Tag: Compensating adjustment

A compensating adjustment is an adjustment in which the taxpayer reports a transfer price for tax purposes that is, in the taxpayer’s opinion, an arm’s length price for a controlled transaction, even though this price differs from the amount actually charged between the associated enterprises. This adjustment would be made before the tax return is filed.

Czech Republic vs Aisan Industry Czech, s.r.o., April 2022, Supreme Administrative Court, Case No 7 Afs 398/2019 - 49

Czech Republic vs Aisan Industry Czech, s.r.o., April 2022, Supreme Administrative Court, Case No 7 Afs 398/2019 – 49

Aisan Industry Czech, s.r.o. is a subsidiary within the Japanese Aisan Industry Group which manufactures various engine components – fuel-pump modules, throttle bodies, carburetors for independent car manufactures such as Renault and Toyota. According to the original transfer pricing documentation the Czech company was classified as a limited risk contract manufacturer within the group, but yet it had suffered operating losses for several years. Following a tax audit an assessment was issued resulting in additional corporate income tax for FY 2011 in the amount of CZK 11 897 090, and on top of that a penalty in the amount of CZK 2 379 418. The assessment resulted from application of arm’s length provisions where the profitability of Aisan Industry Czech, s.r.o. had been determined on the basis of the profitability of comparable companies – TNMM method. An appeal was filed by Aisan Industry Czech, s.r.o. with the Regional Court which – by judgment of 30 October 2019 – dismissed the ... Read more

TPG2022 Chapter IV paragraph 4.39

However, compensating adjustments are not recognised by most OECD member countries, on the grounds that the tax return should reflect the actual transactions. If compensating adjustments are permitted (or required) in the country of one associated enterprise but not permitted in the country of the other associated enterprise, double taxation may result because corresponding adjustment relief may not be available if no primary adjustment is made. The mutual agreement procedure is available to resolve difficulties presented by compensating adjustments, and competent authorities are encouraged to use their best efforts to resolve any double taxation which may arise from different country approaches to such year-end adjustments ... Read more

TPG2022 Chapter IV paragraph 4.38

At least one OECD member country has a procedure that may reduce the need for primary adjustments by allowing the taxpayer to report a transfer price for tax purposes that is, in the taxpayer’s opinion, an arm’s length price for a controlled transaction, even though this price differs from the amount actually charged between the associated enterprises. This adjustment, sometimes known as a “compensating adjustment”, would be made before the tax return is filed. Compensating adjustments may facilitate the reporting of taxable income by taxpayers in accordance with the arm’s length principle, recognising that information about comparable uncontrolled transactions may not be available at the time associated enterprises establish the prices for their controlled transactions. Thus, for the purpose of lodging a correct tax return, a taxpayer would be permitted to make a compensating adjustment that would record the difference between the arm’s length price and the actual price recorded in its books and records ... Read more

TPG2022 Chapter I paragraph 1.150

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 ... Read more
France vs SA Compagnie Gervais Danone, June 2021, CAA, Case No. 19VE03151

France vs SA Compagnie Gervais Danone, June 2021, CAA, Case No. 19VE03151

SA Compagnie Gervais Danone was the subject of an tax audit at the end of which the tax authorities questioned, among other things, the deduction of a compensation payment of 88 million Turkish lira (39,148,346 euros) granted to the Turkish company Danone Tikvesli, in which the french company holds a minority stake. The tax authorities considered that the payment constituted an indirect transfer of profits abroad within the meaning of Article 57 of the General Tax Code and should be considered as distributed income within the meaning of Article 109(1) of the Code, subject to the withholding tax provided for in Article 119a of the Code, at the conventional rate of 15%. SA Compagnie Gervais Danone brought the tax assessment to the administrative court. In a decision of 9 July 2019 the Court discharged SA Compagnie Gervais Danone from the taxes in dispute. This decision was appealed to Administrative Court of Appeal by the tax authorities. Judgement of the Court ... Read more
France vs SARL Elie Saab France, June 2021, Conseil d'État, Case No 433985

France vs SARL Elie Saab France, June 2021, Conseil d’État, Case No 433985

The French tax authorities had issued an assessment to SARL Elie Saab France in which they asserted that the French subsidiary had not been sufficiently remunerated for additional expenses and contributions to the value of the SARL Elie Saab trademark. The Supreme Administrative Court upheld the decision of the tax authorities. “It is clear from the statements in the judgment under appeal that the company Elie Saab France is responsible for the management, manufacture and distribution for the Elie Saab group of the top-of-the-range daywear line, distributes “Elie Saab” brand accessories for all the group’s entities, as well as the distribution in France and for European customers of the haute couture line, and sells, in its Paris boutique and to boutiques distributing the brand worldwide, a line of evening wear and accessories developed by the group’s Lebanese subsidiary. In addition, Elie Saab France has a showroom in the Paris boutique to present the brand’s haute couture creations, for which it ... Read more

OECD COVID-19 TPG paragraph 30

One potential solution to the uncertainty caused by the COVID-19 pandemic would be to allow for the inclusion of price adjustment mechanisms in controlled transactions. This may provide for flexibility while maintaining an arm’s length outcome. In particular, this approach to the extent permissible by domestic law would allow the adjustment of prices relevant for FY2020 through adjusted invoicing or intercompany payments effectuated in a later period (likely FY2021), when more accurate information to establish the arm’s length transfer price becomes available. In jurisdictions that use the outcome-testing approach, price adjustment mechanisms to reflect updated information relevant to determining an arm’s length price are often used. A jurisdiction that temporarily allows the outcome-testing approach could also temporarily allow the use of price adjustment mechanisms for that purpose and the taxpayer would be expected to describe the application of the price adjustment mechanism in its transfer pricing documentation. Such price adjustment mechanisms (provided that they are consistent with the arm’s length ... Read more

OECD COVID-19 TPG paragraph 23

Where possible, and on a temporary basis during the pandemic, tax authorities that otherwise use the price-setting approach could consider allowing taxpayers, for those controlled transactions affected by the pandemic, to take into account information that becomes available after the close of the taxable year in filing their returns (where legally permissible and properly described in the transfer pricing documentation). Tax administrations could provide flexibility to allow amendments to FY 2020 tax returns such that transfer prices are set on an arm’s length basis and using available information. Also given the potential for double taxation that may arise as a result of unilateral adjustments, consideration may be given by tax administrations to: Provide for flexibility in the allowance of “compensating adjustments” to be made before the tax return is filed, where it is legally permissible, in order to allow for any available contemporaneous information to be better evaluated by taxpayers and tax administrations such that arm’s length prices can be ... Read more
Finland vs A Oy, April 2020, Supreme Administrative Court, Case No. KHO:2020:34

Finland vs A Oy, April 2020, Supreme Administrative Court, Case No. KHO:2020:34

A Oy had operated as the marketing and sales company of an international group in Finland. With the exception of 2008, the company’s operations had been unprofitable in 2003-2011, while at the same time the Group’s operations had been profitable overall. A Oy had purchased the products from the contract manufacturers belonging to the group. The method used in the Group’s transfer pricing documentation for product purchases had been characterized as a modified cost-plus / profit margin method (TNMM). The tested parties were contract manufacturers belonging to the group, for whom four comparable independent companies had been found in a search of the Amadeus database. According to the documentation, the EBITDA target margin for the Group’s contract manufacturers was set at two percent. When submitting A Oy’s tax return for 2010, the tax Office had considered, on the basis of the OECD’s 2010 Transfer Pricing Guidelines (paragraphs 1.70 – 1.72), that in independent business transactions the sales company would have ... Read more
Poland vs K. sp. z o.o., January 2020, Supreme Administrative Court, Case No II FSK 191/19 - Wyrok

Poland vs K. sp. z o.o., January 2020, Supreme Administrative Court, Case No II FSK 191/19 – Wyrok

K. sp. z o.o. is a Polish company belonging to an international group. The main activity of K is local sale of goods purchased from a intra group supplier. K is best characterized as a limited risk distributor and as such should achieve an certain predetermined level of profitability as a result of its activities. In order to achieve the determined level of profitability, the group had established that, if the operating margin actually achieved by the distributor during a given period is less or more than the assumed level of profit, it will be adjusted. The year-end adjustment will not be directly related to the prices of goods purchased from the intra-group supplier and will be made after the end of each financial year. The Administrative Court decided that the year-end adjustment is not sufficiently linked to obtaining, maintaining or securing the company’s income. Hence the adjustment cannot be recognized as a deductible cost within the meaning of Article 15 ... Read more
Czech Republic vs Aisan Industry Czech, s.r.o., October 2019, Regional Court, Case No 15 Af 105/2015

Czech Republic vs Aisan Industry Czech, s.r.o., October 2019, Regional Court, Case No 15 Af 105/2015

Aisan Industry Czech, s.r.o. is a subsidiary within the Japanese Aisan Industry Group which manufactures various engine components – fuel-pump modules, throttle bodies, carburetors for independent car manufactures such as Renault and Toyota. According to the original transfer pricing documentation the Czech company was classified as a limited risk contract manufacturer within the group, but yet it had suffered operating losses for several years. Following a tax audit an assessment was issued resulting in additional corporate income tax for FY 2011 in the amount of CZK 11 897 090, and on top of that a penalty in the amount of CZK 2 379 418. The assessment resulted from application of arm’s length provisions where the profitability of Aisan Industry Czech, s.r.o. had been determined on the basis of the profitability of comparable companies – TNMM method. An appeal was filed by Aisan Industry Czech, s.r.o. with the Regional Court. Judgement of the Regional Court The court dismissed the appeal and ... Read more
Norway vs A/S Norske Shell, September 2019, Borgarting lagmannsrett, Case No LB-2018-79168 – UTV-2019-807

Norway vs A/S Norske Shell, September 2019, Borgarting lagmannsrett, Case No LB-2018-79168 – UTV-2019-807

A/S Norske Shell – an entity within the Dutch Shell group – had operations on the Norwegian continental shelf and conducted research and development (R&D) through a subsidiary. All R&D costs were deducted in Norway. The Norwegian tax authority applied the arms length principle and issued a tax assessment. It was assumed that the R&D expense was due to a joint interest with the other upstream companies in the Shell group. The Court of Appeal found that the R&D conducted in Norway also constituted an advantage for the foreign companies within the group for which an independent company would demand compensation. The resulting reduction in revenue provided the basis for determining the company’s income on a discretionary basis in accordance with section 13-1 of the Tax Act. The tax authorities determination of the amount of the income reduction had not based on an incorrect or incomplete fact, nor did the result appear arbitrary or unreasonable. The Court of Appeal concluded ... Read more
Italy vs J.T.G.P. spa, September 2019, Lombardi Regional Tribunal, Case No 928/20/2019

Italy vs J.T.G.P. spa, September 2019, Lombardi Regional Tribunal, Case No 928/20/2019

The Italian company J.T.G.P spa, a subsidiary in a multinational pharma group ALPHA J, had recorded operating losses for fiscal years 1997 to 2013, where, at a consolidated level, the group had showed positive results. According to the Italian tax authorities, the reason why the Italian company was still in operation was due to the fact that the group had an interest in keeping an international profile, and to that end the Italian company performed marketing activities benefiting the Group. An assessment was issued where the taxable income of the Italian company was added compensation for inter-company marketing services carried out by the Italian company on behalf of the group. The company argued that the pharmaceutical market and the governmental policy on the prices of medicines in Italy was the reason for the losses. In support of this claim the company submitted broad documentary evidence during the audit. Judgement of the regional Court The Court held in favor of the ... Read more

TPG2017 Chapter I paragraph 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 ... Read more