On 4 June 2015 the OECD issued a further discussion draft in connection with Action 8 of the action plan on base erosion and profit shifting (BEPS). Action 8 is concerned with assuring that transfer pricing outcomes for intangibles are in line with value creation. The latest discussion draft is concerned with considerations for the pricing of intangibles when valuation is highly uncertain at the time the transaction takes place and with special considerations for hard-to-value intangibles.

The discussion draft contains suggested amendments to section D3 of the OECD transfer pricing guidelines in respect of arm’s length pricing when valuation is highly uncertain at the time of the transaction, and section D3.1 on hard-to-value intangibles.

Tax administrations have difficulty in pricing transactions in certain categories of intangibles because of information asymmetry – the tax administration does not necessarily have as much information about the situation as the taxpayers involved in the transaction and is reliant on the taxpayer’s transfer pricing documentation with projections relating to the transaction.

The discussion draft presents an approach to arm’s length pricing based on the pricing arrangements that would exist in a similar transaction between independent parties. This aims to protect tax administrations from the negative aspects of information asymmetry in certain situations and to ensure that a transfer pricing adjustment will only be made where the difference between expected and actual outcomes can only be explained by inappropriate transfer pricing.

Hard-to-value intangibles

Hard-to- value intangibles are defined as intangibles or rights in intangibles for which there are no sufficiently reliable comparables at the time of their transfer and there is at that time no reliable projection of future cash flows or income expected to be derived from the transferred intangible, or where the assumptions used in valuing the intangible are highly uncertain.

Intangibles in this category could for example be only partially developed at the time of transfer; not anticipated to be exploited commercially until some years after the transaction takes place; connected to the development of other intangibles that are hard to value; or intended to be exploited in a way that is new at the time of the transfer.

Information about developments after the date of the transaction would in this case provide evidence of the reliability of the information used for pricing at the time of the transaction. The tax administration may have difficulty performing a risk assessment at the time of the transfer owing to the information asymmetry between the taxpayer and tax administration. So in this case it would be appropriate for the tax administration to take into account evidence of financial outcomes subsequent to the date of the transaction to determine the appropriateness of the pricing.

The tax administration may consider any contingent pricing arrangements that would have been made by independent enterprises at the time of the transaction. These might for example provide that the amount and timing of payments or the possibility of renegotiation are dependent on contingent events such as achievement of certain sales or profit levels.

Situations in which the “ex post” approach will not apply

This approach would only be taken where there is a significant difference between the subsequent outcome and the projection at the time of the transaction. It would therefore not apply if the taxpayer provided full details of its projections at the time of the transfer, including accounting for risks (probability weighting) and comprehensive consideration of foreseeable events and risks.

The approach would also not apply if the taxpayer provides evidence that the differences between projections and outcomes are due to unforeseen events that could not have been anticipated by the related parties at the time of the transaction.

Comments on the discussion draft

The OECD is asking for comments from interested parties on mechanisms that could be adopted to provide greater certainty for taxpayers on hard-to-value intangibles. It is also looking for suggestions on any other situations in which the “ex post” approach taking into account subsequent financial information would not be applied.

Comments also invited on a definition of a significant difference between projections at the time of the transaction and the financial outcomes, and what methods could be used to determine its significance. Suggestions are also required on further guidance or practical implementation of the approach. The deadline for submitting comments on the discussion draft is 18 June 2015.