The Administrative Court of Zug on 5 December 2024 underscored the importance of the principle of periodicity in transfer pricing practice, concluding that the tested party’s transfer prices must satisfy the arm’s-length standard for each fiscal year.
The case involved a Zug-based subsidiary of a multinational pharmaceutical group that recorded a -21.8% (negative) operating margin in fiscal year 2018 to achieve an overall average operational margin of 1.2% over a three-year period (2016-2018). Citing a benchmarking study whose interquartile range for comparable distributors spanned a 1.1% – 7.3% range, the taxpayer asserted that the average result over a three-year period was within the arm's-length range. The cantonal tax authority rejected the multiyear approach, applying the low end of the interquartile range (1.1%) to the 2018 period and issuing an upward adjustment of approximately CHF 9 million.
The Administrative Court upheld the cantonal tax authority's position, holding that multiyear averaging cannot smooth a non-arm’s-length single-year operating result.
The judges based their reasoning on two pillars. First, Article 58 of the Swiss Federal Direct Tax Act hard-codes the periodicity principle: taxable income must be determined once per year, based on that year’s facts. Second, the court found no extraordinary external event, such as a product recall, supply-chain shock, or regulatory ban that could be used to justify a negative margin for a routine distributor whose very business model is to earn a steady, low-risk return. In the court’s view, the 2018 adjustment was inconsistent with both the entity’s limited-risk profile and with the principle of periodicity.
The decision highlights the notion that transfer pricing results must align with the entity’s functional profile in the tested period.
Before 2018, the Swiss tested party functioned as a full-risk entrepreneur: it owned and funded research and development (R&D), set the strategic marketing direction, managed demand forecasting, and bore broad market and inventory risks. After 2018, those high-value functions, assets, and risks were transferred to a foreign principal under an internal restructuring. After the restructuring, the Swiss tested party's functional profile narrowed down to limited-risk distribution activities (order fulfilment and debt administration, for example) with exposure limited to routine inventory and credit risk. A party with this limited-risk profile would normally earn a modest operating margin proportionate to the risk profile. The –21.8 % loss reported for 2018 therefore signalled a disconnect between the new profile and the applied transfer-pricing policy: either the functions-and-risks transfer had not been followed in practice, or the transfer pricing policy was out of sync with the new profile. The court reached the latter conclusion, and made a correction to the minimum arm’s-length margin.
Both the OECD Transfer Pricing Guidelines and Swiss practice acknowledge that multiyear data can enhance comparability by capturing business cycles and structural trends. Such data may be used when selecting and testing comparables only when it improves the reliability of the analysis; it cannot justify a tested-party result that falls outside the arm’s-length range for the specific year under review. The Federal Tax Administration’s 2024 administrative guidance reiterates that annual testing remains the default and that any reliance on multiyear averages must be supported by robust, contemporaneous evidence.
The cantonal tax authority, along with the administrative court, accepted the benchmark analysis conducted by the Swiss taxpayer and relied on the same interquartile range of results. The core of the dispute centred on timing: the taxpayer utilised a three-year interquartile range to assess operating results across a three-year period, citing common price lags in the pharmaceutical supply chain. However, both the tax authority and the court insisted on a single-year testing approach. Setting the 2018 margin at 1.1%, the lower quartile of the arm's-length range, the authority exhibited both restraint and resolve. This decision demonstrated restraint by choosing the lowest defensible profit and resolve by disallowing a loss for a routine distributor without compelling external justifications, which were absent in the tested party's case. Moving forward, negative margins will require closer scrutiny to ensure they are genuinely market-driven and align with the functional profile of the tested party.
The Zug decision is unlikely to remain an outlier. Other cantonal courts may look to it when faced with similar disputes, and the ESTV’s recent guidance suggests a push for stricter, year-by-year enforcement.
Groups with Swiss operations should revisit their transfer pricing policies to ensure alignment with the functional profiles before the 2025 year-end closes.
For more information on the court decision or transfer pricing in general, please consult your regular BDO contact or the authors of this article.
Tomas Medina
Tulika Lall
BDO in Switzerland
Facts of the Case
The case involved a Zug-based subsidiary of a multinational pharmaceutical group that recorded a -21.8% (negative) operating margin in fiscal year 2018 to achieve an overall average operational margin of 1.2% over a three-year period (2016-2018). Citing a benchmarking study whose interquartile range for comparable distributors spanned a 1.1% – 7.3% range, the taxpayer asserted that the average result over a three-year period was within the arm's-length range. The cantonal tax authority rejected the multiyear approach, applying the low end of the interquartile range (1.1%) to the 2018 period and issuing an upward adjustment of approximately CHF 9 million.The Administrative Court upheld the cantonal tax authority's position, holding that multiyear averaging cannot smooth a non-arm’s-length single-year operating result.
Administrative Court's Decision
The judges based their reasoning on two pillars. First, Article 58 of the Swiss Federal Direct Tax Act hard-codes the periodicity principle: taxable income must be determined once per year, based on that year’s facts. Second, the court found no extraordinary external event, such as a product recall, supply-chain shock, or regulatory ban that could be used to justify a negative margin for a routine distributor whose very business model is to earn a steady, low-risk return. In the court’s view, the 2018 adjustment was inconsistent with both the entity’s limited-risk profile and with the principle of periodicity.
Importance of Functional Profile
The decision highlights the notion that transfer pricing results must align with the entity’s functional profile in the tested period.Before 2018, the Swiss tested party functioned as a full-risk entrepreneur: it owned and funded research and development (R&D), set the strategic marketing direction, managed demand forecasting, and bore broad market and inventory risks. After 2018, those high-value functions, assets, and risks were transferred to a foreign principal under an internal restructuring. After the restructuring, the Swiss tested party's functional profile narrowed down to limited-risk distribution activities (order fulfilment and debt administration, for example) with exposure limited to routine inventory and credit risk. A party with this limited-risk profile would normally earn a modest operating margin proportionate to the risk profile. The –21.8 % loss reported for 2018 therefore signalled a disconnect between the new profile and the applied transfer-pricing policy: either the functions-and-risks transfer had not been followed in practice, or the transfer pricing policy was out of sync with the new profile. The court reached the latter conclusion, and made a correction to the minimum arm’s-length margin.
Guidance on Multiyear Aanalysis
Both the OECD Transfer Pricing Guidelines and Swiss practice acknowledge that multiyear data can enhance comparability by capturing business cycles and structural trends. Such data may be used when selecting and testing comparables only when it improves the reliability of the analysis; it cannot justify a tested-party result that falls outside the arm’s-length range for the specific year under review. The Federal Tax Administration’s 2024 administrative guidance reiterates that annual testing remains the default and that any reliance on multiyear averages must be supported by robust, contemporaneous evidence.
Comparability and Benchmarking Nuances
The cantonal tax authority, along with the administrative court, accepted the benchmark analysis conducted by the Swiss taxpayer and relied on the same interquartile range of results. The core of the dispute centred on timing: the taxpayer utilised a three-year interquartile range to assess operating results across a three-year period, citing common price lags in the pharmaceutical supply chain. However, both the tax authority and the court insisted on a single-year testing approach. Setting the 2018 margin at 1.1%, the lower quartile of the arm's-length range, the authority exhibited both restraint and resolve. This decision demonstrated restraint by choosing the lowest defensible profit and resolve by disallowing a loss for a routine distributor without compelling external justifications, which were absent in the tested party's case. Moving forward, negative margins will require closer scrutiny to ensure they are genuinely market-driven and align with the functional profile of the tested party.
Practical Guidance for Swiss-Based Groups
- Annual testing: Confirm each Swiss entity’s margin falls within the arm’s-length range for the year under review. When an adjustment is needed, implement it before year-end and document the pricing logic.
- Contemporaneous evidence: If supply disruptions, regulatory delays, or exceptional write-offs occur, record and quantify them immediately. Timely memos and board minutes carry more weight than explanations prepared during an audit.
- Align substance with form: Intercompany contracts, day-to-day conduct, and financial results should align. A limited-risk distributor is not expected to shift from double-digit profits to significant losses absent a demonstrable business driver.
- Benchmark maintenance: Update comparable sets regularly. Multiyear data can illustrate trends but should not be used to defend an annual result that is otherwise outside the arm’s-length corridor.
- Consider frequent transfer pricing-related true-ups: Include contractual provisions that permit more frequent transfer pricing-related adjustments toward the median of a defensible range; this approach is more robust than large retroactive year-end corrections that may draw attention.
Looking Ahead
For multinationals, the timing of this decision is significant. Cantonal tax offices are increasingly coordinating with the Swiss Federal Tax Administration’s (ESTV’s) specialist transfer pricing unit, applying common analytical toolkits and sharing sector know-how. The pandemic years left a trail of losses that many groups have attempted to offset through multiyear averaging or pandemic adjustments. This decision suggests that the Swiss tax authorities may attempt to separate genuine external shocks -- documented in real time -- from losses created by internal pricing shifts. The message: expect deeper data analytics, expect more pointed questions about functional profiles, and expect little tolerance for after-the-fact smoothing.The Zug decision is unlikely to remain an outlier. Other cantonal courts may look to it when faced with similar disputes, and the ESTV’s recent guidance suggests a push for stricter, year-by-year enforcement.
Groups with Swiss operations should revisit their transfer pricing policies to ensure alignment with the functional profiles before the 2025 year-end closes.
For more information on the court decision or transfer pricing in general, please consult your regular BDO contact or the authors of this article.
Tomas Medina
Tulika Lall
BDO in Switzerland