Finnish SAC ruling aligns the selection of an appropriate point in the arm’s length range with the OECD guidance
16 September 2021
On 13 September 2021 the Finnish Supreme Administrative Court (SAC) released a decision (KHO:2021:127) addressing the use of comparable data and the range of results in calculating transfer pricing adjustments. The SAC ruled in a favor of the taxpayer. According to the decision, the adjustment to the Finnish taxpayer’s taxable income should have been calculated by adjusting foreign subsidiaries’ results to the upper quartile of the range provided by the comparable companies, instead of the median. Interquartile range was determined to provide the arm`s length range of results in this case.
The parent company, A Oy, of A Group had been subject to transfer pricing audit covering the tax years 2010 - 2012. As an outcome of the audit the Finnish tax authorities concluded that A Oy had not received sufficient compensation for the use of its IP by some of the Group’s foreign subsidiaries.
As of 2011 A Group introduced a royalty model in which the amount of royalty was based on a profit split method. The profit exceeding a routine profitability level of the foreign subsidiaries was split between A Oy and its foreign subsidiaries in accordance with a contribution analysis. The routine profitability level was determined by preparing a benchmarking study. In 2011 only part of the A Group`s subsidiaries were part of the royalty arrangement.
Based on the benchmarking study A Group had determined a routine operating margin level of 4.5% for the subsidiaries included in the royalty arrangement. The determined routine profit was slightly above the median of the benchmarking results. Based on the tax reassessment decision, the same routine level should have been applied to all foreign subsidiaries that should have been included in the royalty arrangement. A Oy and the tax authorities shared the view that there are altogether nine relevant third party companies to be included in the benchmark study. The benchmark study gave a range from -0,24 percent to 13,50 percent.
In its appeal to the SAC A Oy presented two claims. As a primary claim, A Oy stated that when evaluating the arm`s length royalty the full range of the benchmarking study should be accepted as the arm`s length range and the reassessment should be limited by calculating the routine profit of the foreign subsidiaries based on the maximum value of the full range. As a secondary claim, A Oy stated that when evaluating an arm’s length royalty the interquartile range provided by the benchmarking study should be accepted as the arm`s length range and the reassessment should be limited by calculating the routine profit of the foreign subsidiaries based on the upper quartile of the arm’s length range.
In its decision the SAC ruled that in line with the OECD Transfer Pricing Guidelines 2010) paragraph 3.57, statistical tools could be used to determine the arm’s length level of subsidiaries’ routine compensation. This conclusion was impacted by the number of the comparable companies, the dispersion of the comparable companies’ operating margin results and the fact that results of some of the comparable companies earned less than the routine profitability level determined by A Group. The SAC concluded that the royalties charged by A Oy from its subsidiaries were at arm’s length provided that the subsidiaries profitability was within the interquartile range. Adjustments could be made only to the extent the foreign subsidiaries’ profits exceeded the interquartile range and the adjustment needs to be calculated based on the upper quartile of the range, not median. The SAC refers to the OECD Transfer Pricing Guidelines paragraph 3.60 stating that: “If the relevant condition of the controlled transaction (e.g. price or margin) is within the arm’s length range, no adjustment should be made”. Thereby, the SAC removed the reassessments that resulted from the subsidiaries’ operating margin within the interquartile range 4.5-8.4%.
In the ruling the SAC confirmed, in alignment with the OECD Transfer Pricing Guidelines, that the determination of the applicable point in the arm’s length range is subject to case by case analysis. Median, use of which has been the prevailing practice in Finland in transfer pricing related reassessments, does not present the only and absolute arm’s length value. In its reasoning, the SAC referred to the OECD Transfer Pricing Guidelines paragraphs 3.57 and 3.60, according to which statistical tools may be helpful in narrowing wide range of results achieved by the comparable companies study but an adjustment should not be made if the tested party’s result already is within the arm’s length range. The interpretation is also aligned with court practice in several other countries.
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