If there are differences between the tested party and an uncontrolled comparable that would materially affect the profits determined under the relevant profit level indicator, adjustments should be made according to the comparability provisions of § 1.482-1(d)(2). In some cases, the assets of an uncontrolled comparable may need to be adjusted to achieve greater comparability between the tested party and the uncontrolled comparable. In such cases, the uncontrolled comparable’s operating income attributable to those assets must also be adjusted before computing a profit level indicator in order to reflect the income and expense attributable to the adjusted assets. In certain cases it may also be appropriate to adjust the operating profit of the tested party and comparable parties. For example, where there are material differences in accounts payable among the comparable parties and the tested party, it will generally be appropriate to adjust the operating profit of each party by increasing it to reflect an imputed interest charge on each party’s ... Read more

Other factors listed in § 1.482-1(d)(3) also may be particularly relevant under the comparable profits method. Because operating profit usually is less sensitive than gross profit to product differences, reliability under the comparable profits method is not as dependent on product similarity as the resale price or cost plus method. However, the reliability of profitability measures based on operating profit may be adversely affected by factors that have less effect on results under the comparable uncontrolled price, resale price, and cost plus methods. For example, operating profit may be affected by varying cost structures (as reflected, for example, in the age of plant and equipment), differences in business experience (such as whether the business is in a start-up phase or is mature), or differences in management efficiency (as indicated, for example, by objective evidence such as expanding or contracting sales or executive compensation over time). Accordingly, if material differences in these factors are identified based on objective evidence, the reliability of the ... Read more

An operating profit represents a return for the investment of resources and assumption of risks. Therefore, although all of the factors described in § 1.482-1(d)(3) must be considered, comparability under this method is particularly dependent on resources employed and risks assumed. Moreover, because resources and risks usually are directly related to functions performed, it is also important to consider functions performed in determining the degree of comparability between the tested party and an uncontrolled taxpayer. The degree of functional comparability required to obtain a reliable result under the comparable profits method, however, is generally less than that required under the resale price or cost plus methods. For example, because differences in functions performed often are reflected in operating expenses, taxpayers performing different functions may have very different gross profit margins but earn similar levels of operating profit ... Read more

“XZ SA” is a Spanish parent of a tax consolidation group which is part of a multinational group. The Spanish group participates in the group’s cash pooling system, both as a borrower and as a provider of funds. The objective of cash pooling agreements is to manage the cash positions of the participating entities, optimising the group’s financial results by channelling the excess liquidity of the group companies that generate it to the group companies that need financing, resorting to third-party financing when the group itself is not able to finance itself. This achieves greater efficiency in the use of the group’s funds, as well as improving their profitability and reducing the administrative and general financial costs of the entities participating in the agreement. The tax authorities issued an assessment in which the interest rates on deposits and withdraws had been aligned and determined based on a group credit rating. A complaint was filed with the TEAC by XZ SA ... Read more

In accurately delineating the actual financial transaction, a functional analysis is necessary. This analysis seeks to identify the functions performed, the assets used and the risks assumed by the parties to that controlled transaction ... Read more

In transfer pricing cases involving intangibles, the determination of the entity or entities within an MNE group which are ultimately entitled to share in the returns derived by the group from exploiting intangibles is crucial. A related issue is which entity or entities within the group should ultimately bear the costs, investments and other burdens associated with the development, enhancement, maintenance, protection and exploitation of intangibles. Although the legal owner of an intangible may receive the proceeds from exploitation of the intangible, other members of the legal owner’s MNE group may have performed functions, used assets, or assumed risks that are expected to contribute to the value of the intangible. Members of the MNE group performing such functions, using such assets, and assuming such risks must be compensated for their contributions under the arm’s length principle. This Section B confirms that the ultimate allocation of the returns derived by the MNE group from the exploitation of intangibles, and the ultimate ... Read more

RKS, whose business consists of the manufacture of very large custom bearings for the civil and military industries, is controlled by the Swedish group SKF through (SAS) SKF Holding France. RKS was subject to a tax audit for FY 2009 and 2010, at the end of which the tax authorities adjusted the prices at which it had invoiced its products to the SKF group’s distribution companies abroad. According to the tax authorities, RKS was a simple manufacturing company that did not have control over strategic and operational risks, at therefore should not have losses resulting from such risks. As a result of the adjustment, SKF Holding France (the immediate parent of RKS) was subject to additional corporate income taxes amounting to EUR 5,385,325, including penalties. In a 2018 judgment the Montreuil Administrative Court discharged the additional taxes. However, this decision was set aside by the Versailles Administrative Court of Appeal in a judgment of 22 June 2020 in which the ... Read more

RKS, whose business consists of the manufacture of very large custom bearings for the civil and military industries, is controlled by the Swedish group SKF through (SAS) SKF Holding France. RKS was subject to a tax audit for FY 2009 and 2010, at the end of which the tax authorities adjusted the prices at which it had invoiced its products to the SKF group’s distribution companies abroad. According to the tax authorities, RKS was a simple manufacturing company that did not have control over strategic and operational risks, at therefore should not have losses resulting from such risks. In a 2018 judgment the Montreuil Administrative Court discharged the additional taxes. However, this decision was set aside by the Versailles Administrative Court of Appeal in a judgment of 22 June 2020 in which the appeal of the tax authorities was granted. This judgement was then appealed by SKF to the Supreme Court. Judgement of the Supreme Administrative Court The court decided ... Read more

“X Iberica SA” is a Spanish subsidiary of a multinational group and also a participant in the group’s cash pooling system, both as a borrower and as a provider of funds. When the group is not able to finance itself, the vehicle called THE X TES US comes into play, which raises these funds from outside the group as a group and on the basis of the group’s credit quality. The objective of cash pooling agreements is to manage the cash positions of the participating entities, optimising the group’s financial results by channelling the excess liquidity of the group companies that generate it to the group companies that need financing, resorting to third-party financing when the group itself is not able to finance itself. This achieves greater efficiency in the use of the group’s funds, as well as improving their profitability and reducing the administrative and general financial costs of the entities participating in the agreement. The tax authorities issued ... Read more

According to Amphenol Interconnect the TNMM was the most appropriate method for determining the arm’s length price in respect of exports and import of goods from the related parties. And since the net profit margin of Amphenol was comparable to the net profit margin of the comparable companies, the transactions were at arm’s length. The tax authorities disagreed and issued an assessment for FY 2012-2013 where the controlled transactions had instead been priced using the CUP method. Judgement of the Tribunal The Tribunal decided in favor of Amphenol. Excerpt “The Hon’ble High Court after analyzing the issues at length has held that CUP method would not be the most appropriate method in view of various adjustments, which would have to be made due to differences in FAR, in order to arrive at the arm’s length price of finished goods. The Hon’ble High Court notes that the Tribunal had taken into account the fact that for overwhelming majority of exports to ... Read more

Circular on transfer pricing – profitability rates and ranges for certain transactions – Limited Risk Distributors (LRDs) ... Read more

According to Colgate Palmolive, following a restructuring, the local group company in Spain was changed from being a “fully fledged distributor” responsible for all areas of the distribution process to being a “limited risk distributor” (it only performs certain functions). A newly established Swiss company, Colgate Palmolive Europe, instead became the principal entrepreneur in Europe. The changed TP setup had a significant impact on the earnings in the Spanish group company. Net margins was reduced from around 16% before the restructuring, to 3.5% after the restructuring. Following a thorough examination of the functions, assets and risks before and after application of the new setup, the Tax administration held that Colgate Palmolive Europe could not be qualified as the “principal entrepreneur” in Europe. The swiss company was in substance a service provider for which the remuneration should be determined based on the cost plus method. Judgement of the Court The High Court held in favour of the tax administration and dismissed ... Read more

In transfer pricing cases involving intangibles, the determination of the entity or entities within an MNE group which are ultimately entitled to share in the returns derived by the group from exploiting intangibles is crucial. A related issue is which entity or entities within the group should ultimately bear the costs, investments and other burdens associated with the development, enhancement, maintenance, protection and exploitation of intangibles. Although the legal owner of an intangible may receive the proceeds from exploitation of the intangible, other members of the legal owner’s MNE group may have performed functions, used assets, or assumed risks that are expected to contribute to the value of the intangible. Members of the MNE group performing such functions, using such assets, and assuming such risks must be compensated for their contributions under the arm’s length principle. This Section B confirms that the ultimate allocation of the returns derived by the MNE group from the exploitation of intangibles, and the ultimate ... Read more

“Paper Trading B.V.” was active in the business of buying and selling paper. The paper was purchased (mostly) in Finland, and sold in the Netherlands, Belgium, France, and Germany. The purchasing and selling activities were carried out by the director of Paper Trading B.V. “Mr. O” who was also the owner of all shares in the company. In 1994, Mr. O set up a company in Switzerland “Paper Trader A.G”. The appointed director of “Paper Trader A.G” was a certified tax advisor, accountant, and trustee, who also acted as director of various other companies registered at the same address. The Swiss director took care of administration, correspondence, invoicing and corporate tax compliance. A couple of years later, part of the purchasing and selling of the paper was now carried out through “Paper Trader A.G”. However, Mr. O proved to be highly involved in activities on behalf of “Paper Trader A.G”, and the purchase and sale of its paper. Mr. O ... Read more