by Julie Martin
The final version of the rewrite of Chapter 1 of the OECD Transfer Pricing Guidelines concerning delineation of transactions, risk, recharacterization, and special measures will be “quite different” from draft guidance on the topic released last December, Joe Andrus, consultant and former head of the transfer pricing unit at the OECD, said June 10.
Speaking at the 2015 OECD International Tax Conference in Washington, Andrus said that a summary of the changes to be made to the Chapter 1 draft will be presented at an OECD consultation on July 6–7. He said there are no plans to release a revised draft prior to that time.
Andrus said that the final Chapter 1 guidance will include a revised section on risk. “The discussion on moral hazard, which was commented on quite heavily, will likely disappear entirely from the draft” and will be replaced with a step-by-step process, he said.
The current thinking is that to determine allocation of risk, one must first identify the commercially significant risks; the contractual allocation of the risks; and the operations of the parties related to risk, including how the parties control risk and mitigate risk, and where the relevant risk-related costs and risk premiums are.
Once this fact finding exercise is complete, a determination must be made as to whether the parties’ conduct is consistent with the contractual allocation of risk, particularly whether the party that is allocated the risk is in control of the risk, he said.
If there is a difference between control of risk and where it was allocated, the risk may need to be allocated to a place other than where it was specified in the contract, he said.
Once these steps are completed, the transaction can be priced, Andrus said.
Michael McDonald, a financial economist at US Treasury, characterized the new thinking on risk as a “threshold notion,” closer to the approach used in Chapter 9 of the OECD Transfer Pricing Guidelines.
Andrus said many hard questions remain with respect to the project, including what it means to control risk; whether more than one member of a group can control risk, and if so, how that should be handled; whether it is consistent with the arm’s length principle to require risk bearing to be aligned with control over risk; and whether financial capacity to bear risk plays any role in the analysis.
Recharaterization & cash boxes
Andrus also said that most countries still believe that a recharacterization remedy is necessary in the transfer pricing guidelines. The consensus is that the recharaterization rules should be changed so they are more like those in paragraph 1.65 of the OECD Transfer Pricing Guidelines, which provides for recharaterization of transactions that are commercially irrational, he said.
McDonald said that countries are trying write rules for “cash box”companies that make a distinction between entities that are capable of making investment decisions versus those that just hold “dumb cash.” He said the effort to “tease out” this distinction is based on a desire to provide good policy outcomes without the need for a special measure.
McDonald also defended the decision, in draft guidance on cost contributions arrangements, to use value as opposed to cost to measure contributions, insisting that value is the appropriate measure.
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