The OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations were first implemented in 1995, with the intent to minimise conflicts between Multinational Enterprises (MNE) and Public Administrations in transactions involving Transfer Pricing (TP) around the world. More than 20 years later, in January of 2022, a new and updated version was published due to the rapid and unprecedented pace towards a digitalised economy and the fast-paced globalisation process. This latest version provides the revised version of the application of the profit method, the approach towards hard-to-value intangibles (HTVI) and considerations for financial transactions. Below you will find a summary of the OECD Transfer Pricing guidelines.
OECD Tranfer Pricing Guidelines Chapters
The guidelines provide a set of principles and methods that can be used to determine the arm’s length price of a transaction. Members of the OECD adopted the arm’s length principle in order to ensure the correct application of the separate entity approach to intra-group transactions. Even though they are not legally binding instruments, they have become the widely recognised international standard for transfer pricing.
The guidelines are divided into ten chapters, each covering a focal part of Transfer Pricing. The first chapter introduces the Arm’s Length Principle (ALP) and the application of this concept. The second chapter delves into the topic of transfer pricing methods. The selected method is crucial for determining the arm’s-length price for a specific case, and it should be evaluated based on its strengths, weaknesses, and suitability in the particular case, as well as the availability of reliable information and the level of comparability adjustments that may be required. They can be divided into two big groups: the traditional transaction methods and the transactional transaction methods.
Traditional Transaction Methods
- The Comparable Uncontrolled Price Method (CUP) compares the price charged between related parties to the price that would have been charged when the parties were unrelated under similar circumstances to ensure market conditions. It will be comparable whenever one of the following conditions is met: a) The price in the open market should not be significantly impacted by any differences between the transactions or between the enterprises involved in those transactions, or b) adjustments can eliminate the effects of the differences.
It is worth mentioning that this method is considered to be the most widely used method of transfer pricing and the most direct method of determining the arm’s-length price.
- Resale Price Method (RPM) is considered a “one-sided transfer pricing method”. The rationale is to determine a good’s price based on the Gross Margin that the distributor would make at an Arm’s length. In other words, the RPM is used when one party sells goods or services to a related party, who then resells them to an unrelated party; the price, however, will be determined by comparing the resale price to the costs (including additional costs or the risk incurred by the reselling party).
- Cost Plus Method (CPM) is frequently used to determine the transfer pricing between a MNE and a supplier of services or property. This method is particularly handy when the services provided are complex and difficult to value. In order to find the price that would be in line with the separate entity approach, all the costs incurred by the supplier (indirect and indirect costs) have to be identified and added up, and subsequently, add a markup to these costs, taking into account any additional costs or risk incurred by the provider of the services or property.
Transactional Profit Methods
These methods evaluate and consider the profits earned from controlled transactions between associated enterprises.
- Transactional Net Margin Method (TNMM) compares the net profit relative to an appropriate base of an uncontrolled to a controlled transaction; it is, however, unlikely to provide accurate results whenever the parties to the transactions make unique and valuable contributions.
- Transactional Profit Split Method (TPSM) identifies the profits (including losses) that will be split in controlled transactions and subsequently splits them between the associated enterprises based on an economically valid basis; in other words, the division of profits has to be by the arm’s length.
In the 2022 version, this method was revised, responding to Action 10 Base Erosion and Profit Shifting (BEPS) of the OECD. It maintains that TPSM should be applied when it is the most suitable method for a specific case. Moreover, it includes a more detailed explanation of when it is appropriate to use this method (Shared assumption of economically significant risks, separate assumption of closely related risks, unique and valuable contributions by each of the parties to the transaction and highly integrated business operations) and how to apply it. Lastly, MNE’s can diverge from the stipulated methods to find the arm’s length price as long as they are not less appropriate than the ones recognised by the OECD.
The third chapter covers the comparability analysis. The difference between the search for comparables and the comparability analysis must be borne in mind. The former is part of the latter, and it depends on the prior analysis of two things:
- The taxpayer’s-controlled transactions, and
- Characteristics which are economically relevant or comparability factors.
The comparability analysis, in practice, is a nine-step, not a linear process, which may be repeated multiple times until a satisfactory outcome is achieved. General guidance on comparability, nonetheless, can be found in section D of Chapter 1.
Chapter four deals with administrative approaches to avoiding and resolving transfer pricing disputes. The fifth chapter focuses on documentation. The sixth chapter deals with the special considerations for intangibles, one of the chapters that underwent a more substantial modification in this new edition. Annex II to Chapter VI integrates the Hard-to-Value-Intangibles (HTVI) considerations; initially, it was addressed in the BEPS Actions 8-10 report (incorporated into the 2017 guidelines).
It focuses on three main areas to address the asymmetric information available to taxpayers and the administrations in cases of the potential value of an HTVI when it is transferred.
- Certainty of the principles that underline the application of the HTVI approach;
- A variety of examples are provided to demonstrate the implementation of this approach;
- Details on how this approach interacts with the MAP.
Chapters seven, eight and nine deal with the special consideration for intra-group services, cost contribution arrangements (CCA), and transfer pricing aspects of business restructurings. The last chapter, chapter ten, can be considered the most significant addition to this 2022 edition. It provides guidance to determine whether the pricing of financial transactions (treasury functions, intra-group loans, cash pooling, hedging, guarantees, and captive insurance) are consistent with Chapter 1 and offers guidance on calculating a risk-free rate of return and a risk-adjusted rate of return.
- Vega, Alberto, International Governance Through Soft Law: The Case of the OECD Transfer Pricing Guidelines (July 4, 2012). Working Paper of the Max Planck Institute for Tax Law and Public Finance No. 2012-05, Available at SSRN: http://dx.doi.org/10.2139/ssrn.2100341
- Monsenego, J. (2015). Introduction to Transfer Pricing. Wolters Kluwer
- SETH, S. (2022, March 17). Transfer Pricing. Investopedia. Retrieved August 19, 2022, from https://www.investopedia.com/terms/t/transfer-pricing.asp
- OECD (2022) Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations
- der, V. R. van. (2018). Transfer pricing and business restructurings: A legal comparison between the Oecd Transfer Pricing Guidelines and the German Transfer Pricing Rules (thesis). Tilburg University. International Business Taxation, Available at http://arno.uvt.nl/show.cgi?fid=147120