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 ...

26. The facts in this example are the same as in Example 8, except as follows: Under the contract between Primair and Company S, Company S is now obligated to develop and execute the marketing plan for country Y without detailed control of specific elements of the plan by Primair. Company S bears the costs and assumes certain of the risks associated with the marketing activities. The agreement between Primair and Company S does not specify the amount of marketing expenditure Company S is expected to incur, only that Company S is required to use its best efforts to market the watches. Company S receives no direct reimbursement from Primair in respect of any expenditure it incurs, nor does it receive any other indirect or implied compensation from Primair, and Company S expects to earn its reward solely from its profit from the sale of R brand watches to third party customers in the country Y market. A thorough functional analysis reveals that Primair exercises a lower level of control over the marketing activities of Company S than in Example 8 in that it does not review and approve the marketing budget or design details of the marketing plan. Company S bears different risks and is compensated differently than was the case in Example 8. The contractual arrangements between Primair and Company S are different and the risks assumed by Company S are greater in Example 9 than in Example 8. Company S does not receive direct cost reimbursements or a separate fee for marketing activities. The only controlled transaction between Primair and Company S in Example 9 is the transfer of the branded watches. As a result, Company S can obtain its reward for its marketing activities only through selling R brand watches to third party customers. As a result of these differences, Primair and Company S adopt a lower price for watches in Example 9 than the price for watches determined for purposes of Example 8. As a result of the differences identified in the functional analysis, different criteria are used for identifying comparables and for making comparability adjustments than was the case in Example 8. This results in Company S having a greater anticipated total profit in Example 9 than in Example 8 because of its higher level of risk and its more extensive functions. 27. Assume that in Years 1 through 3, Company S embarks on a strategy that is consistent with its agreement with Primair and, in the process, performs marketing functions and incurs marketing expenses. As a result, Company S has high operating expenditures and slim margins in Years 1 through 3. By the end of Year 2, the R trademark and trade name have become established in country Y because of Company S’s efforts. Where the marketer/distributor actually bears the costs and associated risks of its marketing activities, the issue is the extent to which the marketer/distributor can share in the potential benefits from those activities. Assume that the enquiries of the country Y tax administrations conclude, based on a review of comparable distributors, that Company S would have been expected to have performed the functions it performed and incurred its actual level of marketing expense if it were independent from Primair. 28. Given that Company S performs the functions and bears the costs and associated risks of its marketing activities under a long-term contract of exclusive distribution rights for the R watches, there is an opportunity for Company S to benefit (or suffer a loss) from the marketing and distribution activities it undertakes. Based on an analysis of reasonably reliable comparable data, it is concluded that, for purposes of this example, the benefits obtained by Company S result in profits similar to those made by independent marketers and distributors bearing the same types of risks and costs as Company S in the first few years of comparable long-term marketing and distribution agreements for similarly unknown products. 29. Based on the foregoing assumptions, Company S’s return is arm’s length and its marketing activities, including its marketing expenses, are not significantly different than those performed by independent marketers and distributors in comparable uncontrolled transactions. The information on comparable uncontrolled arrangements provides the best measure of the arm’s length return earned by Company S for the contribution to intangible value provided by its functions, risks, and costs. That return therefore reflects arm’s length compensation for Company S’s contributions and accurately measures its share of the income derived from exploitation of the trademark and trade name in country Y. No separate or additional compensation is required to be provided to Company S ...

20. Primair, a resident of country X, manufactures watches which are marketed in many countries around the world under the R trademark and trade name. Primair is the registered owner of the R trademark and trade name. The R name is widely known in countries where the watches are sold and has obtained considerable economic value in those markets through the efforts of Primair. R watches have never been marketed in country Y, however, and the R name is not known in the country Y market. 21. In Year 1, Primair decides to enter the country Y market and incorporates a wholly owned subsidiary in country Y, Company S, to act as its distributor in country Y. At the same time, Primair enters into a long-term royalty-free marketing and distribution agreement with Company S. Under the agreement, Company S is granted the exclusive right to market and distribute watches bearing the R trademark and using the R trade name in country Y for a period of five years, with an option for a further five years. Company S obtains no other rights relating to the R trademark and trade name from Primair, and in particular is prohibited from re-exporting watches bearing the R trademark and trade name. The sole activity of Company S is marketing and distributing watches bearing the R trademark and trade name. It is assumed that the R watches are not part of a portfolio of products distributed by Company S in country Y. Company S undertakes no secondary processing, as it imports packaged watches into country Y ready for sale to the final customer. 22. Under the contract between Primair and Company S, Company S purchases the watches from Primair in country Y currency, takes title to the branded watches and performs the distribution function in country Y, incurs the associated carrying costs (e.g. inventory and receivables financing), and assumes the corresponding risks (e.g. inventory, credit and financing risks). Under the contract between Primair and Company S, Company S is required to act as a marketing agent to assist in developing the market for R watches in country Y. Company S consults with Primair in developing the country Y marketing strategy for R watches. Primair develops the overall marketing plan based largely on its experience in other countries, it develops and approves the marketing budgets, and it makes final decisions regarding advertising designs, product positioning and core advertising messages. Company S consults on local market issues related to advertising, assists in executing the marketing strategy under Primair’s direction, and provides evaluations of the effectiveness of various elements of the marketing strategy. As compensation for providing these marketing support activities, Company S receives from Primair a service fee based on the level of marketing expenditure it incurs and including an appropriate profit element. 23. Assume for the purpose of this example that, based upon a thorough comparability analysis, including a detailed functional analysis, it is possible to conclude that the price Company S pays Primair for the R watches should be analysed separately from the compensation Company S receives for the marketing it undertakes on behalf of Primair. Assume further that based upon identified comparable transactions, the price paid for the watches is arm’s length and that this price enables Company S to earn an arm’s length level of compensation from selling the watches for the distribution function it performs, the assets it uses and the risks it assumes. 24. In Years 1 to 3, Company S embarks on a strategy that is consistent with its agreement with Primair to develop the country Y market for R watches. In the process, Company S incurs marketing expenses. Consistent with the contract, Company S is reimbursed by Primair for the marketing expenses it incurs, and is paid a mark-up on those expenses. By the end of Year 2, the R trademark and trade name have become well established in country Y. The compensation derived by Company S for the marketing activities it performed on behalf of Primair is determined to be arm’s length, based upon comparison to that paid to independent advertising and marketing agents identified and determined to be comparable as part of the comparability analysis. 25. Under these circumstances, Primair is entitled to retain any income derived from exploiting the R trademark and trade name in the country Y market that exceeds the arm’s length compensation to Company S for its functions and no transfer pricing adjustment is warranted under the circumstances ...

When one compares a situation where a long-established full-fledged distributor is converted into a limited risk distributor with a situation where a limited risk distributor has been in existence in the market for the same duration, there might also be differences because the full-fledged distributor may have performed some functions, borne some expenses (e.g. marketing expenses), assumed some risks and contributed to the development of some intangibles before its conversion that the long-existing “limited risk distributor” may not have performed, borne, assumed or contributed to. The question arises whether at arm’s length such additional functions, assets and risks should only affect the remuneration of the distributor before its being converted, whether they should be taken into account to determine a remuneration of the transfers that take place upon the conversion (and if so how), whether they should affect the remuneration of the restructured limited risk distributor (and if so how), or a combination of these three possibilities. For instance, if it is found that the pre-restructuring activities led the full-fledged distributor to own some intangibles while the long-established limited risk distributor does not, the arm’s length principle may require these intangibles either to be remunerated upon the restructuring if they are transferred by the full-fledged distributor to a foreign associated enterprise, or to be taken into account in the determination of the arm’s length remuneration of the post-restructuring activities if they are not transferred (see Section E.2 of Part I above and Chapter VI of these Guidelines) ...

A profit splitting factor based on expenses may be appropriate where it is possible to identify a strong correlation between relative expenses incurred and relative value contributed. For example, marketing expenses may be an appropriate factor for distributors-marketers if advertising generates unique and valuable marketing intangibles, e.g. in consumer goods where the value of marketing intangibles is affected by advertising. Research and development expenses may be suitable for manufacturers if they relate to the development of unique and valuable intangibles such as patents. However, if, for instance, each party contributes different valuable intangibles, then it is not appropriate to use a cost- based factor unless cost is a reliable measure of the relative value of those intangibles or costs can be risk-weighted to achieve a reliable measure of relative value. Even where each party contributes the same kind of intangibles, risk-weighting will be an appropriate consideration. For example, where the risk of failure at an early stage of development is several times higher than the risk of failure at a later stage or in the development of incremental improvements to an already proven concept, then the costs incurred in that early stage will have a higher risk weighting than the costs incurred at a later stage or on incremental improvements. Employee remuneration may be relevant in situations where functions relating to the skills and experience of staff are the primary factor in generating the relevant profits ...

When one compares a situation where a long-established full-fledged distributor is converted into a limited risk distributor with a situation where a limited risk distributor has been in existence in the market for the same duration, there might also be differences because the full-fledged distributor may have performed some functions, borne some expenses (e.g. marketing expenses), assumed some risks and contributed to the development of some intangibles before its conversion that the long-existing “limited risk distributor” may not have performed, borne, assumed or contributed to. The question arises whether at arm’s length such additional functions, assets and risks should only affect the remuneration of the distributor before its being converted, whether they should be taken into account to determine a remuneration of the transfers that take place upon the conversion (and if so how), whether they should affect the remuneration of the restructured limited risk distributor (and if so how), or a combination of these three possibilities. For instance, if it is found that the pre-restructuring activities led the full-fledged distributor to own some intangibles while the long-established limited risk distributor does not, the arm’s length principle may require these intangibles either to be remunerated upon the restructuring if they are transferred by the full-fledged distributor to a foreign associated enterprise, or to be taken into account in the determination of the arm’s length remuneration of the post-restructuring activities if they are not transferred (see Section E.2 of Part I above and Chapter VI of these Guidelines) ...

In this case the Slovenian Supreme Court explains that a legal act created by an international organisation can be directly applicable in a Member State only if the Member State has transferred part of its sovereign rights to the organisation, which the Republic of Slovenia has not done by ratifying the OECD Convention. The OECD Guidelines themselves are therefore not directly binding on the Member State, which is already clear from the OECD’s internal acts (Article 18 of the Rules of Procedure of the OECD). It concludes that the mere existence of marketing costs does not mean that they are incurred as a result of the implementation of a business strategy. That link is possible if its substance is demonstrated. It is not possible to determine which costs are causally linked to the implementation of a business strategy if it is not clear what is included in the business strategy in the first place. It is only when an activity can be linked to its implementation costs in a meaningful way that the facts about the level of those costs become legally determinative. It is not possible to refer to the costs of a strategy without demonstrating the content of the strategy.” Click here for English translation Click here for other translation ...