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OECD Guidance on Profit Splits, Hard to Value Intangibles and Permanent Establishments

OECD Releases Final Guidance Report on Profit Splits

In June 2018, the OECD issued the final report on profit splits, which replaces a previous discussion draft from June 2017. This revised report is the fourth and final guidance relating to the transactional profit split method.

This final report continues to focus on the question of how the “risk control” framework of the revised Chapter I of the Transfer Pricing Guidelines (“TPG”) might apply in the context of selecting the transactional profit split as the most appropriate transfer pricing method, and the application of a split factor that may reasonably result in an arm’s length outcome.

The report further sets out three factors that may indicate that the transactional profit split method may be the most appropriate method. Those three factors are:

• Whether each party is making unique and valuable contributions;

• Whether the business operations of the parties are so highly integrated that the parties’ contributions cannot be reliably evaluated in isolation from each other; and

• Whether the parties share the assumption of economically significant risks or separately assume closely related risks.

The report also defines the term “unique and valuable contributions” which covers not just assets used (such as intangibles) but also “functions performed.” Furthermore, the 2018 final report states that the existence of unique and valuable contributions is “perhaps the clearest indicator” that a transactional profit split may be appropriate.

The report contains the same two profit split methods as contained in the 2017 discussion draft - the contribution analysis and the residual analysis methods.

• The contribution analysis divides profits on the basis of the relative contribution of the enterprises; and

• The residual analysis is a two-step process; in the first step the returns that can be reliably benchmarked are determined, and in the second step the remaining profits are split using a contribution analysis.

For more information in relation to the final report, please refer to our Deloitte Global Transfer Pricing Alert.

OECD releases guidance in relation to Hard to Value Intangibles

In June 2018, the OECD released a report on the implementation and approach to hard-to-value intangibles (“HTVIs”). The 2018 report supplements the approach set out in Action 8-10 of the BEPS project and has been incorporated as an annex to Chapter VI of the new 2017 TPG.

The 2018 HTVI report aims at reaching a common understanding and practice among tax administrations on how to apply adjustments resulting from the application of the HTVI approach. The guidance sets out to improve consistency and reduce the risk of economic double taxation.

The 2018 HTVI report -

• presents the principles that should underlie the application of the HTVI approach by tax administrations;

• provides examples intended to clarify the application of the HTVI approach in different scenarios; and

• addresses the interaction between the HTVI approach and access to the MAP process under an applicable tax treaty.

The report focuses on information asymmetry between taxpayers and tax administrations, and states that the application of the HTVI approach should be underpinned by various main principles.

The final HTVI guidance provides tax administrations with a powerful tool, because it does not provide any mechanism requiring tax administrations to be held to the same standards as taxpayers when assigning probabilities to uncertain events, including providing evidence that every possible risk outcome has been considered and a probability measure assigned to it.

Furthermore, the HTVI implementation guidance will require taxpayers to prepare fairly detailed and extensive documentation, documenting the risks that were considered and how those risks were weighted in arriving at the price for a transaction.

For more information in relation to the 2018 HTVI report, please refer to our Deloitte Global Transfer Pricing Alert

OECD releases additional guidance on Attribution of Profits to Permanent Establishments

In May 2018, the OECD released additional guidance on the attribution of profits to a permanent establishment (PE) under Action 7 of the base erosion and profit shifting (BEPS) project: Preventing the Artificial Avoidance of Permanent Establishment Status. .

The 2018 guidance sets out high-level general principles in light of the comments received on earlier drafts and maintains the same approach as the preceding 2017 discussion draft.

In particular, it continues to affirm that there should be no double taxation when attributing profits to a PE, either through the double counting of risks or in the combined application of Articles 7 and 9 of the MTC. The guidance also reaffirms that the net profit attributable to a PE may be positive, negative, or a loss.

The guidance continues to provide that countries may keep implementing administratively convenient procedures for recognizing the existence of a PE and collecting the tax in the host country, regardless of whether they have adopted the Authorized OECD Approach (“AOA”).

The four examples that were set out in the 2017 discussion draft are also included in the 2018 guidance. The examples were revised to provide a more robust analysis of how the profits would be attributed to the PEs.

For more information in relation to the new discussion draft, please refer to our Deloitte Global Transfer Pricing Alert

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