BEPS Action Plan: Action 10 – Transfer pricing and other high-risk transactions

The objective of action 10 in the OECD’s BEPS Action Plan is to develop rules to prevent abusive transactions which would not, or would only very rarely, occur between unrelated parties. We provide commentary and links to content on action 10.

 

Updates

Read our response to the latest discussion draft

 

11 February 2015

Our response of 6 February is one of 82 comment letters published by the OECD on the 19 December BEPS discussion draft on Risk, recharacterisation and special measures (see also our comments on Action 8). The OECD has also published comments it received on:

 

6 February 2015

In our response to the discussion draft on commodity transactions we point out the value of...

using taxpayers’ internal comparable data, industry standards, existing guidance and the practical experience gained by taxpayers and tax authorities that have applied the so-called sixth method over the years. We provide comments on a number of detailed areas.

Our recommendations focus on the following aspects:

  • Ensuring consistency with the existing consensus around the selection of the most appropriate transfer pricing method to the circumstances of the case;
  • Recognition of the value of using taxpayers’ internal comparable data, industry standards, existing guidance and the practical experience gained by taxpayers and tax authorities that have applied the so-called sixth method over the years;
  • Recognition that at arm’s length, pricing in commodity-related transactions is likely to result in a range of outcomes, rather than a single pricing point;
  • Clarifying the scope and the applicability of the guidance, in particular with respect to the use of the deemed pricing date.

The language of some of the suggestions in the Draft in the areas listed above may require further clarification; but, once this is addressed, we believe the revised paper will assist taxpayers in ensuring their transfer pricing remains arm’s length and will address concerns tax authorities have raised about the potential for the erosion of their tax base in this area.

 

6 February 2015

In our response to the discussion draft on profit splits we point out that to a certain extent, the Discussion Draft seems to use concepts such as “integration” and “global value chains” to...

make it easier for tax administrations to apply the profit split method rather than to improve the guidance on choosing the most reliable transfer pricing method. The profit split method has previously been described as a “method of last resort”; the Discussion Draft contains elements that may in certain situations permit taxing authorities to, in effect, apply it as a default method.

The Discussion Draft recommends the use of transactional profit split methods in a number of scenarios and as a corroborative method. We would like to point out that in many situations, one-sided analyses are appropriate and reliable. In scenarios where one-sided methods are appropriate and reliable based on a thorough functional analysis, we feel corroborative profit split methods may be a precursor to formulary apportionment, as they may improperly suggest higher returns to entities performing routine functions that can be reliably benchmarked. To this end, we would like to emphasize that a value chain analysis and a profit split are not, and should not be considered to be, synonymous.

PwC recommends the revisions to the Discussion Draft focus on providing objective advice to MNEs. We believe the Discussion Draft includes many subjective terms that may be pejorative and therefore interpreted differently by rational decision makers.

PwC recommends that the OECD view the revisions to the Discussion Draft in the context of the BEPS action plan as a whole. Other Action items may alleviate some of the concerns surrounding transfer pricing issues. The work to address base erosion and profit shifting should be viewed holistically, and other workstreams may address transfer pricing issues sufficiently enough that the arm’s length principle and the guidance on use of profit split methods does not need to be radically altered.

Overall, PwC recommends that the OECD devote sufficient time for deliberation and consideration in considering any change to the guidance on use of profit split methods. To this end, we emphasize that the Transfer Pricing Guidelines already address profit split analyses and the selection of the most appropriate method. Lastly, any changes in guidance on profit splits should reflect the principle that functional analyses are critical to transfer pricing analysis.

 

21 January 2015

Our response on the low value-adding services discussion draft is part of a consolidated document covering all 65 responses which is now…

published on the OECD website:

Comments received by OECD on BEPS Action 10 Low Value-Adding Services (PDF, 11MB)

The input will be discussed during a public consultation at the OECD Conference Centre on 19-20 March 2015 at which we intend to be represented. It is expected that this meeting will be broadcast live on the internet - no advanced registration is required for this internet access.

 

9 January 2015

Insofar recharacterisation is envisaged wjhere substantive analysis of the parties’ economic behavior in the context of the multinational’s entire value chain dictates…

tax authorities could change or replace a contract’s terms to reflect risks and functions the authorities believe are actually being assumed and performed, viewed in light of risk allocation measures the parties in a similar commercial or financial relationship might take.

In establishing criteria for non-recognition, the OECD replaces the ‘commercial rationality’ test in the existing Transfer Pricing Guidelines with the ‘fundamental economic attributes’ concept. The draft says it is difficult to know what independent enterprises behaving in a commercially rational manner would have done. The new test requires the arrangement to afford both parties an opportunity “to enhance or protect their commercial or financial positions,” evaluated in light of potential alternative arrangements.

The OECD concedes that related parties may legitimately engage in transactions that unrelated parties may not, and that those transactions should be recognized and priced for tax purposes. However, the draft also states that non-recognition may be appropriate when related party transactions do not have the ‘arm’s length attributes’ or ‘fundamental commercial attributes’ of unrelated-party transactions.

The draft invites comments addressing to what extent “imputed moral hazard and contractual incentives play [a role] with respect to determining the allocation of risks and other conditions between associated enterprises.” The OECD suggests that parties acting at arm’s length would take steps to mitigate any moral hazard created by a lack of incentive to guard against risk where a party is protected from the consequences. The presumption is that related parties have less incentive to bargain for their own interests or to proportionately allocate risk based on which parties are the most exposed to the consequences of the risk.

The questions include ways to deal with value creation that are either within or beyond the arm’s length principle.

All of the options for special measures raise concerns regarding consistency with the arm’s length principle (including many existing income tax treaties) and the separate-entity concept on which the international tax rules have been historically based.

 

5 January 2015

On the commodity transactions discussion draft, many commodity-dependent developing countries are not OECD members and may not adopt all aspects of the Transfer Pricing Guidelines, so...

if the final recommendations do not encourage consistency on a global basis, new countries might introduce different variations of the Sixth Method as an application of the CUP method.

Comparability adjustments to quoted prices would be particularly important in applying the CUP method to account for physical differences, different specifications, freight, etc.

The OECD and World Bank intend to provide practical tools to help developing economies make maximum use of quoted prices for commodities, beginning with minerals. The draft directs taxpayers using the CUP method to document it in writing, detailing the application of market data, including formulas used. Such details (especially formulas) typically vary between commodities and markets, and are often highly confidential. Practitioners may need to reconcile those formulas with formulas their competitors have previously communicated to tax authorities. Taxpayers may welcome further OECD guidance on implementation.

Tax authorities in developing countries may have limited expertise and resources for verifying pricing dates in commodities contracts. This applies particularly where the contracts allow optionality in fixing the pricing date and reliable evidence is lacking for the date actually agreed.

The OECD suggests tax authorities impute a date where they believe that related parties’ behavior is inconsistent with an agreed pricing date. The imputed date should be consistent with facts of the case and industry practices. Absent such evidence, the shipment date could be deemed the pricing date (subject to appropriate comparability adjustments).

In general, commodities industry pricing is complex, with many variations, so setting a single rule for pricing dates may be challenging. It may not be possible to price certain commodities at delivery. Other activities, such as pricing of optionality around delivery dates, may need to be accounted for be means other than pricing dates (e.g., by comparability adjustments).

 

23 December 2014

The broad scope of options put forward on profit splits may inhibit the OECD’s ability to modify the Transfer Pricing Guidelines in...

a flexible manner that considers the variety of situations taxpayers face.

The draft follows closely the conceptual paradigm in the Action 1 report on the the digital economy, which seems to muddle the distinction between an origin-based income tax and a destination-based VAT.

The OECD views a business’ success as depending on ‘integration’ of related parties, with various entities carrying out ‘interdependent’ functions and strategic risks being jointly managed and controlled by multiple entities, leading to ‘synergies’.

The OECD also sees many multinationals as having ‘fragmentation’ or splitting functions within a value chain, with certain entities undertaking only specific, limited functions for which it may be difficult to identify comparables with similarly limited functions.

The OECD seems to mix economic concepts with long-established tax principles by treating a multinational as a single firm operating in a coordinated fashion to maximize opportunities in a global economy. This approach makes corporate legal structures and individual legal entities less important in transfer pricing analysis.

‘Integration’ and ‘fragmentation’ are used in a way that casts doubt on the viability of proposed comparable transactions and one-sided methods.

The discussion draft’s concept of a ‘global value chain’ raises questions in the context of transfer pricing. It is not clear how this approach would contribute to the transfer pricing analysis for most related-party transactions, except as a part of formulary apportionment. This sort of analysis is consistent with the new ‘master file’ documentation requirement, which provides tax authorities with information on the entire group.

In general, the notion of superseding separate entity accounting in transfer pricing for multinationals raises questions with regard to Article 9 of the OECD Model Tax Treaty. That provision respects separate entity accounting and is the foundation for the Transfer Pricing Guidelines.

The draft asks how to develop objectivity in profit split factors and whether there are particular factors that are likely to reflect value creation for particular industries or sectors.

The draft also asks what aspects may be particularly relevant for transactions involving hard-to-value intangibles.

It also questions how the transactional profit split method can be applied to deal with unanticipated results and whether it may be appropriate to split losses differently from how profits are shared.

 

20 December 2014

On 19 December, the OECD released a transfer pricing discussion draft within Actions 8-10 covering risk and situations calling for recharacterisaton or ‘special measures’...

  • Part I proposes to revise the Transfer Pricing Guidelines by focusing on accurate delineation of transactions in accordance with the parties’ substantive commercial and financial relationships. The proposed revisions address
    • the relevance and allocation of risk
    • controlled transactions’ economically relevant characteristics
    • recharacterisation or non-recognition of transactions.

The draft’s basic theme is that contractual risk allocations are a starting point, but there is still a need for substantive analysis of the parties’ economic behavior in the context of the multinational’s entire value chain. The basic criterion is that a transaction would be disregarded if it does not have the “fundamental economic attributes of arrangements between unrelated parties.”

  • Part II has options for various special measures with regard to:
    • intangible assets
    • risk
    • over-capitalisation.

    It sets forth potential options for some special measures with regard to certain situations that are difficult to value. The options include:

    • a deemed contingent payment pricing mechanism
    • special rules for independent investors in “capital-rich, asset-owning companies”
    • an option for dealing with ‘thick capitalization’
    • a proposal for reallocating the profits reported by certain “minimal functional entities.”

 

17 December 2014

On 16 December, the OECD released two BEPS transfer pricing discussion drafts under Action 10, addressing the following topics...

  • Transfer pricing using profit splits in the context of global value chains
    • The various views and options offered do not represent a consensus of the parties involved.
    • The OECD sees profit splits as potentially more reliable where a multinational has pooling among entities of functions and risks.
    • The OECD also sees many multinationals as having ‘fragmentation’ or splitting functions within a value chain, with certain entities undertaking only specific, limited functions for which it may be difficult to identify comparables with similarly limited functions.
    • In general, the OECD seems to consider profit split methods as the solution where a lack of comparables renders one-sided methods unreliable.
    • The OECD considers transactional profit splits to be a means of aligning profit with value creation, but it acknowledges profit splits’ perceived subjectivity, due to the difficulty of objectively verifying allocation keys.
    • The OECD also considers applying profit splits to the valuation of partially developed intangibles.
    • The discussion draft questions how the transactional profit split method can be applied to deal with unanticipated results.
    • Another scenario addresses where it may be appropriate to split losses differently from how profits are shared.
  • Transfer pricing for commodity-related transactions (Action 10)
    • This discussion draft seeks to reconcile developments in taxing commodity transactions with existing transfer pricing guidance, focusing on the broadly-defined ‘Sixth Method.’
    • The OECD posits that the various Sixth Method versions are essentially variations of the Comparable Uncontrolled Price (CUP) method.
    • The OECD would create a framework in the Transfer Pricing Guidelines for applying Sixth Method within existing transfer pricing systems.
    • The draft directs taxpayers using the CUP method to document it in writing, detailing the application of market data, including formulas used.

 

4 November 2014

Proposed modifications to Chapter VII of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations for management fees and other low value-adding services…

do not yet represent a consensus view and are intended to provide stakeholders with substantive proposals for analysis and comment.

The Working Party seems to have taken a step in the right direction to achieve a balance between appropriate charges and protecting the tax base, but the draft fails to substantially address how the additional guidance will be impacted by the other BEPS work.

These proposals mainly consist of an elective, simplified alternative approach to the usual TP exercise.

There is a definition of what constitutes the low value-adding services that would be covered and a number of examples of things which the OECD doesn’t think would qualify.

The single mark-up to be utilised for all these services would function as a safe-harbour and thus not require to be supported by a benchmarking study and would be between 2% and 5% of the relevant cost base.

The OECD has asked for comments to be submitted by interested parties no later than 14 January 2015 and intends to hold a public consultation on this discussion draft and other topics on 19 and 20 March 2015.

 

14 November 2013

At the public consultation on transfer pricing at the OECD on 11/12 November, Joe Andrus said in fulfilling the OECD’s secretariat function for Working Party 6...

that the scope of Action 10 was still under discussion.

We were asked to make one of the lead presentations in the area of financial transaction, where the transfer pricing considerations would, it was agreed, depend to some extent on the outcome of the work on interest deductibility limitations (Action 4). Sharing our views on what the BEPS work on financial transactions should address, we stressed that taxpayers were in desperate need of unified guidance.

In determining appropriate arm’s length prices for loans and guarantees between related parties, it is first necessary to determine the debt capacity of the relevant company. However, even this preliminary task requires consideration of a number of factors, including industry variables and arm’s length comparables, thin capitalisation rules / concessions and group / parent affiliation.

Determining an appropriate price for loans and guarantees then becomes important. An approach based upon market behaviour could be used (for example, taking into account implicit guarantees – which almost entirely depend on the lender’s risk profile, as opposed to the borrower or their parent).

 

2 September 2013

The overall approach adopted may indicate a marked increase in importance of directly-relevant comparable pricing information. However, in our view…

the arm’s length principle doesn’t require that comparables between unrelated parties exist for every transaction and also that when they don’t transactions can still be priced by resort to transfer pricing methods. Increasing use of recharacterisation could lead to uncertainty and double taxation. 

 

15 August 2013

Several countries have been advocating that transactions which would not, or would rarely, occur among independent parties should not be respected…

and should be recharactised for tax (including TP) purposes, instead of adopting a pricing solution. Countries like Australia, France and Germany are strong advocates of recharacterisation while the US and, more latterly, the UK seem to consider it less appropriate.

 

19 July 2013

Rules will be developed to prevent BEPS by engaging in transactions which would not realistically occur between unrelated parties. This will require …

clarification of the circumstances in which transactions can be recharacterised.  There is also to be a clarification of TP methods, in particular profit splits, which should be applied in the context of global value chains. The work will also aim to provide protection against common types of base eroding payments, such as management fees and head office expenses. The work is to be completed within two years.



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