Persistent or recurring losses within a controlled group sit at the intersection of the arm’s length standard and the fundamental question of how economic risk is allocated among related parties. In transfer pricing, the central legal issue is whether a tested party that bears limited functional risk — a contract manufacturer, a limited-risk distributor, or a service provider designated as a principal’s agent — can legitimately report losses that would not be sustained by a comparably positioned independent enterprise. The arm’s length standard, codified in Article 9 of the OECD Model Tax Convention and implemented through domestic provisions such as Section 13-1 of Norway’s Taxation Act or Section 98 of Zimbabwe’s Income Tax Act, requires that conditions between associated enterprises reflect those that unrelated parties would have agreed under comparable circumstances.

Disputes arise when a controlled entity reports losses — sometimes for multiple consecutive years — while the multinational group as a whole remains profitable. Tax authorities typically challenge this by arguing that the contractual risk allocation is either inconsistent with the entity’s actual conduct or that intercompany charges — management fees, royalties, or service fees — have been set at levels that effectively strip taxable profit from the local entity. In Aisan Industry Czech, the authority successfully challenged losses in a contract manufacturer classified as limited-risk, while in Eli Lilly ČR and DHL Norway the courts found that the functional profile and contractual arrangements genuinely supported the reported results. The SKF France litigation illustrates that sustained losses since 2005 prompted reassessment of whether the arm’s length principle had been respected across multiple years.

The OECD Transfer Pricing Guidelines address this directly in Chapter I, particularly paragraphs 1.57–1.58 on loss-making comparables, and in Chapter II on transactional net margin methodology, which is frequently applied to test the profitability of limited-function entities. Chapter VI guidance on intangibles and Chapter IX on business restructurings are also relevant where losses follow a reorganisation. Paragraphs 3.18–3.19 address the use of multiple-year data, which is important when assessing whether losses are transitory or structural.

Courts examine whether the contractual allocation of risk is backed by genuine financial capacity and actual decision-making authority, consistent with the guidance in Chapter I paragraphs 1.60–1.106 on delineating transactions. The choice of comparables, the adjustments made to eliminate differences in cost structure or extraordinary items, and whether a tested party’s losses fall outside the interquartile range of independent comparables are determinative factual questions.

Practitioners researching this category will find that loss cases test the coherence of a group’s entire transfer pricing model, making contemporaneous documentation of risk assumption and functional analysis essential to a sustainable position.