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- Herausgeber: NWB Verlag
- Kategorie: Fachliteratur
- Sprache: Deutsch
This book presents the complex area of transfer pricing in a clear and structured way by means of a case study. The case study involves cross-border transactions of a fictive company group. Every chapter includes specific aspects relating to the initial case. The authors base the case-solving on OECD Transfer Pricing Guidelines for Multinational Enterprises with multiple references made to German tax law. It is the aim of the book to introduce beginners in to the basics of transfer prices for tax purposes. In principle everything could be reduced to a globally unified standard: the arm‘s length principle. The book grants the reader an entertaining, practical and structured introduction into the world of transfer pricing giving the necessary orientation and at the same time raising awareness which can also be supportive for advanced practitioners. Table of Contents: 1. Introduction – the arm’s length principle 2. The first step: Value Chain Analysis 3. Transfer Pricing Methods 4. Comparability Analysis 5. Supply of materials 6. Intangibles 7. Services 8. Cost Sharing Arrangements 9. Cost Contribution Arrangements 10. Business restructuring/transfer of functions 11. Financial Transactions 12. Tax challenges arising from the digitalisation of the economy 13. Permanent Establishments 14. Obligation to cooperate – Transfer pricing documentation 15. Country-by-Country Reporting 16. Litigation, dispute avoidance and resolution
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Veröffentlichungsjahr: 2021
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ISBN: 978-3-482-02391-0
FOREWORD
The field of transfer pricing is perceived as extraordinarily complex and resembles a jungle of regulations worldwide in which only specialists know their way around, although in principle everything could be reduced to a globally unified standard: the arm’s length principle. According to this principle, cross-border business relationships between related parties or transactions between associated enterprises should be established as if they were conducted with a third party for tax purposes and thus for the allocation of taxation rights to different countries. Consequently, a market-conform action should be introduced into a multinational enterprise group, the economic unit of the group of companies should be partially ignored and the individual associated business units should be taxed on the basis of the separate entity approach. In order to ensure this, countries around the world have issued regulations. International standard setters such as the OECD or UN have drawn up extensive guidelines.
It was difficult for us to enter this world and we would have liked to have had a manageable and practical book to help us get started. In view of this background we want to offer an entertaining, practical and structured introduction to the transfer pricing world with this book, which provides a necessary orientation and guidance for both beginners and for those who have been working in this field for years.
This book is therefore addressed to all those who are (or want to be) interested in the topic, especially newcomers to the field of transfer pricing, students, especially in the field of law and economics, who are interested in the area of tax law or transfer pricing, students of law and economics, who are dedicated to tax law or tax theory, trainee tax consultants, consultants in the field of corporate taxation and transfer pricing, employees of tax authorities, employees in corporate tax departments and in controlling, public prosecutors and judges.
We have deliberately chosen to base our approach on a concept that focuses on practical case application. The case study developed for this purpose is intended to introduce the topic. It focuses on a fictitious multinational enterprise group and its cross-border transactions. In each chapter, specific aspects are addressed in a structured manner, all of which relate to the one initial case. The focus in this book is clearly on a practice-oriented approach and basically covers all common transfer pricing issues. As the „world” of transfer pricing seems endless, we like to point out, that there are many aspects of this topic and individual special issues which are subject to specialist literature. Also, please bear in mind that all circumstances and effects depend on the individual case given. However, after studying the book or individual chapters, you will be able to manoeuvre your way through the jungle of regulations, to basically classify and solve transfer pricing issues, to address the right questions and you will have developed risk awareness.
In a nutshell: the book serves as a helpful tool for practical work.
This English language version of the original publication concentrates on the application of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations and refers to the United Nations Practical Manual on Transfer Pricing for Developing Countries. The worldwide transfer pricing standards are defined here, allowing us to write a book that is generally applicable to all jurisdictions. At the same time, reference is repeatedly made to the design of the arm’s length principle in German tax law as a practical example.
Berlin, May 2021, Eva and Dr. Stefan Greil
EDITORS AND AUTHORS
Eva Greil is managing director of the Institute of Finance and Taxes (Berlin, Germany). Prior to this, she worked for several years in tax consulting for international groups in the area of transfer pricing and as (in-house) lawyer in political interest groups in the field of corporate taxation. She is also head of the Women of IFA Network (WIN) in the Berlin-Brandenburg region.
Dr. Stefan Greil works in the tax administration in the field of international corporate taxation and external tax law. He is also a university lecturer and speaker for international corporate taxation and external tax law, delegate of the OECD Working Party 6, member of the United Nations Subcommittee on Transfer Pricing, author of numerous publications and active in various (scientific) advisory boards. In 2019 he was listed in the Global Tax 50 published by the International Tax Review.
Katharina Becker is a lecturer for international tax law and corporate tax law in the tax administration. Previously, she also worked in the tax administration in the field of mutual agreement and arbitration proceedings as well as Advance Pricing Agreements, international administrative assistance and international tax policy. She gained experience abroad at the OECD Tax Secretariat in Paris (transfer pricing, project against harmful tax competition) and at the EU Commission (Common Consolidated Corporate Tax Base (CCCTB)). At the beginning of her professional career, Ms. Becker was a tax consultant in an internationally operating tax firm.
Kerstin Dürrbeck is a Senior Associate in Transfer Pricing at PricewaterhouseCoopers in Munich. Before joining PwC in January 2018, she wrote her master thesis on „Implementation of the new transfer pricing documentation rules in German and Austrian companies”. Kerstin Dürrbeck has focused on controlling, finance, accounting and tax law in both her bachelor’s and master’s degree in business administration.
Eleonore Kaluza works in the tax administration area of international corporate taxation and external tax law. She is also a guest lecturer for foreign tax law at the Federal Academy of Finance. Prior to this, she worked for several years in tax consulting for international corporations.
Felix Loose is Director Transfer Pricing in the area of International Tax and Transaction Services at EY in Eschborn. He advises internationally oriented clients on a wide range of transfer pricing issues. He has also gained experience in other tax-related topics at several industrial companies and is a regular speaker at EY and various working groups and associations.
Dr. Julian Maier works in the central tax department of Siemens in the Business Group Tax division, where he is primarily concerned with transfer pricing. Prior to this, he worked for several years at various Big Four companies in the field of transfer pricing consulting. He is also the author of various publications in the field of transfer pricing.
Professor Dr. Stephan Rasch is an attorney at law/specialist attorney for tax law and transfer pricing partner at PricewaterhouseCoopers in Munich, honorary professor and lecturer at the University of Augsburg as well as co-editor of the handbook Internationale Verrechnungspreise and the journal Internationale Steuer-Rundschau (ISR). Before joining PwC at the end of 2013, Professor Dr. Rasch worked for another Big Four Company as a Transfer Pricing Partner for 13 years (since 2008).
Dr. Sebastian Schulz studied at the University of Mannheim, he is a doctorate from the University of Hohenheim and employee of SAP’s global tax department with a focus on transfer pricing.
Professor Dr. Christian Schwarz is a professor for empirical economic research and development of business models at the University of Applied Sciences in Düsseldorf and actively represents the research field of quantitative methods in the area of transfer pricing in the scientific community. In addition, he is managing partner of QUANTUM StB GmbH. His transfer pricing research focuses on economic analysis, digital business models, intangible assets and benchmarking. He is the author of numerous publications and also lectures regularly on these topics.
Dr. Stefan Stein is managing partner at QUANTUM StB GmbH and partner at Stein & Partner PartG mbB. He deals with current issues concerning transfer prices and permanent establishments from the perspective of tax consulting and science. His activities focus on the planning, documentation and defense of transfer pricing structures as well as transfer pricing advice on intangible assets and permanent establishments. He is the author of numerous publications on transfer prices and the allocation of profits of permanent establishments and also lectures regularly on these topics.
Lars Wargowske works in the tax administration of the State of Brandenburg, specifically in the area of international corporate taxation and foreign tax law. He is also a lecturer at the University of Hamburg and works as a lecturer and speaker in the field of tax law. Furthermore, he is the author of tax law essays as well as co-author of corresponding commentaries and member of various scientific advisory boards.
The authors of this book merely express their personal opinion. The respective contributions therefore do not necessarily reflect the views of the respective employers.
1. Introduction – the arm’s length principle
1.1. Description of the facts
Zeitgaist multinational enterprise group. Zeitgaist AG has its headquarters and management in Frankfurt am Main (Germany). It has several subsidiaries and branches abroad and is the ultimate parent entity (UPE) of the multinational enterprise group (MNE group) „Zeitgaist”. The MNE group specializes in particular in the manufacturing and sale of watches. It also produces and sells accessories, such as bags and belts, to a small extent. With its products and 1,740 employees, it generates a consolidated turnover of approx. EUR 1 billion.
Product range. The product range of the MNE group includes watches from three different brands, each of which is aimed at a different customer target group.1)
Companies of the Zeitgaist group. The Zeitgaist group includes the following entities and permanent establishments (PEs):
Profit and loss statement, consolidated balance sheet and extract from the CbCR. The following profit and loss statement and consolidated balance sheet comprise all business units. The country-specific report contains only the entities and countries listed above.
1.2. Regulatory framework
Preface. A significant volume of global trade consists of international transfers of goods and services, capital (such as money) and intangibles (such as intellectual property) within a group of associated companies with business establishments in two or more countries – so called MNE group. Such transfers are called intragroup transactions. There is evidence that intragroup trade has been growing steadily since the mid-20th century and arguably accounts for a high portion of all international transactions.
An entity that is part of an MNE group is a multinational enterprise (MNE). MNE groups create organizational structures and develop strategies to arrange the cross-border production of goods and services in locations around the world and to determine the level of intra-entity or intra-group integration. The structure of transactions within an MNE group is determined by a combination of market and group driven forces which can differ from the open market conditions operating between independent parties. A large number of international transactions within MNEs are therefore not governed directly by market forces but driven by the common interest of the MNE group.
For tax purposes, an MNE group is granted no separate legal personality. The individual entities which are part of the MNE group are therefore taxed as if they were legally and economically independent. In general, each enterprise within the MNE group is a separate entity. Therefore, each individual group member is subject to tax on the income arising to it on a residence or a source basis, depending on whether the country uses a residence-based or a source-based (or both) system. The taxable profits determined by income and expenses of an MNE can be influenced by transfer prices. Transfer prices influence the income of both parties involved in the cross-border transaction. Thus, it becomes important to establish the appropriate price, called the „arm’s length price”, for intragroup transfers of goods, intangibles and services to allocate taxation rights properly between states.
Transfer pricing is the general term for the pricing of transactions between related parties. Transfer pricing therefore refers to the setting of prices for transactions between associated enterprises involving the transfer of physical goods, intangible assets or services. These transactions are also referred to as controlled transactions, as distinct from uncontrolled transactions between parties that are not associated with each other and can be assumed to operate independently (on an arm’s length basis) in setting terms for such transactions.
The conditions of the relations between associated enterprises may differ from those between independent enterprises which are usually determined by external market forces. It should be emphasised that, even if transfer pricing may be used for tax avoidance, it should not be automatically assumed that associated enterprises manipulate their profits in order to decrease their tax burden. Between associated enterprises difficulties can arise to determine a market price. The transfer price must be in accordance with the so-called arm’s length principle (ALP), which is generally understood as the taxpayers applying a constructed (or fictional) market on their non-market transactions. The ALP was established as an attempt to objectify transfer prices and to allocate taxation rights properly between states. The ALP is based on economic principles and ensures a level playing field between associated and unrelated enterprises. Although the ALP has been criticized, it remains (for the time being) the globally accepted standard in this regard.
Transfer prices which are not determined in an adequate manner affect tax liabilities and could lead to distortions. To correct distortions created by inadequate transfer prices, countries – in particular OECD member states – have agreed upon the adjustment of those transfer prices in accordance with the ALP.
1.2.1. Adjustment of income – domestic law (Germany)
In general, domestic issues are not considered in this book, instead we focus on the international aspects of transfer pricing. However, in the following we provide an example on how German tax authorities may adjust income. If no double tax treat y is concluded, the case at hand will be assessed regarding the cross-border transactions by national tax law only. As a consequence of the examination of the appropriateness of the transfer prices, taxable profit adjustments may follow. There are various rules in German tax law for this purpose, such as
The profit adjustment can lead to a back-tax demand, to interest to be paid on it in accordance with Sec. 233a Fiscal Code and, if applicable, to penalty surcharges (e. g. Sec. 162 para. 4 Fiscal Code).
1.2.1.1. Hidden profit distribution
Sec. 8 para. 3 Sentence 2 of the Corporation Tax Code stipulates that hidden profit distribution shall not reduce the income of a corporation. The regulation itself does not provide any further explanation.
Thus, definition and further requirements for the interpretation of a hidden profit distribution was defined by judgements of the Federal Tax Court: a hidden profit distribution consists of (i) a decrease of a corporation’s assets or a prevention of the increase of a corporation’s assets caused (ii) by the corporation-shareholder relationship which (iii) reduced the income of the corporation and (iv) was not based on a regular profit resolution under company law.
A hidden profit distribution also serves to adjust the allocation of the profit to the shareholder as well as to the company in cross-border situations and is intended to prevent a shift of the profit from the company to the shareholder. Whether a hidden profit distribution exists and, if so, to what extent, is to be assessed on the basis of an objective disproportion between performance and consideration.
1.2.1.2. Hidden capital contribution
Income can also be adjusted according to Sec. 4 para. 1 Income Tax Code in conjunction with Sec. 8 para. 1 and 3 of the Corporation Tax Code. Again, as for the definition of a hidden capital contribution, the regulation itself does not provide further explanation. Thus, definition and further requirements for the interpretation of a hidden capital contribution was defined by judgements: Where a shareholder or a related party of the shareholder makes a contribution to the corporation based on the shareholder relationship only, a hidden capital contribution can be assumed. If a hidden capital contribution takes place, the income of the parties involved are to be adjusted. It should be emphasized that the valuation of the contribution is based on the so-called partial value (Teilwert) according to Sec. 8 para. 1 Corporation Tax Code in conjunction with Sec. 6 para. 1 no. 5, para 6 sent. 2 Income Tax Code. According to judgements, the partial value is generally equal to the market value and means the value an asset purchaser would pay when buying the enterprise as a whole.
Only tangible assets or intangibles can be subject to a contribution, thus, the use of property or rendering services without remuneration for instance is not considered a contribution in this regard. Imbalances arise where the decreased income of the shareholder is not compensated and cannot be adjusted by the tax auditors by taking into account a hidden capital contribution.
1.2.1.3. Section 1 External Tax Relations Act
In addition to the aforementioned regulations, section 1 of the External Tax Relations Act (Außensteuergesetz – AStG) is a legal basis for adjusting domestic income (regarding cross-border intra-group transactions). Sec. 1 AStG stipulates that, „if a taxpayer’s income from international business relations with a related party is reduced as a result of the taxpayer agreeing on terms, particularly prices (transfer prices), that diverge from those which independent third parties would have agreed upon under the same or similar circumstances (arm’s length principle), the taxpayer’s income must, without prejudice to other provisions, be corrected in such a way that it reflects terms that would have been agreed between unrelated third parties.”
Sec. 1 AStG is the only regulation in German tax law that explicitly refers to the ALP. If an income adjustment based on Sec. 1 AStG leads to a higher taxation than the hidden profit distribution and the hidden capital contribution, sec. 1 AStG is to be applied in this respect. An adjustment of income based on sec. 1 AStG requires related parties. Thus, the definition of the relationship between legally separate persons is stipulated in sec. 1 para. 2 AStG. Persons are related if one of the following criteria is met, whereas „person” stands for individuals or entities likewise:
i.
ii.
iii.
Section 1 AStG applies to cross-border transactions between associated enterprises as well as to the income allocation between an enterprise and its foreign PE.
Several ordinances and Finance Ministry circulars provide detailed information about German legislation relating to transfer pricing issues. Translations of these documents can be found on the Website2) of the German Federal Ministry of Finance. It should be emphasised that only the original documents in German language are authoritative for the application of the tax law.
1.2.2. Double taxation agreement
The primary purpose of an Agreement for the Avoidance of Double Taxation and of Tax Evasion with respect to Taxes on Income and Capital (double taxation agreement – hereinafter DTA) generally is to avoid double taxation by allocating taxing rights between the treaty partner jurisdictions. DTAs also usually provide a mechanism (by way of credit or exemption) to address cases where taxpayers are subject to double taxation. If a cross-border transaction takes place between associated enterprises whose countries of residence have concluded a DTA between themselves, and the relevant DTA contains an article based on Article 9 of the OECD Model Tax Convention on Income and on Capital3) (hereinafter OECD-MTC) then the ALP must be considered for the allocation of taxation rights.
The Commentaries on the Articles of the Model Tax Convention (hereinafter OECD-Commentary) and the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereinafter TPG) are particularly relevant for interpreting the articles. DTAs, particularly with developing countries, are based on the United Nations Model Double Taxation Convention (hereinafter UN-Model). This also contains an article corresponding to Article 9 OECD-MTC. This means that the official United Nations Commentary and the United Nations Practical Manual on Transfer Pricing for Developing Countries (hereinafter TP-Manual) may have to be taken into account when interpreting articles, particularly in the case of more recent agreements with these countries. Since both model conventions basically follow the ALP, we refer primarily to the TPG.
Article 9 (1) of the OECD-Model forms the basis of the adjustment of profits of associated enterprises for tax purposes by applying the ALP as the underlying standard – dealing at arm’s length; the provision thus presupposes the allocation of the right of taxation under Article 7 OECD-Model.
By means of Article 9 OECD-MTC and the ALP as a legal fiction, taxation rights are therefore to be allocated according to a certain scale: profits should be taxed where they are generated economically. In the international context, the ALP is thus an expression of the territoriality principle and serves the principle of reason. It aims at an equitable allocation of taxation rights between states (inter-nation equity) and is intended to ensure that the same conditions of competition apply between independent and associated enterprises.
This is accompanied by the more secondary objective of avoiding economic double taxation. This is to be ensured in particular by the corresponding adjustment in Article 9 (2) OECD-MTC, provided that the other state shares the view of the state which made the primary adjustment in terms of the reason and amount; thus, the avoidance of double taxation is a combination of Article 9 (1) and (2) OECD-MTC.
At the same time, it follows from the objectives of avoiding double taxation, the fair allocation of taxing rights and the associated taxation at the place of economic activity that tax evasion or tax avoidance is undesirable. The prevention of tax avoidance is thus to be regarded merely as a reflex to the actual objective of regulating the allocation of taxation rights between the Contracting States and not as an independent objective in itself. Thus, the ALP is always to be applied in the same way, irrespective of any (low) tax rates, and is not aimed, among other things, at addressing arrangements which use preferential regimes or low-taxing states. As long as economic substance is available in these states (in the form of exercising functions, assuming risks and using assets), a corresponding share of the group’s profits is also allocated to these states.
The conditions for such an adjustment of profits are provided in Article 9 OECD-MTC and include the existence of associated enterprises in the Contracting States which are bound in their commercial or financial relations by agreed or imposed conditions which differ from those which independent enterprises would agree between themselves, whereby one of the two enterprises could have made higher profits without such agreements.
If a Contracting State makes an transfer pricing adjustment with regard to cross-border intra-group transactions (so-called primary adjustment), the function of Article 9 (1) OECD-MTC is to limit such adjustments to the level of profits which would have accrued under conditions made between independent parties.
The application of Article 9 (1) OECD-MTC requires a connection between the enterprises concerned:
i.
ii.
Article 9 (1) OECD-MTC distinguishes between the affiliation of two enterprises and the commercial or financial relations between them. It follows from this distinction that the shareholder relation that establishes or changes the relationship between the two enterprises must be excluded from the commercial and financial relationships. This does, however, not mean that the relations based on the shareholder relationship are excluded from Article 9 OECD-MTC. Shareholder relations may certainly qualify as financial relations unless they serve to establish or change the relationship between the two enterprises.
Commercial or financial relations between the associated enterprises are to be bound by made or imposed conditions. The requirement of commercial or financial relations is to be understood on the basis of the interconnectedness of two enterprises. Commercial or financial relations are not a constituent element of the relationship between the two enterprises. The terms commercial and financial relations are not defined in Article 9 OECD-MTC. Therefore, they cannot be clearly defined and distinguished from each other. The broad terms were intended to cover all possible constellations.
Participation in management, control and/or capital alone does not justify a profit adjustment. In addition, made or imposed conditions that do not comply with the ALP and therefore have an impact on the profits of the two enterprises must occur. Consequently, the participation must give the opportunity to have an impact on these conditions. The term conditions again, is subject to a broad interpretation. By way of example the TPG refer to „the price of goods transferred or services provided and the conditions of the transfer or provision” (see para. 1.2 TPG) and „including prices, but not only prices” (see para. 1.7 TPG). These conditions do not have to be agreed in writing, they can also be agreed orally and can be reflected in the behaviour of the parties involved. The conditions are normally negotiated by the associated companies. In this context, the assumption of conditions agreed does not prevent one of the two associated enterprises from exercising its dominant influence when the agreement is concluded. In the utmost cases, this can result in conditions being imposed by the dominant party. However, the conditions must be within the companies’ sphere of influence. If the conditions are external circumstances which cannot be influenced by the parties involved, then they are not accessible to the ALP (see also section 1.3). These include effects due to membership of the group, such as group support (implicit support), or circumstances which the law links to MNE groups (for example, the subordinated debt service of loans).
The ALP follows the approach of treating each MNE group member as if they were independent entities (separate entity approach). Hence, attention is focused on the nature of the transaction between the MNE group members and on whether the conditions differ from conditions which would have obtained between independent enterprises in comparable transactions and comparable circumstances, so-called comparable uncontrolled transactions. Given this, the analysis of controlled and uncontrolled transactions – the so-called comparability analysis which is further explained in Chapter 4 of this book – is „at the heart of the application of the ALP” (para. 1.6 TPG).
Any conditions that deviate from the ALP and are agreed or imposed between the associated companies must result in a reduction in profit for one entity. The term reduction in profit refers to the profit shown in the accounts of one of the two associated companies.
As for any other provision of the OECD-MTC, Article 9 is based on the principle that the provision does not oblige the Contracting States to adjust profits. An adjustment is allowed according to the relevant domestic law. Thus, the existence of relevant domestic regulations is a necessary condition for making the profit adjustment. If the domestic law of the Contracting States provide for the possibility of an adjustment, it is likely to be based on the ALP. In this respect, Article 9 (1) basically also defines the scope of the ALP. Article 9 (1) OECD-MTC however, does not provide a method of the profit adjustment, this is subject to the domestic law of the relevant Contracting State.
Article 9 (1) OECD-MTC is designed in such a way that a profit adjustment must first be made at the entity whose profit was reduced in deviation from the ALP. The term profit also includes losses which, contrary to the ALP, are shown too high. The relevant profit is always to be determined in accordance with the domestic law of the Contracting States. The amount of the reduction in the differential amount that has occurred and thus the amount of the profit adjustment to be made is also determined by domestic law.
Whereas Article 9 (1) OECD MTC forms the primary adjustment, Article 9 (2) OECD-MTC provides the basis for the so-called corresponding adjustment. The aim of Article 9 (2) OECD-MTC is to compensate the adjustment of income made by one Contracting State by an appropriate corresponding adjustment of income by the other Contracting State in order to avoid economic double taxation. This mechanism is intended to ensure that income should be taxed as if the controlled transaction had been undertaken at arm’s length conditions in the first place (para. 4.32 TPG). A corresponding adjustment is only made by a state to the extent that it shares the opinion of the state making the primary adjustment in terms of both reason and amount. However, the corresponding adjustment is not mandatory (OECD-Commentary, Article 9 para. 6.).
In order to make the actual profit allocation consistent with the primary adjustment, some countries assert a so-called constructive transaction under their domestic law. The constructive transaction will take the form of constructive dividends, constructive private equity contributions (or repatriations) or constructive loans (para. 4.68 et seq. TPG; see also EU-JTPF, https://ec.europa.eu/taxation_customs/sites/taxation/files/docs/body/jtpf_015add_2010_en.pdf).
1.2.3 UN Model
DTAs with developing and emerging economies are based primarily on the UN-Model, in which an article corresponding to Article 9 OECD-MTC has also been included as a basis for profit adjustments. The ALP is thus the generally accepted guiding principle in establishing an appropriate transfer price under Article 9 of the UN Model.
The UN Model contains provisions (Article 9 (3)) which stipulate that a Contracting State is not required to make the corresponding adjustment referred to in Article 9 (2) where judicial, administrative or other legal proceedings have resulted in a final ruling that, by the actions giving rise to an adjustment of profits under Article 9(1), one of the enterprises concerned is liable to a penalty with respect to fraud, or to gross or willful default.
1.2.4 OECD Transfer Pricing Guidelines
Neither Article 9 (1) OECD-MTC nor the UN-Model contains a concrete definition of the ALP. It would be almost impossible for an MNE group to make an accurate allocation of profits to each entity in the group without incurring economic double taxation if each state had established different profit allocation rules or a different understanding of the ALP.
Accordingly, the OECD, for example, has been endeavouring for years to ensure a uniform interpretation of the ALP. In 1979, the OECD issued a report Transfer Pricing and Multinational Enterprises, which contained methods that were acceptable for determining transfer prices. This report was influenced by the United States of America, the first country which prepared precise regulations for certain types of intra-group transactions in 1968. It was also the United States which had a great influence in the discussion in the OECD (and maybe still has). The 1979 report was included in a recommendation of the OECD Council of Ministers to the Governments of the Member Countries but was not legally binding. In the following years, the report was continuously amended and updated. In the current version as of 2017, the TPG contain nine chapters. In 2020, another chapter has been released, thus a total of ten chapters now provide guidance an intend primarily to „govern the resolution of transfer pricing cases in mutual agreement proceedings between OECD member countries and, where appropriate, arbitration proceedings” (Preface, para 17 TPG). The TPG comprises more than approximately 700 pages, including appendix, which attempt to determine the application of the ALP. They are intended to help both taxpayers and tax administrations to find satisfactory solutions to transfer pricing issues.
In particular, Chapter I of the TPG discusses the ALP as the basic standard for the determination of transfer prices. In this context, transfer pricing methods have been developed to take account of the application of the ALP. However, difficulties can arise while applying the ALP to intra-group transactions. Thus, „transfer pricing is not an exact science” (para. 1.13 TPG) and the one transfer price does not exist.
The UN-Manual can also be of importance in cases involving developing countries. This UN-Manual is intended in particular to take into account the needs of developing countries when applying the ALP. The application should be consistent with the OECD Transfer Pricing Guidelines. However, Brazil, China, Mexico, India and South Africa present their views on their interpretation of the ALP4), which show differences in the application of this principle compared to the application of the OECD countries.
The TPG are designed in particular to determine the decisions of the competent authorities in (advance) mutual agreement and arbitration procedures between OECD member states. Thus, the TPG are perhaps the most relevant document for the interpretation of an article of the OECD-MTC. In general, they are – at least from a German point of view – not directly legally binding for both the taxpayer and the tax administration. The TPG were approved by the Committee on Fiscal Affairs on 27 June 1995 and are the object of the recommendation of the OECD Council C(95)126/Final dated 13 July 1995. The recommendation is based on Art 5(b) of the Convention on the OECD.
Since 1992, Article 9 (1) OECD Commentary refers to the TPG and stating: „That report represents internationally agreed principles and provides guidelines for the application of the arm’s length principle of which the Article is the authoritative statement.” It can be concluded that, although the TPG are not legally binding to follow their guidance when interpreting a DTA is recommended. However, several countries refer to the TPG in their domestic legislation. In order to ensure to what extent a country follows the rules of the TPG one has to check the relevant domestic legislation.5)
1.3. Economic Principles
Transfer pricing is a term that is also used in economics, so it is useful to see how economists define it. In business economics a transfer price is considered to be the amount that is charged by a part or segment of an organization for a product, asset or service that it supplies to another part or segment of the same organization. This definition is therefore consistent with the approach described above. The economic aspects result from or follow the functions of the ALP. If corporate profits are to be taxed where they are economically generated or where value is generated, and if it is to be ensured that the same competitive conditions apply between associated and unassociated companies, then economic considerations determine the respective profit that is to be allocated to the companies and taxed accordingly. Since there may be different views on this, the TPG and the UN-Manual, for example, should set out principles to find a solution in the international context that also allows double taxation to be avoided.
The ALP requires a comparison of the terms and conditions between related parties to the terms and conditions between unrelated parties in a comparable situation and an analysis of the effect on the profit. For example, Article 9 (1) OECD-MTC refers to conditions agreed or imposed between associated enterprises which differ from those which independent enterprises would agree for their commercial or financial relations. It is therefore a question of the conditions which are within the control of the associated enterprises and which can be agreed accordingly or imposed by one party. The external circumstances which cannot be influenced are therefore not the subject of the ALP. They are to be assumed as given and their effects are to be considered when conducting the ALP. The consequence of this is a kind of limited ALP and not a fiction of completely independent enterprises. The latter would also be contrary to the principle of ensuring a level playing field, as completely incomparable facts would be compared fictitiously.
According to this provision, it cannot be ignored when conducting the ALP that the associated enterprises belong to an MNE group and for this reason alone other circumstances, such as increased transparency of information or legal regulations that only apply to MNE groups, must be considered.
However, it is questionable whether the ALP should be based on comparable market transactions (market approach or concrete arm’s length comparison) or whether hypothetical considerations (intended economic target behaviour) should be made based on internal data. At the very least, a comparison based on commercial or financial relations is required. Accordingly, the actual facts of the case must be determined, which must then be compared or economically assessed. If market data exists, this could provide a verifiable and objective measure of value.
Apparently, the US in 1968 and the OECD in its 1979 report had assumed that reliable comparable data could be found in sufficient numbers. Even today, market data and the so-called comparability analysis (Chapter III of the TPG) are still considered to be extremely important against the arm’s length background. According to this analysis, a comparison of an intra-group transaction (controlled transaction) with an external transaction or transactions (uncontrolled transaction) is to be made. However, the question of the comparability of the data arises. The TPG state in this respect that intra-group transactions are comparable with transactions with third parties if none of the differences between the transactions can materially affect the factor examined by the method (e. g. price or margin) or if sufficiently precise adjustments can be made to eliminate the material effects of these differences (see TPG glossary regarding comparability analysis).
In practice, in order to verify the arm’s length nature of transfer prices, it is sometimes necessary to compare the key return figures of comparable independent entities with the key return figures of the entity concerned – so called tested party. In order to determine these return ratios of independent entities, publicly accessible databases are used and so-called benchmark analyses are prepared. However, these allow for a large and sometimes arbitrary range of comparables. In addition, the quantitative assessment and pricing of the association to the MNE group causes difficulties – especially the recognition and the impact of synergies, network effects and information symmetries -, as these cannot be determined by market data. Hence, in practice no adjustment calculations are made in this respect. Also, the value-chain process of the MNE group is ignored when considering individual transactions or the key return figures in isolation. However, this is a basic prerequisite for taxing corporate profits where they are generated economically or where the value is generated. An unreflected comparison of facts which are not comparable per se (associated versus independent enterprises) therefore lacks the functions of the ALP and also leads to misallocations and tax planning potential.
By the same token, economic reason and the use of commercially reasonable techniques recognized by the expert community should not be ignored in order to demonstrate the proper application of the ALP. If the associated enterprises are associated with each other within the meaning of Article 9 (1) OECD-MTC, the expression would agree proves that the ALP to be applied is based on a hypothetical model. Independence is assumed to exist, which in fact does not exist. However, this does not go so far as to ignore the fact that the associated enterprises belong to an MNE group. Only the conflict of interests has to be considered between the associated enterprises.
A strictly transaction-based analysis and an isolated consideration of the individual transactions from an economic point of view is hardly possible. Nor does the wording of Article 9 (1) OECD-MTC provide for a focus on the transaction in question; rather, the focus is on the profit of an associated enterprise, even if the TPG repeatedly stipulates a transaction-oriented approach.
It is therefore necessary to identify and assess the situation within the MNE group. As a result, one has to familiarize oneself with the MNE group and its value chain, value network or value shop and a complete value chain analysis has to be carried out. In this way, the external circumstances that cannot be influenced are properly included in the arm’s length analysis. Only then it is possible to assess how third parties would have assessed the facts and whether there is a misallocation of profits.
A step in this direction is being taken within the TPG with the transactional profit split method (TPSM), especially in the form of contribution analysis. Under this method, the total profit from intra-group transactions is divided between the associated enterprises on the basis of the relative value of the functions performed by the individual enterprises involved in the transactions (taking into account the assets used and the risks assumed). This method is based primarily on internal data, and within this method, so-called valuation techniques such as capitalized earnings value or discounted cash flow methods can also be applied. Certainly, such an economically sound approach is provided with subjective latitude and may therefore arouse scepticism among the parties involved and seem to complicate the application of ALP. However, the recourse to market data (in the form of arm’s length transactions) is neither legally mandatory nor less subjective. However, this approach is the prevailing opinion and is at least the standard in the TPG.
Nevertheless, it is of crucial importance to have fully identified and assessed the facts and circumstances and to assess them from an economically sound point of view. Only then a lasting and convincing line of argumentation can be established in the context of an audit.
1.4. Further readings
Calderòn: The OECD Transfer Pricing Guidelines as a Source of Tax Law: Is Globalization Reaching the Tax Law? Interax: Volume 35, Issue 1.
Ernst & Young: Worldwide Transfer Pricing Reference Guide, 2019-20.
European Court of Justice (ECJ), 21 January 2010, C-311/08 (SGI), ECLI:EU:C:2010:26.
ECJ 31 May 2018, C-382/16 (Hornbach), ECLI:EU:C:2018:366.
Ismer/Ruß: What Is International Double Taxation? Intertax, Vol. 48 (2020), 555.
Keuschnigg & Devereux: The arm’s length principle and distortions to multinational firm organization, Journal of International Economics, Vol. 89, 432.
Lang/Petruzzi: Transfer Pricing Developments Around the World 2020, Kluwer Law International, 2020.
Langbein & Fuss: The OECD/G20-BEPS-Project and the Value Creation Paradigm: Economic Reality Disemboguing into the Interpretation of the ‘Arm’s Length’ Standard, The International Lawyer, Volume 51, 2018, 259.
Li: Global Profit Split: An Evolutionary Approach to International Income Allocation, Canadian Tax Journal, Vol. 50, No. 3, 2002, 823.
Monsenego: Introduction to Transfer Pricing, Kluwer Law International, 2015.
Navarro: The Arm’s Length Standard and Tax Justice: Reflections on the Present and the Future of Transfer Pricing, World Tax Journal 2018, 351.
OECD: Transfer Pricing and Multinational Enterprises (OECD Report 1979).
Phelps: Guide to International Transfer Pricing: Law, Tax Planning and Compliance Strategies, Kluwer Law International, 8th Ed., 2018.
Raimondos-Möller & Scharf: Transfer pricing rules and competing governments, Oxford Economic Papers, Volume 54, Issue 2, 2002, 230.
Reimer/Rust: Klaus Vogel on Double Taxation Conventions, 4th Ed., Kluwer Law International, 2015.
Samuelson: The Multinational Firms with Arm’s Length Transfer Price Limits. Journal of International Economics, Vol. 13, 365.
Schreiber & Fell: International Profit Allocation, Intangibles, and Sales-Based Transactional Profit Split, World Tax Journal 9, 1.
Teixeira, Tax Treaty Consequences of Secondary Transfer Pricing Adjustments, Intertax, Vol. 37 (2009), 449.
Wittendorff: The Transactional Ghost of Article 9(1) of the OECD Model, Bulletin for International Taxation 63 (3), 107.
2. The first step: Value Chain Analysis (Christian Schwarz and Stefan Stein)
2.1. Value Chain Analysis
Basic Problem. A good and substantiated understanding of value creation in an MNE group is the initial starting point for transfer pricing analysis. This principle is internationally recognized and formulated in Section 1.51 of the TPG as follows:
„In particular, it is important to understand how value is generated by the group as a whole, the interdependencies of the functions performed by the associated enterprises with the rest of the group, and the contribution that the associated enterprises make to that value creation.”
