Tax officials at a March 19 consultation on draft revisions to OECD transfer pricing guidelines expressed interest in adopting a special measure proposed in the draft that would address hard-to-value intangibles. Officials also discussed the weight that should be accorded a related party contract when attempting to delineate the “real deal” between the parties and addressed methods of assessing risk allocations between related parties.
The consultation concerned a discussion draft prepared by Working Party No. 6 (WP6) of the OECD’s Committee on Fiscal Affairs which proposes significant revisions to OECD transfer pricing guidelines to address base erosion and profit shifting (BEPS).
The draft, released December 19, seeks to provide a more accurate delineation of related party transactions, provides guidance on the relevance and allocation of risk, and provides for the nonrecognition of transactions in some cases. The draft also sets out options for five potential “special measures” to address BEPS, including some which fall outside the arm’s length standard.
Hard-to-value intangibles
The HMRC’s Maura Parsons, UK delegate to WP6, reported that special measures option one, which concerns hard-to-value intangibles, appears to have “some support” among the country delegates. She said that work on the other special measures will also continue.
Similarly, a US delegate said that countries are interested in option one, but that “there [is] not much appetite for [options] two, three, and four.” The official said that he would appreciate stakeholder input on how to structure option one if the OECD decides to adopt a commensurate with income (CWI) approach similar to current US transfer pricing regulations. To be consistent with the arm’s length standard using CWI, would the OECD need to give taxpayers the ability to rebut a presumption of information asymmetry? he asked.
The US IRS’s Christopher Bello explained that the US is attempting to convince counties to adopt rules similar to the US CWI regulations because the rules work and are designed to address the types of problems that the BEPS project is concerned with.
Bello, who is Branch Chief (Branch 6) in the IRS Office of Associate Chief Counsel, also contested a business representative’s statement made during the consultation that the US CWI rules do not effectively prevent BEPS because taxpayers take advantage of provisions that allow them to rebut the assumptions mandated by the regulations. According to Bello, the US regulations have successfully changed taxpayer behavior.
Caroline Silberztein, who spoke on behalf of a group of about 24 MNEs known as the International Alliance for Principled Taxation, was one of several business representatives that argued that it is premature to go forward with work on special measures. It is not yet clear whether any BEPS risks will remain after the OECD completes its work on the transfer pricing guidelines and other BEPS measures, Silberztein said, so delaying work on special measures will avoid the risk of “overlapping and possibly even divergent guidance.”
According to a UK delegate though, there is a “real danger” in suspending work on special measures. “It would be a strange outcome,” the tax official said, “if it was concluded that transfer pricing rules did not have a big part to play in addressing the BEPS behaviors that are identified in the actual [BEPS] plan,” the UK delegate said.
China’s delegate said that special measures are needed to counterbalance an arm’s length standard which “does not work in most cases.” The official said she was involved with about 200 audits and 30 bilateral advance pricing agreement negotiations last year, and, in each case, no true comparables could be identified.
“The majority of cases end up with numbers games,” the Chinese delegate said, because, with no comparables, any party can argue for whatever profit level they want. Special measures would allow tax authorities to address the difficulties in applying the arm’s length standard in a legitimate way, helping to solve issues of lack of transparency, the official said.
Contracts versus conduct
Much discussion concerned the amount of weight that should be accorded related party contracts when delineating the terms of the actual agreement between related parties. As expected, business representatives argued that tax officials should respect the terms of their intercompany agreements.
Mervyn Skeet of BIAC was among witnesses that argued that an analysis of the arrangement between related parties should start with the terms of contracts between the parties and, only if this information is insufficient, should one look at the actual conduct of the parties. He said that intercompany contracts should be accorded the same value as contracts with third parties. The OECD paper seems to treat intragroup transactions as “second class citizens,” he said.
Jörg Schindler of BDI argued that contracts “are the hardest and strongest” evidence of parties intent, as they are legally binding. The guidance should specify that contract terms should not be disregarded, as this would add uncertainty and promote controversy, Schindler said.
Italy’s delegate, Giammarco Cottani of the Italian tax administration, questioned how the draft guidance departs from existing transfer pricing guidelines which state that the identification of the actual transaction should not be limited by the legal form of the contract, but rather determined by the capabilities and conduct of the parties.
“Are you assuming, when you are trying to highlight the fact that contracts should always be the starting point, there must be hierarchy among the comparability factors [namely,] should contracts always take the lead?” he asked.
Cottani also asked about reliance on contracts when an integrated company makes decisions from many different locations. “Do you think that contracts will always help when reconstructing the accuracy of the value chain when there are different centers of excellence among a group, or should we maybe look at those other comparability factors?” he asked.
Bello added that the government drafters are trying to convey the idea that an intragroup contract is one of a combination of facts used to figure out the arrangement of the parties, but, at the same time, not say that governments can just ignore a contract if they do not like the deal that the parties struck. He said he would appreciate suggestions for the “magic combination of words” that describes this idea.
“It would be irrational to look at a contract and just assume that everything it says is true and assume that the parties actually complied with its terms. Similarly, I think it would be irrational to ignore the fact that it exists,” Bello said.
Bello also said that he expected the final guidance to say that, in figuring out the “real deal” between related parties, in some cases the correct conclusion is that no transaction occurred at all between the parties.
The US has concerns, though, Bello said, about nonrecognition provisions proposed in the draft which would allow tax authorities to treat a transaction as not occurring even if they conclude it did in fact occur.
France’s delegate said his country’s view regarding intragroup contracts is that we “have to look at them [and] we have to respect them, unless very specific circumstances” exist.
France will work to ensure that whatever guidance is drafted would be compatible with process to eliminate double taxation. “If we don’t achieve this, then we would have missed part of the goal,” he said.
The French delegate also noted that under the draft, nonrecognition would only occur in exceptional circumstances. He said that provision could be reinforced in later drafts, if deemed necessary.
Risk
US delegate and WP6 co-chair Michael McDonald said a goal of the draft is to provide governments with some way to verify allocations of risk between related parties. The draft borrows concepts from Chapter 9 of the OECD transfer pricing guidelines, allocating risk based on which parties control the risk, he said.
McDonald asked if stakeholders agree that the concepts proposed in the draft regarding risk are the “bridge we are looking for.” He also said he wanted to learn if practitioners have had good or bad experiences with the risk allocation provisions of Chapter 9.
Philippe Penelle of Deloitte said that the discussion draft should be modified to better distinguish between risk control and risk management. For an arrangement to have substance, Penelle said, the risk bearing entity, namely, the entity that puts up capital and bears the upside and the downside of the risk, must also control the risk.
Responding to questions from Andrew Hickman, Head of Transfer Pricing at the OECD Centre for Tax Policy and Administration, Penelle said that in the context of an MNE, for an entity to control risk it would need sufficient industry experience and access to information to be able to assess and monitor the risk manager’s activities, as well as the authority to replace the risk manager if the results are not in line with what was expected.
Risk management, unlike risk control, is a routine function that should command routine returns because it does not provide companies with permanent competitive advantages, Penelle said.
Penelle also said he disagreed with conclusions in the example in paragraph 63 of the OECD draft dealing with an oil rig. In that example, as long as the legal entity that provides the capital to invest in the rig also has the ability to hire or fire a third party to manage the rig, the outcome should be arm’s length, Penelle said.
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