Our latest transfer pricing update takes us to Kenya, where a dispute involving the growing and selling of pineapples evolved into a fundamental debate about tested party selection, functional analysis, and the limits of contractual risk allocation under transfer pricing regulations.
The case illustrates how tax authorities evaluate controlled transactions, assess transfer pricing risks, and apply the OECD Transfer Pricing Guidelines when reviewing cross-border intercompany transactions.
The Facts: A Grower–Distributor Model Under Scrutiny
Del Monte Kenya, a grower and processor of pineapples, faced a tax audit for the 2018 tax year. The dispute concerned sales of processed goods to its related party, Del Monte International GmbH (DMI GmbH).
The taxpayer applied one of the standard transfer pricing methods — the Transactional Net Margin Method (TNMM) — using a 4.83% full cost mark-up and positioning itself as the tested party.
However, the Kenya Revenue Authority (KRA) rejected this approach. The KRA argued that the Kenyan entity was not a routine manufacturer but rather the economically complex party, bearing significant agricultural and market risks such as:
- Crop failure and weather volatility
- Inventory and logistics risks
- Market price fluctuations
- Production and quality control risks
In contrast, the related distributor performed only limited support functions.
As a result, the KRA reassessed the transactions using the Deductive Method (customs valuation principles) and disallowed various intercompany charges and loan interest, resulting in transfer pricing adjustments and increased income tax exposure.
Tribunal Findings: Functional Analysis Matters
The Tribunal ruled in favor of the KRA on all grounds.
Central to the decision was the inadequacy of the taxpayer’s functional analysis. The Tribunal found that the FAR (Functions, Assets, and Risks) analysis was “inaccurate and unreliable,” particularly in its characterization of the distributor as the principal risk-bearing entity.
Evidence demonstrated that the Kenyan entity performed the operational heavy lifting in its business operations, including:
- Quality control
- Logistics to port
- Inventory management
- Production oversight
- Agricultural risk management
Because the grower bore substantial operational and commercial risks, the Tribunal concluded it could not serve as the tested party under TNMM. Instead, the distributor — performing routine functions — should have been tested, or treated as a low-value service provider with a limited mark-up.
Consequently, the ruling reinforces that transfer pricing methods must align with economic reality, not simply contractual allocation.
Substance Over Form and OECD Alignment
Under the OECD Transfer Pricing Guidelines, risk allocation requires more than contractual language. The party assuming risk must demonstrate:
- Decision-making authority
- Control over the risk
- Financial capacity to bear the consequences
In this case, the distributor failed to demonstrate control over key agricultural and operational risks. As a result, the Tribunal applied a substance-over-form analysis consistent with international transfer pricing regulations and global efforts to address base erosion and profit shifting (BEPS).
This decision underscores that improper characterization of entities in controlled transactions may lead to significant transfer pricing audit exposure, increased tax liabilities, and potential double taxation where corresponding adjustments are not granted in other tax jurisdictions.
Comparability Analysis and Tested Party Selection
One of the core lessons from this dispute is the importance of defensible tested party selection and robust comparability analysis.
In a manufacturer–distributor model, practitioners frequently encounter questions such as:
- Should the grower receive treatment as a routine contract manufacturer?
- Does the distributor truly act as the entrepreneurial principal?
- Should a two-sided method be considered to share residual profits?
Where a one-sided method such as TNMM applies, the tested party must be the least complex entity with reliable comparable data. Furthermore, failure to align the transfer pricing method with actual economic substance significantly increases transfer pricing risks and audit scrutiny.
Documentation Requirements and Audit Readiness
This case also highlights the importance of strong documentation requirements, including:
- A comprehensive Master File outlining global value chains
- A detailed Local File documenting local intercompany transactions
- Clear alignment between contracts and operational reality
- Thorough comparability analysis supported by reliable benchmarks
Inconsistent or unsupported documentation weakens a taxpayer’s position during a transfer pricing audit and increases the risk of penalties.
The Broader Implications: Avoiding Penalties and Double Taxation
When tax authorities impose transfer pricing adjustments in one jurisdiction, taxpayers face the risk of double taxation if the counterparty’s jurisdiction does not grant a corresponding adjustment.
The Kenyan case demonstrates how weak functional positioning can trigger reassessments that go beyond pricing — potentially affecting the deductibility of charges and intercompany financing arrangements.
For multinational groups, therefore, proactive compliance with OECD-aligned transfer pricing regulations is critical to:
- Mitigate transfer pricing risks
- Avoid penalties
- Prevent profit reallocation under BEPS frameworks
- Ensure defensible pricing of transactions with unrelated party benchmarks
A Practical Perspective
Tested party selection is not a mechanical exercise. Rather, it is the product of a well-documented functional analysis, consistent contractual arrangements, and alignment with actual business operations.
Cases like this reinforce a simple principle: substance determines outcome.
For multinational groups operating across multiple tax jurisdictions, centralized and consistent transfer pricing documentation — including Master File, Local File, and comparability analysis — is essential to managing audit exposure and ensuring alignment with OECD standards.
In disputes where authorities scrutinize substance line by line, clarity, consistency, and defensibility are often the decisive factors in avoiding costly adjustments and protecting against erosion and profit shifting challenges.