Iceland's Court of Appeals has upheld the country's first-ever transfer pricing ruling, confirming that companies must prove related-party transactions meet the arm's length standard — and that failing to do so carries serious consequences.
The Icelandic Court of Appeals (Landsréttur) upheld the ruling of the District Court of Reykjavík in Iceland’s first transfer pricing case (No. 213/2025) on 19 February 2026. The court confirmed that taxpayers must prove that related-party transactions comply with the arm’s length principle.
The dispute involves the reassessment of taxes for the 2016 tax year, specifically focusing on whether transactions with an Irish parent company followed the arm’s length principle. Authorities determined the company used an incorrect cost-plus pricing method by excluding essential production expenses like labour and depreciation, resulting in undervalued sales and shifted profits.
The court ultimately upheld the original tax authority rulings, noting that the company failed its legal burden to provide sufficient documentation proving fair market pricing. Consequently, the firm was ordered to pay the adjusted tax amounts along with significant penalties and legal costs.
The following sections elaborate on the core aspects of the case:
Core of the dispute: Transfer pricing
The primary conflict centred on transfer pricing—the pricing of goods in transactions between related entities. Íslenska kalkþörungafélagið ehf., which operates a calcified algae factory in Bíldudalur, sold nearly all its raw materials to its Irish parent company, Marigot Ltd.
The Icelandic tax authorities argued that the sales price was set too low, effectively shifting profits from Iceland to Ireland, where the tax environment might be different. The central question was whether these transactions were conducted on an arm’s length basis (armslengdargrundvöllur), meaning at a price comparable to what unrelated parties would agree upon.
The “cost-plus” method controversy
To determine the transfer price, the company used the cost-plus method based on OECD guidelines. They aimed for a 50% gross margin added to the production costs. However, a major disagreement arose regarding what constituted “production costs”:
- The company’s stance: They excluded labour costs and depreciation of fixed assets from the cost base, treating them as fixed costs unrelated to the production volume.
- The tax authority’s stance: They maintained that labour and depreciation are typical direct and indirect production costs. By excluding them, the company created an artificially low cost base, resulting in an undervalued sales price even when the 50% margin was applied.
Facts
An Icelandic taxpayer sold goods to its Irish parent using a cost base excluding labour costs, which were classified as fixed costs independent of production. The cost base included materials, packaging, transportation, electricity, and harvesting costs with a 50% markup applied.
Tax authorities challenged this approach, adding labour costs back into the cost base while maintaining the 50% margin. The taxpayer had not filed transfer pricing documentation for tax year 2016 (financial year 2015) but later submitted documentation for tax year 2019 (financial year 2018), arguing the same methodology should apply retroactively to 2016.
The taxpayer’s benchmark study showed:
- Unadjusted weighted average gross margins of 4.8% to 93.8% among comparables, versus the taxpayer’s 54.8%.
- Net cost-plus markups of 1.3% to 19.6% for 19 benchmark companies, compared to the taxpayer’s 2.8%.
Legal framework and burden of proof
The court’s decision relied heavily on Article 57 of Act No. 90/2003 on Income Tax and Regulation No. 1180/2014 regarding documentation and transfer pricing. Key legal points included:
- Burden of proof: Under Icelandic law and OECD guidelines, the taxpayer bears the burden of proof to demonstrate that their pricing with related parties is at arm’s length.
- Documentation requirements: Companies are legally required to maintain extensive documentation to justify their transfer pricing. The court found that the company’s documentation from 2018 was “insufficient” and lacked a valid comparative analysis with unrelated parties.
- OECD guidelines: These guidelines are considered a vital interpretive tool for Icelandic tax law regarding transfer pricing.
Final judgment
The Landsréttur upheld the District Court of Reykjavik’s decision, confirming the tax authorities’ reassessment that added labour costs and depreciation to the cost base while retaining the 50% margin. This increased the company’s 2016 tax base by approximately ISK 487.5 million, eliminating transferable losses and resulting in substantial tax liability. The court also sustained a 25% penalty, rejecting the company’s good faith defence. The Icelandic State was acquitted of all claims, and Íslenska kalkþörungafélagið ehf. was ordered to cover the state’s legal costs.
