New Precedent on Comparability Analyses and Statistical Tools to Enhance Reliability

The Finnish Supreme Administrative Court (“SAC”) issued a precedent concerning the comparability analyses and the determination of the arm’s length operating profit last week (SAC 2021:127). Borenius assisted company A Oy during the proceedings before the SAC. In its precedent, the SAC partly overturned the earlier decision handed down by the Administrative Court of Helsinki and ruled the matter in favour of the taxpayer in accordance with the taxpayer’s secondary claim.

The main question concerned the determination of the arm’s length operating profit of group companies in a concept fee model as well as the application of statistical tools to enhance the reliability of the comparability analysis. The Finnish Tax Administration had determined the arm’s length operating profit of the group companies to be between the median and the upper quartile of the profits earned by the comparables. The SAC rejected this approach and concluded that the arm’s length profit should be based on the interquartile range of the profits of the nine comparables.

A Oy was the parent company of the international A Group. When the Finnish Tax Administration (“FTA”) conducted a tax audit in A Oy for the years 2010–2012, it noticed that A Oy had not charged royalties (the so-called concept fee) from all of its foreign subsidiaries. A Oy had started to charge royalties from its subsidiaries that used the group’s intellectual property in 2011. However, some of the subsidiaries were exempted from paying the concept fee, the amount of which was used to adjust their profit to guarantee that the profit for their routine functions is at arm’s length.

A Oy provided grounds for the exemption, e.g. that the subsidiaries operated more independently than other subsidiaries. Nonetheless, the FTA deemed that part of the value generated by the subsidiaries was connected to the intellectual property owned by A Oy. The FTA determined the subsidiaries’ arm’s length profit on the basis of the profits gained by nine comparables. The profits of the comparables ranged from -0.24% to 13.50%, the interquartile range being 1.1%–8.4% and the median 3.7%. After that, the FTA considered that the arm’s length profit of the subsidiaries is 4.5 percent, which was just above the median and corresponded to the profit that A Oy applied in its concept fee model. The FTA deemed that the profits of the subsidiaries that exceeded the point of adjustment constitute A Oy’s taxable income and adjusted A Oy’s taxation.

A Oy appealed the FTA’s decision to the Board of Adjustment and claimed that the arm’s length profit of the subsidiaries should be any point within the full range that is determined based on the profits of all the comparables. The Board of Adjustment rejected most of the arguments presented by A Oy and maintained the FTA’s decision mainly unchanged. A Oy appealed to the Administrative Court of Helsinki, which dismissed the appeal and kept the Board of Adjustment’s decision unchanged.

A Oy submitted an appeal to the SAC. In its appeal, A Oy argued that the whole range calculated on the basis of the profits of the comparables should be deemed at arm’s length, and therefore the profits of the subsidiaries in the total range should be deemed to be at arm’s length. Consequently, only the profits of the subsidiaries that exceed the maximum of the arm’s length range could be adjusted. In its secondary claim, A Oy requested that the interquartile range be deemed at arm’s length and that adjustments only be made to the profits that exceed the upper quartile.

The SAC referred to Chapter III of the OECD Transfer Pricing Guidelines and highlighted that even if in some cases it would be it is possible to apply the arm’s length principle to arrive at a single figure, there would still be many occasions where the application of the most appropriate method or methods produces a range of figures all of which are relatively equally reliable. In these cases, the differences in the figures that constitute the range may be caused by the fact that in general the application of the arm’s length principle only produces an approximation of conditions that would have been established between independent enterprises. It is also possible that the different points in a range represent the fact that independent enterprises that have engaged in comparable transactions under comparable circumstances may not have established exactly the same price for the transaction.

The factors that the SAC took into consideration were the number of comparables, the deviation in their profits and the width of the full range as well as the fact that the profit of five comparable companies was below 4.5%, which was used in A Oy’s concept fee model. The SAC then concluded that several different prices or margins could be considered to be at arm’s length and that statistical tools may have been used to narrow the range to enhance the reliability of the analysis. Thus, the SAC considered the arm’s length range to equal to the interquartile range with an upper quartile of 8.4% and that the royalties invoiced from the subsidiaries would have been at arm’s length if the profits of the subsidiaries had been within the interquartile range.

Therefore, the transfer pricing adjustment could only apply to the subsidiaries’ profits that exceed the interquartile range. In such case, the profits could be adjusted to the arm’s length range, i.e. the upper quartile.

Even if the FTA and A Oy had agreed the comparables to be used to determine the arm’s length range, the SAC also took the number of comparables, the deviation in their profits and the width of the full range, the fact that the profit of five comparable companies was below 4.5%, i.e. the percentage that was used in A Oy’s concept fee model, as well as the differences in the role of A Oy with relation to the subsidiaries into consideration in its decision. The SAC highlighted that transfer pricing is not an exact science and statistical tools may be used to narrow the range to enhance the reliability of the analysis.

Borenius’ lawyers are available to assist in addressing any questions you may have regarding the precedent and its implications for the taxation of your business.