Following an audit, the Colombian tax authorities determined that Masterfoods Colombia’s results for FY2008 were outside the interquartile range and issued a tax assessment that adjusted the results to the median. The tax authorities had used the cost-plus method instead of the transactional net margin method used by Masterfoods.
Masterfoods lodged an appeal, which was later upheld by the court of first instance.
The tax authorities then appealed to the Supreme Administrative Court.
Judgment
The Supreme Administrative Court upheld the decision of the Court of First Instance to annul the assessment and ruled in favour of Masterfoods.
Excerpts in English
“Taking into account the aforementioned evidentiary study and the considerations set out in paragraph 2.1. above, for the Chamber, the cost plus method chosen by the defendant determines an arm’s length price based on the cost of production plus an appropriate gross profit margin, which implies the exclusion of operating expenses in the analysis of the comparable unrelated transaction. The TNMM method, on the other hand, examines the transaction on the basis of a net profit margin, i.e. the selling price minus the costs of the good and operating expenses. Comparing the two methods, the one established by the administration was based on the assumption that the internal comparables (customers of the plaintiff) used were relevant because the transactions assumed similar costs that were duly discriminated by third party according to the information provided by the taxpayer; however, the evidence in the file shows that the functions and risks assumed with the companies in the sample taken by the authority that ended up being the internal comparables, in contrast to the functions and risks assumed in the transactions with the related companies abroad, were different. In this regard, the transfer pricing study (specifically the financial information annex), the content of which was not challenged by the DIAN, segmented the manufacturing operation of the plaintiff taking into account the differences in functions and risks that materialised in higher expenses in operations with local independent companies, so that a method that considered only the gross profit could not be adopted.
On the other hand, it is imperative to point out that this corporation is not unaware that the OECD guidelines have established that the cost plus method “is likely to be at its most useful” when applied, among other events, to sales of semi-finished products between associated parties; However, it is also true that the OECD explained that if the differences between the levels and types of expenses related to the functions performed and the risks assumed by the parties reflected a “functional difference” not considered at the time of applying the method, adjustments to the “margin over cost” might be required, so that the operating expenses incurred in the transactions with third parties, which materialised the exercise of higher functions and risks, could not be disregarded by the government in the transfer pricing analysis.
Finally, the Chamber is aware that the application of the TNMM method by the plaintiff reflected that its profit margins in transactions with related parties were below the interquartile range set by the taxpayer itself, hence (in principle) the legal consequence provided for in paragraph 2 of Article 260-2 of the ET was appropriate. In this regard, the rule established as a mandatory mandate that, in all kinds of situations in which the factual assumption foreseen therein is verified, i.e. that the controlled transactions disregard the arm’s length principle because they are outside the range, the corresponding adjustment to the median must be made (judgment of 05 November 2020, exp. 21990, CP: Julio Roberto Piza Rodríguez)39. However, the content of the contested acts showed that the DIAN did not support the modification to the income tax report based on this fact, but chose to change the transfer pricing method used by the company, hence this Section is prohibited from making any modification in the first sense.
Conclusion
2.4- In light of the above considerations, the Court concludes that the cost plus method applied by the defendant was not the appropriate one, as opposed to the TNMM method applied by the plaintiff in its transfer pricing study, taking into account the characteristics of the transactions analysed, the different functions and risks assumed by the company in the transactions carried out with related parties and independent third parties, a method which, although it showed that the transaction with related parties was outside the interquartile range, was not the basis for the amendment of the income tax return for the taxable year 2008.
Regarding the appellant’s assertion that, in accordance with the OECD and the interpretative criteria, it was advisable not to make adjustments, which did not mean that they could not be made if necessary, as the rules themselves enshrine them, a premise under which it concludes that the appellant’s argument, The argument is incomplete, because although it recognises the possibility of making adjustments when they are required, even if it is not advisable, it does not support the reasons for their inappropriateness. In any case, according to the analysis carried out, it could be established that there were differences in comparability that ruled out the method chosen by the DIAN, which corresponded to the object of the debate.
3- In accordance with the analysis, this corporation finds that the addition of income derived from adjusting the transfer prices in the sales transactions carried out by the plaintiff to its related companies in Peru and Venezuela based on the use of a different method and comparables was not appropriate and, therefore, neither was the higher tax payable determined nor the penalties for inaccuracy and rejection of losses in accordance with the law. Consequently, the judgment of first instance will be confirmed, however, the second paragraph of the decision will be modified in the sense of adjusting the reinstatement of the right consequent to the declared nullity, that is to say, the private liquidation of the taxable year 2008 will be declared final.”
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