Transfer pricing for SMEs

Case 1: The risk is in the detail

1. facts of the case

AUTOMATION CH is the Swiss subsidiary of AUTOMATION NL, the headquarters of the medium-sized AUTOMATION Group, which has been active in the field of precision machinery for over 30 years.

The AUTOMATION Group's business is very capital-intensive, particularly at the level of the production units in Germany and India. In order to reduce the Group's liquidity risk, the Group's management decided in 2010 to centralize the Group's liquidity management and treasury activities at AUTOMATION NL. As a result, AUTOMATION NL's treasury department manages, among other things, the issuing of loans to the Group's subsidiaries. With the aim of minimizing the Group's financial exposure to external banks, the same team is also responsible for managing payment terms to customers and suppliers and for managing the currency risk associated with the various financial positions (the Group's companies work with five different currencies).

AUTOMATION CH is responsible for the distribution of AUTOMATION products in Switzerland, Germany and Austria. In 2018, AUTOMATION CH hired a new Finance Manager who previously worked in the SME department of a Swiss bank. In order to ensure that intra-Group financing transactions are correctly reported in the accounting systems at Group and local level, AUTOMATION NL asked AUTOMATION CH - namely its Finance Manager - to support the Group's finance department in the controlling and accounting activities related to the Group's liquidity management. Accordingly, AUTOMATION NL and AUTOMATION CH entered into a Service Level Agreement in 2018 in which AUTOMATION CH invoices AUTOMATION NL for the services provided by its Finance Manager to the Group Finance Team ("Finance Support Services") at cost plus a mark-up of 5%.

In May 2023, AUTOMATION CH will receive a request to provide the documents listed below as part of the tax assessment for FY 2022:

• Job description of the finance manager.
• Benchmark analysis to support the 5% mark-up applied or an OECD-compliant description of the low value-added nature of Finance Support Services.
• Intercompany agreement between AUTOMATION NL and AUTOMATION CH for the provision of Finance Support Services.
• Transfer pricing documentation (if available), i.e. Local File of AUTOMATION NL and/or AUTOMATION CH and Group Master File for FY 2022.

The Group has no TP documentation. There is also no documentation proving the provision of Finance Support Services. The only available document besides the general job description for the role of Finance Manager is the Service Level Agreement from 2018. When reviewing this document, the Managing Director of AUTOMATION CH notes that the Finance Support Services are described rather generally and in particular the following activities are listed among the activities performed by AUTOMATION CH:

• "Authorization of funds requested by the Borrower [i.e. subsidiary of AUTOMATION NL].
• Fund transfers from the Group's reference bank account to the borrower's bank account.
• Authorize credit facility extension".

Question

• What information should AUTOMATION CH submit to the Swiss tax authorities?

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Case 2: An overpaid service provider

1. facts of the case

Founded in 2018, LikeNew CH is a start-up that buys, refurbishes and repairs used electronic devices and then sells them on the market as "renewed" products.

The products are purchased by LikeNew CH from both private individuals and companies at a specific purchase price. The products are then forwarded to the subsidiary based in Slovenia ("LikeNew SI"), which then carries out the necessary repairs, refurbishment and renewal of the hardware and software components. Another subsidiary based in Austria ("LikeNew AT") takes care of the administration, maintenance and development of the online platform on which the refurbished products are sold.

When preparing the budget for 2024, the new CFO (who was appointed six months earlier) notes that LikeNew SI paid more tax than the other companies in the group in each of FY 2020, 2021 and 2022, even though there was no revenue. And this is likely to be the case in FY 2023 as well. He looks at the IC agreement between LikeNew CH and LikeNew SI and notes that:

• LikeNew CH sells the products to LikeNew SI at the purchase price plus 3%; and
• LikeNew SI sells the refurbished products back to LikeNew CH or LikeNew AT at the purchase price minus 10% ("resale minus 10%").

The CFO is aware that LikeNew SI also retains around 10% of the repaired products in order to sell them on Eastern European markets. However, this is a secondary activity to the repair of the products. In the meantime, the founders have asked the CFO to ensure compliance with TP regulations without having a budget for this.

Questions

• What could be the reason for LikeNew SI's disproportionate tax burden, knowing that LikeNew SI's bookkeeping and accounting are correct?
• What information does the CFO need to keep LikeNew SI's profitability in line with the arm's length principle?

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Case 3: Pragmatic price definition

1. facts of the case

CABLE CH is a Swiss-based manufacturer and distributor of electronic cables and components (switches, connectors, etc.). With around 20 employees, it sells its products to customers (B2B) mainly in Switzerland and in the neighboring markets of Germany and Austria. 

In order to keep the costs of products sold in European countries competitive, CABLE CH decides to expand into Portugal: It establishes a wholly-owned subsidiary there ("CABLE PT") and uses it as a contract manufacturer, which is paid a 4% cost premium. The production manager of CABLE CH has many years of experience in the sector and has also worked for three of the major players in the European market. In this sense, she believes that a 4% mark-up reflects the average behavior of the market.

The management of CABLE CH has decided to use the company's available liquidity (which is largely generated through the sale of products) primarily for the purchase of a suitable facility in Portugal and for the acquisition of state-of-the-art machinery in order to maintain the high quality standards of the products manufactured by CABLE PT. The management of CABLE CH assumes that after at least three years of operation, CABLE PT will achieve a level of turnover that is sufficient to cover all costs.

For the first year in which CABLE PT operates, only the funds required to comply with the usual regulations (payroll, annual financial statements, tax returns) are available.

Questions

• Would it be conceivable that CABLE CH does not carry out an economic (benchmark) analysis to prove the arm's length nature of the 4% mark-up?
• What documents does CABLE PT need to prepare to support its TP setup ^well1?

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Case 4: A start-up on an expansion course

1. facts of the case

INNOVATIVE CH is a start-up that has developed a machine learning-based solution for converting images and information captured by video cameras and sensors into room occupancy data.

Five years after its foundation, INNOVATIVE CH (and its subsidiary INNOVATIVE AT) is already one of the most important IoT players in Europe and has already reached break-even. The co-founders and shareholders have therefore decided to expand into the neighboring markets of France and Italy within the next three years. In order to comply with local legal requirements for data collection and processing, INNOVATIVE CH established a unit in each country responsible for support services (e.g. a hotline for customers who want to complain about data quality; troubleshooting support). Each local unit charges INNOVATIVE CH a cost and profit mark-up.

The investors have asked the founders of INNOVATIVE CH to ensure that the transfer prices are adhered to throughout the Group in order to avoid the results achieved to date being nullified by tax challenges. However, this should not be at the expense of the resources needed to develop the new version of the solution, which is also scheduled for launch in the next two years.

Question

• What ^{documentation2} guarantees INNOVATIVE CH efficient support for its transfer pricing, now and in the countries where it will continue to expand?

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¹ Portuguese transfer pricing regulations do not currently require local companies to prepare specific transfer pricing documents, although they expect intra-group transactions to be at arm's length.

² INNOVATIVE CH is aware of the "penalty protection regulation" applicable in Italy, but is not yet prepared to invest in the creation of a local file and a master file in accordance with the Italian TP regulations.