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 the new Chapter VI of the OECD Transfer Pricing Guidelines on Intangibles. 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 transfer pricing analysis. Legal ownership alone does not determine entitlement to returns from the exploitation of intangibles. Associated enterprises performing important value-driving functions related to development, enhancement, maintenance, protection and exploitation (DEMPE) of the intangibles can expect appropriate remuneration. A group company assuming risks with respect to the DEMPE of the intangibles must exercise control over the risks and have the financial capacity to assume these risks. If a group company is only providing funding, and does not exercise control over the financial risks, it is only entitled to a risk-free return. In case of artificial structures, non-recognition of the transaction applies. The report provides guidance on the situations in which valuation techniques can appropriately be used.
Hard-to-value intangibles (HTVI)
The report argues that it is difficult for a tax authority to evaluate the reliability of information used by a taxpayer to price a hard-to-value intangible given the information asymmetry between tax authorities and taxpayers. Thus, a tax authority may consider ex post evidence about actual financial outcomes to gauge the reasonableness of the ex ante price determined by the taxpayer. Ex post evidence is only to be used in situations when the difference between ex ante projections and ex post outcomes is "significant," and when such a difference is due to events that were foreseeable at the time of the transaction. In addition, ex post evidence cannot be used when the HTVI is covered by an APA, when the difference in compensation for the HTVI is not material (not more than 20 percent) and under certain circumstances when a commercialization period of five years has passed. The OECD has mentioned that implementation guidance on HTVI will follow in the near future.
Cost Contribution Arrangements (CCAs)
The report makes an explicit distinction between CCA’s for joint development of tangible and intangible assets and CCA’s for the provision of services, the definition of a CCA remains broadly the same. However it does make clear that the former may involve not just development but also enhancement, maintenance, protection or exploitation of such assets. The key difference between the two types is that the former typically generate future benefits whereas the latter typically generate current benefits only. In addressing the valuation of contributions the report advocates using ‘value’ by way of general rule, with cost being used only exceptionally, such as for low value-added services. In determining whether a party is a participant in a CCA, the report has regard not only to whether there is a reasonable expectation that it will benefit (as in the existing Guidelines) but also to whether the party exercises control over the specific risks it assumes under the CCA and has the financial capacity to bear those risks. In summary, the guidance ensures that CCAs are appropriately analyzed and produce outcomes that are consistent with how and where value is created. The new guidance of the report is included in the new Chapter VIII of the OECD Transfer Pricing Guidelines on the application of the arm’s length principle to CCAs.
Impact of Action 8 for the Netherlands
The 2013 Transfer Pricing Decree (“2013 Decree”) is already in line with the report. As such, we do not anticipate any material additions and/or changes to the existing Dutch guidance as outlined above for the 2013 Decree to be in accordance with the new OECD Transfer Pricing Guidelines. Currently the following specific items are already covered in the 2013 Decree:
The 2013 Decree already includes some guidance on HTVI. Under certain circumstances the Dutch tax administration takes the position that it is not consistent with the arm’s length principle to agree on a fixed price when the valuation is highly uncertain at the time of the transaction, as the Ministry of Finance assumes that independent parties in a similar situation would not have agreed on a fixed price. This view of HTVI already is reflected in section 5 of the 2013 Decree, which gives the example of a situation where a new intangible asset has been developed and is transferred to an associated enterprise at a moment when its success still is insufficiently visible. In this situation the valuation at the time of the transaction is highly uncertain, and the Dutch Ministry of Finance argues that stipulating a price adjustment clause would be reasonable.
In addition the following example is included. In the situation whereby an intangible asset is transferred to a (foreign) intra-group company and subsequently this intangible asset is largely (for instance for more than 50 percent) licensed to the transferring Dutch company and/or to associated entities of this company established in the Netherlands, a price adjustment clause will be deemed to have been agreed unless the taxpayer makes it plausible that i) there are business motives for the transaction and ii) the valuation at the moment of entering into the agreement can be determined to such an extent that independent enterprises would not have demanded a price adjustment clause.
The 2013 Decree also covers guidance on CCAs in accordance with the OECD Transfer Pricing Guidelines, according to which the amount of the compensation of the participants in a CCA should not differ (materially) from the compensation which the respective enterprises would receive if they would cooperate outside a CCA. The OECD Guidelines prescribe in the current Chapter VIII that the relative share of each participant in the contributions to the CCA corresponds with the relative share of that participant in the total benefits expected. Whether this is the case must be assessed in practice on a case-by-case basis. According to the Netherlands the arm's length principle involves that the relative share of each participant in the contributions to the CCA as well as the relative share of that participant in the total benefits expected is determined on the basis of the value in the open market. The 2013 Decree states that if it is plausible that the average relative added value of the individual performances contributed by the various participants to the CCA is approximately equal, it will be in accordance with the arm's length principle to take the cost price of the contributions as a starting point when determining whether every party's share in the total benefits expected corresponds with every party's share in the contributions.