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The new OECD transfer pricing guidelines


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After 15 years without major changes, the OECD has recently published a revised version of the OECD Guidelines, the document that provides the principles and recommendations used for transfer pricing analysis in many countries of the world.

The revised text includes a complete overhaul of Chapters I to III, the chapters covering the introduction, comparability analysis and use of methods. The new text also includes a completely new Chapter IX related to business restructuring. This new Chapter IX builds on earlier discussion papers from the OECD on the subject of business restructuring.

In this presentation, the transfer pricing specialists of DLA Piper will summarize the changes for you and will discuss the implications that the new OECD guidelines has for companies preparing transfer pricing documentation or planning their transfer pricing policies.

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The new OECD transfer pricing guidelines

  1. 1. The new OECD Transfer Pricing Guidelines Ágata Uceda & Frank Schwarte DLA Piper Amsterdam 22 September 2010
  2. 2. Frank Schwarte Senior Associate Ágata Uceda EMEA Transfer Pricing Director
  3. 3. The New Guidelines The Old Guidelines <ul><li>Chapter I: Arm's Length Principle </li></ul><ul><li>Chapter II: Transfer Pricing Methods </li></ul><ul><li>Chapter III: Comparability </li></ul><ul><li>Chapter IV: Administrative Approaches to Avoiding and Resolving Transfer Pricing Disputes </li></ul><ul><li>Chapter V: Documentation </li></ul><ul><li>Chapter VI: Intangible Property </li></ul><ul><li>Chapter VII: Services </li></ul><ul><li>Chapter VIII: CCAs </li></ul><ul><li>Chapter IX: Business Restructurings </li></ul><ul><li>Chapter I: Arm's Length Principle </li></ul><ul><li>Chapter II: Traditional Transaction Methods </li></ul><ul><li>Chapter III: Other Methods </li></ul><ul><li>Chapter IV: Administrative Approaches to Avoiding and Resolving Transfer Pricing Disputes </li></ul><ul><li>Chapter V: Documentation </li></ul><ul><li>Chapter VI: Intangible Property </li></ul><ul><li>Chapter VII: Services </li></ul><ul><li>Chapter VIII: CCAs </li></ul>
  4. 4. Main changes to the OECD Guidelines <ul><li>Small revisions to Chapter I , the arm's length principle </li></ul><ul><li>Former Chapter II and III (methods) have been combined in the new Chapter II , the hierarchy of methods has been eliminated </li></ul><ul><li>New Chapter III , comparability </li></ul><ul><li>New Chapter IX , business restructuring </li></ul><ul><li>New examples and annexes </li></ul>
  5. 5. Main changes to the OECD Guidelines <ul><li>These are the first fundamental changes to the OECD Guidelines since 1995 </li></ul><ul><li>The Guidelines become a lot more descriptive (with the examples) and have more similarities with US Regs </li></ul><ul><li>The OECD will start a new project on Intangibles revisiting Chapters VI and VIII </li></ul>
  6. 6. New Chapter I <ul><li>Includes a few new paragraphs emphasizing the importance of comparability - see also Chapter III </li></ul><ul><li>Language remains confusing about profit level indicators: </li></ul><ul><ul><li>Par 1.9: &quot;There are also many cases where a relevant comparison of transactions can be made at the level of financial indicators such as mark-up on costs, gross margin, or net profit profit indicators.&quot; </li></ul></ul><ul><ul><li>The concepts net profit and operating profit are (still) used interchangeably along the whole Guidelines </li></ul></ul><ul><li>The section explaining why formulary apportionment is not an acceptable solution expanded from 2 paragraphs to 17 </li></ul>
  7. 7. New Chapter I <ul><li>There are a few new paragraphs included in the comparability section, economic circumstances, discussing when it is appropriate (or not) to perform &quot;multi country analysis&quot; </li></ul><ul><ul><li>the paragraph is very vague and simply acknowledges the problem </li></ul></ul><ul><ul><li>the paragraph seems to be referring to the question about whether regional searches are acceptable yes or not under certain circumstances, but the language is about comparability in general, not about comparable searches </li></ul></ul><ul><ul><li>the concept of &quot;factors determining comparability&quot; (former par 1.19 to 1.35) and &quot;comparable searches&quot; is sometimes mixed up in the new guidelines, specially in the new Chapter III </li></ul></ul>
  8. 8. New Chapter I <ul><li>Former famous paragraphs 1.36 to 1.39 (about re-characterization of transactions) are not changed, however they are now 1.64 to 1.67 </li></ul><ul><li>The section about the interaction between valuation for customs purposes and valuation for transfer pricing purposes has been expanded </li></ul><ul><li>There is a clear request to the member countries to increase the cooperation between the customs administrations and income tax administrations </li></ul>
  9. 9. New Chapter II <ul><li>One of the main changes of the new Guidelines is the removal of the former hierarchy of methods with a &quot;most appropriate method rule&quot; </li></ul><ul><li>This means that for each transaction the &quot;most appropriate method&quot; should be chosen </li></ul><ul><li>However, if two methods are &quot;equally reliable&quot; the CUP method is preferred </li></ul><ul><li>In practice the CUP analysis needs to be done in all cases </li></ul><ul><li>It is not necessary to show that a particular method is not appropriate, except for difficult cases (par. 2.11) </li></ul><ul><li>Preference is given to higher degrees of comparability, however CUPs should not be rejected because of rigid comparability criteria </li></ul>
  10. 10. New Chapter II <ul><li>All the explanations about the use and application of the CUP method, the Cost Plus method and the resale price method remain the same </li></ul><ul><li>The explanations about the application of the TNMM is expanded with additional examples about when it is appropriate and not appropriate to use the TNMM </li></ul><ul><ul><li>There are several examples about profit level indicators that can be used with the TNMM: OP/SALES, OP/TOTAL COSTS, OP/ASSETS, BERRY RATIO </li></ul></ul><ul><ul><li>Practical problems like how to determine a transfer price when a company buys and/or sells to several related parties (par 2.67) or whether to use book value or market value when doing a ROA analysis </li></ul></ul>
  11. 11. New Chapter II <ul><ul><li>These problems were not mentioned in the former Guidelines. Now they are mentioned although no clear solution is provided &quot;depends on the facts and circumstances&quot; is the general answer given </li></ul></ul><ul><li>The addition of the berry ratio is remarkable as many countries do not accept it in practice under audit (do they have to now?) </li></ul><ul><ul><li>The conditions mentioned about when berry ratio can be applicable are very general and this can lead to miss-use of the berry ratio </li></ul></ul><ul><li>The PSM is not anymore a method of last resort and has a new (long!) name: transactional profit split method </li></ul><ul><li>There is a new section with extensive &quot;guidance for application&quot; of the PSM </li></ul>
  12. 12. New Chapter II <ul><li>The section makes a reference to the difference about using the PSM ex-ante or ex-post </li></ul><ul><li>It is clearly mentioned that the way the PSM is implemented also needs to be explained </li></ul><ul><li>The concept of bargaining power is introduced (this is also very important in the new Chapter IX) </li></ul><ul><li>As before, the use of hindsight is prohibited (par 2.127 - 2.130) but the discussion about using actual or projected profits and the additional details about the PSM makes the statement less clear </li></ul><ul><li>Overall the PSM is described with more details than before and the language and examples used leads to think that there will me more occasions where the PSM needs to be applied </li></ul>
  13. 13. New Chapter II <ul><li>The conclusion to the transactional profit methods includes these two sentences: </li></ul><ul><li>&quot;The recognition that the use of transactional profit methods may be necessary is not intended to suggest that independent enterprises would use these methods to set prices.&quot; </li></ul><ul><li>And the very last sentence of the chapter: </li></ul><ul><li>&quot;In addition, these conclusions assume that countries will have a certain degree of sophistication in their underlying tax systems before applying these methods.&quot; </li></ul><ul><li>Is this a consensus closing? What does it mean for the hierarchy of methods? </li></ul>
  14. 14. New Chapter III <ul><li>This is a completely new chapter that elaborates on the subject of comparability </li></ul><ul><li>It includes the former paragraphs about bundling or un-bundling transactions and about the use of multiple year data </li></ul><ul><li>It includes also: </li></ul><ul><ul><li>A list of steps that need to be taken to do a comparability analysis </li></ul></ul><ul><ul><li>A detailed reference to the use of external comparables, commercial databases and their appropriate use </li></ul></ul><ul><ul><li>The chapter is overall confusing for a non expert reader as it is not well organized and mixes the concept of comparability analysis with comparable searches </li></ul></ul>
  15. 15. New Chapter III <ul><li>The steps described are the following: </li></ul><ul><ul><li>Determine years to be covered </li></ul></ul><ul><ul><li>Analysis of taxpayer circumstances </li></ul></ul><ul><ul><li>Understanding of the transactions </li></ul></ul><ul><ul><li>Review internal comparables </li></ul></ul><ul><ul><li>Determine sources for external comparables </li></ul></ul><ul><ul><li>Selection of TP method and PLI </li></ul></ul><ul><ul><li>Identify comparables </li></ul></ul><ul><ul><li>Make comparability adjustments </li></ul></ul><ul><ul><li>Interpretation and use of the data to determine range </li></ul></ul>
  16. 16. New Chapter IX <ul><li>It is the culmination of a project that started at the end of 2005 </li></ul><ul><li>Final version is a consensus document on a difficult subject </li></ul><ul><li>Final Guidance does not provide an effective date: will countries use the new chapter to resolve prior business restructuring controversies? </li></ul><ul><li>Final chapter covers four issues: </li></ul><ul><ul><li>The allocation and transfer of risks among related parties </li></ul></ul><ul><ul><li>Whether the internal business restructuring transaction requires arm’s length compensation or indemnification </li></ul></ul><ul><ul><li>The application of transfer pricing rules to the parties post-business restructuring </li></ul></ul><ul><ul><li>When can a tax authority disregard a business restructuring? </li></ul></ul>
  17. 17. New Chapter IX <ul><li>Business Restructuring is a cross border redeployment of assets, functions and risks among affiliated entities of a multinational group </li></ul><ul><li>Central Issue: </li></ul><ul><ul><li>Is there a transfer of “something of value” (rights or assets) or a termination or substantial renegotiation of existing arrangements? </li></ul></ul><ul><ul><li>Would that transfer, termination or substantial renegotiation have been compensated between independent enterprises in comparable circumstances? </li></ul></ul>
  18. 18. New Chapter IX: key messages <ul><li>OECD argues that a compensation would not be provided only with regard to transfers of narrowly defined property interests; that is why the phrase “something of value” is used, which is intentionally vague and broad </li></ul><ul><ul><li>Chapter IX expands on circumstances where a transfer of going concern may arise, viz. , it is necessary to have transferred a functioning integrated business unit ( i.e. , a transfer of assets bundled with the ability to perform certain functions and bear certain risks) </li></ul></ul><ul><ul><li>&quot;Assets&quot; and intangible assets are not defined. Next OECD project </li></ul></ul><ul><li>Potential conflict with legal and accounting treatment where no discernable asset transfer can be identified </li></ul><ul><li>Rights under commercial legislation and case law should be a relevant consideration, but not the only one in determining whether indemnification should be provided </li></ul>
  19. 19. New Chapter IX: key messages <ul><li>Options realistically available </li></ul><ul><ul><li>Concept plays a key role in the chapter </li></ul></ul><ul><ul><li>The concept has its most important application at the individual entity level ( i.e. , the alternatives theoretically available to each party should be taken into account in determining appropriate levels of compensation to be paid) </li></ul></ul><ul><ul><li>Chapter seems to require that the parties to the business restructuring need to assess their realistically available options although it is not necessary to document all options realistically available </li></ul></ul><ul><li>Crown Jewels: discussion draft argued that high value intangibles cannot be transferred, final guidance deleted crown jewels example </li></ul>
  20. 20. New Chapter IX: part I <ul><li>Special considerations for risks </li></ul><ul><li>The issue is closely aligned with potential disregard of transactions </li></ul><ul><ul><li>Two critical factors that may lead to either TP adjustment or disregard of risk allocation are: </li></ul></ul><ul><ul><ul><li>Assessment on whether conduct of associated enterprises conforms to the contractual allocation of risks </li></ul></ul></ul><ul><ul><ul><li>Assessment on whether contractual risk allocation is arm’s length </li></ul></ul></ul>
  21. 21. New Chapter IX: part I <ul><li>Reminds us that the location of control over risk is an important determinant for transfer pricing purposes </li></ul><ul><li>Discussion of financial capacity to assume risk expanded and clarified </li></ul><ul><li>Risk assumption: </li></ul><ul><ul><li>Capacity to bear consequences of risk should it materialize </li></ul></ul><ul><ul><li>Mechanism to cover risk </li></ul></ul><ul><li>If purported risk bearer does not have the functional and financial capacity to assume risk, risk may be borne by another party </li></ul>
  22. 22. New Chapter IX: part I <ul><li>Determination of risk allocation: </li></ul><ul><ul><li>By comparable evidence how third parties actually divide risk (although no requirement to search for comparables) </li></ul></ul><ul><ul><li>If no comparable evidence, then by how third parties would have allocated risk </li></ul></ul><ul><ul><li>The absence of comparables for a particular risk allocation does not necessarily mean that it is not arm’s length </li></ul></ul><ul><li>Determination generally made by location of control over risk and financial capacity to bear risk, although these factors are not intended as standard </li></ul><ul><ul><li>OECD believes that the capacity to assess the outcome of risk monitoring and risk administration is a necessary element of controlling risk </li></ul></ul>
  23. 23. New Chapter IX: part II <ul><li>Arm's length compensation for the restructuring itself </li></ul><ul><li>The section remains very similar to the former draft: the concept &quot;transfer of something of value&quot; and &quot;options realistically available&quot; are still key concepts </li></ul><ul><li>The examples of conversion for full fledge distributor to LRD and from manufacturer to toll manufacturer are the same </li></ul><ul><li>The use of hindsight in these situations is more clearly mentioned as prohibited </li></ul><ul><li>The reference to accounting standards is erased leaving room for intangibles greater than those defined for accounting purposes </li></ul>
  24. 24. New Chapter IX: part III <ul><li>Remuneration post-restructuring </li></ul><ul><ul><li>Discussion Draft discussion was shortened substantially </li></ul></ul><ul><ul><li>Key Principle: Transactions among controlled entities occurring after a business restructuring should be governed by the same transfer pricing rules as apply to controlled transactions that do not follow from a restructuring </li></ul></ul><ul><li>Section retains: </li></ul><ul><ul><li>Discussion about sharing of location savings </li></ul></ul><ul><ul><li>Examples for procurement structures </li></ul></ul><ul><li>Documentation: </li></ul><ul><ul><li>The preparation of appropriately comprehensive and contemporaneous transfer pricing documentation is a good practice that can assist taxpayers in their compliance efforts and assist tax administrations in enforcing transfer pricing laws </li></ul></ul>
  25. 25. New Chapter IX: part IV <ul><li>Transaction will be disregarded only when exceptional ( i.e. , in rare or unusual circumstances). </li></ul><ul><li>Exceptional circumstances: </li></ul><ul><ul><li>Substance differs from form </li></ul></ul><ul><ul><li>Independent parties in comparable circumstances would not have characterized or structured their affairs in a manner similar to associated enterprises and an arm’s length price can not be reliably determined </li></ul></ul>
  26. 26. New Chapter IX: part IV <ul><li>Recognition of the economic effects of a transaction will not be challenged merely because: </li></ul><ul><ul><li>Third parties would not have entered into a similar transaction </li></ul></ul><ul><ul><li>The transaction may have been motivated by tax reasons ( i.e ., to achieve tax benefits) </li></ul></ul><ul><li>The transaction must be evaluated based on “commercially rational” standards </li></ul><ul><ul><li>Use “options realistically available” standard </li></ul></ul>
  27. 27. Contact Frank Schwarte Senior Associate E: T: +31 (0)20 5419 235 Ágata Uceda EMEA Transfer Pricing Director E: T: +31 (0)20 5419 268