By Heikki Vesikansa, Partner and Head of Tax, Jenni Parviainen, Managing Associate, and Stefan Stellato, Senior Associate, Hannes Snellman Attorneys Ltd., Helsinki
In one of the most important transfer pricing rulings by the Finnish Supreme Administrative Court in recent years, the court in a 2 June ruling (SAC 2021:73) confirmed the acceptability of a foreign accounting standard as a basis for transfer pricing.
In addition, the court concluded that loss-making comparable companies can be taken into account and do not have to be dismissed when determining the arm’s length operating margin of a low-risk distributor company.
Also of note, the court placed evidential importance on advance pricing agreements (APAs) and decisions of other countries’ tax authorities.
Background
In the case, a Finnish low-risk distributor company was part of a major multinational group with a US parent.
The group had determined the Finnish company’s annual profit under the transactional net margin method (TNMM) based on an operating margin of 0.5% under US GAAP (generally accepted accounting principles), in accordance with the group’s transfer pricing policy. This operating margin level for the group’s low-risk distributor companies, including the Finnish company, had been determined based on a comparability analysis.
The competent authorities of the group’s European manufacturing companies’ states of residence had entered into an APA in 2011 in which transfer pricing was monitored in accordance with the group’s accounting standard (US GAAP) and the operating margin of low-risk distributors was 0.5%. The tax authorities of certain other countries had also already accepted the 0.5% profit margin for local distributor companies.
Tax administration claims
Following a transfer pricing adjustment made in the accounts of the Finnish company for 2010, the company’s profits under FAS (Finnish accounting standards) and taxable income for the tax year 2010 turned negative. The Finnish Tax Administration found that the application of US GAAP and an operating margin of 0.5% did not lead to an arm’s length result.
According to the tax administration, the profit of the Finnish company could not be adjusted based on an operating margin determined under US GAAP, although it was the standard used by the group globally. Instead, the tax administration determined FAS should have been applied as a basis.
Furthermore, the tax administration demanded the application of a 1% operating margin instead of the 0.5% operating margin applied by the group, by, for example, dismissing loss-making comparables and applying the averaging method instead of the pooling method used by the group.
The company appealed the tax administration’s decision to the adjustment board and onwards to the administrative court, which both dismissed the company’s appeals.
The ruling
The Supreme Administrative Court issued a leave to appeal and accepted both the use of US GAAP as a basis for transfer pricing and the operating margin of 0.5%.
In its ruling, the court concluded that the company’s operating margin could be determined in accordance with US GAAP, because the group’s financial statements were generally prepared in accordance with this accounting standard and the group’s transfer pricing was monitored on the basis of US GAAP accounting.
Moreover, according to the court, the APA concluded between the competent authorities of the group’s European manufacturing companies’ states of residence and the decisions of the tax authorities of other states of residence of low-risk distributor companies had to be given evidential value.
In addition, concluding that loss-making comparables that meet the conditions of the comparability analysis should not be rejected on the sole ground that they suffer losses, the court upheld that the 0.5% profit determined for the company in accordance with the US GAAP accounting standard was arm’s length in the present circumstances.
The court thereby overturned the previous decisions of the tax administration, the adjustment board, and the administrative court and returned the matter to the tax administration for the calculation of taxable income based on the profit of the financial year, adjusted in accordance with a 0.5% operating margin under US GAAP.
Conclusions
Based on the ruling, the accounting standard used for monitoring transfer pricing and preparing consolidated financial statements can be used as a basis for market-based pricing, even if calculation of local taxable income is based on a different accounting standard.
Furthermore, decisions and APAs by other countries’ tax authorities may have evidentiary value even if the Finnish tax administration has not signed or approved them and they therefore lack formal binding effect. In addition, loss-making comparables that meet the criteria for comparability analysis should not be rejected on the sole ground that they suffer a loss. The ruling further underlines the protection of the transfer pricing method determined by the taxpayer.
The authors represented the company in the Supreme Administrative Court.
Is there an English translation of this decision? I’m curious as to what was the product being distributed as well as what was the operating expense/sales ratio for the distribution affiliate.