RBRT’s Comments on Public Discussion Draft on BEPS Action 10: Proposed Modifications to Chapter VII (Low-Value Adding Services)

By Robert Robillard - 15 January 2015

This blogpost originally appeared on rbrt.ca.

Comments on the Public Discussion Draft  BEPS Action 10:  Proposed Modifications to Chapter VII of the Transfer Pricing Guidelines Relating to Low Value-Adding Intra-Group Services

January 13, 2015

Mr. Andrew Hickman
Head of Transfer Pricing Unit
OECD, Centre for Tax Policy and Administration
By email: TransferPricing@oecd.org


We are pleased to comment on public discussion draft BEPS Action 10: Proposed Modifications to Chapter VII of the Transfer Pricing Guidelines Relating to Low Value-Adding Intra-Group Services through the consultation taking place from November 3, 2014 to January 14, 2015.

This document may be posted on the OECD website. Full credit goes to Robert Robillard, RBRT Transfer Pricing. [1]

1. General comments on new Chapter VII

1.1. Part D of new Chapter VII of the OECD Transfer Pricing Guidelines exacerbates a conceptual drift that is already palpable in the Guidance on Transfer Pricing Aspects of Intangibles released on September 16, 2014. [2]

1.2. The Guidance on Transfer Pricing Aspects of Intangibles suggests “that transfer pricing methods not directly based on comparables, including profit split methods and valuation techniques” may be used to establish the arm’s length price of a controlled transaction. [3]

1.3. This is, in other words, formulary apportionment for transfer pricing purposes.

1.4. We do not adhere to the alternate thesis that Part D of the draft is an application of the safe harbour principles suggested in Part E of Chapter IV of the OECD Transfer Pricing Guidelines (as it was amended on May 16, 2013). There are simply too many indirect references to formulary apportionment in the public discussion drafts released by the OECD lately.

2. Specific comments on new Chapter VII

2.1. Parts A, B and C of the draft do not differ significantly from the actual Chapter VII of the OECD Transfer Pricing Guidelines.

2.2. However, there is little doubt regarding the fact that Part D of the draft is indeed grounded in the formulary apportionment philosophy, as it would apply to alleged “low value-adding” intra-group services through the use of a one-sided transfer pricing method.

2.3. Surprisingly, paragraph 7.46 states that “[…] the guidance in this section is not applicable to services that would ordinarily qualify as low value-adding intra-group services where such services are rendered to unrelated customers of the members of the MNE group. In such cases it can be expected that reliable internal comparables exist and can be used for determining the arm’s length price for the intra-group services.”

2.4. This signals a troublesome first-step drift from the arm’s length principle toward formulary-like approaches.

2.5. These transactions, which would be considered with the arm’s length principle granted they are also provided to third parties, must now be considered otherwise when they are rendered in the absence of internal comparables.

2.6. The OECD is hence inferring that internal comparables are better than external comparables for comparability purposes. Language in Chapter III of the OECD Transfer Pricing Guidelines should be updated accordingly. [4]

2.7. To apply this purported elective approach, the MNE group must identify the low value-adding intra-group services. To that effect, paragraphs 7.47-7.50 of the draft take a second step toward the edge of the formulary apportionment cliff by suggesting a comprehensive definition of what may indeed qualify as “low value-adding intra-group services”.

2.8. Remarkably, no clear or direct relationship is made to the relevance of the comparability analysis as per Chapter I of the OECD Transfer Pricing Guidelines. [5]

2.9. The cosmetic references in paragraphs 7.8, 7.34 and 7.43 to “actual facts and circumstances” and “functional analysis” are insufficient to provide the much-needed clarity in light of the wide-ranging definition of low value-adding intra-group services in paragraphs 7.47-7.50 of the draft.

2.10. Paragraph 7.57 of the draft finally jumps head first into the formulary-like approaches precipice, stating:

“In determining the arm’s length charge for low value-adding intra-group services, the MNE provider of services shall apply a profit mark-up to all costs in the pool. The same mark-up shall be utilised for all low value-adding services irrespective of the categories of services. The mark-up selected by the taxpayer should be no less than 2% of the relevant cost and should be no greater than 5% of the relevant cost.”

2.11. The OECD then curiously adds in that same paragraph of the draft that:

“It should be noted that these intra-group services mark-ups should not, without further justification and analysis, be used as benchmarks for the determination of the arm’s length price for services not within the definition of low value-adding services, nor for similar services not within the elective, simplified scheme.” [emphasis added]

2.12. It is somewhat troubling to see that this formulary-like approach may therefore be used, with further justification and analysis, for services that are not within the definition of low value-adding intra-group services.

2.13. Moreover, other issues may arise. For example, which analysis may be performed and which justifications may be provided considering the stringent definition of “low value-adding intra-group services” in paragraph 7.48 of the draft? How could this formulary-like approach be used for such other types of intra-group services in the first place?

2.14. As for benchmarking, it is defined in the Merriam-Webster dictionary as follow: “a point of reference from which measurements may be made”. [6]

2.15. Part D of new chapter VII of the OECD Transfer Pricing Guidelines is undeniably all about benchmarking and formulary-like approaches as far as purported low value-adding intra-group services are concerned.

2.16. As a point of comparison, in the United States, the notion of “low margin covered services” is indeed found in §1.482-9(b)(3)(ii) of the transfer pricing regulations “for which the median comparable markup on total services costs is less than or equal to seven percent.” Benchmarking to be sure.

2.17. However, the US regulations explicitly refer back to the functional analysis in order to make the determination that a service is in fact a “low value-adding intra-group services” prior to benchmarking its value for transfer pricing purposes. [7]

2.18. Benchmarking on profit markup is also seen in the European transfer pricing approach to intra-group services; although there is no conclusive definition of what may be a “low value-adding” service. [8]

2.19. To this day, benchmarking is absent from the Canadian transfer pricing landscape. [9]

3. Conclusion

3.1. The benchmarking rules contained in Part D of new Chapter VII of the OECD Transfer Pricing Guidelines in regard to some categories of intra-group services will likely generate a new stream of double taxation cases.

3.2. The temptation by tax administrations all around the world to assign a “low value-adding” label to various intra-group services will likely become more and more common to circumvent the transfer pricing issues arising from these types of legitimate commercial transactions.

3.3. However, it has always been our understanding that the OECD member countries are against global formulary apportionment and formulary-like approaches to transfer pricing.

3.4. After all, paragraph 1.32 of the OECD Transfer Pricing Guidelines indicates that: “[…] the theoretical alternative to the arm’s length principle represented by global formulary apportionment should be rejected.”

3.5. Based on the draft of new Chapter VII, global formulary apportionment does not sound so “theoretical” anymore…

3.6. As it was said before: “Would you tell me, please, which way I ought to go from here?” To which it was wisely answered: “That depends a good deal on where you want to get to.” [10]

3.7. And here we are at the gates of global formulary apportionment for intra-group services….

Robert Robillard, CPA, CGA, MBA, M.Sc. Economics
Transfer Pricing Chief Economist, RBRT Transfer Pricing (RBRT Inc.)
Professor, Université du Québec à Montréal

January 13, 2015

[1] Robert Robillard, CPA, CGA, MBA, M.Sc. Economics, is the Transfer Pricing Chief Economist at RBRT Transfer Pricing (RBRT Inc.) and also Professor at Université du Québec à Montréal; 514-742-8086; robert.robillard@rbrt.ca. He is a former Competent Authority Economist and Audit Case Manager at the Canada Revenue Agency.

[2] OECD (2014), Guidance on Transfer Pricing Aspects of Intangibles, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing.

[3 ]Ibid., par. 6.57

[4] See paragraph 3.27-3.35.

[5] This may have been an oversight. Although based on the complete draft, this omission makes sense.

[6] See http://www.merriam-webster.com/dictionary/benchmark.

[7] See for example §1.482-9(b)(5) which indicates that “[…] in evaluating the reasonableness of the conclusion required by this paragraph (b)(5), consideration will be given to all the facts and circumstances.” More to the point, see §1.482-9(a) which refers directly to the comparability analysis found in §1.482-1(d).

[8] See European Commission, JTPF Report: Guidelines On Low Value Adding Intra-Group Services, Meeting of 4th February 2010, Brussels, par. 8 and 61-65.

[9] It is nowhere to be found in section 247 of the Canadian Income Tax Act or in Information Circular IC 87-2R International Transfer Pricing.

[10] Lewis Carroll, Alice in Wonderland; the Cheshire Cat in answer to Alice question… Previously quoted in Robillard, Robert, OECD Request for input (ref.: BEPS ACTION 11: Establish methodologies to collect and analyse data on BEPS and the actions to address it), September 17, 2014.

See in pdf format here

Robert Robillard, CPA, CGA, MBA, M.Sc. Econ.
Transfer Pricing Chief Economist, RBRT Inc.
514-742-8086; robert.robillard “at” rbrt.ca

RBRT Inc. is all about transfer pricing. We specialize in transfer pricing, tax treaties and other international tax matters. Our services include transfer pricing documentation (transfer pricing policies and procedures, BEPS and C-doc), transfer pricing dispute resolution, tax treaty matters including double tax relief, tax treaty-based returns and waivers, advanced pricing agreement (APA), value chain management and TP planning, transfer pricing training. The information in this blog post is general information only. Data and information come from sources believed to be reliable but complete accuracy cannot be guaranteed. RBRT Inc. and the author are not responsible or liable for any error, omission or inaccuracy in such information. Readers should seek tax advice and tax counsel from RBRT Inc. as required.