On 19 and 20 March 2015 the OECD held a public consultation on transfer pricing matters arising from the action plan on base erosion and profit shifting. The first day of the conference dealt with the draft amendments and additions to Chapter 1 of the OECD transfer pricing guidelines, and the proposed options for additional special measures. On the second day of the conference the sessions dealt with profit splits in the context of global value chains and low value-adding intragroup services. The final session looked at the transfer pricing aspects of cross-border commodity transactions.

Discussion of draft amendments to Chapter 1 of the OECD guidelines

The first session looked at the necessity in the transfer pricing analysis to delineate the actual transactions that have occurred before continuing with the comparability analysis. After the transaction is accurately delineated the next step is to price this accurately delineated transaction by means of an appropriate transfer pricing method and comparable transactions.

A session was held on the role of contracts. The accurate delineation of the transaction depends on first looking at the written contracts involving the parties to the transaction. In addition to looking at contracts it is also necessary to examine the conduct of the parties in their commercial and financial relations. Where the conduct of the parties contradicts or adds to the written contracts this additional information must supplement the written contractual arrangements in arriving at the correct delineation of the actual transactions.

A session was held on the identification and importance of risk; the reward to capital and reward to capability; allocation of risk and moral hazard; and the trade-off between risk and return. According to the OECD’s consultation document specific risks would need to be identified and their role in the specific business environment would need to be assessed. Valuable risk management activities would then be suitably compensated and the risk should only be allocated to a party that controls that risk.

According to the consultation document control over risk means the capability to take a decision to take on the risk and on whether and how to manage the risk. If the risk mitigation is outsourced, control of the risk would mean the ability to assess, monitor and direct the outsourced measures that affect risk outcomes.

The conference examined the examples on risk included in the OECD discussion document (paragraph 89 and the example in paragraph 90).

In another session attention was paid to the distinction between delineating the actual transaction and non-recognition, and the need for non-recognition in certain cases. Non-recognition would only occur in very exceptional circumstances. The circumstances in which non-recognition would apply are where the transaction does not make commercial sense. According to the discussion draft this might be a transaction that does not provide the parties with the possibility to protect or enhance their commercial and financial positions. This could be regarded as a transaction without economic substance.

Some concern was expressed that the reference to a transaction by which the parties protect or enhance their commercial and financial positions would require a positive net present value from the transaction, and this might not always be present even in a transaction that has substance. Also, a more precise definition would be needed of what is meant by the commercial or financial positions of the parties and the distinction between the two expressions commercial and financial.

Some comments were contributed by the insurance company working group specifically on the relevance of the proposals to the financial services sector.

A session was held on the potential special measures proposed to supplement the updated guidance in the OECD transfer pricing guidelines. The updates to the guidelines will strengthen the arm’s length principle but may not prevent all possibilities for base erosion and profit shifting. Opportunities for profit shifting will still exist because of information asymmetries and the allocation of capital to entities with minimum functions that are subject to low tax. Part II of the discussion draft therefore sets out some options for special measures that could be taken to deal with the remaining BEPS concerns. The advantages and disadvantages of the various options for special measures were considered.

Profit splits in the context of global value chains

On the second day of the conference the morning sessions focused on the use of profit splits in the context of global value chains. This centered on issues contained in the discussion draft on this subject issued on 16 December 2014 and the comments received that were published on the OECD website in February 2015.

As MNEs undergo greater integration it can be difficult to arrive at a suitable allocation of profits among the jurisdictions where the MNE operates, especially where the level of integration is high and unique intangibles are used. The discussion draft outlined the need for increased reliance on value chain analysis and profit split methods. This considered situations where no comparables are available and considered amendments to the existing guidance on the profit split method.

The discussion draft looked at a number of scenarios where the transactional profit split method may be suitable and it posed certain questions on the application of the profit split. These questions focused on the circumstances in which the profit split method would be suitable and how the factors used to split the profits could bring about an alignment of allocated profits with value creation. The discussions looked at practical difficulties in applying the profit split.

Low value adding intragroup services

The public consultation devoted a session to the treatment of low value adding intragroup services. In November 2014 the OECD issued a discussion document in relation to action 10 on low value adding intragroup services and this proposed changes to the OECD guidelines to define these low value-adding services including shareholder activities and duplicative costs. The draft suggested guidance on suitable mark-ups for these services; cost allocation methods and a simplified benefit test. The discussion draft also suggested guidance on documentation that needs to be prepared in relation to the simplified approach.

Transfer pricing aspects of cross-border commodity transactions

The final session dealt with transfer pricing aspects of cross-border commodity transactions, looking at the use of the CUP method; the deemed pricing date for commodity transactions; the value chain and comparability adjustments to the quoted price.

The discussions focused on the draft issued for consultation by the OECD dealing with issues often encountered in transfer pricing of commodity transactions, especially by developing countries. These include the use of pricing date conventions that allow the taxpayer to choose the most favorable quoted price; significant adjustments to the transfer price by related parties; charging large fees to the taxpayer in the developing country for transportation, packaging, distribution or marketing; or involvement in the supply chain of entities with limited functionality based in opaque low tax jurisdictions. In response to these challenges some countries have adopted their own specific measures such as the so-called “sixth method” employed in some South American countries.

The OECD proposes in the discussion document to amend the transfer pricing guidelines to clarify that the CUP method can be used to price commodity transactions and that the quoted or publicly available prices may be used as a benchmark to arrive at the transfer price. Additional guidance would be given on the adoption of a deemed pricing date for related party commodities transactions if there is no actual pricing date agreed by the parties. Additional guidance would also be given on comparability adjustments.