Recent cases on TP – Chile vs Avery Dennison Chile SA (FY 2012)

Continuing the effort to monitor the intercompany operations, on 31 March 2021, the Chilean Tax Court has ruled in favour of Avery Dennison Chile SA in a case that characterises the literalness of the transfer pricing regulatory framework in Chile to date. The Chilean Tax Court found that the Chilean Tax Administration failed to demonstrate that their allegations against marketing operations carried out by the taxpayer during FY 2012 with related parties were not at market value (Assessment No. 210 dated 30 August 2016).

Although there were two main types of operations: purchase of finished products and cash pooling operations, we will focus on the results and implications of the former.

One of the main topics was precisely the period of the audit (FY 2012): Opportunely the taxpayer claimed a misapplication of the former Article 38 of the Tax Law regarding Article 41E, indicating that the observed operations were in the transitional stage² of local transfer pricing rules.

This led the taxpayer to indicate as arbitrary an application of the interquartile range, that removes the upper 25% and lower 25% of profitability from the sample of comparable companies, indicating that neither the current legislation nor the former legislation contemplates the obligation to apply some interquartile statistical adjustment over the full range.

Regarding transfer pricing methodology, the taxpayer relied on an analysis of gross margins, indicating that its analysis was consistent with the resale price method (RPM). The Chilean Tax Administration’s position was based on an application of the transactional net margin method (TNMM) and there was also some disagreement on the selection of publicly traded distributors to be used as alleged comparable companies (whilst the taxpayer criterion was focused on companies with similar products, the Chilean Tax Administration’s criteria for selecting comparable companies emphasises the functions performed by these companies over the marketed product, in addition to considering that the companies included in the comparability have products that are similar in terms of the risks assumed).

On this topic, the taxpayer argued that the RPM was the appropriate approach, as it is the most direct method applicable to the margins observed at gross levels, in addition to concentrating the main intercompany transactions (purchase of finished products for resale, at the cost of sale level). The taxpayer, therefore, argued that the Chilean Tax Administration misused the TNMM, given that what generated a reduction in operating margins is not related to an increase in the acquisition costs of the products that are subsequently resold, but rather to a decrease in the selling prices of those products and the circumstances that led it to make that determination (explained by a market penetration strategy to increase sales in Chile, even with negative profitability, “agreed” with its main offices). The Chilean Tax Court dismissed the alleged “taxpayer business strategies” implied to select the TNMM instead of the RPM, given that that the Chilean Tax Administration could not demonstrate that those strategies were sustained over time.

The Chilean Tax Court also dismissed the Chilean Tax Administration’s position regarding the rejected range chosen in the transfer pricing report and arbitrarily decided to apply the interquartile range, even bearing in mind that the use of this range must be examined on a case-by-case basis. The same happened with the adjustment to comparable companies, in which case it could not justify the previous allegations.

As we can see, a blundering strategy of the Chilean Tax Administration, which could not in a timely way justify and support its allegations regarding the selected method by the taxpayer, adjustments to the comparable companies or the opportunity of the interquartile range construction, led the Chilean Tax Court to rule in favour of Avery Dennison Chile, leaving Assessment No. 210 without effect.

² The Chilean Transfer Pricing regulations reform occurred with Law 20.630 dated 27 September 2012 and given that the largest volume of taxpayer operations observed by the Chilean Tax Administration are prior to that date, it could even be considered as a strong argument to invalidate the transfer pricing audit.

Read the WTS Global Transfer Pricing Newsletter here.