Jelena Mihic
Managing Director at Kreston MDM Serbia
Defending loss situations in transfer pricing
December 2, 2025
Defending loss situations in transfer pricing (TP) is not about denying losses, but demonstrating, through clear evidence, that they reflect genuine commercial conditions. Jelena Mihić Munjić, Managing Director at Kreston MDM Serbia and Chair of the Kreston Global Europe Committee, explores how businesses can navigate these challenges in her article for International Tax Review. Click here to access the full article, or read the summary below.
Why defending loss situations in transfer pricing causes scrutiny
Losses often arise from start-up activity, industry cycles, strategic investments, or shocks such as COVID-19. Yet in TP audits, persistent losses are treated as a warning sign. Tax authorities may view them as evidence that intercompany pricing does not reflect the arm’s-length principle (ALP). Multinationals must therefore be able to demonstrate that any loss allocation is commercially sensible and consistent with independent-party behaviour.
Arm’s-Length Principle and risk allocation
Under the OECD Transfer Pricing Guidelines (2022), related-party arrangements must mirror what third parties would accept. Independent entities rarely tolerate long-term losses without some offsetting benefit. For that reason, companies with routine or limited-risk profiles, such as contract manufacturers or distributors, should not typically remain in prolonged loss positions. If a subsidiary lacks the authority or financial strength to bear risk, assigning losses to it may contravene ALP expectations.
Commercial reasons for losses
Recognising legitimate drivers
Losses are not inherently inconsistent with arm’s-length behaviour, provided they arise from credible economic circumstances, such as:
- Start-up or market entry investments backed by business plans and projected profitability
- Industry-wide downturns or cyclical performance
- Extraordinary disruptions including supply shocks or pandemics
- Group-level strategies where losses support long-term brand or synergy objectives
Robust documentation should clearly connect losses to these drivers.
Benchmarking and comparability challenges
Benchmarking loss-making entities often requires additional justification. Authorities frequently question whether loss-making comparables should be included; however, they can still be appropriate where losses are temporary or aligned with industry conditions.
Multi-year averaging may help in cyclical markets, but will be dismissed if economic environments differ substantially between the tested entity and comparables. Well-supported adjustments, for capacity utilisation, extraordinary events, and differing risk allocations, are usually necessary when defending a loss position.
How tax authorities view losses, case studies
Argentina – Dart Sudamericana (2023)
- CUP used for pricing imports, but persistent losses weren’t supported by strong comparability evidence.
- Authorities applied TNMM; courts agreed due to weak adjustments and narrow comparables.
- Insight: A preferred method fails in loss scenarios without a clear explanation of comparability.
Czech Republic – Stora Enso Wood Products (2023)
- Subsidiary sold below cost following parent-company directives.
- Court questioned whether the entity had genuine decision-making authority or the capacity to bear risk.
- Insight: When losses arise from group strategy, compensation or pricing adjustments may be required.
France – ST Dupont (2023)
- French company showed long-running losses while a foreign affiliate was profitable.
- Authorities challenged the lack of a credible explanation and profit recovery plan.
- Insight: Losses are acceptable only when backed by a clear commercial narrative and evidence.
Strengthening documentation and audit defence
Effective defence involves more than meeting standard local-file requirements. Taxpayers should include:
- A clear explanation of loss drivers
- A detailed functional and risk profile
- Forecasts demonstrating a route back to profitability
- Compensation mechanisms if group strategy compels losses
During exceptional disruptions (e.g., COVID-19), pricing and agreements should be revisited to reflect actual commercial conditions.
Jurisdictional differences
Approaches to loss-making entities differ across countries:
- Germany generally accepts start-up losses for up to three years, expecting profitability shortly after.
- Argentina applies strict scrutiny when comparability support is weak, as seen in Dart Sudamericana.
- Czech Republic emphasises functional capacity, illustrated by Stora Enso.
- France requires that losses align with a credible business rationale, shown in ST Dupont.
These variations underscore the need to align global strategies with local regulatory expectations.
What this means for multinationals
Losses are not inherently non-arm’s-length, but they must be clearly explained and supported. Without a credible commercial rationale and solid comparability evidence, tax authorities are likely to challenge them. Multinationals should monitor results closely, update intercompany arrangements when conditions change, and ensure that documentation across jurisdictions tells a consistent story. In essence, defending loss situations means showing that the losses flow naturally from real business circumstances and reflect what independent parties would reasonably accept.
For more information on transfer pricing, click here.
