On 4 July 2016 the OECD released a consultation document containing revised guidance on profit splits. This is part of the follow-up work on BEPS actions 8 to 10 in relation to assuring that transfer pricing outcomes are in line with value creation. The discussion draft aims to strengthen the guidance on profit split. New text is proposed to replace Part III Section C of the 2010 version of the OECD transfer pricing guidelines.
Comments are invited from interested parties by 5 September 2016. A public consultation on the proposed guidance is to be held on 11 and 12 October 2016.
Actual or projected profits
The guidance indicates that under the 2010 OECD Guidelines the profit split method could be applied to either actual profits or projected profits. The consultation document attempts to distinguish further between these two situations. A transactional profit split of actual profits is seen as the most appropriate method for evaluating pricing of the accurately delineated transaction. A transactional profit split of anticipated profits is possible but this would normally be performed in combination with a discounted cash flow technique.
A transactional profit split using actual profits would take the combined profits of the enterprises and split the actual profits derived from commercializing intangibles on the basis of the respective contributions of the parties. Although the basis for splitting the profits would be established ex ante it would be applied to the actual profits. The consultation document notes that a split of actual profits requires a greater integration of activities and that there is a greater sharing of uncertain outcomes resulting from risk.
Commentators are asked for their views on whether the distinction between splits of actual and projected profits is clear in the proposed guidance. They are also asked to comment on the link between the integration of business activities and sharing of risks, and the application of a profit split to actual profits. They are invited to give examples of situations where a split of actual profits or of projected profits would be most appropriate.
Strengths and weaknesses
In relation to the section of the guidance on the strengths and weaknesses of the profit split method commentators are asked to comment on whether these are correctly summarized. Comments are also invited on whether transactional profit splits based on actual or projected profits would have different strengths and weaknesses.
Economically significant risks
The draft suggests that the sharing of economically significant risks is a factor indicating that a transactional profit split based on actual profits may be appropriate. Commentators are asked for suggestions on clarifying the concept of risk sharing in this context. They are also requested to comment on whether the consultation document helps to clarify the circumstances in which the transactional profit split method is the most appropriate.
With regard to a profit split based on anticipated profits and using certain valuation techniques commentators are invited to submit examples of how this could be done.
Highly integrated operations
In some cases there is a high level of commonality in the functions, assets and risks of related parties. The paper suggests that this is more likely to be the case where there is parallel integration of the associated enterprises in the value chain, rather than where there is sequential integration. Commentators are asked to comment on whether this distinction between parallel and sequential integration is useful in determining whether the profit split is the most appropriate method, and if so how should the concept of parallel integration be further refined.
Unique and valuable contributions
The profit split may also be appropriate where multiple parties are making unique and valuable contributions. This will be the case where the contributions are not comparable to contributions made by independent parties in comparable circumstances and where the use of the intangibles in business operations is a key source of actual or potential economic benefits.
Commentators are asked to comment on the relation between the making of unique and valuable contributions by all parties and the sharing of economically significant risks. They are asked for comments on whether there are situations where parties make unique and valuable contributions but do not share the economically significant risks associated with outcomes of the situation. Suggestions for guidance on such situations are invited.
Group synergies
The draft refers to the incremental or marginal system profits from group synergies that are shared between the associated enterprises. The draft suggests that the sharing of these benefits can be done by the use of appropriate allocation keys and that there is no need to combine the total profits and use the transactional profit split method just because there are group synergies. The allocation key would just be applied to the additional system profits from the synergies. Commentators are invited to comment on this point.
Value chain analysis
A value chain analysis can be useful in determining when a profit split is appropriate and in determining how the method may be applied. The value chain analysis should consider where and how the value is created by the business operations and consider whether the value creation is sustainable. This analysis can contribute to accurately delineating the transaction and also determine the level of integration of the related parties. The value chain analysis is however simply a tool and does not in itself indicate that the transactional profit split is the most appropriate method.
Commentators are asked whether this is a proper description of the value chain analysis and if such an analysis can serve a greater purpose in relation to profit splits.
Approaches to splitting profits
The consultation document also contains some additions to the sections on approaches to splitting profits. Commentators are asked to suggest any further useful factors to use in splitting profits, and comment on how they meet to requirement of reliable and verifiable measurement. Suggestions for further guidance and examples are requested.