Intragroup services would include centralized services such as administration, accounting, legal, computer, staff matters and training, which are all considered to be intragroup services.

Arm’s length charge

Having determined that the services were actually rendered it is necessary to compute the arm’s length fee. The tax administration must begin by determining the arrangements that have been put in place within the group for charging for intragroup services. A group should often be in a position to put in place direct charging arrangements, especially where services are rendered to independent parties as well as associated enterprises.

Where a direct charge is not possible, groups make arrangements for computing the charge in other ways. These may not be readily identifiable and could be part of a charge for other transfers allocated among the group. In some cases the charge for services may not be allocated at all among the group. In this case groups may need to use cost allocation and apportionment methods. These indirect charge methods generally require some estimation but are allowable if the group looks at the value of the services and the extent to which comparable services are provided between independent parties. There should always be an identifiable and reasonably foreseeable benefit from the services provided if a charge is to be made.

When an indirect charge method is used there may be no clear relationship between the services provided and the fee charged, so the enterprise receiving the service may not relate the charge to the service.

Allocation could be based on turnover, staff employed or another basis e.g. relative expenditure on computer equipment by group members. The charge for some services such as technical assistance may be included with other charges such as the price of licensing a patent or know-how.

Low value-adding services

The discussion draft defines low value-adding services as being services of a supportive nature; not part of the core business of the group; that do not involve the use of, or lead to the creation of, unique and valuable intangibles; and that do not involve the assumption or creation of significant risk.

The example given to illustrate that the services must not be part of the core business of the group is that of a group company performing credit risk analysis for a shoe manufacturer. This could be performing low value-added services while a group company performing those services for an international banking group in relation to potential counterparties for derivative transactions and preparing a credit report for the worldwide investment banking group would not be performing low value-adding services.

The discussion draft suggests that a group could elect to use a simplified method for low-value adding services covering all the countries in which it operates. The issues could also be dealt with by using cost contribution arrangements.

The group should begin by identifying cost pools associated with the various services rendered by group members to a number of other group companies. Services provided by just one company to one other company in the group should be excluded. These cost pools should then be allocated among group members using an allocation key suitable for each service, which should be applied consistently. A profit mark-up of no less than 2% and no more than 5% should then be applied.

The charge for intragroup services to a particular group member would then be the cost allocated to that particular company in respect of the services provided, plus the mark-up, plus the charge for services provided by a group member only to that particular company including the mark-up.

In looking at the benefit test with respect to intragroup services the discussion document suggested that tax administrations should look at categories of services rather than each specific charge. The taxpayer should demonstrate that assistance was provided with a category of service such as payroll processing and make available certain documentation and information to the tax administration. The charge could then be supported by a single annual invoice for each category without the need for other evidence of individual acts.

The taxpayer would be required to make available:

• A description of categories of low value adding services provided, reasons why they are considered to be low value adding, the rationale for providing these services within the group; the benefits or expected benefits from each category of service; the allocation keys used and reasons for their selection; and confirmation of the mark-up used;
• Intercompany service agreements with updates for any changes made to comply with the requirements on low value adding services;
• Calculations of the cost pool, with categories and relevant costs, including the costs of services provided to just one group member; and
• Calculations showing how the allocation keys were applied.

Comments received

Comments received concerned issues such as the definition of low value adding services, the allocation keys, the size of the mark-up required, the need for a group to apply the simplified method on a worldwide basis, and the extent of documentation required with the use of the simplified method,

On the size of the mark-up on low value adding services, recommended in the discussion draft at between 2% and 5% on cost, some commentators have pointed out that certain countries permit mark-ups on low value adding services that are outside this range, for example 0% mark-up or a mark-up of 7% or more. Alternatively some commentators suggested a fixed mark-up rather than a range.

The point is also made by certain contributors that the simplified treatment proposed for low value-adding services could also be applied to non-low value adding services. These would simply be differentiated by the application of a higher mark-up on the services. Some contributors refer to the work of the EU Joint Transfer Pricing Forum on low value adding services and would prefer to see more coordination with their approach, for example on the mark-up.

The simplified approach would only be successful if adopted by a large number of countries, so that both tax administrations involved in an intragroup service transaction will accept the approach. It might be necessary in the view of some contributors to have a dispute resolution procedure for a situation where one tax administration challenges the treatment.

A further point raised is that there could be problems where services are provided by a high cost industrialized country to a lower cost less developed country. The costs allocated to the service provision could be high and the fee charged as a result of using the 2% to 5% mark-up might appear unnecessarily high to the tax administration of the less developed country.