Treatment of taxes in the cost basis, in the context of Cost-Based Transfer Pricing Methods

Introduction

The question of whether taxes should be included or excluded from the cost base when applying the cost-plus (C+) transfer pricing method has sparked significant debate in recent years. The Federal Tax Administration ("FTA") clarified its position on this matter in February last year, aligning with the OECD guidelines. However, a ruling by the Federal Supreme Court on June 11, 2024 (9C_37/2023), appeared to challenge this approach in a specific context, prompting the FTA to issue further clarification in October of the same year.

FTA Position and OECD Guidelines

On February 23, 2024, the FTA published its official practice online, confirming that taxes should be excluded from the cost base when applying cost-based transfer pricing methods. This approach is based on OECD guidelines, which state that only expenses directly related to the production of goods or services should be included in transfer pricing calculations (i.e., operational costs directly tied to rendered services). According to the OECD, it is essential to distinguish between operating costs, which generate added value—expenses a company regularly incurs to maintain business processes and deliver services—and non-operating costs, such as taxes and financing costs. Since they do not contribute to value creation, non-operating costs should generally not be included in the cost base.

The exclusion of taxes is justified for several reasons:

Taxes are not directly related to the provision of goods or services and represent a burden for the company;
Including taxes in the cost base would distort the comparability of the Cost Plus Method (CPM) and the Transactional Net Margin Method (TNMM) with independent companies due to varying tax rates across jurisdictions;
These variations could lead to tax adjustments by foreign authorities in the context of international transactions;
Including taxes in the cost base could distort profit margins and affect the arm's length analysis; and
Strict adherence to OECD principles ensures uniform practices across jurisdictions, minimizing the risk of double taxation or tax adjustments.

Federal Supreme Court Ruling of June 11, 2024 (9C_37/2023)

In this ruling, the Federal Supreme Court addressed an issue unrelated to international transfer pricing: the application of Article 58(3) of the Federal Act on Direct Federal Taxation (LIFD) and Article 24(5) of the Federal Tax Harmonization Act (LHID) to mixed-economy enterprises. The court concluded that the concept of "current production cost" includes all expenses, including taxes. This decision is based on historical Swiss practice and certain doctrinal references.

However, the ruling does not challenge OECD principles applicable to international transfer pricing. Specifically:

The Federal Supreme Court emphasized that Article 58(3) LIFD is a domestic legal provision not designed for international transactions;
The economic logic of comparability analyses, essential in transfer pricing, requires the exclusion of taxes to ensure consistency with the cost bases of comparable companies;
Including taxes in the cost base could create methodological inconsistencies between Swiss and foreign companies applying OECD principles; and
The court's legal interpretation is based on a specific reading of domestic legislation, which cannot be transposed to the international transfer pricing framework.

FTA Confirmation in October 2024

In response to questions raised by the Federal Supreme Court ruling on June 11, 2024 (9C_37/2023), the FTA issued a clarification on October 8, 2024, reaffirming that the exclusion of taxes from the cost base remains applicable to international transfer pricing. Three key arguments were presented:

Article 58(3) LIFD does not apply to international transactions;
OECD principles require limiting the cost base to elements directly related to the provision of goods or services; and
Including taxes in the cost base would compromise the comparability of transfer pricing studies.

Thus, companies must align their cost base calculations with commonly accepted practices in transfer pricing studies to avoid disadvantageous tax adjustments. The FTA also emphasized that non-compliance with these guidelines could be perceived as a higher tax risk, particularly in the context of enhanced intra-group transaction controls.

Conclusion

The exclusion of taxes from the cost base in transfer pricing remains the FTA's adopted position, aligned with OECD principles and the economic logic of comparability analyses. The ruling 9C_37/2023 pertains only to a specific domestic context and cannot be applied to international transfer pricing. Companies must continue to adhere to the FTA’s guidelines to ensure the correct application of the CPM and TNMM in an international framework. Additionally, multinational companies should pay particular attention to documenting their transfer pricing to ensure compliance and anticipate potential tax adjustments due to differing interpretations.

We are available to provide our expertise in assessing financial costs while emphasizing the need for taxable margin calculations to be approved by the relevant tax authorities.