Transfer Pricing Handbook Guidance for the OECD Regulations

PART I: BASIC TRANSFER PRICING STANDARDS 1

Chapter 1: Introduction 3

• Control 4
• Tax Havens 5
• Complexities 5

Chapter 2: Arm’s Length Principle 7

• General Explanation of the Arm’s Length Principle 8
• Formal Statement as to the Arm’s Length Principle 10
• Comparability Considerations 11
• Rationale behind the Arm’s Length Principle 11
• Compensation Issues 12
• Applying the Arm’s Length Principle to Contribution Analysis 13
• Oligopolistic Conditions 14
• Transactions That Independent Enterprises Would Not Undertake 15
• Administrative Burdens of the Arm’s Length Principle 15
• Maintaining the Arm’s Length Principle as the International Consensus 16
• Rejection of Alternative Transfer Pricing Approaches 17
• Notes 18

Chapter 3: Arm’s Length Range 19

• Single-Figure Approach to the Arm’s Length Range 19
• Reliability Requirement 20
• Comparability Considerations 20
• Consequences of Applying More Than One Transfer Pricing Method 21
• Selecting the ‘‘Most Appropriate Point’’ in the Range 22
• Extreme Results: Comparability Considerations 23
• Notes 24

Chapter 4: Safe Harbor Simplification 27

• Safe Harbor Burdens and Benefits 28
• Defining ‘‘Safe Harbor’’ 29
• Scope of the Safe Harbor Provisions 30
• How Arbitrary Are the Safe Harbor Provisions? 31
• Factors Supporting the Use of Safe Harbors 31
• Problems That Safe Harbors Present 33
• Multiple Jurisdictions 39
• Possibility of Opening Avenues for Tax Planning 40
• Statistical Data and a Safe Harbor Example 40
• Undertaxation 41
• Safe Harbor Principles 41
• Equity and Uniformity Issues 41
• Recommendations as to the Use of Safe Harbors 42
• Safe Harbors as Surrender of the Tax Administration’s Discretionary Power 43
• Flexible Practices 43
• Country-Specific Practices 44
• Comprehensive Example 44
• Notes 45

Chapter 5: Modifying Safe Harbor Simplification 47

• The Study 47
• Eleven Specific Transfer Pricing Measures 48
• Notes 55

Chapter 6: Global Formulary Apportionment 57

• Profit Split Methodologies 58
• Global Dealing 58
• Attack on Global Formulary Apportionment 58
• Impact of the Arm’s Length Principle 59
• Comparing Global Formulary Apportionment with the Arm’s Length Principle 60
• Double Taxation 60
• Lack of a Common Accounting System 61
• Factor Selection 62
• Transitional Issues 62
• Economic Issues 62
• Impact of Exchange Rate Movements 63
• Compliance Costs and Data Requirements 63
• Valuation Difficulties 64
• Separate Entity Approach versus Global Formulary Apportionment 64
• Bilateral Tax Treaties 65
• Members of the Multinational Group Excluded from Global Formulary Apportionment 65
• OECD’s Rejection of Non–Arm’s Length Methods 66
• Safe Harbors 66
• Notes 67

PART II: TRANSFER PRICING METHODOLOGIES 69

Chapter 7: Transactional Profit Split Measures 71

• Transactional Profit Split Method Concepts 72
• Strengths and Weaknesses of the Transactional Profit Split Method 73
• Availability of Comparables in Applying the Transactional Profit Split Method 74
• Importance of Functional Analysis in Applying Transactional Profit Split Methods 74
• Transactional Profit Split Method Weaknesses 75
• Applying Transactional Profit Split Methods 76
• Guidelines Profit Splitting Approaches 77
• Determining the Combined Profits to Be Split 79
• Actual Profits versus Projected Profits 80
• Different Profit Measures When Applying the Transactional Profit Split 81
• How to Split the Combined Profits 82
• Reliance on Comparable Uncontrolled Transactions Data 83
• Allocation Keys 83
• Reliance on Internal Data 86
• Conclusions as to Transactional Profit Split Methods 88
• Notes 89

Chapter 8: Profit Split Illustrations 91

• Three Basic Assumptions 91
• Three Residual Profit Split Alternatives 92
• Commentary 96
• Notes 97

Chapter 9: Residual Profit Split Examples 99

• Presumptions and Preconditions 99
• Essential Factual Pattern Conflict 100
• Functional Activities 100
• Selecting Transfer Pricing Approaches 101
• Applying the Residual Profit Split Approach 101
• Drafters’ Disclaimer 104
• Contribution Approach 104
• Notes 105

Chapter 10: Transactional Net Margin Method 107

• Initial TNMM Considerations 107
• How the Transactional Net Margin Method Works 108
• TNMM Reliability 109
• Strengths of the TNMM 110
• Weaknesses of the TNMM 111
• Applying the Comparability Standard to the TNMM 112
• Database Issues: The Audio Player Example 114
• Impact on the Arm’s Length Range 114
• Selecting the TNMM 115
• Selecting the Net Profit Indicator 115
• Exclusion and Measurability 120
• Cases in Which Net Profits Are Weighted to Sales 120
• Cases in Which Net Profits Are Weighted to Costs 121
• Cases in Which Net Profits Are Weighted to Assets 123
• Berry Ratios 124
• Other Guidance 126
• TNMM Examples 126
• How the OECD Views the TNMM 128
• Notes 128

Chapter 11: Selecting Profit Indicators 133

• Illustration 1 134
• Illustration 2 136
• Illustration 3 138
• Notes 139

Chapter 12: Selecting Transfer Pricing Methods 141

• When Can a Business Apply a Multisided Transfer Pricing Method? 142
• When Should a Business Not Apply a Multisided Transfer Pricing Method? 144

PART III: COMPARABILITY ANALYSIS 147

Chapter 13: How Comparability Analysis Works 149

• Determining When Transactions Are Comparable 149
• Factors and Comparability 152
• Functional Analysis 155
• Economic Circumstances 161
• Business Strategies 162
• Return on Investment 164
• Recognizing the Actual Transactions Undertaken 165
• Associated Enterprises and Independent Enterprises: In Contrast 167
• Alternatively Structured Transactions 167
• Losses 168
• Multinational Enterprises 168
• Implementing Business Strategies 169
• Impact of Governmental Policies 170
• Notes 173

Chapter 14: Comparability Techniques 177

• General Comparability Guidance 177
• Typical Comparability Processes 179
• Broad-Based Analysis of the Taxpayer’s Circumstances 181
• Controlled Transaction and Choice of a Tested Party 181
• Comparable Uncontrolled Transactions 188
• Selecting or Rejecting Potential Comparables 193
• Additive Approach 193
• Comparability Adjustments 196
• Arm’s Length Range 199
• Notes 202

Chapter 15: Timing and Comparability 205

• Timing of Origin 206
• Timing of Collection 206
• Valuation That Is Highly Uncertain 207
• Data from Years Following the Year of the Transaction 208
• Multiple-Year Data 208
• Compliance Tools 210
• Notes 210

PART IV: ADMINISTRATIVE APPROACHES 213

Chapter 16: Transfer Pricing Audits 215

• Transactional Profit Split Method 216
• Simultaneous Tax Examinations and Transfer Pricing 216
• Tax Arrangements 217
• Potential Levels of Cooperation between Tax Administrations 218
• Examples 220
• Notes 224

Chapter 17: Monitoring the Guidelines 227

• Understanding the Monitoring Process 228
• Method Selection 228
• Specific Monitoring Processes 229
• Working Party No. 6 Peer Reviews 229
• Three Peer Review Levels 230
• Peer Review Selection Criteria 231
• Difficult Case Paradigms 231
• Biennial Members of Tax Examiners 232
• Business Community Involvement 233
• Business Industry Advisory Committee 233
• Business’s Role in Contributing to the OECD 235
• Peer Reviews and the Business Community 235
• Business Community’s Updates on Legislation and Practice 236
• Role of the U.S. Council for International Business 236
• Notes 237

PART V: ADVANCED OECD ANALYSIS 239

Chapter 18: Documentation Requirements 241

• Introductory Issues and Burden of Proof 241
• Guidance on Documentation Rules and Procedures 242
• Useful Information for Determining Transfer Pricing 244
• Summary of Recommendations on Documentation 245
• Notes 245

Chapter 19: Intangible Property 247

• Basic OECD Intangible Property Provisions 247
• Future Intangible Property Developments 248
• Arm’s Length Intangible Property Issues 249
• OECD Intangible Property Developments 249
• Soft Intangibles 250
• Highly Uncertain Valuation Issues 250
• Steps That an Independent Enterprise Might Undertake to Resolve Uncertainty 251
• Tax Administrator’s Response 253
• Timing Considerations 254
• OECD Highly Uncertain Valuation Examples 254
• What the OECD Should Do Now 259
• Notes 260

Chapter 20: Service Arrangements 263

• Overview 263
• Scope of Intragroup Arrangements 264
• Shareholder Activities and Stewardship Activities 267
• Adjusting to the Form of the Arm’s Length Consideration 270
• ‘‘On Call’’ Services 270
• Evaluating ‘‘On Call’’ Services 271
• Determining an Arm’s Length Charge for the Intragroup Service 272
• Including Service Costs in the Transfer of Goods 275
• Double-Taxation Risks 276
• Examining the Actual Use of the Services 276
• Calculating the Arm’s Length Consideration 276
• Applying Transfer Pricing Methods 277
• Functional Analysis 278
• Business Strategies: Profits for the Service Provider 278
• Applying the Cost-Plus Method for Intragroup Services 279
• Cost-Benefit Issues and Safe Harbor 280
• Intragroup Service Examples 281
• Specialized Services 283
• Multinational Service Enterprises 283
• Specialized Service Industries 284
• Applying the Transactional Profit Split Method to Services 284
• Notes 285

Chapter 21: Cost Contribution Arrangements 289

• Overview 289
• Cost Contribution Arrangement Criteria 291
• Mandatory CCA Arm’s Length Requirements 296
• Applying an Applicable Allocation Key 300
• Tax Treatment of Contributions and Balancing Payments 302
• Entry, Withdrawal, and Termination of a Cost Contribution
• Arrangement 306
• Recommendations for Monitoring and Structuring
• Cost Contribution Arrangements 309
• Documentation 310
• Notes 312

Chapter 22: Business Restructuring 315

• Special Risk Considerations 316
• Compensation for Undertaking the Restructuring 318
• Postrestructuring Remuneration 321
• Recognition of the Actual Transactions Undertaken 323
• Notes 325

PART VI: PUTTING THE GUIDELINES TO WORK 327

Chapter 23: Malaysia-Singapore Allocation Keys 329

• Importance of Allocation Keys 329
• When the Transactional Profit Split Method Is the
• ‘‘Most Applicable’’ Transfer Pricing Method 330
• Specialized Services 331
• Applying the Transactional Profit Split Method 332
• Four Allocation Key Categories 333
• Key Functions 333
• Selecting Potential Allocation Keys 334
• Selecting among Allocation Keys 336
• ‘‘Strong Correlation’’ Standard 337
• Allocation Keys 337
• Transfer Pricing Strategies 342
• Notes 343

Chapter 24: China-Taiwan Trade 345

• Taiwan and China: A History Lesson 345
• Tax Considerations 348
• Transactional Profit Split Method Criteria 352
• APA Process 355
• Notes 356

Chapter 25: Reverse Engineering the Transfer Pricing Process 357

• Transactional Profit Split 358
• Simultaneous Tax Examinations and Transfer Pricing 358
• Tax Arrangements 359
• How the Reverse Engineering Transfer Pricing Process Works 367
• Functional Analysis Considerations 369
• Transactional Profit Split Method 370
• Success Parameters to the Reverse Engineering Process 370
• Synergistic Activities 371
• Undertaking Multijurisdictional Production Processes 372
• Engaging in Extensive R&D Activities 373
• Dealing in Unique Intangibles 374
• Participating in a Cost Contribution Arrangement 374
• Creating or Providing Specialized Services 375
• Distributions of Generic Goods or Standardized Goods 376
• Contract Manufacturers and Contract Service Activities 377
• Planning 377
• International LP Gas Companies Face Multinational Tax Claims 377
• Multinational Service Enterprises 379
• Notes 380

PART VII: CONNECTING TRANSFER PRICING AND PERMANENT ESTABLISHMENT 383

Chapter 26: Permanent Establishment Parameters 385

• OECD’s Permanent Establishment Provisions 386
• Overall Tax Considerations 388
• OECD Approach to Determine Permanent Establishment 389
• Hong Kong Applies the OECD Permanent Establishment Provisions 389
• Common Law Permanent Establishment Criteria 391
• Declining Businesses 394
• ‘‘Preparatory to’’ and ‘‘Auxiliary from’’ Exemptions 395
• Will the OECD Approach Prevail? 395
• Notes 396

Chapter 27: Focus on Permanent Establishment 397

• Background Considerations 398
• Twenty-five Proposed Changes 398
• Notes 413

About the Authors 415

Index 417