Íslenska kalkþörungafélagið ehf. (“the Icelandic Limestone Algae Company”) operated a calcified algae factory in Iceland, harvesting seaweed from the seabed, cleaning, drying and exporting it almost entirely to its Irish parent company, Marigot Ltd. Marigot Ltd. further processed the raw material into animal feed, soil improvers and other products sold worldwide. The company applied a cost-plus method in its transfer pricing, targeting a minimum 50% gross profit margin on the cost of goods sold. However, in determining the cost base, the Icelandic Limestone Algae Company excluded wage costs and depreciation of fixed assets, classifying them as fixed costs independent of production. The cost base included only material costs, packaging and shipping costs, electricity costs and harvesting costs.
Following a request for transfer pricing documentation in August 2020, the tax authorities concluded that the documentation submitted in October 2020 was insufficient and did not allow a satisfactory assessment of whether pricing complied with the arm’s length principle. The Director of Taxation reassessed the company’s public taxes for the 2016 assessment year, increasing business income by ISK 487,525,000 and imposing a 25% surcharge on undeclared taxable income. The tax authorities held that the exclusion of wage costs and depreciation from the cost base was inconsistent with both the OECD Transfer Pricing Guidelines (paragraphs 2.46 and 2.48) and generally accepted accounting principles, resulting in a significant undervaluation of the cost of goods sold. The Tax Appeals Board upheld this decision.
The Icelandic Limestone Algae Company argued that the tax authorities had breached their duty of investigation under the Administrative Procedure Act by basing the reassessment on documentation they themselves deemed insufficient. The company contended that if the cost base were expanded to include wages and depreciation, the markup percentage should correspondingly be reduced, as the original 50% margin was premised on the narrower cost base. The company further argued that Marigot Ltd. bore almost all operational risks and had invested significantly in research, development, production facilities and international sales networks, justifying a larger share of group profits accruing to the parent company. The company also submitted that the reassessment resulted in an unrealistic profit margin of approximately 40%, far exceeding what would reflect its limited-risk role as a contract manufacturer.
Judgment
The Court of Appeal (Landsréttur) upheld the District Court’s judgment dismissing all of the Icelandic Limestone Algae Company’s claims. The court noted that it was undisputed that the company had submitted insufficient documentation following the tax authorities’ request. The court held that under Article 57(3) and (5) of the Income Tax Act No. 90/2003, a broad legal obligation rested on the taxpayer to demonstrate to the tax authorities, with documents and information, that pricing in transactions with related parties was in accordance with the arm’s length principle. The court further noted that the OECD Transfer Pricing Guidelines, which were to be taken into account in interpreting the provisions of the Income Tax Act, provided that the burden of proof may lie with the taxpayer, as was the case under Icelandic law. The Court of Appeal agreed with the District Court that the Icelandic Limestone Algae Company had not discharged its burden of proving that the price and terms in its transactions with Marigot Ltd. were in accordance with the arm’s length principle. The company was ordered to pay costs of ISK 1,000,000 to the respondent.
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