by Julie Martin
The EU Commission on June 3 released a working paper identifying several categories of Member State transfer pricing rulings that raise potential State aid concerns because they sanction profit allocations that deviate from the arm’s length standard.
The assessment is based on the Commission’s review of about 1,000 Member State tax rulings issued from 2010–2013. It follows up on a Commission communication, issued May 19, which states that if an advance pricing agreement (APA) adheres to OECD Transfer Pricing Guidelines, it is unlikely to give rise to State aid.
According to one US tax expert, the paper appears designed to send a strong signal that the Commission fully intends to play a role in monitoring these transactions.
The Commission working paper identifies as problematic some APAs that set the remuneration of group financing companies; that sanction deductions for virtual payments between group companies; that use the comparable uncontrolled price method (CUP) but don’t identify comparables; and that inappropriately apply the transaction net margin method (TNMM), such as by using operating costs as a net profit indicator.
The “focus is on cases where there is a manifest breach of the arm’s length principle,” the paper says.
Elaborating on comments made by EU competition commissioner Margrethe Vestager in April, the paper states that the Commission is concerned about some APAs issued to group financing companies whose only function is to pass on funds or intellectual property rights between group members.
State aid concerns arise if an APA determines the taxable profit of a financing company “in a uniform manner as a margin of the underlying transaction, without a clear economic analysis,” the paper states. The paper notes that in 2002 the Commission determined that Luxembourg’s similar practice of setting margins at 12.5 basis points of the loan amount was incompatible State aid.
The Commission also said State aid concerns arise from rulings that endorse tax deductions between group companies in cases where payments are not actually made to the group member.
“Such virtual payments seem possible only in a group context and not between independent companies transacting on the market at arm’s length,” the paper said.
The paper further relates concerns about Member State APAs that use the comparable uncontrolled price (CUP) method to set transfer prices, yet present no comparables. “In such situations, the use of the CUP method may not result in a reliable approximation of a market-based outcome in line with the arm’s length principle,” the paper states.
Further, the paper expresses concerns with some APAs that use the TNMM, noting that the method addresses only one side of a transaction.
Last April, Vestager told the EU Parliament TAXE 2 committee that her office was concerned with about 100 APAs in this category. Use of a one-sided method “creates a potential for loopholes,” Vestager said, because while profit attributed to activities of one group member is determined, the remaining profit may not be taxed at all.
Such one-sided methods are often used when a group company located in another jurisdiction holds IP, the paper says.
The paper identifies particular concern with APAs that use the TNMM with operating expenses as an indicator. “Where the TNMM is used, operating expenses are often retained when the taxable base is determined as a mark-up on a performance indicator. In some cases, it seems that this choice of operating expenses as a performance indicator is made systematically, without necessarily representing the commercial value of the functions of the company,” the paper states.
US Treasury officials and some US Republican legislators have repeatedly expressed strong concerns about the impact of the Commission’s State aid decisions on US MNEs.
According to Marc Levey of Baker & McKenzie, New York, though, the document sends a clear signal that the EU Commission “will be a player” when it comes to ensuring that “at least a semblance” of the arm’s length principle is applied in tax rulings. The Commission has made it clear that it does not “want to see financing or IP rulings which give a fictitious spread when nothing is really going on,” Levey said.
The EU position on financing seems aimed at Luxembourg, Levey said, as Lux Leaks showed that the country issued tax rulings on spreads on financing transactions and hybrid notes that arguably had no economic substance other than to create a mismatch.
He added that the Commission’s action can also be seen as a part of the global movement asserting that multinationals do not pay a fair share of tax. “There is a fiction there. A lot of these are good companies that are following the law,” he said. The law does need to be updated, though, he added.
– Julie Martin is a US tax attorney and a member of MNE Tax’s editorial staff.
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