Over several decades and in step with the globalization of the economy, world-wide intra-group trade has grown exponentially. Transfer pricing rules, which are used for tax purposes, are concerned with determining the conditions, including the price, for transactions within a multi-national enterprise (MNE) group resulting in the allocation of profits to group companies in different countries. The impact of these rules has become more significant for business and tax administrations with the growth in the volume and value of intra-group trade. As the Action Plan on Base Erosion and Profit Shifting (BEPS Action Plan, OECD, 2013) identified, the existing international standards for transfer pricing rules can be misapplied so that they result in outcomes in which the allocation of profits is not aligned with the economic activity that produced these profits. The work under Actions 8-10 of the BEPS Action Plan has targeted this issue, to ensure that transfer pricing outcomes are aligned with value creation.
The guidance on the arm’s length principle has been upgraded to ensure that economic reality determine results, rather than the paper reality. The BEPS action proposed to modify the OECD Transfer Pricing Guidelines to contain a clear framework indicating that while contractual arrangements are important, and serve as the starting point of any transfer pricing analysis, the arm’s length principle does not and cannot rely on self-serving contracts, which do not reflect the conduct of the parties on the ground. The revised guidance clarifies how risks and risk-related returns are to be allocated within a group of companies, how returns on intangible property (IP) will be allocated, with detailed guidance on the transfer pricing treatment of synergies, location-savings and local market features, as well as assembled workforce. Recognizing the difficulty in valuing IP, a special approach for hard-to-value IP has been devised. Simplification mechanisms have been developed in the areas of commodity transactions and low value-adding services, two areas of particular relevance to developing countries, and for which their contribution was paramount to understand the concerns and identify the best way to address them. The scope for new and more detailed guidance on the application of profit-split methods for global value chains has been agreed and such guidance will be finalized soon.
This holistic approach to tackling BEPS behavior is supported by the transparency requirements agreed under Action 13. In a major step toward improved transparency on MNE operations, the requirements for transfer pricing documentation have been substantially revised (Action 13). MNEs will be required to submit information regarding their global business operations and transfer pricing policies in a “Master File,” as well as more detailed information regarding relevant related party transactions and the amounts involved in such operations in a “Local file.” Country-by-country reporting (CbCR) will provide a clear overview of where profits, sales, employees and assets are located and where taxes are paid and accrued. Guidance and tools to ensure a swift and consistent implementation of CbCR across countries have been developed to ensure the widest possible dissemination of information among tax administrations, while respecting the agreed safeguards on confidentiality, appropriate use and consistency. Transfer pricing analysis depends on access to relevant information. The access to the transfer pricing documentation provided by Action 13 will enable the transfer pricing guidance to be applied in practice, based on relevant information on global and local operations in the master file and local file. In addition, the CbCR will enable better risk assessment practices by providing information about the global allocation of the MNE group’s revenues, profits, taxes, and economic activity.
Transfer pricing depends on facts and circumstances analysis and can involve subjective interpretations of these facts and circumstances. In order to address the risk of disputes, the work under Action 14 to improve the effectiveness of dispute resolution mechanisms includes a new minimum standard providing for access to the Mutual Agreement Procedure of Article 25 of the Model Tax Convention for all transfer pricing cases. Interaction with Action 14 on dispute resolution will ensure that the transfer pricing measures will not result in double taxation.
In light of the BEPS actions on transfer pricing, MNE groups is likely to need to further substantiate activities conducted and value created by the group entities in various countries to support their transfer pricing. A more thorough functional analysis may be needed. Transfer pricing policies merely based on contractual arrangements and legal ownership will need review. With regard to transfer pricing aspects of IP, MNE groups will need to evaluate whether their existing transfer pricing policy is aligned with the broad definition of IP and the guidance on allocation of IP-related returns within a MNE group. Furthermore, they should establish whether their policy correctly reflects comparability factors such as market-specific characteristics and synergies.