Denmark Supreme Court rules in Tetra Pak transfer pricing case

By Susi Baerentzen, Ph.D., Carlsberg Foundation Postdoctoral Fellow, Copenhagen

On April 26, the Danish Supreme Court delivered its ruling in a landmark transfer pricing case involving a Danish company that produced and sold plants for manufacturing ice cream – Tetra Pak. Upholding the 2020 ruling from the Danish Western High Court, the Supreme Court concluded that the tax administration was entitled to make a discretionary assessment due to the company’s inadequate transfer pricing documentation.

The Tetra Pak case is one in a string of transfer pricing cases following the Supreme Court’s 2019 Microsoft decision, in which the Supreme Court ruled against the tax administration’s formalistic approach.  

The facts of the case

The Danish corporation Tetra Pak Processing Systems A/S (formerly known as Tetra Pak Hoyer A/S) is part of the Tetra Pak Group, which is in turn part of the Tetra Laval Group.

The Danish corporation is part of the processing solutions business line of the group, which makes up approximately 10% of the entire group. The business is represented in more than 165 countries through sales companies on six different continents. The sale of the ice cream production plants is done through these sales corporations.

The intra-group transactions between the Danish corporation and the sales units include the sale of the ice processing plants, spare parts, service, and upgrades. These transactions make up approximately 2% of the turnover in the sales units.

For fiscal years 2005–2009, the Danish Tax Agency conducted a discretionary assessment in a ruling from 2011 and increased the taxable income for the Danish corporation by approximately USD 57.5 million. This was based on the argument that its transactions with the Tetra Pak Group had not been on arm’s length terms. In 2017, the Danish Tax Tribunal lowered the increase to approximately USD 52.8 million.

The tax administration had conducted a discretionary assessment based on the group’s transfer pricing documentation being inadequate and based on continuing losses in the Danish company.

The heart of the matter was whether the documentation was sufficiently flawed to justify this assessment. In this regard, the High Court quoted the Microsoft case, stating that documentation that is inadequate to the extent that it does not provide a proper base for the tax administration to assess whether the arm’s length principle is met is equal to missing documentation.

In its reasoning, the High Court stated that the tax administration had been entitled to carry out the discretionary assessment. In addition, for this purpose, it had been justified in applying the transaction net margin method (TNMM) using the Danish company as the tested party, as sufficiently reliable information on the group’s sales companies had not been provided. In relation to the comparability analysis, the court found that the tax administration’s selection of companies was based on functions, assets, and risks comparable to that of the Danish company.

The importance of the comparability analysis 

In terms of the potentially inadequate transfer pricing documentation, the Supreme Court referred to the Microsoft case and the Adecco case.

In its transfer pricing documentation, the Danish corporation used the resale method based on the average profit gain of the sales corporations. The documentation indicates an average profit (EBIT level) of 7% for the income years 2006–2008 on the sales corporations’ resale to the end customers. This assessment was built on the argument that it was reasonable based on the risks, responsibilities, and investments of the sales corporations in light of the commercial judgement of the Danish corporation.

In its assessment, the Supreme Court found that this documentation did not contain a comparability analysis of what is considered a reasonable profit for the sales corporations, which essentially only affects the discretionary assessment of the Danish corporation. No information was enclosed on what a sales corporation could achieve in a similar transaction with independent parties. The stated profits did not solely relate to the transactions between the Danish corporation and the sales corporations, but also to controlled transactions with other group companies and independent parties.

In addition, the Supreme Court highlighted that some of the numbers were estimated, including assessments relating to information accessible for the Danish corporation and numbers that could not be contributed to the individual product categories within the sales corporations. Thus, the transfer pricing documentation was surrounded by a great deal of uncertainty, and therefore it did not comprise sufficient information about the actual price determination.

The consequence was that the documentation was found to be inadequate because it did not provide a proper base for the tax administration to assess whether the arm’s length principle was met, i.e., it was equated with absent documentation and ground for a discretionary assessment by the administration.

In its discretionary assessment, the tax agency had applied the TNMM.  According to the OECD transfer pricing guidelines point 3.18, this entails testing the party which is most suitable for the method to be applied in the most trustworthy manner and for whom the benchmark is most reliable. In practice, this will often be the least complex party with regard to functions, etc., but this requires that adequate documentation be provided to sufficiently test this part.

Due to the considerable uncertainties surrounding the documentation for the sales companies’ profit within the Tetra Pak Group, the Supreme Court found that it would not be sufficient to conduct the TNMM with the sales corporations as the tested party and that, therefore, the tax agency was right in applying the Danish corporation as the tested party. 

For its benchmark analysis, the tax agency used the Amadeus database of comparable financial information for public and private companies across Europe, which is a valid source of information according to the preparatory work for the Danish transfer pricing rules.

The Danish company argued that this analysis was not valid as some of the selected corporations were based in countries with a lower wage level than Denmark, which the Supreme Court did not agree with. In addition, the Danish company argued that for the income years 2005–2009 it was subject to atypical and extraordinary costs, which should be left out of the calculation of the net gain in the TNMM in accordance with the OECD transfer pricing guidelines, point 2.80, which the Supreme Court did not accept either.

Practical implications of the ruling

The past two years have produced several landmark transfer pricing rulings from the Danish courts. Overall, the outcome has been that the formalistic approach by the Danish tax administration has not been accepted. As evidenced by the Supreme Court in the Tetra Pak ruling, the onus is on the taxpayer to show appropriate documentation and relevant comparability analysis.

The Tetra Pak ruling does not alter the string of defeats for the Danish Tax Administration, but it does shore up the fundamental Danish transfer pricing framework in terms of specifying the documentation requirements.

For income years beginning January 1, 2021, or later, the Danish transfer pricing rules have been tightened, meaning that companies must submit their master and Danish local files within 60 days after the deadline for submission of the corporate income tax return. In contrast, under the previous rules, these documents had to be finalized but not submitted by the deadline for filing the corporate income tax return.

The amendments to the transfer pricing rules are intended to clarify the tax administration’s discretionary assessment power in cases of insufficient transfer pricing documentation following the questioning of the scope of these rules after the 2019 Danish Supreme Court ruling in the Microsoft case. The amendments mean that if the taxpayer fails to submit the documentation on time, the tax administration may conduct a discretionary assessment; however, any information provided by the taxpayer afterward must also be taken into consideration.