In October 2015, the OECD released the final draft text of all points in the Action Plan on Base Erosion and Profit Shifting (BEPS). Following a series of discussions, the OECD approved Actions 8, 9 and 10 and several amendments to Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, which come into force when they are published on the OECD’s website, hence today.
The adopted amendments cover two areas and apply the arm’s length principle to intangibles. The revised text of Chapter VI, devoted to intangible property, changes the definition, aims to distinguish between actual and legal owners and, among other things, provides for additional factors that should be compared in a comparability analysis of intangibles. The Guidelines also include 33 illustrative examples to be used to better understand the issue.
Economies of scale at the group level
Amendments related to application of the arm’s length principle include a separate section devoted to synergies at the group level. The Guidelines emphasise the importance in an analysis of judging whether the synergies result from a group’s deliberate action or from passive association by enterprises in the group. If synergies result from deliberate action by any member of the group, then it is necessary to determine how much of an advantage there is, the benefits for group members and then how they should be distributed among individual members.
Example: A classic example of a synergy is economies of scale in centralised purchasing. If such purchasing is accomplished within a group and one of the members, for example a regional manager, negotiates quantitative bonuses with independent contractors and consequently individual branches order goods from these independent contractors at discounted prices, it can be stated that the group is taking deliberate action and producing a positive synergy for the group that should be taken into account, even though the goods do not pass directly through an enterprise. Subsequently, the synergy created would be distributed among individual members in the volume of purchases.
However, when a contractor provides favourable conditions to a member of a group with the intention of attracting other members in the group, no synergy is created because there has been no deliberate action in terms of the group.
Intangible assets
The revised Chapter VI of the Guidelines defines “intangible” as something which is not a physical asset or a financial asset, which is capable of being owned or controlled for use in commercial activities and whose use or transfer, would be compensated had it occurred in a translation between independent parties in comparable circumstances. It is important to stress that its classification in terms of transfer pricing can vary from its accounting classification. This means, for example, that in the case of development, expenditures associated therewith are charged to costs even though they are recognised in the balance sheet as an intangible asset. Nevertheless, these assets can create economic value for an enterprise and therefore should be valued as an intangible asset in terms of transfer pricing.
In an analysis, it is always necessary to distinguish the actual owner from the legal owner, which is determined by a contract or registration of certain rights. There needs to be assurance that the legal owner earning overall profits from an intangible asset also bears all the risks and performs all the functions that contribute to maintaining, improving and protecting it. However, this does not mean activities cannot be outsourced either to an independent enterprise or a related party.
Among other things, the Guidelines define additional factors that should be compared in the case of intangible property and are included in the comparability analysis. Exclusivity, scope and duration of legal protection, geographical area, useful life, stage of development, right to improve the product and expected future benefits of the intangible asset are arranged here.
