Wed, Aug 21, 2013

Transfer Pricing Times: Volume X, Issue 8

During the week of July 30, 2013, the National Association of Business Economists (“NABE”) hosted its third annual Transfer Pricing Symposium in Arlington, Virginia, drawing presenters, panelists, and attendees from a diverse group of business leaders, transfer pricing practitioners, and representatives of various tax authorities.   

A number of timely issues were raised and discussed during this symposium, the highlights of which are summarized below.

Valuing Various Intangibles and Their Compensability 
Transfer pricing valuation of intangibles and their compensability was a key theme for the NABE symposium this year. The panel topics covered discussions concerning intangibles ranging from the more commonly recognized intangibles (e.g., patents, licenses, know-how, designs) to other less conventional intangibles (e.g., intangibles created from business opportunity and location savings). Considerations were given to definition, value creation, and compensable nature of these intangibles, as well as the determination of the arm’s-length charges. The panelists presented case laws, offered conceptual and theoretical guidance, and evaluated economic methods for determining arm’s-length charges.

In addition, two panels focused on intangible issues specific to the financial services and pharmaceutical industry, while another panel presented business opportunity as a type of intangible asset that creates economic value compensable under certain circumstances. This latter scenario was defined as instances where the opportunity generates “expected returns to investment in excess of an appropriate cost of capital given the risks of investment.” For determining the arm’s-length charges for such an instance, the panelists presented the income method and residual profit split method, but also suggested consideration of other unspecified methods (e.g., using brokerage models to determine a “finder’s fee”). The panel also discussed the differences between legal and economic interpretation of business opportunity, and their relative importance in determining value and compensability (i.e., a business opportunity might have value in economic terms but is not compensable under the law).

OECD’s Revised Intangibles Draft, White Paper on Documentation, and Base Erosion and Profit Shifting (“BEPS”) Initiatives 
This year’s symposium concluded with a special session on the OECD’s BEPS action plan, which was released on July 19, 2013 and calls for 15 major international tax reforms over the next two years, four of which address transfer pricing. The timing of the session coincides with the OECD’s release of the revised discussion draft on intangibles and white paper on documentation on July 30, 2013, both of which are meant to address the BEPS transfer pricing actions.

At the symposium, Marlies de Ruiter, head of the OECD’s division for tax treaties, transfer pricing, and financial transactions, presented the BEPS action plan, noting that while the OECD recognizes that transfer pricing is not the only issue contributing to BEPS, it is one of the OECD’s top three priorities, along with hybrid mismatches and interest deductibility. We discuss key items identified in the BEPS Action Plan in the following article.

One of the BEPS transfer pricing actions requires the OECD to re-examine transfer pricing documentation. Release of the white paper on documentation serves to address this issue. The presenting panelists emphasized that the work force behind the white paper recognizes the challenges that companies may face in complying with new documentation rules, which require a high level of information. The work paper is meant to facilitate dialog with companies and practitioners, and to that end the workforce is requesting comments from interested parties by October 1, 2013.

Another major release under the BEPS initiative concerns the revision of the initial draft of intangibles. The revised discussion draft on intangibles (“RDD”) included extensive changes from the draft issued on June 2012. A few of these key revisions are highlighted in the article below.

OECD to Implement Action Plan on Base Erosion and Profit Shifting
On July 19, 2013, the OECD released its full Action Plan on Base Erosion and Profit Shifting (“BEPS”), with expectations to roll out the specific items presented therein over the next two years. The draft of the BEPS Action Plan comes after the OECD released its report Addressing Base Erosion and Profit Shifting (commissioned by the Group of Twenty Finance Ministers and Central Bank Governors, more commonly known as the G-20) in February 2013 (see Transfer Pricing Times, Volume X, Issue 3). According to the OECD, the BEPS Action Plan will allow countries to draft coordinated, comprehensive, and transparent standards that governments need to prevent BEPS, while at the same time update the current rules to reflect modern business practices.

The released BEPS Action Plan calls for 15 specific actions, summarized below (along with proposed timelines):

  • Action 1: Address the Tax Challenges of the Digital Economy - identify the main difficulties that the digital economy poses to the application of existing international tax rules, as well as to develop detailed options to address these difficulties (September 2014).
  • Action 2: Neutralize the Effects of Hybrid Mismatch Arrangements - develop model treaty provisions and recommendations regarding the design of domestic rules to neutralize the effect of hybrid instruments and entities (September 2014).
  • Action 3: Strengthen Controlled Foreign Company (“CFC”) Rules - develop recommendations regarding the design of controlled foreign company rules (September 2015).
  • Action 4: Limit Base Erosion via Interest Deductions and Other Financial Payments - develop recommendations regarding best practices in the design of rules to prevent base erosion through the use of interest expense (September 2015).
  • Action 5: Counter Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance - improve transparency, including compulsory spontaneous exchange on rulings related to preferential regimes, and requiring substantial activity be present for any preferential regime (September 2014).
  • Action 6: Prevent treaty abuse - develop model treaty provisions and recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances (September 2014).
  • Action 7: Prevent the Artificial Avoidance of Permanent Establishment (“PE”) Status - develop changes to the definition of PE status in relation to BEPS, including through the use of commissionaire arrangements and specific activity exemptions (September 2015).
  • Actions 8, 9, and 10: Assure that Transfer Pricing Outcomes are in Line with Value Creation - develop rules to prevent BEPS, by (i) adopting a broad and clearly delineated definition of intangibles; (ii) ensuring that profits associated with the transfer and use of intangibles, capital, or other high-risk transactions are appropriately allocated in accordance with value creation; (iii) developing transfer pricing rules for transfers of hard-to-value intangibles; and, (iv) updating the guidance on cost contribution arrangements (September 2015).
  • Action 11: Establish Methodologies to Collect and Analyze Data on BEPS and the Actions to Address it - develop recommendations regarding indicators of the scale and economic impact of BEPS and ensure that tools are available to monitor and evaluate the impact of BEPS actions on an ongoing basis (September 2015).
  • Action 12: Require Taxpayers to Disclose their Aggressive Tax Planning Arrangements - develop recommendations regarding the design of mandatory disclosure rules for aggressive or abusive transactions, arrangements, or structures, taking into consideration the administrative costs for tax administration and taxpayers, as well as drawing on experiences of the increasing number of countries that have such rules (September 2015).
  • Action 13: Re-examine Transfer Pricing Documentation - develop rules regarding transfer pricing documentation to enhance transparency for tax administrations, taking into consideration the compliance costs for taxpayers (September 2014).
  • Action 14: Make Dispute Resolution Mechanisms More Effective - develop solutions to address obstacles that prevent countries from solving treaty-related disputes under MAP (September 2015).
  • Action 15: Develop a Multilateral Instrument - develop a multilateral instrument to enable jurisdictions that wish to do so to implement measures introduced in the course of the work on BEPS to amend bilateral tax treaties (December 2015).

From the 15 action items listed in the BEPS Action Plan, four relate specifically to transfer pricing, while several others indirectly address this area as well. We note the following observations as being especially relevant to multinational enterprises (“MNEs”) operating in the current transfer pricing environment:

  • MNEs in the “digital economy” should expect significant focus as part of the BEPS project.
  • Further guidance on related party financial transactions (e.g., financial / performance guarantees, derivatives, insurance, etc.) may be forthcoming over the next two years.
  • The BEPS Action Plan may inadvertently be opening the door to a possible departure from the arm’s length standard in certain situations related to IP, risk, and capitalization.
  • Relatively harsh language regarding management fee and head-office expense allocations may prompt increased focus on what the OECD notes as “common types of base eroding payments.”
  • Action 13 calls for a re-vamp of Transfer Pricing Documentation. The OECD simultaneously released a White Paper2 concerning this proposal and is accepting comments until October 1, 2013. It is prudent for interested parties to submit their thoughts prior to this date, as it will likely shape the future of transfer pricing documentation compliance.
  • The BEPS Action Plan may generate support for re-characterizing transactions that would not have occurred between unrelated third parties.

As mentioned above, the actions outlined in the BEPS Action Plan will be rolled out over the course of the next two years by the joint OECD / G20 BEPS Project, which involves all OECD members and the G20 countries on an equal basis. In addition, in order to ensure that the measures discussed in the BEPS Action Plan can be implemented quickly and effectively, the OECD / G20 BEPS Project intends to develop a multilateral instrument through which interested countries can amend their existing network of bilateral treaties.

OECD Releases Revised Discussion Draft on Transfer Pricing Intangibles3 
On June 6, 2012, the OECD published an Initial Discussion Draft (“IDD”) on intangibles. Taxpayers, practitioners, and other interested parties were then invited to submit comments on this draft, which were later published on October 29, 2012 and discussed by Working Party No. 6 of the Committee on Fiscal Affairs (“WP6”) at its November 2012 meeting. This meeting was followed by a Public Consultation held in Paris from November 12 through November 14, 2012. Based on the comments received and the discussions at the Public Consultation, the OECD WP6 prepared a Revised Discussion Draft on Transfer Pricing Aspects of Intangibles (“RDD”), which was released on July 30, 2013. The RDD made several important changes to the IDD, including more than 30 examples illustrating the application of provisions introduced in the IDD. We highlight a few of the other key revisions below:

  • Comparability Factors – The RDD presents a new section that addresses additional comparability factors that require consideration (e.g., local market features, location savings, assembled workforce, and corporate synergies) and for which comparability adjustments may be required.
  • Clarification to the definition of intangibles – The OECD clarifies that the word “intangible” is meant to address “something which is not a physical asset or a financial asset, which is capable of being owned or controlled for use in commercial activities, and whose use or transfer would be compensated had it occurred in a transaction between independent parties in comparable circumstances.” In addition, the RDD provides additional guidance as to the categorization of intangibles (i.e., between hard and soft, routine and non-routine, etc.).
  • Revisions to Section B: Ownership of Intangibles and Transactions Involving the Development, Enhancement, Maintenance and Protection of Intangibles – The RDD adopts a more transactional approach than the IDD when determining the allocation of income with respect to intangibles, while still preserving a clear focus on the importance of functions performed, assets employed, and risks assumed.
  • Use of the Company Name – Section B.4.c. of the RDD addresses the transfer pricing aspects of the use of a corporate name. The OECD recognizes that questions often arise regarding the arm’s length compensation for the use of group names, trade names, and other similar intangibles. The RDD advises that taxpayers use Section B of the RDD to resolve such questions. However, in general, no payment should be made for transfer pricing purposes for simple recognition of group membership or the use of the group name merely to reflect the fact that the entity is a part of the group.
  • Reorganization of Section D: Supplemental Guidance for Determining Arm’s Length Conditions in Cases Involving Intangibles – The RDD reorganizes material in Section D and provides supplementary guidance on the selection and application of the most appropriate transfer pricing methods and comparability analysis.
  • Additional Examples – The RDD presents additional examples in the Appendix, as well as a revision of some of the examples originally presented in the IDD.

The OECD is currently accepting comments on the revisions and content provided in the RDD. Comments on the RDD are due by October 1, 2013, with a public consultation conference to discuss such comments scheduled for November 12 to November 13, 2013. Given the importance of the issue at hand (intangibles has been a controversial topic for both taxpayers and taxing authorities around the world), the OECD is strongly encouraging interested parties to submit their comments expressing their perspective on the proposals for the treatment of intangibles in transfer pricing. The OECD anticipates releasing a final draft on intangibles by September 2014.

A New Transfer Pricing Landscape in Australia
The Australian Senate recently enacted new transfer pricing laws, contained in the Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Act 2013 (“2013 Amendments”), which have also recently received Royal Assent. The new transfer pricing regime is effective for financial years commencing on or after 1 July 2013. From this date, the 2013 Amendments replace the 2012 Amendments, as well as the domestic transfer pricing legislation contained in Division 13 of the Income Tax Assessment Act 1936. Subdivision 284-E of Schedule 1 to the Taxation Administration Act 1953 also contains new rules related to transfer pricing documentation.

The 2013 Amendments are intended to modernize the Australian transfer pricing laws to align with and statutorily embed OECD guidance, as well as to enhance the Commissioner’s capability to address perceived threats to the tax base. The transfer pricing law re-write has been accompanied by: (i) the Australian Tax Organiation’s (“ATO’s”) establishment of an anti-profit shifting taskforce; (ii) notification of a significant increase in ATO investigations of multi-national corporations operating in Australia; (iii) the revision of general anti-avoidance legislation; (iv) increased reporting and disclosure requirements through the introduction of the International Dealings Schedule and the Reportable Tax Position schedule, and (v) a planned reduction of thin capitalization safe harbors, which will likely result in increased taxpayer reliance on the arm’s length debt test under those provisions.4

The new transfer pricing regime is comprised, in pertinent part, of the following sections: 

  • Subdivision 815-B – Arm’s length principle for cross border conditions between legal entities.
  • Subdivision 815-C – Arm’s length principle for permanent establishments.
  • Subdivision 815-D – Record keeping requirements.
  • Subdivision 815-E – Special rules for trusts and partnerships.

Subdivision 815-B above requires the application of arm’s length “commercial and financial conditions” between the parties for taxation purposes. Arm’s length conditions must be determined with regard to the legal form and economic substance of the arrangements, as well as by reference to whether independent parties in comparable circumstances would have entered into those arrangements. This legislation potentially grants broad reconstruction powers to the ATO, but also requires taxpayers to assess their taxation outcomes on the basis of arm’s length conditions when preparing their tax returns. Key concerns in this regard include: (i) the practical application of the provisions, and associated compliance burden; (ii) uncertainty, given the inherent subjectivity of the economic substance and arm’s length doctrines; (iii) timing issues, particularly in relation to long term transactions and/or transactions which straddle taxation years; and, (iv) the ATO’s use of hindsight in reviews and audits. Furthermore, in relation to self-assessment, Australian taxpayers may increase their taxable income through a transfer pricing adjustment, but cannot decrease their taxable income through transfer pricing adjustments made in their tax returns.

Subdivision 815-C requires the attribution of income and expenses of an entity between its parts (i.e., the head office and its permanent establishment(s)) to reflect an allocation that would be expected if the parts of the entity were separate entities dealing wholly independently with each other. The decision of whether or not Australia should adopt the OECD-endorsed “separate entity approach” continues to be the subject of separate domestic law review.

The failure to prepare the required transfer pricing documentation by the time the relevant tax return is lodged will mean that the taxpayer will not have a reasonably arguable position for penalty purposes. In practice, this means that failure to support a transfer pricing position with contemporaneous transfer pricing documentation will result in a minimum penalty of 25 percent on any subsequent adjustment to taxable income imposed by the ATO. Such preparedness is especially important for the documentation of high risk taxpayers / transactions, including (i) business restructuring transactions; (ii) substantial financing arrangements – particularly hybrid arrangements and highly leveraged subsidiaries;5 (iii) loss-making taxpayers and/or low profitability; and (iv) transactions involving tax haven and/or low tax jurisdictions. Transfer pricing documentation, internal reviews of financial outcomes, and related transfer pricing adjustments have become more time sensitive, and should preferably occur before each year-end.


1.For more information, please refer to the full Base Erosion and Profit Shifting Action Plan available on the OECD website ( 
2.For more information on the OECD’s proposal for the simplification of Transfer Pricing documentation, please refer to the OECD White Paper on Documentation, available on the OECD’s website (
3.For more information, please refer to the full OECD Revised Discussion Draft on Transfer Pricing Aspects of Intangibles available on the OECD website (  
4.On 14 May 2013, the Australian Government announced a tightening of Australia’s thin capitalization rules. The safe harbor debt limits will be reduced as follows:
-For general entities: from 75% to 60% of adjusted Australian assets (from 3:1 to 1.5:1 debt to equity); and
-For non-bank financial entities: from 95.24% to 93.75% of adjusted Australian assets (from 20:1 to 15:1 debt to equity).The changes are proposed to apply to income years beginning on or after 1 July 2014.
5.The new legislation effectively codifies the ATO’s positions contained in Taxation Ruling 2010/7.

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