Case of use of comparable uncontrolled price methodALTax
Summary of business of corporation and foreign-related person
German corporation P is a distributor of products A and B, and 10 years previously it established corporation S in Albania as a subsidiary to distribute product A.
Summary of foreign-related transaction
Company P sells product A to company S, which then sells it to approximately 200 third-party retailers in Albania.
Company P has sold product B to third-party agent T in Albania since company S’s establishment, and company T then sells the product to retailers in Albania. At company P,Â product B is classified as a different product (i.e. has a different model number) from product A,Â but the two are similar in terms of properties, construction, functions, and so forth.
Functions and activities of corporation and foreign-related person
The function performed by company P in the sale of product A to company S and the sale of product B to company T (hereinafter referred to as the two transactions) is that of purchase of inventories of product A and product B, and the sale of these inventories to company S and company T. Company P engages in no unique activities, and there are no differences between the two transactions in function. In neither case is use made of trademarks or other such properties.
Terms of contracts for sale of product A and product B
The two transactions are the same in market level (e.g. retail or wholesale), and substantially the same in volume. The terms of the contracts for the two transactions (e.g., delivery terms, payment terms, product warranties, and the conditions for returns) are also, with the exception of the transaction price, the same.
Treatment for transfer pricing taxation purposes
Consideration of applicability of traditional transaction methods
As precedence is given to application of the traditional transaction methods when selecting the method of calculation of the arm’s length price under the provisions of Article 36/2 of Income Tax Law in Albania (No.8438/ 1998) an examination of comparable transactions in accordance and other relevant provisions produced the following findings.
? Product A and product B were found to be the same type of product in terms of properties, construction, functions and so forth, despite being classified into different product categories at company P.
– Both company S and company T are wholesale traders selling products to retailers in Albania, and there was found to be no difference in market level between the two transactions.
– The two transactions are substantially the same in volume and also the same as regards the terms of contracts, and there were found to be no differences in the volumes and contract terms of the transactions.
– There were found to be no differences in company P’s business strategies toward product A and product B.
– No differences were found in the role and functions of P in the two transactions, and no use was made of intangible properties.
– As both company S and company T are corporations located in Albania, the market conditions are the same, and there are no government regulations on either product AÂ or product B.
Selection of method of calculation of arm’s length price
Of the traditional transaction methods, it was consequently found to be appropriate in this case to calculate the arm’s length price by applying the CUP method to the sale of inventories of product A by company P to company S, and treating the sale of product B by company P to company T as the comparable transaction.
- In order to calculate the arm’s length price, it is necessary to select a reasonable method that is in keeping with the particular facts and in compliance with the requirements laid down by law.
When selecting the method of calculation of arm’s length price, it is first necessary to consider the applicability of the traditional transaction methods. While any judgment as to the applicability of the traditional transaction methods shall conform to the particular facts, the presence of internal comparable transactions or external comparable transactions is generally considered on the basis of (1) internal information, such as materials concerning transactions engaged in by the corporation or foreign-related person, together with (2) corporate information, such as financial statements, (3) database information such as financial data on corporations, and (4) external information, such as information from industry associations (information falling under (2) through (4) is hereinafter referred to as publicly available information in this and the following cases).
In order to be employed as comparable transactions for calculating the arm’s length price, each type of foreign-related transaction needs to be examined in accordance with provisions of Chapter V of Income Tax Law. With regard to whether they qualify as comparable transactions, a judgment shall be made by thoroughly examining the similarity of the factors listed in instruction of Income Tax Law to those of uncontrolled transactions.
When foreign-related transactions involve intangible properties, the comparability shall be considered focusing in particular on the factors listed in instruction of Minister based on Income Tax Law.
- When considering application of the traditional transaction methods, it is often comparatively simple to determine whether internal comparable transactions engaged in by a corporation or foreign-related person qualify as comparable transactions as described in 1 above, as the corporation or foreign-related person will have information on these transactions.
In contrast, however, there are also cases where sufficient information to make such a judgment cannot be obtained using only publicly available information on external comparable transactions engaged in by a corporation and third parties other than foreign-related persons.
In the cases of the RP method and the CP method, for instance, which use the profit margin calculated from the gross profit on sales of comparable transactions, it is often not possible to obtain sufficient information concerning transactions deemed comparable with the foreign-related transactions. This is due to differences in the systems for disclosure of corporate financial data in different countries in order to apply the RP method when the foreign-related person is the buyer of inventories involved in a foreign-related transaction, and in order to apply the CP method when the foreign-related person is the seller of inventories in foreign-related transactions. Even if the information required to examine comparability is sought from financial data at the level of individual enterprises on the basis of publicly available information, moreover, this information may not be available in cases where an enterprise does business in a number of segments unless financial data on a specific segment is extracted from the overall data.
Methods of application consistent with the traditional transaction methods prescribed in Income Tax Law and other methods prescribed in the Instruction of Minister.
Even where comparable transactions for application of the traditional transaction methods cannot be selected given the scope of the publicly available information, and arm’s length price is calculated by a method other than the traditional transaction methods, it is advisable, when it is possible to identify transactions that can be confirmed as having a certain degree of comparability according to the publicly available information, to verify the validity of the results of these calculations using these transactions as necessary.
- Legal provision is made for methods consistent with each of the traditional transaction methods in the case where the traditional transaction methods cannot be applied. These methods are considered to leave the way open to employing reasonable methods suited to the content of transactions provided that they do not diverge from the concept behind the traditional transaction methods.
In the cases of foreign-related transactions for which comparable transactions cannot easily be found when applying the traditional transaction methods as prescribed by law, there are instances in which it is possible to select comparable transactions by using reasonable similar methods of calculation focusing on the various forms of these transactions, or in which the arm’s length price can be calculated by adopting reasonable transactions as comparable transactions. As these methods allow a wider choice of comparable transactions than the traditional transaction methods, comparability therefore needs to be considered, bearing in mind the possibility of applying the methods consistent with the traditional transaction methods.