Macroeconomic circumstances may lead to changes in the financing costs in the market. In such a context, a transfer pricing analysis with regard to the possibilities of the borrower or the lender to renegotiate the terms of the loan to benefit from better conditions will be informed by the options realistically available to both the borrower and the lender ...

The transfer pricing analysis of the arm’s length nature of the conditions of the termination or substantial renegotiation of an agreement should take account of both the perspectives of the transferor and of the transferee. Taking account of the transferee’s perspective is important both to value the amount of an arm’s length indemnification, if any, and to determine what party should bear it. It is not possible to derive a single answer for all cases and the response should be based on an examination of the facts and circumstances of the case, and in particular of the rights and other assets of the parties, of the risks assumed by the parties, of the economic rationale for the termination, of the determination of what party(ies) is (are) expected to benefit from it, and of the options realistically available to the parties. This can be illustrated as follows ...

As another example, assume a full-fledged distributor is operating under a long term contractual arrangement for a given type of transaction. Assume that, based on its rights under the long term contract with respect to these transactions, it has the option realistically available to it to accept or refuse being converted into a limited risk distributor operating for a foreign associated enterprise, and that an arm’s length remuneration for such a low risk distribution activity is estimated to be a stable profit of +2% per year while the excess profit potential associated with the risks would now be attributed to the foreign associated enterprise. Assume for the purpose of this example that the restructuring leads to the renegotiation of the existing contractual arrangements, but it does not entail the transfer of assets other than its rights under the long term contract. From the perspective of the distributor, the question arises as to whether the new arrangement (taking into account both the remuneration for the post-restructuring transactions and any compensation for the restructuring itself) is expected to make it as well off as its realistic – albeit riskier – alternatives. If not, this would imply that the post-restructuring arrangement is not priced at arm’s length and that additional compensation would be needed to appropriately remunerate the distributor for the restructuring, or that an assessment of the commercial rationality of the transaction based on Section D.2 may be necessary. Furthermore, for transfer pricing purposes, it is important to determine whether risks contractually transferred as part of the business restructuring, are assumed by the foreign associated enterprise in accordance with the guidance in Section D. 1 of Chapter I ...

In order to determine whether, at arm’s length, compensation would be payable upon a restructuring to any restructured entity within an MNE group, and if so the amount of such compensation as well as the member of the group that should bear such compensation, it is important to accurately delineate the transactions occurring between the restructured entity and one or more other members of the group. For these purposes, the detailed guidance in Section D of Chapter I of these Guidelines is applicable ...

A business restructuring may involve cross-border transfers of something of value, e.g. of valuable intangibles, although this is not always the case. It may also or alternatively involve the termination or substantial renegotiation of existing arrangements, e.g. manufacturing arrangements, distribution arrangements, licences, service agreements, etc. The first step in analysing the transfer pricing aspects of a business restructuring is to accurately delineate the transactions that comprise the business restructuring by identifying the commercial or financial relations and the conditions attached to those relations that lead to a transfer of value among the members of the MNE group. This is discussed in Section B. Section C discusses the recognition of accurately delineated transactions that comprise the business restructuring. The relationship between a business restructuring and the reallocation of profit potential is addressed in Section D. The transfer pricing consequences of the transfer of something of value are discussed in Section E of this part and the transfer pricing consequences of the termination or substantial renegotiation of existing arrangements are discussed in Section F ...

There is no legal or universally accepted definition of business restructuring. In the context of this chapter, business restructuring refers to the cross-border reorganisation of the commercial or financial relations between associated enterprises, including the termination or substantial renegotiation of existing arrangements. Relationships with third parties (e.g. suppliers, sub-contractors, customers) may be a reason for the restructuring or be affected by it ...

If independent enterprises in comparable circumstances would have agreed on the inclusion of a mechanism to address high uncertainty in valuing the intangible (e.g. a price adjustment clause), the tax administration should be permitted to determine the pricing of a transaction involving an intangible or rights in an intangible on the basis of such mechanism. Similarly, if independent enterprises in comparable circumstances would have considered subsequent events so fundamental that their occurrence would have led to a prospective renegotiation of the pricing of a transaction, such events should also lead to a modification of the pricing of the transaction between associated enterprises ...

Also, independent enterprises may determine to assume the risk of unpredictable subsequent developments. However, the occurrence of major events or developments unforeseen by the parties at the time of the transaction or the occurrence of foreseen events or developments considered to have a low probability of occurrence which change the fundamental assumptions upon which the pricing was determined may lead to renegotiation of the pricing arrangements by agreement of the parties where it is to their mutual benefit. For example, a renegotiation might occur at arm’s length if a royalty rate based on sales for a patented drug turned out to be vastly excessive due to an unexpected development of an alternative low-cost treatment. The excessive royalty might remove the incentive of the licensee to manufacture or sell the drug at all, in which case the licensee will have an interest in renegotiating the agreement. It may be the case that the licensor has an interest in keeping the drug on the market and in retaining the same licensee to manufacture or sell the drug because of the skills and expertise of the licensee or the existence of a long-standing co-operative relationship between them. Under these circumstances, the parties might prospectively renegotiate to their mutual benefit all or part of the agreement and set a lower royalty rate. In any event, whether renegotiation would take place, would depend upon all the facts and circumstances of each case ...

In any application of a transactional profit split, care should be exercised to ensure that the method is applied without hindsight. See paragraph 3.74. That is, irrespective of whether a transactional profit split of anticipated or actual profits is used, unless there are major unforeseen developments which would have resulted in a renegotiation of the agreement had it occurred between independent parties, the basis upon which those profits are to be split between the associated enterprises, including the profit splitting factors, the way in which relevant profits are calculated, and any adjustments or contingencies, must be determined on the basis of information known or reasonably foreseeable by the parties at the time the transactions were entered into. This is so notwithstanding the fact that in many cases, the actual calculations can necessarily only be performed some time afterwards, where, for example they apply profit splitting factors determined at the outset to the actual profits. Additionally, it should be remembered that the starting point in the accurate delineation of any transaction will generally be the written contracts which may reflect the intention of the parties at the time the contract was concluded. See paragraph 1.42 ...

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

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

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

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

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

When considering the risks assumed by a party to a controlled transaction, tax administrations should carefully consider the commercial rationale for any purported change in the risks assumed by a party before and after the outbreak of COVID-19 (and taking into consideration the accurate delineation of such purported change). In particular, concerns may arise where before the outbreak of COVID-19 a taxpayer argues that a “limited-risk” distributor did not assume any marketplace risk and hence was only entitled to a low return, but after the outbreak argues that the same distributor assumes some marketplace risk (for example, due to changes in risk management functions) and hence should be allocated In this scenario, consideration should be given to re-examining whether prior to the outbreak of COVID-19 the “limited-risk” distributor genuinely did not assume any marketplace risk, whether after the outbreak the “limited risk” distributor did not actually assume any marketplace risk, and/or whether the assumption of this risk following the outbreak of COVID-19 is a result of a business restructuring. If a prior risk allocation is recognised under an accurate delineation, in order for a reallocation of that risk to be recognised under a subsequent updated accurate delineation, such new risk allocation must be supported by an analysis of all the facts and circumstances and relevant evidence should be obtained and documented to substantiate the position. In this respect, the guidance in Chapter IX of the OECD TPG may be relevant. In general, consideration should be given to whether a taxpayer is taking inconsistent positions pre- and post- pandemic and, if so, whether either position is consistent with the accurate delineation of the transaction ...

Finally, the COVID-19 pandemic has created conditions in which associated parties may consider whether they have the option to apply force majeure clauses, revoke or otherwise revise their intercompany agreements. This may impact the allocation of losses and COVID-19 specific costs between associated parties, and therefore also requires specific consideration in the current economic environment ...

The challenges associated with performing a comparability analysis may vary depending on the impact of the COVID-19 pandemic on the economically relevant characteristics of the accurately delineated transaction. For example, if a controlled transaction is covered by a pre-existing intercompany agreement (for example, if in 2018 it was determined that at arm’s length a party should receive an agreed fixed return for five years, and that parties at arm’s length would remain bound by that agreement), there may be no need to perform a comparability analysis for Financial Year (“FY”) 2020 provided that the facts and circumstances of the accurately delineated controlled transaction have not changed. In reaching this conclusion, it is important to consider any changes in the economically relevant characteristics, including the terms and conditions of the agreement, and whether at arm’s length, unrelated parties would have tried to renegotiate those terms and conditions.6 In contrast, where the arm’s length price of a controlled transaction is determined on an annual basis, it will be necessary to perform a comparability analysis for FY 2020. 6 See also the discussion in paragraphs 42 to 46 in this regard ...

The question in this case was whether royalty payments from a loss making Danish subsidiary Adecco A/S (H1 A/S in the decision) to its Swiss parent company Adecco SA (G1 SA in the decision – an international provider of temporary and permanent employment services active throughout the entire range of sectors in Europe, the Americas, the Middle East and Asia – for use of trademarks and trade names, knowhow, international network intangibles, and business concept were deductible expenses for tax purposes or not. In  2013, the Danish tax authorities (SKAT) had amended Adecco A/S’s taxable income for the years 2006-2009 by a total of DKK 82 million. Adecco A/S submitted that the company’s royalty payments were operating expenses deductible under section 6 (a) of the State Tax Act and that it was entitled to tax deductions for royalty payments of 1.5% of the company’s turnover in the first half of 2006 and 2% up to and including 2009, as these prices were in line with what would have been agreed if the transactions had been concluded between independent parties and thus compliant  with the requirement in section 2 of the Tax Assessment Act (- the arm’s length principle). In particular, Adecco A/S claimed that the company had lifted its burden of proof that the basic conditions for deductions pursuant to section 6 (a) of the State Tax Act were met, and the royalty payments thus deductible to the extent claimed. According to section 6 (a) of the State Tax Act expenses incurred during the year to acquire, secure and maintain income are deductible for tax purposes. There must be a direct and immediate link between the expenditure incurred and the acquisition of income. The company hereby stated that it was not disputed that the costs were actually incurred and that it was evident that the royalty payment was in the nature of operating costs, since the company received significant economic value for the payments. The High Court ruled in favor of the Danish tax authorities and concluded as follows: “Despite the fact that, as mentioned above, there is evidence to suggest that H1 A/S’s payment of royalties for the use of the H1 A/S trademark is a deductible operating expense, the national court finds, in particular, that H1 A/S operates in a national Danish market, where price is by far the most important competitive parameter, that the company has for a very long period largely only deficit, that it is an agreement on payment to the company’s ultimate parent company – which must be assumed to have its own purpose of being represented on the Danish market – and that royalty payments must be regarded as a standard condition determined by G1 SA independent of the market in which the Danish company is working, as well as the information on the marketing costs incurred in the Danish company and in the Swiss company compared with the failure to respond to the relevant provocations that H1 A/S has not lifted the burden of proof that the payments of royalties to the group-affiliated company G1 SA, constitutes a deductible operating expense, cf. section 6 (a) of the State Tax Act. 4.5 and par. 4.6, the national court finds that the company’s royalty payment cannot otherwise be regarded as a deductible operating expense.” Adecco appealed the decision to the Supreme Court. The Supreme Court overturned the decision of the High Court and ruled in favor of Adecco. The Supreme Court held that the royalty payments had the nature of deductible operating costs. The Supreme Court also found that Adecco A/S’s transfer pricing documentation for the income years in question was not insufficient to such an extent that it could be considered equal to lack of documentation. The company’s income could therefore not be determined on a discretionary basis by the tax authorities. Finally, the Supreme Court did not consider that a royalty rate of 2% was not at arm’s length, or that Adecco A/S’s marketing in Denmark of the Adecco brand provided a basis for deducting in the royalty payment a compensation for a marketing of the global brand. Click here for translation ...

The question in this case was whether royalty payments from a loss making Danish subsidiary Adecco A/S (H1 A/S in the decision) to its Swiss parent company Adecco SA (G1 SA in the decision – an international provider of temporary and permanent employment services active throughout the entire range of sectors in Europe, the Americas, the Middle East and Asia – for use of trademarks and trade names, knowhow, international network intangibles, and business concept were deductible expenses for tax purposes or not. In  2013, the Danish tax authorities (SKAT) had amended Adecco A/S’s taxable income for the years 2006-2009 by a total of DKK 82 million. “Section 2 of the Tax Assessment Act. Paragraph 1 states that, when calculating the taxable income, group affiliates must apply prices and terms for commercial or economic transactions in accordance with what could have been agreed if the transactions had been concluded between independent parties. SKAT does not consider it in accordance with section 2 of the Tax Assessment Act that during the period 2006 to 2009, H1 A/S had to pay royalty to G1 SA for the right to use trademark, “know-how intangibles” and “ international network intangibles ”. An independent third party, in accordance with OECD Guidelines 6.14, would not have agreed on payment of royalties in a situation where there is a clear discrepancy between the payment and the value of licensee’s business. During the period 2006 to 2009, H1 A/S did not make a profit from the use of the licensed intangible assets. Furthermore, an independent third party would not have accepted an increase in the royalty rate in 2006, where the circumstances and market conditions in Denmark meant that higher profits could not be generated. H1 A/S has also incurred considerable sales and marketing costs at its own expense and risk. Sales and marketing costs may be considered extraordinary because the costs are considered to be disproportionate to expected future earnings. This assessment takes into account the licensing agreement, which states in Article 8.2 that the termination period is only 3 months, and Article 8.6, which states that H1 A/S will not receive compensation for goodwill built up during the contract period if the contract is terminated. H1 A/S has built and maintained the brand as well as built up “brand value” on the Danish market. The company has contributed to value of intangible assets that they do not own. In SKAT’s opinion, an independent third party would not incur such expenses without some form of compensation or reduction in the royalty payment, cf. OECD Guidelines 6.36 – 6.38. If H1 A/S was not associated with the trademark owners, H1 A/S would, in SKAT’s opinion, have considered other alternatives such as terminating, renegotiating or entering into more profitable licensing agreements, cf. OECD Guidelines 1.34-1.35. A renegotiation is precisely a possibility in this situation, as Article 8.2 of the license agreement states that the agreement for both parties can be terminated at three months’ notice. The control of the group has resulted in H1 A/S maintaining unfavorable agreements, not negotiating better terms and not seeking better alternatives. In addition, SKAT finds that the continuing losses realized by the company are also due to the Group’s interest in being represented on the Danish market. In order for the Group to service the global customers that are essential to the Group’s strategy, it is important to be represented in Denmark in order to be able to offer contracts in all the countries where the customer has branches. Such a safeguard of the Group’s interest would require an independent third party to be paid, and the company must therefore also be remunerated accordingly, especially when the proportion of global customers in Denmark is significantly lower than in the other Nordic countries.“ Adecco A/S submitted that the company’s royalty payments were operating expenses deductible under section 6 (a) of the State Tax Act and that it was entitled to tax deductions for royalty payments of 1.5% of the company’s turnover in the first half of 2006 and 2% up to and including 2009, as these prices were in line with what would have been agreed if the transactions had been concluded between independent parties and thus compliant  with the requirement in section 2 of the Tax Assessment Act (- the arm’s length principle) . In particular, Adecco A/S claimed that the company had lifted its burden of proof that the basic conditions for deductions pursuant to section 6 (a) of the State Tax Act were met, and the royalty payments thus deductible to the extent claimed. According to section 6 (a) of the State Tax Act expenses incurred during the year to acquire, secure and maintain income are deductible for tax purposes. There must be a direct and immediate link between the expenditure incurred and the acquisition of income. The company hereby stated that it was not disputed that the costs were actually incurred and that it was evident that the royalty payment was in the nature of operating costs, since the company received significant economic value for the payments. The High Court ruled in favor of the Danish tax authorities and concluded as follows: “Despite the fact that, as mentioned above, there is evidence to suggest that H1 A/S’s payment of royalties for the use of the H1 A/S trademark is a deductible operating expense, the national court finds, in particular, that H1 A/S operates in a national Danish market, where price is by far the most important competitive parameter, that the company has for a very long period largely only deficit, that it is an agreement on payment to the company’s ultimate parent company – which must be assumed to have its own purpose of being represented on the Danish market – and that royalty payments must be regarded as a standard condition determined by G1 SA independent of the market in which the Danish company is working, as well as the information on the marketing costs incurred in the Danish company and in the Swiss company compared with the failure to respond to ...

In any application of a transactional profit split, care should be exercised to ensure that the method is applied without hindsight. See paragraph 3.74. That is, irrespective of whether a transactional profit split of anticipated or actual profits is used, unless there are major unforeseen developments which would have resulted in a renegotiation of the agreement had it occurred between independent parties, the basis upon which those profits are to be split between the associated enterprises, including the profit splitting factors, the way in which relevant profits are calculated, and any adjustments or contingencies, must be determined on the basis of information known or reasonably foreseeable by the parties at the time the transactions were entered into. This is so notwithstanding the fact that in many cases, the actual calculations can necessarily only be performed some time afterwards, where, for example they apply profit splitting factors determined at the outset to the actual profits. Additionally, it should be remembered that the starting point in the accurate delineation of any transaction will generally be the written contracts which may reflect the intention of the parties at the time the contract was concluded. See paragraph 1.42 ...

The transfer pricing analysis of the arm’s length nature of the conditions of the termination or substantial renegotiation of an agreement should take account of both the perspectives of the transferor and of the transferee. Taking account of the transferee’s perspective is important both to value the amount of an arm’s length indemnification, if any, and to determine what party should bear it. It is not possible to derive a single answer for all cases and the response should be based on an examination of the facts and circumstances of the case, and in particular of the rights and other assets of the parties, of the risks assumed by the parties, of the economic rationale for the termination, of the determination of what party(ies) is (are) expected to benefit from it, and of the options realistically available to the parties. This can be illustrated as follows ...

As another example, assume a full-fledged distributor is operating under a long term contractual arrangement for a given type of transaction. Assume that, based on its rights under the long term contract with respect to these transactions, it has the option realistically available to it to accept or refuse being converted into a limited risk distributor operating for a foreign associated enterprise, and that an arm’s length remuneration for such a low risk distribution activity is estimated to be a stable profit of +2% per year while the excess profit potential associated with the risks would now be attributed to the foreign associated enterprise. Assume for the purpose of this example that the restructuring leads to the renegotiation of the existing contractual arrangements, but it does not entail the transfer of assets other than its rights under the long term contract. From the perspective of the distributor, the question arises as to whether the new arrangement (taking into account both the remuneration for the post-restructuring transactions and any compensation for the restructuring itself) is expected to make it as well off as its realistic – albeit riskier – alternatives. If not, this would imply that the post-restructuring arrangement is not priced at arm’s length and that additional compensation would be needed to appropriately remunerate the distributor for the restructuring, or that an assessment of the commercial rationality of the transaction based on Section D.2 may be necessary. Furthermore, for transfer pricing purposes, it is important to determine whether risks contractually transferred as part of the business restructuring, are assumed by the foreign associated enterprise in accordance with the guidance in Section D. 1 of Chapter I ...

In order to determine whether, at arm’s length, compensation would be payable upon a restructuring to any restructured entity within an MNE group, and if so the amount of such compensation as well as the member of the group that should bear such compensation, it is important to accurately delineate the transactions occurring between the restructured entity and one or more other members of the group. For these purposes, the detailed guidance in Section D of Chapter I of these Guidelines is applicable ...

A business restructuring may involve cross-border transfers of something of value, e.g. of valuable intangibles, although this is not always the case. It may also or alternatively involve the termination or substantial renegotiation of existing arrangements, e.g. manufacturing arrangements, distribution arrangements, licences, service agreements, etc. The first step in analysing the transfer pricing aspects of a business restructuring is to accurately delineate the transactions that comprise the business restructuring by identifying the commercial or financial relations and the conditions attached to those relations that lead to a transfer of value among the members of the MNE group. This is discussed in Section B. Section C discusses the recognition of accurately delineated transactions that comprise the business restructuring. The relationship between a business restructuring and the reallocation of profit potential is addressed in Section D. The transfer pricing consequences of the transfer of something of value are discussed in Section E of this part and the transfer pricing consequences of the termination or substantial renegotiation of existing arrangements are discussed in Section F ...

There is no legal or universally accepted definition of business restructuring. In the context of this chapter, business restructuring refers to the cross-border reorganisation of the commercial or financial relations between associated enterprises, including the termination or substantial renegotiation of existing arrangements. Relationships with third parties (e.g. suppliers, sub-contractors, customers) may be a reason for the restructuring or be affected by it ...