What Are the Dutch Transfer Pricing Methodologies and Rules?

Comparing the various transfer pricing methodologies available under US and Dutch laws, this series of articles examines and identifies which country’s body of law appears to be more substantive (i.e., provides more guidance for the taxpayers and tax authorities of that country) than does the body of law of the other country. My intention, however, is not to expressly conclude—or by implication, suggest—that one country’s law concerning transfer pricing is superior to the other. Rather, my intention is for these articles to serve as a useful resource for both US and Dutch tax professionals. Specifically, it is my hope that tax professionals from these two nations can utilize these articles in order to obtain a better understanding of what law is available to their counterparts as well as what their counterparts must adhere to and satisfy when negotiating a bilateral or multilateral advance pricing agreement with their respective taxing authority.

Pre-2002 Dutch Arm’s-Length Principle Rules

Prior to 2002, Dutch tax law principles generally ensured that the profits derived from a business were to be determined based on the arm’s-length principle. See van Dam and Dijkstra, 6965 T.M., Foreign Income: Transfer Pricing: Rules and Practice in Selected Countries (M-P).

Article 3.8 of the Dutch Income Tax Act of 2001 (ITA) and Article 10 of the 1969 Corporate Income Tax Act (CITA) enable both the courts as well as the tax authorities to adjust the reported taxable income to the extent that such income does not result from business but rather can be attributed to the relationship between a company and its shareholders. See van Dam and Dijkstra, 6965 T.M., Foreign Income Series: Transfer Pricing: Rules and Practice in Selected Countries (M-P).

The State Secretary of Finance for the Netherlands has provided – based on both Article 3.8 ITA and Article 10 CITA – that the Netherlands accepts the principles set out in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (2022). See van Dam and Dijkstra, 6965 T.M., Foreign Income Series: Transfer Pricing: Rules and Practice in Selected Countries (M-P).

The Organization for Economic Co-operation and Development is a 38-member intergovernmental organization established in 1961 with the mission to stimulate economic development and world trade.Both the Netherlands and the US are current members.

2002 Enactment of Article 8b CITA

In 2002, the arm’s-length principle was codified in the Netherlands with the enactment of Article 8b of the Corporate Income Tax Act (CITA) of 1969. See van Dam and Dijkstra, 6965 T.M., Foreign Income Series: Transfer Pricing: Rules and Practice in Selected Countries (M-P).

The transactions affected by Article 8b CITA are limited to those between entities (primarily corporations).These transactions remain subject to the general tax law principles which ensure that parties act at arm’s length. The criteria established in Article 8b CITA applies to both domestic transactions as well as cross-border transactions. See van Dam and Dijkstra, 6965 T.M., Foreign Income Series: Transfer Pricing: Rules and Practice in Selected Countries (M-P).

However, irrespective of the type of transaction, Article 8b CITA does not prescribe the manner in which a transfer pricing adjustment should be made.Therefore, the Dutch taxpayer and Dutch tax practitioner should look to the most recent, controlling decree issued by the Ministry of Finance (Ministerie van Finaciën) (in this case, the most up-to-date decree is Decree No. 2022/0000139020) as well as the 2022 OECD TP Guidelinesfor guidance. See van Dam and Dijkstra, 6965 T.M., Foreign Income Series: Transfer Pricing: Rules and Practice in Selected Countries (M-P).

2001-2018 Decrees

Beginning in 2001 and continuing to 2018, the State Secretary of Finance indicated – on the basis of Article 3.8 ITA and Article 10 of the CITA—that the Netherlands accepted the principles set out in the 2022 OECD TP Guidelines. Specifically, this was first confirmed in IFZ2001/295M. The 2001 Decree was replaced three years later with 2004/680M. The 2004 Decree was then replaced by IFZ 2013/184M, which, in turn, was replaced by IFZ 2018/6865. See van Dam and Dijkstra, 6965 T.M., Foreign Income Series: Transfer Pricing: Rules and Practice in Selected Countries (M-P).

Decree No. 2018/6865

Decree No. 2018/6865 replaced IFZ 2013/184M. This 2018 decree involved major changes to the following areas of Dutch tax law which were first introduced in IFZ 2013/184M:

1. Clarification of the process in which a transaction between associated parties is characterized;
2. A further explanation of the application of transfer pricing methods in specific situations;
3. Adjustments to the section on the pricing of intangible assets when the valuation is highly uncertain;
4. A new section on hard-to-value intangibles (HTVI);
5. A new section on the purchase of shares in an unrelated company followed by a business restructuring;
6. A section on renumeration for low value adding services; and
7. Textual changes to bring domestic terminology more in line with terminology used in the amended 2022 OECD TP Guidelines.

Decree 2022/0000139020

On June 14, 2022, Decree No. 2022/0000139020 replaced Decree No. 2018/6865. This new decree’s focus – among other aspects of transfer pricing—is on the arm’s-length principle.

Section 1.3 of Decree No. 2022/0000139020 provides that transfer pricing is not an exact science. Tax administrators are encouraged to be flexible in their approach and not demand precise accuracy from taxpayers related to transfer pricing issues which may be unrealistic in light of all of the facts and circumstances.

In the field of transfer pricing, constructive cooperation between the Dutch Tax Administration (Belastingdienst) and the taxpayer is appropriate.It is important for each party to understand the position and interest of the other. See Decree No. 2022/0000139020, §1.3.

The foregoing does not alter the fact that there may be situations where there is profit sharing which is based on a non-arm’s-length transaction, and therefore action is required.In such a situation, the Belastingdienst will assess – based on all facts and circumstances – the extent to which the imposition of a fine is appropriate. See Decree No. 2022/0000139020, §1.3, fn 4.

Section 1.5 of Decree No. 2022/0000139020 provides that the 2022 OECD TP Guidelines were created in order to provide insight into how the arm’s-length principle should be applied in practice. Continuing, the Dutch consider that the 2022 OECD TP Guidelines play an important role in the administration of treaties as well as the avoidance of double taxation. The Guidelines are also instrumental in assisting tax authorities in combating tax evasion. See Decree No. 2022/0000139020, §1.5.

As the 2022 OECD TP Guidelines provide an internationally accepted interpretation of the arm’s-length principles, the State Secretary of Finance (Nederlandse Minister van Financiën) held in 2022 that the Guidelines serve as an appropriate explanation and clarification of Article 8b of the Corporation Tax Act of 1969. See Decree No. 2022/0000139020, §1.5.

On several topics, the 2022 OECD TP Guidelines leave room for interpretation. Other topics, however, require clarification of the Guidelines. Decree No. 2022/0000139020 provides insight into the Dutch viewpoints; and wherever possible, removes ambiguities. See Decree No. 2022/0000139020, §1.5.

If the interpretation and/or application of the 2022 OECD TP Guidelines leads to a situation where a transfer price dispute arises within a group operating internationally and the dispute may, in turn, result in part of the group’s profits not being subject to profit-based taxation, the Tax Administration (Belastingdienst) may deviate from the interpretation of Decree No. 2022/0000139020 to prevent a transfer price difference. A deviation will only be permitted, however, if it leads to an outcome based on the arm’s-length principle. See Decree No. 2022/0000139020, §1.5.

Starting Point for a Transfer Price Investigation

The 2022 OECD TP Guidelines discuss five transfer pricing methods. Depending on the circumstances, one of these should be chosen. See Decree No. 2022/0000139020, §3.1; see van Dam and Dijkstra, 6965 T.M., Foreign Income Series: Transfer Pricing: Rules and Practice in Selected Countries (M-P).

The Dutch Tax Administration will always start its transfer pricing audit from the perspective of the method used by the taxpayer at the time of the transaction.The taxpayer may choose one of the five transfer pricing methods; however, the method should lead to an arm’s-length result in the transaction at issue. See Decree No. 2022/0000139020, §3.1.

In certain situations, however, one method will be more suitable than another. Although a taxpayer is expected to consider the reliability of the method for the situation at issue, the taxpayer is not expected to assess all methods and then explain why the method chosen leads to the desired result under the best methods rule. See Decree No. 2022/000139020, §3.1.

In some situations, a combination of methods may be used.A taxpayer is not obliged to use multiple methods.A taxpayer must be prepared, however, to make a plausible case for its choice(s). See Decree No. 2022/0000139020, §3.1.

Typically, the comparable uncontrolled price (CUP) method is difficult to apply in practice because comparable uncontrolled transactions are generally not available.This is one of the reasons why, in practice, the transactional net margin method (TNMM) is often used as the preferred transfer pricing method. An exception to this general rule involves financial transactions. Typically, comparable uncontrolled transactions can be found in financial transactions. See Decree No. 2022/0000139020, §3.1.

If a transfer pricing method is chosen where the results of the transactions of one of the associated parties are compared with the results of comparable transactions of independent parties, this comparison should be made to the associated party with the least complex functions (i.e., the “tested party”). Typically, the tested party will be the taxpayer that is not – based on its functions, assets, and risks – entitled to the proceeds associated with the intangible fixed assets in use. See Decree No. 2022/0000139020, §3.1.

Types of Transfer Pricing Methods

The Belastingdienst applies the 2022 OECD TP Guidelines as supplemented by Decree No. 2022/0000139020 to transfer pricing questions. In line with the 2022 OECD TP Guidelines, Dutch authorities adhere to the three traditional transaction-based transfer pricing methods, which are:

1. the CUP method;
2. the resale price method; and
3. the cost plus method.

In addition, the Belastingdienst also utilizes the following profit-based methods:

1. profit-split method; and
2. TNMM.

See van Dam and Dijkstra, 6965 T.M., Foreign Income Series: Transfer Pricing: Rules and Practice in Selected Countries (M-P).

These different methods will be discussed individually in turn (see infra).

Comparable Uncontrolled Price Method (the CUP Method)
The CUP method adopted by the Netherlands through Decree No. 2022/0000139020, and earlier legislation, is based on Chapter II of the 2022 OECD TP Guidelines,¶¶2.14-2.26. It is a traditional transaction method.

The CUP method compares the price charged in a transaction between related parties concerning either property or services with the price which would have been charged in the same type of transaction between unrelated business organizations. See 2022 OECD TP Guidelines ¶2.14.

Paragraphs 2.18 and 2.20 of the 2022 OECD TP Guidelines note that the CUP method is particularly appropriate if a transaction involves the transfer of commodities between related parties. These two paragraphs indicate that the economically relevant characteristics of commodities include (but are not limited to): (1) the physical features and quality of the commodity; and (2) the contractual terms of the commodity-related transaction, such as: (a) volume traded; (b) period of the arrangement; (c) the timing and terms of delivery; (d) transportation; (e) insurance; and (f) foreign currency terms.

Paragraph 2.15 of the 2022 OECD TP Guidelines provides that an uncontrolled transaction is comparable for purposes of the CUP method if either one of the two following conditions are met: (1) none of the differences (if any) between the transactions being compared or between the enterprises undertaking those transactions could materially affect the price in the open market; or (2) reasonably accurate adjustments can be made to eliminate the material effects of such differences.

The Dutch Government looks upon the use of this method with a rather jaundiced eye. Specifically, in 2022, the Ministerie van Finaciën provided that the CUP method is difficult to apply in practice because comparable uncontrolled transactions are almost impossible to find. Therefore, the Belastingdienst considers the TNMM as the method of choice in transfer pricing inquiries. See Decree No. 2022/0000139020, §3.1.

It appears that under Dutch law, the CUP method is more theoretical and therefore does not serve as a practical instrument in which to evaluate a transfer pricing issue. Reasonably accurate adjustments can be difficult to calculate under the CUP method.However, the CUP method should be used in relation to commodities and other fungible goods which are widely traded. See 2022 OECD TP Guidelines, ¶¶2.17-2.18.

Resale Price Method
The resale price method adopted by the Netherlands through Decree No. 2022/0000139020, and earlier legislation, is based on Chapter II of the 2022 OECD TP Guidelines, ¶¶2.27-2.44. It is a traditional transaction method.

This method applies to the uncontrolled resale of a product purchased from a related business organization.The arm’s-length purchase price is determined by reducing the resale price by the appropriate gross margin. See 2022 OECD TP Guidelines, ¶2.27.

The appropriate gross margin (the “resale price margin”) can be determined in one of two ways. The first way is through the resale of property by the tested party (the reseller) to an independent, third-party and the property at issue was initially purchased by the reseller at issue from an independent, third-party (internal comparable). The second way is through the resale of property by an independent, third-party to an independent, third-party and the initial purchase was from another independent, third-party (external comparable). See 2022 OECD TP Guidelines, ¶2.28.

Paragraph 2.29 of the 2022 OECD TP Guidelines provides that an uncontrolled transaction is comparable for purposes of the resale price method if one of two conditions of the following disjunctive test are met: (1) none of the differences (if any) between the transactions being compared or between the enterprises undertaking those transactions would materially affect the price on the open market; or (2) reasonably accurate adjustments can be made to eliminate the material effects of such differences.

Comparability for purposes of the resale price method can typically be achieved with fewer adjustments than under the CUP method.The reason for this is because minor product differences are less likely to influence profit margins. For this reason, the resale price method may be more appropriate than the CUP method when the controlled and uncontrolled transactions are comparable except for product characteristics. See 2022 OECD TP Guidelines, ¶2.30 and ¶2.32.

This method is sensitive to a number of potential differences between controlled and uncontrolled transactions. These potential differences include, but are not limited to, the following: (1) the ways the associated enterprises and the independent enterprises carry out their respective businesses which can affect costs and profitability but not the ultimate price of the goods sold or services rendered; (2) any additional commercial activity; (3) marketing; (4) risks assumed; (5) creation and maintenance of intangibles; (6) amount of time between initial purchase and resale; (7) reprocessing; (8) functions of intermediate companies; and (9) exclusive rights to resell.Therefore, before using this method, Dutch tax practitioners should identify any discernable differences and then analyze these differences to determine whether this method should be utilized. See 2022 OECD TP Guidelines, ¶¶2.33-2.41.

Cost Plus Method
The cost plus method adopted by the Netherlands through Decree No. 2022/0000139020, and earlier legislation, is based on Chapter II of the 2022 OECD TP Guidelines, ¶¶2.45-2.61. It is a traditional transaction method.

This method determines the arm’s-length price for both property sold as well as services rendered to a related business organization by adding a mark-up to the supplier’s costs. This method is especially applicable in the following types of controlled transactions: (1) the sale of semi-finished goods; (2) joint facility agreements; (3) long-term buy-and-supply agreements; and (4) transactions involving services. See 2022 OECD TP Guidelines, ¶2.45.

Paragraph 2.47 of the 2022 OECD TP Guidelines provides that an uncontrolled transaction is comparable for purposes of the cost plus method if one of two conditions of the following disjunctive test are met: (1) none of the differences (if any) between the transactions being compared or between the enterprises undertaking those transactions would materially affect the cost plus mark-up on the open market; or (2) reasonably accurate adjustments can be made to eliminate the material effects of such differences.

This method is one that is subject to adjustments.This method must be applied to a comparable cost base and adjustments may be required in a number of varying situations where there are differences between controlled and uncontrolled transactions.Examples of situations where potential adjustments may arise include: (1) the differences in the level and types of operating expenses associated with functions performed and risks assumed; (2) the differences in the level and types of non-operating expenses associated with functions performed and risks assumed; (3) differences in management (supervisory, general and administrative) efficiencies; (4) differences in accounting practices and accounting terms; especially related to direct and indirect costs; and (5) differences in the assumption of overhead or other costs from a related supplier. See 2022 OECD TP Guidelines, ¶¶2.50-2.54, ¶2.56.

Costs which vary over time, such as material, labor and transportation, as well as costs of fixed assets, may be averaged within – and even across – product groups. Costs such as replacement costs and marginal costs may also be considered where these costs can be measured and result in a more accurate estimate of the appropriate profit. See 2022 OECD TP Guidelines, ¶2.55.

Profit Split Method
The profit split method adopted by the Netherlands through Decree No. 2022/0000139020, and earlier legislation, is based on Chapter II of the 2022 OECD TP Guidelines, ¶¶2.114-2.187. It is a transactional profits method.

The existence of unique and valuable contributions by each party to a controlled transaction is likely the clearest indicator that the profit split method may be the most appropriate method to use in a particular controlled transaction analysis. The context of the transaction, including the industry in which it occurs and the factors affecting business performance in that particular sector, can be particularly relevant when evaluating the contributions of the parties and whether such contributions are unique and valuable. Depending on the facts of the case, other indicators that the profit split method may be the most appropriate method can include a high level of integration in the business operations that the transactions relate and/or the shared assumption of economically significant risks by the parties to the transactions. See 2022 OECD TP Guidelines, ¶2.126.

Contributions will be considered “unique and valuable” in cases where: (1) they are not comparable to contributions made by uncontrolled parties in comparable circumstances; and (2) they represent a key source of actual or potential economic benefits in business operations. See 2022 OECD TP Guidelines, ¶2.130.

In general, the presence of factors indicating that a transactional profit split is the most appropriate method will correspond to an absence of factors indicating that an alternative transfer pricing method – one which relies on entirely on comparables – is the most appropriate method pursuant to ¶2.2 of these Guidelines. See 2022 OECD TP Guidelines, ¶2.143.

The profit split method first identifies the profits to be split from the controlled transactions – the relevant profits – and then splits them between the associate enterprises on an economically valid basis that approximates the division of profits that would have been agreed to at arm’s length. As is the case with all transfer pricing methods, the aim is to ensure that profits of the associated enterprises are aligned with the value of their contributions. See 2022 OECD TP Guidelines, ¶2.114.

The profit split method is particularly useful when the compensation of the associated enterprises can be more reliably valued by reference to the relative shares of their contributions to the profits arising in relation to the transaction(s) than by a more direct estimation of the value of those contributions. See 2022 OECD TP Guidelines, ¶2.114.

The main strength of this method is that it can offer a solution for highly integrated operations in which a one-sided method would not be appropriate. A high degree of integration is defined as the way one party to a transaction performs functions, uses assets and assumes risks which is interlinked with – and cannot be reliably evaluated in isolation from – the way in which another party to the transaction performs functions, uses assets and assumes risks. An example of highly integrated operations would be global trading and financial instruments used between related business entities. See 2022 OECD TP Guidelines, ¶2.120, ¶¶2.133-2.138.

The profit split method may also be found to be the most appropriate method in cases where both parties to a transaction make unique and valuable contributions (such as intangibles) to the transaction. In such a case, independent parties might effectively price the transaction in proportion to their respective contributions, making a two-sided method more appropriate. Furthermore, since these contributions are unique and valuable, there will be no reliable comparables which could be used to price the entirety of the transaction under a more reliable method. In such a case, the allocation of profits under the profit split method may be based on the contributions made by associated enterprises, through reference to the relative values of their respective functions, assets and risks. See 2022 OECD TP Guidelines, ¶2.119, ¶¶2.130-2.132.

The profit split method also offers flexibility in that it can consider specific, possibly unique facts and circumstances, of the associated enterprise which may not be present in an independent enterprise. Moreover, where thereis a high degree of uncertainty for each of the parties in relation to the transaction – for example in transactions involving the shared assumption of economically significant risks by all parties (or the separate assumption of closely related economically significant risks) – the flexibility of the profit split method may allow for the determination of arm’s-length profits for each party that vary with the actual outcomes of the risks associated with the transaction. See 2022 OECD TP Guidelines, ¶2.121, ¶¶2.130-2.132, ¶¶2.139-2.142.

Under the profits split method, the relevant profits are to be split between the associated enterprises on an economically valid basis which approximates the division of profits that would have been anticipated and reflected in an agreement made at arm’s length.The combined profits to be split under this particular method are those of the associated enterprise arising as a result of the controlled transaction under review. See 2022 OECD TP Guidelines, ¶¶2.147-2.154.

The determination of the profits to be split, including whether those profits are actual profits or simply anticipated profits, or some combination thereof, should be aligned with the accurately delineated transaction. See 2022 OECD TP Guidelines, ¶2.158.

In determining the relevant profits, it is essential to first identify and accurately delineate the transactions to be covered and then identify the relevant income and expenses for each party. See 2022 OECD TP Guidelines, ¶2.154.

Where the relevant profits to be split are comprised of profits of two or more associated enterprises, the relevant financial data of the parties to the transaction to which a transactional profit split is applied need a common basis as to accounting practices and currency.Because accounting standards can have significant effects on the determination of profits to be split, accounting standards should be selected in advance and applied consistently over the lifetime of the arrangement. See 2022 OECD TP Guidelines, ¶2.155.

Except in circumstances where the total activities of each of the parties are the subject of the profit split, the financial data will need to be segregated, and allocations made in accordance with the accurately delineated transaction(s) so that the profits relating to the combined contributions made by parties are identified. See 2022 OECD TP Guidelines, ¶2.157.

There are a number of profit split approaches.Two of the most common ones are the contribution analysis and the two-stage residual analysis. See 2022 OECD TP Guidelines, ¶2.149.

Under the contribution analysis, the relevant profits – which are the total profits from the controlled transactions under review – are divided between the associated enterprises to arrive at a reasonable approximation of division that independent enterprises would have achieved by engaging in comparable transactions. This division can be supported by data reflecting comparables where available.In the absence thereof, it should be based on the relative value of the contributions by each of the associated enterprises participating in the controlled transactions. This can be determined using information internal to the related group, e.g. as a proxy for the division that independent enterprises would have achieved. In cases where the relative value of the contributions can be measured, it may not be necessary to estimate the actual market value of each party’s contribution. See 2022 OECD TP Guidelines, ¶2.150.

The OECD TP Guidelines acknowledge that it may be difficult to determine the relative value of the contribution that each of the associated enterprises makes to the relevant profits, and the approach will depend on the facts and circumstances of each case.The determination might be made by comparing the nature and degree of each party’s contribution of differing types (for example, provision of services, development expenses incurred, assets used or contributed, capital invested), and assigning a percentage based upon the relative comparison and external market data. See 2022 OECD TP Guidelines, ¶2.151.

Where the contributions of the parties are such that some can be reliably valued by references to a one-sided method and benchmarked using comparables, while others cannot, the application of a residual analysis may be appropriate. A residual analysis divides the relevant profits from the controlled transactions under examination into two categories.The first category consists of profits attributable to contributions which can be reliably benchmarked; typically, less complex profits for which reliable comparables can be found.Ordinarily, this initial remuneration would be determined by applying one of the traditional transaction methods or the TNMM to identify the remuneration of comparable transactions between independent enterprises. Thus, it would generally not account for the return that would be generated by a second category of contributions which may be unique and valuable, and/or attributable to a high level of integration or the shared assumption of economically significant risks. See 2022 OECD TP Guidelines, ¶2.152.

Regardless of which of the two analyses is utilized, profits should be split on an economically valid basis that reflects the relative contributions of the parties to the transaction and thus approximates the division of profits that would have been obtained at arm’s length.The relevance of comparable uncontrolled transactions or internal data and the criteria used to achieve an arm’s length division of profits depend on the facts and circumstances of the case. For this reason, the drafters of the 2022 OECD TP Guidelines determined that it was not advisable to establish a prescriptive list of criteria or profit splitting factors. See 2022 OECD TP Guidelines, ¶2.166.

The division of the relevant profits under the profit split method is generally achieved using one or more profit splitting factors. The functional analysis and an analysis of the context in which the transaction takes place (e.g. the industry and the environment) are essential to the process of determining the relevant factors to use in splitting profits. See 2022 OECD TP Guidelines, ¶2.169.

Depending on the facts and circumstances of the case, a factor can be a figure (e.g. a 30%-70% split based on evidence of a similar split achieved between independent parties in comparable transactions), or a variable (e.g. relative value of one of the participant’s marketing contributions) which could be calculated based on a single profit splitting factor or a weighting of multiple factors. See 2022 OECD TP Guidelines, ¶2.170.

Profit splitting factors based on assets or capital (e.g. operating assets, production assets, retail assets, IT assets and/or intangibles), or costs (e.g. relative spending and/or investment in key areas such as research and development, engineering and marketing) may be used where these capture the relative contributions of the parties to the profits being split and they can be measured reliably. See 2022 OECD TP Guidelines, ¶2.171.

Asset-based or capital-based profit splitting factors can be used where there is a strong correlation between tangible assets or intangibles, or capital employed and creation of value in the context of the controlled transaction.In order for a profit splitting factor to be meaningful, it should be applied consistently to all of the parties to the transaction at issue. See 2022 OECD TP Guidelines, ¶2.179.

Where one or more of the parties makes a contribution in the form of intangibles, difficult issues can arise in relation to both their identification and their valuation. See 2022 OECD TP Guidelines, ¶2.180.

A profit splitting factor based on expenses may be appropriate where it is possible to identify a strong correlation between relative expenses incurred and relative value contributed.Marketing costs as well as research and development costs may be relevant profit splitting factors if these two different types of costs create unique and valuable intangibles. See 2022 OECD TP Guidelines, ¶2.181.

Typically, marketing costs as well as research and development costs should not be used as cost-based profit splitting factors if each party to the transaction contributes different valuable intangibles. These two types of costs can be used in this type of situation, however, if costs are considered to be a reliable measure of the relative value of the different types of intangibles or costs can be risk-weighted to achieve a reliable measure of relative value. See 2022 OECD TP Guidelines, ¶2.181.

The Dutch tax practitioner needs to bear in mind a number of issues which may arise while attempting to identify and apply appropriate cost-based profit splitting factors.These issues may include the following: (1) the timing of each of the parties’ respective expenditures; (2) whether the relevant costs are part of a larger cost pool of one or more of the parties; (3) location savings of one or more of the parties; and (4) differences and changes in accounting classifications of costs. See 2022 OECD TP Guidelines, ¶2.182.

Transactional Net Margin method
The TNMM adopted by the Netherlands through Decree No. 2022/0000139020, and earlier legislation, is based on Chapter II of the 2022 OECD TP Guidelines, ¶¶2.62-2.113. It is a transactional profits method.

The TNMM examines the net profit relative to an appropriate base (costs, sales, or assets) that a taxpayer realizes from a controlled transaction.The net profit indicator ratio of the taxpayer at issue (see infra) in the controlled transaction should ideally be established by reference to the net profit indicator ratio that the same taxpayer earns in comparable uncontrolled transactions. See 2022 OECD TP Guidelines, ¶2.64.

As previously discussed, the Ministerie van Finaciën provided in 2022 that the CUP method is difficult to apply in practice because comparable uncontrolled transactions are almost impossible to find.The Belastingdienst considers the TNMM as the method of choice in transfer pricing inquiries. See Decree No. 2022/0000139020, §3.1. Therefore, considering the TNMM is the most utilized transfer pricing method by Dutch tax professionals and governmental personnel, this article will devote additional attention to this particular method.

The net profit of any business is the actual profit a business enjoys after working expenses which have not been included in the calculation of gross profits have been paid. Working expenses include operating expenses, non-operating expenses, taxes and the payment of preferred stock dividends to shareholders.

Net profit indicators are ratios of net profit relative to a base, such as costs, sales or assets. The net profit indicator ratios that a taxpayer realizes from a controlled transaction are compared with the net profit indicator ratios earned in comparable, uncontrolled transactions. For costs bases, see 2022 OECD TP Guidelines, ¶¶2.98-2.102. For sales bases, see 2022 OECD TP Guidelines, ¶¶2.96-2.97. For assets bases, see 2022 OECD TP Guidelines, ¶¶2.103-2.104.

The net profit margin for the purposes of the TNMM is calculated through the employment of a functional analysis which can take the form of a mathematical formula (see infra). Specifically, the net profit margin will be formed when a quotient is produced through the division of the two parts of a ratio.

If both parties make valuable, unique contributions, the profit split method is generally the more suitable method.However, if only one of the related parties makes such contributions, the TNMM may be applied to the party not making such contributions. See 2022 OECD TP Guidelines, ¶¶2.65-2.67.

One strength of the TNMM is that the net profit indicator ratios (e.g. return on assets and operating income to sales) are less affected by differences in product or service characteristics than are the prices used in the Traditional CUP method. See 2022 OECD TP Guidelines, ¶2.68.

An additional favorable characteristic of the TNMM is that it is only necessary to examine the finances of one of the related parties in the transaction (the tested party). This helps avoid the necessity of having to restate the books and records of both parties on a common basis. See 2022 OECD TP Guidelines, ¶2.69, ¶2.72.

Two noteworthy shortcomings of the TNMM involve net margins and available information. Net margins under the TNMM may be influenced by factors which would have less affect on the price or gross margin if a transaction were between independent, third parties. These aspects may make the accurate and reliable determination of arm’s-length net profit indicators difficult. Also, net profit information may be limited to that which was available at the time of the transaction. See 2022 OECD TP Guidelines, ¶2.70, ¶2.71.

Net profit indicators may also introduce volatility in transfer prices due generally to the potential variations in: (1) operating costs; (2) capacity utilization; and (3) competitive position.Moreover, net profit indicator ratios may also be influenced by the following industry forces: (1) the threat of new entrants being introduced into a particular sector or market; (2) the threat of substituted products being introduced into a particular sector or market; (3) management efficiency and strategies; (4) age of plant and equipment; and (5) differences in the cost of capital. See 2022 OECD TP Guidelines, ¶2.76, ¶2.77.

This method should not be used unless the net profit indicator ratios are determined from uncontrolled transactions of the same taxpayer in comparable circumstances; or where the comparable uncontrolled transactions are those of an independent enterprise and any differences between the associated enterprises and the independent enterprises that have a material effect on the net profit indicator ratio being used are identified and adequately considered. See 2022 OECD TP Guidelines, ¶2.80.

The factors encompassing both the numerator and the denominator of the profit level indicator ratio are not set in stone. The 2022 OECD TP Guidelines establish a series of conditions for both the numerator and the denominator which affect the calculation of net profits.

The numerator of the profit level indicator ratio (the net margin fraction) represents the operating profits of the tested party.Differences in the treatment of depreciation, reserves and other items which affect net profits must be taken into consideration. See Maruca, McDonald and Osborn, 6936-2nd T.M., Foreign Income Series: Transfer Pricing: OECD Pricing Guidelines; 2022 OECD TP Guidelines, ¶2.81.

If a company engages in a variety of controlled transactions, financial data must be sufficiently categorized to permit the exclusion of material costs which are unrelated to the transactions being tested. See Maruca, McDonald and Osborn, 6936-2nd T.M., Foreign Income Series: Transfer Pricing: OECD Pricing Guidelines; 2022 OECD TP Guidelines, ¶2.84.

Hedging transactions must be treated consistently. See Maruca, McDonald and Osborn, 6936-2nd T.M., Foreign Income Series: Transfer Pricing: OECD Pricing Guidelines; 2022 OECD TP Guidelines, ¶2.88.

For purposes of the numerator of the profit level indicator ratio (the net margin fraction), the controlled party should exclude profits from unrelated transactions. Non-operating items, such as interest expenses, taxes, as well as exceptional and extraordinary items, need to be excluded from net profits. See Maruca, McDonald and Osborn, 6936-2nd T.M., Foreign Income Series: Transfer Pricing: OECD Pricing Guidelines; 2022 OECD TP Guidelines, ¶2.85, ¶2.86.

Interest income should also be excluded unless: (1) there is a correlation between credit terms and sales prices as related to working capital; or (2) a controlled party is a lending institution. See Maruca, McDonald and Osborn, 6936-2nd T.M., Foreign Income Series: Transfer Pricing: OECD Pricing Guidelines; 2022 OECD TP Guidelines, ¶2.87, ¶2.89.

Whether foreign exchange gains and losses should be excluded will depend on whether the gains or losses were incurred in respect of a trade payable or receivable. See Maruca, McDonald and Osborn, 6936-2nd T.M., Foreign Income Series: Transfer Pricing: OECD Pricing Guidelines; 2022 OECD TP Guidelines, ¶2.88.

Depreciation, amortization, stock option, and pension costs can raise difficult issues when determining the net profits of the controlled party. The expected effects on the appropriateness of this method must be weighed against the reliability of the comparison. See Maruca, McDonald and Osborn, 6936-2nd T.M., Foreign Income Series: Transfer Pricing: OECD Pricing Guidelines; 2022 OECD TP Guidelines, ¶2.90.

Finally, for purposes of formulating the net profits of the numerator of the profit level indicator ratio (the net margin fraction), the question of including start-up costs and termination costs in the calculation depends on how those costs would be borne between the enterprise, customers and/or principals in an uncontrolled situation. See Maruca, McDonald and Osborn, 6936-2nd T.M., Foreign Income Series: Transfer Pricing: OECD Pricing Guidelines; 2022 OECD TP Guidelines, ¶2.91.

The denominator of the profit level indicator ratio (the net margin fraction) represents the appropriate base in which profits are measured. This base can consist of: (1) operating expenses for distribution activities; (2) full costs for services or manufacturing activities; or (3) operating assets for utilities and other capital-intensive activities. The denominator (the appropriate base) should be independent of all controlled transactions. Specifically, the costs of goods sold should not be used for the resale of goods purchased from an associated enterprise. Moreover, the denominator must reflect the allocation of risk that independent parties would typically seek and adhere to in an arm’s-length transaction. See Maruca, McDonald and Osborn, 6936-2nd T.M., Foreign Income Series: Transfer Pricing: OECD Pricing Guidelines; 2022 OECD TP Guidelines, ¶¶2.92-2.94.

Costs included in the denominator should typically include all direct and indirect costs as well as an allocation of overhead.The question of whether some costs should be passed on to the customer without a profit element should be based on the practice of independent sellers in that particular industry (e.g industry standards) and not on whether the costs can be classified as “internal” or “external.”Depending on the circumstances, it may be appropriate to use actual costs, budgeted costs, or standard costs in the denominator. See Maruca, McDonald and Osborn, 6936-2nd T.M., Foreign Income Series: Transfer Pricing: OECD Pricing Guidelines; 2022 OECD TP Guidelines, ¶2.99, ¶2.101.

In asset-intensive or capital-intensive activities, operating assets or capital can be the appropriate denominator.In businesses outside of the financial industry, investments and cash balances are generally not operating assets. See Maruca, McDonald and Osborn, 6936-2nd T.M., Foreign Income Series: Transfer Pricing: OECD Pricing Guidelines; 2022 OECD TP Guidelines, ¶2.103.

The utilization of book value may, in certain situations, be less costly than the use of market value. Market value is itself subject to reliability issues, especially with intangibles, where the valuation of the assets is uncertain. However, the Dutch tax practitioner must also be cognizant of the fact that the use of the book value of assets may introduce depreciation-based distortions based on the acquisition dates of: (1) the operating assets at issue; and (2) the operating assets being utilized as a comparison. Any distortions may possibly be alleviated by adjustments. See Maruca, McDonald and Osborn, 6936-2nd T.M., Foreign Income Series: Transfer Pricing: OECD Pricing Guidelines; 2022 OECD TP Guidelines, ¶2.104.

In conjunction with the calculation of either the numerator or the denominator of the net margin fraction, Decree No. 2022/0000139020 notes that ¶2.98 of the 2022 OECD TP Guidelines establishes that a transfer pricing method which bases the transaction-related profit on costs is only appropriate if these costs are the relevant indicator of the value of the functions performed, assets used and risks assumed. This means that the costs that do not constitute a relevant indicator for this value should not form part of the cost base for calculating the profit. See Decree No. 2022/0000139020, §3.2.2.

Decree No. 2022/0000139020 then goes on to provide that when the TNMM is used and the profit is related to costs incurred, part of these costs may be kept outside the base if an independent party would not make a profit in relation to such costs in a similar transaction. It is noteworthy that in doing so, the Ministerie van Finaciën was essentially directing the Belastingdienst not to follow ¶2.99 of the 2022 OECD TP Guidelines; thereby permitting the Dutch taxing authority to keep some types of costs outside the base in certain situations when examining a transaction under the TNMM. See Decree No. 2022/0000139020, §3.2.2.

Intangibles and the OECD TP Guidelines

The OECD TP Guidelines provide special provisions that focus on intangibles. These Guidelines are found in Chapter VI of the 2022 OECD TP Guidelines. These Guidelines can assist a Dutch tax practitioner when faced with a transaction involving the transfer of intangibles in controlled situations.

Part A of Chapter VI provides guidance as to identifying intangibles. Part A specifically covers the following: (1) general introductory issues; (2) the relevance of Chapter VI related to other tax purposes; and (3) categories of intangibles. See 2022 OECD TP Guidelines, ¶¶6.5-6.17.

Part A of Chapter VI also provides guidance as to illustrations related to: (1) patents; (2) know-how and trade secrets; (3) trade names, trademarks and brands; (4) rights under contracts and government licenses; (5) licenses and similar limited rights in intangibles; (6) goodwill and ongoing concern value; (7) group synergies; and (8) market specific characteristics. See 2022 OECD TP Guidelines, ¶¶6.18-6.31.

Part B of Chapter VI examines legal ownership and other contractual terms related to intangibles along with guidance on the evaluation of the conduct of the parties based on functions, assets and risks related to intangibles. See 2022 OECD TP Guidelines, ¶¶6.32-6.85.

Paragraphs 6.35 through 6.46 of the 2022 OECD TP Guidelines focus on contractual terms relating to intangibles.

Paragraphs 6.47 through 6.49 of the 2022 OECD TP Guidelines focus on functions, assets and risks related to intangibles in cross-border transactions.

Paragraphs 6.50 through 6.58 of the 2022 OECD TP Guidelines examine the interrelationship between performance and control of intangibles in cross-border transactions.

Paragraphs 6.59 through 6.64 of the 2022 OECD TP Guidelines focus on how the use of assets effects intangibles in cross-border transactions.

Paragraphs 6.65 through 6.68 of the 2022 OECD TP Guidelines focus on the assumption of risk generally associated with cross-border transactions involving intangibles.

Paragraphs 6.69 through 6.70 of the 2022 OECD TP Guidelines address issues which can arise related to actual, ex post returns as opposed to anticipated ex ante profitability.

Paragraphs 6.71 through 6.72 of the 2022 OECD TP Guidelines address when ex ante returns will be recognized as profits.

Paragraphs 6.73 through 6.74 of the 2022 OECD TP Guidelines focus on price and other conditions for controlled transactions involving intangibles.

Paragraphs 6.75 through 6.78 of the 2022 OECD TP Guidelines address the development and enhancement of marketing intangibles.

Paragraphs 6.79 through 6.80 of the 2022 OECD TP Guidelines address research, development and process improvement arrangements in cross-border transactions.

Paragraphs 6.81 through 6.85 of the 2022 OECD TP Guidelines focus on the payments for use of the company name.

Part C of Chapter VI outlines typical transactions involving intangibles. These include: (1) transactions involving the transfer of intangibles or rights in intangibles; and (2) transactions involving the use of intangibles in connection with the sale of goods or performance of services. See 2022 OECD TP Guidelines, ¶¶6.86-6.106.

Part D of Chapter VI provides guidance for determining arm’s-length conditions in cases involving intangibles. For the purposes of this specific article, this is the most relevant part of Chapter VI of the 2022 OECD TP Guidelines. See 2022 OECD TP Guidelines, ¶¶6.107-6.212.

Paragraph 6.108 of the 2022 OECD TP Guidelines establishes that the use or transfer of intangibles may raise challenging issues regarding comparability, selection of transfer pricing methods, and the determination of arm’s-length conditions for transactions.

Paragraphs 6.110 through 6.114 of the 2022 OECD TP Guidelines focus on the general principles applicable in transactions involving intangibles.

Paragraph 6.115 of the 2022 OECD TP Guidelines provides that Section D of Chapter VI is not intended to provide comprehensive guidance with regard to transfer pricing treatment of such intangibles transfers. The intent of this section is to supplement the otherwise applicable provisions of Chapters I-III of these Guidelines.

Paragraph 6.127 of the 2022 OECD TP Guidelines concludes that if for any reason there is a significant discrepancy between the anticipated future benefit of using one intangible as opposed to another, then it is difficult to consider the intangibles sufficiently comparable to support a comparable-based transfer pricing analysis in the absence of reliable comparability adjustments.

In situations where amounts attributable to comparability adjustments represent a large percentage of the compensation for the intangible, there may be reason to believe – depending on the specific facts – that the computation of the adjustment is not reliable and the intangibles being compared are not sufficiently comparable to support a valid transfer pricing analysis. If reliable comparability adjustments are not possible, it may be necessary to select a transfer pricing method that is less dependent on the identification of comparable intangibles or comparable transactions. See 2022 OECD TP Guidelines, ¶6.129.

In selecting the most appropriate transfer pricing method in a case involving the transfer of intangibles or rights in intangibles, attention should be given to: (1) the nature of the relevant intangibles; (2) the difficulty of identifying comparable, uncontrolled transactions and corresponding intangibles in many, if not all, cases; and (3) the difficulty of applying the methods set forth in Chapter II of these guidelines (see supra) to the transfer of intangibles. See 2022 OECD TP Guidelines, ¶6.131.

Continuing, the OECD TP Guidelines provide that when selecting the most appropriate transfer pricing method in connection with a transfer of intangibles or rights to intangibles, it is important to consider the economic consequences of the transaction rather than proceeding on an arbitrary label. See 2022 OECD TP Guidelines, ¶6.132.

The selection of the most appropriate transfer pricing method related to transactions between related entities involving intangibles should be based on a functional analysis that provides a clear understanding of the different parties’ global business processes and how the transferred intangibles interact with other functions, assets and risks that comprise global business. The functional analysis should identify all factors that contribute to value creation and may include risks borne, specific market characteristics, location, business strategies, and group synergies, among others.The transfer pricing method selected, and any adjustments incorporated in that method based on the comparability analysis, should consider all the relevant factors materially contributing to the creation of value. See 2022 OECD TP Guidelines, ¶6.133.

The principles set out in paragraphs 2.12, 3.58 and 3.59 of the 2022 OECD TP Guidelines regarding the use of more than one transfer pricing method apply to matters involving the transfer of intangibles or rights in intangible. See 2022 OECD TP Guidelines, ¶6.134.

Paragraphs 3.9 through 3.12 as well as paragraph 3.37 of the 2022 OECD TP Guidelines provide guidance regarding the aggregation of separate transactions for purposes of transfer pricing analysis. These paragraphs apply to transactions between related entities involving goods, services, intangibles or a combination of same. See 2022 OECD TP Guidelines, ¶6.135.

Depending on the specific facts, any of the five OECD transfer pricing methods set forth in Chapter II of the Guidelines might constitute the most appropriate transfer pricing method in transactions involving the transfer of intangibles or rights in intangibles. See 2022 OECD TP Guidelines, ¶6.136.

Where information regarding reliable comparable uncontrolled transactions cannot be identified, the arm’s-length principle requires the use of another method to determine the price uncontrolled parties would have agreed to under comparable circumstances. In making such determinations, the tax practitioner should bear in mind the following: (1) the functions, assets and risks of the respective parties to the transaction; (2) the business reasons for engaging in the transaction; (3) the perspectives of and options realistically available to each of the parties to the transaction; (4) the competitive advantages conferred by the intangibles, including the relative profitability of products and services or potential products and services related to the intangibles; (5) the expected economic benefits of the transaction; and (6) other comparability factors, such as features of local markets, location savings, assembled workforces and related group synergies. See 2022 OECD TP Guidelines, ¶6.139.

The resale price method and the TNMM are generally not considered to be reliable methods for directly valuing intangibles, since they are one-sided methods. See 2022 OECD TP Guidelines, ¶6.141.

The use of transfer pricing methods that seek to estimate the value of intangibles based on the cost of intangible development is generally discouraged. There is rarely any correlation between the cost of developing intangibles and their value or transfer price once developed.Therefore, transfer pricing methods based on the cost of intangible development should be avoided if possible. See 2022 OECD TP Guidelines, ¶6.142.

The OECD TP Guidelines provide that the Traditional CUP method and the Transactional profit split method are the two methods that a tax practitioner should consider utilizing when faced with a controlled transaction involving intangibles. See 2022 OECD TP Guidelines, ¶6.145.

The guidance set forth in Paragraphs 2.114 through 2.183 of the 2022 OECD TP Guidelines as to the Transactional profit split method are “fully applicable” as to controlled transactions involving intangibles. See 2022 OECD TP Guidelines, ¶6.148.

Section D.2.6.3 of Chapter VI the OECD TP Guidelines provides guidance on the use of valuation techniques. See 2022 OECD TP Guidelines, ¶¶6.153-6.157.

Section D.2.6.3 of Chapter VI of the January 2022 OECD TP Guidelines establishes that when situations arise where reliable comparable uncontrolled transactions involving intangibles cannot be identified, it may be possible to use valuation techniques to estimate the arm’s-length price for intangibles transferred between associated enterprises.Specifically, the application of income-based valuation techniques – especially valuation techniques premised on the calculation of the discounted value of projected future income streams or cash flows derived from the exploitation of the intangible being valued – may prove to be particularly useful when properly applied. Valuation techniques may be used, depending on the facts and circumstances, by taxpayers and government authorities as part of one of the five recognized transfer pricing methods described in Chapter II of the January 2022 OECD TP Guidelines.Valuation techniques may also be utilized as a tool when attempting to identify an arm’s-length price. See 2022 OECD TP Guidelines, ¶6.153.

Where valuation techniques are utilized in a transfer pricing analysis involving intangibles (either through an outright transfer or a question of rights), it is necessary to apply such techniques in a manner that is consistent with the arm’s-length principle and the principles set forth in the OECD TP Guidelines. The principles set forth in Chapters I through III of the Guidelines are of particular importance. Principles related to options, economically relevant characteristics, such as assumption of risk and aggregation of transactions, are applicable to situations where valuation techniques are utilized in a transfer pricing analysis. See 2022 OECD TP Guidelines, ¶6.154.

The 2022 Guidelines establish that it is essential to consider the assumptions and other motivations that may underlie particular applications of valuation techniques. To begin, some valuation assumptions related to accounting may be too conservative and this, in turn, may make what is contained on a company’s balance sheet too narrow for transfer pricing purposes. This is because the final estimate may not be consistent with arm’s-length principles. Caution should therefore be exercised in accepting valuations performed for accounting purposes, unless a thorough examination of the underlying assumptions is first conducted. See 2022 OECD TP Guidelines, ¶6.155.

Valuation techniques, generally, can be difficult to utilize in a transfer pricing analysis.However, where these techniques can be applied in a manner which takes into account: (1) the specific facts in the transaction at issue; (2) the OECD TP Guidelines; (3) sound valuation principles and practices; and (4) the validity of any assumptions underlying the valuation, then such techniques can serve as useful tools in a transfer pricing analysis where reliable comparable uncontrolled transactions are not available. See 2022 OECD TP Guidelines, ¶6.156.

Section D.2.6.4 of the OECD TP Guidelines addresses specific areas of concern in applying methods based on the discounted value of projected cash flows.The Dutch taxpayer and Dutch tax practitioner should pay particular attention to Paragraphs 6.161 and 6.162 because these paragraphs address both transfer pricing analysis and transfer pricing methods. See 2022 OECD TP Guidelines, ¶¶6.158-6.178.

The reliability of a valuation of a transferred intangible using discounted cash flow techniques is dependent on the accuracy of the projections of future cash flow or income on which the valuation is based. However, because the accuracy of financial projections is contingent on developments in a particular marketplace that are both unknown and unknowable at the time the valuation is determined, it is imperative for both taxpayers and tax practitioners to examine carefully the assumptions underlying the projections of both future revenues and future expenses. See 2022 OECD TP Guidelines, ¶6.163.

When evaluating financial projections, the source and purpose of the projections can be particularly important.In some cases, taxpayers will regularly prepare financial projections for business planning purposes.Typically, projections prepared for non-tax business planning purposes are more reliable than projections prepared exclusively for tax purposes, or exclusively for purposes of a transfer pricing analysis. See 2022 OECD TP Guidelines, ¶6.164.

Discount rates consider the time value of money and the risk or uncertainty of anticipated cash flows.As small variations in selected discount rates can produce large variations in the calculated value of intangibles, it is essential for taxpayers and tax practitioners to pay close attention to the analysis performed and the assumptions made in selecting the discount rate(s) utilized in the valuation model at issue. See 2022 OECD TP Guidelines, ¶6.170.

Section D.3 of Chapter VI of the 2022 OECD TP Guidelines focuses on arm’s length pricing of transactions involving intangibles for which valuation is highly uncertain at the time of the transaction.

A question arises when a valuation of an intangible or rights to an intangible at the time of a transaction is uncertain. The question specifically is how arm’s length pricing should be determined.This question can be resolved by reference to the actions independent enterprises would have taken in a comparable situation. As both taxpayers and tax authorities need to consider similar circumstances, this analysis will, by necessity, be governed by comparable facts. See 2022 OECD TP Guidelines, ¶6.181.

There are several mechanisms that independent enterprises may adopt to address uncertainty in the valuation of an intangible at the time of the transaction. As previously noted, these mechanisms are dependent on comparable facts and circumstances to the transaction at issue. See 2022 OECD TP Guidelines, ¶6.182.

One mechanism is to use anticipated benefits as a means for establishing the pricing at the outset of the transaction.In determining the anticipated benefits, the taxpayer or taxing authority must consider all relevant economics factors.The OECD TP Guidelines also note that when determining the anticipated benefits, independent enterprises would consider the extent to which subsequent developments are both foreseeable and predictable.If an independent business entity finds subsequent developments sufficiently predictable, then that entity might also find anticipated benefits are also sufficiently reliable to fix the pricing at the outset of the transaction. See 2022 OECD TP Guidelines, ¶6.182.

Another mechanism involving arm’s length pricing involves the use of contracts.Independent enterprises might determine that pricing based solely on anticipated benefits does not provide adequate protection against the risks posed by the uncertainty in valuing the intangible at issue. Contracts may include price adjustment clauses and/or payment structures. The payment structures essentially involve any arrangements in which the quantum or timing of payments depends on contingent events, such as predetermined thresholds in sales or profits. See 2022 OECD TP Guidelines, ¶6.183.

Section D.4 of the OECD TP Guidelines examines hard-to-value intangibles (HTVI). See generally 2022 OECD TP Guidelines, ¶¶6.186-6.195.

HTVIs are intangibles which, at the time of the transfer between related business entities, satisfy the following two-part, conjunctive test: (1) no reliable comparable intangible exists; and (2) the projection of future cash flow or the anticipated income to be derived from the transferred intangible, or the assumptions used in valuing the intangible, are highly uncertain, making it difficult to predict the level of the ultimate viability or success of the intangible. See 2022 OECD TP Guidelines, ¶6.189.

HTVIs may exhibit one or more of the following features: (1) the intangible is only partially developed at the time of the transfer; (2) the intangible is not expected to be exploited commercially for several years following the transaction; (3) the intangible is expected to be exploited in an unprecedented manner at the time of the transfer and the absence of a track record of development or exploitation of similar intangibles makes projections highly uncertain. See 2022 OECD TP Guidelines, ¶6.190.

The Guidelines recognize that for such intangibles, information asymmetry between the taxpayer and tax authorities, including what information the taxpayer considered in determining the pricing of the transaction, may be acute and could exacerbate the difficulty in verifying the arm’s-length basis on which pricing was determined. See 2022 OECD TP Guidelines, ¶6.191.

In these situations, tax authorities are permitted to consider ex post results as presumptive evidence concerning the appropriateness of the ex ante pricing arrangement at issue (the ex post/ex ante approach). See 2022 OECD TP Guidelines, ¶6.192.

Ex post evidence provides presumptive evidence as to the following: (1) the existence of uncertainties at the time of the transaction; (2) whether the taxpayer appropriately considered reasonably foreseeable developments or events at the time of the transaction; and (3) the reliability of the information used ex ante in determining the price for the transfer of such intangibles. See 2022 OECD TP Guidelines, ¶6.188.

Continuing, ex post evidence should be based on a determination that such evidence is necessary to assess the reliability of the information on which ex ante pricing has been based. However, where the tax administration can confirm the reliability of the information on which ex ante pricing has been based, then adjustments based on ex post profit levels should not be made. See 2022 OECD TP Guidelines, ¶6.192.

However, if the taxpayer provides detailed ex ante projections that were used at the time of the transfer of HTVIs to establish price arrangements or risk assessments and then reliable evidence subsequently arises which establishes that any significant differences between financial projections and actual outcomes was caused by unforeseeable subsequent developments, then the ex post/ex ante approach should not be used. See 2022 OECD TP Guidelines, ¶6.193.

Moreover, the ex post/ex ante approach should not be utilized if any of the following situations exist: (1) any significant difference between the financial projections and actual outcomes does not increase or reduce the HTVI’s compensation by more than 20% of the compensation determined at the time of the transaction; (2) a commercialization period of five years has passed following the year in which the HTVI first generated unrelated party revenues and any difference between financial projections and actual outcomes was not greater than 20% of the projections for that period; or (3) the existence of a controlling bilateral or multilateral advance pricing agreement. See 2022 OECD TP Guidelines, ¶6.193.

Section D.5 of the OECD TP Guidelines provides supplemental guidance for transactions involving the use of intangibles in connection with the sale of goods or rendering of services. See generally 2022 OECD TP Guidelines, ¶6.196-6.212.

Section D.5.1 examines the issue of comparability in transactions involving the use of intangibles. See generally 2022 OECD TP Guidelines, ¶¶6.197-6.202.

In a transfer pricing analysis involving intangibles, where the most appropriate method is the resale price method, the cost plus method, or the TNMM, the less complex of the parties to the controlled transaction is typically selected as the tested party. In many cases, an arm’s-length price or level of profit for the tested party can be determined without the need to value the intangibles used in connection with the transaction. This would typically be the case where only the non-tested party utilizes intangibles. See 2022 OECD TP Guidelines, ¶6.198.

In certain cases, however, the tested party may utilize intangibles notwithstanding its relatively non-complex operations.Similarly, parties to potentially comparable uncontrolled transactions may use intangibles. Whenever either of these situations exist, it is necessary to consider the intangibles used both by the tested party and by parties to potentially comparable uncontrolled transactions as one comparability factor in the analysis. See 2022 OECD TP Guidelines, ¶6.198.

Where the tested party and the potential comparable, uncontrolled entity have comparable intangibles, the intangibles will not be considered unique and valuable within the meaning of ¶6.17 and therefore no comparability adjustments will be required. The potential comparable will, in these circumstances, provide the best evidence of the profit contribution of the tested party’s intangibles. If, however, either the tested party or the potential comparable business entity uses unique and valuable intangibles in its operations, it may be necessary to either: (1) make appropriate comparable adjustments; or (2) revert to a different transfer pricing method. See 2022 OECD TP Guidelines, ¶6.201.

The principles contained within Paragraphs 6.116 through 6.130 apply in evaluating the comparability of intangibles in such situations. See 2022 OECD TP Guidelines, ¶6.201.

Section D.5.2 examines arm’s-length prices for transactions involving the use of intangibles in connection with the sale of goods or performance of services. Section D.5.2.1 examines situations where reliable comparables do, in fact, exist. See 2022 OECD TP Guidelines, ¶6.203.

The Guidelines provide that any of the five transfer pricing methodologies recognized by the OECD can, under certain circumstances, constitute the most appropriate transfer pricing method where the transaction involves the use of intangibles in connection with either goods or services. See 2022 OECD TP Guidelines, ¶6.204.

Where the tested party does not use unique and valuable intangibles, and reliable comparables can be identified, it will often be possible to determine arm’s-length prices on the basis of one-sided methods including the CUP method, the resale price method, the cost plus method, and the TNMM method.Typically, taxpayers and tax authorities will find the guidance supplied in Chapters I-III of the January 2022 Guidelines sufficient to assist them in determining arm’s-length prices in this type of situation. See 2022 OECD TP Guidelines, ¶6.205.

In situations involving intangibles utilized by the tested party which are not unique and valuable, prices paid or received or margins or returns earned by parties to comparable uncontrolled transactions may provide a reliable basis for determining arm’s-length conditions. The OECD TP Guidelines make it clear that only when the intangibles used by the tested party are unique and valuable will it become necessary to either make comparability adjustments or, in the alternative, select a transfer pricing method which is less dependent on comparable uncontrolled transactions. Likewise, where a difference in the nature of the intangibles has a material impact on price but is not subject to accurate estimation, the Guidelines suggest that it may be necessary to utilize a transfer pricing method that is less dependent on the identification of reliable comparables. See 2022 OECD TP Guidelines, ¶6.206, ¶6.207.

Finally, as to intangibles, the OECD TP Guidelines provide that, in certain circumstances, transfer pricing methods and valuation techniques not dependent on the identification of reliable comparable uncontrolled transactions may also be utilized to determine arm’s-length conditions for the sale of goods or the provision of services where intangibles are involved in the transaction. See 2022 OECD TP Guidelines, ¶6.212.

Services and the OECD TP Guidelines

The OECD TP Guidelines provide special provisions which focus on services. These Guidelines are found in Chapter VII of the January 2022 OECD TP Guidelines. These Guidelines can assist the Dutch tax practitioner when faced with a controlled transaction involving services.

The OECD TP Guidelines establish that there are two overriding issues which must be addressed in a transfer pricing analysis involving intra-group services. The first involves the question of whether intra-group services have been provided. This preliminary issue is beyond the scope of this article.However, sections B.1.1 through B.1.6 of Chapter VII provide detailed guidance as to this issue and I would recommend that the reader examine these thorough and well-reasoned sections of the Guidelines. See generally 2022 OECD TP Guidelines, ¶7.5-7.18.

The second issue involves the question of whether what was charged for intra-group services represents what non-related entities would have charged one another in an arm’s-length transaction. See 2022 OECD TP Guidelines, ¶7.5.

Section B.2 of Chapter VII of the Guidelines addresses this second issue in some detail. See 2022 OECD TP Guidelines, ¶¶7.19-7.37.

The three transfer pricing methods the OECD TP Guidelines identify as being the most appropriate in services-related controlled transactions are: (1) the CUP method; (2) the cost plus method; and (3) the TNMM. See 2022 OECD TP Guidelines, ¶7.31.

If the CUP method is used, it is likely to be the most appropriate method where there is a comparable service provided between independent enterprises in the recipient’s market. See 2022 OECD TP Guidelines, ¶7.31.

In the alternative, where a CUP method is not available, the cost plus method and the TNMM would likely be the most appropriate methods where the nature of the activities involved, assets used and risks assumed are comparable to those undertaken by independent, third-party enterprises. See 2022 OECD TP Guidelines, ¶7.31.

Finally, for purposes of this article, section D.5 of Chapter VI of the OECD TP Guidelines applies to both the use of intangibles as well as the provision of services. See generally 2022 OECD TP Guidelines, ¶¶6.196-6.212.

The next article in this series will compare the transfer pricing methodologies under US and Dutch laws.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Patrick Beattie‘s practice areas include tax planning, tax controversy, estate planning, insurance coverage actions, toxic tort litigation, and commercial litigation in the Philadelphia area.

This article, initially prepared as a continuing legal education class at the Jenkins Law Library in Philadelphia in 2022, has been extensively modified and additional sections, including content on the revised OECD TP Guidelines and the Dutch Ministry of Finance’s new decree replacing Decree 2018/6865, have been added prior to publication. The information contained herein is of a general nature and based on authorities that are subject to change. This article represents the views of the authors only and are for informational purposes only.

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