The treatment of loss-making comparables in transfer pricing analyses has long been a contentious issue between tax authorities and taxpayers. At the heart of the debate is the practice of benchmarking, which involves identifying comparable transactions to determine arm’s length pricing. A carefully conducted benchmark, supported by comprehensive and defensible documentation, is critical for justifying profit levels in related-party transactions and demonstrating compliance with tax authorities. However, the inclusion or exclusion of loss-making comparables remains a highly debated topic, as it can significantly impact the determination of arm’s length pricing. In July 2024, the Supreme Court of Italy issued a landmark ruling on this subject, bringing renewed attention to the treatment and relevance of loss-making comparables. Transfer pricing practitioners should take note of these developments, as they could have significant implications across jurisdictions.

Reasons for excluding loss-making comparables

Historically, the common practice in transfer pricing analyses has been to exclude loss-making comparables from benchmarking sets, particularly when assessing the profitability of so-called routine companies, which are typically rewarded with low but stable returns. This approach is based on the assumption that entities with persistent losses are not representative of typical market conditions. The rationale is that companies consistently incurring losses would eventually exit the market, rendering them unreliable as benchmarks for arm’s length transactions. Persistent losses have often been attributed to extraordinary factors such as market inefficiencies, poor management or unique business strategies—factors perceived as diverging from the profit-maximizing behavior expected of independent businesses in competitive markets.

Accordingly, some tax authorities have historically taken the stance that loss-making comparables should be excluded from benchmarking studies for routine entities. For instance, China’s State Administration of Taxation has issued guidance, notably “Circular 2” (2009) and “Bulletin 6” (2017), asserting that entities with routine functions should maintain a reasonable level of profit, with loss-makers subject to heightened scrutiny.¹ However, approaches vary across jurisdictions; some exclude loss-making comparables outright, while others allow them based on context.

The exclusion of loss-makers also served a practical purpose: It simplifies analyses, especially when applying methods like the Transactional Net Margin Method (TNMM). By omitting loss-making comparables, analysts could reduce disputes over adjustments and avoid distortions in interquartile ranges, which might otherwise lower benchmarks and complicate assessments. However, this practice has faced growing criticism for failing to reflect economic realities, particularly during periods of economic downturn or industry-wide challenges (e.g., the impact of the COVID-19 pandemic on industries such as hospitality), when losses may genuinely reflect prevailing operating conditions. Excluding loss-making entities can unduly narrow the range of comparables and fail to capture legitimate business scenarios, such as aggressive market entry strategies or temporary restructuring phases—factors that are essential for a comprehensive and balanced analysis.

Court rulings on loss-making comparables

Recent legal decisions across the globe demonstrate a shift towards a more nuanced approach to loss-making comparables.

In Decision No. 19512/2024 (July 2024), the Italian Supreme Court ruled that loss-making comparables cannot be excluded solely due to their financial outcomes.² The case involved a call center service provider whose markup had been recalculated by tax authorities after excluding entities with negative results. The court emphasized that legitimate business strategies, such as market penetration or high startup costs, might justify temporary losses. This ruling reinforced the principle that benchmarking should consider broader economic and strategic contexts, rather than rely solely on financial metrics. The decision aligns with international standards and ensures a more balanced reflection of arm’s length pricing.

In Case No. 7 Afs 398/2019-49 (April 2022), the Czech Supreme Administrative Court upheld the exclusion of loss-making comparables in a dispute involving a contract manufacturer with a limited functional and risk profile.³ The case arose when the tax authorities challenged the manufacturer's reported losses, arguing they were inconsistent with its routine role in the multinational group's value chain. The court sided with the tax authorities, rejecting multi-year averaging to justify persistent losses, affirming that routine entities must achieve at least minimal operating profitability to align with the arm’s length principle. The decision underscores the need for robust documentation and consistent benchmarking methodologies to ensure accurate reflections of market conditions.

In Panama, the Administrative Tax Tribunal ruled in Resolution No. TAT-RF-002 (January 2020) on a transfer pricing dispute involving loss-making comparables.⁴ The case involved a taxpayer operating in the Colón Free Zone, which was affected by economic downturns. While the Tribunal rejected the outright exclusion of loss-making comparables, it noted that their inclusion requires a thorough analysis of the reasons behind the losses and whether they reflect normal business conditions, in line with OECD Transfer Pricing Guidelines. This decision underscores the importance of applying comparability standards consistently and reflects a nuanced approach to the role of loss-making comparables in transfer pricing analyses.

Key takeaways

These cases underscore the critical importance of benchmarking in transfer pricing and highlight the complexities surrounding the treatment of loss-making comparables. Courts have increasingly acknowledged the need to account for economic and strategic considerations when evaluating comparables. However, these rulings also reveal significant inconsistencies in how local tax authorities interpret and apply international guidelines, reflecting divergent views on comparability. This lack of global consensus emphasizes the importance of tailoring approaches to local regulations and practices while aligning them with overarching international principles.

For taxpayers, the key takeaway is the imperative to maintain robust and comprehensive transfer pricing documentation. This documentation should include a detailed analysis of comparables, clearly justifying the inclusion or exclusion of potential comparable companies based on sound economic rationale and functional alignment. Understanding the market dynamics and strategic context of all comparables is essential to building a defensible position and minimizing the risk of disputes.

Ultimately, taxpayers dealing with loss-making comparables should adopt a proactive and well-documented approach, ensuring that benchmarks are of the highest quality, reflect economic realities, and are supported by thorough, jurisdiction-specific analyses. Such preparation will help taxpayers effectively navigate increased scrutiny from tax authorities and establish credible positions capable of withstanding challenges.

1. Guo Shui Fa [2009] No. 2 (Circular 2) (State Administration of Taxation, January 2009); SAT Public Notice No. 6 (State Administration of Taxation, March 2017).
2. Italy vs Convergys Italy S.R.L, July 2024, Supreme Court, Case No 19512/2024.
3. Czech Republic vs Aisan Industry Czech, s.r.o., April 2022, Supreme Administrative Court, Case No 7 Afs 398/2019 – 49.
4. Panama vs “AC S.A.,” January 2020, Administrative Tribunal, Case No TAT-RF-002.