9.46 At arm’s length, the response is likely to depend on the rights and other assets of the parties, on the profit potential of the distributor and of its associated enterprise in relation to both business models (full-fledged and low risk distributor) as well as the expected duration of the new arrangement. In particular, in evaluating profit potential, it is necessary to evaluate whether historic profits (determined in accordance with the arm’s length principle) are an indicator of future profit potential, or whether there have been changes in the business environment around the time of the restructuring that mean that past performance is not an indicator of profit potential. For example, competing products could have the effect of eroding profitability, and new technology or consumer preferences could render the products less attractive. The consideration of these factors from perspective of the distributor can be illustrated with the following example.
TPG2017 Chapter IX paragraph 9.46
Category: D. Reallocation of profit potential, OECD Transfer Pricing Guidelines (2017), TPG2017 Chapter IX: Transfer Pricing Aspects of Business Restructurings | Tag: Business restructuring, Conversion of full-fledged distributors, Economically neutral to take on (or lay off) risk, Example - conversion to limited risk distributor, Limited Risk Distributors (LRD), Reallocation of profit potential, Risk return trade off
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- TPG2022 Chapter IX paragraph 9.47In scenario no. 1, the distributor is surrendering a profit potential with significant uncertainties for a relatively low but stable rate of profitability. Whether an independent party would be willing to do so would depend on its anticipated return under both scenarios, on...
- TPG2022 Chapter IX paragraph 9.46At arm’s length, the response is likely to depend on the rights and other assets of the parties, on the profit potential of the distributor and of its associated enterprise in relation to both business models (full-fledged and low risk distributor) as well...
- TPG2022 Chapter IX paragraph 9.48Sections E. 1 to E.3 below contain a discussion of some typical transfers that can arise in business restructurings: transfers of tangible assets, of intangibles and rights in intangibles, and of activities (ongoing concern)....
- TPG2022 Chapter IX paragraph 9.22In any analysis of risks in controlled transactions, one important issue is to assess whether a risk is economically significant, i.e. it carries significant profit potential, and, as a consequence, whether that risk may explain a significant reallocation of profit potential. The significance...
- TPG2022 Chapter IX paragraph 9.23For instance, where a full-fledged distributor is converted into a limited-risk distributor or commissionnaire resulting in the reduction or elimination of risks relating to inventory in the restructured enterprise, in order to determine whether such risk is economically significant the tax administration may...
- TPG2022 Chapter IX paragraph 9.42In order to determine whether at arm’s length the restructuring itself would give rise to a form of compensation, it is essential to understand the restructuring, including the changes that have taken place, how they have affected the functional analysis of the parties,...
- TPG2022 Chapter IX paragraph 9.106Where a restructuring involves a transfer to a foreign associated enterprise of risks that were previously assumed by a taxpayer, it may be important to examine whether the transfer of risks only concerns the future risks that will arise from the post-restructuring activities...
- TPG2022 Chapter IX paragraph 9.19Risks are of critical importance in the context of business restructurings. Usually, in the open market, the assumption of risk associated with a commercial opportunity affects the profit potential of that opportunity, and the allocation of risk assumed between the parties to the...
- EU Report on Improving the Functioning of the Arbitration Convention (2015)In April 2015 the Forum agreed on a Report on Improving the Functioning of the Arbitration Convention including a revised Code of Conduct for the effective implementation of the Arbitration Convention. The report and the revised Code of Conduct are the result of...
- South African Revenue Service releases comprehensive Interpretation Note on intra-group loansThe South African Revenue Service (SARS) has published a comprehensive Interpretation Note on intra-group loans. The note provides taxpayers with guidance on the application of the arm’s length principle in the context of the pricing of intra-group loans. The pricing of intra-group loans...
Related Case Law
- Greece vs “Agri Ltd”, july 2020, Court, Case No A 1514A Greek MNE Group, “Agri Ltd”, was active and specialised in wholesale trade of agricultural machinery, parts and tools. In 2012 a German company was established by the group to distribute products in the Central European region. The pricing of the goods sold...
- Spain vs “SGGE W T Spanish branch”, January 2023, TEAC, Case No Rec. 00/07503/2020/00/00SGGE W T is a Spanish branch of SGG that carries out distribution and marketing activities related to the information technology network products and services. SGG is part of the KF group which “is an international group that provides solutions and services in...
- Austria vs. “Yogo Food-Distributor”, August 2021, Bundesfinanzgericht, Case No RV/3100163/2018“Yogo Food-Distributor” is a subsidiary in the “Yogo Group” and trades in spices and canned meat and vegetables from the territory of the former Yugoslavia. The main sales markets are Austria and Germany (90%), the remainder being distributed among France, Scandinavia, Great Britain...
- Germany vs “Cutting Tech GMBH”, November 2019, FG Munich, Case No 6 K 1918/16 (BFH Pending – I R 54/19)Due to the economic situation of automotive suppliers in Germany in 2006, “Cutting Tech GMBH” established a subsidiary (CB) in Bosnien-Herzegovina which going forward functioned as a contract manufacturer. CB did not develop the products itself, but manufactured them according to specifications provided...