OECD – Transfer pricing and BEPS Action 10 discussion draft

ovember 10: The Organisation for Economic Co-operation and Development (OECD) last week published a discussion draft on Action 10 (Proposed Modifications to Chapter VII of the Transfer Pricing Guidelines Relating to Low Value-Adding Intra-Group Services) as an additional deliverable under the OECD’s base erosion and profit shifting (BEPS) action plan.

The BEPS action plan calls for the development of rules to prevent base erosion and profit shifting by taxpayers engaging in transactions that would not, or would only very rarely, occur between third parties—including base-erosion payments such as management fees and head office expenses.

BEPS Action 10 discussion draft

In the BEPS Action 10 discussion draft [PDF 837 KB], the OECD proposes removing current Chapter VII of the OECD Transfer Pricing Guidelines related to intra-group services and replacing it with the text in the discussion draft.

Principal proposed changes would be to add a definition of “low value-adding intra-group services” and to provide a “simplified method” for such services. These proposals are described below.

For the remainder of the Chapter VII of the OECD Transfer Pricing Guidelines for intra-group services, the OECD proposed some changes including:

Additional examples of shareholder activities

A note that “costs that would hypothetically be incurred by the recipient were it to perform the service for itself” may be relevant to determining arm’s length charges for intra-group services

A statement that for an entity that serves as an agent or intermediary for services provided by another party, it may be appropriate to apply a mark-up only to the costs of the agency services themselves

Revisions to an example on contract research and development activities, emphasizing the relevance of Section B.2 of the revised Chapter VI on transfer pricing of intangibles to the analysis of appropriate compensation

Defining “low value-adding intra-group services”

The BEPS Action 10 discussion draft defines “low value-adding intra-group services” as those that:

Are supportive in nature

Are not part of the core business of the multinational enterprise (MNE)

Do not require the use or creation of unique and valuable intangibles

Do not involve the assumption or creation of substantial or significant risk

The BEPS Action 10 discussion draft provides a list of services that would not qualify as low value-adding services eligible for the simplified approach. These include research and development (R&D), manufacturing, sales, marketing, and distribution, corporate senior management.

Examples of services that would likely meet the definition of low value-adding services include accounting and auditing, accounts receivable/payable, human resources, legal, certain information technology, among others.

Simplified method

The new “simplified method” for low value-adding intra-group services would be elective and, if so elected, would have to be applied on a consistent group-wide basis in all countries where the MNE operates.

The BEPS Action 10 discussion draft outlines a step-by-step process for application of the simplified method including: (1) determining the cost pool; (2) allocating low value-adding services costs; and (3) applying a profit markup.

Finally the BEPS Action 10 discussion draft outlines four documentation and reporting requirements that must be made available upon request from the tax administration.

Other notable items from the simplified method include:

A recommendation for a markup between 2% to 5% for intra-group services qualifying for low value-adding services

A presumption that the benefit test is met if the MNE satisfies the documentation and reporting requirements for low value-adding intra-group services

A single annual invoice describing a category of services as being sufficient as long as the documentation and reporting requirements are met

With regard to documentation, the BEPS Action 10 discussion draft states:

In evaluating the benefits test, tax administrations should consider benefits only by categories of services and not on a specific charge basis. Thus, the taxpayer need only demonstrate that assistance was provided with, for example, payroll processing, rather than being required to specify individual acts undertaken that give rise to the costs charged.

KPMG observation

Tax professionals have observed that the proposed simplified method for low value-adding intra-group services, if widely adopted, could significantly mitigate the compliance costs of some multinational taxpayers. As has been noted, some tax authorities currently request detailed documentation of services received in order to support a deduction. To the extent the proposed simplified method would reduce or eliminate such requests for low value-adding services, the costs of compliance in such instances could be reduced.

The BEPS Action 10 discussion draft also maintains a relatively narrow definition of shareholder and duplicative costs as under the existing OECD guidelines, but with additional language and examples illustrating their narrow application.

It has been further observed that the reference to “hypothetical costs of the recipient” could be used by tax authorities in low-cost jurisdictions to challenge the pricing of services provided by entities in high-cost jurisdiction. Also, the statement regarding “agency services” may serve to limit certain pricing methods, which result in high profits relative to costs when markups are applied to so-called “pass-through” costs.

Finally, the BEPS Action 10 discussion draft’s proposal relating to contract R&D would coordinate this proposal on intra-group services to the revised Chapter VI on intangibles.

What’s next?

The OECD is requesting comments on the BEPS Action 10 discussion draft to be submitted by 14 January 2015 with public consultation to be held 19-20 March 2015 at the OECD Conference Center in Paris, France.