Revisions to the OECD transfer pricing guidelines: Chapters 1-3

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Episode 43: Revisions to the OECD transfer pricing guidelines – Chapters 1-3

Release date: January 17, 2012
Guest: Elisabeth Finch
Running time: 9:05 minutes

In this episode Elisabeth Finch talks about the revisions to the OECD transfer pricing guidelines including why companies should pay attention to them, how they might be affected, and how they should respond.

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Through interviews with prominent PwC tax subject matter professionals, Tax Tracks is an audio podcast series that is designed to bring succinct commentary on tax technical, policy and administrative issues that provides busy tax directors information they require.

Revisions to the OECD transfer pricing guidelines: Chapters 1-3

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Gerry Lewandowski: Today we’re joined by Elisabeth Finch, a Transfer Pricing partner in PwC’s Vancouver office. A materials scientist by training, Elisabeth has numerous years of diverse transfer pricing experience including the development of consistent global transfer pricing policies and resolution of transfer pricing disputes for numerous multinational clients.

Thank you for joining us Elisabeth.

Elisabeth: you are welcome Gerry

Gerry: I know we’re set to talk about the revisions to the OECD transfer pricing guidelines, but before we do, just to put all of this in context, how about a brief overview of the OECD and the guidelines in general?

Elisabeth: Sure, no problem. The OECD, which stands for the Organization for Economic Cooperation and Development, is an international organization established to help governments address the challenges (particularly the economic challenges) of a globalized economy.

Gerry: And how do the transfer pricing guidelines fit in?

Elisabeth: Well, with increased globalization, transfer pricing has been an enormous challenge to governments and it’s still considered a grey area for both taxpayers and practitioners. The guidelines were initially developed to provide some clarity around the issues presented by transfer pricing, which really means the pricing by multinationals of their intercompany transactions. Tax authorities became concerned that multinationals could adjust their profits and their tax payable based on how they priced these transactions, that means they could gain tax advantages by virtue of their size and presence in many countries, even though many companies transacting are distinct legal entities and should be doing business together just like that. The issue is inherently global in scope because the taxpayers in question do business globally; the transfer pricing guidelines are meant to provide a consistent set of principles and guidance that are applicable worldwide.

Gerry: And I assume that Canada follows these Guidelines?

Elisabeth: Yes absolutely, the Canada Revenue Agency (or the CRA) explicitly adopts the principles in the Guidelines, and in particular, the arm’s length principle, which is a cornerstone of transfer pricing. Our Income Tax Act, in the transfer pricing section, includes definitions of “arm’s length allocation” and “arm’s length transfer price.” These terms are central to the concept of transfer pricing, which as I just described, attempts to ensure that intercompany cross-border transactions are conducted (that is, priced) as though the two companies involved are unrelated (or, as we say, dealing at arm’s length). The result is that multinationals can’t price these transactions to gain a tax advantage, by, for example, paying an inflated price for a service provided by a company in a lower tax jurisdiction.

Gerry: This all sounds pretty complicated. Is the guidance geared toward governments and tax authorities only? What should taxpayers pay attention to it?  

Elisabeth: Actually, the guidelines are for multinational enterprises and tax administrations; both are included in the full title of the guidelines, as both were looking for (and need) as much clarity as possible with respect to these issues: the tax authorities, in order to properly do their jobs and collect the right amount of tax; and the multinationals, in order to avoid audit adjustments and penalties. As I said though, it’s still very much a grey area, which is why the OECD recently revised the guidelines, to provide even greater clarity, in this case on comparability and some other related issues.

Gerry: Which brings us to the recent changes. Why are these important and how do they affect taxpayers?

Elisabeth: Well, first, we should note that the guidelines are always evolving. In this sense we don’t consider these to be changes so much as more detailed guidance on concepts already addressed in the guidelines. Our goal in transfer pricing is always to find that really elusive arm’s length price, which starts with a search for transactions and/or companies that can be considered comparable to the transaction you’re trying to price. This is not an exact science by any means. One interesting thing about the revised guidelines is that they explicitly acknowledge the difficulty of this task, emphasizing the importance of making best efforts to find the most comparable transaction in this very murky scenario. So in a way we’re entrusted to make the least imperfect comparison, as it were.

Essentially a big focus of this work has been on the question of comparability which comes up when we try to make sure that the price of a transaction between companies in the same multinational group is OK - priced at arm’s length - with reference to comparable transactions, or the financial results of comparable companies. In transfer pricing analysis we often use the financial results of companies from publicly available databases, to test the arm’s length nature of the profit of a company in a multinational group. But comparability is critical for the application of any transfer pricing method.

A relatively balanced approach has been taken in the revisions, in that the wording on comparability has been tightened in order to raise standards, while more scope is acknowledged for the use of data analysis (for example, adjustments and the use of statistical methods to draw conclusions from the data that has been found).

Gerry: So then how should taxpayers respond to the revisions? Will they need to change their transfer pricing policies?

Elisabeth: No, I would not say flat out that taxpayers will have to change their policies, but that would apply to taxpayers that have already carefully selected and documented their approach. Similarly, the CRA does not see the revisions as changing any requirements under the Income Tax Act, but still the taxpayer will need to provide a more detailed analysis of its consideration of the various methods, showing that it has made best efforts to choose, again, the least imperfect approach. Some taxpayers may find themselves reconsidering their approach or their level of documentation noticing that they don’t have the most detailed policies, or that they haven’t given careful consideration to the most appropriate method.

Gerry: Before the introduction of this new “least imperfect” approach method, what method did companies use to determine arms length transfer pricing?

Elisabeth: Well, the previous guidelines really pointed to a hierarchy of transfer pricing methods, with some being clearly preferred over others. In particular, the transactional net margin method or TNMM came to be considered a method of last resort by tax authorities based on the OECD guidelines, whereas in practice it was and is frequently used by tax payers to show that their transfer prices are at arm’s length. Now, with the revisions, we have clear acknowledgement in the guidelines that there are situations when a method which previously would have been considered ‘lower ranking’ can now be considered more appropriate than other previously higher ranking methods, in certain circumstances. This is a really helpful change, but still, it’s really important to carefully consider all the methods, and the data that might be available to apply the methods, to make sure that you really do select the most appropriate method in the circumstances.

Overall, I think the spirit of the revisions can be found in the new nine-step process the OECD has added to the guidelines as an example of how its recommendations can be applied in practice. The guidelines are explicit that following these suggested steps will not necessarily lead to an arm's length result and, conversely, that following a different process will not preclude an arm's length result. What is important though is that there is a process and that it be reliable and transparent, so that a tax auditor can examine, follow and test the process where necessary.

Gerry: It sounds like our listeners need to carefully consider which “least imperfect” transfer pricing method they should use to show their transfer prices are at arms length. Thank you for joining us today Elisabeth.

Elisabeth: You’re welcome Gerry.

Gerry: For additional Transfer Pricing information, please visit our PwC website at

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