OECD Working Party 6, which deals with transfer pricing and intangibles, held its final public consultation on Actions 8-10 (transfer pricing) of the BEPS project on 6 and 7 July 2015.
The key messages from the update are as follows.
TP Guidance changes
Chapter I – delineation of the actual transaction, risk and recognition of the accurately delineated transaction
The work of WP6 is built around risk and recognition of the accurately delineated transaction.
The most important part is delineating the actual transaction, with focus on the clarity provided on the relationship between contractual arrangements and conduct.
Contractual arrangements form the starting point of the analysis and knowing the parties’ conduct is relevant to assess whether there are contradictions between contractual arrangements and conduct. This knowledge will help fill in gaps in the contractual arrangement and interpret the contracts for transfer pricing purposes.
Non recognition (i.e. re-characterisation) builds on the existing guidance and links to the notion of commercial rationality. New examples are included that do not depend on behaviour or on moral hazard.
The guidance on risk is now part of the guidance on the functional analysis. A materiality threshold is included and economically significant risks need to be identified with specificity. Based on the comments received, the draft does not include anything on moral hazard and recognises risk-return trade offs. Control over risk has been clarified, financial capacity to assume a risk is included as a criterion on equal footing with control in the analysis on assumption of risk. The special character of the financial services industry and the interaction between the proposed guidance and the future work on financial transactions is recognised
For the practical application of the guidance to risk, an analytical framework was provided, as follows:
1. Identify economically significant risks with specificity
2. Identify contractual assumption of the specific risk
3. Functional analysis. Establish conduct and other facts
4. (i) is the contractual assumption aligned with the conduct and the other facts of the case? (ii) is the party assuming the risk under (i) exercising control and does it have the financial capacity to assume the risk?
5. If the party assuming the risk does not control the risk or does not have the financial capacity to assume the risk, then allocate the risk to the group company having most control and having the financial capacity to assume the risk
6. Price, taking into account the full functional analysis of the transaction, including the analysis on risk.
In response to comments received, WP6 has incorporated (in the draft) the notion that risk mitigation and preparatory work relating to the decision making may be outsourced. If such activities are outsourced, the group company in control of the risk should set the objectives of the outsourced activities, assess whether the objectives are met, and have authority to hire or fire the service provider.
The guidance also recognises that the parties performing risk mitigation activities and the parties making decisions that shape the policy environment in which the specific risks are assumed do not exercise control over the specific risk.
It is also recognised that the mere formalising of the decision making in the form of, for example, minutes of a board meeting and signing of the documents of a board meeting does not qualify as exercising a decision making function sufficient to demonstrate control over risk.
As regards the financial capacity to assume a risk, not only equity levels are deemed to be
relevant, the relevant test relates to access to funding on the basis that the associated enterprise is operating as an independent party in the same circumstances as the associated enterprise.
In the context of this update, cash box is a capital rich entity with low or no functionality. If the cash box is not exercising control (or sufficient control) over the financing risk that is connected with the provision of the funding, then the risk is allocated to the group entity that is performing such control functions.
The non-recognition rules may also be applicable.
A cash box with no or low functionality will get no more than a risk free rate of return for the funding itself.
It is expected that other BEPS action points could impact cash boxes such as interest deductibility rules (BEPS Action 4), controlled foreign company (CFC) rules (BEPS Action 3), and the minimum standard on treaty abuse (BEPS Action 6) and the application of domestic anti-abuse rules.
The OECD will monitor the progress on these points and further work on cash box depends on the outcome of the proposed measures.
Chapter 6 – Intangibles including Hard to Value Intangibles
No fundamental changes will be made to the proposed guidance developed in 2014. Moreover, corresponding changes based on the new guidance on risk and recognition of the accurately delineated transaction are necessary. Additional guidance on the allocation of the difference between the actual profits and the excepted profits is included; this allocation will be determined based on the way the risks that were assumed by group companies play out. Information asymmetry issues and the risk of mis-pricing are addressed through the guidance on hard to value intangibles.
WP6 will finalise the work in July and process the papers in August. The reports will be submitted for formal approval of CFA and for final approval of Council in early October. The Reports will be discussed at the G20 Finance Ministers Meeting on 8 October.