The Australian Taxation Office (ATO) has released a new draft of Compliance Guidelines on Intangible Arrangements, PCG 2023/D2. When finalised, the guidelines will set out the ATO’s compliance approach to the development, use and transfer of intangible assets. The guidelines focus on tax risks associated with the potential application of the transfer pricing provisions, withholding tax provisions, capital gains tax (CGT), capital allowances, the general anti-avoidance rule (GAAR) and the diverted profits tax (DPT). Examples of high-risk intangibles arrangements under the draft guidelines include centralisation of intangible assets bifurcation (separation) of intangible assets non-recognition of local intangible assets and DEMPE activities migration of pre-commercialised intangible assets (HTVI) transfer of intangibles assets to a foreign hybrid entity ...

In 2011, Petrolia SE established a wholly owned subsidiary in Norway – Petrolia Noco AS – to conduct oil exploration activities on the Norwegian shelf. From the outset, Petrolia Noco AS received a loan from the parent company Petrolia SE. The written loan agreement was first signed later on 15 May 2012. The loan limit was originally MNOK 100 with an agreed interest rate of 3 months NIBOR with the addition of a margin of 2.25 percentage points. When the loan agreement was formalized in writing in 2012, the agreed interest rate was changed to 3 months NIBOR with the addition of an interest margin of 10 percentage points. The loan limit was increased to MNOK 150 in September 2012, and then to MNOK 330 in April 2013. In the tax return for 2012 and 2013, Petrolia Noco AS demanded a full deduction for actual interest costs on the intra-group loan to the parent company Petrolia SE. An assessment was issued by the tax authorities for these years, where the interest deductions had been partially disallowed. The assessment for these years was later upheld in court. For FY 2014, 2015 and 2016, Petrolia Noco AS had also claimed a full deduction for actual interest costs on the entire intra-group loan to the parent company. It is the assessment for these years that is the subject of dispute in this case. The assessment was first brought to the Court of Oslo where a decision in favour of the tax authorities was issued in November 2021. This decision was appealed by Petrolia Noco AS to the Court of Appeal. Judgement of the Court The Court of Appeal dismissed the appeal and decided in favour of the Norwegian tax authorities. Excerpts “The Court of Appeal also agrees with the state that neither the cost plus method nor a rationality analysis can be considered applicable in this case. With the result the Court of Appeal has reached so far, the CUP method should be preferred – in line with the OECD guidelines. After this, in summary, it appears clear that the interest margin on the intra-group loan is significantly higher than in a comparable and independent market and thus not an arm’s length price. The higher interest implies a reduction in the appellant’s income, cf. Tax Act section 13-1 first paragraph. The Court of Appeal cannot see that the adjustments claimed by the appellant change this. In the Court of Appeal’s view, it is also clear that the reduction in income has its cause in the community of interest. Whether adjustments should be made to the basis of comparison at the time of the price change, the Court of Appeal comes back to when assessing the exercise of discretion. Consequently, there was access to a discretionary determination of the appellant’s income according to Section 13-1 first paragraph of the Tax Act, also with regard to the interest margin.” “In the Court of Appeal’s view, additional costs that would have been incurred by independent parties, but which are not relevant in the controlled transaction, must be disregarded. Reference is made to the OECD guidelines (2020) point C.1.2.2, section 10.96: In considering arm’s length pricing of loans, the issue of fees and charges in relation to the loan may arise. Independent commercial lenders will sometimes charge fees as part of the terms and conditions of the loan, for example arrangement fees or commitment fees in relation to an undrawn facility. If such charges are seen in a loan between associated enterprises, they should be evaluated in the same way as any other intra-group transaction. In doing so, it must be borne in mind that independent lenders’ charges will in part reflect costs incurred in the process of raising capital and in satisfying regulatory requirements, which associated enterprises might not incur. The decisive factor is whether the costs or rights that the effective interest margin in the observed exploration loans between independent parties is an expression of, are also relevant in the intra-group loan. As far as the Court of Appeal understands, the appellant does not claim that various fees or costs incurred in exploration loans from a bank have been incurred in the intra-group loan, and in any case no evidence has been provided for this. In the Court of Appeal’s view, such costs and fees are therefore not relevant in the comparison. The appellant, on the other hand, has stated that the loan limit that Petrolia SE had made available, and the fact that the loan limit was increased if necessary, means that a so-called “commitment fee”, which accrues in loans between independent parties where an unused credit facility is provided, must be considered built into the agreed interest rate. In the Court of Appeal’s view, Petrolia SE cannot be considered to have had any obligation to make a loan limit available or to increase the loan limit if necessary. It appears from the loan agreement point 3.2 that the lender could demand repayment of the loan at its own discretion. The appellant has stated that this did not entail any real risk for the borrower. It is probably conceivable that Petrolia SE did not intend for this clause to be used, and that the appellant had an expectation of this. In this sense, it was a reality in the loan framework. However, it is clear, and acknowledged by the appellant, that the point of financing the appellant through loans rather than higher equity was Petrolia SE’s need for flexibility. Thus, it appears to the Court of Appeal that it is clear that the appellant had no unconditional right to the unused part of the loan limit. The Court of Appeal therefore believes that the Board of Appeal has not made any mistakes by comparing with nominal interest margins. On this basis, the Court of Appeal can also see no reason why it should have been compared with the upper tier of the observed nominal interest margins in the exploration loans between independent parties. In ...

35. The facts in this example are the same as in Example 9, except that Company S now enters into a three-year royalty-free agreement to market and distribute the watches in the country Y market, with no option to renew. At the end of the three-year period, Company S does not enter into a new contract with Primair. 36. Assume that it is demonstrated that independent enterprises do enter into short-term distribution agreements where they incur marketing and distribution expenses, but only where they stand to earn a reward commensurate with the functions performed, the assets used, and the risks assumed within the time period of the contract. Evidence derived from comparable independent enterprises shows that they do not invest large sums of money in developing marketing and distribution infrastructure where they obtain only a short-term marketing and distribution agreement, with the attendant risk of non-renewal without compensation. The potential short-term nature of the marketing and distribution agreement is such that Company S could not, or may not be able to, benefit from the marketing and distribution expenditure it incurs at its own risk. The same factors mean that Company S’s efforts may well benefit Primair in the future. 37. The risks assumed by Company S are substantially higher than in Example 9 and Company S has not been compensated on an arm’s length basis for bearing these additional risks. In this case, Company S has undertaken market development activities and borne marketing expenditures beyond what comparable independent enterprises with similar rights incur for their own benefit, resulting in significantly lower profit margins for Company S than are made by comparable enterprises. The short term nature of the contract makes it unreasonable to expect that Company S has the opportunity of obtaining appropriate benefits under the contract within the limited term of the agreement with Primair. Under these circumstances, Company S is entitled to compensation for its at risk contribution to the value of the R trademark and trade name during the term of its arrangement with Primair. 38. Such compensation could take the form of direct compensation from Primair to Company S for the anticipated value created through the marketing expenditures and market development functions it has undertaken. Alternatively, such an adjustment could take the form of a reduction in the price paid by Company S to Primair for R watches during Years 1 through 3 ...

The accurate delineation of the actual transaction in scenarios involving captive insurance requires identifying whether the captive insurance is performing control functions regarding the economically significant risks associated to the underwriting function – in particular the insurance risk – to determine whether those risks should be allocated to the captive ...

Insurance requires the assumption of insurance risk by the insurer. In the event of a claim, the insured does not suffer the financial impact of a potential economic loss to the extent that insurance risk has been assumed by the insurer, because the loss is offset by the insurance payment ...

In order to consider the transfer pricing implications of a transaction with a captive insurance, it is first necessary to identify the commercial or financial relations between the associated enterprises and the conditions and economically relevant circumstances attaching to those relations in order that the actual transaction is accurately delineated. The initial question will therefore be whether the transaction under consideration is one of insurance, as defined above. This analysis requires consideration of whether the risk has been assumed by the insurer and whether risk diversification has been achieved ...

Captive insurances may be self-managed from within the MNE group, or managed by an unrelated service provider (often a division of a large insurance broker). Typically this management would include ensuring compliance with local law, issuing policy documents, collecting premiums, paying claims, preparing reports and providing local directors. If the captive insurance is managed from within the MNE group it is necessary to determine which entity manages it (if such management is not exercised by employees of the captive insurance) and to appropriately reward that management ...

The insurer is carrying out a risk mitigation function in respect of the insured party’s risk but not actually assuming that risk. It is assuming the risk of insuring (i.e. mitigating) the insured party’s risk. That risk will be controlled by either the insurer or (more likely in a captive insurance scenario) another entity within the MNE group that makes the decision that the risk should be assumed by the insurer. (See paragraph 10.223). The insurer (or other entity) can make decisions as to how to respond to this risk – in accordance with paragraph 1.61 (ii) – by, for example, further diversifying its portfolio of insured risks or by reinsuring ...

Although the quantum of the risk reward for the insured party and the insurer might be dependent upon exactly the same events in both cases, that quantum could be significantly different (for example, if the insured risk materialises and a claim is made, the insured party could potentially receive significant upside relative to the premium paid whereas the insurer’s income will be limited to the insurance premiums and investment income it has received regardless of the quantum of risk reward received by the insured party) ...

The principles of accurate delineation of the actual transactions and allocation of risk detailed in Chapter I of these Guidelines apply to captive insurance and reinsurance in the same manner that they apply to any other intra-group transactions. However, this section addresses mainly captive insurance (as well as captive reinsurance – fronting). In particular, it should be borne in mind that: the carrying on of risk mitigation functions falls within the wider concept of risk management but not within that of control of risk (see paragraphs 1.61 and 1.65); there is a difference between the specific risk being insured (the party taking the decision to insure – i.e. mitigate – or not, controls this risk; that party will usually be the insured but may be another entity within the MNE group) and the risk taken on by the insurer in providing insurance to the insured party ...

Assume that the accurate delineation of the actual transaction shows that the effect of passive association raises Company D’s credit standing from BBB to A, and that the provision of the explicit guarantee additionally enhances the credit standing of Company D to AAA. Assume further that independent lenders charge an interest rate of 8% to entities with a credit rating of A, and of 6% to entities with a credit rating of AAA. Assume further that Company M charges Company D a fee of 3% for the provision of the guarantee so the guarantee fee more than completely offsets the benefit of Company D’s enhanced credit standing derived from the provision of such guarantee ...

This section considers financial guarantees on certain intra-group transactions. To consider any transfer pricing consequences of a financial guarantee, it is first necessary to understand the nature and extent of the obligations guaranteed and the consequences for all parties, accurately delineating the actual transaction in accordance with Section D.1 of Chapter I ...

As with many types of financial transactions, different intent and understanding can be ascribed to the labels or descriptions attached to particular transactions. Each case must be considered on its own facts and circumstances and in each case accurate delineation of the actual transactions in accordance with the principles of Chapter I will be needed before any attempt to decide on an approach to pricing a transaction ...

Once the actual transaction has been accurately delineated, arm’s length interest rates can be sought based on consideration of the credit rating of the borrower or the rating of the specific issuance taking into account all of the terms and conditions of the loan and comparability factors ...

When evaluating the transfer pricing issues related to treasury activities, as with any case, it is important to accurately delineate the actual transactions and determine exactly what functions an entity is carrying on rather than to rely to any extent upon a general description such as “treasury activities” ...

For example, consider that Company A, a member of AB Group, advances funds with a term of 10 years to an associated enterprise, Company B, which will use the funding for short-term working capital purposes. This advance is the only loan in Company B’s balance sheet. AB Group’s policy and practices demonstrate that the MNE group uses a one-year revolving loan to manage short-term working capital. In this scenario, under the prevailing facts and circumstances, the accurate delineation of the actual transaction may conclude that an unrelated borrower under the same conditions of Company B would not enter into a 10-year loan agreement to manage its short-term working capital needs and the transaction would be accurately delineated as a one-year revolving loan rather than a 10-year loan. The consequences of this delineation would be that assuming the working capital requirements continue to exist, the pricing approach would be to price a series of refreshed one-year revolver loans ...

In accurately delineating the actual financial transaction, a functional analysis is necessary. This analysis seeks to identify the functions performed, the assets used and the risks assumed by the parties to that controlled transaction ...

The terms and conditions of a financial transaction between independent enterprises are usually explicitly stated in a written agreement. However, between associated enterprises the contractual arrangements may not always provide information in sufficient detail or may be inconsistent with the actual conduct of the parties or other facts and circumstances. It is therefore necessary to look to other documents, the actual conduct of the parties – notwithstanding that such consideration may ultimately result in the conclusion that the contractual form and actual conduct are in alignment – and the economic principles that generally govern relationships between independent enterprises in comparable circumstances in order to accurately delineate the actual transaction in accordance with Section D.1.1 of Chapter I ...

In accordance with the guidance established in Chapter I, the accurate delineation of the actual transaction should begin with a thorough identification of the economically relevant characteristics of the transaction – consisting of the commercial or financial relations between the parties and the conditions and economically relevant circumstances attaching to those relations –, including: an examination of the contractual terms of the transaction, the functions performed, assets used, and risks assumed, the characteristics of the financial instruments, the economic circumstances of the parties and of the market, and the business strategies pursued by the parties ...

As described in Chapter I, the process of accurate delineation of the actual transaction also requires an understanding of how the particular MNE group responds to those identified factors. In this regard, the MNE group’s policies may inform the accurate delineation of the actual transaction through the consideration of, for instance, how the MNE group prioritises the funding needs among different projects; the strategic significance of a particular MNE within the MNE group; whether the MNE group is targeting a specific credit rating or debt-equity ratio; or whether the MNE group is adopting a different funding strategy than the one observed in its industry sector (see Section B.3.5) ...

As with any controlled transaction, the accurate delineation of financial transactions requires an analysis of the factors affecting the performance of businesses in the industry sector in which the MNE group operates. Because differences exist among industry sectors, factors such as the particular point of an economic, business or product cycle, the effect of government regulations, or the availability of financial resources in a given industry are relevant features that have to be considered to accurately delineate the controlled transaction. This examination will take account of the fact that MNE groups operating in different sectors may require, for example, different amounts and types of financing due to different capital intensity levels between industries, or may require different levels of short-term cash balances due to different commercial needs between industries. Where the relevant MNEs are regulated, such as financial services entities subject to regulations consistent with recognised industry standards (e.g. Basel requirements), due regard should be had to the constraints those regulations impose upon them ...

In accurately delineating an advance of funds, the following economically relevant characteristics may be useful indicators, depending on the facts and circumstances: the presence or absence of a fixed repayment date; the obligation to pay interest; the right to enforce payment of principal and interest; the status of the funder in comparison to regular corporate creditors; the existence of financial covenants and security; the source of interest payments; the ability of the recipient of the funds to obtain loans from unrelated lending institutions; the extent to which the advance is used to acquire capital assets; and the failure of the purported debtor to repay on the due date or to seek a postponement ...

Particular labels or descriptions assigned to financial transactions do not constrain the transfer pricing analysis. Each situation must be examined on its own merits, and subject to the prefatory language in the previous paragraph, accurate delineation of the actual transaction under Chapter I will precede any pricing attempt ...

Although countries may have different views on the application of Article 9 to determine the balance of debt and equity funding of an entity within an MNE group, the purpose of this section is to provide guidance for countries that use the accurate delineation under Chapter I to determine whether a purported loan should be regarded as a loan for tax purposes (or should be regarded as some other kind of payment, in particular a contribution to equity capital) ...

In the context of the preceding paragraphs, this subsection elaborates on how the concepts of Chapter I, in particular the accurate delineation of the actual transaction under Section D.1, may relate to the balance of debt and equity funding of an entity within an MNE group ...

The accurate delineation of the transactions comprising the business restructuring requires performing a functional analysis that seeks to identify the economically significant activities and responsibilities undertaken, assets used or contributed, and risks assumed before and after the restructuring by the parties involved. Accordingly, the analysis focuses on what the parties actually do and the capabilities, as well as the type and nature of assets used or contributed by the parties in a pre-restructuring and post-restructuring scenarios. See Section D. 1.2 of Chapter I. Given the importance of risk in the analysis of business restructurings, the following section provides specific guidance on the analysis of risk in transactions comprising the business restructuring ...

The Australian Taxation Office (ATO) has issued draft Compliance Guidelines on intangible arrangements, PCG 2021/D4. These Guidelines will (when finalised)  set out the ATO’s compliance approach to international arrangements connected with the development, enhancement, maintenance, protection and exploitation of intangible assets, specifically, the potential application of the transfer pricing, general anti-avoidance rule (GAAR) and the diverted profits tax (DPT) provisions. The capital gains tax and capital allowances provisions will also be discussed in this Guideline where these may be considered alongside, or relevant to, the ATO’s transfer pricing, GAAR or DPT risk assessment. The draft Guidelines sets out ATO’s compliance approach to international arrangements connected with the development, enhancement, maintenance, protection and exploitation (DEMPE) of intangible assets and/or involving a migration of intangible assets. The Guidelines applies to Intangibles Arrangements and focuses on tax risks associated with the potential application of the transfer pricing provisions. It also focuses on other tax risks that may be associated with Intangibles Arrangements, specifically the withholding tax provisions, capital gains tax (CGT), capital allowances, the general anti-avoidance rule (GAAR) and the diverted profits tax (DPT). The Guidelines has been prepared to accompany the release and publication of Taxpayer Alerts TA 2018/2 Mischaracterisation of activities or payments in connection with intangible assets and TA 2020/1 Non-arm’s length arrangements and schemes connected with the development, enhancement, maintenance, protection and exploitation of intangible assets. It is not the intention of the Guidelines to limit, deter or prevent arm’s length dealings involving intangible assets. Rather it is intended that the Guideline will serve as a point of reference and assist in understanding arrangements which is seen as representing a higher risk from a compliance perspective. Examples of high risk arrangements centralisation of intangible assets bifurcation (separation) of intangible assets non-recognition of local intangible assets and DEMPE activities migration of pre-commercialised intangible assets non-arm’s length licence arrangements ...

The above analysis outlines the factors that should be considered when determining whether associated parties may at arm’s length consider revising their intercompany agreements and/or their conduct in their commercial relationships as a consequence of the COVID-19 pandemic. However, it is important to emphasise that in the absence of clear evidence that independent parties in comparable circumstances would have revised their existing agreements or commercial relations, the modification of existing intercompany arrangements and/or the commercial relationships of associated parties is not consistent with the arm’s length principle. Accordingly, such modifications should be treated with caution and well-supported by documentation outlining how the modification is in line with the arm’s length principle ...

Determining whether a renegotiation of a commercial arrangement (including pricing under the arrangement going forward and any potential compensation for the renegotiation itself) represents the best interests of the parties to a transaction requires careful consideration of their options realistically available26 and the long-run effects on the profit potential of the parties.27 For example, an entity may agree to restructure a transaction if the alternative option is losing a key customer or supplier, where it considers that the restructuring will maximise its profits in the long-run. Consideration should also be given to whether the economic impact resulting from the renegotiation may require indemnification (as defined in OECD TPG paragraph 9.75) of the harmed party.28 26 It should be noted that in an uncontrolled transaction one party might attempt to force a renegotiation by threatening to violate the terms of an existing agreement, believing that the other party will not find it worthwhile to seek judicial enforcement of the agreement, whereas this course of action may not realistically be available in the context of a controlled transaction. 27 Paragraphs 9.78-9.97 of Chapter IX of the OECD TPG. 28 Paragraphs 9.78-9.97 of Chapter IX of the OECD TPG ...

For example, assume that Distributor X purchases products, the controlled transaction, from a related party Company Y, and sells these products to third party customers. Further assume that a major customer of Distributor X does not pay for products purchased within its standard 30-day term, and that this causes a cash flow issue for Distributor X, who bears credit risk under the accurately delineated transaction. Under these circumstances, Distributor X may seek to renegotiate its payment terms on a temporary basis with Company Y. The determination of whether this renegotiation is arm’s length should be based on what independent parties would do under comparable circumstances and if there have been situations at arm’s length where contractual terms have not been enforced, or have been amended, this may form reasonable evidence for taxpayers to justify revised terms in intra-group agreements where the situations are comparable ...

Given the current economic environment, it is possible that independent parties may not strictly hold another party to their contractual obligations, particularly if it is in the interest of both parties to renegotiate the contract or to amend certain aspects of their For example, unrelated enterprises may opt to renegotiate a contract to support the financial survival of any of the transactional counterparties given the potential costs or business disruptions of enforcing the contractual obligations, or in view of anticipated increased future business with the counterparty. This behaviour should be considered when determining whether or not associated parties would agree to revise their intercompany agreements in response to COVID-19 ...

In response to the COVID-19 pandemic, independent parties could seek to renegotiate certain terms in their existing agreements.25 Associated parties may also consider revising their intercompany agreements and/or their conduct in their commercial relationships. Tax administrations should therefore review the agreements and/or the conduct of associated enterprises, in light of the guidance in section D of Chapter I of the OECD TPG, together with observations of relevant behaviour of independent parties and this guidance, in order to ascertain whether any such renegotiation should be respected under the OECD TPG. The accurate delineation of the controlled transaction will determine whether the revision of intercompany agreements is consistent with the behaviour of unrelated parties operating under comparable circumstances. 25  Part 1, Section F of Chapter IX of the OECD TPG ...

“P Services! provided services to a Peruvian consortium. In 2014, the parties entered into an interest-free loan agreement. According to the loan agreement, payment for the services performed in 2013 was going to be offset against the funds received under the agreement. The tax authorities found that the “loan arrangement”, in reality constituted advances for the services provided by “P Services”- According to the authorities the arrangement had been established for the purpose of avoiding VAT on the advances received for the services. Decision of the Tax Court The tax court issued a decision in favour of the tax authorities. Click here for English translation Click here for other translation ...

Captive insurances may be self-managed from within the MNE group, or managed by an unrelated service provider (often a division of a large insurance broker). Typically this management would include ensuring compliance with local law, issuing policy documents, collecting premiums, paying claims, preparing reports and providing local directors. If the captive insurance is managed from within the MNE group it is necessary to determine which entity manages it (if such management is not exercised by employees of the captive insurance) and to appropriately reward that management ...

The insurer is carrying out a risk mitigation function in respect of the insured party’s risk but not actually assuming that risk. It is assuming the risk of insuring (i.e. mitigating) the insured party’s risk. That risk will be controlled by either the insurer or (more likely in a captive insurance scenario) another entity within the MNE group that makes the decision that the risk should be assumed by the insurer. (See paragraph 10.223). The insurer (or other entity) can make decisions as to how to respond to this risk – in accordance with paragraph 1.61 (ii) – by, for example, further diversifying its portfolio of insured risks or by reinsuring ...

Although the quantum of the risk reward for the insured party and the insurer might be dependent upon exactly the same events in both cases, that quantum could be significantly different (for example, if the insured risk materialises and a claim is made, the insured party could potentially receive significant upside relative to the premium paid whereas the insurer’s income will be limited to the insurance premiums and investment income it has received regardless of the quantum of risk reward received by the insured party) ...

The principles of accurate delineation of the actual transactions and allocation of risk detailed in Chapter I of these Guidelines apply to captive insurance and reinsurance in the same manner that they apply to any other intra-group transactions. However, this section addresses mainly captive insurance (as well as captive reinsurance – fronting). In particular, it should be borne in mind that: the carrying on of risk mitigation functions falls within the wider concept of risk management but not within that of control of risk (see paragraphs 1.61 and 1.65); there is a difference between the specific risk being insured (the party taking the decision to insure – i.e. mitigate – or not, controls this risk; that party will usually be the insured but may be another entity within the MNE group) and the risk taken on by the insurer in providing insurance to the insured party ...

As described in Chapter I, the process of accurate delineation of the actual transaction also requires an understanding of how the particular MNE group responds to those identified factors. In this regard, the MNE group’s policies may inform the accurate delineation of the actual transaction through the consideration of, for instance, how the MNE group prioritises the funding needs among different projects; the strategic significance of a particular MNE within the MNE group; whether the MNE group is targeting a specific credit rating or debt-equity ratio; or whether the MNE group is adopting a different funding strategy than the one observed in its industry sector (see Section B.3.5) ...

As with any controlled transaction, the accurate delineation of financial transactions requires an analysis of the factors affecting the performance of businesses in the industry sector in which the MNE group operates. Because differences exist among industry sectors, factors such as the particular point of an economic, business or product cycle, the effect of government regulations, or the availability of financial resources in a given industry are relevant features that have to be considered to accurately delineate the controlled transaction. This examination will take account of the fact that MNE groups operating in different sectors may require, for example, different amounts and types of financing due to different capital intensity levels between industries, or may require different levels of short-term cash balances due to different commercial needs between industries. Where the relevant MNEs are regulated, such as financial services entities subject to regulations consistent with recognised industry standards (e.g. Basel requirements), due regard should be had to the constraints those regulations impose upon them ...

In accurately delineating an advance of funds, the following economically relevant characteristics may be useful indicators, depending on the facts and circumstances: the presence or absence of a fixed repayment date; the obligation to pay interest; the right to enforce payment of principal and interest; the status of the funder in comparison to regular corporate creditors; the existence of financial covenants and security; the source of interest payments; the ability of the recipient of the funds to obtain loans from unrelated lending institutions; the extent to which the advance is used to acquire capital assets; and the failure of the purported debtor to repay on the due date or to seek a postponement ...

Particular labels or descriptions assigned to financial transactions do not constrain the transfer pricing analysis. Each situation must be examined on its own merits, and subject to the prefatory language in the previous paragraph, accurate delineation of the actual transaction under Chapter I will precede any pricing attempt ...

Although countries may have different views on the application of Article 9 to determine the balance of debt and equity funding of an entity within an MNE group, the purpose of this section is to provide guidance for countries that use the accurate delineation under Chapter I to determine whether a purported loan should be regarded as a loan for tax purposes (or should be regarded as some other kind of payment, in particular a contribution to equity capital) ...

In the context of the preceding paragraphs, this subsection elaborates on how the concepts of Chapter I, in particular the accurate delineation of the actual transaction under Section D.1, may relate to the balance of debt and equity funding of an entity within an MNE group ...

HMRC Profit Diversion Compliance Facility Chapter 1 – introduction 1.1 Background Companies should recognise and pay tax on profits where the economic activities to generate those profits are carried out. HMRC has found that some Multinational Enterprises (MNEs) have adopted cross border pricing arrangements which are based on an incorrect fact pattern and/or are not consistent with the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines (TPG), as clarified through Actions Points 8-10 of the OECD Base Erosion and Profit Shifting Project. This is for 2 main reasons: Firstly, some have made incorrect assumptions, or not implemented arrangements as originally intended or declared to HMRC, so that there is a divergence between the fact pattern on which the Transfer Pricing (TP) analysis is based, and what is actually happening on the ground. This could be for a variety of reasons, including: insufficient understanding or incorrect/misleading statements on the nature or relative value of functions, assets and risks at the outset businesses change over time so that the functional profile may become different from that originally assumed or intended some businesses undervalue the contributions made by staff in the UK and overvalue the contributions of staff in other tax jurisdictions Secondly, the TP policies are not in accordance with the OECD TPG, for example because of: over reliance on TP policies predicated on contractual assumption of risk and legal ownership of assets, giving insufficient weight to the location of the control functions and/or the contributions to those control functions in relation to the risk and/or the important functions in relation to the assets too heavy a reliance on inappropriate comparables These arrangements often result in a reduction of UK profits, and may involve the diversion of UK profits to an overseas entity where the profits are taxed at lower rates or not at all. In a high proportion of investigations into such arrangements HMRC is finding that the arrangements don’t stand up to scrutiny and significant additional tax is due. The Diverted Profits Tax (DPT) was introduced to encourage MNEs using such arrangements to change their behaviour and pay Corporation Tax on profits in line with economic activity. Many MNEs with arrangements targeted by DPT have changed their TP policy and/or business structure leading to the right amount of UK Corporation Tax being paid, eliminating any potential DPT. 1.2 Co-operative Compliance HMRC prefers MNEs to fully disclose significant tax uncertainties or inaccuracies and to ensure compliance with tax law, and will work co-operatively, proactively and transparently with MNEs to resolve any tax uncertainties and risks. 1.3 Profit Diversion Compliance Facility HMRC is introducing a new Profit Diversion Compliance Facility for MNEs using arrangements targeted by DPT to give them the opportunity to bring their UK tax affairs up to date. HMRC recognises that many MNEs operate TP policies to achieve compliance with the OECD TPG, regularly review and update their policies, and discuss them with HMRC during business risk reviews and at other times. If a MNE is confident that their transfer pricing is up to date and they are paying the right amount of Corporation Tax, then they should not use the new compliance facility. The new facility is designed to encourage MNEs with arrangements that might fall within its scope to review both the design and implementation of their TP policies, change them if appropriate, and use the facility to put forward a report with proposals to pay any additional tax, interest and where applicable, penalties due. This will: enable MNEs to bring their tax affairs up to date openly, efficiently and without investigation by HMRC if a full and accurate disclosure is made give them certainty for the past and a low risk outcome for profit diversion in the future provide an accelerated process, HMRC will aim to respond to the proposal within 3 months of submission allow the MNE to manage its own internal processes around what evidence to gather, who is interviewed, what comparables are used (if any), and how the analysis is presented give unprompted penalty treatment if HMRC has not already started an investigation into profit diversion, 31 December 2019 is an important deadline for registration for some MNEs (see section 3 of chapter 4 of this guidance) This guidance sets out what HMRC would expect to see in such a report. The review of the arrangements should be proportionate to the scale and complexity of the business, the extent of tax at risk, the cause of any inaccuracies and failures to notify, and the proposals. The report should be free standing and self-explanatory. While it will be the responsibility of the MNE to review its arrangements and make a disclosure, HMRC is prepared to meet with MNEs who register to use the facility at the outset of the process to discuss plans for the review and later again before the final report and proposal is submitted, so that the MNE can present its findings and conclusions and hear any comments from HMRC. This work will be a priority for HMRC and a specifically designated, experienced team of specialists will risk assess all reports when received and consider whether the facts described and conclusions reached are soundly based on appropriate evidence, and if the TP policy and methodology adopted is reasonable and consistent with the OECD TPG. HMRC expects to be able to accept most proposals if they take account of this guidance and reflect the principles in it. Even if HMRC cannot accept the proposals as first presented, the report should provide a good basis for quick and efficient resolution, through dialogue, of particular differences of view between HMRC and the MNE. While the facility is aimed at arrangements targeted by DPT, businesses do not need to provide a technical analysis of whether DPT applies if they consider that their proposals eliminate any profit potentially chargeable to DPT. All technical analysis and any payment made can be on a without prejudice basis. HMRC will not regard the making of a proposal as indicating that the MNE thinks DPT could, or should, apply. 1.4 HMRC investigations Tackling profit diversion is a priority for HMRC. HMRC is conducting extensive research and data analysis and has invested in new teams of investigators. Investigations into profit diversion are usually resolved by agreeing transfer pricing adjustments. HMRC has identified a number of MNEs in a variety of business sectors which could be diverting profits, ...

The accurate delineation of the transactions comprising the business restructuring requires performing a functional analysis that seeks to identify the economically significant activities and responsibilities undertaken, assets used or contributed, and risks assumed before and after the restructuring by the parties involved. Accordingly, the analysis focuses on what the parties actually do and the capabilities, as well as the type and nature of assets used or contributed by the parties in a pre-restructuring and post-restructuring scenarios. See Section D. 1.2 of Chapter I. Given the importance of risk in the analysis of business restructurings, the following section provides specific guidance on the analysis of risk in transactions comprising the business restructuring ...

The changes in fact pattern from Example (B) support a conclusion that the economic substance of the arrangement does not differ from its form, and that independent enterprises in comparable circumstances acting in a commercially rational manner would have characterised or structured the arrangement as the associated enterprises have. Given this, a tax administration should seek to achieve an arm’s length outcome in this situation by determining arm’s length pricing for the restructuring itself and the parties’ post-restructuring activities based upon recognising the arrangement actually undertaken. (This does not say anything about the possible application of domestic anti- abuse rules.) ...

The fact pattern is the same as in example (B), except that part of Company A’s head office is effectively relocated to Country Z: 30 of the 125 head office employees are dismissed, another 30 are transferred to the new Company Z in Country Z, and 15 new employees are directly hired by Company Z in Country Z to take over functions performed by the dismissed employees. The employees of Company Z have the skills and competences to do the strategic development of the brand name and to execute the worldwide marketing strategy. Furthermore, it is assumed in this example that Company Z has the financial capacity to assume the risks associated with the strategic development of the brand names. Company Z, which is now the legal owner of the brand names actively carries on the development, maintenance and execution of a worldwide marketing strategy. The employees of Company Z have the authority to and actually perform control functions in relation to the risks associated with the strategic development of the brand names. The services provided by the remainder of Company A’s head office in Country A are central services (e.g. human resources management, legal and tax) as well as support marketing functions that are closely monitored by the personnel of Company Z. The main reason for the group entering into this restructuring is to benefit from a favourable tax regime in Country Z compared to the tax regime in Country A ...

A full consideration of all of the facts and circumstances warrants a conclusion that the economic substance of the arrangement differs from its form. In particular, the facts indicate that Company Z has no real capability to assume the risks it is allocated under the arrangement as characterised and structured by the parties. Furthermore, there is no evidence of any business reasons for the arrangement. In such a case paragraph 1.65 allows a tax administration to not recognise the structure adopted by the parties. (This is notwithstanding any possible application of general anti-avoidance rules and notwithstanding the question about Company Z’s place of effective management.) ...

Then a restructuring takes place. The brand names are transferred by Company A to a newly set up affiliate, Company Z in Country Z in exchange for a lump sum payment. After the restructuring, Company A is remunerated on a cost plus basis for the services it performs for Company Z and the rest of the group. The remuneration of the affiliated contract manufacturers and distributors remains the same. The excess profits after remuneration of the contract manufacturers, distributors, and Company A head office services are paid to Company Z. From the comparability analysis the following conclusions can be drawn:• There is no reliable evidence from uncontrolled comparable transactions of the ownership of brand names and attached risks being attributed between independent enterprises in the same manner as in the controlled transaction between Company A and Company Z;• Company Z is managed by a local trust company. It does not have people (employees or directors) who have the authority to and effectively do perform control functions in relation to the risks associated with the strategic development of the brand names. It also does not have the financial capacity to assume these risks.• High ranking officials from Company A’s head office fly to Country Z once a year to formally validate the strategic decisions necessary to operate the company. These decisions are prepared by Company A’s head office in Country A before the meetings take place in Country Z. The MNE considers that these activities are service activities performed by Company A’s head office for Z. These strategic decision-making activities are remunerated at cost plus in the same way as the central services are remunerated (e.g. human resource management, legal, tax).• The development, maintenance and execution of the worldwide marketing strategy are still performed by the same employees of Company A’s head office and remunerated on a cost plus basis. Company A does not have a contractual incentive to maximise the value of the brand names or the market share because it is remunerated on a cost plus basis ...

An MNE manufactures and distributes products the value of which is not determined by the technical features of the products, but rather by the brand name and exposure. The MNE wants to differentiate itself from its competitors through the development of brand names with great value, by implementing a carefully developed and expensive marketing strategy. The brand names are owned by Company A in Country A. The development, maintenance and execution of a worldwide marketing strategy are the main value driver of the MNE, performed by 125 employees at Company A’s head office. The value of the brand names results in a high consumer price for the products. Company A’s head office also provides central services for the group affiliates (e.g. human resource management, legal, tax). The products are manufactured by affiliates under contract manufacturing arrangements with Company A. They are distributed by affiliates who purchase them from Company A. The profits derived by Company A after having allocated an arm’s length remuneration to the contract manufacturers and distributors are considered to be the remuneration for the intangibles, marketing activities and central services of Company A ...

Assuming that in this case the actual conduct of the parties is consistent with the form of the restructuring, the economic substance of the arrangement would not differ from how it is characterised and structured by the parties. It is expected that the determination of arm’s length pricing for the restructuring itself and for the post-restructuring activities would result in an arm’s length outcome for each of the parties, in which case the restructuring transactions would be recognised ...

Company Z is a well known distributor of luxury products. It owns a valuable trade name, valuable retail points, and valuable long term contracts with suppliers. It is acquired by an MNE Group which operates under a global business model whereby all the trade names and other valuable intangibles are owned by Company V in Country V, all the key supplier contracts are held by Company W in Country W which is responsible for the management of group-wide supplier contracts, and all the retail points are owned by a real estate company in Country X. Immediately after the acquisition, the Group decides to restructure Company Z by transferring its trade name to Company V, its valuable supplier contracts to Company W and its retail points to Company X, all in exchange for lump sum payments. As a consequence of the transfer, Company Z is now operating as a commissionnaire for Company W. Its post-restructuring profit potential is dramatically less than its pre-restructuring one. Representatives from the MNE Group explain that the business reason for the restructuring is to align the operating model of Company Z with the operating model of the rest of the MNE Group, and that this prospect was one key factor in the acquisition deal. The management of Company Z has had no other choice than to accept the restructuring given the acquisition that has taken place. It indicates that the transfer of its trade name, contracts and retail points was priced at arm’s length, and that the remuneration for its post-restructuring activities will also be priced at arm’s length ...

That guidance indicates that the tax administration would seek to substitute for the non-recognised transaction an alternative characterisation or structure that comports as closely as possible with the facts of the case, i.e. one that is consistent with the functional changes to the taxpayer’s business resulting from the restructuring, comports as closely as possible with the economic substance of the case, and reflects the results that would have derived had the transaction been structured in accordance with the commercial reality of independent parties. For example, where one element of a restructuring arrangement involves the closing down of a factory, any recharacterisation of the restructuring cannot ignore the reality that the factory no longer operates. Similarly, where one element of a restructuring involves the actual relocation of substantive business functions, any recharacterisation of the restructuring cannot ignore the fact that those functions were actually relocated. As another example, where a restructuring arrangement involves a transfer of property between two parties, any non- recognition of the restructuring arrangement would need to reflect that a transfer of such property occurred between the two parties, although it may be appropriate to replace the character of the transfer with an alternative characterisation that comports as closely as possible with the facts of the case (e.g. a purported transfer of all rights in the property might be recharacterised as a mere lease or licence of the property, or vice versa) ...

Paragraph 1.68 provides some guidance on the case where a tax administration may find it useful to refer to alternatively structured transactions between independent enterprises to determine whether the controlled transaction as structured satisfies the arm’s length principle. Whether evidence from a particular alternative can be considered will depend on the facts and circumstances of the particular case, including the number and accuracy of the adjustments necessary to account for differences between the controlled transaction and the alternative as well as the quality of any other evidence that may be available ...

In both circumstances, Article 9 would allow an adjustment of conditions to reflect those which the parties would have attained had the transaction been structured in accordance with the economic and commercial reality of parties dealing at arm’s length (see paragraph 1.66). In doing so, tax administrations would have to determine what is the underlying reality behind a contractual arrangement in applying the arm’s length principle (see paragraph 1.67) ...

With respect to the second circumstance, paragraph 1.65 contains an example of non-recognition of a sale and note that while it may be proper to respect the transaction as a transfer of commercial property, it would nevertheless be appropriate for a tax administration to conform the terms of that transfer in their entirety (and not simply by reference to pricing) to those that might reasonably have been expected had the transfer of property been the subject of a transaction involving independent enterprises. In such a case, the tax administration would seek to adjust the conditions of the agreement in a commercially rational manner ...

Under the first circumstance of paragraph 1.65, where the economic substance of a transaction differs from its form, the tax administration may disregard the parties’ characterisation of the transaction and re-characterise it in accordance with its substance ...

Provided functions, assets and/or risks are actually transferred, it can be commercially rational from an Article 9 perspective for an MNE group to restructure in order to obtain tax savings. However, this is not relevant to whether the arm’s length principle is satisfied at the entity level for a taxpayer affected by the restructuring (see paragraph 9.178) ...

Under Article 9 of the OECD Model Tax Convention, the fact that a business restructuring arrangement is motivated by a purpose of obtaining tax benefits does not of itself warrant a conclusion that it is a non-arm’s length arrangement. The presence of a tax motive or purpose does not of itself justify non-recognition of the parties’ characterisation or structuring of the arrangement under paragraphs 1.64 to 1.69. (As indicated at paragraph 9.8, domestic anti-abuse rules are not within the scope of this chapter.) ...

Under the second circumstance discussed at paragraph 1.65, a second cumulative criterion is that “the actual structure practically impedes the tax administration from determining an appropriate transfer price.” If an appropriate transfer price (i.e. an arm’s length price that takes into account the comparability – including functional – analysis of both parties to the transaction or arrangement) can be arrived at in the circumstances of the case, irrespective of the fact that the transaction or arrangement may not be found between independent enterprises and that the tax administration might have doubts as to the commercial rationality of the taxpayer entering into the transaction or arrangement, the transaction or arrangement would not be disregarded under the second circumstance in paragraph 1.65. Otherwise, the tax administration may decide that this is a case for not recognising the transaction or arrangement under the second circumstance in paragraph 1.65 ...

Where a restructuring is commercially rational for the MNE group as a whole, it is expected that an appropriate transfer price (that is, compensation for the post-restructuring arrangement plus any compensation payments for the restructuring itself) would generally be available to make it arm’s length for each individual group member participating in it. See Part II of this chapter, Section B ...

There can be group-level business reasons for an MNE group to restructure. However, it is worth re-emphasising that the arm’s length principle treats the members of an MNE group as separate entities rather than as inseparable parts of a single unified business (see paragraph 1.6). As a consequence, it is not sufficient from a transfer pricing perspective that a restructuring arrangement makes commercial sense for the group as a whole: the arrangement must be arm’s length at the level of each individual taxpayer, taking account of its rights and other assets, expected benefits from the arrangement (i.e. consideration of the post-restructuring arrangement plus any compensation payments for the restructuring itself), and realistically available options ...

In assessing the commercial rationality of a restructuring, the question may arise whether to look at one transaction in isolation or whether to examine it in a broader context, taking account of other transactions that are economically inter-related. It will generally be appropriate to look at the commercial rationality of a restructuring as a whole. For instance, where examining a sale of an intangible that is part of a broader restructuring involving changes to the arrangements relating to the development and use of the intangible, then the commercial rationality of the intangible sale should not be examined in isolation of these changes. On the other hand, where a restructuring involves changes to more than one element or aspect of a business that are not economically inter-related, the commercial rationality of particular changes may need to be separately considered. For example, a restructuring may involve centralising a group’s purchasing function and centralising the ownership of valuable intangible property unrelated to the purchasing function. In such a case, the commercial rationality of centralising the purchasing function and of centralising the ownership of valuable intangible property may need to be evaluated separately from one another ...

An independent enterprise would not enter into a restructuring transaction if it sees an alternative option that is realistically available and clearly more attractive, including the option not to enter into the restructuring. In evaluating whether a party would at arm’s length have had other options realistically available to it that were clearly more attractive, due regard should be given to all the relevant conditions of the restructuring, to the rights and other assets of the parties, to any compensation or indemnification for the restructuring itself and to the remuneration for the post-restructuring arrangements (as discussed in Parts II and III of this chapter) as well as to the commercial circumstances arising from participation in an MNE group (see paragraph 1.11) ...

The application of the arm’s length principle is based on the notion that independent enterprises will not enter into a transaction if they see an alternative that is clearly more attractive. See paragraphs 9.59-9.64. As discussed there, a consideration of the options realistically available can be relevant to determining arm’s length pricing for an arrangement. It can also be relevant to the question of whether arrangements adopted by associated enterprises differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner. There may be exceptional cases in which arm’s length pricing cannot reliably be determined for the arrangement actually adopted, and it is concluded that the arrangement would not have been adopted in comparable circumstances by independent enterprises behaving in a commercially rational manner (see Section C.4) ...

What is being tested is whether the outcome (the arrangement adopted) accords with what would result from normal commercial behaviour of independent enterprises; it is not a behaviour test in the sense of requiring the associated enterprises to actually behave as would independent enterprises in negotiating and agreeing to the terms of the arrangement. Thus, whether the associated enterprises actually engaged in real bargaining or simply acted in the best interests of the MNE group as a whole in agreeing to a restructuring does not determine whether the arrangement would have been adopted by independent enterprises behaving in a commercially rational manner or whether arm’s length pricing has been reached ...

Business restructurings often lead MNE groups to implement global business models that are hardly if ever found between independent enterprises, taking advantage of the very fact that they are MNE groups and that they can work in an integrated fashion. For instance, MNE groups may implement global supply chains or centralised functions that are not found between independent enterprises. It is therefore often difficult to assess whether such business models are of the kind that independent enterprises behaving in a commercially rational manner would have implemented. This lack of comparables does not mean of course that the implementation of such global business models should automatically be regarded as not commercially rational ...

Where reliable data show that comparable uncontrolled transactions exist, it cannot be argued that such transactions between associated enterprises would lack commercial rationality. The existence of comparables data evidencing arm’s length pricing for an associated enterprise arrangement demonstrates that it is commercially rational for independent enterprises in comparable circumstances. On the other hand, however, the mere fact that an associated enterprise arrangement is not seen between independent enterprises does not in itself mean that it is not arm’s length nor commercially rational (see paragraph 1.11) ...

The second circumstance in paragraph 1.65 explicitly refers to the situation where the arrangements adopted by the associated enterprises “differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner…” Consistent with paragraph 9.163, tax administrations should not ordinarily interfere with the business decisions of a taxpayer as to how to structure its business arrangements. A determination that a controlled transaction is not commercially rational must therefore be made with great caution, and only in exceptional circumstances lead to the non-recognition of the associated enterprise arrangements ...

The economic substance of a transaction or arrangement is determined by examining all of the facts and circumstances, such as the economic and commercial context of the transaction or arrangement, its object and effect from a practical and business point of view, and the conduct of the parties, including the functions performed, assets used and risks assumed by them ...

In accordance with paragraphs 1.64-1.69, it may exceptionally be appropriate for a tax administration not to recognise the parties’ characterisation or structuring of a transaction or arrangement where, having regard to all of the facts and circumstances, it concludes that:• The economic substance of the transaction or arrangement differs from its form (Section C.2); or• Independent enterprises in comparable circumstances would not have characterised or structured the transaction or arrangement as the associated enterprises have, and arm’s length pricing cannot reliably be determined for that transaction or arrangement (Sections C.3 and C.4).Both of these situations are instances where the parties’ characterisation or structuring of the transaction or arrangement is regarded as the result of conditions that would not have existed between independent enterprises (see paragraph 1.66) ...

Paragraphs 1.64-1.69 explicitly limit the non-recognition of the actual transaction or arrangement to exceptional cases. This indicates that the non-recognition of a transaction is not the norm but an exception to the general principle that a tax administration’s examination of a controlled transaction ordinarily should be based on the transaction actually undertaken by the associated enterprises as it has been structured by them. The word “exceptional” in this context is similar in meaning to “rare” or “unusual”. It reflects that in most cases it is expected that the arm’s length principle under Article 9 can be satisfied by determining arm’s length pricing for the arrangement as actually undertaken and structured. (As noted at paragraph 1.53, it is important to examine whether the conduct of the parties conforms to the terms of the contract or whether the parties’ conduct indicates that the contractual terms have not been followed or are a sham. In such cases, further analysis is required to determine the true terms of the transaction and a pricing adjustment might not be the solution.) ...

A similar reasoning is developed in Part II of this chapter with respect to indemnification rights for the termination or substantial renegotiation of an existing arrangement. Paragraph 9.103 indicates that, in addition to examining whether the arrangement that is terminated, non- renewed or substantially renegotiated is formalised in writing and provides for an indemnification clause, it may be important to assess whether the terms of the arrangement and the possible existence or non-existence of an indemnification clause or other type of guarantee (as well as the terms of such a clause where it exists) are arm’s length ...

A discussion of how to determine whether the allocation of risks in a transaction between associated enterprises is arm’s length is found in Part I of this chapter. As discussed at paragraph 9.11, the examination of risks in an Article 9 context starts from an examination of the contractual terms between the parties, as those generally define how risks are to be divided between the parties. However, as noted at paragraphs 1.48-1.54, a purported allocation of risk between associated enterprises is respected only to the extent that it is consistent with the economic substance of the transaction. Therefore, in examining the risk allocation between associated enterprises and its transfer pricing consequences, it is important to review not only the contractual terms but also whether the associated enterprises conform to the contractual allocation of risks and whether the contractual terms provide for an arm’s length allocation of risks. In evaluating the latter, two important factors that come into play are whether there is evidence from comparable uncontrolled transactions of a comparable allocation of risks and, in the absence of such evidence, whether the risk allocation makes commercial sense (and in particular whether the risk is allocated to the party that has greater control over it). Paragraphs 9.34-9.38 contain an explanation of the difference between making a comparability adjustment and not recognising the risk allocation in the controlled transaction and a discussion of the relationship between the guidance at paragraph 1.49 and paragraphs 1.64-1.69 ...

According to Article 9 of the OECD Model Tax Convention, a tax administration may adjust the profits of a taxpayer where the conditions of a controlled transaction differ from the conditions that would be agreed between independent enterprises. In practice transfer pricing adjustments consist in adjustments of the profits of an enterprise attributable to adjustments to the price and / or other conditions of a controlled transaction (e.g. payment terms or allocation of risks). This does not mean that all transfer pricing adjustments, whether involving an adjustment only to the price or also (or alternatively) to other conditions of a controlled transaction, or as a result of evaluating separately transactions which are presented as a package in accordance to the guidance at paragraphs 3.11 and 6.18, should be viewed as consisting in the non-recognition of a controlled transaction under paragraphs 1.64-1.69. In effect, such adjustments may result from the examination of comparability, see in particular paragraph 1.33. Paragraphs 1.48-1.54 provide guidance on the possibility for a tax administration to challenge contractual terms where they are not consistent with the economic substance of the transaction or where they do not conform with the conduct of the parties ...

In the Article 9 context, an examination of the application of the arm’s length principle to controlled transactions should start from the transactions actually undertaken by the associated enterprises, and the terms of contracts play a major role (see paragraph 1.64). As acknowledged in paragraphs 1.47-1.51 and 1.64-1.69, however, such a review of the contractual terms is not sufficient ...

MNEs are free to organise their business operations as they see fit. Tax administrations do not have the right to dictate to an MNE how to design its structure or where to locate its business operations. MNE groups cannot be forced to have or maintain any particular level of business presence in a country. They are free to act in their own best commercial and economic interests in this regard. In making this decision, tax considerations may be a factor. Tax administrations, however, have the right to determine the tax consequences of the structure put in place by an MNE, subject to the application of treaties and in particular of Article 9 of the OECD Model Tax Convention. This means that tax administrations may perform where appropriate transfer pricing adjustments in accordance with Article 9 of the OECD Model Tax Convention and/or other types of adjustments allowed by their domestic law (e.g. under general or specific anti-abuse rules), to the extent that such adjustments are compatible with their treaty obligations ...

Paragraphs 1.64-1.69 are limited to the non-recognition of transactions for the purposes of making transfer pricing adjustments covered by Article 9 of the OECD Model Tax Convention (i.e. adjustments in accordance with the arm’s length principle). They do not provide any guidance as to a country’s ability to characterise transactions differently under other aspects of its domestic law. A discussion of the relationship between domestic anti-abuse rules and treaties is found in the Commentary on Article 1 of the OECD Model Tax Convention (see in particular paragraphs 9.5, 22 and 22.1 of the Commentary) ...

An important starting point for any transfer pricing analysis is to properly identify and characterise the controlled transaction under review. Paragraphs 1.64-1.69 deal with the relevance of the actual transactions undertaken by associated enterprises and discusses the exceptional circumstances in which it may be legitimate and appropriate for a tax administration not to recognise, for transfer pricing purposes, a transaction that is presented by a taxpayer ...