2010 represented a landmark year for international transfer pricing, with the OECD undertaking a fundamental overhaul of its Transfer Pricing Guidelines as well as initiating a major review of the transfer pricing of intangibles, an area which has been highlighted as a primary concern for taxpayers and authorities alike. In the UK and across the EU a number of welcome developments in practical application and administration of transfer pricing have resulted in clearer guidance for UK taxpayers in relation to APAs, thin capitalization issues and inter-company services.
To view the article in full, please see below:
Full Article
2010 represented a landmark year for international transfer
pricing, with the OECD undertaking a fundamental overhaul of its
Transfer Pricing Guidelines as well as initiating a major review of
the transfer pricing of intangibles, an area which has been
highlighted as a primary concern for taxpayers and authorities
alike. In the UK and across the EU a number of welcome developments
in practical application and administration of transfer pricing
have resulted in clearer guidance for UK taxpayers in relation to
APAs, thin capitalization issues and inter-company services.
Five key developments during that year affecting transfer pricing
were as follows:
1. 2010 update to OECD Transfer Pricing Guidelines
In July 2010 the OECD released a long-awaited update to Transfer
Pricing Guidelines for Multinational Enterprises (MNEs),
incorporating major revisions to Chapters I to III and a new
Chapter IX 'Transfer Pricing Aspects of Business
Restructurings'. This represents the most significant wholesale
modification to the Guidelines since their introduction in 1995.
Draft clauses for the 2011 Finance Bill issued by HMRC confirm that
these guidelines will be the new reference basis for UK
multinationals for accounting periods beginning on or after 1 April
2011.
Why it matters: This definitive guide to
international transfer pricing now contains a number of updates to
reflect changing audit and business practices worldwide. Most
notably the strict hierarchy of selection of pricing methods has
been substantially revised – previously use of the
Comparable Uncontrolled Price method was preferred, followed by
traditional transaction methods such as resale price and cost plus,
and with profit-based methods such as profit split and
transactional net margin relegated to use in only exceptional
circumstances. The guidelines now direct taxpayers to use the most
appropriate method with regard to the specific circumstances of the
transaction being priced, ranking profit methods equally with the
other options. As multinationals have increasingly adopted profit
methods as the most practical means of pricing convoluted
cross-border transactions involving, say, diverse ownership of
intangibles, this change in approach offers some welcome
support.
Transfer pricing on business restructuring is now analysed in
detail in Chapter IX of the Guidelines, covering a topic that has
been subject to consultation and analysis since 2005 and is of
practical interest to many multinationals. Four constituent
elements are discussed, analysing control and management of risk,
compensation for the restructuring exercise itself, remuneration
post-restructuring, and recognition of transactions undertaken. Of
specific interest is the emphasis that, as long as substance
follows form, any restructuring undertaken by an MNE primarily for
tax planning purposes should be considered a commercially viable
exercise, whether at a group or legal entity level, and that the
documentation of transfer pricing and commercial elements before,
during and after the restructuring can make or break the tax
treatment. Various worked examples and suggested tax authority
treatment of pricing and structuring scenarios provide a useful
basis for initial internal analysis of restructuring projects and
the associated transactions.
2. HMRC Thin Capitalisation Manual updated
In March 2010 HMRC released a substantial revision of its
International Tax Manual Thin Capitalisation: Practical Guidance
(INTM570000), which provides guidelines and analysis for review of
thin cap issues by the UK tax authorities.
Why it matters: Detailing practical and commercial
standpoints that tax inspectors are expected to adopt in relation
to the frequently complex issues surrounding thin capitalisation,
the update to this manual now represents a contemporaneous analysis
of debt structuring, in many instances adopting a clearer, more
pragmatic basis for examination than has been seen previously.
Although some concerns still arise in relation to consistent
application of the arm's-length standard for comparables and
associated benchmarking, the expanded guidance is useful in
anticipating HMRC's standpoint in debate over thin
capitalisation concerns. Of particular note is additional analysis
discussing cover and gearing ratios, property lending, private
equity business, and credit ratings.
3. HMRC's revised statement of practice on APAs
A Statement of Practice (SP) was issued in September 2010 by
HMRC, updating Advance Pricing Agreement (APA) procedures
originally implemented in 1999. Following consultation with
practitioners and UK companies a finalised version is expected
shortly.
Why it matters: Although the SP contains limited revisions to the
procedures adopted by HMRC, it is indicative of changes in attitude
towards the use of APAs in practice. To date a continuing concern
of taxpayers has been the convoluted, expensive and lengthy process
of applying for and negotiating an APA. With uncertain and
fluctuating economic conditions in many business sectors, the
usefulness of an agreement that may cover a three- to five-year
period may also be in question where there is the increased
possibility of breaching the APA terms.
Bearing this in mind, an important element of the SP is the
potential for informal, pre-filing discussion with HMRC, giving
taxpayers the opportunity to address potential show-stoppers to an
APA before committing to significant time and expense. Similarly,
HMRC's increased flexibility in addressing the particular
circumstances of any given APA application both in terms of
complexity and potential unilateral adoption should ease what has
often proved to be a particularly cost and time-intensive
process.
4. EU low value adding intra-group services guidelines drafted
Issued in February 2010 by the EU Joint Transfer Pricing Forum
(JTPF), 'Guidelines on Low Value Adding Intra-Group
Services' represents an extended review of typical services
provided between members of an MNE, and seeks to establish a
framework for a standardised approach to recharges and
documentation for transfer pricing purposes.
Why it matters: Expanding on Chapter VII of the
OECD Transfer Pricing Guidelines, this report offers a detailed
analysis of low-risk routine service activities that may take place
within a multinational, and provides a practical reference for
establishing whether a service has actually been provided, costing
the service, allocating those costs to the parties concerned, and
determining an appropriate arm's-length charge. The document
includes a useful list of typical intra-group services which,
although far from exhaustive and subject to the caveat of
overriding OECD principles, is a positive step towards encouraging
consistency in treatment of service recharges by EU tax
authorities.
5. OECD initiates review of transfer pricing aspects of intangibles
Following the release of the 2010 update to its Transfer Pricing
Guidelines for Multinational Enterprises, in July 2010 the OECD
started a consultation process to scope a project on the transfer
pricing of intangibles, carrying out discussions with companies and
practitioners throughout the course of the year.
Why it matters: In recent years the pricing of
intangibles has become one of the most challenging aspects of
transfer pricing, with significant variances in theoretical and
practical approaches by tax authorities resulting in both the
number and size of disputes escalating rapidly. With no consistent
definition of intangibles for legal, accounting and tax purposes,
and a variety of different approaches in treatment of unique,
routine and 'soft' intangibles, multinationals are at
significant risk of material tax adjustments at audit. At present
the OECD guidelines in Chapters VI and VIII fall short in providing
clear practical analysis, particularly regarding the complexities
of valuing and pricing intangible assets in accordance with the
arm's-length principle, and the focussed attention to the issue
and expected adaptation of the existing guidelines should prove of
significant interest.
What's ahead for 2011?
The OECD work on intangibles will continue with a further briefing by Working Party 6 on the scope of the project in early 2011, followed by a meeting of the Special Session on the Transfer Pricing Aspects of Intangibles in March 2011. With the continuing development of local transfer pricing regulations and guidelines by tax authorities, particularly across Europe, adoption of consistent, practical multijurisdictional transfer pricing approaches and methodologies is critical, and we can look forward to renewed work by the OECD and JTPF to establish clear transfer pricing frameworks that can be readily implemented.
This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq
Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.
The original publication date for this article was 06/01/2011.