Transfer Pricing and Attribution
of Income
Master International and European Tax Law
TAX4020
,Table of Contents
List of Abbreviations...................................................................................................................................... 4
Introduction.................................................................................................................................................. 4
Chapter 1 The Key to Understanding Transfer Pricing: The Arm’s Length Principle..........................................5
1.1 Introduction....................................................................................................................................................5
1.2 Possible methods for sharing the profits of multinational enterprises: formulary apportionment or the
arm’s length principle?.........................................................................................................................................5
1.3 The arm’s length principle in theory..............................................................................................................7
1.4 The arm’s length principle in practice............................................................................................................7
1.5 The tax arbitrage resulting from intercompany pricing: the distinction between acceptable and
unacceptable tax planning...................................................................................................................................9
1.6 The OECD Guidelines......................................................................................................................................9
1.7 Transfer pricing documentation...................................................................................................................10
Chapter 2 The transfer pricing methods recognised by the OECD Guidelines.................................................10
2.1 Introduction..................................................................................................................................................10
2.2 Traditional transaction methods..................................................................................................................10
2.2.1 The CUP method...................................................................................................................................10
2.2.2 The resale price method.......................................................................................................................11
2.2.3 The cost plus method...........................................................................................................................11
2.3 Transactional profit methods.......................................................................................................................12
2.3.1 The transactional net margin methods................................................................................................12
2.3.2 The transactional profit split method...................................................................................................13
2.4 The combined use of several transfer pricing methods...............................................................................13
Chapter 3 Transfer Pricing Models................................................................................................................ 14
3.1 Introduction..................................................................................................................................................14
3.2 Standardised transfer pricing models..........................................................................................................15
3.3 Intercompany transactions involving intangible property...........................................................................15
3.4 Common types of intercompany transactions and transfer pricing models................................................16
3.4.1 Research and Development..................................................................................................................16
3.4.2 Manufacturing......................................................................................................................................17
3.4.3 Distribution...........................................................................................................................................18
3.4.4 Intercompany services..........................................................................................................................19
3.4.5 Financial transactions...........................................................................................................................21
3.4.6 Cost contribution arrangements..........................................................................................................22
3.4.7 The centralised entrepreneur model...................................................................................................23
Chapter 4 Cross-Border Business Restructurings...........................................................................................24
4.1 Introduction..................................................................................................................................................24
4.2 Frequent types of cross-border business restructurings..............................................................................25
4.3 Should a cross-border business restructuring give rise to the payment of compensation between the
restructured entities?.........................................................................................................................................26
2
, 4.3.1 Has something of value been transferred from one company to another company?........................26
4.3.2 Does the business restructuring involve the termination or the substantial renegotiation of existing
arrangements?...............................................................................................................................................27
Chapter 5 The Substance Requirement from a Transfer Pricing Perspective..................................................27
5.1 The purpose of the substance requirement.................................................................................................27
5.2 The determination of whether or not an intercompany transaction is supported by sufficient substance.28
5.2.1 Introduction..........................................................................................................................................28
5.2.2 The substance requirement applied to functions................................................................................29
5.2.3 The substance requirement applied to risks........................................................................................29
5.2.4 The substance requirement applied to assets.....................................................................................29
5.3 The substance requirement applied to cross-border business restructurings.............................................30
Chapter 6 The Attribution of Profit to Permanent Establishments.................................................................30
6.1 Introduction: What is a permanent establishment?....................................................................................30
6.2 Background on the attribution of profits to permanent establishments and former principles
recommended by the OECD...............................................................................................................................31
6.3 The authorised OECD approach...................................................................................................................31
6.3.1 The applicability of the Authorised OECD Approach............................................................................31
6.3.2 Rationale of the Authorised OECD Approach.......................................................................................32
6.3.3 The functional and factual analysis......................................................................................................32
6.3.4 The comparability analysis...................................................................................................................34
Chapter 7 The Prevention and the Resolution of Transfer Pricing Disputes....................................................34
7.1 Introduction..................................................................................................................................................34
7.2 Advance pricing arrangements....................................................................................................................35
7.2.1 The purpose of advance pricing arrangements....................................................................................35
7.2.2 The different types of advance pricing arrangements.........................................................................35
7.2.3 The procedure to apply for an advance pricing arrangement.............................................................36
7.3 Mutual agreement procedures....................................................................................................................37
7.3.1 The purpose of a mutual agreement procedure..................................................................................37
7.3.2 The different steps of a mutual agreement procedure........................................................................37
7.4 Arbitration....................................................................................................................................................38
7.4.1 Introduction..........................................................................................................................................38
7.4.2 Arbitration in tax treaties.....................................................................................................................39
7.4.3 The EU Arbitration Convention.............................................................................................................39
3
, List of Abbreviations
APA Advance pricing arrangement
BEPS Base erosion and profit shifting
CCA Cost contribution arrangement
CCCTB Common consolidated corporate tax base
CFC Controlled foreign company
CJEU Court of Justice of the European Union
COGS Cost of goods sold
CUP Comparable uncontrolled price
EU European Union
IP Intangible property
IT Information technology
OECD Organisation for Economic Co-operation and Development
OECD Guidelines OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax
Administrations
OPEX Operating expenses
R&D Research and development
TNMM Transactional net margin method
UN United Nations
Routine vs Key functions:
The testing party is “routine” if the significantly greater part of the risk behind the
contractual relationship is allocated at the other contracting party. Such other party so
becomes “entrepreneurial” in this transaction – and, consequently, can be characterized
non-routine.
From this, we conclude that the tested party which performs routine functions and bears
routine risks bears little consequences of a malfunction of the transactional relationship AND
any other contractual relationship the tested party executes. Vice versa, that corporate unit
(e.g. legal entity of a multinational group, permanent establishment, profit centre, cost
centre) which is defined as non-routine bears the risk of malfunctioning, damages, costs of
underperformance, or even loss and ruin.
Introduction
Transfer pricing is an area of tax law that has significantly expanded over the last few
decades. This is partly explained by the globalisation of business activities: enterprises are
getting more global so as to reach new markets and make their organisation more efficient.
Another reason is related to the tax planning opportunities that are made possible through
cross-border controlled transactions, something that States are willing to monitor so as to
avoid the illegitimate erosion of their tax base.
4
of Income
Master International and European Tax Law
TAX4020
,Table of Contents
List of Abbreviations...................................................................................................................................... 4
Introduction.................................................................................................................................................. 4
Chapter 1 The Key to Understanding Transfer Pricing: The Arm’s Length Principle..........................................5
1.1 Introduction....................................................................................................................................................5
1.2 Possible methods for sharing the profits of multinational enterprises: formulary apportionment or the
arm’s length principle?.........................................................................................................................................5
1.3 The arm’s length principle in theory..............................................................................................................7
1.4 The arm’s length principle in practice............................................................................................................7
1.5 The tax arbitrage resulting from intercompany pricing: the distinction between acceptable and
unacceptable tax planning...................................................................................................................................9
1.6 The OECD Guidelines......................................................................................................................................9
1.7 Transfer pricing documentation...................................................................................................................10
Chapter 2 The transfer pricing methods recognised by the OECD Guidelines.................................................10
2.1 Introduction..................................................................................................................................................10
2.2 Traditional transaction methods..................................................................................................................10
2.2.1 The CUP method...................................................................................................................................10
2.2.2 The resale price method.......................................................................................................................11
2.2.3 The cost plus method...........................................................................................................................11
2.3 Transactional profit methods.......................................................................................................................12
2.3.1 The transactional net margin methods................................................................................................12
2.3.2 The transactional profit split method...................................................................................................13
2.4 The combined use of several transfer pricing methods...............................................................................13
Chapter 3 Transfer Pricing Models................................................................................................................ 14
3.1 Introduction..................................................................................................................................................14
3.2 Standardised transfer pricing models..........................................................................................................15
3.3 Intercompany transactions involving intangible property...........................................................................15
3.4 Common types of intercompany transactions and transfer pricing models................................................16
3.4.1 Research and Development..................................................................................................................16
3.4.2 Manufacturing......................................................................................................................................17
3.4.3 Distribution...........................................................................................................................................18
3.4.4 Intercompany services..........................................................................................................................19
3.4.5 Financial transactions...........................................................................................................................21
3.4.6 Cost contribution arrangements..........................................................................................................22
3.4.7 The centralised entrepreneur model...................................................................................................23
Chapter 4 Cross-Border Business Restructurings...........................................................................................24
4.1 Introduction..................................................................................................................................................24
4.2 Frequent types of cross-border business restructurings..............................................................................25
4.3 Should a cross-border business restructuring give rise to the payment of compensation between the
restructured entities?.........................................................................................................................................26
2
, 4.3.1 Has something of value been transferred from one company to another company?........................26
4.3.2 Does the business restructuring involve the termination or the substantial renegotiation of existing
arrangements?...............................................................................................................................................27
Chapter 5 The Substance Requirement from a Transfer Pricing Perspective..................................................27
5.1 The purpose of the substance requirement.................................................................................................27
5.2 The determination of whether or not an intercompany transaction is supported by sufficient substance.28
5.2.1 Introduction..........................................................................................................................................28
5.2.2 The substance requirement applied to functions................................................................................29
5.2.3 The substance requirement applied to risks........................................................................................29
5.2.4 The substance requirement applied to assets.....................................................................................29
5.3 The substance requirement applied to cross-border business restructurings.............................................30
Chapter 6 The Attribution of Profit to Permanent Establishments.................................................................30
6.1 Introduction: What is a permanent establishment?....................................................................................30
6.2 Background on the attribution of profits to permanent establishments and former principles
recommended by the OECD...............................................................................................................................31
6.3 The authorised OECD approach...................................................................................................................31
6.3.1 The applicability of the Authorised OECD Approach............................................................................31
6.3.2 Rationale of the Authorised OECD Approach.......................................................................................32
6.3.3 The functional and factual analysis......................................................................................................32
6.3.4 The comparability analysis...................................................................................................................34
Chapter 7 The Prevention and the Resolution of Transfer Pricing Disputes....................................................34
7.1 Introduction..................................................................................................................................................34
7.2 Advance pricing arrangements....................................................................................................................35
7.2.1 The purpose of advance pricing arrangements....................................................................................35
7.2.2 The different types of advance pricing arrangements.........................................................................35
7.2.3 The procedure to apply for an advance pricing arrangement.............................................................36
7.3 Mutual agreement procedures....................................................................................................................37
7.3.1 The purpose of a mutual agreement procedure..................................................................................37
7.3.2 The different steps of a mutual agreement procedure........................................................................37
7.4 Arbitration....................................................................................................................................................38
7.4.1 Introduction..........................................................................................................................................38
7.4.2 Arbitration in tax treaties.....................................................................................................................39
7.4.3 The EU Arbitration Convention.............................................................................................................39
3
, List of Abbreviations
APA Advance pricing arrangement
BEPS Base erosion and profit shifting
CCA Cost contribution arrangement
CCCTB Common consolidated corporate tax base
CFC Controlled foreign company
CJEU Court of Justice of the European Union
COGS Cost of goods sold
CUP Comparable uncontrolled price
EU European Union
IP Intangible property
IT Information technology
OECD Organisation for Economic Co-operation and Development
OECD Guidelines OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax
Administrations
OPEX Operating expenses
R&D Research and development
TNMM Transactional net margin method
UN United Nations
Routine vs Key functions:
The testing party is “routine” if the significantly greater part of the risk behind the
contractual relationship is allocated at the other contracting party. Such other party so
becomes “entrepreneurial” in this transaction – and, consequently, can be characterized
non-routine.
From this, we conclude that the tested party which performs routine functions and bears
routine risks bears little consequences of a malfunction of the transactional relationship AND
any other contractual relationship the tested party executes. Vice versa, that corporate unit
(e.g. legal entity of a multinational group, permanent establishment, profit centre, cost
centre) which is defined as non-routine bears the risk of malfunctioning, damages, costs of
underperformance, or even loss and ruin.
Introduction
Transfer pricing is an area of tax law that has significantly expanded over the last few
decades. This is partly explained by the globalisation of business activities: enterprises are
getting more global so as to reach new markets and make their organisation more efficient.
Another reason is related to the tax planning opportunities that are made possible through
cross-border controlled transactions, something that States are willing to monitor so as to
avoid the illegitimate erosion of their tax base.
4
