One common prediction regarding the G20/OECD-led BEPS
initiative was that as rules were implemented and practical
aspects interpreted, a global increase in transfer pricing (TP)
controversy would ensue. That prediction seems to have come
true, as seen by the significant rise in the number of TP court
cases recorded around the world since the BEPS project began.
In turn, that growing body of case law has influenced members
of the OECD's Inclusive Framework (now more than 120
countries), Committee on Fiscal Affairs, and ultimately
country-specific tax law.
Historically, local case law led to changes in local tax
law. In some cases, limited consideration was given to the tax
implications for the country on the other side of the
transaction, as the protection of domestic fiscal policy under
local law usually took precedence. Today, the domestic tax
law-making process brings other countries into the equation.
Proposals from the OECD, supported by case law in various
countries, have actually become law in many other
Country-by-country reporting (CbCR), a proposal orchestrated
as a 'minimum standard' by the OECD Inclusive Framework, is now
implemented into law and practiced in many jurisdictions,
alongside bilateral relationships for the exchange of
information. As of November 2018, 74 signatories to the CbC's
multilateral competent authority agreement (MCAA) have
completed more than 1,900 bilateral exchanges of taxpayer CbC
TP reports. It seems inevitable that future TP controversies
will subsequently arise.
Transfer pricing cases
In 2018, few transfer pricing cases were limited to the
application of local country law, like the US Appeals Court
decision in Altera Corp. and Subsidiaries v. Commissioner
of Internal Revenue (No. 16-70496, 9th Circuit, 2018).
The principal issue in Altera, the inclusion of
stock-based compensation costs in cost sharing, was also
considered by the Israeli Supreme Court in Kontera
Technologies v. Tel-Aviv 3 Assessing Office (943/16).
However, the latter reached the opposite conclusion under
While cases concerning local TP law are important for their
application in that country, other cases may have greater
potential geographic scope, and therefore may be more valuable
to the TP and tax professionals' community. Cases that consider
the application of OECD-based concepts and principles, or that
look at the detailed application of one or more methods to
measure an arm's-length price (or value in particular business
transactions) can have broader application. However, court
decisions in one country will not be binding on tax authorities
or courts elsewhere (but they may be informative), as each
court is interpreting law based on an international treaty
(Article 9 of the OECD Model Tax Convention).
As cases are finalised, a clearer direction regarding
uncertain positions usually arise. With the frequency of TP
cases showing no signs of abating, 2019 may produce a wealth of
guidance regarding the application of TP laws and practices
that have their foundation in the arm's-length principle. In
2018, Denmark provided the most TP court decisions, with four
cases decided. In total, 12 countries contributed to the 29
cases reported in 2018.
In assessing an arm's-length price or value (as between
unconnected parties), one trend that can be identified from
these cases is that courts will look to whether the position
claimed by either side is fair to both parties. The courts will
strike down any analysis that does not result in a fair
allocation of profit to both parties, or is not commensurate
with the way the business generates value, even though it may
have technical, logical, or legal merit.
Several cases in 2018 illustrate this point. In the UK,
Union Castle Mail Steamship Company v. HMRC (UKUT 316)
took into account the value of newly issued shares, while in
Germany, Hornbach-Baumarkt v. Finanzamt Landau (Case
C-382/16) took into account the position of the group parent
when considering whether an interest-free loan would be
In Denmark v. Water Utility Companies (Case No.
27/2018 and 28/2018), the Danish court ruled that the
discounted cash flow method for valuing an asset would be
inappropriate in cases where the income from the asset is
suppressed. In such cases, there are similarities to an earlier
UK case (DSG Retail Ltd v. HMRC, UKFT 31, TC, 2009),
in which the court ruled against an argument (that while
eminently sensible), did not result in a reasonable sharing of
For TP and tax professionals, this should serve as a
reminder to exercise 'good professional judgement' in any work,
and not to rest arguments on the accurate, technical
application of a method that nonetheless produces an
unreasonable or absurd result.
Two other technical points of considerable note were decided
in 2018. The first concerns the ECJ's decision in
Hornbach-Baumark, where the court concluded that TP
legislation does not violate the EU's fundamental freedoms.
While TP legislation applies to cross-border transactions
differently in many jurisdictions to same-country transactions
(potentially in violation of Article 49 of the Treaty on the
Functioning of the EU), it is a necessary and proportionate
response by the tax authorities in the defence of the
consistency of their tax regimes.
The second noteworthy case was the decision of the US Court
of Appeal for the Eighth Circuit in Medtronic &
Consolidated Subsidiaries v. Commissioner of Internal
Revenue (No 17-1866). Justice Shepherd noted that when a
court seeks the arm's-length royalty for use of intellectual
property (IP), this is the same as looking for a reasonable
royalty in patent infringement cases. Shepherd then cited
decisions of the court in commercial infringement cases between
unrelated parties to support his conclusion that insufficient
work had been undertaken in the tax court to demonstrate
comparability of the selected comparable uncontrolled
Justice Shepherd's opinion leads to the following two
points. First, the factors indicating comparability (or a lack
thereof) for intangible cases are not the same as those for
goods or services transactions. TP and tax professionals must
understand the appropriate comparability factors and ensure
that they are addressed in the course of the work.
Second, some third-party decisions will be useful in helping
the assessment of questions that are encountered in TP work.
The Medtronic case involved a CUT comparability
analysis, but there is no reason to think that the relevance of
court decisions in other matters arising in third-party
disputes concerning intangibles could not also be drawn upon in
TP work. There is a significant volume of that material
National court challenge influences on OECD proposals
How may these new court cases manifest themselves in future
OECD proposals and the tax law of different countries? An
examination of history is revealing.
The non-consensus OECD public discussion draft on financial
transactions under BEPS Actions 8–10 (the discussion
draft) from July 2018 contains many concepts from local country
case law. Underlying much of the discussion draft commentary is
local country case law from many different countries covering
related-party (or intragroup) loans, cash pooling, hedging,
guarantees and captive insurance.
Capital structure and loans
In discussion draft Box B.1 and Box B.2, the OECD questions
what type and number of factors should be considered for debt
versus equity classification, and whether the entire amount of
funding must be delineated as equity (or as a partial pro-rata
share that may be debt, with a portion re-classified as
Compare that approach to the US's all-or-nothing
characterisation of debt versus equity in Treasury Regulation
§1.385, which uses a multifactor approach to address the
debt/equity classification. This new US tax law is based on
years of case law (Estate of Mixon v. United States,
464 F.2d 394, 1972), Laidlaw Transportation v. Commissioner
of Internal Revenue (75 TCM 2598, 1998), and
others. However, the documentation provisions under section 385
have been effectively withdrawn under proposed rulemaking.
In contrast, the Australian arm's-length debt test contained
in the Australian thin capitalisation regime in sections
820-105 and 820-215 of the Income Tax Assessment Act 1997 (as
well as Taxation Ruling 2003/1) disallows only a portion of
excess interest on a proportional re-classification of
In discussion draft Box C.8, the OECD questions the
allocation of group synergy benefits among cash pool members.
One relevant case is Norway v. ConocoPhillips
(HR-2016-988-A, 2010), which uses a profit split to allocate
the netting benefit based on deposit contributions (in a clear
benefits allocation) to effectively increase the interest rate
paid to Norway-based depositors. This is the basis of paragraph
127 of the discussion draft. This case also appears to
underline the UK's HMRC guidance (INTM 503200, International
Manual, 2017) to apportion synergy benefits to structural
advantages in cash pooling arrangements.
Paragraph 97 refers to zero balancing, which is the focus of
Switzerland v. Swisscargo AG (Federal Supreme Court,
October 2014, Case No. 4A_138/2014). A case from the Portuguese
tax arbitration court in 2012 for a cash pooling arrangement
also uses a profit split. The court in that case rejected the
comparable uncontrolled price (CUP) method in Anon v. Tax
and Customs Authority (Case 55/2012-T, 2012, Arbitration
Mirroring paragraph 128 of the discussion draft in
Denmark v. Bombardier (Admin. Tax. Ct., Case
12-0189459, 21 Oct. 2013), the court ruled on a zero interest
spread using the same interest rate for both depositors and
borrowers in the cash pool.
In draft box D.1, implicit support is recognised, valued,
and priced under Her Majesty the Queen v. General Electric
Capital Canada Inc. (FCA 344, 2010). However, paragraph
143 notes that a parental guarantee letter to a third-party
bank for loans of an affiliate may confer no benefit.
Germany's revenue authority argued the opposite, valuing the
parental support from a comfort letter at 15 basis points of
the loan amount under Germany's Hornbach-Baumarkt v.
Finanzamt Landau (Case C-382/16) of May 2018, which is not
in line with the comments in paragraphs 142 and 143 of the
Interestingly, in Anon v. Tax and Customs Authority
(Case 55/2012-T, 2012-Arbitration Court), the court agreed that
an implicit guarantee (without a formal guarantee or legal
agreement) by the cash-rich subsidiary to the cash-poor parent
existed in the cash pooling arrangement, and imputed taxable
value to the implicit guarantee.
In Box E.1, the discussion draft questions the existence of
captive insurance, the actual risks and functions of an
insurer. Numerous US captive cases, including Rent-a-Center
and Affiliated Subsidiaries v. Commissioner of Internal
Revenue (142 T.C., No. 1, 2014), Securitas Holdings v.
Commissioner of Internal Revenue (Memo. 2014-225),
Kings River Commodities v. Commissioner of Internal
Revenue (US Tax Court Docket, No. 010448-17), Avrahami
v. Commissioner of Internal Revenue (149 T.C., No. 7,
2017), and Reserve Mechanical Corp. v. Commissioner of
Internal Revenue (T.C. Memo., 2018-86) describe the
factors for insurance to exist in the context of a captive
(actuarial risk of loss, shifting the risk of loss, and the
distribution of risk via pooling over different claims) in the
commonly and accepted sense.
Box E.3's example of a high street retailer of consumer
technology goods mirrors the UK case (DSG Retail Limited v.
HMRC, UKFTT 31, TC, 2009), which allocated the combined
insurance profit between the insurer and the sales agent.
The impact of local case law
Ultimately, if the discussion draft is adopted by the
G20/OECD inclusive framework and becomes law or practice in
various countries, local case law from one country may impact
the tax law and national fiscal policy of another country. By
implication, local case law helps to inform the OECD Committee
on Fiscal Affairs, which published the discussion draft and
BEPS actions, which revenue authorities ultimately help promote
into local country tax and TP law. Post-BEPS, local country tax
and TP case law matters have taken on greater importance, even
if they are not legally precedential in other
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Tel: +61 2 9322 5500
Stan Hales is a transfer pricing partner and
economist in the Deloitte tax practice, based in
Australia. With over 20 years of experience, Stan
collaborates with his clients to solve transfer pricing
and tax-related valuation problems, with a focus on the
banking and financial services industry.
Stan's clients include primarily commercial and
investment banks. Stan led an intragroup bank branch
funding project for compliance and documentation under
the authorised OECD approach for attribution of profits
to permanent establishments, which led to a bilateral
advanced pricing agreement on the branch capital,
interest expense and local deductions.
Other clients include real estate investment trusts,
investment managers, private equity firms, insurance
companies, brokerage firms, trading companies, finance
companies, and treasury operations at technology, media
and pharmaceutical companies. The valuation analyses
cover loan valuations, diverse intercompany fees,
insurance premia, commissions, credit spreads,
guarantees and interest rates on loans, as well as
royalty modeling and cost-sharing analyses for
intangible property, and cost allocation studies.
Stan's tax controversy experience includes IRS field
exams and appeals proceedings; preparing mutual
agreement procedure submissions to revenue authorities
such as the US Internal Revenue Service, the Australian
Taxation Office and the Japanese National Tax Agency;
preparing rebuttal papers concerning proposed tax
adjustments; and negotiating bilateral advance pricing
agreements with revenue authorities.
Tel: +44 20 7303 2218
Training initially with HMRC, John Henshall became a
Deloitte UK partner in 2001. He was the UK firm's lead
transfer pricing technical partner, and represented
Deloitte UK to HMRC on transfer pricing policy and
technical matters until he relocated to Denmark in
2019. John represents Deloitte UK before OECD Working
Parties 1 and 6, dealing with permanent establishment
and transfer pricing issues. During the BEPS
initiative, he contributed significantly to the
revision of Chapter VI of the transfer pricing
guidelines, the PE definition and the branch allocation
In addition to client work, John has consulted for
several governments concerning both compliance with
their tax legislation and legislative changes resulting
from BEPS whilst remaining attractive to business
John publishes regularly. He is the author of
Global Transfer Pricing: Principles and
Practice (2nd and 3rd Editions) [Bloomsbury
Professional] and a contributing author on transfer
pricing to Ray, Partnership Taxation [Lexis