Tag: Profit Level Indicator (PLI)

The Profit Level Indicator or Net profit indicator is a measure of a company’s profitability that is used to compare comparables with the tested party. A PLI may express profitability in relation to (i) sales, (ii) costs or expenses, or (iii) assets.

Italy vs Promgas s.p.a., May 2022, Supreme Court, Cases No 15668/2022

Italy vs Promgas s.p.a., May 2022, Supreme Court, Cases No 15668/2022

Promgas s.p.a. is 50% owned by the Italian company Eni s.p.a. and 50% owned by the Russian company Gazprom Export. It deals with the purchase and sale of natural gas of Russian origin destined for the Italian market. It sells the gas to a single Italian entity not belonging to the group, Edison spa, on the basis of a contract signed on 24 January 2000. In essence, Promgas s.p.a. performes intermediary function between the Russian company, Gazprom Export (exporter of the gas), and the Italian company, Edison s.p.a. (final purchaser of the gas). Following an audit for FY 2005/06, the tax authorities – based on the Transaction Net Margin Method – held that the operating margin obtained by Promgas s.p.a. (0.23% in 2025 and 0.06% in 2006) were not in line with the results that the company could have achieved at arm’s length. Applying an operating margin of l.39% resulted in a arm’s length profit of €4,227,438.07, for the year ... Read more
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 ... Read more
Denmark vs Tetra Pak Processing Systems A/S, April 2021, Supreme Court, Case No BS-19502/2020-HJR

Denmark vs Tetra Pak Processing Systems A/S, April 2021, Supreme Court, Case No BS-19502/2020-HJR

The Danish tax authorities had issued a discretionary assessment of the taxable income of Tetra Pak Processing Systems A/S due to inadequate transfer pricing documentation and continuous losses. Judgement of the Supreme Court The Supreme Court found that the TP documentation provided by the company did not comply to the required standards. The TP documentation did state how prices between Tetra Pak and the sales companies had been determined and did not contain a comparability analysis, as required under the current § 3 B, para. 5 of the Tax Control Act and section 6 of the Danish administrative ordinance regarding transfer pricing documentation. Against this background, the Supreme Court found that the TP documentation was deficient to such an extent that it had to be equated with missing documentation. The Supreme Court agreed that Tetra Pak’s taxable income for FY 2005-2009 could be determined on a discretionary basis. According to the Supreme Court Tetra Pak had not proved that the ... Read more
Chile vs Avery Dennison Chile S.A., March 2021, Tax Court, Case N° RUT°96.721.090-0

Chile vs Avery Dennison Chile S.A., March 2021, Tax Court, Case N° RUT°96.721.090-0

The US group, Avery Dennison, manufactures and distributes labelling and packaging materials in more than 50 countries around the world. The remuneration of the distribution and marketing activities performed Avery Dennison Chile S.A. had been determined to be at arm’s length by application of a “full range” analysis. Furthermore, surplus capital from the local company had been placed at the group’s financial centre in Luxembourg, Avery Management KGAA, at an interest rate of 0,79% (12-month Libor). According the tax authorities in Chile the remuneration of the local company had not been at arm’s length, and the interest rate paid by the related party in Luxembourg had been to low. Judgement of the Tax Tribunal The Tribunal decided in favour of Avery Dennison Chile S.A. “Hence, the Respondent [tax authorities] failed to prove its allegations that the marketing operations carried out by the taxpayer during the 2012 business year with related parties not domiciled or resident in Chile do not conform ... Read more

OECD COVID-19 TPG paragraph 52

First, exceptional costs should generally be excluded from the net profit indicator except when those costs relate to the controlled transaction as accurately delineated.29 The exclusion of exceptional costs must be done consistently at the level of the tested party and the comparables to ensure a reliable outcome, noting that the availability of this information may be limited.30 Care should be taken in order to ensure that such costs are appropriately measured and are consistently accounted for to the extent possible. 29 Paragraph 2.86 of Chapter II of the OECD TPG.30 Paragraph 2.74 of Chapter II of the OECD TPG ... Read more
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 ... Read more
Denmark vs Icemachine Manufacturer A/S, June 2020, National Court, Case No SKM2020.224.VLR

Denmark vs Icemachine Manufacturer A/S, June 2020, National Court, Case No SKM2020.224.VLR

At issue was the question of whether the Danish tax authorities had been entitled to make a discretionary assessment of the taxable income of Icemachine Manufacturer A/S due to inadequate transfer pricing documentation and continuous losses. And if such a discretionary assessment was justified, the question of whether the company had lifted the burden of proof that the tax authorities’ estimates had been clearly unreasonable. The Court ruled that the transfer pricing documentation provided by the company was so inadequate that it did not provide the tax authorities with a sufficient basis for determining whether the arm’s length principle had been followed. The tax authorities had therefore been entitled to make a discretionary assessment of the taxable income. For that purpose the Court found that the tax authorities had been justified in using the TNM method with the Danish company as the tested party, since sufficiently reliable information on the sales companies in the group had not been provided. (In April 2021 ... Read more
Nigeria vs Prime Plastichem Nigeria Limited, February 2020, Tax Appeal Tribunal, Case No TAT/LZ/CIT/015/2017

Nigeria vs Prime Plastichem Nigeria Limited, February 2020, Tax Appeal Tribunal, Case No TAT/LZ/CIT/015/2017

Prime Plastichem Nigeria Limited is a private limited company which engages in the business of trading in imported plastics and petrochemicals. Prime Plastichem Nigeria Limited had applied an internal CUP in determining the arm’s length price of its purchase of petrochemical products from its offshore related party, Vinmar Overseas Limited by comparing the controlled prices of products with the prices whereby the products were sold to third party customers. However, in 2014, Vinmar Overseas Limited did not sell to third party customers in Nigeria and there was no basis for applying the internal CUP. Prime Plastichem Nigeria Limited instead applied the TNMM. In 2016, the Nigerian Tax Authorities reviewed the transfer pricing and disregarded the CUP analysis applied in the 2013 TP documentation, applied TNMM to both 2013 and 2014 transactions, and issued an assessment of ₦1.74 billion. Both parties disagreed on the applicable profit level indicator (PLI) to be adopted in applying the TNMM and the comparables selected in ... Read more
Spain vs Ikea, March 2019, Audiencia Nacional, Case No SAN 1072/2019

Spain vs Ikea, March 2019, Audiencia Nacional, Case No SAN 1072/2019

The tax administration had issued an adjustment to the taxable profit of IKEA’s subsidiary in Spain considering that taxable profit in years 2007, 2008, and 2009 had not been determined in accordance with the arm’s length principle. In 2007 taxable profits had been below the interquartile range and in 2008 and 2009 taxable profits had been within the interquartile range but below the median. In all years taxable profits had been adjusted to the median in the benchmark study. Judgement of the Court In regards to the adjustment mechanism – benchmark study, interquartile range, median – the Court provide the following reasoning “However, the OECD Guidelines in point 3.60 provide that “if the relevant terms of the controlled transaction (e.g. price or margin) are within the arm’s length range, no adjustment is necessary”. Conversely, under rule 3.61, if the relevant terms of the controlled transaction “(e.g., price or margin) are outside the arm’s length range determined by the tax administration, ... Read more
Denmark vs "Contract manufacturing HQ A/S", April 2018, Tax Tribunal, Case No SKM2018.173.LSR

Denmark vs “Contract manufacturing HQ A/S”, April 2018, Tax Tribunal, Case No SKM2018.173.LSR

A Danish HQ acquired goods from an affiliated contract manufacturing company. The Danish tax authorities issued an adjustment of the prices based on the Danish arm’s length provisions contained in section 2 of the Tax Assessment Act. Decision of the Tax tribunal The Tax Tribunal found that the tax authorities had proved that the company’s method for pricing the controlled transactions contained too many uncertainties. The Tax Tribunal further found that the method applied by the tax authorities was in accordance with the OECD Transfer Pricing Guidelines, as the contract manufacturing activities could be equated with a service. Finally, the Tax Tribunal did not find that the pricing of controlled transactions of goods or services could be based on a return on capital employed (ROCE). Pricing of controlled transactions of goods or services was to be based on a comparability analysis of similar transactions between independent companies, cf. OECD Transfer Pricing Guidelines 2010, p. 1.33 and 1.38. Click here for ... Read more

TPG2017 Chapter II Annex I paragraph 5

Under Illustration 3, if a controlled transaction is performed as in case 1 while the third party “comparables” are operating as in case 2, and assuming that the difference in the capacity utilisation is not identified due to insufficiently detailed information on the third party “comparables”, then the risk of error when applying a gross margin method could amount to 16 (2% x 800) instead of 50 (5% x 1000) if a net margin method is applied. This illustrates the fact that net profit indicators can be more sensitive than gross mark-ups or gross margins to differences in the capacity utilisation, depending on the facts and circumstances of the case and in particular on the proportion of fixed and variable costs and on whether it is the taxpayer or the “comparable” which is in an over-capacity situation ... Read more
TPG2017 Chapter II Annex I paragraph 4

TPG2017 Chapter II Annex I paragraph 4

Consequently, enterprises performing different functions may have a wide range of gross profit margins while still earning broadly similar levels of net profits. For instance, business commentators note that the transactional net margin method would be less sensitive to differences in volume, extent and complexity of functions and operating expenses. On the other hand, the transactional net margin method may be more sensitive than the cost plus or resale price methods to differences in capacity utilisation, because differences in the levels of absorption of indirect fixed costs (e.g. fixed manufacturing costs or fixed distribution costs) would affect the net profit but may not affect the gross margin or gross mark-up on costs if not reflected in price differences, as illustrated below. Illustration 3: Effect of a difference in manufacturers’ capacity utilization The example below is for illustration only and is not intended to provide any guidance on the selection of the transfer pricing method or of comparables, or on arm’s ... Read more

TPG2017 Chapter II Annex I paragraph 3

Under Illustration 2, if a controlled transaction is performed as in case 1 while the third party “comparables” are operating as in case 2, and assuming that the difference in the level of risks is not identified due to insufficiently detailed information on the third party “comparables”, then the risk of error when applying a gross margin method could amount to 60 (6% x 1 000) instead of 10 (1% x 1 000) if a net margin method is applied. This illustrates the fact that, depending on the circumstances of the case and in particular of the effect of the differences in the level of risks on the cost structure and on the revenue of the “comparables”, net profit margins can be less sensitive than gross margins to differences in the level of risks (assuming the contractual allocation of risks is arm’s length) ... Read more
TPG2017 Chapter II Annex I paragraph 2

TPG2017 Chapter II Annex I paragraph 2

Under Illustration 1, if a taxpayer is operating with an associated manufacturer as in case 2 while the third party “comparables” are operating as in case 1, and assuming that the difference in the extent and complexity of the marketing function is not identified because of for instance insufficiently detailed information on the third party “comparables”, then the risk of error when applying a gross margin method could amount to 120 (12% x 1 000), while it would amount to 20 (2% x 1 000) if a net margin method was applied. This illustrates the fact that, depending on the circumstances of the case and in particular of the effect of the functional differences on the cost structure and on the revenue of the “comparables”, net profit margins can be less sensitive than gross margins to differences in the extent and complexity of functions. Illustration 2: Effect of a difference in the level of risk assumed by a distributor The ... Read more
TPG2017 Chapter II Annex I paragraph 1

TPG2017 Chapter II Annex I paragraph 1

[See Chapter II, Part III, Section B of these Guidelines for general guidance on the application of the transactional net margin method. The assumptions about arm’s length arrangements in the following examples are intended for illustrative purposes only and should not be taken as prescribing adjustments and arm’s length arrangements in actual cases of particular industries. While they seek to demonstrate the principles of the sections of the Guidelines to which they refer, those principles must be applied in each case according to the specific facts and circumstances of that case. Furthermore, the comments below relate to the application of a transactional net margin method in the situations where, given the facts and circumstances of the case and in particular the comparability (including functional) analysis of the transaction and the review of the information available on uncontrolled comparables, such a method is found to be the most appropriate method to be used.] It is recognised that the transactional net margin method ... Read more

TPG2017 Chapter II paragraph 2.185

As discussed in these Guidelines, there are concerns regarding the use of the transactional net margin method, in particular that it is sometimes applied without adequately taking into account the relevant differences between the controlled and uncontrolled transactions being compared. Many countries are concerned that the safeguards established for the traditional transaction methods may be overlooked in applying the transactional net margin method. Thus, where differences in the characteristics of the transactions being compared have a material effect on the net profit indicators being used, it would not be appropriate to apply the transactional net margin method without making adjustments for such differences. See paragraphs 2.74-2.81 (the comparability standard to be applied to the transactional net margin method) ... Read more

TPG2017 Chapter II paragraph 2.113

The facts are the same as in paragraph 2.42. However, the amount of the warranty expenses incurred by Distributor A proves impossible to ascertain so that it is not possible to reliably adjust the gross profit of A to make the gross profit margin properly comparable with that of B. However, if there are no other material functional differences between A and B and the net profit of A relative to its sales is known, it might be possible to apply the transactional net margin method to B by comparing the margin relative to A’s sales to net profits with the margin calculated on the same basis for B ... Read more

TPG2017 Chapter II paragraph 2.112

A similar approach may be required when there are differences in functions performed by the parties being compared. Assume that the facts are the same as in the example at paragraph 2.44 except that it is the comparable independent enterprises that perform the additional function of technical support and not the associated enterprise, and that these costs are reported in the cost of goods sold but cannot be separately identified. Because of product and market differences it may not be possible to find a CUP, and a resale price method would be unreliable since the gross margin of the independent enterprises would need to be higher than that of the associated enterprise in order to reflect the additional function and to cover the unknown additional costs. In this example, it may be more reliable to examine net margins in order to assess the difference in the transfer price that would reflect the difference in function. The use of net margins ... Read more

TPG2017 Chapter II paragraph 2.111

By way of illustration, the example of cost plus at paragraph 2.59 demonstrates the need to adjust the gross mark-up arising from transactions in order to achieve consistent and reliable comparison. Such adjustments may be made without difficulty where the relevant costs can be readily analysed. Where, however, it is known that an adjustment is required, but it is not possible to identify the particular costs for which an adjustment is required, it may, nevertheless, be possible to identify the net profit arising on the transaction and thereby ensure that a consistent measure is used. For example, if the supervisory, general, and administrative costs that are treated as part of costs of goods sold for the independent enterprises X, Y and Z cannot be identified so as to adjust the mark up in a reliable application of cost plus, it may be necessary to examine net profit indicators in the absence of more reliable comparisons ... Read more

TPG2017 Chapter II paragraph 2.108

A situation where Berry ratios can prove useful is for intermediary activities where a taxpayer purchases goods from an associated enterprise and on-sells them to other associated enterprises. In such cases, the resale price method may not be applicable given the absence of uncontrolled sales, and a cost plus method that would provide for a mark-up on the cost of goods sold might not be applicable either where the cost of goods sold consists in controlled purchases. By contrast, operating expenses in the case of an intermediary may be reasonably independent from transfer pricing formulation, unless they are materially affected by controlled transaction costs such as head office charges, rental fees or royalties paid to an associated enterprise, so that, depending on the facts and circumstances of the case, a Berry ratio may be an appropriate indicator, subject to the comments above ... Read more

TPG2017 Chapter II paragraph 2.107

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

TPG2017 Chapter II paragraph 2.106

“Berry ratios” are defined as ratios of gross profit to operating expenses. Interest and extraneous income are generally excluded from the gross profit determination; depreciation and amortisation may or may not be included in the operating expenses, depending in particular on the possible uncertainties they can create in relation to valuation and comparability ... Read more

TPG2017 Chapter II paragraph 2.105

Other net profit indicators may be appropriate depending on the facts and circumstances of the transactions. For instance, depending on the industry and on the controlled transaction under review, it may be useful to look at other denominators where independent data may exist, such as: floor area of retail points, weight of products transported, number of employees, time, distance, etc. While there is no reason to rule out the use of such bases where they provide a reasonable indication of the value added by the tested party to the controlled transaction, they should only be used where it is possible to obtain reliable comparable information to support the application of the method with such a net profit indicator ... Read more

TPG2017 Chapter II paragraph 2.104

In cases where the net profit is weighted to assets, the question arises how to value the assets, e.g. at book value or market value. Using book value could possibly distort the comparison, e.g. between those enterprises that have depreciated their assets and those that have more recent assets with on-going depreciation, and between enterprises that use acquired intangibles and others that use self-developed intangibles. Using market value could possibly alleviate this concern, although it can raise other reliability issues where valuation of assets is uncertain and can also prove to be extremely costly and burdensome, especially for intangible assets. Depending on the facts and circumstances of the case, it may be possible to perform adjustments to improve the reliability of the comparison. The choice between book value, adjusted book value, market value and other possibly available options should be made with a view to finding the most reliable measure, taking account of the size and complexity of the transaction ... Read more

TPG2017 Chapter II paragraph 2.103

Returns on assets (or on capital) can be an appropriate base in cases where assets (rather than costs or sales) are a better indicator of the value added by the tested party, e.g. in certain manufacturing or other asset-intensive activities and in capital-intensive financial activities. Where the indicator is a net profit weighted to assets, operating assets only should be used. Operating assets include tangible operating fixed assets, including land and buildings, plant and equipment, operating intangible assets used in the business, such as patents and know-how, and working capital assets such as inventory and trade receivables (less trade payables). Investments and cash balances are generally not operating assets outside the financial industry sector ... Read more

TPG2017 Chapter II paragraph 2.102

The use of budgeted costs can also raise a number of concerns where large differences between actual costs and budgeted costs result. Independent parties are not likely to set prices on the basis of budgeted costs without agreeing on what factors are to be taken into account in setting the budget, without having regard to how budgeted costs have compared with actual costs in previous years and without addressing how unforeseen circumstances are to be treated ... Read more

TPG2017 Chapter II paragraph 2.101

Depending on the facts and circumstances of the case, actual costs, as well as standard or budgeted costs, may be appropriate to use as the cost base. Using actual costs may raise an issue because the tested party may have no incentive to carefully monitor the costs. In arrangements between independent parties, it is not rare that a cost savings objective is factored into the remuneration method. It can also happen in manufacturing arrangements between independent parties that prices are set on the basis of standard costs, and that any decrease or increase in actual costs compared to standard costs is attributed to the manufacturer. Where they reflect the arrangements that would be taken between independent parties, similar mechanisms could be taken into account in the application of the cost-based transactional net margin method. See paragraph 2.58 for a discussion of the same issue in relation to the cost plus method ... Read more

TPG2017 Chapter II paragraph 2.100

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

TPG2017 Chapter II paragraph 2.99

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

TPG2017 Chapter II paragraph 2.98

Cost-based indicators should only be used in those cases where costs are a relevant indicator of the value of the functions performed, assets used and risks assumed by the tested party. In addition, the determination of what costs should be included in the cost base should derive from a careful review of the facts and circumstances of the case. Where the net profit indicator is weighted against costs, only those costs that directly or indirectly relate to the controlled transaction under review (or transactions aggregated in accordance to the principle at paragraphs 3.9-3.12) should be taken into account. Accordingly, an appropriate level of segmentation of a taxpayer’s accounts is needed in order to exclude from the denominator costs that relate to other activities or transactions and materially affect comparability with uncontrolled transactions. Moreover, in most cases only those costs which are of an operating nature should be included in the denominator. The discussion at paragraphs 2.86-2.91 above also applies to ... Read more

TPG2017 Chapter II paragraph 2.97

One question that arises in cases where the net profit indicator is weighted against sales is how to account for rebates and discounts that may be granted to customers by the taxpayer or the comparables. Depending on the accounting standards, rebates and discounts may be treated as a reduction of sales revenue or as an expense. Similar difficulties can arise in relation to foreign exchange gains or losses. Where such items materially affect the comparison, the key is to compare like with like and follow the same accounting principles for the taxpayer and for the comparables ... Read more

TPG2017 Chapter II paragraph 2.96

A net profit indicator of net profit divided by sales, or net profit margin, is frequently used to determine the arm’s length price of purchases from an associated enterprise for resale to independent customers. In such cases, the sales figure at the denominator should be the re-sales of items purchased in the controlled transaction under review. Sales revenue that is derived from uncontrolled activities (purchase from independent parties for re-sale to independent parties) should not be included in the determination or testing of the remuneration for controlled transactions, unless the uncontrolled transactions are such that they do not materially affect the comparison; and/or the controlled and uncontrolled transactions are so closely linked that they cannot be evaluated adequately on a separate basis. One example of the latter situation can sometimes occur in relation to uncontrolled after-sales services or sales of spare parts provided by a distributor to independent end-user customers where they are closely linked to controlled purchase transactions by ... Read more

TPG2017 Chapter II paragraph 2.95

The denominator should be one that is capable of being measured in a reliable and consistent manner at the level of the taxpayer’s controlled transactions. In addition, the appropriate base should be one that is capable of being measured in a reliable and consistent manner at the level of the comparable uncontrolled transactions. This in practice limits the ability to use certain indicators, as discussed at paragraph 2.105 below. Further, the taxpayer’s allocation of indirect expenses to the transaction under review should be appropriate and consistent over time ... Read more

TPG2017 Chapter II paragraph 2.93

The denominator should be focussed on the relevant indicator(s) of the value of the functions performed by the tested party in the transaction under review, taking account of its assets used and risks assumed. Typically, and subject to a review of the facts and circumstances of the case, sales or distribution operating expenses may be an appropriate base for distribution activities, full costs or operating expenses may be an appropriate base for a service or manufacturing activity, and operating assets may be an appropriate base for capital-intensive activities such as certain manufacturing activities or utilities. Other bases can also be appropriate depending on the circumstances of the case ... Read more

TPG2017 Chapter II paragraph 2.90

Difficult comparability issues can arise where the accounting treatment of some items by potential third party comparables is unclear or does not allow reliable measurement or adjustment (see paragraph 2.81). This can be the case in particular for depreciation, amortisation, stock option and pension costs. The decision whether or not to include such items in the determination of the net profit indicator for applying the transactional net margin method will depend on a weighing of their expected effects on the appropriateness of the net profit indicator to the circumstances of the transaction and on the reliability of the comparison (see paragraph 3.50) ... Read more

TPG2017 Chapter II paragraph 2.88

Whether foreign exchange gains and losses should be included or excluded from the determination of the net profit indicator raises a number of difficult comparability issues. First, it needs to be considered whether the foreign exchange gains and losses are of a trading nature (e.g. exchange gain or loss on a trade receivable or payable) and whether or not the tested party is responsible for them. Second, any hedging of the foreign currency exposure on the underlying trade receivable or payable also needs to be considered and treated in the same way in determining the net profit. In effect, if a transactional net margin is applied to a transaction in which the foreign exchange risk is borne by the tested party, foreign exchange gains or losses should be consistently accounted for (either in the calculation of the net profit indicator or separately) ... Read more

TPG2017 Chapter II paragraph 2.87

In those cases where there is a correlation between the credit terms and the sales prices, it could be appropriate to reflect interest income in respect of short-term working capital within the calculation of the net profit indicator and/or to proceed with a working capital adjustment, see paragraphs 3.47-3.54. An example would be where a large retail business benefits from long credit terms with its suppliers and from short credit terms with its customers, thus making it possible to derive excess cash that in turn may make it possible to have lower sales prices to customers than if such advantageous credit terms were not available ... Read more

TPG2017 Chapter II paragraph 2.85

Similarly, when analysing the transactions between the independent enterprises to the extent they are needed, profits attributable to transactions that are not similar to the controlled transactions under examination should be excluded from the comparison. Finally, when net profit indicators of an independent enterprise are used, the profits attributable to the transactions of the independent enterprise must not be distorted by controlled transactions of that enterprise. See paragraphs 3.9-3.12 on the evaluation of a taxpayer’s separate and combined transactions and paragraph 3.37 on the use of non-transactional third party data ... Read more

TPG2017 Chapter II paragraph 2.84

Costs and revenues that are not related to the controlled transaction under review should be excluded where they materially affect comparability with uncontrolled transactions. An appropriate level of segmentation of the taxpayer’s financial data is needed when determining or testing the net profit it earns from a controlled transaction (or from transactions that are appropriately aggregated according to the guidance at paragraphs 3.9-3.12). Therefore, it would be inappropriate to apply the transactional net margin method on a company-wide basis if the company engages in a variety of different controlled transactions that cannot be appropriately compared on an aggregate basis with those of an independent enterprise ... Read more

TPG2017 Chapter II paragraph 2.83

As a matter of principle, only those items that (a) directly or indirectly relate to the controlled transaction at hand and (b) are of an operating nature should be taken into account in the determination of the net profit indicator for the application of the transactional net margin method ... Read more

TPG2017 Chapter II paragraph 2.81

Another important aspect of comparability is measurement consistency. The net profit indicators must be measured consistently between the associated enterprise and the independent enterprise. In addition, there may be differences in the treatment across enterprises of operating expenses and non-operating expenses affecting the net profits such as depreciation and reserves or provisions that would need to be accounted for in order to achieve reliable comparability ... Read more

TPG2017 Chapter II paragraph 2.77

Net profit indicators may be directly affected by such forces operating in the industry as follows: threat of new entrants, competitive position, management efficiency and individual strategies, threat of substitute products, varying cost structures (as reflected, for example, in the age of plant and equipment), differences in the cost of capital (e.g. self- financing versus borrowing), and the degree of business experience (e.g. whether the business is in a start-up phase or is mature). Each of these factors in turn can be influenced by numerous other elements. For example, the level of the threat of new entrants will be determined by such elements as product differentiation, capital requirements, and government subsidies and regulations. Some of these elements also may impact the application of the traditional transaction methods ... Read more

TPG2017 Chapter II paragraph 2.76

The use of net profit indicators can potentially introduce a greater element of volatility into the determination of transfer prices for two reasons. First, net profit indicators can be influenced by some factors that do not have an effect (or have a less substantial or direct effect) on gross margins and prices, because of the potential for variation of operating expenses across enterprises. Second, net profit indicators can be influenced by some of the same factors, such as competitive position, that can influence price and gross margins, but the effect of these factors may not be as readily eliminated. In the traditional transaction methods, the effect of these factors may be eliminated as a natural consequence of insisting upon greater product and function similarity. Depending on the facts and circumstances of the case and in particular on the effect of the functional differences on the cost structure and on the revenue of the potential comparables, net profit indicators can be ... Read more

TPG2017 Chapter II paragraph 2.70

There are also a number of weaknesses to the transactional net margin method. The net profit indicator of a taxpayer can be influenced by some factors that would either not have an effect, or have a less substantial or direct effect, on price or gross margins between independent parties. These aspects may make accurate and reliable determinations of arm’s length net profit indicators difficult. Thus, it is important to provide some detailed guidance on establishing comparability for the transactional net margin method, as set forth in paragraphs 2.74-2.81 below ... Read more

TPG2017 Chapter II paragraph 2.64

The transactional net margin method examines the net profit relative to an appropriate base (e.g. costs, sales, assets) that a taxpayer realises from a controlled transaction (or transactions that are appropriate to aggregate under the principles of paragraphs 3.9-3.12). Thus, a transactional net margin method operates in a manner similar to the cost plus and resale price methods. This similarity means that in order to be applied reliably, the transactional net margin method must be applied in a manner consistent with the manner in which the resale price or cost plus method is applied. This means in particular that the net profit indicator of the taxpayer from the controlled transaction (or transactions that are appropriate to aggregate under the principles of paragraphs 3.9-3.12) should ideally be established by reference to the net profit indicator that the same taxpayer earns in comparable uncontrolled transactions, i.e. by reference to “internal comparables” (see paragraphs 3.27-3.28). Where this is not possible, the net margin ... Read more

TPG2017 Chapter I paragraph 1.9

The arm’s length principle has also been found to work effectively in the vast majority of cases. For example, there are many cases involving the purchase and sale of commodities and the lending of money where an arm’s length price may readily be found in a comparable transaction undertaken by comparable independent enterprises under comparable circumstances. There are also many cases where a relevant comparison of transactions can be made at the level of financial indicators such as mark-up on costs, gross margin, or net profit indicators. Nevertheless, there are some significant cases in which the arm’s length principle is difficult and complicated to apply, for example, in MNE groups dealing in the integrated production of highly specialised goods, in unique intangibles, and/or in the provision of specialised services. Solutions exist to deal with such difficult cases, including the use of the transactional profit split method described in Chapter II, Part III of these Guidelines in those situations where it ... Read more
India vs BG Exploration and Production Ltd., April 2017, Income Tax Appellate Tribunal Delhi, Case no. 2227/Del/2014 & CO 13/Del/2015

India vs BG Exploration and Production Ltd., April 2017, Income Tax Appellate Tribunal Delhi, Case no. 2227/Del/2014 & CO 13/Del/2015

BG Exploration and Production Ltd. had determined the remuneration for various services provided on an aggregated basis by applying the TNMM method using profit to sales as the Profit Level Indicator. The tax authorities found that a CUP method was the most appropriate method and that the various services provided should be priced separately. On that basis an assessment was issued. BG E&P filed a complaint and the Dispute Resolution Panel set aside the assessment. “Consequently, after verifying that assessee has demonstrated need for those services, benefit derived from those services, evidence of receipt of such services and submitting that those services are neither duplicative in nature and nor are share holder activities, the DRP directed the Ld. transfer pricing officer to delete the adjustment proposed with respect to the intragroup services of Rs. 3329766244/–, deserves to be upheld.” The tax authorities then filed an appeal with the Income Tax Tribunal. Judgement of the Tribunal. “The main issue under these ... Read more