The OECD on December 19 released a discussion draft proposing significant revisions to the OECD transfer pricing guidelines to address base erosion and profit shifting (BEPS). The draft seeks to provide a more accurate delineation of related party transactions, provides guidance on the relevance and allocation of risk, and provides for the recharacterization of transactions in some cases.
The draft also sets out five “special measures,” including some which fall outside the arm’s length standard, to address BEPS risks. The guidance responds to action 8, 9, and 10 of the OECD/G20 BEPS plan.
The draft rules would rewrite Section D of Chapter 1 of the OECD transfer pricing guidelines on applying the arm’s length principle, providing for more precise delineation of actual transactions based on both the contractual arrangements and the conduct of the parties. The draft requires identification of a transaction’s “economically relevant characteristics,” namely, the contractual terms of a transaction; the functions performed, risks assumed and assets used by the parties; the nature of the products or services transferred; and the business strategies pursed by the parties.
“Where no written terms exist, or where the conduct of the parties shows that the contractual terms are ambiguous, incorrect or incomplete, the delineation of the transaction should be deduced, clarified, or supplemented based on the review of the commercial or financial relations as reflected by the actual conduct of the parties,” the guidance states.
Recharacterization
The guidance provides that a transaction should not be recognized for transfer pricing purposes, but should instead be recharacterized, if it does not possesses “the fundamental economic attributes of arrangements between unrelated parties.”
Fundamental economic attributes exist when an arrangement offers “each of the parties a reasonable expectation to enhance or protect their commercial or financial positions on a risk-adjusted (the return adjusted for the level of risk associated with it) basis, compared to other opportunities realistically available to them at the time the arrangement was entered into,” the draft states.
Every effort should be made to determine the actual nature of the transaction and apply arm’s length pricing to an accurately delineated transaction, as opposed to recharacterizing a transaction, because such an approach is contentious and could result in double taxation, the draft notes.
Risk
The draft also discusses the nature and sources of risk relevant to a transfer pricing analysis, and the allocation of risk among related parties.
The draft specifically asks for feedback on a number of issues, including “the extent to which associated enterprises can be assumed to have different risk preferences while they are acting collaboratively in a common undertaking under common control.”
The draft also asks for feedback on how the concept of “moral hazard” — which refers to the lack of incentive to guard against risk where one is protected from its consequences — fits with the arm’s length principle. The concept leads to the conclusion that the allocation of risk between associated enterprises should be based on which party manages and controls the risk.
A further set of questions concerns how “risk-return trade-off,” which establishes equivalence on a present value basis between a higher but less certain stream of income and a lower but more certain stream of income would fit.
Special Measures
The draft adds a section on special measures to address “residual risks [which] mainly relate to information asymmetries between taxpayers and tax administrations and the relative ease with which MNE groups can allocate capital to lowly taxed minimal functional entities (MFEs). This capital can then be invested in assets used within the MNE group, creating base eroding payments to these MFE.”
The draft states that the work on special measures is very preliminary, and seeks feedback on the approaches.
Included is a special measure dealing with transfers of hard-to-value intangibles at a fixed price among related companies. The special measure would permit a tax administration to presume that a price adjustment mechanism was adopted, even though it was not, and base transfer pricing calculations on actual outcome, imputing a contingent payment mechanism.
A special measure would deem interest deductions to “thickly capitalized” companies, with corresponding interest inclusions to a related company that provided excess capital; another would cause profits to be reallocated away from entities with “minimal function” located in low tax jurisdictions to other related entities.
Another measure would consider how an independent investor would operate, targeting circumstances where a capital-rich asset-owning company depends on another group company to generate a return.
And, a special measure would provide that controlled foreign corporation (CFC) rules would tax excess returns subject to a low rate of tax, coupled with a secondary rule that would allocate taxing rights over the excess returns to other jurisdictions if no parent jurisdiction applies the primary rule.
Comments on the draft are due February 6; a public consultation will be held on March 19–20, 2015.
Be the first to comment