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Transfer Pricing Cases of 2020: Case Summaries

Jan. 15, 2021, 8:00 AM

In an earlier article the key transfer pricing cases of 2020 were identified and analyzed to draw out the key themes across the year and over recent years. In this article the cases themselves are summarized, making links to each other and to earlier cases.

Australia

Glencore Investment Pty, Federal Court of Australia Full Court (Case No. [2020] FCAFC 187)

On Sept. 3, 2019, the Federal Court of Australia found for the taxpayer in the case of Glencore Investment Pty. Ltd. The Australian Tax Office appealed to the Full Federal Court of Australia and its judgment was published on Nov. 6, 2020.

The taxpayer had switched to transacting for goods with its Swiss related party Glencore International AG on a new transfer pricing basis, which the ATO wished to set aside on the grounds that it was not commercially rational. This was not accepted by the court, following the decisions in Chevron Australia Holdings Pty. Ltd. ((No 4) (2015) 102 ATR 13; [2015] FCA 1092, (2017), 251 FCR 40; [2017] FCAFC 62). In its appeal, the ATO argued that it is significant that the taxpayer had not shown evidence of arm’s-length parties amending their agreement in the way that Glencore did (i.e. the argument used successfully by the taxpayer in Altera before the decision was overturned in the U.S. Court of Appeals for the Ninth Circuit—see below). It also argued that there are no sufficiently comparable third party agreements for the revised transfer pricing arrangements (despite the decision in SNF (Australia) Pty. Ltd. ((2011) 193 FCR 149) that the bar for comparability must not be set unreasonably high).

The court ruled that the third party agreements were not sufficiently comparable to be used as price benchmarks but nevertheless they confirmed that there was nothing in the related-party agreement that could not be found in contracts between independent parties. The court placed great weight on evidence about norms and conditions in the industry at the time of the related-party transaction, and in particular the evidence of a single industry expert. He confirmed that the new commercial arrangement was “commercial and prudent”, given the benefit to the taxpayer of shifting out of a highly volatile price arrangement at the start of the 2007-2008 economic crisis.

The ATO may be able to appeal to the Australian High Court. See also the Mopani (Glencore Zambia) case below involving a similar arrangement.

Canada

Cameco Corporation, Canadian Federal Court of Appeal (Case No. 2020 FCA 112)
On June 26, 2020, the Canadian Federal Court of Appeal upheld the 2018 decision of the Canadian Tax Court (2018 TCC 195) that Cameco Corporation (of Canada) had transacted with its Swiss subsidiary on arm’s-length terms. The court rejected the Canada Revenue Agency’s argument that the arrangement with the subsidiary should be recharacterised, on the basis that it had not been shown that the arrangements would not have been entered into by arm’s-length parties. This was the first case to consider the recharacterisation provision in Canada’s Income Tax Act. On Oct. 30, 2020, the tax administration announced that it would appeal the decision to the Supreme Court.

AgraCity Ltd., Tax Court of Canada (Case No. 2020 TCC 91)
On Aug. 27, 2020, the Tax Court of Canada gave its decision in the case of AgraCity Ltd. This company originally distributed herbicides to the Canadian end customers of its related party, NewAgco Inc. (in the USA), which in turn purchased them from unrelated parties. The Canadian tax administration did not challenge the transfer pricing arrangements (which left most of the profit outside Canada) until the procurement role of NewAgco Inc US was transferred to another related party, NewAgco Inc, in Barbados. Concluding that NewAgco Barbados had no employees or assets, the tax administration reallocated its profits to AgraCity Ltd.

The court ruled in favour of the taxpayer, on three counts, as follows:

  • Sham—as confirmed in Cameco, a transaction is not a sham simply because it is devoid of economic substance, lacks a business purpose, or serves a tax avoidance purpose. It is also necessary for the parties to misrepresent the nature of their arrangements (for example, in their documents), that is, the actual rights and obligations of the parties. The tax administration had not produced a convincing body of circumstantial evidence to show this misrepresentation.
  • Recharacterization—as confirmed in Cameco, recharacterization can only be justified when a transaction would not have been entered into between independent parties, and was entered into primarily to obtain a tax benefit, and a more rational transaction can be identified. It is then necessary to price that alternative transaction, and it is not permissible for the tax administration to simply assume that no transaction would have taken place. The tax administration failed to produce evidence to show that an arm’s-length party would not have entered into any transaction with NewAgco Bahamas.
  • Transfer pricing—as also confirmed in Cameco, the transfer pricing rules only allow the substitution of a different set of terms and conditions, not the assumption of no transaction. As only the taxpayer had presented any evidence as to arm’s-length pricing for the taxpayer’s transaction, this had to be accepted.

It is interesting that the tax administration pointed to those sections of the OECD Transfer Pricing that state profit from bearing risk or bringing to bear intangible assets cannot be allocated to a party if it does not have the senior personnel who are capable of managing those risks and assets. However, the court made much of the unique license which NewAgco Bahamas inherited to sell the popular product into the Canadian market, notwithstanding its lack of personnel who could manage the IP.

It is also interesting that the court accepted the taxpayer’s new benchmarking report, although the taxpayer had not prepared contemporaneous transfer pricing documentation.

This decision has similarities to the ones in ECCO and Apple below.

Denmark

Engine Branch,Danish National Tax Tribunal (Case No. SKM 2020:30.LSR)
On Jan. 22, 2020, the Danish National Tax Tribunal published its decision in the case of a Danish subsidiary (later a branch) of a German engineering company. The Danish subsidiary helped a German subsidiary to adapt its core engine designs for use in a new situation (for no charge). The Danish subsidiary then agreed to market these new designs, which it would do by licensing them from the German subsidiary and then licensing them on to unrelated parties. In return for the royalties which it received from its customers, the Danish subsidiary would also adapt the engine designs further for the customer’s particular needs.

The companies did not carry out a formal transfer pricing exercise, but they agreed that the Danish company would keep half of its royalty income. This was intended to reward it for (a) its original work to modify the IP, (b) its marketing of the designs, and (c) the adaptation services which it provided to its customers. The companies described this as a profit split method.

Eventually, the German subsidiary decided to terminate the agreement and market the designs itself, providing the adaptation services to the customers. The parties agreed that the Danish subsidiary should receive a termination payment. They referred to termination clauses in other license agreements and concluded that the Danish subsidiary should receive the equivalent of two years’ worth of lost profits.

The tribunal agreed with the tax tribunal that the original adaptation of the designs was a crucial factor in how to calculate the termination fee—in particular, that rather than being a service activity which was later rewarded by a share of royalty income, the original adaptation work had created a lasting intangible asset. This meant that rather than referring to termination clauses in license agreements, the appropriate approach was to perform the valuation of the transferred asset. This should be done on a discounted cash flow basis.

The taxpayer was not successful in sustaining its arguments that:

  • The license agreement should be respected and so it was not appropriate to break it down and analyse its separate components. The Danish subsidiary was rewarded for its early adaptation work through its share of the royalty income. Termination clauses in other license agreements therefore provided the most reliable method of calculating the termination payment.
  • As only part of its income could be the result of the alleged asset (the rest being created by marketing and by customer services), the valuation should not be based on a long-term present value of the entire profit of the company. Instead, part of it should be based on only two years’ worth of the non-asset related component of the profit.

Adecco A/S, Supreme Court of Denmark (Case No. BS-42036/2019-HJR)
On June 25, 2020, the Supreme Court of Denmark ruled in favor of employment agency Adecco A/S, finding that its royalty payments to its Swiss parent Adecco SA should be deductible notwithstanding the losses reported by the licensee over several years. The tax administration argued, inter alia, that the subsidiary was kept going so that other group companies could guarantee their clients an international service. This argument had been accepted by the National Tax Tribunal and Eastern High Court (SKM2019.537.OLR) and was accepted in principle by the Supreme Court, but the court did not feel that the tax administration had provided sufficient evidence to support the argument, or to prove that:

  • the high local marketing expenditure meant that the IP had less value locally (so that the royalty should be lower),
  • there should have been a separately-rewarded marketing service, or
  • there were insurmountable comparability differences between the Danish license transaction and the company’s benchmarks.

In particular, the tax administration had not shown what the royalty rate should have been, rather than moving straight to a different method (the TNMM).

The taxpayer successfully explained its losses by reference to its ambitious but unsuccessful business expansion strategy.

Pharma Distributor A/S, Eastern High Court of Denmark (Case No. SKM2020.105.OLR)
On March 11, 2020, the Eastern High Court of Denmark released its ruling in the case of a pharmaceutical distribution subsidiary that achieved profit margins significantly below the benchmarked range. Unlike the National Tax Tribunal, the Eastern High Court ruled that the company’s goodwill amortization costs could not be added back to the profit margin of the company before comparing it with the independent company EBIT benchmarks. While this was permissible in principle, the taxpayer had not proven that the benchmark companies had similar goodwill and that they had not capitalized/amortized it.

Ice Machine Manufacturer A/S, Danish Western High Court (Case No. SKM2020.224.VLR)
On June 8, 2020, the Danish Western High Court released its decision in the case of a local manufacturing subsidiary that reported continued losses. The company produced machinery, which was used in the production of packaging of ice cream. It was quite autonomous in its group, had a high level of expertise, and was the world leader. However, although its sales were high value they were also irregular. The company viewed itself as the risk-taking entrepreneur which engaged its related-party sales companies to help to find customers but which often provided its technical knowledge to help them to complete the sale.

The taxpayer had reported at least 10 years of losses while its group remained profitable. The court concluded that the company had not been able to show any extraordinary circumstances to justify its losses. It had not identified reliable comparables for the sales companies and had had to estimate some of the figures. Further, the court decided that the high profit margins of the related-party sales companies did not fit with the taxpayer’s description of them, which was a further reason to consider benchmarking the taxpayer instead.

The court ruled that in this case the tax administration was justified in adjusting the results of the company by reference to the net margins of comparable companies, given the inadequate taxpayer transfer pricing benchmarking and documentation.

ECCO Sko A/S, Danish Western High Court (Case No. BS-714/2016 – VLR ECCO Sko A/S)
On July 2, 2020, the Danish Western High Court ruled in favor of ECCO Sko A/S, the Danish parent company of two foreign shoe manufacturing subsidiaries. The court concluded that the Danish Tax Agency had not proven that the taxpayer’s transfer pricing documentation was inadequate, and, if so, that the Tax Agency was entitled to make a discretionary assessment of the income of the company. In reaching its decision the court accepted both transfer pricing documentation prepared at the time of the transaction and transfer pricing documentation prepared in connected with the later tax audit. On this basis, the court decided that the documentation was adequate so that no discretionary assessment was permitted.

Furthermore, the court concluded that the documentation gave an adequate explanation for why the taxpayer made a lower profit margin when it resold its subsidiaries’ products than when it resold shoes made by unrelated manufacturers.

Finally, the court ruled that it was appropriate for the company to sets its transfer prices on the basis of the budgeted costs of the subsidiaries, and that those costs had not been over-budgeted.

The tax administration decided not to appeal to the Supreme Court, and so the decision is final.

European Union

Apple Sales International and Apple Operations Europe (General Court of the European Union (Cases T-7778/16 and T-892/16)
On July 15, 2020, the General Court of the European Union released its decision in the case of Apple Sales International and Apple Operations Europe, which was that the companies had not in fact received illegal state aid from Ireland in the form of agreement to non-arm’s-length methods of profit attribution to the two local permanent establishments. It did not agree with the European Commission that the apparent inability of the head offices of the companies to perform their purported roles was evidence of state aid, because Irish law at the time would also have required the tax administration to confirm that the key profit-generating assets (IP licenses) were under the control of the Irish branches in order to tax that profit, and the Commission had not shown that they were under the control of the branches. Rather, it had merely inferred a wider role for the branches.

On Sept. 25, 2020, the European Commission announced that it would appeal the decision to the Court of Justice of the European Union, on the grounds of a number of errors of law.

See the similar decision in an intercompany situation in AgraCity above.

Finland

A Oy, Supreme Administrative Court of Finland (Case No. KHO:2020:34)
On April 2, 2020, the Supreme Administrative Court of Finland prevented the tax administration from disallowing the almost continuous losses of a local office supplies marketing and sales subsidiary over the period 2003-2011, while at the same time its group as a whole was profitable. The subsidiary purchased goods directly from related-party contract manufacturers, which were allowed to earn a benchmarked EBITDA margin of 2%. In addition the taxpayer paid trademark royalties, administrative service fees and interest to related parties.

The court accepted that there were valid business reasons for the taxpayer’s losses (in particular, a failed strategy of raising prices) and that the tax administration was not allowed to choose the sales company as the tested party without showing why this was a better approach (i.e. better comparability of the sales company comparables than of the manufacturing company and other transaction comparables). The court accepted that the contract manufacturers only made to the order of the sales company and that it was contractually the risk-bearer and also able to manage these risks, so that the contract manufacturers should be the tested parties in the goods transactions.

The court did not accept the argument that the sales company was making an unrecognised supply to other group companies for which it should have received a separate service fee, because the tax administration had not confirmed the existence of such a service or that it was not properly remunerated.

A Oyj, Supreme Administrative Court of Finland (Case No. KHO:2020:35)
Also on April 2 2020, the Supreme Administrative Court of Finland ruled in the case of a contractual transfer of a machinery and equipment rental group’s financing functions (in fact a transfer of existing related-party loans) from the Finnish parent company (the taxpayer) to its new Belgian group finance company subsidiary. The loan assets were transferred as a contribution in kind in return for shares in the new subsidiary, which itself was almost debt-free.

The taxpayer paid the new subsidiary a service fee for performing the treasury functions and this fee was set so as to provide the subsidiary with an arm’s-length rate of return on its investment (i.e. its equity lent to other group companies). The taxpayer would bear any shortfall in the interest income compared to this arm’s-length rate of return (for example, caused by exchange rate losses—a kind of hedging service).

The tax administration proposed instead that the new subsidiary should receive a risk-free rate of return on its investment plus a cost-plus service fee for its functions, on the basis that the key risk decisions were still taken by the parent company (in particular, the new subsidiary acted on the recommendations of the group treasury committee and the members of the treasury committee were employees of the parent company).

Even though the parent company continued to perform some significant financing functions, the court ruled that this did not entitle the tax administration to recharacterize the transaction or to ignore the transfer. It had not been shown that the reorganization of the group’s financial activities had been carried out for tax avoidance purposes.

India

Kellogg India Private Limited, Mumbai Income Tax Appellate Tribunal (Case No. ITA 1906/MUM 2016, 2262/MUM/2016 & 2314/MUM/2017)
On Feb, 24, 2020, the Mumbai Income Tax Appellate Tribunal gave its decision in the case of Kellogg India Private Limited. The tax administration contended that a related party had sufficient influence over the advertising, marketing and promotion (AMP) expenditure of the taxpayer to make it possible that this expenditure was beyond the optimal level for the taxpayer (if this would benefit the related party). The tax administration therefore sought to identify the arm’s-length amount of deductible AMP expenditure, which it did by comparing the taxpayer’s ratio of AMP expenditure to sales to that of comparable companies (in fact, only to two potential comparables).

The court decided that as the taxpayer operated under license from the related party, it incurred AMP expenditure to exploit its license (i.e. for its own benefit only). Furthermore, it was significant that the tax administration had not presented any agreement between the parties under which the taxpayer was obliged to promote the brand of the related party. Finally, it rejected the tax adjustment because in general it did not agree that the “Bright Line Test” was a valid benchmarking approach.

This case is one of the latest in a long saga of such AMP Bright Line Test cases going back many years (see, for example, Maruti Suzuki India Ltd., Delhi High Court, Case No. 2010-TII-01-DELTP), in which it had seemed some time ago that the principles had become so well-established for there to be no scope left for an unsuccessful assessment to be attempted by the tax administration. In particular, the decisions seemed to have the reached the point of acknowledging that the optimal intensity of AMP expenditure would be different for every company, making the simplistic Bright Line Test redundant.

Corbus (India) Private Limited, Delhi Income Tax Appellate Tribunal (Case No. ITA No. 2745/Del/2015)
On March 5, 2020, the Delhi Income Tax Appellate Tribunal published its decision in the case of Corbus (India) Private Limited (now Corbus (India) LLP). The taxpayer provided information technology services to its U.K. related party Global Technologies International Corporation Limited. The tax administration did not challenge the level of the service fees but recharacterized the outstanding receivables (late payment of the service fees) in excess of 45 days as loans bearing an interest rate of 17.77%.

The taxpayer argued that the receivables were not a separate transaction which could be treated as loans, that the taxpayer’s operating profit margin was very high (45.88%), that it also permitted interest-free extended credit to unrelated parties and that it was not funding the extended credit out of any related-party interest-bearing debt.

The tribunal referred to earlier Indian decisions such as Nimbus Communications (ITA No. 8697/Mum/2009) and Bharti Airtel Limited (ITA No. 5816/DEL/2012) which established that receivables could not be separated from sales transactions and that it was only necessary to consider the pricing of the sales transaction (unless the substance of the sales transaction was different from its legal form). The tribunal noted that the arm’s-length median operating margin for comparable companies, after an adjustment for their lower accounts receivable, was only 22.07% so that it followed that the interest-free extended credit should be accepted as a profitable business strategy.

This decision was subsequently confirmed by the Hyderabad ITAT on Sept. 4, 2020, in the case of ValueLabs Technologies LLP (Case No. ITA 1921/HYD/2018), with a similar fact pattern and for the same reasons.

Toyota Kirloskar Auto Parts Private Limited, BangaloreIncome Tax Appellate Tribunal (Case No. IT(TP)A No. 1915/Bang/2017)
On March 18, 2020, the Bangalore Income Tax Appellate Tribunal issued its decision in the case of Toyota Kirloskar Auto Parts Private Limited.

The taxpayer manufactured automotive parts, which it sold to its related party Toyota Kirloskar Motors Limited (in India), making use of technical know-how which it licensed from another related party Toyota Motor Corporation (in Japan). The levels of the goods prices and royalties were set in combination so as to leave the taxpayer with an overall arm’s-length net profit margin.

The tax administration argued that the original know-how had been replaced by new know-how which was the result of subsequent Japanese research and development, and was subject to subsequent exploitation by the taxpayer as entrepreneur. The tax administration argued that this justified the use of a new (profit split) method between developer and exploiter.

The tribunal decided that the original know-how was not exclusively linked to the start-up phase of the taxpayer’s business, and, therefore, that the same transfer pricing method should be applied throughout the period since start-up. Furthermore, the taxpayer was not involved in research and development, made no unique and valuable contribution, the business operations were not integrated and the risks were not shared or closely related (e.g. the Japanese company was not involved in the risky exploitation of the know-how in India). The fact that the taxpayer chose to combine the know-how and goods transactions in its transfer pricing policy did not mean that separate arm’s-length prices could not have been determined for each of these transactions. Therefore the tribunal ruled that a profit split method was not necessary or even preferable, and that the taxpayer’s overall net margin approach was acceptable.

Federal Mogul Anand Bearing India Ltd., Mumbai Income Tax Appellate Tribunal (Case No. TS-580-ITAT-2020(MUM)-TP)
On July 9, 2020, the Mumbai Income Tax Appellate Tribunal ruled in the case of Federal Mogul Anand Bearing India Ltd. The taxpayer is a manufacturer of automotive components. The tax administration imputed a higher operating profit for the company based on a comparable, which the tax administration had identified. The court rejected this comparable for the following reasons:

  • the proposed benchmark company was much larger than the tested party and it could therefore be assumed that it would benefit to a greater extent from economies of scale (reference was made to DHL Express (India) Pvt Ltd);
  • the proposed benchmark company had been established for much longer and had become a market leader with more established and extensive relationships with its customers, so that it could be assumed that it had more valuable intangible assets (reference was made to Maersk Global Service Centre India Pvt Ltd and Lubrizol Advanced Materials India Private Limited); and
  • the tax administration did not reveal how it had selected its proposed benchmark company, so that the possibility of “cherry-picking” of comparables by the tax administration could not be ruled out (reference was made to Bayer Material Science Pvt Ltd, Mentor Graphics (Noida) Ltd, Toshiba India Pvt Ltd, and Allscripts India Pvt. Ltd).

The court also ruled that working capital adjustments could be made to the financial results of comparable companies.

KEC International Ltd., Mumbai Income Tax Appellate Tribunal (Case No. ITA 17 & 115/MUM/2018)
On Sept. 14, 2020, the Mumbai Income Tax Appellate Tribunal ruled in the case of KEC International Ltd, a company involved in the manufacturing and installation of electrical and telecommunications equipment. The tax administration had imputed interest on interest-free loans which the taxpayer had made to a related party, which was a joint venture with an unrelated party. The taxpayer argued that the loans were necessary to see the JV through a short term cash flow problem, and it was to the long term advantage of the taxpayer to advance them even without interest being payable. The court agreed and deleted the tax assessment.

Italy

Società Italiana Per L’Oleodotto Transalpino SPA, Italian Court of Cassation (Case No. Sez. 5 Num. 11837 2020)
On Feb, 25, 2020, the Italian Court of Cassation (the supreme court) gave its decision in the case of Societa Italianà Per L’Oleodotto Transalpino SPA. The taxpayer operates the transalpine oil pipeline together with its Austrian and German related parties.

The three companies had used a gross profit split method based on kilometers of pipeline and value of fixed assets; the tax administration added a third factor, namely expenditure on plant maintenance, considering (a) that this was also an important contributor to value-added, and (b) that this was much higher for the taxpayer given that it operated the uphill section of the pipeline and would therefore have been taken into account in an arm’s-length negotiation.

The court upheld that part of the appeal of the tax administration that related to the failure of the lower level court to explain why the taxpayer’s profit split method was capable of producing an arm’s-length outcome, because that court did not examine in depth each party’s contribution which in turn caused it to overlook a major factor (i.e. plant maintenance expenditure).

Netherlands

Zinc Smelter B.V., Netherlands Court of Appeal (Case No. 17/00714)
On March 13, 2020, the Netherlands Court of Appeal gave its decision in the case of Zinc Smelter B.V. (published on April 16, 2020). In 2010 the taxpayer transferred part of its activity to a Swiss related party and switched from being an entrepreneur to being a toll manufacturer (smelter) receiving a cost plus fee.

The court was asked to consider whether the level of the conversion fee (compensation payment) and the new transfer pricing method were appropriate.

In fact the parties reached agreement after the hearings and these were recorded by the court as follows:

  • after the partial business transfer, the parties were engaged in joint activities such that a profit split method should have been used;
  • there were no routine activities, so a contribution (total) profit split was most appropriate; and
  • the functions, assets, and risks of the taxpayer generated 72% of the total profit after the transfer, so that the conversion fee should have been the present value of 28% of the total profit.

Nigeria

Prime Plastichem Nigeria Limited, Nigerian Tax Appeal Tribunal (Case No. TAT/LZ/CIT/015/2017)
On Feb, 19, 2020, the Nigerian Tax Appeal Tribunal gave its decision (the first transfer pricing judgment in Nigeria) in the case of Prime Plastichem Nigeria Limited. The company traded in imported plastics and petrochemicals, purchasing them from a foreign related party Vinmar Overseas Limited (in the USA). While this related party also sold to another Nigerian related party (Vinmar International Limited), these related-party transactions were used as internal comparable prices. When these other Nigerian sales ended, the transfer pricing method was changed and the prices were set to leave the taxpayer with an arm’s-length net profit margin as benchmarked against independent companies.

The tribunal decided that the taxpayer had not provided sufficient evidence to confirm that its comparable uncontrolled prices (CUPs) or its transactional net margin method (TNMM) comparables were reliable benchmarks or why its transfer pricing method should have changed. The tribunal ruled that a gross margin method would be more reliable in both periods, and anyway expressed strong concerns about any changes to a company’s transfer pricing methods where the functional analysis had not changed, unless it was necessitated by a clear change in the availability of reliable benchmark data.

The trial proceeded without expert witnesses and detailed analysis, and there was some confusion about terminology (TNMM versus resale price method) and as to why the related-party transactions were not reliable CUPs.

Norway

Orange Business Norway AS, Norwegian Court of Appeal (Case No. LB-2018-84331)
On Jan. 20, 2020, the Norwegian Court of Appeal issued its judgment in the case of Orange BusinessNorway AS. The taxpayer had switched from being a cost plus service provider in a central entrepreneur model to being a provider of high value services in a profit split model (thereby sharing the losses of the original central entrepreneur company Orange S.A. in France). The tax administration assessed tax on the basis of the TNMM.

The court concluded that the highly integrated nature of the telecommunications services meant that the profit split method was the most appropriate.

Interestingly, the court adopted an ambulatory approach to the OECD Transfer Pricing Guidelines, but only to the extent that they supported the taxpayer’s position.

A/S Norske Shell, Norwegian Supreme Court (Case No. HR-2020-1130-A)
On May 29, 2020, the Norwegian Supreme Court issued its ruling in the case of A/S Norske Shell. The case concerned the results of the company’s extraction R&D projects, for which it recovered the costs from unrelated license partners and then made the results available to related parties for no further charge.

The court found in favor of the taxpayer, i.e. that no charges should have been made to the related parties for the costs already recovered from unrelated parties because the group companies were parties to a cost sharing agreement in which only net costs (i.e. excluding third party receipts) should be recharged.

U.K.

Irish Bank Resolution Corporation Limited and Irish Nationwide Building Society, Court of Appeal (Civil Division) (Case No. A3/2019/3060, [2020] EWCA Civ 1128)
On Aug. 28, 2020, the Court of Appeal for England & Wales (Civil Division) found that HMRC was correct to deny tax deductions claimed by the British branches of two Irish banks.

In this case, the issue was the amount which the branches of the banks could deduct for their notional payment of interest to their head offices. HMRC argued that U.K. law required the equity and loan capital of the permanent establishments to be assumed to be what they would be if they were standalone entities with the same credit rating as their head offices, and this was different from the amounts in their books of accounts. The taxpayers argued that the relevant paragraphs of the OECD model tax treaty referred to the permanent establishment as it is and not to a hypothetical permanent establishment with a different capital structure.

The Court of Appeal dismissed the taxpayers’ appeal because they had produced no new evidence as to why the model convention Article 8 reference to “an independent engaged in the same or similar business activities” ruled out attributing to this company the capital that it would need to carry on that business.

United States

Altera Corp., U.S. Supreme Court (Case No. 19-1009)
On June 22 2020 the U.S. Supreme Court announced that it would not review the Ninth Circuit June 7 2019 decision in the semiconductor manufacturer Altera Corp. case. That decision required the cost of employee stock option compensation to be included in R&D cost-sharing arrangements (in this case with a Cayman related party), notwithstanding the absence of evidence that independent parties have done so. However, the decision is expected to continue to be litigated in other courts.

The Coca-Cola Company, U.S. Tax Court (Case No. 155, T.C. No. 10)
On Nov. 18, 2020, the U.S. Tax Court found for the IRS in the case of The Coca-Cola Company. The company had allowed its foreign subsidiaries to retain profit equal to 10% of their gross sales and 50% of the remaining profit, in return for licensing the drink formula, proprietary manufacturing process, trademarks, and brand names, to manufacture the concentrate and to sell it to (mainly) third party bottlers (this transfer pricing policy was not actually stated in the transfer pricing agreements). The court agreed with the IRS that this formulary apportionment method of calculating the royalties under-rewarded the taxpayer for its valuable intangibles (it left the subsidiaries with average net margins on costs of around 57%, much higher than the profit margin of the IP owner), but rather than settling on a profit split method the court agreed with the IRS’s approach of using the CPM to benchmark the subsidiaries. In addition, the court accepted the IRS’s use of the independent bottlers as comparables for the related-party manufacturers, on the basis that they were also licensees of a similar bundle of intangibles for use in production and sales activities (albeit rather different ones). This was thought to be a conservative approach because the bottlers appeared to deserve higher returns than the subsidiaries. The arm’s-length mark-up for the subsidiaries was found to be 8.5%.

In addition, the return on assets was accepted as the appropriate profit level indicator. The CUP method was rejected because the taxpayer had not presented evidence of licenses involving a similar bundle of intangibles between independent parties (the third-party bottlers paid for their IP rights in the price of the concentrate, so they did not provide royalty benchmarks).

Zambia

Mopani Copper Mines Plc, Supreme Court of Zambia (Case No. 2017/24)
On May 26 2020, the Zambian Supreme Court gave its decision in the case of Mopani Copper Mines Plc.

The tax administration had assessed additional tax on the main basis that the taxpayer sold copper to its Swiss related party Glencore International AG at a significantly lower price than the price at which it sold copper to unrelated parties and could not fully explain the difference.

The taxpayer sold most of its output to Glencore International AG under a copper marketing and off-take agreement, with the latter company being responsible for sales and marketing of the copper. Contractually, the sales were to be made at an official London Metal Exchange price averaged over a quotation period, plus a premium/less a discount and less a realization charge for freight, and allowing Glencore International AG a 2% sales commission. In practice, a leaked (and contested) draft report by Grant Thornton identified a widening gap between the price achieved by the taxpayer and the LME price (much greater than the contractual 2% sales commission), which they attributed to the relatively long-term fixed prices agreed with its related party, excessive freight charges (based on the costs of delivery to a more distant location), inconsistent discounts, and unexplained deviations from the transfer pricing agreement. The report was the spur to further investigation by the OECD, the UN, and the EU.

The court dismissed the taxpayer’s appeal and ruled in favour of the tax administration. See also the Glencore Investment Pty. (Australia) case above.

Comments

As noted in the related article, the cases of 2018-2020 provide a strong body of references dealing with losses, deviations from transfer pricing agreements, and restructuring of related-party arrangements, and perhaps these rather than the December 2020 OECD guidance will prevent the courts from being dominated by Covid-19 related cases over the next few years.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Danny Beeton is of counsel in the London and Luxembourg offices of Arendt & Medernach. He can be contacted at: daniel.beeton@arendt.com. The views expressed in this article are those of the author only.

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