Recommendations to OECD on intangibles transfer pricing.

• Position: Organisation for Economic Co-operation and Development

September 14, 2010

On September 14, 2010, TEI submitted the following recommendations to the Organisation for Economic Co-operation and Development on a consultation relating to the Transfer Pricing Aspects of Intangibles. TEI's comments were prepared under the aegis of its European Direct Tax Committee whose chair is Anna M. L. Theeuwes of Shell International Exploration and Development B.V. Contributing substantially to the development of TEI's comments were Alain Berlier of Givaudan Flavors Corporation; Johann H. Muller of AP Moller-Maersk; and Peter H. Taylor of Dupont du Nemours International, S.A. Also contributing to the submission were Vincent Alicandri of Hydro Networks, Inc.; Dorothy C. Chao of Baxter International, Inc.; Nick Hasenoehrl of Haemonetics Corporation; Robert B. Huey; Alexander Kolbl of General Dynamics Corporation; Jocelyn P. Krabbenschmidt of Amazon.com, Inc.; Janice L. Lucchesi of Akzo-Nobel, Inc.; Paul Magrath of AstraZeneca Canada Inc.; Paul V. Morton of Reed Elsevier Group, PLC; Karina O of TELUS Corporation; and Alice A. Smith of Eaton Corporation. Jeffery P. Rasmussen, legal staff liaison to TEI's European Direct Tax Committee, coordinated the preparation of the Institute's comments.

On 2 July 2010, the Committee on Fiscal Affairs (CFA) of the Organisation for Economic Co-operation and Development (OECD) announced that Working Party No. 6 is considering a new consultation project on the Transfer Pricing Aspects of Intangibles. The project will review, among other issues, whether Chapters VI and VIII of the Transfer Pricing Guidelines (TPG), which set forth the primary OECD guidance on transfer pricing for intangibles, should be revised.' According to the announcement, Working Party No. 6 is currently "at the stage of scoping" its new project. On behalf of Tax Executives Institute, I am pleased to respond to the OECD's request for comments on the scope of its project.

TEI Background

Tax Executives Institute was founded in 1944 to serve the professional needs of business tax professionals. Today, the organisation has 54 chapters in North America, Europe, and Asia. As the preeminent international association of business tax professionals, TEI has a significant interest in promoting tax policy, as well as the fair and efficient administration of the tax laws, at all levels of government. Our 7,000 members represent 3,000 of the largest companies in the United States, Canada, Europe, and Asia.

Project Background and Objectives

The OECD's guidance on the transfer pricing treatment of intangibles was updated in March 1996 with the release of Chapter VI of the TPG and in March 1997 with the release of Chapter VIII on cost contribution arrangements. Even with that guidance, disputes between taxpayers and tax administrators about transfer pricing for intangibles have increased in frequency, amount, and scope. In addition, during the OECD's review of the comparability and profit methods of the TPG (2) as well as its consultation on business restructuring, (3) the challenges associated with the definition, identification, and valuation of intangibles for transfer pricing purposes were noted by tax administrators and taxpayers alike. As a result, Working Party No. 6 has initiated this consultation in order to solicit stakeholder input and identify:

* The most significant issues encountered in practice in respect of the transfer pricing aspects of intangibles;

* Shortfalls, if any, in the OECD's current guidance;

* Areas ripe for further work; and

* The format of the output from the consultation.

In addition, subsequent to the adoption of the OECD's current guidelines, the domestic transfer pricing rules of Member States have evolved with some issuing new or revised rules affecting the treatment of intangibles. For example, the United States revised its temporary cost-sharing regulations on 31 December 2008. (4) In addition, Germany has adopted legislation that can tax unrealised or potential gains or future profits relating to assets and activities transferred outside of Germany when a business function is transferred. Such domestic rules supplement, overlap, and occasionally conflict with the OECD's guidance, thereby creating an increased risk of double taxation. Thus, this consultation might consider whether or how changes in Member State domestic rules can or should affect the TPG or other OECD guidance, such as the model treaty's rules for resolution of double tax cases among associated enterprises or the allocation of profits to a permanent establishment (PE). Finally, business practices have evolved since the guidelines were issued and the rules may need to be updated to address those new or changed practices.

A public consultation with invited commenters is scheduled for 9 November 2010.

Reaffirm Fundamental Principles of the Current Guidelines

TEI commends the OECD for seeking public input on the scope of its project. For most multinational enterprises (MNEs), intangibles--whether of the "hard" trade intangible variety (as the term is used in Chapter VI of the TPG) or softer "marketing intangible" variety--are a significant component of the value of the business's products or services.

Regrettably, the amorphous and often unique nature of intangible property makes it challenging for taxpayers and tax administrators to identify comparables in order to properly value the contribution of the intangible property separately from the contributions from tangible property, capital, labour, or service components of a business. Despite the challenges, the consistent application of the arm's length principle, which underlies current international norms, helps ensure that (i) the taxable profits reported by MNEs in the countries where they operate reflect the economic activity undertaken there and (ii) taxpayers can avoid the risk of double taxation that may result from a dispute between two countries about the level of remuneration for cross-border transactions. This is because the arm's length principle provides the closest approximation of the open market where goods and services are transferred between associated enterprises. As such, the arm's length method achieves the goal of correlating taxation with economic activity with less risk of double taxation. It also better reflects the economic realities of a controlled taxpayer's particular facts and circumstances. Hence, we recommend that the consultation affirm the OECD's commitment to the arm's length principle as a fundamental basis of transactions between affiliated enterprises. The OECD should resist the calls urging the use of formulary apportionment for determining the remuneration on non-arm's length transactions (whether sales, licenses, or business restructurings) involving intangibles.

In addition, MNEs are organised in myriad entities and forms. Some companies have centralised their most valuable and legally protected intangibles (patents, formulae, trademarks, etc.) in one or a few entities in a global supply chain restructuring whereas others have intangibles dispersed throughout the group. The current TPG, including new Chapter IX on Business Restructuring, acknowledges that taxpayers are entitled to structure (or restructure) their business operations and transactions as they see fit:

Tax administrations do not have the right to dictate to an MNE how to design its structure or where to locate its business operations. MNE groups cannot be forced to have or maintain any particular level of business presence in a country. They are free to act in their own best commercial and economic interests .... In making this decision, tax considerations may be a factor. (5) TEI recommends that this fundamental principle--that businesses are free to organise their business structures and transactions through contractual allocations of risk--also be affirmed in the consultation. Each taxpayer is in the best position to determine which transfer pricing method produces the most reliable results when applied to its unique facts and intangibles. Unless the taxpayer's results fall outside an arm's length range, tax administrators should not be permitted to adjust the taxpayer's results or method.

In applying the arm's length principle, i.e., determining the conditions and prices that independent enterprises would have established for a transaction, it is critical to focus on the conditions that exist at the outset of the transaction. Thus, tax administrators should look solely to the information available to the taxpayer at the time of a transaction and determine whether the taxpayer acted reasonably based on that information. In addition, independent arm's length enterprises generally set prices based on expected or projected costs, volume, profitability, etc. In very rare cases, independent enterprises may agree to renegotiate or reset prices but, if so, only where strictly negotiated conditions that are determined at the outset of an agreement are satisfied. Independent enterprises do not use hindsight to adjust pricing terms and do not make adjustments retroactively. (6) Thus, we urge the OECD to refrain from...