The tax authorities had assessed the income of DHL Forwarding (Norway) AS for the years 2014-2019, and increased the income by a total of NOK 242 million, pursuant to Section 13-1 of the Taxation Act containing the Norwegian arm’s length provisions.
An appeal was filed by DHL Global Forwarding (Norway) AS with the District Court, which later ruled in favour of DHL finding that the conditions for an assessment were not met.
The tax authorities then appealed to the Court of Appeal.
Judgment
The Court of Appeal upheld the decision from the District Court and likewise found that the conditions for discretionary assessment were not met. It had not been substantiated that the company’s income had been reduced due to a common of interest with the DHL Group. It had not been demonstrated that the pricing of transactions between the company and the Group was not arm’s length, in accordance with the OECD Transfer Pricing Guidelines. There was no basis for setting a service charge solely because of persistent losses.
Excerpts from the judgment in English
“The question is then whether the service charge can be calculated on a basis other than actual transactions, as assumed in the decision, more specifically whether OECD Guidelines section 1.130 provides an independent basis for determining the service charge for persistent deficits.
TPG paragraph 1.130 reads:
1.130 The fact that there is an enterprise making losses that is doing business with profitable members of its MNE group may suggest to the taxpayers or tax administrations that the transfer pricing should be examined. The loss enterprise may not be receiving adequate compensation from the MNE group of which it is a part in relation to the benefits derived from its activities. For example, an MNE group may need to produce a full range of products and/or services in order to remain competitive and realize an overall profit, but some of the individual product lines may regularly lose revenue. One member of the MNE group might realize consistent losses because it produces all the loss-making products while other members produce the profit-making products. An independent enterprise would perform such a service only if it were compensated by an adequate service charge. Therefore, one way to approach this type of transfer pricing problem would be to deem the loss enterprise to receive the same type of service charge that an independent enterprise would receive under the arm’s length principle.
Together with section 1.129 of the TPG, section 1.130 indicates that a company’s transfer pricing in the event of persistent losses should be subject to a closer examination. In the Court of Appeal’s view, it is most obvious to understand the provision in such a way that an investigation should be carried out in accordance with the guidelines that apply to the control of the arm’s length principle. There does not appear to be any basis for interpreting the provision in such a way that it basically provides an independent “legal basis” for imposing a service charge, regardless of whether pricing in breach of the arm’s length principle has been uncovered. In the Court of Appeal’s view, this would in this case involve a form of structural adjustment, cf. below.”
[…]
“A reduction in revenue may also be due to the fact that the related parties have agreed on a transaction structure that deviates from the structure that commercially rational, independent parties would have agreed on under comparable circumstances. Transaction structure refers to contractual terms in addition to price, such as the definition of the object of the agreement, termination clauses or provisions regulating the functions to be performed by the parties and the risks they bear. An adjustment of such contractual terms is often referred to as a “structural adjustment” (as opposed to a “price adjustment” or “value adjustment”), see e.g. Prop. 98 L (2018-2019) section 9.1 p. 63; Bullen (2007), p. 112-113. The question of making a structural adjustment arises after the content of the controlled transaction has been clarified, cf. section 1B step 1 above.
The clear starting point is that section 13-1 of the Tax Act should only be used to assess the transfer price in the actual transaction, and that no structural adjustments should therefore be made. This principle, which is referred to as the “as-structured principle”, is set out in the OECD Guidelines, point 141, which reads as follows:
“Every effort should be made to determine pricing for the actual transaction as accurately delineated under the arm’s length principle (…). A tax administration should not disregard the actual transaction or substitute other transactions for it unless the exceptional circumstances described in the following paragraphs 1.142-1.145 apply”.
The principle is based, among other things, on the need to prevent arbitrary adjustments and economic double taxation, see Bullen (2011), pp. 231-273.
A structural adjustment as described above implies disregarding the transaction structure agreed by the parties, for example, agreements within the group on the division of functions and distribution of risk between different companies. As stated in section 1.121 of the TPG, “exceptional circumstances” are required in order to make such an adjustment. The more detailed conditions are set out in sections 1.122 – 1.125.
In the Court of Appeal’s view, calculating the service charge solely on the basis of losses over time, as the decision is based on, would involve a far more far-reaching “adjustment” than changing, for example, agreements as mentioned. In reality, such an adjustment implies that DGF Norway’s entire business is “set aside”, not just certain elements of it. Since neither specific transactions nor specific contractual relationships in the Group that are not market-based have been demonstrated, it is obvious to consider the decision to be based on the fact that, in the tax office’s view, the entire business is not run “at arm’s length”.
The coherence of the regulations thus clearly indicates that the conditions for making such an adjustment cannot be less strict than for other structural changes. On this basis, the Court of Appeal finds that the provisions in section 1.130 of the TPG cannot be considered an independent legal basis for determining a service charge. An adjustment where the taxpayer’s entire business is effectively set aside must be made according to the same principles that apply to other structural adjustments.
Firstly, this means that the threshold for making such an adjustment is that there are “exceptional circumstances”, as this condition is described in TPG sections 1.122 – 1.125.
TPG paragraph 1.122 states:
This section sets out circumstances in which the transaction between the parties as accurately delineated can be disregarded for transfer pricing purposes. Because non-recognition can be contentious and a source of double taxation, every effort should be made to determine the actual nature of the transaction and apply arm’s length pricing to the accurately delineated transaction, and to ensure that non-recognition is not used simply because determining an arm’s length price is difficult.
(…)
The transaction as accurately delineated may be disregarded, and if appropriate, replaced by an alternative transaction, where the arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner in comparable circumstances, thereby preventing determination of a price that would be acceptable to both of the parties taking into account their respective perspectives and the options realistically available to each of them at the time of entering into the transaction.
The strict requirements for making a structural adjustment are justified by the risk of double taxation, and “every effort should be made” to clarify the transaction in question and apply the arm’s length principle. It is also stated that there are no grounds for disregarding a transaction just because “determining an arm’s length price is difficult”.
The tax office’s decision does not include an assessment of whether the conditions for making a structural adjustment have been met. This must be assumed to be due to the fact that the decision assumes that section 1.130 of the TPG in itself provides sufficient authority to set a service charge. In the Court of Appeal’s view, this involves an incorrect application of the law.
Furthermore, the Court of Appeal is not aware of any court decisions, either in Norway or abroad, in which it has been held that section 1.130 of the TPG constitutes an independent legal basis for setting a service charge.
In any case, the decision does not provide a more detailed analysis of the background to the persistent losses in DGF Norway. It is assumed that the company had a utility value for the DHL Group that meant that the business was maintained, despite the losses.
It must generally be assumed that companies in an international group mutually benefit from each other. The extent to which DGF Norway had such a benefit for the rest of the group, which meant that the business for this reason alone was continued despite the losses, is not substantiated further. The decision must be understood as resting in this respect on the tax office’s opinion that this is the only explanation for the continuation of the business, without this being further substantiated.
Nor has there been any evidence that functions or business risks have been distributed in the DHL Group in a way that implies that DGF Norway engages in loss-making activities for the benefit of the rest of the Group. In this regard, it is assumed that the majority of DGF Norway’s turnover originates from external customers, and that this customer portfolio belongs to the Norwegian company.
The relevance of the aforementioned factors in relation to the determination of the service charge, in a case where the tax authorities did not find a basis for assessing intra-group transactions on the basis of the arm’s length principle, is dealt with in a decision from the Danish National Tax Tribunal on October 8, 2018 (j.nr. 14-2741293). The following is quoted from the decision:
SKAT’s increase in the company’s taxable income is justified by the fact that the company is to receive compensatory remuneration for contributing to the group’s strategy of local presence in order to maintain a distribution network and customer base in Denmark. The increase is also justified by the fact that the company sells products with low profit while other group companies sell products with higher profit, which SKAT finds comparable with section 1.71 of the OECD Transfer Pricing Guidelines. 1.71 in the OECD Transfer Pricing Guidelines 2010.
(…)
It appears from the legislative history of Act no. 408 of June 1, 2005 (L 120 of March 2, 2005, section 2) that SKAT’s discretion must always be exercised in accordance with the principles of the OECD Transfer Pricing Guidelines. The National Tax Tribunal does not find that SKAT’s discretion meets this condition. In this regard, it is considered that the specific circumstances of the case cannot lead to a ruling that there is no economic or commercial transaction between the company and one or more group companies. In this connection, it is emphasized that the company’s local presence in the Danish market, as part of the group’s pan-European strategy, must be considered to be a common characteristic of being part of a global group, and therefore cannot in this specific case be considered to constitute an intra-group service. Furthermore, there is no basis for the assumption that the company’s distribution network and customers would constitute a value for the Group’s other companies, as the company’s customers in Denmark primarily consist of local companies, which is why the risk and ownership in relation to the Danish customers belong to the company. Finally, there is no basis for point 1.71. of the OECD Transfer Pricing Guidelines 2010 being relevant in this case. 1.71. should be relevant in this specific case, as there are no indications that the company’s product range is related to the Group’s overall product range in the sense that the Danish company sells loss-making products to other Group companies.
In the Court of Appeal’s view, the decision supports the fact that any application of TPG section 1.130 requires a specific assessment of how the group in question is organized and, among other things, how risks are distributed and what benefit the taxpayer in question has for the group. Such an assessment has not been made in this case.”
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