Key features of the final report - ‘Aligning Transfer Pricing Outcomes with Value Creation’
The report ‘Aligning Transfer Pricing Outcomes with Value Creation’ regarding Action 8 (‘report’) contains the wording for Chapter I, Section D of the OECD Transfer Pricing Guidelines on guidance for applying the arm’s length principle. The new section covers the following items:
Accurately delineation of transaction
As a general theme, contractual arrangements will come under greater scrutiny and pressure as the location of key functional substance (i.e. key personnel) will take increasing precedence over contractual entitlement (as well as financial capital and other assets) when allocating rewards as part of a TP analysis. The revised guidance requires careful delineation of the actual transaction between the associated enterprises by analyzing the contractual relations between the parties in combination with the conduct of the parties. The conduct will supplement or replace the contractual arrangements if the contracts are incomplete or are not supported by the conduct. The examination of conduct includes the actual allocation of risk between the associated parties. In circumstances where the transaction between associated enterprises lacks commercial rationality, the guidance continues to authorize the disregarding of the arrangement for transfer pricing purposes.
Identifying risks in commercial or financial relations – risk management and risk allocation
The report contains a substantially new section on the identification of risk in commercial or financial relations. Control over risk should be understood as the capability and authority to decide to take on the risk, and to decide whether and how to respond to the risk. A party requires both capability and functional performance as described above in order to exercise control over a risk. The report determines that risks contractually assumed by a party that cannot in fact exercise meaningful and specifically defined control over the risks, or does not have the financial capacity to assume the risks, will be allocated to the party that does exercise such control and does have the financial capacity to assume the risks. Capital-rich entities without any other relevant economic activities (‘cash boxes’), and therefore unable to exercise control over investment and other risks, will not be entitled to any premium returns. The profit that the cash box is entitled to retain will be equivalent to no more than a risk-free financial return.
Non-recognition of transactions
In exceptional circumstances the transaction as accurately delineated may disregarded when the exceptional circumstances of commercial irrationality apply. The key question in the analysis is whether the actual transaction possesses the commercial rationality of arrangements that would be agreed between unrelated parties under comparable economic circumstances, and not whether the same transaction can be observed between independent parties. Importantly, the mere fact that the transaction may not be seen between independent parties does not mean that it does not have characteristics of an arm’s length arrangement. It is the fundamental underlying basis of the arrangements that matters, not whether the same transaction is observable between independent parties.
MNE group synergies
Benefits of synergies should generally be shared by members of the group in proportion to their contribution to the creation of the synergy.
Given the holistic nature of the BEPS Action Plan, the goals set with regards to the development of transfer pricing rules have been achieved without the need to develop special measures outside the arm’s length principles.
Impact of Action 9 for the Netherlands
The 2013 Decree already covers a number of matters related to aligning value creation with transfer pricing outcomes, which is closely linked to Action 9. More specifically the Dutch guidance addresses the matter in three examples:
(In)tangible fixed assets
In this example, the situation is described where an (in)tangible fixed asset is transferred to a group company that does not have the required functionality to manage the risks associated with the intangible fixed asset. Under the 2013 Decree, the transfer of assets to an acquiring group company that has no added value is regarded as not being at arm’s length. Because the joint profit will not increase, the price offered by a potential purchaser will be less than the asking price of the potential vendor. The transfer of the asset will then not come about, since the transfer will also involve transaction costs.
Central purchasing within the group
It is known from local independent procurement agents that they particularly provide supporting activities and are generally rewarded with a remuneration related to the purchase value. Their remuneration is generally based on the cost of the purchases. In practice, it appears difficult to find reliable comparables for a purchasing office, which can be used to carry out a comparison based on a percentage of the cost of purchases. In such situations, the Dutch tax administration will therefore generally apply a cost plus method as test to assess the arm’s length nature of the remuneration. The cost base is limited to the purchasing office’s own operating costs, given the routine tasks performed by it, but excludes the cost price of the purchases.
Internal insurance/reinsurance activities
In some cases these companies lack the activities that are characteristic of a professional insurer/reinsurer, such as product development, marketing and sales, screening of potential policyholders, asset/liability management and developing an independent reinsurance policy. Nor do these companies ‘actively’ diversify (i.e. outside the group) the risks run by the reinsurer in respect of the internal insurance/reinsurance activities; any diversification that takes place is ‘passive’, i.e. within the group. Two types of insurance/reinsurance activities are explained in more detail, i.e. the passive pooler and insurance as by-product. The Deputy Minister is of the opinion that these cases solely involve an administrative function that justifies no more than a limited payment.
We do not anticipate any material additions and/or changes to the existing Dutch guidance as outlined in the 2013 Decree.