The OECD has no actual legislative power over individual countries’ tax regulations, but some countries formally incorporate the OECD guidelines into their transfer pricing regulations. For these countries, the updated guidelines have served as de facto transfer pricing legislation. Among those countries that do not rely on the OECD guidelines or see them as merely supplemental guidance to their own regulations, the response has been varied. Many countries have introduced or passed legislation addressing certain BEPS action items, while no action has been taken on others.
Although the purpose of the OECD guidelines is to establish a consistent international framework for addressing transfer pricing issues, this environment has created a new patchwork of transfer pricing approaches and regulations. MNEs need to be prepared for increased controversy caused by conflicting approaches and legislation among taxing authorities and to be alert to potential future regulatory changes in countries where they have operations.
2017 changes: A response to BEPS
Historically, the OECD guidelines have been an important source of transfer pricing guidance for both MNEs and tax administrations, especially when applying the arm’s-length principle, which is the internationally accepted standard for valuing cross-border transactions between associated enterprises for income tax purposes. In short, the arm’s-length principle requires that associated enterprises (that is, entities under common ownership or control, such as a parent company and subsidiary) price transactions between themselves as if they were third parties.
Exhibit 1: OECD Guidelines and BEPS Reports Timeline
The most significant of the 2017 revisions to the OECD guidelines were in response to the following 2015 BEPS reports:
- Actions 8-10, Aligning Transfer Pricing Outcomes with Value Creation. These actions focused on issues relating to intangible asset transactions, the allocation of risks and corresponding profits, the level of return for funding, and other high-risk areas.
- Action 13,Transfer Pricing Documentation and Country-by-Country Reporting. This action outlines a standardized three-tier approach for documentation. The first tier, the master file, contains high-level information regarding an MNE’s global business. The second tier, the local file, supplements the master file with specific information and analyses regarding a local company’s business and intercompany transactions. The third tier, the country-by-country report, contains aggregate information relating to the global allocation of income, taxes paid, and economic activities between taxing jurisdictions.
There has been significant legislative activity regarding Action 13, with many countries now requiring a three-tier documentation framework, though the U.S. is a notable exception. Given the complexity of Actions 8-10 and the differences in the resulting 2017 OECD guidelines and historical transfer pricing paradigms, less legislation has emerged concerning these specific action items to date. For countries that have formally incorporated the OECD guidelines into their transfer pricing regulations, however, the updated OECD guidelines have functionally served as legislation concerning each of these action items.
Analysis: A closer look at the conflicts
A deeper analysis of several of the most significant revisions contained in the 2017 OECD guidelines demonstrates why countries’ varied responses are causing such challenges for MNEs and tax administrators alike.
Historically, with some exceptions, countries generally have recognized the entity that contractually bears the risk related to the development of intangible property (IP) as the economic owner. Under the 2017 OECD guidelines, however, if a company is not active in overseeing the development of IP and does not exercise control over the associated risks or have the financial capacity to assume these risks, but merely provides financing for IP development, that company is entitled to a risk-free return only for its funding activities. Because some countries have legislatively recognized the OECD’s new guidance while others have not, two tax authorities—such as the U.S. and the U.K.—could recognize two different parties as the owner of the same IP. Given the importance of IP to many businesses today, this situation creates a significant amount of uncertainty for taxpayers.
The 2017 OECD guidelines also outline a safe-harbor method for pricing low value-adding intra-group services. Assuming the requirements outlined are met, certain services can be charged with a 5% markup on cost without requiring a formal benchmarking analysis. But unless the intra-group service provider and recipient both are located in countries that allow this safe harbor, many MNEs will face situations where one jurisdiction still requires benchmarking. This set of circumstances effectively cancels the benefit of having the safe harbor in the first place.
Master file requirements set out in Chapter V of the 2017 OECD guidelines offer another example of the complexities that arise when MNEs must separately monitor various local countries’ responses. Not all countries have implemented the OECD’s recommended documentation requirements, causing confusion among many MNEs—especially those whose parent entity, which is usually best equipped to prepare the master file, is located in a jurisdiction such as the U.S. that does not have this requirement. Moreover, certain countries, such as the Netherlands, have very low thresholds for master file requirements, which puts an additional compliance burden on many companies that otherwise would not need to prepare a master file at all.
Next steps: Where MNEs go from here
Many MNEs still need to recalibrate their transfer pricing in response to these changes and the complexities created by countries’ varying response to the BEPS Action Plan. In addition, all MNEs should stay on top of the evolving regulatory environments in countries where they operate, since the updated OECD guidelines will continue to fuel additional controversy and awareness in an area that is already top-of-mind for many tax authorities worldwide.
Because many countries see the OECD guidelines as supplemental guidance, some tax authorities might be tempted to employ a “pick-and-choose” approach. In other words, they might choose to rely on some of the 2017 guidance when it advances their position but ignore other aspects that conflict with their desired outcomes. This approach can create additional uncertainties regarding MNEs’ transfer pricing positions. Furthermore, since some countries formally incorporate the OECD guidelines into their transfer pricing legislation while others do not, in some instances two tax authorities could arrive at differing conclusions regarding the same issues.
To add to the complexity, the OECD currently is extending its efforts related to BEPS Action Item 1, Tax Challenges Arising from Digitalization. Based on the current proposals, this action will have a significant impact on international taxation rules, even for companies that do not operate what typically would be considered a digital business. This initiative is still underway, so it remains to be seen how individual countries might react or what changes, if any, will be incorporated into another version of the OECD guidelines.
Today—and for the foreseeable future—financial officers and tax managers in MNEs should be prepared for additional audit scrutiny and controversy regarding their transfer pricing practices. They also should continue to closely monitor individual countries’ regulatory developments, as well as future OECD actions that could add further complexity to the international tax environment.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Barry Freeman, Ph.D., is a principal in tax services at Crowe LLP, an accounting, consulting and technology firm with offices are the world. He has more than 25 years of transfer pricing and related economic experience and leads the firm’s national transfer pricing services group.+1 646 965 5697 firstname.lastname@example.org
John Lamszus, CPA, is a senior manager in tax services within the transfer pricing services group at Crowe LLP. He has more than 10 years of transfer pricing and corporate tax experience and assists clients with transfer pricing planning, compliance and audit defense. +1 312 605 3333 email@example.com