In this case, a Romanian manufacturer and distributor (A. SA) in the Electrolux group (C) had been loss making while the group as a whole had been profitable.
The tax authorities issued an assessment, where the profit of A. SA had been determined based on a comparison to the profitability of independent traders in households appliances. When calculating the profit margin of A. SA certain adjustments was made to the costs – depreciations, extraordinary costs etc.
When comparing A. SA’s net profit to financial results with those of the group to which it belongs, it emerged that, during the period under review, the applicant was loss-making while C. made a profit. With reference to paragraphs 1.70 and 1.71 of the OECD Transfer Pricing Guidelines, when an affiliated company consistently makes a loss while the group as a whole is profitable, the data may call for a special analysis of the transfer pricing elements, as this loss-making company may not receive an adequate reward from the group of which it is part and with which it does business for the benefits derived from its activities.
An analysis of the way in which the prices at which the applicant’s products are sold to other companies in C. are determined shows that those prices are imposed by the group, and that there is a uniform group policy of remunerating the manufacturing companies within the group and those carrying out distribution activities.
According to the document called “Framework Documentation 2013”, Annex 28 of the transfer pricing file, transfer prices are established on the basis of budgeted estimated costs, comprising direct material cost, direct labour cost and direct manufacturing costs, as well as indirect manufacturing costs and processing costs, plus a margin of 2.5%. Compared to this mark-up, the mark-up applied to B.’s direct and indirect production costs was between 27.04% and 34.87% over the period 2008-2013, as shown in B.’s public financial statements. It is true that B. is an entrepreneur whose activity involves several functions and risks, which may lead to higher mark-ups or higher losses, but it is worth noting that the mark-up applied to the cost of goods sold by B. is 11-14 times higher than that established for A. S.A..
During the entire period subject to tax inspection, the applicant incurred losses, while C. made a profit. In the years 2010, 2011 and 2013, with a turnover of more than 400.000.000 RON, the applicant always recorded a net loss.
According to the tax authorities the court of first instance erred in finding that the comparison between the operating cost margin of 2.50% established by the transfer pricing policy for the applicant’s household appliance manufacturing activities and B.’s gross cost margin was erroneous, given that the applicant failed to identify the source of the cost of goods sold values used for the calculation of B.’s gross cost margin, according to RIF p. 5.
A comparative analysis of the applicant’s sales invoices for household appliances to C. on the one hand and to independent companies on the other found that, for identical products, in similar quantities, at similar times of the year, the applicant sold to independent companies, under conditions presumed to be competitive and negotiated, at unit prices at least 25% higher than the prices at which it sold the same products to group companies.
Judgement of Supreme Court
The Court referred the case back to the lower court, within the limits of the cassation, for the completion of the evidence, in compliance with the rulings given on the questions of law in this decision.
“The Court of First Instance held that the defendant authorities had estimated the income which the applicant should have obtained from transactions with related persons by taking into account the median value of the interquartile range, relying on the provisions of Article 2(2)(b) of the EC Treaty. (2) and (3) of Annex 1 to OPANAF No 222/2008.
These provisions, which concern both the comparison and the adjustment, stipulate, with regard to the first issue, that the maximum and minimum segments of the comparison interval are extreme results which will not be used in the comparison margin. They were held by the court to unduly restrict the range of comparison since neither Article 11 of the Tax Code, to the application of which the Order is given, nor the Methodological Norms for the application of the Tax Code provide for the exclusion of the upper and lower quartiles from the range of comparison. Citing paragraph 2.7 of Chapter II, Part I of the OECD Guidelines, which it held to be of superior legal force to FINANCE Ordinance No 222/2008, the court concluded that, in order to consider that the prices charged in transactions with related persons comply with the arm’s length principle, it is sufficient that the taxpayer’s net margin falls within the interquartile range of comparison, without eliminating the extremes.
The High Court finds that there is no argument to exclude from the application of the provisions of OPANAF No 222/2008 relating to the preparation of the transfer pricing file and, in particular, the provisions cited above, which exclude extreme results from the comparison margin. The Order is a regulatory act and applies in addition to the provisions of Article 11(11) of Regulation (EC) No 1073/2004. (2) of the Tax Code and Art. 79 para. (2) of O.G. no. 92/2003 on the Fiscal Procedure Code. The higher rules do not regulate the comparison method or the adjustment method, which were left within the scope of the secondary rules.
On the other hand, the provisions of the Guidelines cited by the Court of First Instance do not support the thesis that such extreme results are not excluded, since they refer to the choice of the most appropriate method for analysing transfer prices between related persons, and not to the comparability analysis referred to in Chapter III, Section A.7, which allows the use of a comparison range and the exclusion of extremes (paragraph 3.63). Moreover, the comparison interval/interquartile range is a statistical tool which, in order to ensure the best possible degree of comparability, requires the exclusion of extremes.
In comparability analysis, both according to Order No 222/2008 and the OECD Guidelines, when company results are within the comparability interval (down to the lower quartile), no adjustment is necessary.
If, however, the company’s results fall outside the comparability range (excluding the extremes), according to Order No 222/2008, the adjustment is made to the median value of the comparability range, which is taken as the transfer price at market price. This regulation in the secondary standard also corresponds to the OECD Guidelines, which also refer to the adjustment to the median (when the comparison interval does not contain relatively equal and highly reliable results), precisely in order to minimise the risk of error due to imperfections in comparability which cannot be identified or quantified (paragraph 3.62).
As regards the disputed issue of the use, both in the comparison and in the adjustment, of the multi-year average (2008-2013) of the applicant’s operating margins, it is noted that there is no legal basis for the use of this multi-year average. The OECD Guidelines refer to multi-year data only in paragraph 3.77 of Chapter III, section B5, which concerns the determination of comparables. This document, which is intended to guide the analysis of transfer prices, does not recommend the use of multi-year averages or the aggregation of multi-year data.
Therefore, both the comparison and the adjustment must be based on an annual analysis of financial data, both under Order No 222/2008 and under the Guidelines, which consider transaction data as a comparability factor (see paragraphs 1.55 and 3.68). In principle, the Guidelines consider information on the terms of comparable uncontrolled transactions undertaken or performed during the same time period as the controlled transaction as the most reliable information suitable for use in a comparability analysis.”