All you need to know about the OECD Transfer Pricing Guidelines 2022 Update

Knowledge • All you need to know about the OECD Transfer Pricing Guidelines 2022 Update

All you need to know about the OECD Transfer Pricing Guidelines 2022 Update

If you are reading this article the chances are that you enjoy discussing about technical aspects of transfer pricing as much as we do. Any transfer pricing aficionado knows that changes to the OECD Transfer Pricing Guidelines are a reason for excitement in the tax and transfer pricing world.

Why are the OECD Transfer Pricing Guidelines key to learn how to apply transfer pricing principles?

A few reasons come to mind 1) It is one of the most comprehensive official documents that addresses the transfer pricing principles in detailed which are applied worldwide 2) Most tax authorities worldwide (OECD and Non-OECD countries) refer to it when a dispute event happen with tax payers 3) Most courts worldwide also refer to the OECD Guidelines as reference to apply transfer pricing principles 4) Majority of local transfer pricing guidelines around the world (OECD and NON OECD countries) adopt the transfer pricing principles of the OECD TP Guidelines.

The most recent update of the OECD Transfer Pricing Guidelines was issued in January 2022. The new update incorporates key chapters released by the OECD as part of BEPS Action Plan that commence in 2013. The incorporation of these chapters with key topics of transfer pricing was long overdue.

What are the Key changes?

Revision of the transactional Profit Split Method (“PSM”);
Guidance for tax administrations on the application of the approach to Hard-To-Value Intangibles (“HTVI”);
Transfer Pricing aspects of financial transactions;

1. Revision of the transaction profit split method

In summary:	The Guidelines provide (i) clarity on the application of the PSM, and (ii) certain characteristics to aid in determination of when PSM may most be appropriate, the characteristics are: Unique and valuable contributions by each of the parties to the transaction; Highly integrated business operations and it cannot be reliably evaluated in isolation; and Shared assumption of economically significant risks or separate assumption of closely related risks.
In practice:	The Guidelines have updated the PSM section by including OECD’s report on Revised Guidance on the Application of the Profit Split Method which was developed under the mandate of BEPS Action Plan 10 and was Incorporated the PS Method chapter in the OECD Guidelines released as part of BEPS Action Plan Basic Principle for its application: the most appropriate method rule Two types of profit split method still available 1) contribution approach and 2) residual approach The new chapter also covers the following key principles to apply the PSM: How to determine relevant profits to be split Profit splitting factors e.g., capital used, incremental sales, number of employees, employees’ costs. Profit splitting factors need to be objective, verifiable and reliable.
Sections affected	Paragraphs 2.114 to 2.151, Chapter II, Part III, Section C; and Annex II to Chapter II.
Impact	Companies should assess whether the PSM is correctly applied (where it is applied) and whether such application can be made for new related party transactions after taking into account the updated Guidelines. Taxpayers (and vice-versa, tax authorities) can have relief that tax authorities (and vice-versa, taxpayers) would not use the PSM as a fallback in case no comparables data exist. Profit split means also losses split.

2. Hard to value intangibles

In summary:	HTVI covers intangibles of which at the time of the transfer between associated parties no reliable data exist to project future benefit. Therefore, it difficult to predict the level of success and expected profit of the intangible at the time of the transfer. The transfer pricing risks for the taxpayer is for a valuation to be significantly higher or lower when comparing the ex-ante projections vs, the ex-post outcomes. If a disposal is reviewed in the future, tax authorities are entitled to adjust for the difference.
In practice:	The Guidelines has introduced an annexure for HTVI by including OECD’s report on Guidance for Tax Administrations on the Application of the Approach to Hard-to-Value Intangibles which was developed under the mandate of BEPS Action Plan 8 and was approved in 2018. The chapter provides guidelines on the prefer valuation techniques to value HTVI. It also states that the preference if for taxpayers to use income-based valuation techniques e.g., discounted value of projected future income. It also provides circumstances under which a tax authority may not seek an adjustment for discrepancies in the valuation. In particular, ddetails on the following key aspects for taxpayer to consider and be prepared for disputes: Taxpayers need to prepare a reliable valuation analysis before the disposal. If discrepancies are found by the tax authority between the ex-ante vs ex post valuation, the taxpayer needs to provide explanation on whether the discrepancies are due to unforeseeable outcomes The tax authority may not seek ad adjustment if the ex-ante valuation is more than 5 years old. As a guide, the guidelines seem to suggest that a maximum of 20% difference between ex ante and ex post valuation should be allowed. Difference beyond 20% should be investigated.
Sections affected	Annex II to Chapter VI.
Impact	It is important for taxpayers to prepare the audit ready documents in the event of disposal of HTVI as they will be requested by the tax authority in the event of a transfer pricing audit. It is particularly important to set the price of the disposal based on a reliable valuation. The OECD TP Guidelines suggest that income-based valuation methods are the prefer method to value HTVI in the case of disposals.

3. Financial transactions

In summary:	The Guidelines contain considerations to take into account on financial transaction, on aspects containing: Accurate delineation of financial transactions (in particular, capital structures of MNEs); Treasury functions; Intra-group loans; Cash pooling; Hedging; Guarantees; and captive insurance.
In practice:	The Guidelines has introduced a new chapter on financial transactions by including OECD’s report on Transfer Pricing Guidance on Financial Transactions (“Financial Transaction paper”) which was developed under the mandate of BEPS Action Plan 4 (Limiting Base Erosion Involving Interest Deductions and Other Financial Payments) and Actions 8-10, and was published in 2020. These changes are also reflected in a new section on risk-free and risk-adjusted rates of return. The Guidelines have adopted the Financial Transaction paper with no major changes and aims to equip taxpayers to appropriately assess the economic factors involved in intragroup financial transactions and how this translates into the application of the arm’s length principle in the following manner: application of general transfer pricing principles to financial transactions, including how to conduct the accurate delineation analysis (determining the characterisation of a balance as debt or equity, as well as the corresponding commercial or financial relations) of the capital structure of MNE groups, and economically relevant characteristics that inform the analysis of the terms and conditions of financial transactions. guidance is on specific issues to be considered in applying the arm’s length principle to determine an appropriate price for financial transactions within MNE groups. The specific types of transactions covered include treasury functions, intra-group loans, cash pooling, hedging, guarantees and captive insurance.
Sections affected	Chapter X Paragraphs 1.107 to 1.126, Chapter I, Section D
Impact	Given that such activities (intra-group loans / cash pooling / hedging / guarantees and insurance, etc.) within a group of companies are quite common, but often not properly documented and priced, these Guidelines provide a perfect occasion to create a new transfer pricing policy or, where necessary, amend existing policies. Moreover, the Guidelines provide tax administrations with a new toolset to challenge positions taken in the past if not in line with the Guidelines.

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