Tag: Functional analysis

A functional analysis is an analysis of the functions performed (taking into account assets used and risks assumed) by associated enterprises in controlled transactions and by independent enterprises in comparable uncontrolled transactions.

European Commission vs. Amazon and Luxembourg, May 2021, State Aid - European General Court, Case No T-816/17 and T-318/18

European Commission vs. Amazon and Luxembourg, May 2021, State Aid – European General Court, Case No T-816/17 and T-318/18

In 2017 the European Commission concluded that Luxembourg granted undue tax benefits to Amazon of around €250 million.  Following an in-depth investigation the Commission concluded that a tax ruling issued by Luxembourg in 2003, and prolonged in 2011, lowered the tax paid by Amazon in Luxembourg without any valid justification. The tax ruling enabled Amazon to shift the vast majority of its profits from an Amazon group company that is subject to tax in Luxembourg (Amazon EU) to a company which is not subject to tax (Amazon Europe Holding Technologies). In particular, the tax ruling endorsed the payment of a royalty from Amazon EU to Amazon Europe Holding Technologies, which significantly reduced Amazon EU’s taxable profits. This decision was brought before the European Court of Justice by Luxembourg and Amazon. Judgement of the EU Court  The European General Court found that Luxembourg’s tax treatment of Amazon was not illegal under EU State aid rules. According to a press release ” The ... Continue to full case
Norway vs "Distributor A AS", March 2021, Tax Board, Case No 01-NS 131/2017

Norway vs “Distributor A AS”, March 2021, Tax Board, Case No 01-NS 131/2017

A fully fledged Norwegian distributor in the H group was restructured and converted into a Limited risk distributor. The tax authorities issued an assessment where the income of the Norwegian distributor was adjusted to the median in a benchmark study prepared by the tax authorities, based on the “Transactional Net Margin Method” (TNMM method). Decision of the Tax Board In a majority decision, the Tax Board determined that the case should be send back to the tax administration for further processing. Excerpt “…The majority agrees with the tax office that deficits over time may give reason to investigate whether the intra-group prices are set on market terms. However, the case is not sufficiently informed for the tribunal to take a final position on this. In order to determine whether the income has been reduced as a result of incorrect pricing of intra-group transactions and debits, it is necessary to analyze the agreed prices and contract terms. A comparability analysis will ... Continue to full case
Denmark vs. "H Borrower and Lender A/S", January 2021, Tax Tribunal, Case no SKM2021.33.LSR

Denmark vs. “H Borrower and Lender A/S”, January 2021, Tax Tribunal, Case no SKM2021.33.LSR

“H Borrower and Lender A/S”, a Danish subsidiary in the H Group, had placed deposits at and received loans from a group treasury company, H4, where the interest rate paid on the loans was substantially higher than the interest rate received on the deposits. Due to insufficient transfer pricing documentation, the tax authorities (SKAT) issued a discretionary assessment of taxable income where the interest rate on the loans had been adjusted based on the rate received on the deposits. Decision of the Tax Tribunal The National Tax Tribunal stated that the documentation was deficient to such an extent that it could be equated with a lack of documentation. The tax authorities had therefore been entitled to make a discretionary assessment. The National Tax Tribunal referred, among other things, to the fact that the company’s transfer pricing documentation lacked a basic functional analysis of the group treasury company with which the company had controlled transactions. “The National Tax Tribunal finds that ... Continue to full case
Panama vs "Petroleum Wholesale Corp", September 2020, Administrative Tribunal, Case No TAT-RF-062

Panama vs “Petroleum Wholesale Corp”, September 2020, Administrative Tribunal, Case No TAT-RF-062

“Petroleum Wholesale Corp” is engaged in the wholesale of petroleum products, accessories and rolling stock in general in Panama. Following a thorough audit carried out by the Tax Administration in Panama, where discrepancies and inconsistencies had been identified between the transfer pricing documentation and financial reports and other publicly available information, an assessment was issued for FY 2013 and 2014 resulting in additional taxes and surcharges of approximately $ 14 millions. Petroleum Wholesale Corp disagreed with the assessment and brought the case before the Administrative Tribunal. The Administrative Tribunal decided in favor of the tax authorities with a minor adjustment in the calculations for 2014. “…we consider that the Tax Administration adhered, in this case, to the powers conferred by law, and that there is no defenselessness, since it was verified that, in the course of the audit, several requests for information were made (as evidenced in the minutes of the proceedings in the background file), and then, in the ... Continue to full case
Poland vs "Fish Factory" sp. z o.o., July 2020, Administrative Court, I SA/Gd 184/20 - Wyrok

Poland vs “Fish Factory” sp. z o.o., July 2020, Administrative Court, I SA/Gd 184/20 – Wyrok

The activity of Spółka A sp. z o.o. included salmon breeding, processing, smoking and sale and distribution of the finished products. The company operated within Group A with head quarter in the Netherlands. By decision of 27 May 2019, the tax authorities determined that the operating expenses determined by transactions with related parties were inflated by PLN 29,613,156.00. The authorities did not accept calculations presented by the Company, as there were no reliable accounting records regarding the amount of costs incurred. Furthermore, the authorities held that the cost plus method, which should guarantee profit on the transaction in the Company, had been applied incorrect. The dispute before the administrative Court boils down to assessing whether the court of first instance, in compliance with the provisions in force, reversed the decision of the authorities in its entirety and referred the case back for reconsideration due to the deficiencies found in the evidentiary proceedings, making it necessary to conduct the proceedings in ... Continue to full case

TPG2020 Chapter X paragraph 10.27

In some instances, the functions of the lender and the borrower may be undertaken by the same entity in different transactions. That could be the case, for example, of centralised treasury activities within an MNE group where the treasury entity raises and provides funds to other members of the MNE group. In those circumstances, the functional analysis should consider the applicability of the guidance in Section C of this chapter, and, in particular, paragraphs 10.44 and 10.45 ... Continue to full case

TPG2020 Chapter X paragraph 10.26

From the perspective of the borrower, the relevant functions would usually refer to ensuring the availability of funds to repay the principal and the interest on the loan in due time; providing collateral, if needed; and monitoring and fulfilling any other obligation derived from the loan contract (see comments upon “The lender’s and borrower’s perspectives” in Section C.1.1.1 of this chapter) ... Continue to full case

TPG2020 Chapter X paragraph 10.25

When, under accurate delineation, the lender is not exercising control over the risks associated to an advance of funds, or does not have the financial capacity to assume the risks, such risks should be allocated to the enterprise exercising control and having the financial capacity to assume the risk (see paragraph 1.98 of Chapter I). For instance, consider a situation where Company A advances funds to Company B. Consider further that the accurate delineation of the actual transaction indicates that Company A does not exercise control functions related to the advance of funds but that Company P, the parent company of the MNE group, is exercising control over those risks, and has the financial capacity to assume such risks. Under Chapter I analysis, Company P will bear the consequences of the playing out of such risks and Company A will be entitled to no more than a risk-free return (see Section D.1.2.1 in Chapter I) ... Continue to full case

TPG2020 Chapter X paragraph 10.24

For instance, in the particular case of an intra-group loan, the key functions performed by a lender to decide whether and under which terms to advance funds would typically include an analysis and evaluation of the risks inherent in the loan, the capability to commit capital of the business to the investment, determining the terms of the loan and organising and documenting the loan. This may also include any ongoing monitoring and periodic review of the loan. Such a functional analysis is likely to include consideration of similar information to that which a commercial lender or ratings agency would consider in determining the creditworthiness of the borrower. An associated lender will not necessarily perform all of the same functions at the same intensity as an independent lender. However, in considering whether a loan has been advanced on conditions which would have been made between independent enterprises, the same commercial considerations and economic circumstances are relevant (see comments on “The lender’s ... Continue to full case

TPG2020 Chapter X paragraph 10.23

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 ... Continue to full case
Zimbabwe vs CF (Pvt), February 2018, High Court, Case No HH 99-18

Zimbabwe vs CF (Pvt), February 2018, High Court, Case No HH 99-18

CF (Pvt) Ltd’s main business was import, distribution and marketing of motor vehicles and spare parts of a specified brand. Following an audit CF had been issued a tax assessment related to the transfer pricing and VAT – import prices, management fees, audit costs etc. Judgement of the High Court The High Court issued a decision predominantly in favor of the tax authorities. In its judgement, the court stated that either the general deduction provision under section 15 (2) or section 24 or section 98 of the Income Tax Act could be employed to deal with transfer pricing matters. Excerpts: “It seems to me that the unsupported persistent assertions maintained by the appellant even after the concession of 14 November 2014 were indicative of both corporate moral dishonesty and a lack of good faith. I therefore find that the appellant through the mind of its management evinced the intention to evade the payment of the correct amount of tax as contemplated ... Continue to full case

TPG2017 Chapter IX paragraph 9.85

Another aspect that may be necessary to examine in assessing whether the conditions of an arrangement in relation to an indemnification clause are arm’s length, is the remuneration of the transactions that are the object of the arrangement and the financial conditions of the termination thereof, as both can be inter-related. In effect, the terms of a termination clause (or the absence thereof) may be a significant element of the functional analysis of the transactions and specifically of the analysis of the risks of the parties, and may accordingly need to be taken into account in the determination of an arm’s length remuneration for the transactions. Similarly, the remuneration of the transactions will affect the determination of whether the conditions of the termination of the arrangement are at arm’s length ... Continue to full case

TPG2017 Chapter IX paragraph 9.18

The accurate delineation of the transactions comprising the business restructuring requires performing a functional analysis that seeks to identify the economically significant activities and responsibilities undertaken, assets used or contributed, and risks assumed before and after the restructuring by the parties involved. Accordingly, the analysis focuses on what the parties actually do and the capabilities, as well as the type and nature of assets used or contributed by the parties in a pre-restructuring and post-restructuring scenarios. See Section D. 1.2 of Chapter I. Given the importance of risk in the analysis of business restructurings, the following section provides specific guidance on the analysis of risk in transactions comprising the business restructuring ... Continue to full case

TPG2017 Chapter VII paragraph 7.32

It may be necessary to perform a functional analysis of the various members of the group to establish the relationship between the relevant services and the members’ activities and performance. In addition, it may be necessary to consider not only the immediate impact of a service, but also its long-term effect, bearing in mind that some costs will never actually produce the benefits that were reasonably expected when they were incurred. For example, expenditure on preparations for a marketing operation might prima facie be too heavy to be borne by a member in the light of its current resources; the determination whether the charge in such a case is arm’s length should consider expected benefits from the operation and the possibility that the amount and timing of the charge in some arm’s length arrangements might depend on the results of the operation. The taxpayer should be prepared to demonstrate the reasonableness of its charges to associated enterprises in such cases ... Continue to full case

TPG2017 Chapter VI paragraph 6.128

In conducting a comparability analysis involving the transfer of intangibles or rights in intangibles, the existence of risks related to the likelihood of obtaining future economic benefits from the transferred intangibles must be considered, including the allocation of risk between the parties which should be analysed within the framework set out in Section D. 1.2 of Chapter I. The following types of risks, among others, should be considered in evaluating whether transfers of intangibles or combinations of intangibles are comparable, and in evaluating whether the intangibles themselves are comparable. Risks related to the future development of the intangibles. This includes an evaluation of whether the intangibles relate to commercially viable products, whether the intangibles may support commercially viable products in the future, the expected cost of required future development and testing, the likelihood that such development and testing will prove successful and similar considerations. The consideration of development risk is particularly important in situations involving transfers of partially developed intangibles ... Continue to full case

TPG2017 Chapter VI paragraph 6.89

In transactions involving the transfer of intangibles or rights in intangibles, it is essential to identify with specificity the nature of the intangibles and rights in intangibles that are transferred between associated enterprises. Where limitations are imposed on the rights transferred, it is also essential to identify the nature of such limitations and the full extent of the rights transferred. It should be noted in this regard that the labels applied to transactions do not control the transfer pricing analysis. For example, in the case of a transfer of the exclusive right to exploit a patent in Country X, the taxpayer’s decision to characterise the transaction either as a sale of all of the Country X patent rights, or as a perpetual exclusive licence of a portion of the worldwide patent rights, does not affect the determination of the arm’s length price if, in either case, the transaction being priced is a transfer of exclusive rights to exploit the patent ... Continue to full case

TPG2017 Chapter VI paragraph 6.49

The relative importance of contributions to the creation of intangible value by members of the group in the form of functions performed, assets used and risks assumed will vary depending on the circumstances. For example, assume that a fully developed and currently exploitable intangible is purchased from a third party by a member of a group and exploited through manufacturing and distribution functions performed by other group members while being actively managed and controlled by the entity purchasing the intangible. It is assumed that this intangible would require no development, may require little or no maintenance or protection, and may have limited usefulness outside the area of exploitation intended at the time of the acquisition. There would be no development risk associated with the intangible, although there are risks associated with acquiring and exploiting the intangible. The key functions performed by the purchaser are those necessary to select the most appropriate intangible on the market, to analyse its potential benefits ... Continue to full case

TPG2017 Chapter VI paragraph 6.48

In identifying arm’s length prices for transactions among associated enterprises, the contributions of members of the group related to the creation of intangible value should be considered and appropriately rewarded. The arm’s length principle and the principles of Chapters I – III require that all members of the group receive appropriate compensation for any functions they perform, assets they use, and risks they assume in connection with the development, enhancement, maintenance, protection, and exploitation of intangibles. It is therefore necessary to determine, by means of a functional analysis, which member(s) perform and exercise control over development, enhancement, maintenance, protection, and exploitation functions, which member(s) provide funding and other assets, and which member(s) assume the various risks associated with the intangible. Of course, in each of these areas, this may or may not be the legal owner of the intangible. As noted in paragraph 6.133, it is also important in determining arm’s length compensation for functions performed, assets used, and risks ... Continue to full case

TPG2017 Chapter VI paragraph 6.3

The principles of Chapters I – III of these Guidelines apply equally to transactions involving intangibles and those transactions which do not. Under those principles, as is the case with other transfer pricing matters, the analysis of cases involving the use or transfer of intangibles should begin with a thorough identification of the commercial or financial relations between the associated enterprises and the conditions and economically relevant circumstances attaching to those relations in order that the actual transaction involving the use or transfer of intangibles is accurately delineated. The functional analysis should identify the functions performed, assets used, and risks assumed1 by each relevant member of the MNE group. In cases involving the use or transfer of intangibles, it is especially important to ground the functional analysis on an understanding of the MNE’s global business and the manner in which intangibles are used by the MNE to add or create value across the entire supply chain. Where necessary, the analysis ... Continue to full case

TPG2017 Chapter I paragraph 1.118

An additional consideration is whether there is a plausible expectation that following the business strategy will produce a return sufficient to justify its costs within a period of time that would be acceptable in an arm’s length arrangement. It is recognised that a business strategy such as market penetration may fail, and the failure does not of itself allow the strategy to be ignored for transfer pricing purposes. However, if such an expected outcome was implausible at the time of the transaction, or if the business strategy is unsuccessful but nonetheless is continued beyond what an independent enterprise would accept, the arm’s length nature of the business strategy may be doubtful and may warrant a transfer pricing adjustment. In determining what period of time an independent enterprise would accept, tax administrations may wish to consider evidence of the commercial strategies evident in the country in which the business strategy is being pursued. In the end, however, the most important consideration ... Continue to full case