In its judgement 9C_37/2023 of 11 June 2024, the Federal Supreme Court (FSC) dealt, among other things, with the question of whether or not tax expenses should be taken into account in the cost base when applying the cost plus method in the context of Article 58 paragraph 3 of the Federal Act of 14 December 1990 on Direct Federal Taxation (DFTA; SR 642.11). The FSC came to the conclusion, in an interpretation of Article 58 paragraph 3 DFTA, that recorded taxes must be included in the cost base. Article 58 paragraph 3 of the DFTA is a provision of purely domestic law that is not designed for cross-border situations. This judgement by the FSC therefore does not change the recently clarified practice published in the FTA's Q&A on the cost plus method, namely that tax expenses are not to be included in the cost base for cross-border transactions.
The aforementioned FSC judgement was based on the following facts: power plants A. AG (respondent) operates a power plant. The material issue to be examined was whether the respondent invoiced its services to the shareholders (so-called partners) in the tax periods 2009 to 2011 in accordance with the arm's length principle (as prescribed by Art. 58 para. 3 of the DFTA). For this purpose, according to the FSC, it is necessary to determine the hypothetical arm's length price as it results from the electricity deliveries made by the respondent to its partners in the 2009 to 2011 tax periods.
In Article 58 paragraph 3 of the DFTA, the legislator mentions the three generally recognised approaches that are commonly used in an international context under the term "traditional transaction methods"; according to the FSC, this list is exhaustive. In the aforementioned judgement, the FSC stated that the suitability of the cost plus method was undisputed in the present case. Specifically, a hypothetical comparison was made, which was based on calculation assumptions. This required a closer examination, in particular with regard to the components of the cost base ("production costs" – as an undefined legal term – before the cost mark-up is applied). The dispute centres on the question of what should be included in the cost base or excluded from it. According to the FSC, the "production costs" mentioned in Article 58 paragraph 3 of the DFTA are based on a clear economic concept that places the full costs at the centre. In this way, the legislator indicates that taxes should also be included in the cost base.
Based on the current FSC case law, the FTA asserts the following:
The hypothetical/calculatory approach applied by the FSC in the aforementioned judgement does not equate to the comparison with actual transactions that is generally provided for in the OECD Transfer Pricing Guidelines. Different requirements must therefore be placed on the comparability of the cost base in a national or international context. In this context, it is not possible to apply the same standards for the comparability of the cost base in cross-border transactions, where comparative values are typically available from benchmarking studies. The FTA's position is based on the following considerations:
Article 58 paragraph 3 of the DFTA as a (special) norm of purely domestic law: Article 58 paragraph 3 of the DFTA is a norm of purely domestic law which – as the FSC also held in its ruling 9C_37/2023 of 11 June 2024 – is not designed for international situations. Indeed, the hypothetical arm's length principle referred to in Article 58 paragraph 3 of the DFTA is an aspect of internal federal law that must be interpreted and applied in accordance with the rules applicable to federal legislation (see FSC judgement 9C_37/2023 of 11 June 2024, point 2.3.6).
Clear regulation in the OECD Transfer Pricing Guidelines for intra-group transactions in an international context: According to the OECD Transfer Pricing Guidelines, the cost plus
method compares the gross profit that related parties realise in an intra-group transaction with the gross profit that independent third parties would realise in a comparable transaction (see OECD Transfer Pricing Guidelines 2022, para. 2.54 and para. 2.59). Conceptually, the OECD Transfer Pricing Guidelines assume that only costs that are closely related to the provision of the service can be passed on to the beneficiary. A fundamental distinction must therefore be made between operating costs, i.e. expenses that a company regularly incurs in order to keep business processes and systems running and to provide services that generate added value, and non-operating costs (costs that are not part of a company's core business). Tax expenses are not related to the functions being tested and is therefore excluded from the relevant calculation basis for determining the cost mark-up.
Comparability of the cost base – methodological aspects when applying the arm's length principle: The application of the cost plus method requires that comparable cost mark-ups are applied to comparable cost bases. For the arm's length compliant use of transfer pricing studies in the context of transactions involving Swiss companies, the cost base must be determined according to the same principles (identical profit indicator), as otherwise the calculated ranges are not comparable. Therefore, if – in accordance with FSC case law – the recorded taxes are included in the cost base, this has a decisive effect on the comparability of benchmark studies for which the calculation methodology does not take tax expenses into account. This is aggravated by the fact that such a restriction on the comparability of benchmark studies cannot be meaningfully remedied by adjustment calculations.
In the opinion of the FTA, any precedential effect of the FSC judgement 9C_37/2023 of 11 June 2024 that exceeds the scope of application of Article 58 paragraph 3 of the DFTA must be rejected. The practice applied by the FSC in this judgement to form the cost base is not in line with the OECD Transfer Pricing Guidelines and is not applied by the FTA in cross-border situations. Therefore, the FTA's practice for intra-group transactions in an international context remains unchanged and non-operating costs such as taxes continue not to be included in the cost base (see www.estv.admin.ch/estv/en/home/international-fiscal-law/transfer-pricing.html).