Transfer pricing is founded on the arm’s length principle which requires transactions between related parties to reflect the conditions that would have been agreed by independent enterprises. However, determining an arm’s length outcome extends beyond contractual arrangements or the labels attached to a business. Tax authorities and courts increasingly examine the commercial substance of related-party transactions by asking who performs the key functions, who controls the significant risks and who has the financial capacity to bear those risks. This emphasis on economic substance over legal form was reaffirmed by the Supreme Court in Zambia Revenue Authority v Nestlé Zambia Limited (2025), a landmark decision that provides valuable guidance on the burden of proof, functional characterisation, transfer pricing documentation, aggregation of transactions and the use of foreign comparables.
Case Background
Nestlé Zambia Limited (NZL), a member of the global Nestlé Group, was established in 2010 to distribute Nestlé products in Zambia. Following several years of continuous losses despite engaging in substantial transactions with related parties, the Zambia Revenue Authority (ZRA) initiated a transfer pricing audit covering the 2010 to 2014 tax years. The audit concluded that NZL’s related-party transactions did not reflect the arm’s length principle, prompting ZRA to adjust the company’s taxable income and issue an additional income tax assessment of ZMW 13.86 million. NZL objected to the assessment, arguing that it had complied with the arm’s length principle, that ZRA had applied inappropriate transfer pricing methods and that its use of foreign comparables was unreliable. While the Tax Appeals Tribunal upheld the legitimacy of the audit, it found that ZRA had used an inappropriate transfer pricing methodology and ordered a reassessment. NZL appealed the Tribunal’s decision to the Supreme Court, resulting in a landmark judgment that provides valuable judicial guidance on the application of key transfer pricing principles.
Court’s Reasoning and Decision
The Supreme Court held that once a transfer pricing assessment has been issued the taxpayer bears the statutory burden of proving that the assessment is excessive or incorrect. The Court found that the Tax Appeals Tribunal had erred by shifting this burden to ZRA instead of requiring NZL to demonstrate that its related-party transactions complied with the arm’s length principle. The Court reaffirmed that a taxpayer must support its transfer pricing position with sufficient evidence and cannot merely challenge the methodology adopted by the revenue authority. The Court further upheld the Tribunal’s finding that NZL was properly characterised as a limited-risk distributor, noting that strategic decision-making, financing and the assumption of significant business risks remained largely with related entities within the multinational group. It emphasised that transfer pricing outcomes should be determined by the economic substance of the arrangements rather than the contractual allocation of risks alone, reinforcing the principle that risk follows control. In addition, the Court recognised that closely linked controlled transactions may be analysed on an aggregated basis where they form part of a single commercial arrangement and are economically connected. It also confirmed that, where reliable local comparables are unavailable, foreign comparable companies may be used provided appropriate adjustments are made to improve comparability. Finally, the Court held that the Commissioner has statutory authority to request transfer pricing documentation necessary to verify compliance with the arm’s length principle, even before the introduction of detailed transfer pricing documentation regulations. Accordingly, the Supreme Court allowed ZRA’s appeal, dismissed NZL’s cross-appeal.
Key Takeaway
The Supreme Court’s decision confirms that, in transfer pricing, risk follows control and substance prevails over form. Taxpayers must ensure that their transfer pricing positions are supported by robust documentation and evidence demonstrating the actual functions performed, risks controlled and assets employed.