Action Plan 8-10 - Aligning Transfer Pricing Outcomes with Value Creation - International Taxation - Income Tax

Action Plan 8-10 - Aligning Transfer Pricing Outcomes with Value Creation Action Plan Details 8 Addresses transfer pricing issues relating to controlled transactions involving intangibles, since intangibles are by definition mobile and they are generally difficult to value. Misallocation of the profits generated by valuable intangibles is a significant cause of BEPS. 9 Contractual allocations of risks are respected only when they are supported by actual decision making and thus exercising control over these risks, Moreover, Action 9 addressees the level of returns to funding provided by a capital-rich MNE group maker, where those returns do not correspond to the level of activity undertaken by the funding company. 10 This action focus on other high-risk areas, which include: The scope for addressing profit allocations resulting from controlled transactions which are not commercially rational. The scope for targeting the use of transfer pricing methods in a way which results in diverting profits from the most economically important activities of the MNE group, and The use of certain types of payments between members of the MNE group (such as management fees and head office expenses) to erode tax base in the absence of alignment with the value creation. BEPS Actions 8-10 address transfer pricing guidance to ensure that transfer pricing outcomes are better aligned with value creation of the MNE group. In this regard, Actions 8-10 clarify and strengthen the existing standards, including the guidance on the application of the arm s length principle and an approach for appropriate pricing of hard-to-value-intangibles within the arm s length principle. Significant recommendations in the Final Report 2015 Analysis of contractual relations between parties in combination with the conduct of the parties. Risks and returns to be allocated to the party exercising control and having financial capacity to assume the risks. Allocations of returns to MNE group members controlling economically significant risks and contributing assets. The actual nature of transaction to be determined for pricing, in a case where economic substance differs from form. Pricing methods to ensure that the profits are allocated to the most important economic activities. Actions taken Transactional Profit Split Method Revised guidance on the transactional profit split In June 2018, under the mandate of BEPS Action 10, the OECD released the final report on the revised guidance on the application of the transactional profit split method. This revised guidance, while not being prescriptive, clarifies and significantly expands the guidance on when a profit split method may be the most appropriate method. It describes presence of one or more of the following indicators as being relevant: Each party makes unique and valuable contributions; The business operations are highly integrated such that the contributions of the parties cannot be reliably evaluated in isolation from each other; The parties share the assumption of economically significant risks, or separately assume closely related risks. The guidance makes clear that while a lack of comparables is, by itself, insufficient to warrant the use of the profit split method, if, conversely, reliable comparables are available it is unlikely that the method will be the most appropriate. Moreover, the revised text expands the guidance on how the profit split method should be applied, including determining the relevant profits to be split, and appropriate profit splitting factors. Sixteen examples are included in the revised guidance to illustrate the principles discussed in the text and demonstrate how the method might be applied in practice. These will be included in Annex II to Chapter II of the Guidelines. Hard to Value Intangibles Guidance for tax administrations on the application of the approach to hard-to-value intangibles In June 2018, under the mandate of BEPS Action 8, the OECD released additional guidance for tax administrations on the application of the approach to Hard-to-Value Intangibles (HTVI). The guidance contained in this report aims at reaching a common understanding and practice among tax administrations on how to apply adjustments resulting from the application of the HTVI approach. This guidance should improve consistency and reduce the risk of economic double taxation. In particular, the new guidance: Presents the principles that should underlie the application of the HTVI approach by tax administrations; Provides a number of examples clarifying the application of the HTVI approach in different scenarios; and Addresses the interaction between the HTVI approach and the access to the mutual agreement procedure under the applicable tax treaty. The guidance for tax administration on the application of the HTVI approach contained in this document has been incorporated into the Transfer Pricing Guidelines as an annex to Chapter VI. Financial Transactions Transfer pricing guidance on financial transactions In February 2020 under the mandate of BEPS Action 4 and 8-10, the OECD released Transfer Pricing Guidance on Financial Transactions. The guidance is significant because it is the first time the OECD Transfer Pricing Guidelines include guidance on the transfer pricing aspects of financial transactions, which will contribute to consistency in the interpretation of the arm s length principle and help avoid transfer pricing disputes and double taxation. The report includes a number of examples to illustrate the principles discussed in the report. Section B provides guidance on the application of the principles contained in Section D.1 of Chapter I of the OECD Transfer Pricing Guidelines to financial transactions. In particular, Section B.1 of this report elaborates on how the accurate delineation analysis under Chapter I applies to the capital structure of an MNE within an MNE group. It also clarifies that the guidance included in that section does not prevent countries from implementing approaches to address capital structure and interest deductibility under their domestic legislation. Section B.2 outlines the economically relevant characteristics that inform the analysis of the terms and conditions of financial transactions. Sections C, D and E address specific issues related to the pricing of financial transactions (e.g. treasury functions, intra-group loans, cash pooling, hedging, guarantees and captive insurance). This analysis elaborates on both the accurate delineation and the pricing of the controlled financial transactions. Finally, Section F provides guidance on how to determine a risk-free rate of return and a risk-adjusted rate of return.