On 29 March 2021 the OECD issued a public discussion draft on proposed changes to the commentary to Article 9 (associated enterprises) of the OECD Model Tax Convention. The amendments are to be included in the next update of the OECD Model.

Article 9 of the OECD Model permits the tax authorities to adjust the profits in relation to transactions between associated enterprises if conditions are made or imposed that would not apply to independent enterprises operating at arms length. The second paragraph of Article 9 provides that if a transfer pricing adjustment is made by one of the contracting states a corresponding adjustment may be made to the profits of the other party to the transaction in the other contracting state.

Work has been done within the relevant OECD Working Parties in relation to clarification of the application of Article 9, especially in relation to domestic law on interest deductibility. This follows on from the work in 2020 on transfer pricing guidance for financial transactions.

Proposed revisions

The revised commentary clarifies that in determining if an interest payment is made at arm’s length the tax authority should, in addition to reviewing the terms and conditions of the loan, also look whether, in the facts and circumstances, the transaction should be regarded as a loan or as another kind of transaction. The amount may for example be a contribution to equity capital rather than a loan. The tax authority would take into account the provisions of its domestic law and the provisions of the OECD Transfer Pricing Guidelines.

The revised commentary also notes that following the allocation of profits under the arm’s length principle the taxation of the arm’s length profits, including the question of the deductibility of expenses, is to be decided under the domestic law of the relevant State, subject to the provisions of the tax treaty. In addition to expenses such as entertainment expenses that may not be deductible in a State, this also applies to rules limiting the deductibility of interest such as recommended in the final report on Action 4 of the OECD project on base erosion and profit shifting (BEPS).

The amended commentary also emphasises that any mismatch in this domestic law treatment of expenses, for example where a type of expense is deductible in one State but not in the other, does not in itself result in economic double taxation that is contrary to the treaty. The other contracting State does not therefore need to make a corresponding adjustment in relation to the non-deductible expenses. So for example if one contracting State applies a limitation on the deductibility of interest and that increases taxable profits in that State, this is not a reason for the other contracting State to grant a corresponding adjustment to the other party to the transactions.

The commentary on Article 25 (mutual agreement procedure) would be amended to emphasise that States should provide access to the mutual agreement procedure in transfer pricing cases, as a primary transfer pricing adjustment could otherwise lead to economic double taxation, not in accordance with the provisions of the treaty.

Comments are invited from interested parties by 28 May 2021.