Legal Alert – Court Ruling KHO 2013:36 on Location Savings
The legal question in this case was the arms length nature of the contract manufacturing service fee when the imputed location savings were included in the cost base when calculating the service fee for the contract manufacturing services provided by the Estonian subsidiary B AS for the Finnish parent A Oyj. The case concerned the transactions performed in 2004 and 2005.
The Finnish company A Oyj had a contract manufacturing subsidiary B AS established in Estonia. A Oyj had transferred part of its manufacturing to its Estonian affiliate. The pricing of the intra-group services rendered by B AS was established by applying the TNMM (Transactional Net Margin Method). When applying the TNMM half of the imputed Location Savings were added to the cost base when calculating the remuneration for B AS. During the annual assessments and in the reassessment decision made after the conducted tax audit, only actually realised costs and mark-up were accepted as tax-deductible expenses for A Oyj in respect of the acquired contract manufacturing services.
There are two significant questions that are at the core of this ruling. First is the concept of Location Savings described in Subsection E of Chapter IX of the OECD Transfer Pricing Guidelines and the allocation of such benefits between the transacting group entities.
Secondly in the ruling the Finnish Supreme Administrative Court stated that the OECD Transfer Pricing Guidelines are not binding on the OECD Member States but they do have a position as a global standard when interpreting the arms length principle. The Court also stated that although Chapter IX was included in the OECD Transfer Pricing Guidelines in the update of July 2010, it could be used as a reference when discussing the arms length nature of the transactions conducted in 2004 and 2005 since it did not contain any fundamental changes to the interpretation of the arms length principle.
The Supreme Administrative Court recognised the concept of Location Savings although it rejected the existence of such in this case and ruled that based on the facts and circumstances of this particular case the judgement cannot be based on the concept of Location Savings. The main argument was that although A Oyj had transferred part of its manufacturing to its Estonian affiliate, the Court stated that the manufacturing functions performed by B AS were significantly different from those performed by A Oyj in Finland and therefore this situation is not in line with the principles stated in the OECD Transfer Pricing Guidelines regarding the Location Savings and they should not be recognised in this case.
The Supreme Administrative Court also discussed the Bargaining Power of the group entities in the context of price setting.
It is also worth of mentioning that the Supreme Administrative Court retained the decision to lower the punitive tax increases originally ruled by the Board of Appeals of the Large Taxpayers Office.