TEI comments on BEPS Action 10: profit splits and global value chains.

• Position: Tax Executives Institute, base erosion and profit sharing

On February 6, 2015, TEI submitted comments to the OECD regarding its BEPS public discussion draft entitled BEPS Action 10: Discussion Draft on the Use of Profit Splits in the Context of Global Value Chains. TEI's comments focused on the need for transfer pricing analysis to begin with the contractual arrangements between related parties within a multi-national group. The Institute's recommendations included that a profit split generally continue to be considered as a transfer pricing method of last resort. TEI's comments were prepared under the aegis of TEI's European Direct Tax Committee, whose chair is Nick Hasenoehrl. Benjamin R. Shreck, TEI Tax Counsel, coordinated the preparation of TEI's comments.

On July 19, 2013, the OECD published an Action Plan on Base Erosion and Profit Shifting (hereinafter the Action Plan or the Plan) setting forth 15 actions the OECD will undertake to address a series of issues that contribute to the perception that individual countries' tax bases are being eroded or profits shifted improperly. Pursuant to Action 10 of the Plan, on December 16, 2014, the OECD published a document entitled BEPS Action 10: Discussion Draft on the use of Profit Splits in the Context of Global Value Chains (hereinafter the Discussion Draft or Draft).

The OECD solicited comments from interested parties no later than February 6, 2015.

On behalf of Tax Executives Institute, Inc. (TEI), I am pleased to respond to the OECD's request for comments.

TEI Background

TEI was founded in 1944 to serve the needs of business tax professionals. Today, the organisation has 56 chapters in Europe, North and South America, and Asia. As the preeminent association of in-house tax professionals worldwide, 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 nearly 7,000 individual members represent over 3,000 of the largest companies in the world. (1)

TEI Comments

Background Comments

TEI commends the OECD for posing questions about experiences and best practices in applying transactional profit splits to further the overall goal of the BEPS project with respect to the arm's length principle to ensure transfer pricing outcomes are in line with value creation. TEI agrees that there are situations where the use of profit splits may be appropriate. We recommend, however, that the use of profit split methodologies be limited to scenarios where traditional transfer pricing methodologies do not provide reliable arm's length pricing. For example, instead of properly analysing or characterising the functions and risks, treaty partners and taxpayers may resort to the use of profit splits as an easy way out, which may lead to a profit allocation based more on convenience instead of arm's length principles.

Regrettably, the Discussion Draft provides very brief examples, describes the application of the profit split, and then asks whether and under what circumstances a profit split would be appropriate. This is a somewhat awkward approach, as the simple examples do not lend themselves to comprehensive replies from stakeholders that take into account the complexity inherent in business today. A more detailed approach, with real life examples at its base, would provide a better process for public input. Moreover, the examples in the Discussion Draft refer primarily to functions performed (although still very briefly) and rarely to risks assumed and assets used. This approach creates the risk that certain tax authorities will use the highly simplified examples in asserting transfer pricing adjustments against taxpayers without consideration of the taxpayers' specific circumstances and local market conditions.

Comments on Specific Portions of the Discussion Draft and Answers to Certain Questions Asked about Various Scenarios

The Discussion Draft states that: "there seems to be very little experience of using a transactional profit split method in a way that could appropriately and comprehensively reflect the range of contributions to value in a diverse value chain." (2) TEI concurs with this statement, and asks why this is the case? TEI submits that this may be because (i) the profit split method is extraordinarily complex to implement, and (ii) tax authorities would in many cases be unhappy with its outcome, particularly if it results in a lower profit allocation to their jurisdiction. In addition, the profit split method is arguably less consistent with the arm's length standard than other transfer pricing methods.

Scenario 1. Applying a profit split to this scenario would be a complex endeavor and would have the same negative effects for tax administration as formulary apportionment, i.e., applying a profit split will likely cause multi-national enterprises (MNEs) to move more functions into countries with a lower corporate tax rate.

Scenario 2. Question 5: Can transaction profit split methods be used to provide an appropriate transfer pricing solution in the case of Scenario 2? If so, how?

TEI suggests that, in the absence of a functional analysis that defines what kind of activities the local subsidiaries perform to "generate demand" and who bears the contractual risks of the transactions, it is not possible to adequately answer this question. Based on the brief factual description, however, a profit split is not likely to be the applicable method since the activities of the local subsidiaries are probably routine, especially in comparison with the functions and intangibles of Company R. Thus, a profit split would not be the right solution since one of the parties performs simpler functions than the other. On the other hand, it could be the case that subsidiaries generating demand are uniquely valuable to the organisation, because of the type of product...