Are there tax risks to the razor-and-blade model?

This model is popular. We see it all the time for the following pairs of products/services:
n Razors and blades (Of course!)
n Mobile phones and network service contracts
n Inkjet printers and ink cartridges
n Game consoles and games
n Water purifiers and refills
Companies follow this strategy, making their products incompatible with those of their competitors, to “lock in” the customers and sell the “refills” expensively. Looking at each product separately, sales of the initial durable products may suffer losses.
However, looking at the sales of the bundles, the companies would earn profits. This is a common business practice and is reasonable in the commercial aspect.
What about the tax aspect? Does this business model involve any tax risks?
Section 65(4) of the Revenue Code gives revenue officers the power to assess a taxpayer’s income in the case where the transfer of goods, the provision of service, or the lending of money is not compensated or is compensated at a price below the market price, without justifiable ground.
Under the razor and blade business model, if a taxpayer were to segment its financial by products, the sales of the initial durable products would generally be below the market price. In many cases, such durable products are even given for free (thus way below the market price).
Can the explanation of the razor and blade business model be considered “justifiable ground” from a tax perspective?
In practice, it is likely that such strategy is challenged by the revenue officers, as they may want to analyse the pricing and the profitability by products. From our experience, we have witnessed cases where taxpayers utilising this business model are challenged by the revenue officers.
However, there is also evidence supporting the use of such a business model. Ruling Kor Khor 0702/6615 (dated August 17, 2009) outlined a case in which a company sold intravenous fluid sets (IV sets) with and without machine-installation contracts.
 With the installation contract, the company would install the fluid-controlling machines for the customers for free. But the customers would have to sign a contract to buy the IV sets at a certain volume throughout a period of time at an agreed price. The price or the IV sets would be set high to cover the machine-usage cost.
Thus this price is higher than what customers would pay if they were to buy just the IV sets without the machine-installation contracts.
In this case, the ruling concluded that although the company allowed its customers to use the machine for free (service rendered without compensation), the pricing strategy of the IV sets under the contract (in which the price already took into account the machine-usage cost) constituted a justifiable ground per Section 65 (4) of the Revenue Code. Thus the company should not be assessed any additional service income.
The above example shows that the razor and blade business model could constitute a justifiable ground for selling some products or providing certain services below the market price or without compensation, given that in bundles, taxpayers are still compensated at market price and earn appropriate profits.
In summary, under Section 65 (4) of the Revenue Code, we believe that the razor and blade business model could be defended, with sufficient supporting documents and appropriate presentation of the case (given that, in bundles, the taxpayers would still earn adequate profits).
It is the best practice for taxpayers to maintain appropriate documents and provide the “right” information when requested by the revenue officers during audits. Providing poorly or naively prepared information to the officers may result in obstacles, lowering the possibility of the taxpayers winning the cases.