Landmark TP case from the Finnish Supreme Administrative Court
In today’s landmark decision KHO 2018:173, the Finnish Supreme Administrative Court (SAC) overturned previous decisions of the Helsinki Regional Administrative Court and the Finnish Tax Administration (FTA) and struck down transfer pricing adjustments amounting to 50 million euros for years 2006-2008.
A Ltd is a parent company for Group A that manufactures and sells insulation products in Finland and in other European countries. In 2006-2008, Group had manufacturing units in Finland, Poland, Sweden and Lithuania, and sales units in 13 European countries. Manufacturing units compensated the use of A Ltd’s technology with royalty payments. Royalty rates were set with CUP-method. Sales of raw materials from A Ltd to the manufacturing units were priced with cost plus method. Product sales from manufacturing units to sales units were priced with resale price method.
FTA conducted a transfer pricing audit for years 2006-2008. FTA disregarded the transfer pricing methods that A Ltd had actually applied and documented. FTA claimed that Group A’s business operations were highly integrated and that the key value driver of the business was technology that was owned by A Ltd. FTA calculated the transfer pricing adjustments for years 2006-2008 by applying residual profit split method. FTA defined a routine profit to each local unit, and thereafter the residual profit was allocated on the basis of technology related costs. Most of the residual profit was allocated to A Ltd.
A Ltd appealed FTA’s reassessment decisions and subsequently the decision of the Board of Adjustment. A Ltd claimed that the reassessment amounts to re-characterization of transactions which is prohibited in case SAC 2014:119, and that the transfer pricing adjustment is not based on correct factual basis. Although Helsinki Regional Administrative Court arranged an oral hearing, it declined the company’s appeal on February 2017.
In SAC, A Ltd demonstrated that the Group’s business operations were not highly integrated and that Group’s business and value creation depends on local manufacturing and sales activities. A Ltd also pointed out that allocation of residual profits to A Ltd would mean that value of the significant investments that manufacturing entities have made to local production capacity would turn out to be of negative value.
SAC held that Group’s manufacturing and sales activities are not integrated to the extent that would make it impossible to apply the traditional transfer pricing methods that A Ltd had actually applied and documented. Instead of disregarding the methods that A Ltd had actually applied, FTA could have tested the arm’s length pricing separately for licensing and sales of raw materials by making corrections to the benchmarks that A Ltd had documented. Because it was possible to test the arm’s length profit of A Ltd with the methods that A Ltd had actually chosen and applied, SAC found that there were no legal grounds to reassess A Ltd’s taxable income for years 2006-2008 by applying the residual profit split method. A Ltd won the case in full. In its ruling, SAC also indicated that – contradictory to FTAs earlier guidance based on which e.g. BEPS guidance could have retroactive effect - FTA should apply in tax audits such version of the OECD Guidelines that was available at the time of filing the tax returns for the year(s) in question.
Case 2018:173 has a major importance in the Finnish transfer pricing landscape. Many recent Finnish transfer pricing audits have been based on FTA’s assumption that Finnish-owned IP is the most important value driver of the business and, consequently, most part of the global residual profits should be allocated to Finland. Case 2018:173 makes clear that this approach may cause serious errors in interpretation of facts and lead to transfer pricing adjustments that do not meet the arm’s length requirement. Case 2018:173 also demonstrates that in current TP controversies it is highly important for the taxpayers to be able to support juridical argumentation with crystallized descriptions of the value drivers and the exact nature of their business. In this case, this was done at SAC level by Deloitte’s systematic Value Chain Analysis.
For further information, please contact:
M: +358 (0)40 834 3226
M: +358 (0)40 749 0660
TP Controversy Specialist
M: +358 (0)50 529 4125