Denmark: No Transfer Pricing Adjustment for Factory Closure
On October 8, 2018 the National Tax Tribunal published a decision in a case (SKM2018.501LSR) on the transfer pricing aspects related to the closure of a factory in Denmark.
The case is of interest as it addresses a number of transfer pricing issues that are relevant to the closure of production facilities not only in Denmark but generally when the arm’s length principle is applied using the OECD Transfer Pricing Guidelines as the standard. Below a summary of the case is presented.
1. Facts and assessment
A corporation closed its factory in Denmark after it had 4 years of loss-making operations with negative EBIT margins between -3.33% and -32.40% in a 5-year period. As part of the closure, land, buildings and machinery were sold to third parties. Significant costs were incurred as a result of the closure.
The factory operated at a market characterised by structural excess production capacity. The factory performed standard manufacturing operations without the use of any significant intangibles such as patents or know-how, and its production accounted for less than 1% of the total market volume in Europe.
The demand for the products manufactured was price driven, and customer loyalty based on branding or reputation was minimal.
The Danish tax administration increased the taxable income of the factory through a transfer pricing adjustment based on the argument that the closure had resulted in benefits for the corporation in general and that third parties therefore would have arranged for compensation.
Another important argument of the tax administration was that the factory in its transfer pricing documentation had not included the intercompany transaction related to its closure. Hence, the transfer pricing documentation was incomplete, which in turn allowed the tax administration to make a discretionary assessment.
2. The decision
The National Tax Tribunal disagreed and rejected the transfer pricing adjustment. The tax tribunal motivated its decision by firstly stating that the tax administration did not prove that an intercompany transfer of assets took place and furthermore pointed out that as the manufacturing operations did not require the use of any significant intangibles, there could not have been a transfer of intangibles upon closure. Secondly, no intercompany transfer of customer relationships as a consequence of the closure appeared to have taken place, neither directly or indirectly. Thirdly, there was no contractual arrangements upon which a claim for compensation could be based.
Furthermore, the tax tribunal made it clear that the burden of proof rested with the tax administration because the factory company was not required to include a description of its business restructuring in its transfer pricing documentation for the year in dispute (such requirement only being applicable as from 2006).