The OECD has approved the amended section of the OECD transfer pricing guidelines concerning safe harbours. The draft revised guidelines developed by the OECD were initially published for public consultation in June 2012. Following the receipt of comments and further discussion at a public consultation in November 2012 the draft was revised and considered further within the OECD. The final version has now been published.

The revised version of the Guidelines is rather more favourable to the concept of safe harbours than the original Guidelines. It is acknowledged that the existence of safe harbours may allow taxpayers to save compliance costs and obtain certainty that less complex or lower risk transactions will not be subject to a transfer pricing adjustment. At the same time the tax administration may also be in a position to save time and this may be valuable in allowing tax auditors to concentrate on higher risk transactions. This may be particularly important for developing country tax administrations that are attempting to deal with complex transfer pricing issues using limited resources in terms of personnel.

The previous negative commentary in the Guidelines in respect of safe harbour did not reflect the practice in some OECD countries which have implemented safe harbour provisions. The guidance did not cover the possibility of bilateral agreements between countries in respect of safe harbour provisions, although these have been implemented successfully in practice among some OECD member countries.

The draft discussed the possibility of designing safe harbour provisions that could assist the tax administration and relieve the burden of compliance on taxpayers. The guidelines now accept that bilateral or multilateral provisions in respect of safe harbours may if correctly designed provide certainty for taxpayers without giving rise to double taxation or to double non-taxation. Provisions on safe harbours must however be designed so as to minimize opportunities for tax avoidance by taxpayers. The safe harbour must provide sufficient proximity to arm’s length prices to keep to a minimum the possibility of opportunities to plan outcomes involving double non-taxation of the related parties or different treatment of taxpayers in similar situations. The existence of safe harbours must also avoid the possibility of double taxation arising from different approaches by different jurisdictions or from the non-arm’s length nature of pricing that may nevertheless fall within the safe harbour provisions.

Where safe harbour provisions are introduced the taxpayer should be given an option to follow a set of simple rules in the pricing of clearly defined types of transaction. Taxpayers following these rules would not be subject to a transfer pricing adjustment in respect of those transactions. Alternatively safe harbour provisions could exempt a defined category of taxpayers or a distinct type of transaction from the transfer pricing provisions.

Safe harbour provisions are a compromise between the need to conform to the arm’s length principle and the need for administrative simplicity and reduction of compliance costs. Safe harbour provisions cannot take into account the varying facts of transactions and the different circumstances of taxpayers. Taxpayers may have to use a different transfer pricing method under the transfer pricing provisions to the method they would otherwise have used, and this may lead to a transfer price that is higher than it would have been without the safe harbour provision.

This disadvantage for taxpayers may be avoided by allowing the taxpayer an option of following the safe harbour or computing an arm’s length price in the usual way. This would however take away some of the administrative advantages of the safe harbour provisions for the tax administration. If taxpayers were permitted to opt in or out of this system at will, there could be a loss of revenue.

The new section of the guidelines concludes that safe harbours bring benefits in the case of small taxpayers and less complex transactions that outweigh the disadvantages. If safe harbour provisions are negotiated between two or more countries they can ensure cost and administration advantages without giving rise to the possibility of double taxation or of profits escaping tax altogether. Such a safe harbour could not however be binding on a country that had not agreed to use it. In the case of more complex transactions it is not possible for the benefits of safe harbours to outweigh the potential disadvantages in terms of non-arm’s length outcomes.

The new section of the Guidelines includes sample Memoranda of Understanding for competent authorities to establish bilateral safe harbours. The sample memoranda relate to low risk distribution functions, low risk manufacturing functions and low risk research and development functions. Bilateral safe harbour provisions could be agreed with countries having similar tax rates, to minimize the possibility of tax planning advantages. They could initially be limited to small taxpayers or to small transactions. The competent authorities could agree to modify the provisions periodically to keep them up to date with the changing business environment. For developing countries these bilateral agreements could protect the local tax base at the same time as saving limited tax administration resources.

The terms of a Memorandum of Understanding (MoU) would set out the functions performed, risks borne and assets employed by parties as a condition of using the safe harbour provision. Also, the types of entity that are not included in the safe harbour provisions, for example owing to size, would be defined. The qualifying transactions to be covered by the MoU would also be clearly defined. The MoU would determine the arm’s length range within which the compensation of the tested party should fall and would indicate the years covered. The MoU would state that it is binding on the tax administrations involved and would set out reporting and monitoring procedures. Also included would be a description of the type of documentation to be kept by enterprises in respect of transactions falling within the safe harbour provision and a mechanism for resolving any disputes arising in respect of the provision.