TEI Comments on OECD Discussion Draft Regarding Revised Profit Split Guidance.

AuthorParsons, Giles
PositionTax Executives Institute, Organisation for Economic Co-operation and Development

On September 8, 2017, TEI submitted comments to the OECD on its recent public discussion draft regarding revised guidance on the use of profits splits for transfer pricing purposes. TEI's comments focused on the need for additional and more detailed examples in the final OECD guidance, as well as the need for greater recognition that losses among related parties in transfer pricing transactions also need to be split, among other things. The Institute's comments were prepared under the aegis of TEI's European Direct Tax Committee, whose chair is Giles Parsons. Ben Shreck, TEI tax counsel, coordinated the preparation of TEI's comments.

The Organisation for Economic Co-operation and Development (OECD) published final reports pursuant to its base erosion and profit shifting (BEPS) project on October 5, 2015. The reports were the culmination of the OECD's Action Plan on Base Erosion and Profit Shifting (hereinafter the Plan) published in 2013. The Plan set forth 15 actions the OECD would undertake to address a series of issues that contribute to the perception of tax bases being eroded or profits shifted improperly. Included in the October 2015 final reports was a report under Actions 8-10 of the Plan, Aligning Transfer Pricing Outcomes with Value Creation. Subsequently, on June 22, 2017, the OECD issued a public discussion draft under BEPS Action 10 regarding Revised Guidance on Profit Splits (the Discussion Draft or Draft). The OECD requested comments from stakeholders regarding the Draft's proposed revised guidance on the application of the transactional profit split method, as well as responses to specific questions.

I am pleased to respond to the OECD's request for comments on behalf of Tax Executives Institute, Inc. (TEI). TEI also requests the opportunity to speak in support of these comments at the public consultation to be held in November 2017 in Paris.

TEI Background

TEI was founded in 1944 to serve the needs of business tax professionals. Today, the organization 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 2,800 of the leading companies in the world. (1)

TEI Comments

General Comments on the Discussion Draft

TEI commends the OECD for the additional guidance on the use of the profit split method set forth in the Discussion Draft. Tax authorities have increasingly used the profit split method to address transfer pricing issues and thus the attention paid to this method by the OECD is appropriate. That said, we recommend the OECD clearly state in final guidance that the Discussion Draft is not intended to change the manner in which tax authorities and taxpayers identify the best transfer pricing method. The OECD has at various occasions confirmed in discussions that the additional profit split method guidance in the Draft is not intended to promote the method to make it more prevalent, but rather to assist tax authorities and taxpayers in the methods application.

In TEI's view, and we understand the OECD agrees, the comparable uncontrolled price (CUP) method continues to be the most reliable way to apply the arm's length standard. Thus, where the CUP or other transfer pricing methods are considered the most appropriate method to assess the arm's length nature of transactions, there should be no requirement to use the profit split method as an additional or corroborative method. Moreover, when tax authorities apply the profit split method, they should be subject to the same diligence requirements as taxpayers and should avoid simplistic approaches to splitting profits.

We also note that, as a whole, the Discussion Draft appears to imply that it is easier to apply the profit split method than other transfer pricing methods, in particular the CUP. To dispel this implication, TEI recommends that the OECD note in final guidance that when confronted with complex taxpayer operational structures and supply chains, applying the profit split method correctly is at least as problematic as applying another method.

In addition, the Discussion Draft and its examples appear to assume that either the entire transactional profit should be split between the parties or, if another method is more appropriate, none of the profit should be split. While that may be the case in many situations, there are other situations where the profit split is the most appropriate method, but should only apply to a portion of the profit. Parties to a transaction that make unique and valuable contributions also often have activities that are routine and do not constitute unique and valuable contributions to the value chain. For example, parties may conduct both research and development (R&D) activities and manufacturing. While the R&D may constitute a unique contribution, manufacturing may not. Therefore, it may be appropriate to first use a one-sided traditional method to calculate the profit attributable to manufacturing, and then apply the profit split method to the residual profits. Because the Draft does not discuss these frequent situations, TEI recommends the OECD include such a discussion in final guidance. (2)

The phrase "unique and valuable" is often used in the Discussion Draft. It would be helpful if the OECD clarified the meaning of this phrase in final guidance, especially given that the references and descriptions used for the phrase within the Draft are somewhat inconsistent. For example, in Paragraph 16, the phrase is narrowly defined implying a high threshold for a contribution to be described as "unique." However, Example 9 implies a lower threshold.

Another definitional issue arises in Paragraph 1, which states that the profit split method "first identifies the profits to be split from the controlled transactions--the relevant profits...." However, nowhere in the Draft is the term "relevant profits" clearly delineated. Additional guidelines on the meaning of this term, as well as a discussion of how to take into account certain costs (e.g., restructuring costs, foreign exchange costs), would be helpful.

TEI commends the OECD for recognizing in Paragraph 1 that...

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