ITPJ JULY/AUGUST 2000 II. COMPARABILITY ANALYSIS IN APPLYING gross margins to be applied to fashionable articles. The THE RESALE PRICE METHOD appropriate gross margin as determined by the tax auditors was therefore 28 per cent. According to the statement of A. Relationship between resale price method and the facts by the Court, this was justified by the tax auditors comparability analysis on the grounds that Apart from the formal aspects of the case, the Tax Court of the plaintiff sold fashionable wear which was predomi Dusseldorf also dealt with the substance of the arm's nantly manufactured in Italy and, hence, in a country which was used to quite different standard sizes because south length principle. For determining an appropriate transfer European people were normally smaller than central Euro- price, both the tax office and the Tax Court applied differ pean people. Also, it was to be taken into account that the ent approaches; however, these approaches were always manufacturer was located in a country which had the repu based on the resale price method. An analysis appears tation for delivering ordered goods either with defects, with interesting because the Court and the tax auditors have a delay, or not at all. In addition, it was to be taken into been confronted with difficulties similar to those experi account in determining an appropriate margin that the plain enced by the taxpayer in applying the resale price method tiff was engaged in the trading of high-price fashionable The Tax Court of Dusseldorf case is typical, in so far as in wear which was only purchased by very few customers practice there are often only transactions with unrelated This meant that the plaintiff had only a limited growth potential because it could only deliver its goods to selected suppliers that are barely comparable. The problem of retailers.Also, enterprises distributing high-priced luxury barely comparable transactions draws attention to another articles were more likely to be more strongly affected by issue related to the determination of transfer prices political and economic crises than enterprises distributing namely the appropriate application of the comparability goods for everyday demand. 2 analysi Given the above circumstances the tax auditors deter The term comparability analysis was coined by the OECD. mined a five per cent premium on the gross margin of 23 It means that in comparing a transaction between related per cent as provided by the industry average, resulting in a and unrelated companies, all economically relevant differ- gross margin of 28 per cent ences are to be adjusted. 1 A direct comparison of the First, it is remarkable that this computation is not meant to transactions (i.e. without adjustment) is only possible in be an estimate but a determination of an appropriate trans exceptional cases This means that the comparability ana- fer price, considering that the administrative principles lysis is of crucial importance in determining the appropr require a transactio obas ed analysis . Therefore, the shift in two steps. In the first step, all differences between the must first be justified. This shift can be reasonable if the There may be differences in functions performed (e.g. tions are performed over time or differences in specific advertising, service or transport), risks (e.g. inventory, transactions can be ignored for reasons of practicality.34 price,currency,credit or collection risk), contractual terms Although the administrative principles generally do not (e. g. terms of payment or delivery), economic circum- allow an aggregation of transactions, it seems to be fair stances(e.g. property of trademark rights or geographic that an aggregation should be admissible in the Dusseldorf markets), and business strategies. In a second step, exist- Tax Court case. Thus, the question of comparability will ing differences must be quantified and adjusted accord- arise ngly As discussed above all differences must be identified and In the Dusseldorf Tax Court case, there were also consid uantified, although the OECD emphasizes that only those erable differences between the transactions to be com- differences that impact the margin are to be adjusted, 35The ared. For this reason, it is interesting to see how adjust ax auditors'analysis, however, also provides for the ments are to be computed in the opinion of the tax adjustment of differences that are of minor importance within the scope of the resale price method. For example, the tax auditors emphasized that on account of smaller B. Resale price method applied by the tax office standard sizes in Italy, the German distributor was likely to realize a higher gross margin than an average distributor The constructive dividends were determined by the tax However, an advantage of the resale price method(as office using an external gross margin comparison, follow- compared with the comparable uncontrolled pr nce metho ing two approaches. The first approach was based on that product differences play a much less significant role industry averages, while the second(as already described (if any at all). 3 Furthermore, the tax auditors did not take above)was based on gross margins realized by four into account the comparative group(i.e. German distribu wholesalers in the same indust tors)that probably distributes the same standard sizes In the first approach, the appropriate gross margin was determined on the basis of publicly available industry averages collected by the tax authorities. According to the 31. See OECD Guidelines, notes 1.15-1.35: US Treas Reg. Sec. 1.482-1(d) tax auditors' file of wholesalers in the textile industry 2. See sTrE20(1999),at788 appropriate gross margins range from 17 per cent to 23 per 33. See Administrative Principles, Sec. 2. 1.2. cent.The industry data, however, also allowed higher 35. See OECD Guidelines, note 1.15 36. See OECD Guidelines, note 2. 17: US Treas. Reg. Sec. 1. 482-3(c)(3(II(B) 2000 IBFD Publications BV