TEI comments on BEPS Actions 8-10: risk and recharacterization.

• 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 Actions 8,9 and 10: Revisions to Chapter I of the Transfer Pricing Guidelines (Including Risk, Recharacterisation, and Special Measures). TEI's comments emphasized the complexity of global business operations today and the difficulty that presents for applying a transfer pricing approach that is based primarily on functions. TEI also recommended, among other things, that the ability of tax authorities to recharacterize taxpayer's business arrangements for tax purposes be strictly limited to cases of abuse. 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 Actions 8-10 of the Plan, on December 1, 2014 the OECD published a public discussion draft entitled BEPS Actions 8, 9, and 10: Discussion Draft on Revisions to Chapter I of the Transfer Pricing Guidelines (Including Risk, Recharacterisation, and Special Measures) (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. In addition, TEI requests the opportunity to speak in support of these comments at the public consultation meeting regarding this Discussion Draft, scheduled for March 19-20, 2015, in Paris.

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

General Comments

TEI commends the OECD for its theoretically sound discussion of transfer pricing principles and analysis as set forth in the Discussion Draft. We concur that it is essential for multi-national enterprises to correctly identify and weigh the economic value of functions and risks of each activity in the framework of their value chain. This review should be done on a regular basis since businesses are usually not static.

As MNEs become more globalised and integrated and supply chains become more complex, it is becoming extremely difficult to determine where functions and risks lie and to monitor operations without expending substantial time, effort, and resources. For efficiency, many companies operate as if there are no borders and no separate statutory entities. Similarly, many functions are managed centrally and on a global basis while others may be managed locally or, in many cases, there may be a combination of both. Therefore, it is extremely difficult to find knowledgeable resources that can help determine functions and risks from a tax perspective since an MNE's management structure may be quite different. To do transfer pricing analyses at the level of detail that is discussed in the paper would require an enormous amount of resources from both tax authorities and taxpayers.

A correct application of the arm's length principle commands first an understanding of the value drivers of the group as a whole (a holistic approach) and the relevant risks involved from both a short- and longer-term perspective, as well as how responsibility for those risks is shared among the participants.

In general, the shift to more economic and holistic analyses will downplay the importance of pure transactional analyses. On the other hand, the transfer pricing guidelines continue to focus essentially on testing intercompany prices and not the setting of such prices. In the reality of MNEs, transactions are driven by the business model and the relations between the related companies. The transfer pricing guidelines should reflect this shift and be less demanding of MNEs on the transactional side as they have spent a significant effort in documenting their price setting.

The first paragraph of the Discussion Draft refers to two key aspects of the comparability analysis at the heart of the arm's length principle: (i) accurately delineating the actual transactions, and (ii) comparing the conditions of the controlled transaction with the conditions of uncontrolled transactions. This is reminiscent of the two-step approach under Article 7 of the OECD's Model Tax Convention on Income and Capital (Model Convention), regarding attribution of profits to permanent establishments. The authorised OECD approach (AOA) to such attribution adopts a similar two-step method. The circumstances under Article 7, however, are different from those under Article 9 Associated Enterprises because under Article 7 the goal is to allocate profits between a company and the company's permanent establishment. The similarity between the AOA and the Discussion Draft raises the question of the extent to which the OECD envisages merging the approaches under Articles 7 and 9. The OECD should explicitly set forth its intent in this regard.

The text of the proposal refers to "conduct of the parties" in many places. Analysing the conduct of the parties can be difficult, however, and thus is subject to different interpretations and views, much more so than the written agreements that underlie the contractual arrangements. In today's world, companies operate through multiple layers of decision-making. Management teams are not generally located in a single jurisdiction but instead are spread across the globe and the process of determining the conduct of the parties is not as straightforward as it once might have been, especially for a single tax authority. This presents the possibility of creating wide differences between the taxpayer's and tax authority's view of an MNE's transfer pricing processes, leading to potentially substantial tax adjustments by authorities, which may then lead to double taxation if a second...