On 10 February 2015 the OECD published on its website comments received in response to the discussion draft issued on 16 December 2014 on profit splits in the context of global value chains.

One consequence of the ever greater integration of MNEs is that it can be more difficult to arrive at an appropriate allocation of profits of the MNE among the jurisdictions in which it operates, especially where the level of integration is high and unique intangibles are used. In these situations one-sided transfer pricing methods such as the transactional net margin method (TNMM) may not suffice. As part of the action plan on base erosion and profit shifting the OECD issued a discussion draft in respect of evaluating the need for increased reliance on value chain analysis and profit split methods. This would look at situations where no comparables are available and consider amendments to guidance on profit split and other profit methods.

The OECD has therefore considered a number of scenarios where the transactional profit split method may be appropriate and in the light of these scenarios the discussion draft posed certain questions as to the application of the profit split. These questions concerned the circumstances in which applying the method would be suitable and the ways in which the factors used to split the profits could bring about an alignment of allocated profits with value creation.

Around 60 responses were received from businesses, industry organizations and professional firms to the discussion draft. The view is expressed by many but not all commentators that the arm’s length principle is still the best way of allocating income between countries based on economic activity and that this should continue to be clearly stated. There is a concern among some commentators that any perception that the arm’s length principle is no longer considered applicable in many cases would lead to the proliferation of special measures in many countries with the pretext that the broad issues of the BEPS action plan are being addressed by these measures. The new guidance should therefore be built on established principles.

Related to these issues are concerns about recharacterization of transactions which are set out in a legal agreement or contract. There may be circumstances where this is appropriate but only where the existing transfer pricing principles cannot be applied. A full functional analysis provides more certainty for taxpayers but tax administrations may be tempted to move quickly to recharacterization. Ultimately the allocation of profits on the basis of a full functional analysis is beneficial for governments as this will lead to fewer disputes about the allocation of profits. Commentators therefore are generally of the opinion that the arm’s length principle and respect for the legal form agreed by the related parties is the starting point for dealing with transfer pricing issues.

Commentators suggest that the new guidance should not have the effect of creating any bias in favor of using the profit split and that it would be useful to include examples of scenarios where the profit split would not be appropriate. The guidance would need to emphasize that reliable data needs to exist for the application of a profit split. The fact that use of one-sided approaches does not produce a perfect outcome does not mean that the profit split has to be used – the use of another approach however imperfect in the situation could still be more reliable than the profit split.

Commentators on a number of occasions state the view that more work needs to be done on the examples given in the discussion draft to provide clarification of situations where the profit split would be appropriate and situations where it would not be suitable, and guidance on whether other methods might still be appropriate in some of these situations. Otherwise there is a danger that the examples could be applied automatically by some tax administrations without further thought as to the facts and circumstances of the taxpayer’s transactions. This tendency to automatic application of the profit split by the tax administrations could be made more likely by the availability of the global data relating to MNEs through the country by country reporting requirement for transfer pricing documentation.

In addition to determining when the profit split is appropriate the commentators in many cases consider that more work needs to be done on expanding the guidance on the reliable application of the profit split.

The issues raised by commentators will be considered during the public consultation to be held by the OECD on 19 and 20 March 2015 in Paris.