Summarizing the key learning of Swedish Tax Agency’s ruling in case of Puma (A thread) (1/19)

#Taxtwitter #Transferpricing #BEPS #Puma #OECD #Riskcontrol #lossmaking #Tax
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Puma group has been designing, developing and selling marketed shoes, clothing and accessories under the Puma brand for over 65 years. The Puma brand is considered to be one of the world's leading sports brand.

Puma distributes its products through three different sales channels: wholesale, own stores and the Pumas e-commerce store. The wholesale channel represents 77% of overall revenue. The majority of Puma's production is done by external manufacturers.

The group's employees are mainly engaged into marketing, design & product development. Puma designs its advertising both globally and locally, and advertising platforms are primarily various forms of mainstream media such as magazines, television, cinema & outdoor advertisement.

Puma AB (Swedish co) is an indirect wholly-owned subsidiary of the German parent company Puma SE. Puma AB has two main transaction flows with the Puma group:

1) Purchase of goods from Puma International Trading GmbH (PIT)

2) Payment for marketing license from Puma SE

1) Purchase of goods from PIT
PIT purchases products from external contract manufacturers and sells it to Puma AB. To compensate, Puma AB pays PIT a commission of 8.5% on the cost of production.

In relation to the product development and design functions performed, Puma AB pays 2.5%-4% on the manufacturing cost to PIT.

2) Payment for marketing license from Puma SE
Puma SE owns the Puma brand & has significant investments in marketing, communication and sponsorship

The distribution companies of the Puma group use the content produced by Puma SE under a licensing arrangement. Distribution companies pay royalty of 9% for all sales to external customers

Puma AB had used CUP/CUT method to benchmark the above intercompany transactions. Puma AB’s operating margin for sales to external customers for the years 2017, 2016 and 2015 was (7.95%), (9.76%) and (6.57%) respectively.

Analysis by Swedish Tax Agency (STA)

The STA relied on the six-step procedure to identify the economically significant risks recommended under the OECD Base Erosion and Profit Shifting (BEPS) Action 9

The STA identified Puma group’s two significant risks as Brand risk and Product development risk.

Based on the conduct of the parties, the STA held that Puma Nordic AB, Puma group’s Swedish distributor, did not bear the identified significant risks

As a result, a distributor not exposed to key risks should not incur losses for several years, as per the arm length standard. Instead, Puma AB should be compensated based on the margins earned by independent comparable companies.

Based on this analysis, the STA challenged the losses incurred by Puma AB. It was compared to the profits of independent distributors in the European region through a comparability analysis on the Amadeus database to work out the transfer pricing adjustment.

This ruling highlights the importance of risk control analysis in light of OECD Action Plan 9. Distributors should perform a health check analysis to assess whether the group’s transfer pricing policy is in compliance with risk control framework as per the 2017 OECD guidelines.

Conclusion

If a distributor is making a loss, some questions that could be asked are whether -

1) The distributor is making losses for reasons other than internal pricing? For instance, start-up losses or losses in connection with market penetration strategy?

2) The losses are temporary or continuous for a longer period? Temporary reasons may be ineffective management, distortion in local markets, or extraordinary circumstances. If the losses are continuous, the reason for continuing the business?

3) The group follows a centralised or decentralised model? In a centralised model, since key decisions reside with Headquarter Company (HQ co), tax authorities may question the losses at distributor level as the residual profit/ loss should be borne by the HQ co.

If the distributor is a Limited Risk Distributor, whether it is selected as the tested party as it is the least complex entity in the group?

In all situations, taking into account the approach suggested by BEPS Action 8-10, it will be prudent to look at the group’s value creation activities and entities bearing economically significant risks before characterising the entity.

End of thread (19/19)