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Evaluating TP policies in loss-making companies
Antonella Della Rovere and Federico Vincenti of Crowe Valente / Valente Associati GEB Partners pick through the nitty-gritty of TP policy making in loss-making companies that are part of multinational groups

During tax audits, tax authorities frequently
focus on companies within multinational groups that book steady losses over several
years. In these companies, behind the losses authorities often find transfer
pricing policies that are not in compliance with the arm’s-length principle. This
observation is supported by the 2017 OECD Transfer Pricing Guidelines 2017
(para 1.129 – 1.131).
According to the OECD Guidelines, when a
company that belongs to a multinational group consistently books losses while its
multinational parent remains profitable, authorities must analyse its tax
practices, paying particular attention to the TP policies.
This is because an independent company
would not tolerate recurring losses for an undetermined period. It would
rather, under those conditions, opt to cease its activities. However, a company
that belongs to a multinational group can tolerate such losses if its
commercial activities generate benefits for the multinational group as a whole.
In some cases, as provided for by the
OECD Transfer Pricing Guidelines, recurring losses, borne for a reasonable
period, can be justified by a company strategy of establishing low prices in
order to enter a market and launch a new product. However, those low prices can
only be applied for a limited period with the goal of increasing profits in the
long term.
If this pricing strategy lasts too long,
an adjustment to the transfer prices could be deemed appropriate. This would especially
be the case where data reveals that losses have been suffered for a longer period
than in the case of comparable independent companies.
Alternatively, a multinational group could
be compelled to produce a full range of products and/or services to remain
competitive and realise an overall profit, while some product lines regularly
recorded losses. A company in a multinational group could also realise significant
losses from the manufacturing of loss-making products while other members of
the group manufactured profitable products. In this case, the necessary
remuneration granted to the company should be accounted for.
It is therefore necessary to understand the
reasons behind losses on a case by case basis, and only later to evaluate how TP
policies affect the negative results. It is also important to carefully analyse
the TP method adopted and the profit indicators that are selected for compliance-checking
the TP policy with the arm’s-length principle.
In certain cases, the TP policy may not indicate
any problems; for example, if a company uses the resale minus method and selects
gross profit as the profit level indicator, and this profit indicator is in
line with the selected comparables.
On the contrary, using operating profit margins
as the profit level indicator may be out of line with the one of the
comparables because, for example, the taxpayer has a heavy cost structure with an
effect on the operating profit margin, or there are extraordinary costs unconnected
to the intercompany transactions that should not be considered in the
identification of the profit level indicator.
Recently, the Regional Tax Commission of
Lombardy (decision no. 928/20/2019) expressed its view on this topic. The
Italian taxpayer in the case had an operative loss for an extended period (1997
to 2013), while the consolidated balance sheet of the group showed positive
results over the same period. According to the auditors, the existence of the
Italian company was justified by the fact that the group wished to keep an
international profile and the Italian company performed marketing activities in
favour of the foreign holding which boosted the visibility and presence of the
group in the Italian market.
This led to the claim over missed remuneration
for the intercompany marketing services carried out by the Italian company.
During the tax audit, the taxpayer
explained to the auditors the management evolution, the type of marketed products,
the peculiarity of the pharmaceutical market and the governmental policy on the
prices of medicines that triggered the company’s losses in the Italian market. However,
the losses were supported by the foreign shareholder, which continuously provided
the Italian company with the financial and capital means to ensure its
continuity.
According to the Regional Tax Commission
of Lombardy, the Revenue Agency assumed that there were unsubstantiated intercompany services. However, the taxpayer demonstrated that the loss was not due to
transfer pricing policies that failed to comply with the arm’s-length principle.
The taxpayer did this by submitting broad documentary evidence during the audit
and explaining the economic reasons behind the loss.
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