• Service: Tax, Global Transfer Pricing Services, Global Compliance Management Services
  • Type: Regulatory update
  • Date: 3/25/2013

Finland - No notional “location savings” deduction on contract-manufacturing transfer 

March 25: The Finnish Supreme Administrative Court—in a March 2013 case concerning the arm’s length service fee for contract-manufacturing services, and when “location savings” can be allocated to foreign low-cost subsidiary—held that notional location savings may be relevant when functions previously located in a high-cost country are transferred to a low-cost country.

However, in this case, the court found that the nature of the functions performed by the low-cost country subsidiary were not the same as those previously conducted by the taxpayer in Finland.


The Finnish group parent company (A Oyj) had a subsidiary (B AS) in Estonia.

  • The Estonian subsidiary manufactured goods solely for Company A.
  • Based on the contractual arrangement, the Estonian subsidiary (Company B) could be regarded as contract manufacturer.

Company A had previously manufactured goods in Finland, but relocated the production to Company B in 2004. Company B then further developed the manufacturing process by introducing new manufacturing technologies and automating certain production steps that previously were performed by hand in Finland and, in some instances, in workers’ homes. Most of the manufacturing methods in Estonia were never used by Company A in Finland.

The fee charged by the Estonian Company B was based on manufacturing costs plus a mark-up of 7.95% and half of the notional location savings that were derived from relocating the manufacturing activity to Estonia (a lower cost country). The mark-up, however, was not applied to all invoiced costs, but only to the final invoice for the year—which included both manufacturing expenses and the allocated location savings.

For benchmarking purposes, net cost plus was selected as profit level indicator, and the mark-up was determined using TNMM.

Court’s decision

Finland’s Large Taxpayer’s Office applied 2010 amendments of the OECD Transfer Pricing Guidelines retroactively in making tax assessments in this case (i.e., for tax years prior to 2010), and the Finnish Supreme Administrative Court (Super hallintotuomioistuimessa) upheld such retroactive application of these OECD provisions in this case.

The Finnish Supreme Administrative Court confirmed its earlier position that despite the fact the OECD Transfer Pricing Guidelines are not legally binding in Finland, the OECD Guidelines nevertheless are recognized as an international standard for purposes of interpreting the arm’s length principle.

Further, the Supreme Administrative Court explained that even though Chapter IX was incorporated to the OECD Guidelines in 2010, that chapter does not include any groundbreaking, new interpretation (but rather provides clarification on principles set out in Chapter I). Thus, the court found the guidance presented in Chapter IX can be retrospectively (retroactively) applied to the facts in this case.

The court turned to consider the issue of notional “location savings” in this case and held that location savings is relevant if the functions located in a high-cost country were transferred to a low-cost country. However, in this case, the court found that the nature of the functions performed by the Estonian subsidiary were not the same as those previously conducted by Company A in Finland. Thus, the facts in this case did not correspond to the location savings example presented in Chapter IX of the OECD Transfer Pricing Guidelines.

Further, the court held that the locations savings could not be determined by comparing the actual costs in the low-cost country and notional costs in the high-cost country.

The court, however, reasoned that even though the location savings amounts claimed by the Finnish taxpayer were not acceptable, there was no obstacle to finding an acceptable margin that would be favorable to the Finnish company—even though the company had not requested application of a higher profit margin.

The court found that the margins of companies operating in low-cost jurisdictions may be higher than of that of companies operating in high-cost jurisdictions. Thus, location saving would be accepted through application of higher (arm’s length) mark-up.

In this case, the mark-up of the operating expenses was derived from comparing two Estonian companies, which were included in the initial pan-European benchmark study provided by the taxpayer. The Estonian companies included in the final set of comparable companies had higher profit margins than the western European comparables.

KPMG observation

The Supreme Administrative Court’s decision follows closely the guidance presented in the OECD Guidelines. However, tax professionals in Finland have observed that court’s interpretation of the OECD Guidelines was “quite mechanical” and that Finnish taxpayers need to take this into consideration when planning the relocation of functions.

Further, from reading this decision, it may be concluded that the court approves the location savings approach, but the benefit for the low-cost subsidiary must be realized through arm’s length mark-up supported by a benchmark study—and not by allocating notional location savings between the parties.

The Supreme Administrative Court’s decision includes observations of the qualitative issues related to determining the arm’s length mark-up, such as size of the comparable companies, balance sheet structure, and assets within (intangibles).

For more information, contact a tax professional with KPMG’s Global Transfer Pricing Services group:

Mikko Palmu

+358 20760 3405

Sanna Laaksonen

+358 20760 3417

Contact a tax professional with KPMG's Global Transfer Pricing Services.

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