Guidelines.” (Emphasis ours) 139. Separately, Paragraph 2.64 of the OECD Guidelines provide as follows regarding the application of the TNMM method: “ The transactional net margin method examines the net profit relative to an appropriate base (e.g. costs, sales, assets) that a taxpayer realises from a controlled transaction (or transactions that are appropriate to aggregate under the principles of paragraphs 3.9 -3.12). Thus, a transactional net margin method operates in a manner similar to the cost plus and resale price methods. This similarity means that in order to be applied reliably, the transactional net margin method must be applied in a manner consistent with the manner in which the resale price or cost plus method is applied. This means in particular that the net profit indicator of the taxpayer from the controlled transaction (or transactions that are appropriate to aggregate under the principles of paragraphs 3.9 -3.12) should ideally be established by reference to the net profit indicator that the same taxpayer earns in comparable uncontrolled transactions, i.e. by reference to “internal comparables” (see paragraphs 3.27-3.28). Where this is not possible, the net margin that would have been earned in comparable transactions by an independent enterprise (“external comparables”) may serve as a guide (see paragraphs 3.29-3.35) ...

In 2017 the European Commission concluded that Luxembourg had granted undue tax benefits to Amazon of around €250 million. According to the Commission, a tax ruling issued by Luxembourg in 2003 – and prolonged in 2011 – lowered the tax paid by Amazon in Luxembourg without any valid justification. The tax ruling enabled Amazon to shift the vast majority of its profits from an Amazon group company that is subject to tax in Luxembourg (Amazon EU) to a company which is not subject to tax (Amazon Europe Holding Technologies). In particular, the tax ruling endorsed the payment of a royalty from Amazon EU to Amazon Europe Holding Technologies, which significantly reduced Amazon EU’s taxable profits. This decision was brought before the European Courts by Luxembourg and Amazon, and in May 2021 the General Court found that Luxembourg’s tax treatment of Amazon was not illegal under EU State aid rules. An appeal was then filed by the European Commission with the European Court of Justice. Judgement of the Court The European Court of Justice upheld the decision of the General Court and annulled the decision of the European Commission. However, it did so for different reasons. According to the Court of Justice, the OECD Transfer Pricing Guidelines were not part of the legal framework against which a selective advantage should be assessed, since Luxembourg had not implemented these guidelines. Thus, although the General Court relied on an incorrect legal framework, it had reached the correct result. Click here for other translation ...

Two issues were adressed in this case – transfer pricing and withholding taxes. The transfer pricing issue concerned whether the Danish tax authorities (SKAT) had been entitled to issue an assessment on controlled transactions made between “Soy A/S” and a flow-through company in the group located in a low tax jurisdiction. The withholding tax issue concerned whether the 13 transfers actually constituted taxable dividends under section 31, D of the Danish Corporation Tax Act, which “Soy A/S” was subsequently liable for not having withheld tax at source, cf. section 69(1) of the Danish Withholding Tax Act. Judgement of the High Court In regards of the transfer pricing issue, the High Court found that the company’s TP documentation was subject to a number of deficiencies which meant that the documentation did not provide the tax authorities with a sufficient basis for assessing whether the transactions were made in accordance with the arm’s length principle. The High Court emphasised, among other things, that the documentation did not sufficiently describe how prices and terms had actually been determined. The High Court also emphasised that there had only been a very general description and very sparse information about the sister company’s business activities, contractual terms and financial circumstances, including no information about to whom and at what prices the goods from the sister company were resold. SKAT was therefore entitled to make a discretionary assessment of the company’s taxable income. The High Court found no basis to set aside SKAT’s estimate, as the company had neither demonstrated that the estimate was exercised on an erroneous basis nor led to a manifestly unreasonable result. The High Court emphasised, among other things, the extent and nature of the deficiencies in the information basis and the fact that SKAT had unsuccessfully attempted to obtain additional information for use in the tax assessment. As regards the arm’s length interval used by SKAT, the High Court found, after an overall assessment, that SKAT had been entitled to use the interquartile range and adjusted the price to the third quartile. The High Court stated that the company had a central and value-creating function in the group, and that the comparability analysis was based on “limited risk distributors”, which were not directly comparable with the company. The High Court also found that the foreign sister company had to be considered a pure flow-through company that had no independent business justification in the group. In this connection, the High Court stated that there had been changing information about the sister company’s employees and that there was no documentation that there had been employees to carry out the alleged activities in the company. The analyses prepared after the tax assessment, including the capital adjustment test and the berry ratio analysis, as well as the other factors invoked by the company could not lead to a different assessment. In regards of the withholding tax issue the High Court found that the foreign sister company could only be considered to have acted as a flow-through company that did not bear any risk with the commodity trade. The High Court emphasised, among other things, that no hedging contracts had been presented. In light of the other circumstances of the case, the High Court found that the 13 transfers, which did not take place until 2010, could not be considered to have been made pursuant to the aforementioned agency agreement. The High Court stated that in the situation at hand, the company had a heightened burden of proof that there was no basis for considering the payments as subsidies/dividends with derived liability for withholding tax. The High Court found that the Danish company had not met this burden of proof through the testimony of the company’s former CEO and auditor. Finally, the High Court found that the Danish company was aware of all the circumstances surrounding the transfers to the foreign sister company in Y1 country, and that the transfers were very significant without documentation. On this basis, the High Court found that the Danish company had acted negligently and was therefore liable for the missing withholding tax, cf. section 69(1) of the current Withholding Tax Act, cf. section 65(1). Click here for English translation Click here for other translation ...

This paragraph (f) applies where the relevant business activity of the tested party as determined under § 1.482-5(b)(2) is the rendering of services in a controlled services transaction. Where the tested party determined under § 1.482-5(b)(2) is instead the recipient of the controlled services, the rules under this paragraph (f) are not applicable to determine the arm’s length result ...

The tested party’s operating profit must first be adjusted to reflect all other allocations under section 482, other than adjustments pursuant to this section ...

For purposes of this section, the tested party will be the participant in the controlled transaction whose operating profit attributable to the controlled transactions can be verified using the most reliable data and requiring the fewest and most reliable adjustments, and for which reliable data regarding uncontrolled comparables can be located. Consequently, in most cases the tested party will be the least complex of the controlled taxpayers and will not own valuable intangible property or unique assets that distinguish it from potential uncontrolled comparables ...

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Kellogg India Private Limited is engaged in manufacturing and sales of breakfast cereals and convenience foods and it operates as a licensed manufacturer under the Kellogg brand. During the year under consideration, Kellogg India had commenced business of distributing Pringles products in the Indian markets. Kellogg India purchases the Pringles product from its AE Pringles International Operations SARL, based in Singapore. Singapore AE does not manufacture pringles, but in turn gets it manufactured from a third party contract manufacturer. Thereafter, the goods are supplied at a cost plus mark up of 5% on third party manufacturer’s cost. These Pringles are later imported by Kellogg India from its AE and distributed in the Indian market. Kellogg India characterised itself as a distributor of Pringles products and is responsible for the strategic and overall management of Pringles business in India. Singapore AE, being the least complex entity, was selected as the tested party for benchmarking the international transaction of import of finished goods. Kellogg India conducted a search in the Asia Pacific region to identify manufacturers and based on benchmarking analysis carried out, an arithmetic mean of 14 comparable companies with Gross Profit / Direct and Indirect Cost as the Profit Level Indicator (PLI) was determined at 50.07%. The tax authorities disregarded the benchmarking approach adopted by Kellogg India and instead selected the Indian entity as the tested party. The Transactional Net Margin Method (TNMM) was chosen as the Most Appropriate Method (MAM) for the transaction and based on 8 comparable companies the arm’s length profit margin was determined at 4.33%. Singapore AE was rejected as tested party by the tax authorities on the ground that the financial details of the company and the foreign comparables were not available. Judgement of the Tax Appellate Tribunal The Tribunal decided in favor of Kellogg India and set aside the assessment. Excerpt “In view of the aforesaid observations, we hold that Singapore AE should be considered as the tested party, being the least complex entity, in the facts and circumstances of the case, which has been rightly done by the assessee. Hence no adjustment to ALP is required to be made. Even if the comparables chosen by the ld TPO are considered, undisputably since the assessee is only engaged in purchase and resale of goods without any substantial value addition thereon, RPM would be the MAM and in case of RPM only the gross margins are to be compared. We find that gross margins of assessee are much more than the gross margins of comparable companies chosen by the ld TPO. Hence no adjustment to ALP is to be made in respect of import of finished goods even if the comparable companies chosen by the ld TPO are upheld. Hence we hold that no adjustment to ALP is required to be made in the instant case in respect of import of finished goods in either case. Accordingly, the said adjustment of Rs 1,31,60,199/- is hereby directed to be deleted. Accordingly, the Additional Grounds raised by the assessee are allowed.” ...

14. In Year 1, a multinational group comprised of Company A (a country A corporation) and Company B (a country B corporation) decides to develop an intangible, which is anticipated to be highly profitable based on Company B’s existing intangibles, its track record and its experienced research and development staff. The intangible is expected to take five years to develop before possible commercial exploitation. If successfully developed, the intangible is anticipated to have value for ten years after initial exploitation. Under the development agreement between Company A and Company B, Company B will perform and control all activities related to the development, enhancement, maintenance, protection and exploitation of the intangible. Company A will provide all funding associated with the development of the intangible (the development costs are anticipated to be USD 100 million per year for five years), and will become the legal owner of the intangible. Once developed, the intangible is anticipated to result in profits of USD 550 million per year (years 6 to 15). Company B will license the intangible from Company A and make contingent payments to Company A for the right to use the intangible, based on returns of purportedly comparable licensees. After the projected contingent payments, Company B will be left with an anticipated return of USD 200 million per year from selling products based on the intangible. 15. A functional analysis by the country B tax administration of the arrangement assesses the functions performed, assets used and contributed, and risks assumed by Company A and by Company B. The analysis through which the actual transaction is delineated concludes that although Company A is the legal owner of the intangibles, its contribution to the arrangement is solely the provision of funding for the development of an intangible. This analysis shows that Company A contractually assumes the financial risk, has the financial capacity to assume that risk, and exercises control over that risk in accordance with the principles outlined in paragraphs 6.63 and 6.64. Taking into account Company A’s contributions, as well as the realistic alternatives of Company A and Company B, it is determined that Company A’s anticipated remuneration should be a risk-adjusted return on its funding commitment. Assume that this is determined to be USD 110 million per year (for Years 6 to 15), which equates to an 11% risk-adjusted anticipated financial return.1 Company B, accordingly, would be entitled to all remaining anticipated income after accounting for Company A’s anticipated return, or USD 440 million per year (USD 550 million minus USD 110 million), rather than USD 200 million per year as claimed by the taxpayer. (Based on the detailed functional analysis and application of the most appropriate method, the taxpayer incorrectly chose Company B as the tested party rather than Company A) ...

The principles described in Sections D.2.1 to D.2.4 of this chapter should be applied in determining whether the use of intangibles by the tested party will preclude reliance on identified comparable uncontrolled transactions or require comparability adjustments. Only when the intangibles used by the tested party are unique and valuable intangibles will the need arise to make comparability adjustments or to adopt a transfer pricing method less dependent on comparable uncontrolled transactions. Where intangibles used by the tested party are not unique and valuable intangibles, prices paid or received, or margins or returns earned by parties to comparable uncontrolled transactions may provide a reliable basis for determining arm’s length conditions ...

Where the tested party does not use unique and valuable intangibles, and where reliable comparables can be identified, it will often be possible to determine arm’s length prices on the basis of one-sided methods including the CUP, resale price, cost plus and TNMM methods. The guidance in Chapters I – III will generally be sufficient to guide the determination of arm’s length prices in such situations, without the need for a detailed analysis of the nature of the intangibles used by the other party to the transaction ...

In a transfer pricing analysis where the most appropriate transfer pricing method is the resale price method, the cost-plus method, or the transactional net margin method, the less complex of the parties to the controlled transaction is often selected as the tested party. In many cases, an arm’s length price or level of profit for the tested party can be determined without the need to value the intangibles used in connection with the transaction. That would generally be the case where only the non-tested party uses intangibles. In some cases, however, the tested party may in fact use intangibles notwithstanding its relatively less complex operations. Similarly, parties to potentially comparable uncontrolled transactions may use intangibles. Where either of these is the case, it becomes necessary to consider the intangibles used by the tested party and by the parties to potentially comparable uncontrolled transactions as one comparability factor in the analysis ...

Intangibles may be used in connection with controlled transactions in situations where there is no transfer of the intangible or of rights in the intangible. For example, intangibles may be used by one or both parties to a controlled transaction in connection with the manufacture of goods sold to an associated enterprise, in connection with the marketing of goods purchased from an associated enterprise, or in connection with the performance of services on behalf of an associated enterprise. The nature of such a transaction should be clearly specified, and any relevant intangibles used by either of the parties in connection with such a controlled transaction should be identified and taken into account in the comparability analysis, in the selection and application of the most appropriate transfer pricing method for that transaction, and in the choice of the tested party. Supplemental guidance regarding the determination of arm’s length conditions for transactions involving the use of intangibles in connection with the sale of goods or the provision of services is contained in Sections D. 1 and D.4 of this chapter ...

Group members that use assets in the development, enhancement, maintenance, protection, and exploitation of an intangible should receive appropriate compensation for doing so. Such assets may include, without limitation, intangibles used in research, development or marketing (e.g. know-how, customer relationships, etc.), physical assets, or funding. One member of an MNE group may fund some or all of the development, enhancement, maintenance, and protection of an intangible, while one or more other members perform all of the relevant functions. When assessing the appropriate anticipated return to funding in such circumstances, it should be recognised that in arm’s length transactions, a party that provides funding, but does not control the risks or perform other functions associated with the funded activity or asset, generally does not receive anticipated returns equivalent to those received by an otherwise similarly-situated investor who also performs and controls important functions and controls important risks associated with the funded activity. The nature and amount of compensation attributable to an entity that bears intangible-related costs, without more, must be determined on the basis of all the relevant facts, and should be consistent with similar funding arrangements among independent entities where such arrangements can be identified. See the guidance in Section D.1.2.1.6 of Chapter I, and in particular Example 3 in paragraphs 1.85 and 1.103, which illustrate a situation where the party providing funding does not control the financial risk associated with the funding ...

Because the important functions described in paragraph 6.56 are often instrumental in managing the different functions performed, assets used, and risks assumed that are key to the successful development, enhancement, maintenance, protection, or exploitation of intangibles, and are therefore essential to the creation of intangible value, it is necessary to carefully evaluate transactions between parties performing these important functions and other associated enterprises. In particular, the reliability of a one-sided transfer pricing method will be substantially reduced if the party or parties performing significant portions of the important functions are treated as the tested party or parties. See Example 6 ...

As explained above, transfer pricing analysis necessitates some information to be available about foreign associated enterprises, the nature and extent of which depends especially on the transfer pricing method used. However gathering such information may present a taxpayer with difficulties that it does not encounter in producing its own information. These difficulties should be taken into account in developing rules and/or procedures on documentation ...

Where the most appropriate transfer pricing method in the circumstances of the case, determined following the guidance at paragraphs 2.1-2.12, is a one-sided method, financial information on the tested party is needed in addition to the information referred to in paragraph 3.20 – irrespective of whether the tested party is a domestic or foreign entity. So if the most appropriate method is a cost plus, resale price or transactional net margin method and the tested party is the foreign entity, sufficient information is needed to be able to reliably apply the selected method to the foreign tested party and to enable a review by the tax administration of the country of the non-tested party of the application of the method to the foreign tested party. On the other hand, once a particular one-sided method is chosen as the most appropriate method and the tested party is the domestic taxpayer, the tax administration generally has no reason to further ask for financial data of the foreign associated enterprise outside of that requested as part of the country-by-country or master file reporting requirements (see Chapter V) ...

Where the most appropriate transfer pricing method in the circumstances of the case, determined following the guidance in paragraphs 2.1- 2.12, is a transactional profit split, financial information on all the parties to the transaction, domestic and foreign, is needed. Given the two-sided nature of this method, the application of a transactional profit split necessitates particularly detailed information on the foreign associated enterprise party to the transaction. This includes information on the five comparability factors in order to appropriately characterise the relationship between the parties and demonstrate the appropriateness of the transactional profit split method, as well as financial information (the determination of the relevant profits to be split and the splitting of the profits both rely on financial information pertaining to all the parties to the transaction, including the foreign associated enterprise). Accordingly, where the most appropriate transfer pricing method in the circumstances of the case is a transactional profit split, it would be reasonable to expect that taxpayers be ready to provide tax administrations with the necessary information on the foreign associated enterprise party to the transaction, including the financial data necessary to calculate the profit split. See Chapter V ...

In order to select and apply the most appropriate transfer pricing method to the circumstances of the case, information is needed on the comparability factors in relation to the controlled transaction under review and in particular on the functions, assets and risks of all the parties to the controlled transaction, including the foreign associated enterprise(s). Specifically, while one-sided methods (e.g. cost plus, resale price or transactional net margin method which are discussed in detail in Chapter II) only require examining a financial indicator or profit level indicator for one of the parties to the transaction (the “tested party” as discussed in paragraphs 3.18-3.19), some information on the comparability factors of the controlled transaction and in particular on the functional analysis of the non-tested party is also needed in order to appropriately characterise the controlled transaction and select the most appropriate transfer pricing method ...

This can be illustrated as follows. Assume that company A manufactures two types of products, P1 and P2, that it sells to company B, an associated enterprise in another country. Assume that A is found to manufacture P1 products using valuable, unique intangibles that belong to B and following technical specifications set by B. Assume that in this P1 transaction, A only performs simple functions and does not make any valuable, unique contribution in relation to the transaction. The tested party for this P1 transaction would most often be A. Assume now that A is also manufacturing P2 products for which it owns and uses valuable unique intangibles such as valuable patents and trademarks, and for which B acts as a distributor. Assume that in this P2 transaction, B only performs simple functions and does not make any valuable, unique contribution in relation to the transaction. The tested party for the P2 transaction would most often be B ...

When applying a cost plus, resale price or transactional net margin method as described in Chapter II, it is necessary to choose the party to the transaction for which a financial indicator (mark-up on costs, gross margin, or net profit indicator) is tested. The choice of the tested party should be consistent with the functional analysis of the transaction. As a general rule, the tested party is the one to which a transfer pricing method can be applied in the most reliable manner and for which the most reliable comparables can be found, i.e. it will most often be the one that has the less complex functional analysis ...

The review of the controlled transaction(s) under examination aims at identifying the relevant factors that will influence the selection of the tested party (where needed), the selection and application of the most appropriate transfer pricing method to the circumstances of the case, the financial indicator that will be tested (in the case of a transactional profit method), the selection of comparables and where relevant the determination of comparability adjustments ...

See in particular paragraphs 3.18-3.19 for guidance on the tested party, paragraphs 3.55-3.66 for guidance on the arm’s length range, and paragraphs 3.75-3.79 for guidance on multiple year data ...

Another practical strength of the transactional net margin method is that, as with any one-sided method, it is necessary to examine a financial indicator for only one of the associated enterprises (the “tested” party). Similarly, it is often not necessary to state the books and records of all participants in the business activity on a common basis or to allocate costs for all participants as is the case with the transactional profit split method. This can be practically advantageous when one of the parties to the transaction is complex and has many interrelated activities or when it is difficult to obtain reliable information about one of the parties. However, a comparability (including functional) analysis must always be performed in order to appropriately characterise the transaction between the parties and choose the most appropriate transfer pricing method, and this analysis generally necessitates that some information on the five comparability factors in relation to the controlled transaction be collected on both the tested and the non-tested parties. See paragraphs 3.20-3.23 ...

A transactional net margin method is unlikely to be reliable if each party to a transaction makes unique and valuable contributions, see paragraph 2.4. In such a case, a transactional profit split method will generally be the most appropriate method, see paragraph 2.119. However, a one-sided method (traditional transaction method or transactional net margin method) may be applicable in cases where one of the parties makes all the unique and valuable contributions involved in the controlled transaction, while the other party does not make any unique and valuable contribution. In such a case, the tested party should be the less complex one. See paragraphs 3.18-3.19 for a discussion of the notion of tested party ...

“Construction Service S.A.” is active in Design, Repair and Construction of buildings. During the FY 2011-2013 it paid for services – management services and construction services – rendered from related parties. Following an audit the tax authorities issued an assessment where payments for these services had been adjusted by reference to the arm’s length principle. According to the authorities the benchmark studies in the company’s transfer pricing documentation suffered from comparability defects and moreover it had not been sufficiently demonstrated that the services had been effectively provided. The tax authorities pointed out that since the company is not considered comparable to the taxpayer, the interquartile range would be from 5.15% to 8.30% with a median of 5.70%; therefore, the taxpayer’s operating margin of 4.07% is outside the interquartile range. Not satisfied with the adjustment “Construction Service S.A.” filed an appeal with the Tax Court Judgement of the Tax Court The court ruled in favour of “construction S.A” and revoked the decision of the tax authorities. Excerpts “Without prejudice to the foregoing, we must clarify that the adjustments to the financial information must use, precisely, the financial information, which leads us to disagree with the decision of the taxpayer’s expert to use the information from the income tax return for the calculation of the operating margin, knowing that there are quantitative and qualitative differences with respect to the financial information (page 565 of the Court’s file), and even with the information contained in the transfer pricing studies, which makes his answers to questions 1 and 2 less reliable, since the information used to determine the interquartile range is based on financial information (not tax information) of the comparables.” “In this regard, this Court considers that although the OECD Transfer Pricing Guidelines indicate in the section entitled “Multi-year data” of the Comparability Analysis Section, in paragraphs 3.75 to 3. 79, the possibility of using data relating to several years for the profitability analysis or multi-year data, the Tax Administration, used information from 2010 to 2012 of comparable companies since the appellant itself indicated in the 2012 Transfer Pricing Study, the total transactions carried out with its related parties abroad, taking into account that it was in this period, in which the transactions were carried out, according to the global financial information of the audited Financial Statements as of 31 December 2012 by , therefore the operating margin that should be adjusted to the median of free competition, the costs of the operations with related parties of ———— to the year 2012, but we agree with the Tax Administration that the additional liquidation for the Income Tax is the one declared for the fiscal period 2013, since it was in that period due to the opted method where the total gross income, costs and expenses were allocated, which includes as already mentioned the adjustment of the operating margin (See fs. 221 to 244 of Volume 1 of the DGI’s file). Therefore, it is not possible for the taxpayer, at this stage, to point out that the Tax Administration should have used the information from the periods of the companies selected as comparable, in accordance with the Transfer Pricing guidelines, taking into consideration the income tax return for the 2013 tax period, which includes the 3 years of operations of the work, i.e. from 2011 to 2013 (instead of 2010-2012), and which yields a profitability indicator or operating margin according to ————, (even though the company ——————– has been rejected, and maintaining those that the DGI did accept), of 4. 58%, a median of 4.67% and 7.85%, which, in its opinion, would place it within the range of compliance with the arm’s length principle. Similarly, we consider it important to point out that in the same way that the taxpayer cannot claim to use its aggregated financial information, ignoring the analysis made in its transfer pricing report submitted in the 2012 period, neither is it correct for the tax authorities to make an adjustment to the taxpayer’s segmented financial information (2012), and use, for the purposes of the additional assessment, the taxpayer’s accumulated income tax return, corresponding to the entire project. It is essential that any adjustment to the taxpayer’s financial/tax information is made in a congruent manner, i.e. taking into account the accumulated activity and not in a partial manner.” “preceding paragraphs and on the OECD’s guidelines in points 1.42, 1.52, 1.53, 1.55, 1.57 and 1.59 of Chapter I, which deals with the Arm’s Length Principle of the Transfer Pricing Guidelines.” “In this sense, this Court has stated in Resolution n.° TAT-RF-002 of 10 January 2020, regarding the possible manipulation of comparables known by the Anglo-Saxon expression “cherry picking”, in the following terms: “just as the criteria for discarding must be applied uniformly by the taxpayer, they must also be applied uniformly by the Tax Administration, regardless of whether the results of the analysis are in favour of or against the Treasury (The three companies challenged by the Tax Administration were those that presented the lowest operating margins: 1. 00%; -0.03% and -23.64% respectively), concluding that “it is incongruous to object to comparables that are in similar circumstances with others that have been accepted, i.e. that have a reasonable level of comparability with the examined party”.” “By virtue of the allegations made by both parties, we consider from the procedural evidence in the file that the process followed to identify potential comparables by both parties has been systematic and verifiable; however, we agree with the taxpayer that the companies selected by them are comparable with ————, and comply with the Principle of Full Competition, therefore, they should be taken into account within the interquartile range, since we consider that the elements of the comparability analysis, indicated by the DGI, are not compromised. In view of the above, as we do not agree with the objection made to this comparable company by the Tax Administration, and as the taxpayer is within the range of full competence, this Court must revoke Resolution no. 201-3306 of ...

SONY Music Entertainment Colombia S.A. had filed transfer pricing information and documentation, on the basis of which the Colombian tax authorities concluded that payments for administrative services provided by a related party in the US had not been at arm’s length. SONY Colombia then filed new transfer pricing information and documentation covering the same years, but where the tested party had been changed to the US company. Under this new approach, the remuneration of the US service provider was determined to be within the arm’s length range. The tax authorities upheld the assessment issued based on the original documentation. A complaint was filed by SONY and later an appeal. Judgement of the Administrative Court The court allowed the appeal and issued a decision in favor of SONY. Excerpts “The legal problem is to determine, for the tax return of the taxable period 2007 of the plaintiff: (i) Whether it is appropriate to take into account the correction of the transfer pricing information return submitted by the plaintiff and its supporting documentation, and whether the information submitted is sufficient to determine compliance with the arm’s length principle. … In the present case, the DIAN [tax authorities], by means of the contested acts, disregards operating expenses of $1,963,235,000 of the plaintiff’s income tax return for the taxable period 2007, because it considered that the administrative expenses that the plaintiff paid to its related party in the United States of America (United States) were not adjusted to market prices, which had been agreed with other suppliers. In order to justify the disregard of the aforementioned expenses, the DIAN took as reference the individual informative declaration of transfer prices (DIIPT) and the supporting documentation initially submitted by the plaintiff, in which it was determined that it was outside the market range. Furthermore, it stated that if the corrections to the DIIPT and the supporting documentation are taken into account, there is no reason to justify that the analysis of administrative expenses should be carried out for the company located abroad. For its part, the plaintiff considers that the DIIPT and the initial supporting documentation should not have been taken into account, due to the fact that the correction was made in which it is demonstrated that the expenditure operation was carried out at market values, since the related company in the United States should be analysed, and not the company in Colombia as was done in the original declaration. … From the cited provisions it is clear that there is room to impose a sanction in the case of the correction of the individual informative declaration or of the supporting documentation, in the event of errors or inconsistencies in these documents. On previous occasions, this Court has recognised that it is appropriate to correct the information return and supporting documentation. However, regardless of whether the correction of the return or of the supporting documentation is punishable, such corrections should be examined by the Administration, in order to determine whether the transactions recorded by the taxpayer with his economic partners were in accordance with the arm’s length principle. …. In addition, the documentation clarifies that the reason for the study from the company abroad was an administrative services contract that had been in place since 2005, for which the company abroad was paid $3,569,194,000, a payment that was corroborated by the DIAN in the audit process by means of the withholdings made, transactions carried out and items paid. This contract was submitted to the file and shows that Sony Colombia and Sony United States agreed that “The Services provided by SBME will be invoiced to the Company at a rate calculated at cost plus an increase of 8%. The Services will be billed periodically, but in no case will they be billed for periods longer than one year”, a clarification together with the global situation of the music industry that justifies the Markup analysed, and the comparable companies in the supporting documentation. … Consequently, it is reiterated that the change of the tested party was supported and it is clarified that such change only affects the information of the administrative services transaction, since the transfer pricing methods apply to individual transactions, as determined by article 260-2 of the Tax Statute. … In this context, the plaintiff could correct its DIIPT and its supporting documentation, the information submitted in its corrections should have been taken into account, the plaintiff was free to choose to carry out its analysis of the foreign company, and it complied with the requirements of its supporting information together with the arm’s length principle. Consequently, the contested measures should be annulled, and the other pleas in law are dismissed as the main plea is well founded.” Click here for English translation Click here for other translation ...

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.” ”] ...

This case deals with arm’s length pricing of limited risk manufacturing services. Following an audit of the X Ltd, the prices paid to a foreign manufacturer in the group was determined by the Grees tax authorities to have been above the arm’s length price. On that basis an upwards adjustment of the taxable income of X Ltd. was issued. Judgement of the Court The court dismissed the appeal of the X Ltd. Since the audit findings as recorded in the partial income tax audit report of the Head of the C.E.M.E.P. dated 08/07/2020 are found to be valid, thorough and fully substantiated, the present appeal must be dismissed. Click here for English translation Click here for other translation ...

In 2017 the European Commission concluded that Luxembourg granted undue tax benefits to Amazon of around €250 million.  Following an in-depth investigation the Commission concluded that a tax ruling issued by Luxembourg in 2003, and prolonged in 2011, lowered the tax paid by Amazon in Luxembourg without any valid justification. The tax ruling enabled Amazon to shift the vast majority of its profits from an Amazon group company that is subject to tax in Luxembourg (Amazon EU) to a company which is not subject to tax (Amazon Europe Holding Technologies). In particular, the tax ruling endorsed the payment of a royalty from Amazon EU to Amazon Europe Holding Technologies, which significantly reduced Amazon EU’s taxable profits. This decision was brought before the European Court of Justice by Luxembourg and Amazon. Judgement of the EU Court  The European General Court found that Luxembourg’s tax treatment of Amazon was not illegal under EU State aid rules. According to a press release ” The General Court notes, first of all, the settled case-law according to which, in examining tax measures in the light of the EU rules on State aid, the very existence of an advantage may be established only when compared with ‘normal’ taxation, with the result that, in order to determine whether there is a tax advantage, the position of the recipient as a result of the application of the measure at issue must be compared with his or her position in the absence of the measure at issue and under the normal rules of taxation. In that respect, the General Court observes that the pricing of intra-group transactions carried out by an integrated company in that group is not determined under market conditions. However, where national tax law does not make a distinction between integrated undertakings and standalone undertakings for the purposes of their liability to corporate income tax, it may be considered that that law is intended to tax the profit arising from the economic activity of such an integrated undertaking as though it had arisen from transactions carried out at market prices. In those circumstances, when examining a fiscal measure granted to such an integrated company, the Commission may compare the tax burden of that undertaking resulting from the application of that fiscal measure with the tax burden resulting from the application of the normal rules of taxation under national law of an undertaking, placed in a comparable factual situation, carrying on its activities under market conditions. In addition, the General Court points out that, in examining the method of calculating an integrated company’s taxable income endorsed by a tax ruling, the Commission can find an advantage only if it demonstrates that the methodological errors which, in its view, affect the transfer pricing do not allow a reliable approximation of an arm’s length outcome to be reached, but rather lead to a reduction in the taxable profit of the company concerned compared with the tax burden resulting from the application of normal taxation rules. In the light of those principles, the General Court then examines the merits of the Commission’s analysis in support of its finding that, by endorsing a transfer pricing method that did not allow a reliable approximation of an arm’s length outcome to be reached, the tax ruling at issue granted an advantage to LuxOpCo.  In that context, the General Court holds, in the first place, that the primary finding of an advantage is based on an analysis which is incorrect in several respects. Thus, first, in so far as the Commission relied on its own functional analysis of LuxSCS in order to assert, in essence, that contrary to what was taken into account in granting the tax ruling at issue, that company was merely a passive holder of the intangible assets in question, the General Court considers that analysis to be incorrect. In particular, according to the General Court, the Commission did not take due account of the functions performed by LuxSCS for the purposes of exploiting the intangible assets in question or the risks borne by that company in that context.  Nor did it demonstrate that it was easier to find undertakings comparable to LuxSCS than undertakings comparable to LuxOpCo, or that choosing LuxSCS as the tested entity would have made it possible to obtain more reliable comparison data. Consequently, contrary to its findings in the contested decision, the Commission did not, according to the General Court, establish that the Luxembourg tax authorities had incorrectly chosen LuxOpCo as the ‘tested party’ in order to determine the amount of the royalty. Secondly, the General Court holds that, even if the ‘arm’s length’ royalty should have been calculated using LuxSCS as the ‘tested party’ in the application of the TNMM, the Commission did not establish the existence of an advantage since it was also unfounded in asserting that LuxSCS’s remuneration could be calculated on the basis of the mere passing on of the development costs of the intangible assets borne in relation to the Buy-In agreements and the cost sharing agreement without in any way taking into account the subsequent increase in value of those intangible assets. Thirdly, the General Court considers that the Commission also erred in evaluating the remuneration that LuxSCS could expect, in the light of the arm’s length principle, for the functions linked to maintaining its ownership of the intangible assets at issue. Contrary to what appears from the contested decision, such functions cannot be treated in the same way as the supply of ‘low value adding’ services, with the result that the Commission’s application of a mark-up most often observed in relation to intra-group supplies of a ‘low value adding’ services is not appropriate in the present case. In view of all the foregoing considerations, the General Court concludes that the elements put forward by the Commission in support of its primary finding are not capable of establishing that LuxOpCo’s tax burden was artificially reduced as a result of an overpricing of the royalty. In the second place, after examining the ...

The Danish tax authorities had issued a discretionary assessment of the taxable income of Tetra Pak Processing Systems A/S due to inadequate transfer pricing documentation and continuous losses. Judgement of the Supreme Court The Supreme Court found that the TP documentation provided by the company did not comply to the required standards. The TP documentation did state how prices between Tetra Pak and the sales companies had been determined and did not contain a comparability analysis, as required under the current § 3 B, para. 5 of the Tax Control Act and section 6 of the Danish administrative ordinance regarding transfer pricing documentation. Against this background, the Supreme Court found that the TP documentation was deficient to such an extent that it had to be equated with missing documentation. The Supreme Court agreed that Tetra Pak’s taxable income for FY 2005-2009 could be determined on a discretionary basis. According to the Supreme Court Tetra Pak had not proved that the tax authorities’ discretionary assessments were based on an incorrect or deficient basis, or that the assessment had led to a clearly unreasonable result. Hence, there was no basis for setting aside the assessment. The Supreme Court therefore upheld the prior High Court’s decision. In the decision reference is made to OECD 2010 Transfer Pricing Guidelines Importance of Transfer Pricing documentation and comparability analysis: Para 1.6, 2.22, 2.23, 2.78, 3.1, 3.22 and 5.17 Choice of tested party: Para 3.18 Exceptional and extraordinary costs and calculation of net profit indicator/profit level indicator: Para 2.80 Click here for translation ...

At issue was the question of whether the Danish tax authorities had been entitled to make a discretionary assessment of the taxable income of Icemachine Manufacturer A/S due to inadequate transfer pricing documentation and continuous losses. And if such a discretionary assessment was justified, the question of whether the company had lifted the burden of proof that the tax authorities’ estimates had been clearly unreasonable. The Court ruled that the transfer pricing documentation provided by the company was so inadequate that it did not provide the tax authorities with a sufficient basis for determining whether the arm’s length principle had been followed. The tax authorities had therefore been entitled to make a discretionary assessment of the taxable income. For that purpose the Court found that the tax authorities had been justified in using the TNM method with the Danish company as the tested party, since sufficiently reliable information on the sales companies in the group had not been provided. Click here for translation (Part I) Click here for translation (Part II) ...

According to Colgate Palmolive, following a restructuring, the local group company in Spain was changed from being a “fully fledged distributor” responsible for all areas of the distribution process to being a “limited risk distributor” (it only performs certain functions). A newly established Swiss company, Colgate Palmolive Europe, instead became the principal entrepreneur in Europe. The changed TP setup had a significant impact on the earnings in the Spanish group company. Net margins was reduced from around 16% before the restructuring, to 3.5% after the restructuring. Following a thorough examination of the functions, assets and risks before and after application of the new setup, the Tax administration held that Colgate Palmolive Europe could not be qualified as the “principal entrepreneur” in Europe. The swiss company was in substance a service provider for which the remuneration should be determined based on the cost plus method. Judgement of the Court The High Court held in favour of the tax administration and dismissed the appeal of Colgate Palmolive. Excerpt “.…the conclusion, in our opinion, can only be that the Administration is right, since in reality – remember that certain functions were already being carried out by the French Headquarter – there is no significant change in the situation existing prior to the restructuring in the years in question. This being so, it is not surprising that the Agreement reasons that “the existence of transactions between related entities, the Spanish and Swiss entities, determines the application of the regime provided for in Article 16 of the Consolidated Text of the Corporate Income Tax Law (TRLIS) and in its implementing regulations, mainly Chapter V of Title I of the Corporate Income Tax Regulations (RIS), taking into account the change of regulation introduced by Law 36/2006 applicable, in the case of Colgate Palmolive, as from the financial year 2007”. Adding that “in relation to the existence of transactions between related companies, it is also necessary to take into account Article 9 of the Spanish-Swiss Double Taxation Agreement, inspired by the OECD Model Agreement, which provides that the profits of associated companies may be adjusted when the conditions present in their commercial or financial relations differ from those that would be agreed between independent entities. This article recognises the so-called arm’s length principle, the interpretation of which must take into account the OECD Doctrine, contained in the Commentary to Article 9 itself and its 1995 Transfer Pricing Guidelines, which have been significantly updated in 2010”. As reasoned in the Agreement, the Board shares the reasoning, “according to the exhaustive description contained in the verification file, the characterisation of CP Europe as a “principal trader” is inappropriate, it being more correct to consider that such an entity is in reality a service provider. It is therefore considered that the method chosen by the group to value the transactions is inappropriate and that the appropriate valuation method is the cost plus method. This method, in addition to being a traditional method (and therefore preferable under our internal regulations and the Guidelines), is, in accordance with the OECD Guidelines (paragraph 2.32 and 2.39 in the 2010 version), particularly appropriate for valuing the provision of services”. The fact is that ‘the valuation method applied by Colgate Palmolive is not appropriate, as it results in the residual profit of the group’s operations in Spain being concentrated in the CP Europe entity, which makes no sense if the economic activity of each entity (CP USA, CP Spain and CP Europe) in the overall business in our country is taken into account. The Guidelines themselves highlight in their chapter 7 dedicated to intra-group services (paragraph 7.31, before and after 2010) the cost plus method, together with the comparable free price, as the method to be used to value this type of services between related entities. The work of the Joint Transfer Pricing Forum of the European Union, which also assumes that this is the method most frequently used to value this type of transaction”. The Inspectorate adds, quite reasonably, that “until 2005, the group itself valued transactions between the French Headquarter, with the role of service provider, and the other entities of the group – including CP Spain – using the cost plus method”. The consequence of all the above is that, as stated on p. 73 of the report -reasoning endorsed by the Agreement- “in order to value the transactions between CP Europe and CP Spain, the transactional net margin method, taking CP Spain as the analysed party (Tesdet party), is inappropriate. Instead, it is considered that the most appropriate method for valuing the transactions is the cost plus method, which is based on attributing to the provider of those services – CP Europe – a gross margin on the costs it incurs which are attributable to the Spanish market [it should be recalled that following the analysis carried out it has been concluded that CP Europe cannot be considered as a principal trader, but rather as an entity which performs the functions of a service provider]’. This means that, in the years in question, it is not correct to attribute to CP EUROPE the residual profit derived from the group’s operations in Spain, but rather that this residual profit, deducting the remuneration of the owner of the intangible asset -CP USA- and of the service provider -CEP EUROPE-, should fall on CP SPAIN. The calculations are set out in pp. 74 to 81 of the report, as well as in pp. 59 to 62 of the Agreement. The Board, particularly in the absence of any arguments to the contrary, considers them to be correct. For all the foregoing reasons, the plea is dismissed.” Click here for English Translation Click here for other translation ...

The Danish Tax Tribunal found that the tax administration had been entitled to make a discretionary assessment, due to the lack of a comparability analysis in the company’s transfer pricing documentation. The Tax Tribunal also found that the Danish company had correctly been chosen as tested party when applying the TNMM, although the foreign sales companies were the least complex. Information about the foreign sales companies was insufficient and a significant part of the income in the foreign sales companies related to sale of goods not purchased from the Danish production company. Click here for translation ...

The principles described in Sections D.2.1 to D.2.4 of this chapter should be applied in determining whether the use of intangibles by the tested party will preclude reliance on identified comparable uncontrolled transactions or require comparability adjustments. Only when the intangibles used by the tested party are unique and valuable intangibles will the need arise to make comparability adjustments or to adopt a transfer pricing method less dependent on comparable uncontrolled transactions. Where intangibles used by the tested party are not unique and valuable intangibles, prices paid or received, or margins or returns earned by parties to comparable uncontrolled transactions may provide a reliable basis for determining arm’s length conditions ...

Where the tested party does not use unique and valuable intangibles, and where reliable comparables can be identified, it will often be possible to determine arm’s length prices on the basis of one-sided methods including the CUP, resale price, cost plus and TNMM methods. The guidance in Chapters I – III will generally be sufficient to guide the determination of arm’s length prices in such situations, without the need for a detailed analysis of the nature of the intangibles used by the other party to the transaction ...

In a transfer pricing analysis where the most appropriate transfer pricing method is the resale price method, the cost-plus method, or the transactional net margin method, the less complex of the parties to the controlled transaction is often selected as the tested party. In many cases, an arm’s length price or level of profit for the tested party can be determined without the need to value the intangibles used in connection with the transaction. That would generally be the case where only the non-tested party uses intangibles. In some cases, however, the tested party may in fact use intangibles notwithstanding its relatively less complex operations. Similarly, parties to potentially comparable uncontrolled transactions may use intangibles. Where either of these is the case, it becomes necessary to consider the intangibles used by the tested party and by the parties to potentially comparable uncontrolled transactions as one comparability factor in the analysis ...

Intangibles may be used in connection with controlled transactions in situations where there is no transfer of the intangible or of rights in the intangible. For example, intangibles may be used by one or both parties to a controlled transaction in connection with the manufacture of goods sold to an associated enterprise, in connection with the marketing of goods purchased from an associated enterprise, or in connection with the performance of services on behalf of an associated enterprise. The nature of such a transaction should be clearly specified, and any relevant intangibles used by either of the parties in connection with such a controlled transaction should be identified and taken into account in the comparability analysis, in the selection and application of the most appropriate transfer pricing method for that transaction, and in the choice of the tested party. Supplemental guidance regarding the determination of arm’s length conditions for transactions involving the use of intangibles in connection with the sale of goods or the provision of services is contained in Sections D. 1 and D.4 of this chapter ...

Group members that use assets in the development, enhancement, maintenance, protection, and exploitation of an intangible should receive appropriate compensation for doing so. Such assets may include, without limitation, intangibles used in research, development or marketing (e.g. know-how, customer relationships, etc.), physical assets, or funding. One member of an MNE group may fund some or all of the development, enhancement, maintenance, and protection of an intangible, while one or more other members perform all of the relevant functions. When assessing the appropriate anticipated return to funding in such circumstances, it should be recognised that in arm’s length transactions, a party that provides funding, but does not control the risks or perform other functions associated with the funded activity or asset, generally does not receive anticipated returns equivalent to those received by an otherwise similarly-situated investor who also performs and controls important functions and controls important risks associated with the funded activity. The nature and amount of compensation attributable to an entity that bears intangible-related costs, without more, must be determined on the basis of all the relevant facts, and should be consistent with similar funding arrangements among independent entities where such arrangements can be identified. See the guidance in Section D.1.2.1.6 of Chapter I, and in particular Example 3 in paragraphs 1.85 and 1.103, which illustrate a situation where the party providing funding does not control the financial risk associated with the funding ...

As explained above, transfer pricing analysis necessitates some information to be available about foreign associated enterprises, the nature and extent of which depends especially on the transfer pricing method used. However gathering such information may present a taxpayer with difficulties that it does not encounter in producing its own information. These difficulties should be taken into account in developing rules and/or procedures on documentation ...

Where the most appropriate transfer pricing method in the circumstances of the case, determined following the guidance at paragraphs 2.1-2.12, is a one-sided method, financial information on the tested party is needed in addition to the information referred to in paragraph 3.20 – irrespective of whether the tested party is a domestic or foreign entity. So if the most appropriate method is a cost plus, resale price or transactional net margin method and the tested party is the foreign entity, sufficient information is needed to be able to reliably apply the selected method to the foreign tested party and to enable a review by the tax administration of the country of the non-tested party of the application of the method to the foreign tested party. On the other hand, once a particular one-sided method is chosen as the most appropriate method and the tested party is the domestic taxpayer, the tax administration generally has no reason to further ask for financial data of the foreign associated enterprise outside of that requested as part of the country-by-country or master file reporting requirements (see Chapter V) ...

Where the most appropriate transfer pricing method in the circumstances of the case, determined following the guidance at paragraphs 2.1-2.12, is a transactional profit split, financial information on all the parties to the transaction, domestic and foreign, is needed. Given the two- sided nature of this method, the application of a transactional profit split necessitates particularly detailed information on the foreign associated enterprise party to the transaction. This includes information on the five comparability factors in order to appropriately characterise the relationship between the parties and demonstrate the appropriateness of the transactional profit split method, as well as financial information (the determination of the combined profits to be split and the splitting of the profits both rely on financial information pertaining to all the parties to the transaction, including the foreign associated enterprise). Accordingly, where the most appropriate transfer pricing method in the circumstances of the case is a transactional profit split, it would be reasonable to expect that taxpayers be ready to provide tax administrations with the necessary information on the foreign associated enterprise party to the transaction, including the financial data necessary to calculate the profit split. See Chapter V ...

In order to select and apply the most appropriate transfer pricing method to the circumstances of the case, information is needed on the comparability factors in relation to the controlled transaction under review and in particular on the functions, assets and risks of all the parties to the controlled transaction, including the foreign associated enterprise(s). Specifically, while one-sided methods (e.g. cost plus, resale price or transactional net margin method which are discussed in detail in Chapter II) only require examining a financial indicator or profit level indicator for one of the parties to the transaction (the “tested party” as discussed in paragraphs 3.18-3.19), some information on the comparability factors of the controlled transaction and in particular on the functional analysis of the non-tested party is also needed in order to appropriately characterise the controlled transaction and select the most appropriate transfer pricing method ...

This can be illustrated as follows. Assume that company A manufactures two types of products, P1 and P2, that it sells to company B, an associated enterprise in another country. Assume that A is found to manufacture P1 products using valuable, unique intangibles that belong to B and following technical specifications set by B. Assume that in this P1 transaction, A only performs simple functions and does not make any valuable, unique contribution in relation to the transaction. The tested party for this P1 transaction would most often be A. Assume now that A is also manufacturing P2 products for which it owns and uses valuable unique intangibles such as valuable patents and trademarks, and for which B acts as a distributor. Assume that in this P2 transaction, B only performs simple functions and does not make any valuable, unique contribution in relation to the transaction. The tested party for the P2 transaction would most often be B ...

When applying a cost plus, resale price or transactional net margin method as described in Chapter II, it is necessary to choose the party to the transaction for which a financial indicator (mark-up on costs, gross margin, or net profit indicator) is tested. The choice of the tested party should be consistent with the functional analysis of the transaction. As a general rule, the tested party is the one to which a transfer pricing method can be applied in the most reliable manner and for which the most reliable comparables can be found, i.e. it will most often be the one that has the less complex functional analysis ...

The review of the controlled transaction(s) under examination aims at identifying the relevant factors that will influence the selection of the tested party (where needed), the selection and application of the most appropriate transfer pricing method to the circumstances of the case, the financial indicator that will be tested (in the case of a transactional profit method), the selection of comparables and where relevant the determination of comparability adjustments ...

See in particular paragraphs 3.18-3.19 for guidance on the tested party, paragraphs 3.55-3.66 for guidance on the arm’s length range, and paragraphs 3.75-3.79 for guidance on multiple year data ...

Another practical strength of the transactional net margin method is that, as with any one-sided method, it is necessary to examine a financial indicator for only one of the associated enterprises (the “tested” party). Similarly, it is often not necessary to state the books and records of all participants in the business activity on a common basis or to allocate costs for all participants as is the case with the transactional profit split method. This can be practically advantageous when one of the parties to the transaction is complex and has many interrelated activities or when it is difficult to obtain reliable information about one of the parties. However, a comparability (including functional) analysis must always be performed in order to appropriately characterise the transaction between the parties and choose the most appropriate transfer pricing method, and this analysis generally necessitates that some information on the five comparability factors in relation to the controlled transaction be collected on both the tested and the non-tested parties. See paragraphs 3.20-3.23 ...

A transactional net margin method is unlikely to be reliable if each party to a transaction makes unique and valuable contributions, see paragraph 2.4. In such a case, a transactional profit split method will generally be the most appropriate method, see paragraph 2.115. However, a one-sided method (traditional transaction method or transactional net margin method) may be applicable in cases where one of the parties makes all the unique and valuable contributions involved in the controlled transaction, while the other party does not make any unique and valuable contribution. In such a case, the tested party should be the less complex one. See paragraphs 3.18-3.19 for a discussion of the notion of tested party ...

This can be illustrated as follows. Assume that company A manufactures two types of products, P1 and P2, that it sells to company B, an associated enterprise in another country. Assume that A is found to manufacture P1 products using valuable, unique intangibles that belong to B and following technical specifications set by B. Assume that in this P1 transaction, A only performs simple functions and does not make any valuable, unique contribution in relation to the transaction. The tested party for this P1 transaction would most often be A. Assume now that A is also manufacturing P2 products for which it owns and uses valuable unique intangibles such as valuable patents and trademarks, and for which B acts as a distributor. Assume that in this P2 transaction, B only performs simple functions and does not make any valuable, unique contribution in relation to the transaction. The tested party for the P2 transaction would most often be B ...

When applying a cost plus, resale price or transactional net margin method as described in Chapter II, it is necessary to choose the party to the transaction for which a financial indicator (mark-up on costs, gross margin, or net profit indicator) is tested. The choice of the tested party should be consistent with the functional analysis of the transaction. As a general rule, the tested party is the one to which a transfer pricing method can be applied in the most reliable manner and for which the most reliable comparables can be found, i.e. it will most often be the one that has the less complex functional analysis ...

This case concerns the sale of extended warranties to third-party customers of Dixons, a large retail chain in the UK selling white goods and home electrical products. The DSG group captive (re)insurer in the Isle of Man (DISL) insured these extended warranties for DSG’s UK customers. Until 1997 this was structured via a third-party insurer (Cornhill) that reinsured 95% on to DISL. From 1997 onwards the warranties were offered as service contracts that were 100% insured by DISL. The dispute concerned the level of sales commissions and profit commissions received by DSG. The Tax Tribunal rejected the taxpayer’s contentions that the transfer pricing legislation did not apply to the particular series of transactions (under ICTA 88 Section 770 and Schedule 28AA) – essentially the phrases ‘facility’ (Section 770) and ‘provision’ (Schedule 28AA) were interpreted broadly so that there was something to price between DSG and DISL, despite the insertion of a third party and the absence of a recognised transaction between DSG and the other parties involved. The Tax Tribunal also rejected potentially comparable contracts that the taxpayer had used to benchmark sales commissions on similar contracts on the basis that the commission rate depended on profitability, which itself depended on the different level of loss ratios expected in relation to the products covered. A much more robust looking comparable provider of extended warranty cover offered as a benchmark for the market return on capital of DISL was also rejected owing to its differing relative bargaining power compared to DISL. This third-party re-insurer was considered to be a powerful brand providing extended ‘off-the-shelf’ warranty cover through disparate distributors – the tribunal noted that DSG had a strong brand, powerful point of sales advantage through access to customers in their shops and could easily have sourced the basic insurance provided by DISL elsewhere. The overall finding of the Tax Tribunal was that, to the extent that ‘super profits’ were available, these should be distributed between the parties according to the ability of each party to protect itself from normal competitive forces and each party’s bargaining power. The Tax Tribunal noted in this context that DISL was entirely reliant on DSG for its business. According to the facts of this case, the super profits were deemed to arise because of DSG’s point-of-sale advantage as the largest retailer of domestic electrical goods in the UK and also DSG’s past claims data. DISL was considered to possess only routine actuarial know-how and adequate capital, both of which DSG could find for itself. As a result, the tribunal thought that a profit-split approach was the most appropriate, whereby DISL was entitled to a market return on capital, with residual profit over and above this amount being returned to DSG via a profit commission. This decision offers valuable insights into consideration of the level of comparability demanded to support the use of comparable uncontrolled prices; Selection of the appropriate ‘tested party’ in seeking to benchmark a transaction; The importance of bargaining power; Approval of profit split as the most appropriate methodology; That a captive insurer that is underwriting ‘simple’ risks, particularly where the loss ratios are relatively stable and predictable, and that does not possess significant intangibles or other negotiating power, should not expect to earn more than a market return to its economic capital ...