OECD Publishes Updated Transfer Pricing Guidelines for Multinational Enterprises

published: 07.02.2022

Considering current global economy trends, it is necessary to ensure that taxable profits of multinational enterprises (MNEs) are reported in such a way that reflects their economic activity, as well to avoid double taxation.

On January 20, the OECD released the 2022 edition of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, which are mainly directed by the application of the “arm’s length principle”: parties of the transaction should act out of self-interest and stand on equal footing when concluding agreements. This idea represents the international consensus on how cross-border transactions between associated enterprises for income tax purposes should be evaluated. The abovementioned update is the first one in five years, and its largest change concerns transfer pricing procedures for financial transactions.

The guidelines provide recommendations for tax authorities to adjust existing transfer pricing arrangements with regard to profit split approach and hard-to-value intangibles (HTVI), based on information that was not available at the time of entering into the transfer pricing agreements.

Profit Split Method

The guidelines help companies to determine when it is appropriate to apply the profit split method. In order to do so, companies must consider:

  • unique and valuable contributions by each of the parties to the transaction;
  • highly integrated business operations;
  • assumption of economically significant risks or assumption of closely related risks.

According to the updated guidelines, presence of reliable comparables for a transaction makes it unlikely that the profit split method is the most appropriate transfer pricing method. However, absence of comparables does not automatically mean that the profit split should be necessarily applied.

Tax authorities are offered to apply a presumptive evidence approach. When the actual income or cash flows are significantly higher or lower than the anticipated income or cash flows on which the pricing was based, there is presumptive evidence that the projected income or cash flows used in the original valuation should have been higher or lower.

If the profit split method should be applied, the guidelines now also clarify the use of the functional analysis. The profit split should be aligned with the functional analysis and delineated transactions. After that, the profits have to be aligned to match the appropriate accounting period for each of the parties involved. Lastly, it must be determined if the gross profits or operating profits have to be split.

When it is decided whether the profit should be split, the last step is to determine how to do it in the most effective manner. The guidelines mention a few factors: assets of capital used, costs, incremental sales, number of employees or employee compensation. All these should be are objective, verifiable and be supported with comparable data.

Hard-to-Value Intangibles

The term “HTVI” is used for intangibles or rights in intangibles of which, at the time of their transfer between associated enterprises, no reliable comparable existed and, at the time the transaction was entered into, projections of future cash flows or income expected to be derived from the transferred intangible, or the assumptions used in valuing the intangible were uncertain. This makes it difficult to predict the expected profit of the intangible asset at the time of the transfer.

This guidance provides tax authorities with the instructions how to determine in which situations the pricing arrangements set by the taxpayers are made at arm’s length and are based on an appropriate weighting of the foreseeable developments or events that are relevant for the valuation of HTVI, as well as give examples when they should not be treated as such.

In applying the HTVI approach, tax authorities may make appropriate adjustments to the allocation of profits between affiliated enterprises, as well as adapt an alternative pricing structure that differs from that adopted by the taxpayer, but reflects the one which would have been made by independent enterprises in comparable situations.

 

Sources:

OECD’s Press Release on the Guidelines

Text of Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022

 

Read more:

Ukraine Has Approved the Procedure for Preliminary Approval of Transfer Pricing

European Commission Introduces Minimum Substance Test Directive

Stay up to date with the latest news and events!



    To call Send Email