This content is from: Sweden
Swedish ruling examines arm's-length principle
A Swedish court case strengthens the Swedish position that an operating profit margin within an arm’s-length range, that is not in line of a fixed margin stated in an agreement, cannot be considered to be arm’s length. Annika Lindstrom and Karolina Viberg of KPMG discuss.

The ruling, issued by the Swedish Administrative
Court of Appeal on July 5 2017, regarded transfer pricing for remuneration to distributors which
deviates from the contracted level but which is within the arm’s-length range
for comparable companies, as well as a compensatory claim.
The Administrative Court
of Appeal’s ruling
According
to the written agreement with the Swedish company, the group’s distributors
shall report an operating margin of 3% on their sales. For the financial year
in question, the US distributor had reported a margin higher than that which
had been agreed. In practice however, the company maintained that the group had
consistently adjusted earnings to 3% only if it was outside the arm’s-length
range of a benchmarking study, while operating margins within the range had not,
in practice, been adjusted. The company therefore argued that the parties had
consistently applied a scheme which deviated from the written agreement. As the
reported margin was within the interquartile range according to the company’s
benchmarking study, the company therefore maintained that the pricing had been
arm’s length.
Furthermore,
the company contended that the group’s other distributors in Germany had
reported a margin which was too low and that this compensated for the higher
margin which the US distributor had shown, i.e. a compensatory claim. According
to the company, precedence does not support the necessity for compensation to
be between the same contractual parties. Thus, the Swedish company had not reported
a lower income due to incorrect pricing.
The Administrative
Court of Appeal stated in the ruling that the wording of the agreement was
clearly defined and that there was therefore no scope for interpretation. The
agreement had also been followed and the compensation had been adjusted to the
agreed level when additional invoicing had occurred. Solely
the circumstance that the parties had deviated from the terms, only where the
distributor’s operating margin did not fall within the interquartile range, could
not mean that the agreement was imbued with a different meaning. The
Administrative Court of Appeal therefore found that such a derogation would not
have been accepted by an independent party and that it was clear that the
pricing had not been arm’s length which had had a negative effect on the
company’s earnings.
Regarding
the compensatory claim, the Administrative Court of Appeal maintained that the
basis of the assessment was the contractual relationship between the parties.
In the view of the Administrative Court of Appeal, there is therefore no
grounds for considering other transactions than those arising under the contractual
relationship in question.
Written agreement most
important
Our
experience is that it is very common for multinational groups to have written agreements
in place which regulate the level of compensation. Furthermore, our experience
is that, particularly in the case of sales of goods, it is difficult to adjust
prices so that the group’s distributors report an exact margin year on year. As
a result of this, it is also common for the group’s distributors to report
margins which nonetheless fall within the arm’s-length range of a comparability
analysis. Historically, it has been our view that this should be regarded as
arm’s length from a Swedish perspective. It is therefore surprising that a tax
adjustment may occur despite the fact that the operating margin of the US
company in this case was within the arm’s-length range.
As a result
of this Administrative Court of Appeal ruling, it is clear that the court has
largely disregarded the parties’ actual actions and instead placed the greatest
weight on the written agreement. Groups which have entered into agreements with
specific levels of operating margins which are not complied with, even though
the reported margins are within the interquartile range of a comparability
study, are at risk of a tax adjustment and surcharges. We therefore recommend
that groups with such agreements and policies review them in order to minimise
such risks in the future.
![]() | Annika Lindstrom | ![]() | Karolina Viberg |
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