“GILTI Conscience” takes on the world of high-fashion, as Skadden tax partner and host David Farhat is joined by associate Stefane Victor and Giuseppe Abatista, vice president at Banca Popolare di Puglia e Basilicata, as they unravel the intricate transfer pricing challenges facing luxury fashion brands today. From the centralization of IP and marketing functions to the impact of tariffs and evolving global supply chains, this episode offers insights into how top brands are navigating tax scrutiny and regulatory complexity.
Episode Summary
Changes in the luxury fashion industry are reshaping transfer pricing considerations, says Giuseppe Abatista vice president at Banca Popolare di Puglia e Basilicata. In this conversation with Skadden tax partner David Farhat and associate Stefane Victor, Giuseppe shares his insights about how price increases, supply chain centralization and tariff uncertainties are creating new transfer pricing complexities in an industry known for high profitability and strong IP.
Key Points
- Centralization of Functions: Transfer pricing in the luxury fashion sector is heavily influenced by the centralization of key functions, especially around brand power and intellectual property, with a trend toward consolidating core activities and costs at the brand’s headquarters, which increases the complexity of intercompany transactions and reduces the availability of comparables.
- The Luxury Upgrade: Price increases have compressed the gap between aspirational and absolute luxury brands, with aspirational brands raising prices 30-35% in five years, driving consumers to upgrade to top-tier brands rather than pay similar prices for lower-tier luxury items.
- The Lure of APAs: Brands are responding to transfer pricing risks and controversy by securing Advance Pricing Agreements (APAs), particularly bilateral APAs, between key jurisdictions (e.g., Italy/France and the U.S.).
- Handling Expanding Complexity: The importance of maintaining reasonable gross margins and carefully allocating marketing and communication expenses is emphasized, as customs and tax authorities increasingly challenge transfer pricing arrangements.
Speaker 1 (00:02):
This is GILTI Conscience: Casual Discussions on Transfer Pricing, Tax Treaties and Related Topics, a podcast from Skadden that invites thought leaders and industry experts to discuss pressing transfer pricing issues, international tax reform efforts, and tax administration trends. We also dig into the innovative approaches companies are using to navigate the international tax environment and address the obligation everyone loves to hate. Now, your hosts, Skadden partners, David Farhat and Nate Carden.
Stefane Victor (00:36):
Hello and welcome to another episode of GILTI Conscience, hosted by David Farhat and Nate Carden. My name is Stefane Victor. Today, we’re missing Eman Cuyler, but are joined by an exciting guest, Giuseppe Abatista. Giuseppe is currently a vice president at Banca Popolare di Puglia e Basilicata, after having served as a member of the board of directors for a number of years. Previously, he was a group tax director at Ferragamo, advising the group tax department in all tax and custom affairs. On today’s episode, we’ll discuss transfer pricing in the luxury fashion market. A number of factors, high profitability, worldwide physical presence, and strong leverage on intangibles have made the luxury fashion market one of particular focus for transfer pricing scrutiny. Today, we’ll discuss the new, as well as existing, transfer pricing issues facing the industry. Giuseppe, welcome.
Giuseppe Abatista (01:29):
Thank you, Stefane, and thank you very much for inviting me. I’m really excited, because basically, luxury fashion, combined with transfer pricing, is, by far, my favorite topic, of course.
Stefane Victor (01:40):
It’s a fun one. So to get us started, what have you seen in the market recently? What have been the biggest issues facing the luxury fashion market?
Giuseppe Abatista (01:50):
Well, it’s actually a very problematic and transitional phase for the luxury market overall. The five years, going from 2019 to 2023, were years, despite the COVID, let’s say, parenthesis, were years of extremely good growth. The average growth rate for the market was 5% per year, and it was really very generalized. And cross brands, cross geographics, it was something that somehow gave the illusion that the ever-going growth that started basically at the beginning of the 2000s was still there. But from the half of 2024, the whole sector has experienced a strong slowdown. Now, of course, there are many factors at hands here. There are external factors to the industry, of course, the war, the Chinese economy slowdown, and also, lately, the uncertainty driven on the international markets by the Trump tariffs war. Of course, all of this is no good for a lot of businesses, including luxury, luxury in general and luxury fashion specifically.
(03:15):
And then, you have the factor that the luxury fashion consumer is more diverse than in the past, and also, the channels, both the distribution channels and the communication channels, are many, nowadays. Now, we all experience... TV is still there, radio is still there, classic advertising is still there, printed press is still there. But then, we have social media, we have the digital, we have all sorts of communication channels that need to be addressed, and this, of course, ends up in a pretty higher marketing and communication costs, which of course, together with rentals of the retail spaces and cost for salaries, are the three main cost drivers in the luxury fashion industry.
(04:09):
Then the diversity, the higher diversity of the customer base, is another driver. So again, all this is making the whole business less profitable than in the recent past, more complex to manage. And yes, the first answer that could win was, by all the top executives in the industry and basically all of the brands, was, since our consumer is not price sensitive, let’s raise prices, let’s increase prices. And this would remedy to all the rest.
(04:43):
This has worked in the past. I still remember after my first year at Ferragamo, after having funded the group tax department that was optimizing taxation around the world, and as a result, after my first year, the group effective tax rate was lowered by 1%. And when I proudly said that to the CEO, the CEO at the time answered, “Yeah, I understand. But see, I increased prices by 5%. So it was like your tiny 1% in effective tax rate, it’s really nothing.” And this has worked in the past a lot, but recently, the price increases have been continuous and especially... Well, let’s take a step back as a very important concept that one needs to have in mind, which is the luxury pyramid.
(05:37):
The luxury pyramid is usually divided into three layers. You have, at the top of the pyramid, you have the absolute luxury, where a few brands are, in the fashion luxury, of course. Then you have the aspirational layer, and then, you have the third part, the bottom part of the pyramid, that is the accessible luxury. So the bottom part of the pyramid is usually populated by brands that are between luxury and mass. They are like the top tier of the mass and the start of being to access luxury. Then you have the aspirational layer that is the most crowded one. So most of the brands that we know are there, and then, you have the few lucky ones that are in the very top.
(06:26):
So basically, the brands in the aspirational part of the pyramid are those ones that were more aggressive in increasing prices, so that, basically, their prices were becoming too close to the absolute part, the prices of the brands in the absolute part, which raised their prices not proportionally. And this, in a way, drove consumers to say, “I’d rather go a little bit upper in prices and go to the absolute ones, rather than buy a accessible luxury brand, which is 30%, 35% more expensive than it was only five years ago.”
David Farhat (07:09):
So Giuseppe, we really appreciate the background. So for us kind of tax and transfer pricing nerds, talking about the fascinating world of fashion, it sounds like there’s a lot of parallels in what happened with fashion in the last couple of years with what’s happening in tax, right? A lot of change, a lot of transformation. But when we get down to it, transfer pricing for one is all functions, assets, risks. So can we take some of that for our primarily tax audience and put it into transfer pricing speak?
Giuseppe Abatista (07:39):
Sure.
David Farhat (07:39):
Right, from a transfer pricing perspective, how is all of that impacting the industry?
Giuseppe Abatista (07:46):
Well, for sure, when we talk about foreign analysis in luxury fashion, DEMPE test plays a very crucial role, because one of the key functions around the core functions is on the one side to feed the brand power and on the other side to continuously create new products. But not only that, even new creative content for media and new creative content for marketing and communications, there’s a lot of IP involved there. And one of the impacts of the last year’s evolution of the luxury fashion and of the global brands is that these core functions got more centralized and also on retail excellence side, which is another key video creator within the industry. So basically, what changed is this higher centralization of functions, hence, of costs, because basically, all the value chain drivers are the more and more centralized in the house of the brand.
(08:58):
And then, the recent changes in the tariffs, I expect that any way kind of... Even if the tariffs will be canceled by yesterday’s decision of the court, still the level of uncertainty and this step-backing globalization are driving also for changes in the supply chain. I’m sure that the production that’s being decentralized recently will be re-centralized, will be relocated in economies that are perceived as safer, for sure. And then, another very important thing is that the drive for sustainability, which is very present in the luxury fashion evolution, is calling for a further expansion along the supply chain.
(09:57):
But the quest for sustainability, the quest for excellent producers, and even the aim at reducing production costs while keeping the quality extremely high, as it should be, it’s a natural and a must, in the sector, is pushing a lot of brands to expand along the production supply chain. And I must say, especially in Italy, because even the French brands are producing, for example, most of the leather, so shoes, handbags, small leather goods in Italy and they are buying tanneries, production plants, and even specialized producers that only produce part of the production chain. So this is another phenomenon. So basically, transfer pricing naturally keeps expanding the perimeter in the industry. The more and more transactions have become intercompany transactions, while, only recently, where there were third-party transactions. And so, this is driving also towards a progressive lack of comparables.
David Farhat (11:00):
So Giuseppe, as a transfer pricing controversy guy, what you said makes me very nervous. It gives me a lot of heartburn. We’re talking about an industry that, for a long time, has been raising prices. It has luxury in the name. It puts out the idea of being luxury and having a lot of money. It’s expanding across the globe. They touch just about every part of the world doing different things in different parts of the world. Very IP driven. The IP seems to be in higher tax jurisdictions, but also, some very aggressive jurisdictions, if we’re talking about parts of the EU. DEMPE being a big issue, DEMPE is what’s driving a lot of controversy right now. Big markets all over the world, markets where you may not necessarily have the IP. I know you may have some arguments from market jurisdictions saying, “Listen, we should get more of this profit, because the customers are here.” For a long time, luxury has been big in places like Mexico and places like China, where you don’t necessarily have that IP help. Can you give us an overview of that kind of transfer pricing controversy landscape?
Giuseppe Abatista (12:18):
No, there is controversy for sure, and I think we’ve not seen yet the big bang of certain big markets chasing for more revenues and starting from the point that customers are there. And not only this, luxury fashion consumers are global consumers. Just to give you an example, depending on the brands, depending on the year, but usually, 30% of the European retail sales are made to Chinese citizens. And when you look at the non-European tourists, you end up somewhere around the 50 to 55%. And when you consider it, including European travelers that are not buying home, but they’re buying while traveling, the percentage sometimes goes up to 70 to 75%. So there is a frontier that I can see coming. Also, despite, yeah, the IP in the luxury fashion usually concentrated where the maison was born, except from some remainings of the old tax planning structures with brands and trademarks concentrated in Luxembourg and the Netherlands.
(13:58):
But I think it’s a small minority that still has this kind of structure. Then the IP is in high taxing jurisdictions. But then, the markets, the main markets, are, again, high taxing jurisdictions. US usually is the first market for all brands. China tends to be the second one. Japan, by the way, is very strong right now, basically due to an explosion in tourism, also driven by currency, because the yen is not strong. It’s not anymore strong as it used to be. So it’s more convenient to shop in Japan for a lot of nationalities. South Korea, you mentioned Mexico, those are the biggest markets in the world. And of course, Italy and France and the UK, for sure, and Germany, the four big European economies as well. So of course, you see, so where there are consumers, there’s high taxation. And usually, luxury businesses tend to apply TNMM to their local distributors, which on one side, I can say, is even more appropriate now than it was in the past, because I was explaining a lot of strategy, but not even the strategy, even the implementation of the strategy.
(15:22):
So I always keep going back to the famous cheese examples of the IRS from the ‘80s or the ‘90s about this US distributor of French cheese, fromage frais in the examples. And there is this concept of bright line tests. So the bright line of marketing and communication expenses that should be born by a local distributor that I always relate to the DEMPE test, because that is a very good driver to understand whether or not the distributor is just making its job as a distributor. So it supports the products and the brand selling and the market it operates in, while on the other side, since, in the industry, the expense in marketing and communication is very high, usually, it’s eight to 10% of sales, and that’s average. In certain times of the year or in certain markets, you may want to spend even more, up to 15%.
(16:34):
Then it’s very easy for a local jurisdiction willing to find a way to challenge with residual profits play it or profits play it. It’s very easy to challenge the huge amount of marketing and communication expenses borne by the local subsidiary. Yeah, so of course, the absolute luxury is presently living a very good moment, because there’s a lot of polarization. There’s polarization in the brand’s performance. There’s polarization among the customer base. Because if you look at last year’s, 65 to 80% of global sales were driven by 20% of the consumers, so the super high end of the customer’s base in the fashion industry, in the luxury fashion industry. One thing that is common among these very high top brands is that they have fewer stores, extremely profitable. So even for tax authorities that a lot scrutinize whole industries, having at their disposal data about profitability of real direct competitors, those brands can affect an analysis when you are comparing those brands with brands in the second tier of the luxury pyramid. So the aspirational ones.
(18:15):
That’s usually to make the same amount of revenues need a couple of stores more, three stores more. And each store means rental, means CapEx investment, which is continuous in the luxury industry. You make CapEx every year in the same store for renovations, refurbishings, et cetera. And more and more, you relocate in malls, because malls are very progressive and they continuously monitor the sales per square meter of the various brands and force you out. Also, there’s another factor there. The groups, you have Elvémage, you have Kering and the other fashion conglomerates. They have more contractual power with the mall owners, with the shopping malls, because they place 5, 6, 7 brands all together. So they’re able to say, “I am here willing to enter into six different rental agreements, but I want that top spot.”
David Farhat (19:23):
So put another way, to the lay tax person, two things may look exactly alike, but may not be the same at all, just based on their placement on the pyramid, the way they do business, and honestly, the value of the IP, right, the marketing IP, how well it’s known.
Stefane Victor (19:45):
And it seems like, in addition to that, something that Giuseppe touched on was, in these last few years, if we’re looking at two products to the layperson might look similar but not be similar at all, in the last few years, it seems that prices of a aspirational luxury item have moved much closer to the top price. So they’re not even distinguished by price, even if there are differences in their quality, is what we’re assuming. And there might be differences in their quality and I guess differences in their manufacturing.
David Farhat (20:25):
Differences in reputation as well, right? Because if we’re saying a lot of this is driven by the marketing intangible, the price point may not be as much of a differentiator as it used to be. But there are other differentiators there. And I think that marketing intangible, and Giuseppe, correct me if I’m wrong, would be a key one, right?
Giuseppe Abatista (20:47):
Absolutely, yes. I have been at Ferragamo not only a group tax director, but over the years, I became planning and control director as well, but pricing director as well. So I took care of the pricing of 11 collections. And once, I remember clearly, my CEO was questioning me about the possibility to have a general price increase of 6% in one collection. And my answer to her was, “Listen, the brand is not powerful enough yet. I think that, in a couple of collections, we’ll be there.” Because there’s this direct link between the power of the brand, and the power of the brand is kind of a living creature. The brand is a living creature. As an identity changes over the years, changes with the geographies, and sometimes, it’s very strong, sometimes, it is less strong than recently. So you must have this kind of sensitivity. And this is very difficult to translate this in economic analysis.
Stefane Victor (22:00):
And that’s interesting. So you’re talking about the power of the brand might be a driver of increased prices, increased profits, but a consumer might wonder if the enhancement in manufacturing or enhancement in quality might also be the... Brands might decide to spend more on their materials or move their manufacturing to be more centralized, let’s say, in Italy or France, and that might result in an increase in price.
David Farhat (22:44):
But does it though? Is it more...
Stefane Victor (22:44):
Or maybe not. Maybe it’s just how trendy is our brand or how big has the living creature gotten? How much space are they taking?
David Farhat (22:55):
Did the right person wear it at the right time?
Giuseppe Abatista (22:56):
Exactly.
Stefane Victor (22:57):
Yeah.
Giuseppe Abatista (22:57):
Exactly. Also because already the retail to cost multipliers are skyrocketed in the last years. So I won’t make any figures, but if you look even at the group consolidated financial statements in luxury fashion is very common to find the 70, 75% gross margins. And EBIT margin is usually 25, 30%. And that is driven by the gross margin, first of all, because you have like 10 times retail to cost multiplier is very common, 100 euro costs 1000 in boutique.
Stefane Victor (23:41):
But if improvement in manufacturing or improvement in quality of goods is a driver or could be a driver, if it is a driver of increased prices, would that equal a higher return than something like the brand becoming more trendy? Because that might be associated with a much more expensive marketing cost.
David Farhat (24:01):
Well, but you have to compare that with the more expensive set up manufacturing costs, right?
Giuseppe Abatista (24:06):
Exactly.
David Farhat (24:07):
So becoming more sustainable may cost you more, but the right person wearing the right thing may not cost you anything, right? So it gets to this point about comparables and a marketing intangible, because Giuseppe, if I put my nerdy tax hat back on, right, say Stefane’s gotten very famous from the GILTI Conscience podcast, he wears something, it blows up, all the tax people want to wear it, because Stefane’s very trendy. You could tell by the Italian in his intro early. And people start wearing that. As a tax auditor, I’m like, “Well, that isn’t a increased value to the IP. That was done in the home office. That was the right person in a marketing jurisdiction or being presented in a marketing jurisdiction wearing something.” So I may challenge that TNMM or that cost loss. I may say, “No, I should get a bigger portion of that, because Stefane sits in Washington, DC. He does the podcast from Washington, DC. And now, this brand is selling, because everyone watches GILTI Conscience and they saw Stefane wearing it.”
Giuseppe Abatista (25:13):
Exactly. So there is a key factor at hands, and when combined with years and years of marketing and communication heavy expenses in the territory, even if they’re not big, they’re not high costs for marketing and communication expenses, if you see the overall picture, but if you see that P&L, those are high. And so, combined with this, for sure, there’s ground for challenges against the TNMM. And that is why a lot of brands have been securing their TNMM strategy, let’s call it strategy or at least policy, through APAs. There’s a huge number of brands that have a bilateral APA between Italy and USA and France and USA, because the US is usually the first market. So it’s the first market that you want to secure. I know that there are negotiations in place in China, even if the timeline is even longer than usual APAs, because as far as I know, it took three years for the APA request to be recognized as acceptable, legally acceptable, on the office side.
(26:36):
So now, they’re opening the negotiations after more than three years. But it’s really interesting, because it’s the first one. Then talking about South Korea, South Korea, not only you can get an APA, but it’s the only country in the world where you can get an APA that is both valid for customs and corporate tax purposes, which, in fashion luxury, is not that interesting for Italian or French brands. Because we have a free trade agreement between European Union and South Korea. And basically, all the European Union-originated merchandise enters Korea free of customs duty, but for other industries, may be very interesting. So basically, normally, if you enter into a unilateral APA with a country where the headquarters are, you cover half or almost half of your overall transfer pricing risk, and then, you start negotiating bilaterals with the key markets. And basically, in this way, you can achieve a coverage of 80%, 75%.
(27:45):
And still, I’m a big fan of the APAs, because there’s always space for negotiation to explore very much in detail these kind of specifics like the ones we were mentioning now of the industry, of the moment the industry is going through. I was negotiating the first bilateral between Italy and US in the fashion industry during COVID-19. So COVID years were covered, and we all perfectly know that the OECD guideline was not resolving anything. Because basically they were saying, you go for a case-by-case approach concerning all facts and circumstances. Thank you very much, OECD. But it was a very interesting conversation, the one that I had with APMA, and in the end, we ended by applying a different search only for 2020, based on 2020 data. Most of the range was actually below zero, because in the industry, 2020, it was a terrible year. Stores were closed, people were not going out, so basically, they were not buying anything.
Stefane Victor (29:05):
So with US being the biggest market for luxury fashion items, how has the industry reacted to the growing concern and presence of tariffs?
Giuseppe Abatista (29:22):
Well, the absolute pyramid went straight for price increase for the US market. And for goods originated in Europe, it’s 10 to 20%, 10% for sure and possibly 20%. Usually, an increase in prices between five and 8% covers perfectly the increase in applicable duties. On the other side, it has been an accelerator of ways to lower the duty of a base. The smarter fashion brands apply usually for sale costs needed for determining the duty of base when importing into the US, and this was, of course, perfect in times where the purchase order was placed in sales campaign and then, six months after, you were delivering that merchandise, that, since the very beginning, was designed for US only and that was it.
(30:42):
While in times where the distribution change and the allocation change, the demand planning department in the fashion brands has been recently evolving the more and more from a made-to-order to a made-to-stock model, where you have a bulk stock shipped to markets, and then, you do continuous replenishment shipments based on how fast an item is selling. Of course, this calls for TVIS. TVIS is more complex, because especially when you manage both sides of the transaction, like I do usually, I manage the corporate tax side, but also the custom side, then you try to find a balance. And then, in order to be able to apply the TVIS, you should derecognize the intercompany price list as conditioned by the intercompany relationship.
(31:51):
So usually, I get very scared about TVIS, but still, fortunately enough, the test that US customs apply is pretty old, I think. Some customs lawyer from New York City told me once that it’s basically coming out of the ‘60s. So it’s pretty primitive, in terms of economic analysis, especially for TP guys and TP nerds like we are.
David Farhat (32:22):
One of the issues currently with tariffs is they’re announced today and then, they’re delayed or they’re changed later. And so, how has that kind of, I don’t want to say inconsistency, but more like...
Stefane Victor (32:42):
Uncertainty?
David Farhat (32:42):
Uncertainty, thank you, Stefane. How has that uncertainty been handled by folks in the transfer pricing world? Because again, your recommendation to do APAs is awesome. I think it’s a good one and it’s good in times of uncertainty, but I think, even as much of an advocate as I am for APAs, even in the APA world, that could create some conflict, right? Because you sign into a certain kind of transfer pricing, you lock yourself in, and then, you have a bit of havoc on the custom side. So what are some of the strategies or what’s some of the thinking around that?
Giuseppe Abatista (33:16):
Yeah, one, for example, especially from clients that are not in the luxury part, but they are lower in the environment, their stance is, “Okay, let’s keep the intercompany price list as low as possible.” And so, they ask me for good arguments supporting this. So I have one client that is starting retail operations in the US, making a lot of investments with an aggressive opening plan in the next five years. I said, “Okay, you’re in a startup phase in the US, so why not? Let’s lower the intercompany prices immediately. And you can always say to customers that you’re supporting the business there, the investments, not only in terms of profitability, but also, in terms of cash flow.” So you are selling merchandise cheap, because you know that your local subsidiary will spend a lot of CapEx, will have a lot of CapEx investments in order to set up the stores in the biggest American cities.
(34:33):
Of course, for mass market brands, Mexico can be an option. The USCMCA, so former NAFTA deal is still in place. So Mexican origin merchandise enters the US free of duty. And for mass fashion, there’s plenty of space to find suitable producers in Mexico. Or the same can be for food and beverage from Canada, for example. Some raw materials or even to have some production made in Canada can be an option. So for sure, these uncertainty is driving, for sure, rethinking of the supply chain. Is there anything that we can change? Is there any way that we can position ourselves on the safer side, no matter what happens in the future?
(35:35):
For example, I have a brand, I can’t mention the specific part of the industry, but it’s an American brand that has an extremely good quality production in China, organized over the years, leveraging on their know-how, they’re going to move the production into Italy. Or even I heard of a Chinese leather accessories brand that sells a lot in the US and is planning to move their US-designed production into Italy, because it’s the fastest solution to go for it. You have the know-how, you have the facilities, you have the raw materials there. And tariffs, import duties from you are expected to be lower than China. Despite uncertainty, you can make this bet. It’s going to be cheaper. China is not going to be a trade partner, a welcome trade partner into the US in the next future. So for sure, makes more sense to go for the European Union or Turkey or Egypt, other places where fashion is produced and they only have 10%.
David Farhat (36:55):
And all of those movements in and of themselves create different transfer pricing issues as well, right?
Giuseppe Abatista (36:59):
Absolutely. You will transfer know-how, customers list, a lot of... Transfer pricing, it keeps expanding, because the chunk in the global trade, that is made by intercompany transactions, keeps expanding. And the complexity of this on the underlying business on the one side, but also the complexity of the transfer pricing rules and, let’s say, the subtleness of the transfer pricing thought and of the transfer pricing practitioners on both sides, tax authorities and in-house and advisers...
David Farhat (37:41):
And the evolving tax environment, right? We’ve got TCJA here in the US, we’ve got now a new bill coming out of Congress. You’ve got everything with the OECD. So it’s not just the transfer pricing itself, right? It’s the implementation and the interplay with all these other rules. So I think, to your point, with this growing transfer pricing, it’s also growing complexity.
Giuseppe Abatista (38:04):
Absolutely. And that’s why I stopped being a tax director and I went back to consultancy, because that is too much. I prefer to address problems step by step, batch by batch.
David Farhat (38:19):
One at a time. He’s going to have to deal with all of them.
Giuseppe Abatista (38:22):
Tax director goes crazy.
David Farhat (38:26):
Well, to all our tax director listeners out there, we empathize.
Giuseppe Abatista (38:31):
Absolutely we do.
David Farhat (38:36):
No, but Giuseppe, this has been a great conversation and a little bit of inside baseball for the listeners. Before we wrap, any last bit of advice to the tax directors in the fashion industry or in industries across the board that are dealing with all of this kind of expanding transfer pricing and expanding complexity?
Giuseppe Abatista (38:56):
Well, I have a personal opinion. It’s very typical that, when there’s a TNMM policy in place, people stop worrying about the right allocation of all the components of the P&L, because they say, “Well, who cares? In the end, EBIT adjustment covers it, equalizes it.” But I don’t agree with this approach. I think that one should keep a reasonable gross profit and gross margin, because that will help you when customs arrive. I’ve been challenged twice in China and also in other countries by customs, the customs audit, that were only challenging transfer pricing. They were like one month about customs compliance, and then, one year discussing about transfer pricing. Because they were charged.
David Farhat (39:55):
Wow.
Giuseppe Abatista (39:55):
So if you have a price list, intercompany price list, determined under a fairly and a reasonable RPM, consistent within the group, because consistency in transfer pricing is really consistency over time and consistency across countries and cross regions, that helps you a lot, if you have, for example, the right allocation of marketing and communication expenses. As a tax director, I was and I still am, with the companies I permanently advise, I am a maniac in evaluating each big event. Is that corporate? Is that the brand event? Is that a regional event? Is it a merely local event? And if it’s mixed, then let’s have a cost sharing agreement. It’s a 2 million-something event. Why not? We have a cost sharing agreement, participate by the brand, participate by the local distributor.
(40:53):
For example, recently, some years ago, I mean, Soho in New York City exploded. It was a new location. Nobody was in Soho, and it not only exploded and all the luxury brands opened in Soho, but there was this kind of idea that, in Soho, you should have something special, with artworks inside, with fancy architecture, even being a little bit different from the store concept that you implement more or less the same all over the world. And so, something special was expected from the brands, and that was an enabler of brand awareness. So, why not take up a contribution in that case? I’m a big fan of taking care of all the items in the P&L of the cost components, all the deal eval, and then, eventually, you will have an EBIT adjustment. Fine, that will help equalize, but then, if you’re strong and consistent all along, then for sure, you’re in a stronger position.
David Farhat (42:06):
Now, that makes a ton of sense, and I think that’s a great point to close on. Don’t just hang your hat on your transfer pricing, because your economist and all of that, all those measures, show that it’s arm’s length. Look at the business itself, again, your basics of a transfer pricing, functions, assets, risk. And make sure the appropriate folks are bearing the cost and getting credit for those. But Giuseppe, again, thank you so much for the time. We really appreciate it. And once again, this has been GILTI Conscience.
Giuseppe Abatista (42:35):
Thank you. It’s been great.
Speaker 1 (42:41):
Thank you for joining us for today’s episode of GILTI Conscience. If you like what you’re hearing, be sure to subscribe in your favorite podcast app, so you don’t miss any future conversations. Skadden’s tax team is recognized globally for providing clients with creative and innovative solutions to their most pressing transactional, planning, and controversy challenges. Additional information about Skadden can be found at Skadden.com.
Listen here or subscribe via Apple Podcasts, Spotify or anywhere else you listen to podcasts.
