Transfer pricing

Transfer pricing in case law: use of comparison data to determine transfer price

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In this series of articles, we give an overview of case law on international transfer pricing practices.

Author: Parol Jalakas

The Tetra Pak case illustrates the fact that a proper comparability analysis cannot be skipped when determining transfer price. The Danish tax authority increased the taxable income of Tetra Pak Processing Systems A/S due to shortcomings in transfer pricing documentation and continuous losses. The Danish Supreme Court reached the conclusion that the transfer pricing documentation filed by the company did not meet the requirements as the documentation lacked a competent comparability analysis.

More information on the rules and requirements governing transfer pricing can be found in our articles:

Documenting transfer prices to keep tax risks under control

The nine steps for determining transfer pricing

What was the substance of the court decision?

The Danish company Tetra Pak Processing Systems A/S is part of Tetra Pak Group, and Tetra Pak Group is owned by Tetra Laval Group. Tetra Pak Processing Systems A/S is part of Tetra Pak Group’s Processing Solutions business arm, which makes up close to one-tenth of the group.

Tetra Pak Processing Systems A/S (hereinafter Tetra Pak) develops and produces processing plants for ice cream producers, which are marketed through distributors owned by the group. The product range is wide – from equipment, such as deep freezers, to entire processing units. The group is represented through distributors – related parties – in more than 165 countries on six continents. The intragroup transactions between Tetra Pak and its distributors encompass processing plants, spare parts, service and upgrades.

The court case concerns an increase in Tetra Pak’s taxable income in the years from 2005–2009. On 16 December 2011, the Danish Tax Agency decided to increase Tetra Pak’s taxable income by a total of 353,384,000 Danish kroner (47,500,000 euros). The Tax Agency maintained that Tetra Pak did not follow the arm’s length principle when it conducted transactions with related parties.

A higher administrative court found that Tetra Pak’s transfer pricing documentation in 2005–2009 did not encompass comparability analysis and thus transfer prices were determined solely based on Tetra Pak’s own opinion. The documentation failed to adequately analyse how much profit non-related parties would have earned in the case of a comparable transaction. In determining the transfer price, Tetra Pak relied on estimated sales volumes, transactions with related sales companies, transactions with other group companies and sales figures that could not be attributed to specific product groups. In other words, the data used for determining transfer price were untrustworthy and inappropriate.

Both the Danish tax court and the Supreme Court ruled that the Danish tax authority was unable to determine on the basis of the documentation submitted by Tetra Pak whether the arm’s length principle was met in transactions conducted with related parties. Documentation this flawed was considered the equivalent of failing to file documentation altogether.

Use of comparable data to determine transfer price

Tetra Pak’s transfer pricing documentation relied on its resale method and determined transfer pricing based on the operation profitability for the group’s sales enterprises. In this method, the distributor’s gross profit margin is subtracted from the price the product is sold to the end customer. The gross profit margin should match market value – i.e., it should fairly correspond to the distributor’s functions, risks and assets used in its enterprise.

The group’s sales enterprises’ average profit margin set out in the documentation during the period 2006-2008 was about 7%, suggesting that it was reasonable in light of the sales enterprises’ risks, responsibility and investments. This profit margin was based on the company’s business judgment – i.e. its business experience, knowledge of the market situation and the above-mentioned intragroup sales figures. In retrospect, this argumentation proved weak in the eyes of the tax authority and did not comply with the OECD’s standards for determining transfer price.

Where can suitable comparison data be found for determining arm’s length value?

Determining arm’s length transfer price requires the use of appropriate market data. The precise choice of data (e.g. unit price, mark-up for costs, operating profit margin, return on assets etc.) depends on which transfer pricing method is used. Comparable data can come from within the group (e.g. the group’s production arm sells the same product on identical conditions to both a related-party distributor and an independent distributor) or from outside the company (e.g. market analyses, databases).

Correct collection and analysis of comparison data for finding the market value is central for the purposes of transfer price documentation. Grant Thornton Baltic can be of assistance to clients in this area – we have an arsenal of the same tools also used by tax authorities to verify arm's length value in transfer pricing, such as Bureau van Dijk Amadeus (data on European companies), Royalty Range (licensing fee rates), Valutico (company valuations) and S&P Capital IQ (real-time data on a number of asset classes).