RBRT Comments on Chapter I of the Transfer Pricing Guidelines (BEPS risk, recharacterisation and special measures)

By Robert Robillard - 19 February 2015

This blogpost originally appeared on rbrt.ca.

The OECD recently released the Public comments received on discussion draft on Actions 8, 9 and 10 : revisions to Chapter I of the Transfer Pricing Guidelines (Including risk, recharacterisation and special measures) of the BEPS Action Plan in two parts available here.

The opinions expressed in the document below are those of the author.
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Comments on the Public Discussion Draft  BEPS Actions 8, 9 and 10:  Discussion Draft on Revisions to Chapter I of the Transfer Pricing Guidelines (Including Risk, Recharacterisation, and Special Measures)

February 4, 2015

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

Sir,

We are pleased to provide detailed comments on the public discussion draft BEPS Actions 8, 9 and 10: Discussion Draft on Revisions to Chapter I of the Transfer Pricing Guidelines (Including Risk, Recharacterisation, and Special Measures) (the draft) through the consultation taking place from December 1, 2014 to February 6, 2015.

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

1. Overall design of part D

1.1. It may be relevant to start Part D with paragraph 10.

1.2. Part D.1 (Identifying the commercial or financial relations) is in fact about contractual terms. Should it not be labelled as D.1.1? There seems to be some confusion in the hierarchy of the titles and sub-titles.

1.3. For transfer pricing purposes, the analysis should start with the characterization of the product or service and then be followed by the functional analysis.

1.4. The whole draft gives the eerily feeling that contractual terms, in particular the risk profiles of the parties, should be front and center of the transfer pricing comparability analysis.

1.5. Methodologically speaking, this is incorrect from a commercial standpoint (the taxpayer) and from a compliance tax audit perspective (the tax administration).

1.6. Most transfer pricing cases start with a “transaction” which implies that functions have been performed by at least one of the parties, whether it is through the provision of a product or the rendering of a service (see paragraphs 46 and 48 of the draft for that matter).

1.7. The comparability analysis (new part D) should therefore be re-aligned on Part D of Chapter I of the OECD Guidelines (July 2010).

1.8. In general, the examples included in the text make it more cumbersome and unnecessarily 482-flavored. [2]

2. Unchanged paragraphs 102-103

2.1. It is a shame to see that not a single iota of guidance is proposed in this draft to finally align the transfer pricing and custom valuation public policies.

2.2. This international tax confusedness should have been taken care of a long time ago for the benefit of taxpayers and tax administrations alike all around the world.

3. New paragraph 2

3.1. On the one hand, new paragraph 2 introduces the notion of “the rest of the value chain” in the examination of the contractual terms of a specific controlled transaction.

3.2. Although it may seem relevant from a theoretical perspective, such an examination would necessitate access to qualitative information that will not be made available neither through the Master file nor the CbC reporting template.

3.3. That information will likely reside in the Local file which is not meant to be accessible to every tax administration according to Part E of the Guidance on Transfer Pricing Documentation and Country-by-Country Reporting released on September 16, 2014.

3.4. On the other hand, we fail to see the relevance of “the rest of the value chain” for the determination of an arm’s length price.

3.5. Parties dealing at arm’s length would not directly consider the dealings of their other clients or suppliers to establish the terms and conditions of their own dealings.

3.6. Parties dealing at arm’s length would not directly take into account their own dealings with other clients or other suppliers unless the typical principal-agent problem was disrupted (i.e., information asymmetry).

3.7. The introduction of the notion of “the rest of the value chain” is another OECD drift toward global formulary apportionment. [3]

4. New paragraphs 3-6

4.1. These two paragraphs provide additional guidance on the relationship between contractual terms and the actual conduct of the parties.

4.2. These changes and additions are welcome. They will greatly benefit tax administrations in which the audit process has lacked this fine understanding of the proper examination of the contractual terms and their impact on the arm’s length transfer pricing determination.

4.3. The specific examples could have nonetheless been omitted from the text. They make the text more cumbersome.

5. New paragraphs 7-8

5.1. Although they may seem to “flow” from the previous paragraphs, new paragraphs 7-8 read like the creation of controlled transactions “out of thin air” by tax administrations.

5.2. These paragraphs should be removed from the draft.

5.3. They corrupt the “commercial rationality test” of the OECD Guidelines as highlighted and reiterated in paragraphs 88-92 of the draft.

5.4. These paragraphs will create more disputes and litigations between taxpayers and tax administrations and among tax administrations.

6. New paragraphs 10-14

6.1. We suggest removing the notion of “economically relevant characteristics” from these paragraphs in relation to comparability factors.

6.2. The notion of “comparability factors” is more than enough for clarity purposes as they are thoroughly defined in the guidelines.

6.3. With the inclusion of “economically relevant characteristics” in the first sentence of paragraph 11, the last sentence is somewhat circular…

7. New paragraphs 17-18

7.1. The examples provided in theses paragraphs may in fact be “low value-adding intra-group services” based on the curious rational suggested in BEPS Action 10: Proposed Modifications To Chapter VII of The Transfer Pricing Guidelines Relating To Low Value-Adding Intra-Group Services. [4]

7.2. Assuming that the text must be burdened with all those examples, they may not be the best examples available.

8. New paragraph 21

8.1. See our above comments on new paragraph 2.

8.2. This is a clear drift toward global formulary apportionment.

9. New paragraph 38

9.1. This is incorrect. Risks are in fact easily identified.

9.2. It is the quantum related to risks that poses challenges in transfer pricing.

9.3. Quantum means the potential amount of monetary losses which may derive from the realization of various types of risks (see paragraphs 48-49 of the draft on that matter).

9.4. Quantum also means the amount of monetary gains that may ensue from the risk-taking activities (see paragraphs 48-49 of the draft on that matter).

10. A comment on the “risk-return trade-off curse”

10.1. We are of the opinion that this notion has strictly no relevance to the determination of an arm’s length price.

10.2. It is a bottom-line driven notion that has considerably contaminated the transfer pricing comparability analysis in the last 20 years.

10.3. There is a significant amount of risks and uncertainty in any economic endeavour. [5]

10.4. In spite of unfounded assertions to the contrary, the commercial dealings of corporate entities with specific risk profile can be totally reasonable from a legal, regulatory, accounting, economic or commercial perspective.

10.5. The variety of conceivable commercial dealings is made possible since corporate entities are creatures of the legal and commercial minds.

10.6. Paragraphs 41-42 of the draft provide to that effect a better framework to analyze risks in transfer pricing.

10.7. However, the analysis of functions should precede the analysis of risks (see paragraph 43 of the draft and the above comments on the overall design of Part D).

11. New paragraphs 57-59

11.1. New paragraph 57 suggests that “it should not be concluded that the pricing arrangements adopted in the contractual arrangements (see Section D.2.2) determine the respective contributions to risk management.”

11.2. This is simply incorrect in any arm’s length setting.

11.3. Pricing arrangement will indeed reflect the respective contributions to risk management, that is, indirectly.

11.4. This assertion degrades the “commercial rationality test” of the OECD Guidelines as highlighted and reiterated in paragraphs 88-92 of the draft.

11.5. Paragraphs 57-59 should be removed from the draft.

11.6. Otherwise, they will create more disputes and litigations between taxpayers and tax administrations and among tax administrations.

12. New paragraph 60

12.1. New paragraph 60 is incorrect when it states that “the parties’ assumption of risk does not in itself determine that they should be allocated the risk for transfer pricing purposes.”

12.2. This is called arbitrary “re-characterization” of the risk profile.

12.3. Paragraph 60 is also contaminated with the “risk-return trade-off curse” discussed above.

12.4. This paragraph should be removed from the draft.

12.5. It goes against the “commercial rationality test” of the OECD Guidelines as highlighted and reiterated in paragraphs 88-92 of the draft.

12.6. The following paragraphs linger on this unsubstantiated notion in an arm’s length environment.

12.7. These paragraphs will create an explosion of re-characterization cases which will end up in more tax disputes and tax litigations between taxpayers and tax administrations and among tax administrations.

13. New paragraphs 67-69

13.1. New paragraphs 67-69 seem to be misplaced. Perhaps they require a sub-title.

13.2. It should be pointed out that the discussion mixes the notion of alleged “low value-adding intra-group services” with other types of services (with respect to the risk level that they entail).

13.3. More clarity is hence required.

14. New paragraphs 70-71

14.1. New paragraph 70 suggests that risks may be transferred otherwise than at arm’s length. This is trivial.

14.2. The discussion is once more explicitly contaminated with the “risk-return trade-off curse”.

15. New paragraphs 73-78

15.1. It must be underlined that these paragraphs will not create the much-needed balance to prevent the likely abuses by tax administrations identified above.

16. Final comments on “special measures”

16.1. Options #1, #2, and #3 basically suggest indirect partial formulary apportionment mechanisms. [6]

16.2. Option #4 pertaining to “minimal functional entity” directly relates to global formulary apportionment. Option #4 is also about re-characterization.

16.3. Option #5 is (another) direct attack on the sovereignty of specific countries where the taxation mix is not mostly based on income tax.

16.4. In short, these options have every ingredient conducive to more tax disputes and litigations between taxpayers and tax administration and among tax administrations.

Robert Robillard, CPA, CGA, MBA, M.Sc. Economics
514-742-8086
robertrobillard@rbrt.ca

February 4, 2015

[1] Robert Robillard, CPA, CGA, MBA, M.Sc. Economics, is Senior Partner at RBRT Inc. He also teaches tax at Université du Québec à Montréal; 514-742-8086; robertrobillard@rbrt.ca. Robert is the former Transfer Pricing Chief Economist at RBRT Transfer Pricing (RBRT Inc.) and a former Competent Authority Economist and Audit Case Manager at the Canada Revenue Agency. The opinions expressed in this document are those of the author.

[2] Section 1.482 of the Code of Federal Regulations of the United States (transfer pricing) dwells a little too much at length in this “narrative-example cycle”. This does not always result in added clarity for taxpayers.

[3] For more drifts toward global formulary apportionment, see Robert Robillard, 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.

[4] OECD Public Discussion Draft, BEPS Action 10: Proposed Modifications To Chapter VII of The Transfer Pricing Guidelines Relating To Low Value-Adding Intra-Group Services, 3 November 2014 – 14 January 2015, see paragraphs 7.46 and 7.48. We have already provided comments on this draft.

[5] For an introductory point of view, see the classic: Armen A, Alchian (1951), “Uncertainty, Evolution and Economic Theory, The Journal of Political Economy, Vol. 58, No. 3, pp. 211-221.

[6] We do not adhere to the thesis that these “options” are applications of the safe harbour principles in Part E of Chapter IV of the OECD TP Guidelines (as it was amended on May 16, 2013). There are simply too many indirect references to formulary apportionment in the OECD public discussion drafts lately.

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Robert Robillard, Ph.D., CPA, CGA, Adm.A., MBA, M.Sc. Econ., M.A.P.
Senior Partner, RBRT Inc.
514-742-8086; robertrobillard “at” rbrt.ca
www.rbrt.ca

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