“Poly Corp”, a manufacturer of polypropylene products, had an export marketing contract with an group company for overseas sales. The products were sold to unrelated third parties or foreign group companies through this arrangement.
Following an audit, the tax authority claimed that “Poly Corp” sold its products to foreign group companies below the arm’s length price. An assessment of additional taxable income was issued and the amount was treated as dividends to the foreign group companies.
“Poly Corp” appealed and the Administrative Court determined that even though the transfer prices were agreed upon by shareholders without special relationships, they did not automatically qualify as arm’s length prices. For transactions with certain group companies, the tax authority failed to account for sales volume in their comparability analysis, rendering the assessments invalid. However, for transactions with another related companies, the criteria applied were deemed reasonable, and using a single comparable transaction to determine the arm’s length price was sufficient. The court concluded that the tax assessments related to transactions with certain group companies were invalid due to lack of comparability, while those for another group companies were upheld as lawful.
An appeal was then filed with the High Court. The appeal concerned the legal meaning of the arm’s length price under the former National Tax Act, the scope of discretion afforded to the tax authorities in determining that price, and the validity of the authorities’ selection and adjustment of comparable transactions, including whether their reselection of comparables at the appellate stage could cure defects in the original assessments.
Judgment
The High Court dismissed the appeals. It affirmed the first instance judgment, holding that the arm’s length price under the former National Tax Act is not a market price agreed by independent parties but a price reasonably assessed by the tax authorities within the statutory framework.
The court accepted that differences in sovereign market conditions could justify treating transactions with different foreign related parties differently. It rejected the tax authorities’ attempt to justify the disputed adjustments through a late reselection of comparables, finding that the revised comparables still failed to eliminate material differences, particularly in sales scale, and amounted to an arbitrary narrowing of the comparison set. As a result, the portions of the tax assessments found unlawful at first instance remained cancelled, and the remaining portions upheld by the lower court were confirmed.
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