The OECD recently released the comments received on its latest discussion draft on transactional profit splits in the context of the Base Erosion and Profit Shifting initiative (BEPS).
These comments along with the comments received on the latest discussion draft on the attribution of profits to permanent establishments are available here.
RBRT Fiscalité/Tax suggested specific changes to the wording included in the discussion draft on transactional profit splits in the context of the Base Erosion and Profit Shifting initiative (BEPS).
These suggestions are reproduced below.
Comments on the Public Discussion Draft
BEPS Action 10: Revised Guidance on Profit Splits
August 21st, 2017
Tax Treaties, Transfer Pricing and Financial Transactions Division
By email: TransferPricing@oecd.org
We are pleased to provide comments on public discussion draft BEPS Action 10: Revised Guidance on Profit Splits (the draft) through the consultation taking place from June 22, 2017 to September 15, 2017.
This document may be posted on the OECD website. Full credit goes to Robert Robillard, RBRT Inc. 
1. Profit Split Methods Remain Methods of Last Resort
On one hand, paragraphs 7 and 19 of the draft suggest that the “transactional profit split methods” offer a “solution for highly integrated operations”. This assumption is also found in earlier drafts on the profit split methods released in 2014 and 2016. Likewise, this idea is found in previous editions of the guidelines released in 2010 and 1995/1997. Paragraphs 20 and 21 of the draft, as well as Example 6 provide occurrences that may allegedly justify the use of profit split methods according to the OECD.
This guidance remains to this day at best debatable and at worst incorrect in light of the typical franchise business model. Franchisor and franchisees do not “split profits”. More broadly, profit split methods are rarely, if ever, encountered in arm’s length commercial dealings. The guidance included in paragraphs 7 and 19-21 of the draft as well as Example 6 should be revised accordingly.
On the other hand, another option is available to the OECD editors or writers. As it was indicated in the 1995 edition of the guidelines, profit split methods are oftentimes considered as methods of “last resort” in transfer pricing. This specific overarching guidance is missing from the draft with respect to profit split methods. Paragraph 1 of the draft should therefore be improved as follows (suggested additions are in bold characters):
“1. The transactional profit split method seeks to establish arm’s length outcomes or test reported outcomes for controlled transactions by determining the division of profits that independent enterprises would have expected to realise from engaging in a comparable transaction or transactions. Enterprises rarely, if ever, use a transactional profit split method to establish their prices. It should always be considered as a method of last resort. The method first identifies the profits to be split from the controlled transactions—the relevant profits—and then splits them between the associated enterprises on an economically valid basis that approximates the division of profits that would have been agreed at arm’s length. As is the case with all transfer pricing methods, the aim is to ensure that profits of the associated enterprises are aligned with the value of their contributions.”
2. “Unique and Valuable Contributions”
Paragraphs 6, 13 and 16-18 of the draft put forward that profit split methods are more than welcome in cases where each party brings “unique and valuable contributions” to the controlled transaction. There is little doubt based on previous BEPS guidance that “unique and valuable contributions” is meant here to be defined in terms of “contributions to intangible property”.
However, this “guidance” basically goes against what typical arm’s length parties would do in their business dealings. Case in point, every Subway franchisees, McDonald franchisees, Starbuck franchisees, etc., provide “unique and valuable contributions” on top of the marketing campaign, business processes, etc., provided by the franchisor. Each franchisee brings its expertise into the fold. It is usually a prerequisite to actually becoming a franchisee. This know‑how is a central component for the success of the franchisee. It is indeed “intangible property” in the broadest sense of the concept.
However, none of these business arrangements between franchisors and franchisees ever lead to a “split of the profits”. This guidance should therefore be removed from the draft.
Another option available to the OECD editors or writers would be to clearly state the intent behind that construed guidance on profit split methods where it is deemed that every party has “unique and valuable contributions”. In short, profit split methods where each party brings “unique and valuable contributions” to the controlled transaction serve as a mechanism to allocate taxable profits between tax authorities without having to resort to global formulary apportionment. As such, paragraph 6 of the draft should therefore be improved as follows to bring it into line with the arm’s length principle (suggested additions are in bold characters and suggested subtractions have been struck off):
“6. Although it is a method of last resort, the main strength of the transactional profit split method is that it can offer a solution to tax authorities for cases where both parties every party to a transaction is deemed to make unique and valuable contributions (e.g. contribute unique and valuable intangibles) to the transaction. In such a case independent parties might effectively share the profits of the transaction in proportion to their respective contributions, making a two-sided method more appropriate. Furthermore, since those contributions are deemed “unique” and “valuable” by tax authorities there will likely be no reliable comparables information which that could be used to price the entirety of the transaction in a more reliable way, through the application of another method. In such cases, the allocation of profits under the transactional profit split method by tax authorities may be based on the contributions made by the associated enterprises, by reference to the relative values of their respective functions, assets and risks, as well as available external market data. See section C.2.2 below on the nature of the transaction.”
3. “External Market Data”
The relevance of “external market data” in profit split methods is erroneously underlined throughout the draft. Paragraph 14 of the draft suggests that a “lack of information on closely comparable, uncontrolled transactions […] should not per se lead to a conclusion that the transactional profit split is the most appropriate method.” Paragraph 28 of the draft indicates that “if information on reliable comparable uncontrolled transactions is available to price the transaction in its entirety, it is less likely that the transactional profit split method will be the most appropriate method.” This is inaccurate.
The suitability of the profit split method should not be grounded in the availability or lack thereof of “external market data”. Any transfer pricing method starts with the “comparability analysis”, which is at the “heart of the application of the arm’s length principle.” In other words, proper application of the arm’s length principle requires external market data. Without external market data, a profit split method shows no distinctive feature in comparison to global formulary apportionment.
Paragraph 14, 28 and 101-102 should be revised accordingly by the OECD editors or writers to match with the guidance included in paragraph 35 of the draft with the following minor improvements (suggested additions are in bold characters and suggested subtractions have been struck off):
“35. Under a contribution analysis, the relevant profits, which are the total profits from the controlled transactions under examination, are divided between the associated enterprises in order to arrive at a reasonable approximation of the division that independent enterprises would have achieved from engaging in comparable transactions. This division must can be supported by comparables data, where available whether in the comparability analysis or through the implementation of the profit split method. In the absence thereof, It should not be solely based on the relative value of the contributions by each of the associated enterprises participating in the controlled transactions, determined using information internal to the MNE group (see section C.5.2). In cases where the relative value of the contributions can be measured directly, it may not be necessary to estimate the actual market value of each party’s contributions.”
4. The “Contribution Analysis”
Although profit split methods are transfer pricing methods of last resort, they may indeed be some rare occurrences where they should and must be used to determine the respective arm’s length profit margin of each party involved in the controlled transaction. The guidelines have a long-standing tradition regarding the role of the “contribution analysis” to determine each party right to a share of the profits, which dates back to the 1995/1997 edition of the guidelines.
The absence of any reference to the value chain analysis in the draft is nonetheless regrettable, especially in light of the excellent 2013 OECD study on the matter. The value chain analysis is one of the most important features that allow for the arm’s length application of the profit split method in comparison to global formulary apportionment.
Paragraphs 24-27 of the 2016 draft on profit split methods should be included in the guidance after paragraph 33 in the draft (i.e., they would be numbered paragraphs 34-37). These four paragraphs should be included with the following improvements (suggested additions are in bold characters and suggested subtractions have been struck off):
“24.34. A value chain analysis, undertaken as part of the broad-based analysis of the taxpayer’s circumstances (see 1.34), may be useful in helping to identify when theis required to use the transactional profit split method. may be appropriate. Such an analysis may also assist in determining how the method, if indeed it is the most appropriate method, should be applied, including the profits to be split and the relevant splitting factors. It should be emphasised however, that such a value chain analysis is merely a tool to assist in delineating the controlled transactions, in particular in respect of the functional analysis, and thereby determining the most appropriate transfer pricing methodology.
- 35. All business operations can be expressed through a value chain and many MNE groups operate through a global value chain. This alone does not imply that the transactional profit split should be applied. If that were the case, then a profit split would apply in almost every case and risk producing results contrary to the arm’s length principle. Instead, the purpose of the value chain analysis is to identify the features of the commercial or financial relations between the parties described in the paragraphs below which are indicators that the transactional profit split method may be the most appropriate method for a particular case under the guidance in paragraph 2.2. For a transactional profit split of actual profits those features include a sharing in the outcomes of the business activities and associated risks involving highly integrated operations or unique and valuable contributions by the parties.
- 36. A value chain analysis should consider where and how value is created in the business operations, including in particular: (i) consideration of the economically significant functions, assets and risks, which party or parties perform the functions, contribute the assets and assume the risks, as well as whether and how the functions, assets, and risks of the parties may be interdependent or otherwise interlinked; and (ii) how the economic circumstances may create opportunities to capture profits in excess of what the market would otherwise allow, such as those associated with unique intangibles, first mover advantages, or other unique contributions. The starting point of the value chain analysis will generally be the written contracts between the related parties. In considering where and how value is created, the analysis should also consider whether such value-creation is sustainable, for instance, whether market advantages are protected due to barriers to entry to potential competitors or the impact of valuable intangibles. The analysis thus both contributes to the process of accurately delineating the transaction, and also determines the level of integration (which may determine the level at which profits or revenues should be split), and the economically relevant contributions (which may determine the factors to use to split the profits). It is important to note, however, that the value chain analysis is simply a tool to assist in accurately delineating the transaction. Moreover, it does not, of itself, indicate that the transactional profit split is the most appropriate method, even where the value chain analysis shows that there are factors which contribute to the creation of value in multiple places, since all parties to a transaction can be expected to make some contributions to value creation.
- 37. A value chain analysis might usefully provide information about the following aspects of the business activity, relevant to determining whether the transactional profit split is the most appropriate method:
- The key value drivers in relation to the transaction, including how the associated enterprises differentiate themselves from others in the market;
- The nature of the contributions of assets, functions, and risks by the associated enterprises to the key value drivers, including consideration of which contributions are unique and valuable;
- Which parties can protect and retain value through performance of important functions relating to the development, enhancement, maintenance, protection and exploitation of intangibles;
- Which parties assume economically significant risks or perform control functions relating to the economically significant risks associated with value creation;
- How parties operate in combination in the value chain, and share functions and assets in parallel integration as described in paragraph 21 [of the draft which refers to highly integrated operations].”
5. Contractual terms and contractual arrangements
Paragraph 12 and 17 of the draft basically indicate that the “accurate delineation of the transaction” must take into account “the commercial and financial relations between the associated enterprises, including an analysis of what each party to the transaction does, and the context in which the controlled transactions take place.”
Contractual terms are only alluded to in paragraph 46 of the draft as a “reminder”. It is finally acknowledged in paragraph 46 that the “starting point in the delineation of any transaction will generally be the written contracts” for the purpose of the profit split method.
This is incorrect from an arm’s length transfer pricing standpoint. Contractual terms and contractual arrangements are both essential components in the actual delineation of the “commercial and financial relations between the associated enterprises”. Paragraph 12 of the draft should therefore be improved as follows (suggested additions are in bold characters):
“12. The accurate delineation of the actual transaction will be important in determining whether a transactional profit split is potentially applicable. The starting point in the delineation of any transaction will generally be the written contracts, which may reflect the intention of the parties at the time the contract was concluded. See paragraph 1.42. In addition, this process should have regard to the commercial and financial relations between the associated enterprises, including an analysis of what each party to the transaction does, and the context in which the controlled transactions take place. That is, the accurate delineation of a transaction requires a two-sided analysis (or a multi-sided analysis of the contributions of more than two associated enterprises, where necessary) irrespective of which transfer pricing method is ultimately found to be the most appropriate. (See paragraphs 1.33-1.35)”
We are available to discuss these suggested changes at your convenience.
Robert Robillard, Ph.D., CPA, CGA, Adm.A., MBA, M.Sc. Economics., M.A.P.
Senior Partner, RBRT Fiscalité / Tax (RBRT Inc.)
Université du Québec à Montréal
August 21st, 2017
 Robert Robillard, Ph.D., CPA, CGA, Adm.A., MBA, M.Sc. Economics, M.A.P., is Senior Partner at RBRT Fiscalité / Tax (RBRT Inc.) in Canada and blogger on transferpricinghub.com. He teaches at Université du Québec à Montréal; 514‑742-8086; email@example.com. Robert is a former Competent Authority Official and Audit Case Manager at the Canada Revenue Agency.
 OECD (2014), Public Discussion Draft. BEPS Action 10: Discussion Draft on the Use of Profit Splits in the Context of Global Value Chains, public consultations from December 16, 2014 to February 6, 2015, see par. 5‑8 and par. 22-25.
 OECD (2016), Public Discussion Draft. BEPS Actions 8-10. Revised Guidance on Profit Splits, public consultations from July 4, 2016 to September 5, 2016, see par. 21 and par. 24-27.
 See par. 2.115 of the 2010 edition of the guidelines, which is a partial duplicate of par. 3.5 of the 1995/1997 edition of the guidelines.
 This wording comes from par. 3.2 of the 1995/1997 edition of the guidelines.
 See par. 1.6 of the 2017 edition of the guidelines.
 See par. 3.6-3.8.
 OECD (2013), Interconnected Economies. Benefiting from Global Value Chain.
 OECD (2016), op. cit.
The complete library on BEPS and Transfer Pricing is available here.
Robert Robillard, Ph.D., CPA, CGA, Adm.A., MBA, M.Sc. Econ., M.A.P.
Senior Partner, RBRT Fiscalité / Tax (RBRT inc.)
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