Inventec s.r.o. is a Czech manufacturing company that produces electronic equipment and components as part of an international group. The dispute relates to the 2015 tax year and arose from a transfer pricing adjustment made by the Czech tax authorities, who concluded that the prices applied in a controlled transaction did not reflect arm’s length conditions. Having analysed Inventec’s functions and risks, the authorities classified the company as a manufacturer that bore certain material-related risks. Based on this classification, they determined that an independent enterprise in comparable circumstances would have earned a profit mark-up on the costs of material. Using a profitability indicator based on return on total costs – including material costs, they adjusted the company’s results to what they considered to be an arm’s length level. This resulted in an additional corporate income tax assessment of approximately CZK 28 million for 2015, together with a penalty exceeding CZK 5 million. Inventec challenged the assessment, arguing that the tax ... Read more

In FY 2013 Inventec carried out manufacturing activities in the electronics industry on behalf of its parent company. It took formal title to the raw materials, but considered that its role was limited to assembly, without assuming risk or adding value to the materials. Inventec therefore used ROVAC (return on value added costs – not including cost of materials) as a profit level indicator (PLI) in its transfer pricing analysis. The tax authorities disagreed with the choice of PLI and considered ROTC (return on total costs – including materials) to be more appropriate. An appeal was filed by Inventec, which ended up before the Supreme Administrative Court. Judgment The Supreme Administrative Court dismissed the appeal of Inventec s.r.o. and ruled in favour of the tax authorities. (See also the FY 2014 Judgment) Click here for English Translation Click here for other translation ... Read more

The tax authorities issued an assessment against Prysmian s.p.a. for 2012, raising two adjustments: one for over €13 million relating to income attributable to its Singapore subsidiary, Draka Cableteq Asia Pacific Holding, under Italy’s CFC rules, and another for over €1 million relating to transfer pricing. However, on appeal the Provincial Tax Commission annulled the latter adjustment because the disputed transactions were purely domestic, taking place between Prysmian s.p.a. and its Italian subsidiary PCS. Therefore, they were not subject to italian transfer pricing rules. However, the Commission upheld the CFC adjustment. On appeal, the Regional Tax Commission reversed this decision, fully confirming the original assessment. It held that services invoiced by Prysmian to PCS were merely passed on by PCS to foreign subsidiaries, rendering PCS a passive conduit. The Regional Tax Commission did not explicitly rule on the cross-appeal filed by Prysmian against the CFC finding. In an appeal to the Supreme Court, Prysmian advanced three grounds of appeal. Firstly, ... Read more

In FY 2014 Inventec carried out manufacturing activities in the electronics industry on behalf of its parent company. It took formal title to the raw materials, but considered that its role was limited to assembly, without assuming risk or adding value to the materials. Inventec therefore used ROVAC (return on value added costs – not including cost of materials) as a profit level indicator (PLI) in its transfer pricing analysis. The tax authorities disagreed with the choice of PLI and considered ROTC (return on total costs – including materials) to be more appropriate. An appeal was filed by Inventec, which ended up before the Regional Court, which in its decision no. 29 Af 91/2019-147 found that the tax authorities had not taken into account Inventec’s FAR profile and that the alternative choice of profit level indicator – ROTC instead of ROVAC – had therefore not been sufficiently justified. On this basis, the court quashed the assessment and remitted the case ... Read more

The dispute arose after P. sp. z o.o. corrected its 2015 tax return, lowering its declared revenue based on a revised transfer pricing margin (from 8.5% to 6.5%) used in intra-group transactions. The company applied the “cost plus” method, arguing that the 6.5% margin reflected the group’s internal policy applied EU-wide since 1 January 2015. The correction resulted in a claimed overpayment of PLN 142,043. The tax authority, however, rejected the correction, arguing that the margin change was not due to an accounting error but was a retrospective transfer pricing adjustment unsupported by arm’s length analysis. They conducted a new comparability analysis and concluded that a 9.35% margin should apply. They adjusted the taxpayer’s revenue and costs accordingly, disallowing certain “pass-through” costs (e.g. medicine purchases, investigator remuneration, travel expenses) from the cost base and issued a revised tax assessment. An appeal was filed and the Administrative Court later set aside the tax assessment, finding that the tax authorities had failed ... Read more

Inventec carried out manufacturing activities in the electronics industry on behalf of its parent company. It took formal title to the raw materials, but considered that its role was limited to assembly, without assuming risk or adding value to the materials. Inventec therefore used ROVAC (return on value added costs – not including cost of materials) as a profit level indicator (PLI) in its transfer pricing analysis. The tax authorities disagreed with the choice of PLI and considered ROTC (return on total costs – including materials) to be more appropriate. An appeal was filed by Inventec, which ended up before the Regional Court, which in its decision no. 29 Af 91/2019-147 found that the tax authorities had not taken into account Inventec’s FAR profile and that the alternative choice of profit level indicator – ROTC instead of ROVAC – had therefore not been sufficiently justified. On this basis, the court quashed the assessment and remitted the case to the tax ... Read more

Following an audit the tax authorities issued an assessment of additional income resulting from an adjustment of the tax deductions related to marketing expenses. According to the tax authorities the price agreed between the related parties for advertising space was excessive and not determined in accordance with the arm’s length principle. ANITA B s.r.o. filed an appeal against the assessment. The Regional Court dismissed the appeal as unfounded by judgment of 26 October 2021, No. 62 Af 70/2019-48. The Court concluded that the tax authorities had established that the price agreed between ANITA B s.r.o. and its supplier (ELAPROMO) differed from the price that would have been agreed between unrelated parties. The Court upheld the method chosen by the tax authorities and concluded that ANITA B s.r.o. had failed to prove that the advertising costs claimed were justified in full. An appeal was then filed with the Supreme Administrative Court Judgment of the Supreme Administrative Court The court decided in ... Read more

Inventec carried out manufacturing activities in the electronics industry on behalf of its parent company. It took formal title to the raw materials, but considered that its role was limited to assembly, without assuming risk or adding value to the materials. Inventec therefore used ROVAC (return on value added costs – not including cost of materials) as a profit level indicator (PLI) in its transfer pricing analysis. The tax authorities disagreed with the choice of PLI and considered ROTC (return on total costs – including materials) to be more appropriate. An appeal was filed by Inventec, which ended up before the regional court. Judgment The regional court found that the tax authorities had failed to take into account Inventec’s FAR profile and that the alternative choice of profit level indicator – ROTC instead of ROVAC – had therefore not been sufficiently justified. On this basis, the court quashed the assessment and remitted the case to the tax authorities for reconsideration ... Read more

The initial step in applying the simplified approach to low value-adding intra-group services is for the MNE group to calculate, on an annual basis, a pool of all costs incurred by all members of the group in performing each category of low value-adding intra-group services. The costs to be pooled are the direct and indirect costs of rendering the service as well as, where relevant, the appropriate part of operating expenses (e.g. supervisory, general and administrative). The costs should be pooled according to category of services, and should identify the accounting cost centres used in creating the pool. Pass-through costs in the cost pool should be identified for the purposes of applying paragraph 7.61. The cost pool should exclude costs that are attributable to an in-house activity that benefits solely the company performing the activity (including shareholder activities performed by the shareholding company) ... Read more

When an associated enterprise is acting only as an agent or intermediary in the provision of services, it is important in applying a cost based method that the return or mark-up is appropriate for the performance of an agency function rather than for the performance of the services themselves. In such a case, it may not be appropriate to determine arm’s length pricing as a mark-up on the cost of the services but rather on the costs of the agency function itself. For example, an associated enterprise may incur the costs of renting advertising space on behalf of group members, costs that the group members would have incurred directly had they been independent. In such a case, it may well be appropriate to pass on these costs to the group recipients without a mark-up, and to apply a mark-up only to the costs incurred by the intermediary in performing its agency function ... Read more

The selection of the appropriate financial indicator depends on the facts and circumstances of the case, see paragraph 2.82. Concerns have been expressed that Berry ratios are sometimes used in cases where they are not appropriate without the caution that is necessary in the selection and determination of any transfer pricing method and financial indicator. See paragraph 2.98 in relation to the use of cost-based indicators in general. One common difficulty in the determination of Berry ratios is that they are very sensitive to classification of costs as operating expenses or not, and therefore can pose comparability issues. In addition, the issues raised at paragraphs 2.99-2.100 above in relation to pass-through costs equally arise in the application of Berry ratios. In order for a Berry ratio to be appropriate to test the remuneration of a controlled transaction (e.g. consisting in the distribution of products), it is necessary that: The value of the functions performed in the controlled transaction (taking account ... Read more

Where treating costs as pass-through costs is found to be arm’s length, a second question arises as to the consequences on comparability and on the determination of the arm’s length range. Because it is necessary to compare like with like, if pass-through costs are excluded from the denominator of the taxpayer’s net profit indicator, comparable costs should also be excluded from the denominator of the comparable net profit indicator. Comparability issues may arise in practice where limited information is available on the breakdown of the costs of the comparables ... Read more

In applying a cost-based transactional net margin method, fully loaded costs are often used, including all the direct and indirect costs attributable to the activity or transaction, together with an appropriate allocation in respect of the overheads of the business. The question can arise whether and to what extent it is acceptable at arm’s length to treat a significant portion of the taxpayer’s costs as pass-through costs to which no profit element is attributed (i.e. as costs which are potentially excludable from the denominator of the net profit indicator). This depends on the extent to which an independent party in comparable circumstances would agree not to earn a mark-up on part of the costs it incurs. The response should not be based on the classification of costs as “internal” or “external” costs, but rather on a comparability (including functional) analysis. See paragraph 7.34 ... Read more

Ferplast Slovakia s.r.o. is a contract manufacturer of the Italian FIVAC Group. In the reporting years, it sold 90% of its products to related parties and the remaining 10% to unrelated parties. In 2013 a royalty agreement was concluded with Ferplast SpA, according to which the latter pays a royalty of 2%/5% for the use of trademarks, etc. Ferplast Slovakia s.r.o. also paid the group parent – FIVAC SRL – for ORACLE software licenses. The tax authorities excluded the trademark royalty payments from the tax expense to the extent that they were related to the sale of products to related parties (90%), but at the same time allowed the royalty payments related to sale of products to independent customers (10%) in the tax expense. According to the tax authorities, there was no reason for a contract manufacturer to pay royalties on products which it produced on behalf of related parties. Regarding the payments for ORACLE software licenses, the FIVAC SRL had ... Read more

Ferplast Slovakia s.r.o. is a contract manufacturer of the Italian FIVAC Group. In the reporting years, it sold 90% of its products to related parties and the remaining 10% to unrelated parties. In 2013 a royalty agreement was concluded with Ferplast SpA, according to which the latter pays a royalty of 2%/5% for the use of trademarks, etc. Ferplast Slovakia s.r.o. also paid the group parent – FIVAC SRL – for ORACLE software licenses. The tax authorities excluded the trademark royalty payments from the tax expense to the extent that they were related to the sale of products to related parties (90%), but at the same time allowed the royalty payments related to sale of products to independent customers (10%) in the tax expense. According to the tax authorities, there was no reason for a contract manufacturer to pay royalties on products which it produced on behalf of related parties. Regarding the payments for ORACLE software licenses, the FIVAC SRL had ... Read more

Ferplast Slovakia s.r.o. is a contract manufacturer of the Italian FIVAC Group. In the reporting years, it sold 90% of its products to related parties and the remaining 10% to unrelated parties. In 2013 a royalty agreement was concluded with Ferplast SpA, according to which the latter pays a royalty of 2%/5% for the use of trademarks, etc. Ferplast Slovakia s.r.o. also paid the group parent – FIVAC SRL – for ORACLE software licenses. The tax authorities excluded the trademark royalty payments from the tax expense to the extent that they were related to the sale of products to related parties (90%), but at the same time allowed the royalty payments related to sale of products to independent customers (10%) in the tax expense. According to the tax authorities, there was no reason for a contract manufacturer to pay royalties on products which it produced on behalf of related parties. Regarding the payments for ORACLE software licenses, the FIVAC SRL had ... Read more

“A Infrastructure S.A.” had granted loans related parties B and C. The average interest rate borne by A S.A. on its bank loans was lower than the one applied to loans passed on to B and C, but following an audit, the tax authorities observed that other financial expenses (bank commissions and stamp duty) had been deducted by A S.A as financial costs on its bank loans, but not recorded as financial income on the intra-group loans. On that basis an assessment was issued where deductions for these financial costs not passed on to B and C had been disallowed in the ratio of “loans granted to B and C” over “A S.A’s external bank loans”. A appeal was filed by A S.A. with the Administrative Tribunal (CAAD). Judgment of the CAAD The Tribunal granted the appeal and declared the annulment of the income tax assessment. Excerpt “The Court is not unaware that the application of rules, such as those ... Read more

Samsung Electronics Baltic Ltd, is a subsidiary of Samsung Electronics Co. Ltd, which was established at the end of 2007. On 1 January 2008, Samsung Electronics Baltic and Samsung Electronics Co. Ltd entered into Distribution Agreement, under which Samsung Electronics Baltic was appointed as the distributor in the Baltic States of the products manufactured by Samsung Electronics Co. Ltd and its subsidiaries (‘the Distribution Agreement’). In 2008 and 2009, Samsung Electronics Baltic carried out business activities in the territory of Latvia, Lithuania and Estonia distributing the goods received from Samsung Electronics Co. Ltd under the Distribution Agreement. Samsung Electronics Baltic also provided warranty services for the goods sold by engaging service providers for that purpose, namely merchants who carried out repairs of the goods (‘Repair Services’). On 2 January 2008, Samsung Electronics Baltic concluded a Warranty Assumption Agreement (‘the Warranty Assumption Agreement’) with its sister company, Samsung Electronics Overseas B.V. (‘Dutch Samsung’), which was the distributor of Samsung Electronics Co ... Read more

The initial step in applying the simplified approach to low value-adding intra-group services is for the MNE group to calculate, on an annual basis, a pool of all costs incurred by all members of the group in performing each category of low value-adding intra-group services. The costs to be pooled are the direct and indirect costs of rendering the service as well as, where relevant, the appropriate part of operating expenses (e.g. supervisory, general and administrative). The costs should be pooled according to category of services, and should identify the accounting cost centres used in creating the pool. Pass-through costs in the cost pool should be identified for the purposes of applying paragraph 7.61. The cost pool should exclude costs that are attributable to an in-house activity that benefits solely the company performing the activity (including shareholder activities performed by the shareholding company) ... Read more

When an associated enterprise is acting only as an agent or intermediary in the provision of services, it is important in applying a cost based method that the return or mark-up is appropriate for the performance of an agency function rather than for the performance of the services themselves. In such a case, it may not be appropriate to determine arm’s length pricing as a mark-up on the cost of the services but rather on the costs of the agency function itself. For example, an associated enterprise may incur the costs of renting advertising space on behalf of group members, costs that the group members would have incurred directly had they been independent. In such a case, it may well be appropriate to pass on these costs to the group recipients without a mark-up, and to apply a mark-up only to the costs incurred by the intermediary in performing its agency function ... Read more

The selection of the appropriate financial indicator depends on the facts and circumstances of the case, see paragraph 2.82. Concerns have been expressed that Berry ratios are sometimes used in cases where they are not appropriate without the caution that is necessary in the selection and determination of any transfer pricing method and financial indicator. See paragraph 2.98 in relation to the use of cost-based indicators in general. One common difficulty in the determination of Berry ratios is that they are very sensitive to classification of costs as operating expenses or not, and therefore can pose comparability issues. In addition, the issues raised at paragraphs 2.99-2.100 above in relation to pass-through costs equally arise in the application of Berry ratios. In order for a Berry ratio to be appropriate to test the remuneration of a controlled transaction (e.g. consisting in the distribution of products), it is necessary that: The value of the functions performed in the controlled transaction (taking account ... Read more

Where treating costs as pass-through costs is found to be arm’s length, a second question arises as to the consequences on comparability and on the determination of the arm’s length range. Because it is necessary to compare like with like, if pass-through costs are excluded from the denominator of the taxpayer’s net profit indicator, comparable costs should also be excluded from the denominator of the comparable net profit indicator. Comparability issues may arise in practice where limited information is available on the breakdown of the costs of the comparables ... Read more

In applying a cost-based transactional net margin method, fully loaded costs are often used, including all the direct and indirect costs attributable to the activity or transaction, together with an appropriate allocation in respect of the overheads of the business. The question can arise whether and to what extent it is acceptable at arm’s length to treat a significant portion of the taxpayer’s costs as pass-through costs to which no profit element is attributed (i.e. as costs which are potentially excludable from the denominator of the net profit indicator). This depends on the extent to which an independent party in comparable circumstances would agree not to earn a mark-up on part of the costs it incurs. The response should not be based on the classification of costs as “internal” or “external” costs, but rather on a comparability (including functional) analysis. See paragraph 7.34 ... Read more

Cheil Communications India Pvt. Ltd. is a subsidiary of a Korean based advertising agency, Cheil Communications. The Indian affiliate had excluded pass-through costs from its cost base when determining the arm’s length remuneration for its activities. The tax authority included the the pass-through costs in the cost base and issued an assessment for FY 2005-06 where these costs were also marked up. Judgment of the Tribunal The Tribunal annulled the assessment and ruled in favor of Cheil Communications India. Excerpt “(…)For performing the functions for and on behalf of associated enterprises, the assessee is remunerated by its associated enterprises on the basis of a fixed commission/charges based on expenses or cost incurred by the assessee for release of a particular advertisement. It is also to be noted that advertising space (be it media, print or outdoor), has been let out by third party vendors in the name of ultimate customers and beneficiary of advertisement. We have gone through the invoices ... Read more