Functional Analysis Saves The Day

Just ask RKS, a French manufacturer, whose functional analysis just saved the company $6.2 million. RKS, owned by a Swedish group, SKF, was subject to a tax audit for financial years ending in 2009 and 2010, in which the French tax authorities challenged the transfer prices for products sold to the Swedish group’s distributors located outside of France. The result was a potential new tax bill of about $6.2 million, including penalties.

The case went to three courts: the administrative tax court (ruled in favor of the company); the administrative tax court of appeal (ruled in favor of the French tax authorities), and finally the French Supreme Court, who ruled once and for all, in favor of the taxpayer.

What happened? The tax authorities challenged the transfer prices based on a net margin ratio that seemed way out of whack when compared to seemingly appropriate benchmarks:

• The taxpayer’s net margin ratio was -10.46% in 2009 and -21.87% in 2010
• The average for comparison companies was 2.33% in 2009 and 2.62% in 2010.

Based on the numbers, the tax authorities naturally thought, “profit shifting.” However, the taxpayer argued that the tax authorities hadn’t considered the strategic risks the company assumed, which affected profitability, and was supported by a save-the-day functional analysis.

Analyzing The Supply Chain

The tax authorities failed to analyze the functions, assets, and risks throughout the supply chain and instead only focused only on the numbers, which as we all know, is just part of the transfer pricing big picture.