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© 2025 by Michael Firth KC, Gray's Inn Tax Chambers
Contact: michael.firth@taxbar.com
F8. Transfer pricing for associated enterprises
ARTICLE 9: ASSOCIATED ENTERPRISES
Profits which would have accrued but for non-arm's length provisions may be included in profit of enterprise
"(1) Where
a) an enterprise of a Contracting State participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State, or
b) the same persons participate directly or indirectly in the management, control or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State,
and in either case conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly." (Model Article 9)
Corresponding adjustments
"(2) Where a Contracting State includes in the profits of an enterprise of that State — and taxes accordingly — profits on which an enterprise of the other Contracting State has been charged to tax in that other State and the profits so included are profits which would have accrued to the enterprise of the firstmentioned State if the conditions made between the two enterprises had been those which would have been made between independent enterprises, then that other State shall make an appropriate adjustment to the amount of the tax charged therein on those profits. In determining such adjustment, due regard shall be had to the other provisions of this Convention and the competent authorities of the Contracting States shall if necessary consult each other." (Model Article 9)
ARTICLE 9: ASSOCIATED ENTERPRISES
- General purpose: adjusting profits that have been artificially raised
"[96] Mr Peacock also drew our attention to Article 9 of the UK/Canada Convention which concerns associated enterprises. This addresses the risk of tax avoidance where an enterprise in one Contracting State which controls an enterprise in the other Contracting State arranges their commercial or financial relations in a way which ensures that more profits accrue to one member of the group which is resident in the more favourable jurisdiction than would have been the case if the two enterprises had been dealing with each other as independent enterprises. The Article enables the Contracting State of the enterprise whose profits have been artificially lowered to adjust those profits upwards and tax them accordingly. Where that occurs, the Contracting State of the enterprise whose profits have been artificially raised must make an appropriate adjustment to the tax it charges on those profits. In determining such adjustment "the competent authorities of the Contracting States shall if necessary consult each other". This is designed to put associated and independent enterprises on a more equal footing for tax purposes, and avoids the creation of tax advantages or disadvantages that would otherwise distort the relative competitive positions of either company. The Commentaries also note that the purpose of Article 9 is to deal with adjustments to profits that may be made for tax purposes where transactions have been entered into between associated enterprises on other than arm's length terms." (HMRC v. Royal Bank of Canada [2025] UKSC 2, Lady Rose)
- General purpose: adjusting profits that have been artificially raised
- OECD Guidelines represent consensus among OECD Members
"[153] The OECD was organised to promote international trade and commerce due to concern about potential barriers to free trade among its member states. For this reason, the OECD issued a revised commentary in 1995 on the principles to be applied to related party transactions of tangible property. The OECD Guidelines recognise that, in the case of tax administrations, specific problems arise at both policy and practical levels. At the policy level, jurisdictions need to reconcile their legitimate right to tax the profits of a taxpayer based upon income and expenses that can reasonably be considered to arise within their territory with the need to avoid the taxation of the same item of income by more than one tax jurisdiction. Such double or multiple taxation can create an impediment to cross-border transactions in goods and services, and the movement of capital. At a practical level, a jurisdiction's determination of such income and expense allocation may be impeded by difficulties in obtaining pertinent data located outside its own jurisdiction.
[154] The OECD Guidelines represent a consensus among OECD Members, and have largely been followed in domestic transfer pricing regulations of these countries...
[155] The OECD Guidelines provide that the arm's length standard should be used to establish transfer prices between associated enterprises. The key question is how to apply the arm's length principle, in practice, to determine the arm's length price of a transaction." (Lifeplus Europe Ltd v. HMRC [2026] UKFTT 797 (TC), Judge Manyarara)
- OECD Guidelines represent consensus among OECD Members
- Identify the relevant guidelines based on the tax period
"[156] The combined effect of s 164 TIOPA, and one subsequent statutory instrument[4], is that a particular version of the OECD Guidelines is applicable to each of the Appellant's accounting years in question..." (Lifeplus Europe Ltd v. HMRC [2026] UKFTT 797 (TC), Judge Manyarara)
- Identify the relevant guidelines based on the tax period
ARM'S LENGTH PRINCIPLE
ARM'S LENGTH PRINCIPLE
- Conditions of commercial + financial relations expected between independent enterprises in comparable transactions under comparable circumstances
"[1.3]...OECD member countries consider that an appropriate adjustment is achieved by establishing the conditions of the commercial and financial relations that they would expect to find between independent enterprises in comparable transactions under comparable circumstances." (OECD TP Guidance)
- Conditions of commercial + financial relations expected between independent enterprises in comparable transactions under comparable circumstances
- Comparing controlled v. uncontrolled transactions
"[1.6]...Because the separate entity approach treats the members of an MNE group as if they were independent entities, attention is focused on the nature of the transactions between those members and on whether the conditions thereof differ from the conditions that would be obtained in comparable uncontrolled transactions. Such an analysis of the controlled and uncontrolled transactions, which is referred to as a “comparability analysis”, is at the heart of the application of the arm’s length principle." (OECD TP Guidance)
- Comparing controlled v. uncontrolled transactions
- No assumption that conditions deviate from open market
"[1.5] It should not be assumed that the conditions established in the commercial and financial relations between associated enterprises will invariably deviate from what the open market would demand. Associated enterprises in MNEs sometimes have a considerable amount of autonomy and can often bargain with each other as though they were independent enterprises. Enterprises respond to economic situations arising from market conditions, in their relations with both third parties and associated enterprises. For example, local managers may be interested in establishing good profit records and therefore would not want to establish prices that would reduce the profits of their own companies. Tax administrations should keep these considerations in mind to facilitate efficient allocation of their resources in selecting and conducting transfer pricing examinations. Sometimes, it may occur that the relationship between the associated enterprises may influence the outcome of the bargaining. Therefore, evidence of hard bargaining alone is not sufficient to establish that the transactions are at arm’s length." (OECD TP Guidance)
- No assumption that conditions deviate from open market
- Objective is to find a reasonable estimate based on reliable information
"[1.13]...The information that is accessible may be incomplete and difficult to interpret; other information, if it exists, may be difficult to obtain for reasons of its geographical location or that of the parties from whom it may have to be acquired. In addition, it may not be possible to obtain information from independent enterprises because of confidentiality concerns. In other cases information about an independent enterprise which could be relevant may simply not exist, or there may be no comparable independent enterprises, e.g. if that industry has reached a high level of vertical integration. It is important not to lose sight of the objective to find a reasonable estimate of an arm’s length outcome based on reliable information. It should also be recalled at this point that transfer pricing is not an exact science but does require the exercise of judgment on the part of both the tax administration and taxpayer." (OECD TP Guidance)
Limits of the arm's length principle
Limits of the arm's length principle
- Objective is to find a reasonable estimate based on reliable information
- May not account for economies of scale or interrelation of diverse activities
"[1.10]The arm’s length principle is viewed by some as inherently flawed because the separate entity approach may not always account for the economies of scale and interrelation of diverse activities created by integrated businesses. There are, however, no widely accepted objective criteria for allocating between associated enterprises the economies of scale or benefits of integration resulting from group membership." (OECD TP Guidance)
- May not account for economies of scale or interrelation of diverse activities
IDENTIFYING THE COMMERCIAL + FINANCIAL RELATIONS
IDENTIFYING THE COMMERCIAL + FINANCIAL RELATIONS
- Begin with broad-based understanding of industry sector and factors affecting performance
"[1.34] The typical process of identifying the commercial or financial relations between the associated enterprises and the conditions and economically relevant circumstances attaching to those relations requires a broad-based understanding of the industry sector in which the MNE group operates (e.g. mining, pharmaceutical, luxury goods) and of the factors affecting the performance of any business operating in that sector." (OECD TP Guidance)
- Begin with broad-based understanding of industry sector and factors affecting performance
- Business strategies, markets, products, supply chain, key functions, material assets, risks assumed
"[1.34] ...The understanding is derived from an overview of the particular MNE group which outlines how the MNE group responds to the factors affecting performance in the sector, including its business strategies, markets, products, its supply chain, and the key functions performed, material assets used, and important risks assumed..." (OECD TP Guidance)
- Business strategies, markets, products, supply chain, key functions, material assets, risks assumed
- Analyse what each enterprise does + identify its commercial/financial relations with associated enterprises
"[1.35] ...The process then narrows to identify how each MNE within that MNE group operates, and provides an analysis of what each MNE does (e.g. a production company, a sales company) and identifies its commercial or financial relations with associated enterprises as expressed in transactions between them..." (OECD TP Guidance)
- Analyse what each enterprise does + identify its commercial/financial relations with associated enterprises
WHETHER A SERVICE IS BEING PROVIDED
WHETHER A SERVICE IS BEING PROVIDED
- Conduct resulting in a transfer of material value
"[1.49] ... In some circumstances the actual outcome of commercial or financial relations may not have been identified as a transaction by the MNE, but nevertheless may result in a transfer of material value, the terms of which would need to be deduced from the conduct of the parties. For example, technical assistance may have been granted, synergies may have been created through deliberate concerted action (as discussed in Section D.8), or know-how may have been provided through seconded employees or otherwise..." (OECD TP Guidance)
"[6.2] ...Article 9 of the OECD Model Tax Convention is concerned with the conditions of transactions between associated enterprises, not with assigning particular labels to such transactions. Consequently, the key consideration is whether a transaction conveys economic value from one associated enterprise to another, whether that benefit derives from tangible property, intangibles, services or other items or activities. An item or activity can convey economic value notwithstanding the fact that it may not be specifically addressed in Chapter VI. To the extent that an item or activity conveys economic value, it should be taken into account in the determination of arm’s length prices whether or not it constitutes an intangible within the meaning of paragraph 6.6." (OECD TP Guidance)
- Conduct resulting in a transfer of material value
- Example: parent engages and pays for 3rd party to provide service to subsidiary, no reimbursement
"[1.49] ... In reviewing the commercial or financial relations between Company P and its subsidiary companies, it is observed that those subsidiaries receive services from an independent party engaged by Company P. Company P pays for the services, the subsidiaries do not reimburse Company P directly or indirectly through the pricing of another transaction and there is no service agreement in place between Company P and the subsidiaries. The conclusion is that, in addition to a provision of services by the independent party to the subsidiaries, there are commercial or financial relations between Company P and the subsidiaries, which transfer potential value from Company P to the subsidiaries...." (OECD TP Guidance)
- Example: parent engages and pays for 3rd party to provide service to subsidiary, no reimbursement
- Benefits set-off against each other need to be identified
"[3.13]...Such arrangements may sometimes be encountered between independent enterprises and should be assessed in accordance with the arm’s length principle in order to quantify the value of the respective benefits presented as set-offs." (OECD TP Guidance)
- Benefits set-off against each other need to be identified
- Services obtained for the purchaser's own benefit (e.g. audit)
A parent obtaining an audit to be able to report to shareholders is not providing a service to the subsidiaries included in the audit.
- Services obtained for the purchaser's own benefit (e.g. audit)
Synergies
Synergies
- Use of group name where it carries goodwill
"[6.82] Where one member of the group is the owner of a trademark or other intangible for the group name, and where use of the name provides a financial benefit to members of the group other than the member legally owning such intangible, it is reasonable to conclude that a payment for use would have been made in arm’s length transactions. Similarly, such payments may be appropriate where a group member owns goodwill in respect of the business represented by an unregistered trademark, use of that trademark by another party would constitute misrepresentation, and the use of the trademark provides a clear financial benefit to a group member other than that owning the goodwill and unregistered trademark." (OECD TP Guidance)
- Use of group name where it carries goodwill
- Incidental benefits arising as a result of group synergy not an intra-group services
"[1.178] Paragraph 7.13 of these Guidelines suggests that an associated enterprise should not be considered to receive an intra-group service or be required to make any payment when it obtains incidental benefits attributable solely to its being part of a larger MNE group. In this context, the term incidental refers to benefits arising solely by virtue of group affiliation and in the absence of deliberate concerted actions or transactions leading to that benefit. The term incidental does not refer to the quantum of such benefits or suggest that such benefits must be small or relatively insignificant. Consistent with this general view of benefits incidental to group membership, when synergistic benefits or burdens of group membership arise purely as a result of membership in an MNE group and without the deliberate concerted action of group members or the performance of any service or other function by group members, such synergistic benefits of group membership need not be separately compensated or specifically allocated among members of the MNE group." (OECD TP Guidance)
- Incidental benefits arising as a result of group synergy not an intra-group services
- Example: lower borrowing costs due to strength of group balance sheet
"[1.186] Under these circumstances the interest rate charged on the loan by T to S is an arm’s length interest rate because (i) it is the same rate charged to S by an independent lender in a comparable transaction; and (ii) no payment or comparability adjustment is required for the group synergy benefit that gives rise to the ability of S to borrow from independent enterprises at an interest rate lower than it could were it not a member of the group because the synergistic benefit of being able to borrow arises from S’s group membership alone and not from any deliberate concerted action of members of the MNE group." (OECD TP Guidance)
- Example: lower borrowing costs due to strength of group balance sheet
- Synergistic benefit as a result of deliberate concerted group action may involve a service
"[1.178] In some circumstances, however, synergistic benefits and burdens of group membership may arise because of deliberate concerted group actions and may give an MNE group a material, clearly identifiable structural advantage or disadvantage in the marketplace over market participants that are not partof an MNE group and that are involved in comparable transactions. Whether such a structural advantage or disadvantage exists, what the nature and source of the synergistic benefit or burden may be, and whether the synergistic benefit or burden arises through deliberate concerted group actions can only be determined through a thorough functional and comparability analysis." (OECD TP Guidance)
- Synergistic benefit as a result of deliberate concerted group action may involve a service
- Example: centralising purchasing in single company to take advantage of volume discounts
"[1.180] For example, if a group takes affirmative steps to centralise purchasing in a single group company to take advantage of volume discounts, and that group company resells the items it purchases to other group members, a deliberate concerted group action occurs to take advantage of group purchasing power. Similarly, if a central purchasing manager at the parent company or regional management centre performs a service by negotiating a group wide discount with a supplier on the condition of achieving minimum group wide purchasing levels, and group members then purchase from that supplier and obtain the discount, deliberate concerted group action has occurred notwithstanding the absence of specific purchase and sale transactions among group members. Where a supplier unilaterally offers one member of a group a favourable price in the hope of attracting business from other group members, however, no deliberate concerted group action would have occurred." (OECD TP Guidance)
- Example: centralising purchasing in single company to take advantage of volume discounts
- Benefit of synergies should generally be shared by members in proportion to contribution
"[1.182] If important group synergies exist and can be attributed to deliberate concerted group actions, the benefits of such synergies should generally be shared by members of the group in proportion to their contribution to the creation of the synergy. For example, where members of the group take deliberate concerted actions to consolidate purchasing activities to take advantage of economies of scale resulting from high volume purchasing, the benefits of those large scale purchasing synergies, if any exist after an appropriate reward to the party co-ordinating the purchasing activities, should typically be shared by the members of the group in proportion to their purchase volumes." (OECD TP Guidance)
- Benefit of synergies should generally be shared by members in proportion to contribution
- Example: benefit of central purchasing should be passed on subject to remunerating the service of co-ordinating purchasing
"[1.188] Assume that Company A is assigned the role of central purchasing manager on behalf of the entire group. It purchases from independent suppliers and resells to associated enterprises. Company A, based solely on the negotiating leverage provided by the purchasing power of the entire group is able to negotiate with a supplier to reduce the price of widgets from USD 200 to USD 110. Under these circumstances, the arm’s length price for the resale of widgets by Company A to other members of the group would not be at or near USD 200. Instead, the arm’s length price would remunerate Company A for its services of co‑ordinating purchasing activity. If the comparability and functional analysis suggests in this case that in comparable uncontrolled transactions involving a comparable volume of purchases, comparable co‑ordination services resulted in a service fee based on Company A’s costs incurred plus a mark-up equating to a total service fee of USD 6 per widget, then the intercompany price for the resale of the widgets by Company A would be approximately USD 116. Under these circumstances, each member of the group would derive benefits attributable to the group purchasing power of approximately USD 84 per widget. In addition, Company A would earn USD 6 per widget purchased by members of the group for its service functions." (OECD TP Guidance)
- Example: benefit of central purchasing should be passed on subject to remunerating the service of co-ordinating purchasing
- Example: adjustment required if benefit of group purchasing power channelled to one country rather than another
"[1.192] The purchasing employee at the shared services centre then places orders for the required widgets and requests that the supplier invoice the Country B manufacturing affiliate for 5 000 widgets at a total price of USD 50 000 and invoice the Country C manufacturing affiliate for 5 000 widgets at a total price of USD 45 000. The supplier complies with this request as it will result in the supplier being paid the agreed price of USD 95 000 for the total of the 10 000 widgets supplied.
[1.193] Under these circumstances, Country B would be entitled to make a transfer pricing adjustment reducing the expenses of the Country B manufacturing affiliate by USD 2 500. The transfer pricing adjustment is appropriate because the pricing arrangements misallocate the benefit of the group synergy associated with volume purchasing of the widgets..." (OECD TP Guidance)
- Example: adjustment required if benefit of group purchasing power channelled to one country rather than another
Loss making enterprise in profitable group
Loss making enterprise in profitable group
- Enterprise that consistently makes a loss may be providing service to profitable making entities
"[1.150] For example, an MNE group may need to produce a full range of products and/or services in order to remain competitive and realise an overall profit, but some of the individual product lines may regularly lose revenue. One member of the MNE group might realise consistent losses because it produces all the loss-making products while other members produce the profit-making products. An independent enterprise would perform such a service only if it were compensated by an adequate service charge. Therefore, one way to approach this type of transfer pricing problem would be to deem the loss enterprise to receive the same type of service charge that an independent enterprise would receive under the arm’s length principle." (OECD TP Guidance)
- Enterprise that consistently makes a loss may be providing service to profitable making entities
CHARACTERISING THE TRANSACTION(S) TO BE ASSESSED
CHARACTERISING THE TRANSACTION(S) TO BE ASSESSED
Single transaction or composite transactions
Single transaction or composite transactions
- Preference for transaction-by-transaction approach
"[3.9] Ideally, in order to arrive at the most precise approximation of arm’s length conditions, the arm’s length principle should be applied on a transaction-by-transaction basis..." (OECD TP Guidance)
- Preference for transaction-by-transaction approach
- May be necessary to break up a package deal/single transaction
"[3.9] An MNE may package as a single transaction and establish a single price for a number of benefits such as licences for patents, know-how, and trademarks, the provision of technical and administrative services, and the lease of production facilities. This type of arrangement is often referred to as a package deal... In some cases, it may not be feasible to evaluate the package as a whole so that the elements of the package must be segregated. In such cases, after determining separate transfer pricing for the separate elements, the tax administration should nonetheless consider whether in total the transfer pricing for the entire package is arm’s length." (OECD TP Guidance)
- May be necessary to break up a package deal/single transaction
- Transactions so closely linked/continuous that they cannot be evaluated adequately on a separate basis
"[3.9]...However, there are often situations where separate transactions are so closely linked or continuous that they cannot be evaluated adequately on a separate basis. Examples may include: a) some long-term contracts for the supply of commodities or services, b) rights to use intangible property, and c) pricing a range of closely-linked products (e.g. in a product line) when it is impractical to determine pricing for each individual product or transaction. Another example would be the licensing of manufacturing know-how and the supply of vital components to an associated manufacturer; it may be more reasonable to assess the arm’s length terms for the two items together rather than individually." (OECD TP Guidance)
- Transactions so closely linked/continuous that they cannot be evaluated adequately on a separate basis
- Transactions with economic interdependence (e.g. selling one good low to increase sales of another)
"[3.10]...A portfolio approach is a business strategy consisting of a taxpayer bundling certain transactions for the purpose of earning an appropriate return across the portfolio rather than necessarily on any single product within the portfolio. For instance, some products may be marketed by a taxpayer with a low profit or even at a loss, because they create a demand for other products and/or related services of the same taxpayer that are then sold or provided with high profits (e.g. equipment and captive aftermarket consumables, such as vending coffee machines and coffee capsules, or printers and cartridges)..." (OECD TP Guidance)
- Transactions with economic interdependence (e.g. selling one good low to increase sales of another)
ECONOMICALLY RELEVANT CHARACTERISTICS
ECONOMICALLY RELEVANT CHARACTERISTICS
- Economic characteristics at the heart of comparability principle
"[163] Furthermore, as correctly identified in the Appellant's case, at the heart of the comparability principle is the requirement to ensure that the "economically relevant characteristics" of the transactions being compared are "sufficiently comparable" to each other.
[164] "Sufficient comparability" is achieved by one of two routes:
(1) Any differences in the "economically relevant factors" do not have a material effect on the relevant condition or feature of the transaction, so that they are truly comparable to each other; or
(2) The effect of these material differences can be eliminated through making adjustments to the conditions or features of the transactions being compared, so that they can be made to be comparable to each other." (Lifeplus Europe Ltd v. HMRC [2026] UKFTT 797 (TC), Judge Manyarara)
- Economic characteristics at the heart of comparability principle
- Independent enterprises will take into account any economically relevant differences between options realistically available
"[1.38]...Independent enterprises will generally take into account any economically relevant differences between the options realistically available to them (such as differences in the level of risk) when valuing those options. Therefore, identifying the economically relevant characteristics of the transaction is essential in accurately delineating the controlled transaction and in revealing the range of characteristics taken into account by the parties to the transaction in reaching the conclusion that there is no clearly more attractive opportunity realistically available to meet their commercial objectives than the transaction adopted..." (OECD TP Guidance)
- Independent enterprises will take into account any economically relevant differences between options realistically available
- Relevant characteristics may include broader arrangements/transactions
"[1.38]...In making such an assessment, it may be necessary or useful to assess the transaction in the context of a broader arrangement of transactions, since assessment of the options realistically available to third parties is not necessarily limited to the single transaction, but may take into account a broader arrangement of economically related transactions." (OECD TP Guidance)
- Relevant characteristics may include broader arrangements/transactions
- Comparability analysis less reliable if not all characteristics significantly affecting price taken into account
"[1.40]...However, the method becomes a less reliable substitute for arm’s length transactions if not all the characteristics of these uncontrolled transactions that significantly affect the price charged between independent enterprises are comparable." (OECD TP Guidance)
- Comparability analysis less reliable if not all characteristics significantly affecting price taken into account
(1) CONTRACTUAL TERMS OF ACTUAL TRANSACTION
(1) CONTRACTUAL TERMS OF ACTUAL TRANSACTION
- Written contract the starting point if there is one, for identifying responsibilities, risks and anticipated outcomes
"[1.42].Where a transaction has been formalised by the associated enterprises through written contractual agreements, those agreements provide the starting point for delineating the transaction between them and how the responsibilities, risks, and anticipated outcomes arising from their interaction were intended to be divided at the time of entering into the contract. The terms of a transaction may also be found in communications between the parties other than a written contract." (OECD TP Guidance)
- Written contract the starting point if there is one, for identifying responsibilities, risks and anticipated outcomes
- But look at functions actually performed
"[1.43] Taken together, the analysis of economically relevant characteristics in all five categories provides evidence of the actual conduct of the associated enterprises. The evidence may clarify aspects of the written contractual arrangements by providing useful and consistent information. If the contract neither explicitly nor implicitly (taking into account applicable principles of contract interpretation) addresses characteristics of the transaction that are economically relevant, then any information provided by the contract should be supplemented for purposes of the transfer pricing analysis by the evidence provided by identifying those characteristics." (OECD TP Guidance)
- But look at functions actually performed
- Example: marketing function not set out in contract
"[1.44] ...Company P is the parent company of an MNE group situated in Country P. Company S, situated in Country S, is a wholly-owned subsidiary of Company P and acts as an agent for Company P’s branded products in the Country S market. The agency contract between Company P and Company S is silent about any marketing and advertising activities in Country S that the parties should perform. Analysis of other economically relevant characteristics and in particular the functions performed, determines that Company S launched an intensive media campaign in Country S in order to develop brand awareness. This campaign represents a significant investment for Company S. Based on evidence provided by the conduct of the parties, it could be concluded that the written contract may not reflect the full extent of the commercial or financial relations between the parties." (OECD TP Guidance)
- Example: marketing function not set out in contract
- Actual conduct takes priority
"[1.45] If the characteristics of the transaction that are economically relevant are inconsistent with the written contract between the associated enterprises, the actual transaction should generally be delineated for purposes of the transfer pricing analysis in accordance with the characteristics of the transaction reflected in the conduct of the parties.
"[1.46] ... It is, therefore, particularly important in considering the commercial or financial relations between associated enterprises to examine whether the arrangements reflected in the actual conduct of the parties substantially conform to the terms of any written contract, or whether the associated enterprises’ actual conduct indicates that the contractual terms have not been followed, do not reflect a complete picture of the transactions, have been incorrectly characterised or labelled by the enterprises, or are a sham." (OECD TP Guidance)
- Actual conduct takes priority
- Example: contract says licence, but practice shows that licensor controls business risks and output of licensee
"[1.48] Company S is a wholly-owned subsidiary of Company P. The parties have entered into a written contract pursuant to which Company P licenses intellectual property to Company S for use in Company S’s business; Company S agrees to compensate Company P for the licence with a royalty. Evidence provided by other economically relevant characteristics, and in particular the functions performed, establishes that Company P performs negotiations with third-party customers to achieve sales for Company S, provides regular technical services support to Company S so that Company S can deliver contracted sales to its customers, and regularly provides staff to enable Company S to fulfil customer contracts. A majority of customers insist on including Company P as joint contracting party along with Company S, although fee income under the contract is payable to Company S. The analysis of the commercial or financial relations indicates that Company S is not capable of providing the contracted services to customers without significant support from Company P, and is not developing its own capability. Under the contract, Company P has given a licence to Company S, but in fact controls the business risk and output of Company S such that it has not transferred risk and function consistent with a licensing arrangement, and acts not as the licensor but the principal." (OECD TP Guidance)
- Example: contract says licence, but practice shows that licensor controls business risks and output of licensee
- Transaction not formalised: all aspects need to be deducted from evidence of conduct
"[1.49] Where the transaction has not been formalised, all aspects would need to be deduced from available evidence of the conduct of the parties, including what functions are actually performed, what assets are actually used, and what risks are actually assumed by each of the parties." (OECD TP Guidance)
- Transaction not formalised: all aspects need to be deducted from evidence of conduct
(2) FUNCTIONS PERFORMED BY EACH PARTY
(2) FUNCTIONS PERFORMED BY EACH PARTY
- Activities, responsibilities, assets used/contributed, risks assumed, capabilities provided
"[1.51] ...This functional analysis seeks to identify the economically significant activities and responsibilities undertaken, assets used or contributed, and risks assumed by the parties to the transactions. The analysis focuses on what the parties actually do and the capabilities they provide..." (OECD TP Guidance)
- Activities, responsibilities, assets used/contributed, risks assumed, capabilities provided
- Including decision-making and strategy
"[1.51] ...Such activities and capabilities will include decision-making, including decisions about business strategy and risks...." (OECD TP Guidance)
- Including decision-making and strategy
- Identify the contributions each enterprise makes to value creation
"[1.51] ...In particular, it is important to understand how value is generated by the group as a whole, the interdependencies of the functions performed by the associated enterprises with the rest of the group, and the contribution that the associated enterprises make to that value creation..." (OECD TP Guidance)
- Identify the contributions each enterprise makes to value creation
- Economic significance of contributions rather than volume
"[1.51] ...While one party may provide a large number of functions relative to that of the other party to the transaction, it is the economic significance of those functions in terms of their frequency, nature, and value to the respective parties to the transactions that is important..." (OECD TP Guidance)
- Economic significance of contributions rather than volume
- Interdependencies and co-ordination
"[1.55] There may be considerable interdependencies between the fragmented activities. For example, the separation into different legal entities of logistics, warehousing, marketing, and sales functions may require considerable co-ordination in order that the separate activities interact effectively...That required co-ordination may be performed by some or all of the associated enterprises performing the fragmented activities, performed through a separate co-ordination function, or performed through a combination of both. Risk may be mitigated through contributions from all the parties, or risk mitigation activities may be undertaken mainly by the co-ordination function. Therefore, when conducting a functional analysis to identify the commercial or financial relations in fragmented activities, it will be important to determine whether those activities are highly interdependent, and, if so, the nature of the interdependencies and how the commercial activity to which the associated enterprises contribute is co-ordinated." (OECD TP Guidance)
- Interdependencies and co-ordination
Assets
Assets
- Assets used
"[1.54] The functional analysis should consider the type of assets used, such as plant and equipment, the use of valuable intangibles, financial assets, etc., and the nature of the assets used, such as the age, market value, location, property right protections available, etc." (OECD TP Guidance)
- Assets used
- Contractual rights, government licences, know-how necessary to exploit local market may be valuable intangibles
"[1.169] In conducting a transfer pricing analysis it is important to distinguish between features of the local market, which are not intangibles, and any contractual rights, government licences, or know-how necessary to exploit that market, which may be intangibles. Depending on the circumstances, these types of intangibles may have substantial value that should be taken into account in a transfer pricing analysis in the manner described in Chapter VI, including the guidance on rewarding entities for functions, assets and risks associated with the development of intangibles contained in Section B of Chapter VI..." (OECD TP Guidance)
- Contractual rights, government licences, know-how necessary to exploit local market may be valuable intangibles
Intangible assets
Intangible assets
- Allocation of returns from intangible assets should reflect the functions performed, assets used and risks assumed to develop, enhance, maintain, protect + exploit (DEMPE)
"[6.32] ... Although the legal owner of an intangible may receive the proceeds from exploitation of the intangible, other members of the legal owner’s MNE group may have performed functions, used assets,4 or assumed risks that are expected to contribute to the value of the intangible. Members of the MNE group performing such functions, using such assets, and assuming such risks must be compensated for their contributions under the arm’s length principle. This Section B confirms that the ultimate allocation of the returns derived by the MNE group from the exploitation of intangibles, and the ultimate allocation of costs and other burdens related to intangibles among members of the MNE group, is accomplished by compensating members of the MNE group for functions performed, assets used, and risks assumed in the development, enhancement, maintenance, protection and exploitation of intangibles according to the principles described in Chapters I-III." (OECD TP Guidance)
- Allocation of returns from intangible assets should reflect the functions performed, assets used and risks assumed to develop, enhance, maintain, protect + exploit (DEMPE)
- Externally purchased intangible which is fully developed where purchaser funds purchase + maintains + controls exploitation
"[6.49] ... The key asset used is the funding required to purchase the intangible. If the purchaser has the capacity and actually performs all the key functions described, including control of the risks associated with acquiring and exploiting the intangible, it may be reasonable to conclude that, after making arm’s length payment for the manufacturing and distribution functions of other associated enterprises, the owner would be entitled to retain or have attributed to it any income or loss derived from the post-acquisition exploitation of the intangible." (OECD TP Guidance)
- Externally purchased intangible which is fully developed where purchaser funds purchase + maintains + controls exploitation
- Performance: each member should receive compensation for the function it performs
"[6.50] ... Under the principles of Chapters I-III, each member of the MNE group should receive arm’s length compensation for the functions it performs. In cases involving intangibles, this includes functions related to the development, enhancement, maintenance, protection, and exploitation of intangibles." (OECD TP Guidance)
- Performance: each member should receive compensation for the function it performs
- Control: each member should receive compensation for the function it controls
"[6.53] ... Because of the nature of the relationships between associated enterprises that are members of an MNE group, however, it may be the case that outsourced functions performed by associated enterprises will be controlled by an entity other than the legal owner of the intangibles. In such cases, the legal owner of the intangible should also compensate the entity performing control functions related to the development, enhancement, maintenance, protection, and exploitation of intangibles on an arm’s length basis. In assessing what member of the MNE group in fact controls the performance of the relevant functions, principles apply analogous to those for determining control over risk in Section D.1.2.1 of Chapter I. Assessing the capacity of a particular entity to exert control and the actual performance of such control functions will be an important part of the analysis." (OECD TP Guidance)
- Control: each member should receive compensation for the function it controls
- Legal owner may outsource performance of a function
"[6.51] ... It is not essential that the legal owner physically performs all of the functions related to the development, enhancement, maintenance, protection and exploitation of an intangible through its own personnel in order to be entitled ultimately to retain or be attributed a portion of the return derived by the MNE group from exploitation of the intangibles. In transactions between independent enterprises, certain functions are sometimes outsourced to other entities. A member of an MNE group that is the legal owner of intangibles could similarly outsource functions related to the development, enhancement, maintenance, protection or exploitation of intangibles to either independent enterprises or associated enterprises." (OECD TP Guidance)
- Legal owner may outsource performance of a function
- Important functions with special significance (e.g. design + control of research and marketing programmes, quality control)
"[6.55] In considering the arm’s length compensation for functional contributions of various members of the MNE group, certain important functions will have special significance. The nature of these important functions in any specific case will depend on the facts and circumstances. For self-developed intangibles, or for self-developed or acquired intangibles that serve as a platform for further development activities, these more important functions may include, among others, design and control of research and marketing programmes, direction of and establishing priorities for creative undertakings including determining the course of “blue-sky” research, control over strategic decisions regarding intangible development programmes, and management and control of budgets. For any intangible (i.e. for either self-developed or acquired intangibles) other important functions may also include important decisions regarding defence and protection of intangibles, and ongoing quality control over functions performed by independent or associated enterprises that may have a material effect on the value of the intangible. Those important functions usually make a significant contribution to intangible value and, if those important functions are outsourced by the legal owner in transactions between associated enterprises, the performance of those functions should be compensated with an appropriate share of the returns derived by the MNE group from the exploitation of intangibles" (OECD TP Guidance)
- Important functions with special significance (e.g. design + control of research and marketing programmes, quality control)
- Assumption of particular risks may have importance in relation to DEMPE
"[6.65] Particular types of risk that may have importance in a functional analysis relating to transactions involving intangibles include
(i) risks related to development of intangibles, including the risk that costly research and development or marketing activities will prove to be unsuccessful, and taking into account the timing of the investment (for example, whether the investment is made at an early stage, mid-way through the development process, or at a late stage will impact the level of the underlying investment risk);
(ii) the risk of product obsolescence, including the possibility that technological advances of competitors will adversely affect the value of the intangibles;
(iii) infringement risk, including the risk that defence of intangible rights or defence against other persons’ claims of infringement may prove to be time consuming, costly and/ or unavailing;
(iv) product liability and similar risks related to products and services based on the intangibles; and
(v) exploitation risks, uncertainties in relation to the returns to be generated by the intangible.
The existence and level of such risks will depend on the facts and circumstances of each individual case and the nature of the intangible in question.
[6.66] The identity of the member or members of the group assuming risks related to the development, enhancement, maintenance, protection, and exploitation of intangibles is an important consideration in determining prices for controlled transactions. The assumption of risk will determine which entity or entities will be responsible for the consequences if the risk materialises." (OECD TP Guidance)
- Assumption of particular risks may have importance in relation to DEMPE
- Distributor who performs marketing function but does not bear any risks normally entitled only to remuneration for that service
"[6.77] ... One relatively clear case is where a distributor acts merely as an agent, being reimbursed for its promotional expenditures and being directed and controlled in its activities by the owner of the trademarks and other marketing intangibles. In that case, the distributor ordinarily would be entitled to compensation appropriate to its agency activities alone. It does not assume the risks associated with the further development of the trademark and other marketing intangibles, and would therefore not be entitled to additional remuneration in that regard." (OECD TP Guidance)
- Distributor who performs marketing function but does not bear any risks normally entitled only to remuneration for that service
- Distributor may develop their own intangibles (customer lists, relationships, data, logistical know how etc.)
"[6.199] For example, a tested party engaged in the marketing and distribution of goods purchased in controlled transactions may have developed marketing intangibles in its geographic area of operation, including customer lists, customer relationships, and customer data. It may also have developed advantageous logistical know-how or software and other tools that it uses in conducting its distribution business. The impact of such intangibles on the profitability of the tested party should be considered in conducting a comparability analysis." (OECD TP Guidance)
- Distributor may develop their own intangibles (customer lists, relationships, data, logistical know how etc.)
Other advantages
Other advantages
- Assembled workforce
"[1.172] Some businesses are successful in assembling a uniquely qualified or experienced cadre of employees. The existence of such an employee group may affect the arm’s length price for services provided by the employee group or the efficiency with which services are provided or goods produced by the enterprise. Such factors should ordinarily be taken into account in a transfer pricing comparability analysis. Where it is possible to determine the benefits or detriments of a unique assembled workforce vis-à-vis the workforce of enterprises engaging in potentially comparable transactions, comparability adjustments may be made to reflect the impact of the assembled workforce on arm’s length prices for goods or services.
[1.173] In some business restructuring and similar transactions, it may be the case that an assembled workforce is transferred from one associated enterprise to another as part of the transaction. In such circumstances, it may well be that the transfer of the assembled workforce along with other transferred assets of the business will save the transferee the time and expense of hiring and training a new workforce. Depending on the transfer pricing methods used to evaluate the overall transaction, it may be appropriate in such cases to reflect such time and expense savings in the form of comparability adjustments to the arm’s length price otherwise charged with respect to the transferred assets. In other situations, the transfer of the assembled workforce may result in limitations on the transferee’s flexibility in structuring business operations and create potential liabilities if workers are terminated. In such cases it may be appropriate for the compensation paid in connection with the restructuring to reflect the potential future liabilities and limitations." (OECD TP Guidance)
- Assembled workforce
- Group synergies
"[1.177] In some circumstances, MNE groups and the associated enterprises that comprise such groups may benefit from interactions or synergies amongst group members that would not generally be available to similarly situated independent enterprises. Such group synergies can arise, for example, as a result of combined purchasing power or economies of scale, combined and integrated computer and communication systems, integrated management, elimination of duplication, increased borrowing capacity, and numerous similar factors. Such group synergies are often favourable to the group as a whole and therefore may heighten the aggregate profits earned by group members, depending on whether expected cost savings are, in fact, realised, and on competitive conditions. In other circumstances such synergies may be negative, as when the size and scope of corporate operations create bureaucratic barriers not faced by smaller and more nimble enterprises, or when one portion of the business is forced to work with computer or communication systems that are not the most efficient for its business because of group wide standards established by the MNE group." (OECD TP Guidance)
- Group synergies
Risks
Risks
- Actual assumption of risks would influence prices and other conditions
"[1.56] A functional analysis is incomplete unless the material risks assumed by each party have been identified and considered since the actual assumption of risks would influence the prices and other conditions of transactions between the associated enterprises. Usually, in the open market, the assumption of increased risk would also be compensated by an increase in the expected return, although the actual return may or may not increase depending on the degree to which the risks are actually realised. The level and assumption of risk, therefore, are economically relevant characteristics that can be significant in determining the outcome of a transfer pricing analysis." (OECD TP Guidance)
- Actual assumption of risks would influence prices and other conditions
- Risk assumption v. risk management
"[1.63] Risk management is not the same as assuming a risk. Risk assumption means taking on the upside and downside consequences of the risk with the result that the party assuming a risk will also bear the financial and other consequences if the risk materialises. A party performing part of the risk management functions may not assume the risk that is the subject of its management activity, but may be hired to perform risk mitigation functions under the direction of the risk-assuming party. For example, the day-to-day mitigation of product recall risk may be outsourced to a party performing monitoring of quality control over a specific manufacturing process according to the specifications of the party assuming the risk." (OECD TP Guidance)
- Risk assumption v. risk management
- Identifying capacity to assume risk
"[1.64] Financial capacity to assume risk can be defined as access to funding to take on the risk or to lay off the risk, to pay for the risk mitigation functions and to bear the consequences of the risk if the risk materialises. Access to funding by the party assuming the risk takes into account the available assets and the options realistically available to access additional liquidity, if needed, to cover the costs anticipated to arise should the risk materialise. This assessment should be made on the basis that the party assuming the risk is operating as an unrelated party in the same circumstances as the associated enterprise, as accurately delineated under the principles of this section." (OECD TP Guidance)
- Identifying capacity to assume risk
- Providing funding to meet the risk is not the same as assuming the risk
"[1.64] ... Where a party assuming risk receives intra-group funding to meet the funding demands in relation to the risk, the party providing the funding may assume financial risk but does not, merely as a consequence of providing funding, assume the specific risk that gives rise to the need for additional funding..." (OECD TP Guidance)
- Providing funding to meet the risk is not the same as assuming the risk
- Assumption of risk is assessed before the risk materialises or not
"[1.78] A contractual assumption of risk constitutes an ex ante agreement to bear some or all of the potential costs associated with the ex post materialisation of downside outcomes of risk in return for some or all of the potential benefit associated with the ex post materialisation of positive outcomes. Importantly, ex ante contractual assumption of risk should provide clear evidence of a commitment to assume risk prior to the materialisation of risk outcomes..." (OECD TP Guidance)
- Assumption of risk is assessed before the risk materialises or not
- Approach to pricing not necessarily determinative of allocation of risk
"[1.81] ... Therefore, one may not infer from the fact that the price paid between associated enterprises for goods or services is set at a particular level, or by reference to a particular margin, that risks are borne by those associated enterprises in a particular manner. For example, a manufacturer may claim to be protected from the risk of price fluctuation of raw material as a consequence of its being remunerated by another group company on a basis that takes account of its actual costs. The implication of the claim is that the other group company bears the risk. The form of remuneration cannot dictate inappropriate risk allocations. It is the determination of how the parties actually manage and control risks, as set out in the remaining steps of the process of analysing risk, which will determine the assumption of risks by the parties, and consequently dictate the selection of the most appropriate transfer pricing method." (OECD TP Guidance)
- Approach to pricing not necessarily determinative of allocation of risk
- Risk allocated to enterprise exercising control and having financial capacity to assume risk
"[1.98] If it is established in step 4(ii) that the associated enterprise assuming the risk based on steps 1-4(i) does not exercise control over the risk or does not have the financial capacity to assume the risk, then the risk should be allocated to the enterprise exercising control and having the financial capacity to assume the risk. If multiple associated enterprises are identified that both exercise control and have the financial capacity to assume the risk, then the risk should be allocated to the associated enterprise or group of associated enterprises exercising the most control. The other parties performing control activities should be remunerated appropriately, taking into account the importance of the control activities performed." (OECD TP Guidance)
- Risk allocated to enterprise exercising control and having financial capacity to assume risk
- Assumption of risk should be compensated with an appropriate anticipated return
"[1.100] ...The assumption of a risk should be compensated with an appropriate anticipated return, and risk mitigation should be appropriately remunerated. Thus, a taxpayer that both assumes and mitigates a risk will be entitled to greater anticipated remuneration than a taxpayer that only assumes a risk, or only mitigates, but does not do both." (OECD TP Guidance)
- Assumption of risk should be compensated with an appropriate anticipated return
(3) CHARACTERISTICS OF PROPERTY/SERVICES PROVIDED
(3) CHARACTERISTICS OF PROPERTY/SERVICES PROVIDED
- Differences in specific characteristics of what is provided may affect value
"[1.127] Differences in the specific characteristics of property or services often account, at least in part, for differences in their value in the open market. Therefore, comparisons of these features may be useful in delineating the transaction and in determining the comparability of controlled and uncontrolled transactions..." (OECD TP Guidance)
- Differences in specific characteristics of what is provided may affect value
- Property: features such as quality, reliability, availability, volume
"[1.127] ...Characteristics that may be important to consider include the following: in the case of transfers of tangible property, the physical features of the property, its quality and reliability, and the availability and volume of supply;" (OECD TP Guidance)
- Property: features such as quality, reliability, availability, volume
- Services: nature and extent
"[1.127] ...in the case of the provision of services, the nature and extent of the services..." (OECD TP Guidance)
- Services: nature and extent
- Intangible property: form of transaction, type of property, duration, expected benefits
"[1.127] ...and in the case of intangible property, the form of transaction (e.g. licensing or sale), the type of property (e.g. patent, trademark, or know-how), the duration and degree of protection, and the anticipated benefits from the use of the property..." (OECD TP Guidance)
- Intangible property: form of transaction, type of property, duration, expected benefits
- Relevance depends on method (most relevant to comparable uncontrolled price)
"[1.127] ...Among the methods described at Chapter II of these Guidelines, the requirement for comparability of property or services is the strictest for the comparable uncontrolled price method. Under the comparable uncontrolled price method, any material difference in the characteristics of property or services can have an effect on the price and would require an appropriate adjustment to be considered (see in particular paragraph 2.16). Under the resale price method and cost plus method, some differences in the characteristics of property or services are less likely to have a material effect on the gross profit margin or mark-up on costs (see in particular paragraphs 2.29 and 2.47). Differences in the characteristics of property or services are also less sensitive in the case of the transactional profit methods than in the case of traditional transaction methods (see in particular paragraph 2.75). This however does not mean that the question of comparability in characteristics of property or services can be ignored when applying transactional profit methods, because it may be that product differences entail or reflect different functions performed, assets used and/or risks assumed by the tested party...." (OECD TP Guidance)
- Relevance depends on method (most relevant to comparable uncontrolled price)
(4) ECONOMIC CIRCUMSTANCES OF PARTIES + MARKET
(4) ECONOMIC CIRCUMSTANCES OF PARTIES + MARKET
- Same property or service may achieve different price in different market
"[1.130] Arm’s length prices may vary across different markets even for transactions involving the same property or services; therefore, to achieve comparability requires that the markets in which the independent and associated enterprises operate do not have differences that have a material effect on price or that appropriate adjustments can be made. As a first step, it is essential to identify the relevant market or markets taking account of available substitute goods or services. Economic circumstances that may be relevant to determining market comparability include the geographic location; the size of the markets; the extent of competition in the markets and the relative competitive positions of the buyers and sellers; the availability (risk thereof) of substitute goods and services; the levels of supply and demand in the market as a whole and in particular regions, if relevant; consumer purchasing power; the nature and extent of government regulation of the market; costs of production, including the costs of land, labour, and capital; transport costs; the level of the market (e.g. retail or wholesale); the date and time of transactions; and so forth. (OECD TP Guidance)
- Same property or service may achieve different price in different market
- Location savings: do they exist and are they retained by the supplier?
"[1.162] Where the functional analysis shows that location savings exist that are not passed on to customers or suppliers, and where comparable entities and transactions in the local market can be identified, those local market comparables will provide the most reliable indication regarding how the net location savings should be allocated amongst two or more associated enterprises. Thus, where reliable local market comparables are available and can be used to identify arm’s length prices, specific comparability adjustments for location savings should not be required." (OECD TP Guidance)
(5) BUSINESS STRATEGIES PURSUED BY PARTIES
(5) BUSINESS STRATEGIES PURSUED BY PARTIES
- Business strategy may affect pricing (e.g. lower price to try to penetrate market)
"[1.135] Business strategies also could include market penetration schemes. A taxpayer seeking to penetrate a market or to increase its market share might temporarily charge a price for its product that is lower than the price charged for otherwise comparable products in the same market. Furthermore, a taxpayer seeking to enter a new market or expand (or defend) its market share might temporarily incur higher costs (e.g. due to start-up costs or increased marketing efforts) and hence achieve lower profit levels than other taxpayers operating in the same market." (OECD TP Guidance)
- Business strategy may affect pricing (e.g. lower price to try to penetrate market)
- Especially low prices would be expected for a limited period only, with object of improving longer term profits
"[1.151] ...Recurring losses for a reasonable period may be justified in some cases by a business strategy to set especially low prices to achieve market penetration. For example, a producer may lower the prices of its goods, even to the extent of temporarily incurring losses, in order to enter new markets, to increase its share of an existing market, to introduce new products or services, or to discourage potential competitors. However, especially low prices should be expected for a limited period only, with the specific object of improving profits in the longer term. If the pricing strategy continues beyond a reasonable period, a transfer pricing adjustment may be appropriate, particularly where comparable data over several years show that the losses have been incurred for a period longer than that affecting comparable independent enterprises..." (OECD TP Guidance)
FINDING ARM'S LENGTH PRICE
FINDING ARM'S LENGTH PRICE
- Especially low prices would be expected for a limited period only, with object of improving longer term profits
- Every effort should be made to find arm's length price for actual transaction
"[1.141] Every effort should be made to determine pricing for the actual transaction as accurately delineated under the arm’s length principle. The various tools and methods available to tax administrations and taxpayers to do so are set out in the following chapters of these Guidelines. A tax administration should not disregard the actual transaction or substitute other transactions for it unless the exceptional circumstances described in the following paragraphs 1.142-1.145 apply." (OECD TP Guidance)
- Every effort should be made to find arm's length price for actual transaction
- Compare to alternative options (e.g. use of group name v. a different name)
"[6.83] In determining the amount of payment with respect to a group name, it is important to consider the amount of the financial benefit to the user of the name attributable to use of that name, the costs and benefits associated with other alternatives, and the relative contributions to the value of the name made by the legal owner, and the entity using the name in the form of functions performed, assets used and risks assumed. Careful consideration should be given to the functions performed, assets used, and risks assumed by the user of the name in creating or enhancing the value of the name inits jurisdiction. Factors that would be important in a licence of the name to an independent enterprise under comparable circumstances applying the principles of Chapters I-III should be taken into account." (OECD TP Guidance)
- Compare to alternative options (e.g. use of group name v. a different name)
- Realistically available alternative options to each party
"[6.111] In applying the principles of the Guidelines related to the content and process of a comparability analysis to a transaction involving intangibles, a transfer pricing analysis must consider the options realistically available to each of the parties to the transaction." (OECD TP Guidance)
- Realistically available alternative options to each party
- Perspectives of both parties
"[6.112]. In considering the options realistically available to the parties, the perspectives of each of the parties to the transaction must be considered. A comparability analysis focusing only on one side of a transaction generally does not provide a sufficient basis for evaluating a transaction involving intangibles (including in those situations for which a one-sided transfer pricing method is ultimately determined)." (OECD TP Guidance)
- Perspectives of both parties
- Inability of associated enterprise to fully exploit what is provided not itself a reason to reduce the price
"[6.113] For example, a transferor would not be expected to accept a price for the transfer of either all or part of its rights in an intangible that is less advantageous to the transferor than its other realistically available options (including making no transfer at all), merely because a particular associated enterprise transferee lacks the resources to effectively exploit the transferred rights in the intangible. Similarly, a transferee should not be expected to accept a price for a transfer of rights in one or more intangibles that would make it impossible for the transferee to anticipate earning a profit using the acquired rights in the intangible in its business. Such an outcome would be less favourable to the transferee than its realistically available option of not engaging in the transfer at all." (OECD TP Guidance)
- Inability of associated enterprise to fully exploit what is provided not itself a reason to reduce the price
- Alternative distributor/marketer may have similar intangibles available (customers data, logistics etc.)
"[6.200] It is important to note, however, that in many cases where the tested party uses such intangibles, parties to comparable uncontrolled transactions will also have the same types of intangibles at their disposal. Thus, in the distribution company case, an uncontrolled entity engaged in providing distribution services in the tested party’s industry and market is also likely to have knowledge of and contacts with potential customers, collect customer data, have its own effective logistical systems, and in other respects have similar intangibles to the tested party. Where that is the case, the level of comparability may be sufficiently high that it is possible to rely on prices paid or margins earned by the potential comparables as an appropriate measure of arm’s length compensation for both the functions performed and the intangibles owned by the tested party.
[6.201] Where the tested party and the potential comparable have comparable intangibles, the intangibles will not constitute unique and valuable intangibles within the meaning of paragraph 6.17, and therefore no comparability adjustments will be required with regard to the intangibles..." (OECD TP Guidance)
- Alternative distributor/marketer may have similar intangibles available (customers data, logistics etc.)
Recharacterising the actual transaction
Recharacterising the actual transaction
- Does the actual transaction possess the commercial rationality of arrangement between unrelated parties
"[1.143] The key question in the analysis is whether the actual transaction possesses the commercial rationality of arrangements that would be agreed between unrelated parties under comparable economic circumstances, not whether the same transaction can be observed between independent parties. The non-recognition of a transaction that possesses the commercial rationality of an arm’s length arrangement is not an appropriate application of the arm’s length principle. Restructuring of legitimate business transactions would be a wholly arbitrary exercise the inequity of which could be compounded by double taxation created where the other tax administration does not share the same views as to how the transaction should be structured. It should again be noted that the mere fact that the transaction may not be seen between independent parties does not mean that it does not have characteristics of an arm’s length arrangement." (OECD TP Guidance)
- Does the actual transaction possess the commercial rationality of arrangement between unrelated parties
- Example: insuring the uninsurable (disregard the insurance transaction)
"[1.146] Company S1 carries on a manufacturing business that involves holding substantial inventory and a significant investment in plant and machinery. It owns commercial property situated in an area prone to increasingly frequent flooding in recent years. Third-party insurers experience significant uncertainty over the exposure to large claims, with the result that there is no active market for the insurance of properties in the area. Company S2, an associated enterprise, provides insurance to Company S1, and an annual premium representing 80% of the value of the inventory, property and contents is paid by Company S1. In this example S1 has entered into a commercially irrational transaction since there is no market for insurance given the likelihood of significant claims, and either relocation or not insuring may be more attractive realistic alternatives. Since the transaction is commercially irrational, there is not a price that is acceptable to both S1 and S2 from their individual perspectives.
[1.147] Under the guidance in this section, the transaction should not be recognised. S1 is treated as not purchasing insurance and its profits are not reduced by the payment to S2; S2 is treated as not issuing insurance and therefore not being liable for any claim." (OECD TP Guidance)
- A replacement transaction/structure should be as close as possible to the actual transaction
- A replacement transaction/structure should be as close as possible to the actual transaction
"[1.144] The structure that for transfer pricing purposes, replaces that actually adopted by the taxpayers should comport as closely as possible with the facts of the actual transaction undertaken whilst achieving a commercially rational expected result that would have enabled the parties to come to a price acceptable to both of them at the time the arrangement was entered into." (OECD TP Guidance)
- Example: insuring the uninsurable (disregard the insurance transaction)
- Example: sale of future rights where their content and value is so uncertain and speculative as to make it commercially irrational
"[1.148] Company S1 conducts research activities to develop intangibles that it uses to create new products that it can produce and sell. It agrees to transfer to an associated company, Company S2, unlimited rights to all future intangibles which may arise from its future work over a period of twenty years for a lump sum payment. The arrangement is commercially irrational for both parties since neither Company S1 nor Company S2 has any reliable means to determine whether the payment reflects an appropriate valuation, both because it is uncertain what range of development activities Company S1 might conduct over the period and also because valuing the potential outcomes would be entirely speculative. Under the guidance in this section, the structure of the arrangement adopted by the taxpayer, including the form of payment, should be modified for the purposes of the transfer pricing analysis. The replacement structure should be guided by the economically relevant characteristics, including the functions performed, assets used, and risks assumed, of the commercial or financial relations of the associated enterprises. Those facts would narrow the range of potential replacement structures to the structure most consistent with the facts of the case (for example, depending on those facts the arrangement could be recast as the provision of financing by Company S2, or as the provision of research services by Company S1, or, if specific intangibles can be identified, as a licence with contingent payments terms for the development of those specific intangibles, taking into account the guidance on hard-to-value intangibles as appropriate)." (OECD TP Guidance)
- Example: sale of future rights where their content and value is so uncertain and speculative as to make it commercially irrational
ADJUSTMENTS
ADJUSTMENTS
- "re-writing the accounts for tax purposes"
"[1.7]...Paragraph 1 of Article 9 of the OECD Model Tax Convention is the foundation for comparability analyses because it introduces the need for: • A comparison between conditions (including prices, but not only prices) made or imposed between associated enterprises and those which would be made between independent enterprises, in order to determine whether a re-writing of the accounts for the purposes of calculating tax liabilities of associated enterprises is authorised under Article 9 of the OECD Model Tax Convention (see paragraph 2 of the Commentary on Article 9);..." (OECD TP Guidance)
- "re-writing the accounts for tax purposes"
- Matching downward adjustment
"[161] Article 9 of the MTC allows for profit adjustments if the actual price or the conditions of transactions between associated enterprises differ from the price or conditions that would be charged by independent enterprises under normal market commercial terms; i.e., an arm's length basis. It requires that an appropriate "corresponding adjustment" be made by the other Contracting State, in such cases, to avoid economic double taxation and taxation of essentially the same profit in the hands of two different legal entities, if justified in principle and in amount. In other words, if one country increases the profit attributed to one side of the transaction, the other country should reduce the profit attributed to the other side of the transaction. The competent authorities of the Contracting States are, if necessary, to consult with each other in determining the adjustment..." (Lifeplus Europe Ltd v. HMRC [2026] UKFTT 797 (TC), Judge Manyarara)
- Matching downward adjustment
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