In 2010, E S.A. transferred the legal ownership of a trademark to subsidiary S and subsequently entered into an agreement with S for the “licensing of the use of the trademarks”. In 2013, the same trademark was transferred back to E. S.A. As a result of these transactions, E. S.A., between 2010 and 2013, recognised the licence fees paid to S as tax costs, and then, as a result of the re-purchase of those trademarks in 2013 – it again made depreciation write-offs on them, recognising them as tax costs. The tax authority found that E S.A. had reported income lower than what would have been reported had the relationships not existed. E S.A. had  overestimated the tax deductible costs by PLN […] for the depreciation of trademarks, which is a consequence of the overestimation for tax purposes of the initial value of the trademarks repurchased from S – 27 December 2013 – by the amount of PLN […]. The function performed by S between 2010 and 2013 was limited to re-registration of the trademarks with the change of legal ownership. In the tax authority’s view, the expenses incurred by E S.A. for the reverse acquisition of the trademarks did not reflect the transactions that unrelated parties would have entered into, as they do not take into account the functions that E S.A. performed in relation to the trademarks. A tax assessment was issued where – for tax purposes – the transaction had instead been treated as a service contract, where S had provided protection and registration services to E S.A. A complaint was filed by E S.A. Judgement of the Court The Court found that there was no legal basis for re-characterisation in Poland for the years in question and that the issue should instead be resolved by applying the Polish anti-avoidance provision. On that basis, the case was referred back for further consideration. Excerpts “In principle, the tax authorities did not present any argumentation showing from which rules of interpretation they came to the conclusion that such an application of the above-mentioned provisions is legally possible and justified in the present case. It should be noted in this regard that Article 11(1) in fine speaks of the determination of income and tax due without – ‘[…] taking into account the conditions arising from the relationship…’, but does not allow for the substitution of one legal act (a licence agreement) for another act (an agreement for the provision of administration services), and deriving from the latter the legal consequences for the determination of the amount of the tax liability. There should be no doubt in this case that, in fact, the authorities made an unjustified reclassification of the legal act performed in the form of the conclusion of a valid licensing contract, when they concluded (referring to the OECD Guidelines – Annex to Chapter VI – Illustrative Examples of Recommendations on Intangible Assets, example 1, point 4) that the transactions carried out by E. and S. in fact constitute, for the purposes of assessing remuneration, a contract for the provision of trademark administration services and the market price in such a case should be determined for administration services. As the applicant rightly argued, such a possibility exists as of 1 January 2019, since Article 11c(4) uses the expression – “[…] without taking into account the controlled transaction, and where justified, determines the income (loss) of the taxpayer from the transaction appropriate to the controlled transaction”. This is what is meant by the so-called recharacterisation, i.e. the reclassification of the transaction, which is what the tax authorities actually did in the present case. At the same time, the Court does not share the view expressed in the jurisprudence of administrative courts, referring to the content of the justification of the draft amending act, according to which, the solutions introduced in 2019 were of a clarifying rather than normative nature (cf. the judgment of the WSA in Rzeszów of 20 October 2022, I SA/Rz 434/22). The applicant rightly argues in this regard that the new regulation is undoubtedly law-making in nature and that the provisions in force until the end of 2018 did not give the tax authorities such powers. It is necessary to agree with the view expressed in the literature that a linguistic interpretation of Article 11(1) of the A.p.d.o.p. and Article 11c of the A.p.d.o.p. proves that Article 11c of that Act is a normative novelty, as the concepts and premises it regulates cannot be derived in any way from the wording of Art. 11(1) u.p.d.o.p. (cf. H. Litwińczuk, Reclassification (non-recognition) of a transaction made between related parties in the light of transfer pricing regulations before and after 1.01.2019, “Tax Review” of 2019, no. 3).” “It follows from the justification of the contested decisions that, in applying Article 11(1) and (4) of the TAX Act to the facts of this case, the tax authorities referred to the OECD Guidelines, inter alia, to the example provided therein (Anex to Chapter VI – Illustrative Examples of Recommendations on Intangible Assets, example 1, point 4), from which, according to the authorities, it follows that the transactions carried out by E. S.A. and S. for the purposes of assessing remuneration constitute, in fact, a contract for the provision of trademark administration services and, in that case, the market price should be determined for such services. In this context, it should be clarified that the OECD Guidelines (as well as other documents of this organisation), in the light of the provisions of Article 87 of the Constitution of the Republic of Poland, do not constitute a source of universally binding law. Neither can they determine in a binding manner the basic structural elements of a tax, since the constitutional legislator in Article 217 of the Basic Law has subjected this sphere exclusively to statutory regulations. Since these guidelines do not constitute a source of law, they can therefore neither lead to an extension of the powers of the tax authorities nor of the ...

P and S are controlled taxpayers. P licenses a proprietary process to S for S’s use in manufacturing product X. Using its sales and marketing employees, S sells product X to related and unrelated customers outside the United States. If the license between P and S has economic substance, the Commissioner ordinarily will not restructure the taxpayer’s transaction to treat P as if it had elected to exploit directly the manufacturing process. However, because P could have directly exploited the manufacturing process and manufactured product X itself, this realistic alternative may be taken into account under § 1.482-4(d) in determining the arm’s length consideration for the controlled transaction. For examples of such an analysis, see Examples 7 and 8 in paragraph (f)(2)(i)(E) of this section and the Example in § 1.482-4(d)(2) ...

The following example illustrates this paragraph (f)(2)(ii): ...

...

Allocating arm’s length compensation determined under an aggregate analysis – (i) P provides services to S1, which is incorporated in Country A. In connection with those services, P licenses intellectual property to S2, which is incorporated in Country B. S2 sublicenses the intellectual property to S1. (ii) Under paragraph (f)(2)(i)(B) of this section, if an aggregate analysis of the service and license transactions provides the most reliable measure of an arm’s length result, then an aggregate analysis must be performed. Under paragraph (f)(2)(i)(D) of this section, if an allocation of the value that results from such an aggregate analysis is necessary, for example, for purposes of sourcing the services income that P receives from S1 or determining deductible expenses incurred by S1, then the value determined under the aggregate analysis must be allocated using the method that provides the most reliable measure of the services income and deductible expenses ...

Services provided using intangibles. – (i) P’s worldwide group produces and markets Product X and subsequent generations of products, which result from research and development performed by P’s R&D Team. Through this collaboration with respect to P’s proprietary products, the members of the R&D Team have individually and as a group acquired specialized knowledge and expertise subject to non-disclosure agreements (collectively, “knowhow”). (ii) P arranges for the R&D Team to provide research and development services to create a new line of products, building on the Product X platform, to be owned and exploited by S1 in the overseas market. P asserts that the arm’s length charge for the services is only reimbursement to P of its associated R&D Team compensation costs. (iii) Even though P did not transfer the platform or the R&D Team to S1, P is providing value associated with the use of the platform, along with the value associated with the use of the knowhow, to S1 by way of the services performed by the R&D Team for S1 using the platform and the knowhow. The R&D Team’s use of intangible property, and any other valuable resources, in P’s provision of services (regardless of whether the service effects a transfer of intangible property or valuable resources and regardless of whether the property is relatively high or low value) must be evaluated under the section 482 regulations, including the regulations specifically applicable to controlled services transactions in § 1.482-9, to ensure that P receives arm’s length compensation for any value (attributable to such property or services) provided to S1 in a controlled transaction. See §§ 1.482-4 and 1.482-9(m). Under paragraph (f)(2)(i)(A) of this section, the arm’s length compensation for the services performed by the R&D Team for S1 must be consistent with the value provided to S1, including the value of the knowhow and any synergies with the platform. Under paragraphs (f)(2)(i)(B) and (C) of this section, the best method analysis may determine that the compensation is most reliably determined on an aggregate basis reflecting the interrelated value of the services and embedded value of the platform and knowhow. (iv) In the alternative, the facts are the same as above, except that P assigns to S1 all or a pertinent portion of the R&D Team and the relevant rights in the platform. P takes the position that, although the transferred platform rights must be compensated, the knowhow does not have substantial value independent of the services of any individual on the R&D Team and therefore is not an intangible within the meaning of § 1.482-4(b). In P’s view, S1 owes no compensation to P on account of the R&D Team, as S1 will directly bear the cost of the relevant R&D Team compensation. However, in assembling and arranging to assign the relevant R&D Team, and thereby making available the value of the knowhow to S1, rather than other employees without the knowhow, P is performing services for S1 under imputed contractual terms based on the parties’ course of conduct. Therefore, even if P’s position were correct that the knowhow is not an intangible under § 1.482-4(b), a position that the Commissioner may challenge, arm’s length compensation is required for all of the value that P provides to S1 through the interrelated provision of platform rights, knowhow, and services under paragraphs (f)(2)(i)(A), (B), and (C) of this section ...

Aggregation of interrelated manufacturing and marketing intangibles governed by different statutes and regulations. The facts are the same as in Example 8 except that P transfers only the ROW intangibles related to manufacturing to S1 in an exchange described in section 351 and, upon entering into the CSA, then transfers the ROW intangibles related to marketing to S1 in a platform contribution transaction described in § 1.482-7(c) (rather than transferring all ROW intangibles only upon entering into the CSA or only in a prior exchange described in section 351). The value of the ROW intangibles that P transferred in the two transactions is greater in the aggregate, due to synergies among the different types of ROW intangibles, than if valued as two separate transactions. Under paragraph (f)(2)(i)(B) of this section, the arm’s length standard requires these synergies to be taken into account in determining the arm’s length results for the transactions ...

Arm’s length compensation for equivalent provisions of intangibles under sections 351 and 482. P owns the worldwide rights to manufacturing and marketing intangibles that it uses to manufacture and market a product in the United States (“US intangibles”) and the rest of the world (“ROW intangibles”). P transfers all the ROW intangibles to S1 in an exchange described in section 351 and retains the US intangibles. Immediately after the exchange, P and S1 entered into a CSA described in § 1.482-7(b) that covers all research and development of intangibles conducted by the parties. A realistic alternative that was available to P and that would have involved the controlled parties performing similar functions, employing similar resources, and assuming similar risks as in the controlled transaction, was to transfer all ROW intangibles to S1 upon entering into the CSA in a platform contribution transaction described in § 1.482-7(c), rather than in an exchange described in section 351 immediately before entering into the CSA. Under paragraph (f)(2)(i)(A) of this section, the arm’s length compensation for the ROW intangibles must correspond to the value provided between the parties, regardless of the form of the transaction. Accordingly, the arm’s length compensation for the ROW intangibles is the same in both scenarios, and the analysis of the amount to be taken into account under section 367(d) pursuant to §§ 1.367(d)-1T(c) and 1.482-4 should include consideration of the amount that P would have charged for the realistic alternative determined under § 1.482-7(g) (and § 1.482-4, to the extent of any make-or-sell rights transferred). See §§ 1.482-1(b)(2)(iii) and 1.482-4(g) ...

Distinguishing provision of value from characterization – (i) P developed a collection of resources, capabilities, and rights (“Collection”) that it uses on an interrelated basis in ongoing research and development of computer code that is used to create a successful line of software products. P can continue to use the Collection on such interrelated basis in the future to further develop computer code and, thus, further build on its successful line of software products. Under § 1.482-7(g)(2)(ix), P determines that the interquartile range of the net present value of its own use of the Collection in future research and development and software product marketing is between $1000x and $1100x, and this range provides the most reliable measure of the value to P of continuing to use the Collection on an interrelated basis in future research, development, and exploitation. Instead, P enters into an exchange described in section 351 in which it transfers certain intangible property related to the Collection to S1 for use in future research, development, and exploitation but continues to perform the same development functions that it did prior to the exchange, now on behalf of S1, under express or implied commitments in connection with S1’s use of the intangible property. P takes the position that a portion of the Collection, consisting of computer code and related instruction manuals and similar intangible property (Portion 1), was transferrable intangible property and was the subject of the section 351 exchange and compensable under section 367(d). P claims that another portion of the Collection consists of items that either do not constitute property for purposes of section 367 or are not transferrable (Portion 2). P then takes the position that the value of Portion 2 does not give rise to income under section 367(d) or gain under section 367(a). (ii) Under paragraphs (f)(2)(i)(A) and (C) of this section, any part of the value in Portion 2 that is not taken into account in an exchange under section 367 must nonetheless be evaluated under section 482 and the regulations thereunder to determine arm’s length compensation for any value provided to S1. Accordingly, even if P’s assertion that certain items were either not property or not capable of being transferred were correct, arm’s length compensation is nonetheless required for all of the value associated with P’s contributions under the section 482 regulations. Alternatively, the Commissioner may determine under all the facts and circumstances that P’s assertion is incorrect and that the transaction in fact constitutes an exchange of property subject to, and therefore to be taken into account under, section 367. Thus, whether any item that P identifies as being within Portion 2 is properly characterized as property under section 367 (transferable or otherwise) is irrelevant because any value in Portion 2 that is provided to S1 must be compensated by S1 in a manner consistent with the $1000x to $1100x interquartile range of the overall value ...

Consideration of entire arrangement, including imputed contractual terms – (i) P conducts a business (“Business”) from the United States, with a worldwide clientele, but until Date X has no foreign operations. The success of Business significantly depends on intangibles (including marketing, manufacturing, technological, and goodwill or going concern value intangibles, collectively the “IP”), as well as ongoing support activities performed by P (including related research and development, central marketing, manufacturing process enhancement, and oversight activities, collectively “Support”), to maintain and improve the IP and otherwise maximize the profitability of Business. (ii) On Date X, Year 1, P contributes the foreign rights to conduct Business, including the foreign rights to the IP, to newly incorporated S1. S1, utilizing the IP of which it is now the owner, commences foreign operations consisting of local marketing, manufacturing, and back office activities in order to conduct and expand Business in the foreign market. (iii) Later, on Date Y, Year 1, P and S1 enter into a cost sharing arrangement (“CSA”) to develop and exploit the rights to conduct the Business. Under the CSA, P is entitled to the U.S. rights to conduct the Business, and S1 is entitled to the rest-of-the-world (“ROW”) rights to conduct the Business. P continues after Date Y to perform the Support, employing resources, capabilities, and rights that as a factual matter were not contributed to S1 in the Date X transaction, for the benefit of the Business worldwide. Pursuant to the CSA, P and S1 share the costs of P’s Support in proportion to their reasonably anticipated benefit shares from their respective rights to the Business. (iv) P treats the Date X transaction as a transfer described in section 351 that is subject to 367 and treats the Date Y transaction as the commencement of a CSA subject to section 482 and § 1.482-7. P takes the position that the only platform contribution transactions (“PCTs”) in connection with the Date Y CSA consist of P’s contribution of the U.S. Business IP rights and S1’s contribution of the ROW Business IP rights of which S1 had become the owner on account of the prior Date X transaction. (v) Pursuant to paragraph (f)(2)(i)(A) of this section, in determining whether an allocation of income is appropriate in Year 1 or subsequent years, the Commissioner may consider the economic substance of the entire arrangement between P and S1, including the parties’ actual conduct throughout their relationship, regardless of the form or character of the contractual arrangement the parties have expressly adopted. The Commissioner determines that the parties’ formal arrangement fails to reflect the full scope of the value provided between the parties in accordance with the economic substance of their arrangement. Therefore, the Commissioner may impute one or more agreements between P and S1, consistent with the economic substance of their arrangement, that fully reflect their respective reasonably anticipated commitments in terms of functions performed, resources employed, and risks assumed over time. For example, because P continues after Date Y to perform the Support, employing resources, capabilities, and rights not contributed to S1, for the benefit of the Business worldwide, the Commissioner may impute another PCT on Date Y pursuant to which P commits to so continuing the Support. See § 1.482-7(b)(1)(ii). The taxpayer may present additional facts that could indicate whether this or another alternative agreement best reflects the economic substance of the underlying transactions and course of conduct, provided that the taxpayer’s position fully reflects the value of the entire arrangement consistent with the realistic alternatives principle ...

Aggregation of interrelated patents. P owns 10 individual patents that, in combination, can be used to manufacture and sell a successful product. P anticipates that it could earn profits of $25x from the patents based on a discounted cash flow analysis that provides a more reliable measure of the value of the patents exploited as a bundle rather than separately. P licenses all 10 patents to S1 to be exploited as a bundle. Evidence of uncontrolled licenses of similar individual patents indicates that, exploited separately, each license of each patent would warrant a price of $1x, implying a total price for the patents of $10x. Under paragraph (f)(2)(i)(B) of this section, in determining the arm’s length royalty for the license of the bundle of patents, it would not be appropriate to use the uncontrolled licenses as comparables for the license of the bundle of patents, because, unlike the discounted cash flow analysis, the uncontrolled licenses considered separately do not reliably reflect the enhancement to value resulting from the interrelatedness of the 10 patents exploited as a bundle ...

Non-aggregation of transactions that are not interrelated. P enters into a license agreement with S1 that permits S1 to use a proprietary process for manufacturing product X and to sell product X to uncontrolled parties throughout a specified region. P also sells to S1 product Y, which is manufactured by P in the United States and unrelated to product X. Product Y is resold by S1 to uncontrolled parties in the specified region. There is no connection between product X and product Y other than the fact that they are both sold in the same specified region. In evaluating whether the royalty paid by S1 to P for the use of the manufacturing process for product X and the transfer prices charged for unrelated product Y are arm’s length amounts, it would not be appropriate to consider the combined effects of these separate and unrelated transactions ...

Aggregation and reliability of comparable uncontrolled transactions. The facts are the same as in Example 2. In addition, U1, U2, and U3 are uncontrolled taxpayers that carry out functions comparable to those of S1, S2, and S3, respectively, with respect to computers produced by unrelated manufacturers. R1, R2, and R3 constitute a controlled group of taxpayers (unrelated to the P controlled group) that carry out functions comparable to those of S1, S2, and S3 with respect to computers produced by their common parent. Prices charged to uncontrolled customers of the R group differ from the prices charged to customers of U1, U2, and U3. In determining whether the transactions of U1, U2, and U3, or the transactions of R1, R2, and R3, would provide a more reliable measure of the arm’s length result, it is determined that the interrelated R group transactions are more reliable than the wholly independent transactions of U1, U2, and U3, given the interrelationship of the P group transactions ...

Aggregation of interrelated manufacturing, marketing, and services activities. S1 is the exclusive Country Z distributor of computers manufactured by P. S2 provides marketing services in connection with sales of P computers in Country Z and in this regard uses significant marketing intangibles provided by P. S3 administers the warranty program with respect to P computers in Country Z, including maintenance and repair services. In evaluating whether the transfer prices paid by S1 to P, the fees paid by S2 to P for the use of P marketing intangibles, and the service fees earned by S2 and S3 are arm’s length amounts, it would be appropriate to perform an aggregate analysis that considers the combined effects of these interrelated transactions if they are most reliably analyzed on an aggregated basis ...

Aggregation of interrelated licensing, manufacturing, and selling activities. P enters into a license agreement with S1 that permits S1 to use a proprietary manufacturing process and to sell the output from this process throughout a specified region. S1 uses the manufacturing process and sells its output to S2, which in turn resells the output to uncontrolled parties in the specified region. In evaluating whether the royalty paid by S1 to P is an arm’s length amount, it may be appropriate to evaluate the royalty in combination with the transfer prices charged by S1 to S2 and the aggregate profits earned by S1 and S2 from the use of the manufacturing process and the sale to uncontrolled parties of the products produced by S1 ...

The following examples illustrate the provisions of this paragraph (f)(2)(i). For purposes of the examples in this paragraph (E), P is a domestic corporation, and S1, S2, and S3 are foreign corporations that are wholly owned by P ...

In some cases, it may be necessary to allocate one or more portions of the arm’s length result that was properly determined under a coordinated best method analysis described in paragraph (f)(2)(i)(C) of this section. Any such allocation of the arm’s length result determined under the coordinated best method analysis must be made using the method that, under the facts and circumstances, provides the most reliable measure of an arm’s length result for each allocated amount. For example, if the full value of compensation due in controlled transactions whose tax treatment is governed by multiple provisions of the Code or regulations has been most reliably determined on an aggregate basis, then that full value must be allocated in a manner that provides the most reliable measure of each allocated amount ...

Consistent with the principles of paragraphs (f)(2)(i)(A) and (B) of this section, a coordinated best method analysis and evaluation of two or more controlled transactions to which one or more provisions of the Code or regulations apply may be necessary to ensure that the overall value provided, including any synergies, is properly taken into account. A coordinated best method analysis would include a consistent consideration of the facts and circumstances of the functions performed, resources employed, and risks assumed in the relevant transactions, and a consistent measure of the arm’s length results, for purposes of all relevant statutory and regulatory provisions ...

The combined effect of two or more separate transactions (whether before, during, or after the year under review), including for purposes of an analysis under multiple provisions of the Code or regulations, may be considered if the transactions, taken as a whole, are so interrelated that an aggregate analysis of the transactions provides the most reliable measure of an arm’s length result determined under the best method rule of § 1.482-1(c). Whether two or more transactions are evaluated separately or in the aggregate depends on the extent to which the transactions are economically interrelated and on the relative reliability of the measure of an arm’s length result provided by an aggregate analysis of the transactions as compared to a separate analysis of each transaction. For example, consideration of the combined effect of two or more transactions may be appropriate to determine whether the overall compensation in the transactions is consistent with the value provided, including any synergies among items and services provided ...

All value provided between controlled taxpayers in a controlled transaction requires an arm’s length amount of compensation determined under the best method rule of § 1.482-1(c). Such amount must be consistent with, and must account for all of, the value provided between the parties in the transaction, without regard to the form or character of the transaction. For this purpose, it is necessary to consider the entire arrangement between the parties, as determined by the contractual terms, whether written or imputed in accordance with the economic substance of the arrangement, in light of the actual conduct of the parties. See, e.g., § 1.482-1(d)(3)(ii)(B) (identifying contractual terms) and (f)(2)(ii)(A) (regarding reference to realistic alternatives) ...

...

(a) through (f) (2) [Reserved]. For further guidance see § 1.482-1(a) through (f)(2) ...

The Commissioner will evaluate the results of a transaction as actually structured by the taxpayer unless its structure lacks economic substance. However, the Commissioner may consider the alternatives available to the taxpayer in determining whether the terms of the controlled transaction would be acceptable to an uncontrolled taxpayer faced with the same alternatives and operating under comparable circumstances. In such cases the Commissioner may adjust the consideration charged in the controlled transaction based on the cost or profit of an alternative as adjusted to account for material differences between the alternative and the controlled transaction, but will not restructure the transaction as if the alternative had been adopted by the taxpayer. See paragraph (d)(3) of this section (factors for determining comparability; contractual terms and risk); §§ 1.482-3(e), 1.482-4(d), and 1.482-9(h) (unspecified methods) ...

...

A restructuring that followed the acquisition of Timberland by VF Enterprises in 2011 resulted in an intra-group transfer of ownership to valuable intangibles to a Swiss corporation, TBL Investment Holdings. The IRS was of the opinion that gains from the transfer was taxable. Judgement of the US Tax Court The tax court upheld the assessment of the tax authorities. Excerpt: “we have concluded that petitioner’s constructive distribution to VF Enterprises of the TBL GmbH stock that petitioner constructively received in exchange for its intangible property was a “disposition” within the meaning of section 367(d)(2)(A)(ii)(II). We also conclude, for the reasons explained in this part IV, that no provision of the regulations allows petitioner to avoid the recognition of gain under that statutory provision.” “Because we do not “agree[] to reduce the adjustment to income for the trademarks based on a 20-year useful life limitation, pursuant to Temp. Treas. Reg. § 1.367(d)-1T,” we determine, in accordance with the parties’ stipulation, that “[p]etitioner’s increase in income for the transfer of the trademarks is $1,274,100,000.” Adding that figure to the agreed value of the foreign workforce and customer relationships that petitioner transferred to TBL GmbH and reducing the sum by the agreed trademark basis, we conclude that petitioner’s income for the taxable year in issue should be increased by $1,452,561,000 ($1,274,100,000 +$23,400,000 + $174,400,000 − $19,339,000), as determined in the notice of deficiency. Because petitioner did not assign error to the other two adjustments reflected in the notice of deficiency, it follows that respondent is entitled to judgment as a matter of law. Accordingly, we will grant respondent’s motion for summary judgment and deny petitioner’s corresponding motion.” Click here for translation ...

16. Primero is the parent company of an MNE group engaged in the pharmaceutical business and does business in country M. Primero develops patents and other intangibles relating to Product X and registers those patents in countries around the world. 17. Primero retains its wholly owned country N subsidiary, Company S, to distribute Product X throughout Europe and the Middle East on a limited risk basis. The distribution agreement provides that Primero, and not Company S, is to bear product recall and product liability risk, and provides further that Primero will be entitled to all profit or loss from selling Product X in the territory after providing Company S with the agreed level of compensation for its distribution functions. Operating under the contract, Company S purchases Product X from Primero and resells Product X to independent customers in countries throughout its geographical area of operation. In performing its distribution functions, Company S follows all applicable regulatory requirements. 18. In the first three years of operations, Company S earns returns from its distribution functions that are consistent with its limited risk characterisation and the terms of the distribution contract. Its returns reflect the fact that Primero, and not Company S, is entitled to retain income derived from exploitation of the intangibles with respect to Product X. After three years of operation, it becomes apparent that Product X causes serious side effects in a significant percentage of those patients that use the product and it becomes necessary to recall the product and remove it from the market. Company S incurs substantial costs in connection with the recall. Primero does not reimburse Company S for these recall related costs or for the resulting product liability claims. 19. Under these circumstances, there is an inconsistency between Primero’s asserted entitlement to returns derived from exploiting the Product X intangibles and its failure to bear the costs associated with the risks supporting that assertion. A transfer pricing adjustment would be appropriate to remedy the inconsistency. In determining the appropriate adjustment, it would be necessary to determine the true transaction between the parties by applying the provisions of Section D. 1 of Chapter I. In doing so, it would be appropriate to consider the risks assumed by each of the parties on the basis of the course of conduct followed by the parties over the term of the agreement, the control over risk exercised by Primero and Company S, and other relevant facts. If it is determined that the true nature of the relationship between the parties is that of a limited risk distribution arrangement, then the most appropriate adjustment would likely take the form of an allocation of the recall and product liability related costs from Company S to Primero. Alternatively, although unlikely, if it is determined on the basis of all the relevant facts that the true nature of the relationship between the parties includes the exercising control over product liability and recall risk by Company S, and if an arm’s length price can be identified on the basis of the comparability analysis, an increase in the distribution margins of Company S for all years might be made to reflect the true risk allocation between the parties ...

5. The facts related to the development and control of patentable inventions are the same as in Example 1. However, instead of granting a perpetual and exclusive licence of its patents back to Premiere, Company S, acting under the direction and control of Premiere, grants licences of its patents to associated and independent enterprises throughout the world in exchange for periodic royalties. For purposes of this example, it is assumed that the royalties paid to Company S by associated enterprises are all arm’s length. 6. Company S is the legal owner of the patents. However, its contributions to the development, enhancement, maintenance, protection, and exploitation of the patents are limited to the activities of its three employees in registering the patents and maintaining the patent registrations. The Company S employees do not control or participate in the licensing transactions involving the patents. Under these circumstances, Company S is only entitled to compensation for the functions it performs. Based on an analysis of the respective functions performed, assets used, and risks assumed by Premiere and Company S in developing, enhancing, maintaining, protecting, and exploiting the intangibles, Company S should not be entitled ultimately to retain or be attributed income from its licensing arrangements over and above the arm’s length compensation for its patent registration functions. 7. As in Example 1 the true nature of the arrangement is a patent administration service contract. The appropriate transfer pricing outcome can be achieved by ensuring that the amount paid by Company S in exchange for the assignments of patent rights appropriately reflects the respective functions performed, assets used, and risks assumed by Premiere and by Company S. Under such an approach, the compensation due to Premiere for the patentable inventions is equal to the licensing revenue of Company S less an appropriate return to the functions Company S performs ...

In the process of accurately delineating the actual transaction involving a captive insurance, the economically relevant risks associated with issuing insurance policies, i.e. underwriting, must be identified with specificity. Part IV of the Report on the Attribution of Profits to Permanent Establishments provides a description of those risks that include, inter alia, insurance risk, commercial risk or investment risk. These descriptions remain valid for the purpose of this guidance ...

In situations where the captive insurance lacks the scale to achieve significant risk diversification or lacks sufficient reserves to meet additional risks represented by the relatively less diversified portfolio of the MNE group, the accurate delineation of the actual transaction may indicate that the captive insurance is operating a business other than an insurance one (see guidance in Chapter VII) ...

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 ...

A frequent concern when considering the transfer pricing of captive insurance transactions is whether the transaction concerned is genuinely one of insurance, i.e. whether a risk exists and, if so, whether it is allocated to the captive insurance in light of the facts and circumstances. The following are indicators, all or substantially all of which would be found if the captive insurance was found to undertake a genuine insurance business: there is diversification and pooling of risk in the captive insurance; the economic capital position of the entities within the MNE group has improved as a result of diversification and there is therefore a real economic impact for the MNE group as a whole; both the captive insurance and any reinsurer are regulated entities with broadly similar regulatory regimes and regulators that require evidence of risk assumption and appropriate capital levels; the insured risk would otherwise be insurable outside the MNE group; the captive insurance has the requisite skills, including investment skills, and experience at its disposal (see paragraph 10.213); the captive insurance has a real possibility of suffering losses ...

Every effort should be made to determine pricing for the actual transaction as accurately delineated under the arm’s length principle. The various tools and methods available to tax administrations and taxpayers to do so are set out in the following chapters of these Guidelines. A tax administration should not disregard the actual transaction or substitute other transactions for it unless the exceptional circumstances described in the following paragraphs 1.142-1.145 apply ...

The following example illustrates the concept of differences between written contractual terms and conduct of the parties, with the result that the actual conduct of the parties delineates the transaction. Company S is a wholly-owned subsidiary of Company P. The parties have entered into a written contract pursuant to which Company P licenses intellectual property to Company S for use in Company S’s business; Company S agrees to compensate Company P for the licence with a royalty. Evidence provided by other economically relevant characteristics, and in particular the functions performed, establishes that Company P performs negotiations with third-party customers to achieve sales for Company S, provides regular technical services support to Company S so that Company S can deliver contracted sales to its customers, and regularly provides staff to enable Company S to fulfil customer contracts. A majority of customers insist on including Company P as joint contracting party along with Company S, although fee income under the contract is payable to Company S. The analysis of the commercial or financial relations indicates that Company S is not capable of providing the contracted services to customers without significant support from Company P, and is not developing its own capability. Under the contract, Company P has given a licence to Company S, but in fact controls the business risk and output of Company S such that it has not transferred risk and function consistent with a licensing arrangement, and acts not as the licensor but the principal. The identification of the actual transaction between Company P and Company S should not be defined solely by the terms of the written contract. Instead, the actual transaction should be determined from the conduct of the parties, leading to the conclusion that the actual functions performed, assets used, and risks assumed by the parties are not consistent with the written licence agreement ...

An assessment was issued by the Norwegian tax authorities for years 2009 2010 and 2011 concerning the interest on a loan between Exxonmobil Production Norway Inc. (EPNI) as the lender and Exxon Mobile Delaware Holdings Inc. (EMDHI) as the borrower. Both EPNI and EMDHI are subsidiaries in the Exxon Group, where the parent company is domiciled in the United States. The loan agreement between EPNI and EMDHI was entered into in 2009. The loan had a drawing facility of NOK 20 billion. The agreed maturity was 2019, and the interest rate was fixed at 3 months NIBOR plus a margin of 30 basis points. The agreement also contained provisions on quarterly interest rate regulation and a interest adjustment clause allowing the lender to adjust the interest rate on changes in the borrower’s creditworthiness. The dispute concerns the margin of 30 basis points and the importance of the adjustment clause, also referred to as the step-up clause. The Oil Tax office and the Appeals Board for Oil Tax found that the agreed interest rate was not at arm’s length and taxable income for the three relevant years was increased by a total of NOK 95 525 000. EPNI filed an appeal to Oslo District Court. In 2016 the District Court ruled in favor of the tax authorities. EPNI then filed an appeal to the National Court of Appeal. The National Court of Appeal concluded that the interest payments had not been at arm’s length and dismissed the appeal. In the decision, reference is made to the Norwegian Supreme Court decision in the Statoil Angola case from 2007. Click here for translation ...

16. Primero is the parent company of an MNE group engaged in the pharmaceutical business and does business in country M. Primero develops patents and other intangibles relating to Product X and registers those patents in countries around the world. 17. Primero retains its wholly owned country N subsidiary, Company S, to distribute Product X throughout Europe and the Middle East on a limited risk basis. The distribution agreement provides that Primero, and not Company S, is to bear product recall and product liability risk, and provides further that Primero will be entitled to all profit or loss from selling Product X in the territory after providing Company S with the agreed level of compensation for its distribution functions. Operating under the contract, Company S purchases Product X from Primero and resells Product X to independent customers in countries throughout its geographical area of operation. In performing its distribution functions, Company S follows all applicable regulatory requirements. 18. In the first three years of operations, Company S earns returns from its distribution functions that are consistent with its limited risk characterisation and the terms of the distribution contract. Its returns reflect the fact that Primero, and not Company S, is entitled to retain income derived from exploitation of the intangibles with respect to Product X. After three years of operation, it becomes apparent that Product X causes serious side effects in a significant percentage of those patients that use the product and it becomes necessary to recall the product and remove it from the market. Company S incurs substantial costs in connection with the recall. Primero does not reimburse Company S for these recall related costs or for the resulting product liability claims. 19. Under these circumstances, there is an inconsistency between Primero’s asserted entitlement to returns derived from exploiting the Product X intangibles and its failure to bear the costs associated with the risks supporting that assertion. A transfer pricing adjustment would be appropriate to remedy the inconsistency. In determining the appropriate adjustment, it would be necessary to determine the true transaction between the parties by applying the provisions of Section D. 1 of Chapter I. In doing so, it would be appropriate to consider the risks assumed by each of the parties on the basis of the course of conduct followed by the parties over the term of the agreement, the control over risk exercised by Primero and Company S, and other relevant facts. If it is determined that the true nature of the relationship between the parties is that of a limited risk distribution arrangement, then the most appropriate adjustment would likely take the form of an allocation of the recall and product liability related costs from Company S to Primero. Alternatively, although unlikely, if it is determined on the basis of all the relevant facts that the true nature of the relationship between the parties includes the exercising control over product liability and recall risk by Company S, and if an arm’s length price can be identified on the basis of the comparability analysis, an increase in the distribution margins of Company S for all years might be made to reflect the true risk allocation between the parties ...

Every effort should be made to determine pricing for the actual transaction as accurately delineated under the arm’s length principle. The various tools and methods available to tax administrations and taxpayers to do so are set out in the following chapters of these Guidelines. A tax administration should not disregard the actual transaction or substitute other transactions for it unless the exceptional circumstances described in the following paragraphs 1.122-1.125 apply ...

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 ...