TEI comments on OECD revised intangibles discussion draft.

• Position: Tax Executives Institute, Organisation for Economic Co-operation and Development

October 1, 2013

On October 1, TEI submitted a letter to the OECD commenting on its Revised Discussion Draft on Transfer Pricing Aspects of Intangibles. TEI's comments focused on the need to uphold the arm's length principle by respecting the legal and contractual arrangements between related taxpayers with respect to intangible assets. The comments were prepared under the aegis of TEI's European Direct Tax Committee, whose chair is Alexander Kolbl of General Dynamics. Benjamin R. Shreck, TEI Tax Counsel, coordinated the preparation of TEI's letter.

On 6 June 2012 the OECD published a Discussion Draft regarding special considerations for intangibles in Chapter VI of the OECD Transfer Pricing Guidelines (Discussion Draft). A public consultation on the Discussion Draft was held with interested stakeholders in November 2012. On the basis of the comments received, the OECD published a Revised Discussion Draft on Transfer Pricing Aspects of Intangibles on 30 July 2013 (Revised Discussion Draft or Draft) along with a request for written comments from interested parties.

On 19 July 2013, the OECD released an Action Plan on Base Erosion and Profit Shifting (Action Plan). The work on intangibles in the Revised Discussion Draft is closely related to items discussed in the Action Plan, and therefore some portions of the text and examples in the Revised Discussion Draft may be revised during the course of the work produced under the Action Plan. Nevertheless, the OECD's Committee on Fiscal Affairs asked for comments from the business community and others on the Revised Discussion Draft. 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 55 chapters in Europe, North 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 members represent over 3,000 of the largest companies in Europe, the United States, Canada, and Asia.

Overall Direction of Revised Discussion Draft

TEI commends the OECD for its work in addressing the transfer pricing aspects of intangible assets and for the open consultative process that produced the Revised Discussion Draft. In TEI's view, the OECD's effort should be directed toward preventing transfer pricing disputes between taxpayers and tax authorities and avoiding double taxation, rather than pursuing an approach that may increase such disputes. A common set of rules equitably applied by all countries and taxpayers would benefit all parties while reducing the risk of double taxation and double non-taxation.

The new text of the Revised Discussion Draft is an improvement over the OECD's previous effort and a more coherent document. TEI especially appreciates the expansive definition of intangibles and the increased emphasis on a holistic value chain analysis. However, we urge the OECD to recognise that any transfer pricing analysis must begin with the contractual and legal arrangements between the parties. Regrettably, in many places the Draft is too quick to recharacterise transactions between related parties in its transfer pricing analysis without first analysing the relevant legal contracts, as we discuss further below.

The Revised Discussion Draft also emphasises the use of the profit split transfer pricing method. The profit split method may be the most appropriate method in cases where comparable time and effort are spent developing valuable intangibles by both parties to a related party transaction. However, because this method requires a great deal of international cohesion, expertise, and dialogue among different tax authorities, we are skeptical of the ability of certain authorities to apply the profit split method fairly and efficiently. Regular use of the profit split (and similar) methods also raises the specter of increased transfer pricing documentation and compliance costs. In sum, the profit split method presents complex and difficult administrative issues for tax authorities and similar compliance problems for taxpayers.

Regrettably, the overall content of the Revised Discussion Draft creates confusion with respect to key principles. It appears that the OECD's recent focus on base erosion and profit shifting, as reflected in the Action Plan, has given the Draft an "anti-abuse" bias. The introduction of new concepts, such as the focus on "important functions" and "control" in setting transfer prices for intangible assets, has also muddied the waters. The new concepts give the impression that the Draft's direction in setting transfer prices is not driven by respecting contractual arrangements between parties that satisfy the arm's length principle. The many examples that permit tax authorities to recharacterise contractual relationships strongly implies that contracts and legal ownership (1) can be easily disregarded or that they must at least be challenged.

Transfer pricing is not an exact science, and the guidelines should allow for a pragmatic and flexible approach. In that respect, the Draft is at times too detailed and prescriptive and also misses the nuances and complexity of intangibles transfer pricing. We fear that certain subjects in the Revised Discussion Draft are susceptible to literal application by tax authorities without further analysis, which will lead to unnecessary controversy and double taxation.

The Draft also downplays the investor and governance role of intellectual property (IP) holding companies (also called "central entrepreneurs"), while overstating the contribution of other affiliates. Where multinational enterprises have such a structure in place, the central entrepreneur is unquestionably the primary investor in intangibles and bears most (if not all) of the risk with respect to IP. By allocating intangible related returns from an IP holding company to other affiliates in a multi-national enterprise's (MNE) group, the Draft risks creating a significant increase in international tax disputes.

In addition, the suggested piecemeal approach that consists of analysing each intangible item separately is likely to lead to non-arm's length valuations. A fragmented methodology to intangible valuation contradicts the business reality of many MNEs where the combination or centralisation of many innovative activities (e.g., research and development, product, process, marketing and organisational) creates a competitive advantage.

Finally, it is unfortunate that the Revised Discussion Draft reflects a general anti-abuse orientation, which we attribute to the influence of countries that are generally less experienced in applying the arm's length principle. Such countries already have a regrettable inclination to apply the arm's length standard in an unprincipled manner. As a result, the in-country affiliates of MNEs face great difficulty in justifying arm's length payments for the use of intangibles held abroad and often must resort to costly litigation to obtain a fair result. The combination of unclear guidelines and an anti-abuse bias of the Draft will further incentivise those countries to pursue opportunistic and unprincipled adjustments in contradiction of the arm's length principle. The Revised Discussion draft should clearly state that the arm's length principle is not a tool to tackle tax avoidance or abusive transactions but a standard to value transactions. A shorter and less prescriptive document setting key and clear principles would better serve taxpayers and tax administrations.

General Comments The Overall Tax Climate--Global Economic Policy

TEI's members are concerned that economic globalisation and the revenue needs of countries after the 2008 financial crisis have seriously eroded the relationship between MNEs and tax authorities. As a result, our members have seen a sharp increase in the number of unprincipled adjustments, most acutely in the transfer pricing area, in both developed and developing countries with a corresponding increase in unrelieved double taxation.

From a global economic policy view, it is clear that this negative relationship and the hostile political climate with respect to MNEs increases the cost of conducting international business. This generates an economic distortion at the expense of companies, both those who want to expand internationally and ones that are already active internationally, because they incur increased compliance costs. Unprincipled adjustments present an unpredictable risk that is not conducive to the rule of law, a key component underlying the global economy.

In addition, the ability of taxpayers to appeal disputed adjustments or to invoke a mutual agreement procedure (MAP), if one is available, is limited for many reasons. For example, a local appeal may render a MAP process unavailable, tax authorities may threaten increased penalties if the taxpayer does not waive its right to appeal or to the MAP process, or the cost and length of time required to complete an appeal or MAP process makes them unappealing.

For these reasons, local government agendas are not necessarily aligned with the OECD's goals for its intangibles project. In the current difficult economic climate it is critical that the OECD limit this divergence by reinforcing transfer pricing principles rather than suggesting deviations from those principles as the Revised Discussion Draft does in several respects (e.g., by downplaying the significance of legal ownership and risk bearing).

Influence of the OECD's Base Erosion and Profit Shifting Project

Much of the Revised Discussion Draft is "testing focused," that is, it is aimed at systematically challenging or testing the arm's length principle in different ways, such as looking to the conduct of the...