16 December 2024, the US Treasury Department and the Internal Revenue Service issued a Notice announcing their intention to issue regulations that would provide a new method under the US tranfer pricing rules in Section 482 for pricing certain controlled transactions that involve baseline marketing and distribution activities. The new method, referred to in the US notice 2025-04 as the Simplified and Streamlined Approach (“SSA”), is based on OECD’s Pillar One – Amount B report from February 2024 ...

Annex I to Chapter IV Sample Memoranda of Understanding for Competent Authorities to Establish Bilateral Safe Harbours Introduction This Annex contains sample Memoranda of Understanding (MOUs) for use by Competent Authorities in negotiating bilateral safe harbours for common categories of transfer pricing cases involving low risk distribution functions, low risk manufacturing functions, and low risk research and development functions. It is intended to provide countries with a tool to adapt and use in addressing, through bilateral safe harbours, important classes of transfer pricing cases that now take up a great deal of time and effort when processed on a case by case basis. Competent authorities are of course free to modify, add or delete any provision of the sample agreement when concluding their own bilateral agreements. Reasons for Concluding a Bilateral Safe Harbour MOU As described in Chapter IV, Section E.4 of these Guidelines, one of the potential problems arising from the use of unilateral transfer pricing safe harbours is that they may increase the risk of double taxation and double non-taxation. This can occur if the country granting the unilateral safe harbour shades the safe harbour towards the high end of an acceptable arm’s length profit range, while a treaty partner on the other end of the transaction disagrees with the assertion that the defined safe harbour profit level reflects arm’s length dealing. Some critics contend that there is a tendency for safe harbour profit ranges to increase over time, exacerbating this potential problem. It is also sometimes suggested that unilateral safe harbours can tend to force taxpayers into reporting higher than arm’s length levels of income, and to incur some resulting double taxation, as the price to be paid for administrative convenience and simplicity. Finally, unilateral safe harbours can, at times, provide a windfall to taxpayers whose specific facts might suggest that income above the safe harbour level would be more consistent with arm’s length dealing. These double tax and windfall issues would likely be quite pronounced in connection with safe harbours directed at some of the most common types of transfer pricing transactions. Transactions such as sales of goods to a local distribution affiliate for resale on a limited risk basis in the local market, contract manufacturing arrangements, and contract research arrangements could clearly raise these issues. It is perhaps for this reason that few countries, if any, have developed functioning safe harbours for dealing with these common types of transfer pricing issues. Distribution margins and manufacturing mark-ups can sometimes be quite consistent across geographies and across many industries. Therefore guidance on normal settlement ranges for these types of cases could have the effect of reducing the number of transfer pricing audits and reducing competent authority dockets and other transfer pricing controversy by a substantial margin if reasonable ranges of results could be agreed bilaterally and published. These types of cases could potentially be addressed through bilateral MOUs adopted and publicised by competent authorities. Some countries have adopted such arrangements on a bilateral basis. The general view of such countries is that treaty provisions based on Article 25(3) of the OECD Model Tax Convention provide sufficient authority to support a bilateral competent authority agreement on a safe harbour rule that would apply to numerous similarly situated taxpayers. Article 25(3) provides: “The competent authorities of the Contracting States shall endeavour to resolve by mutual agreement any difficulties or doubts arising as to the interpretation or application of the Convention. They may also consult together for the elimination of double taxation in cases not provided for in the Convention.” A competent authority agreement on a bilateral transfer pricing safe harbour should properly be characterised as a “mutual agreement” that “resolves difficulties or doubts arising as to the interpretation or application” of Article 9 of the Treaty. Although nothing would prevent the countries’ competent authorities from adopting safe harbour provisions under Article 25(3) on a multilateral basis if the conditions and circumstances so allow, the particular types of transactions described above are such that countries will often adopt a bilateral approach. If such MOUs existed, qualifying taxpayers would be able to manage their financial results to fall within the agreed safe harbour range, secure in the understanding that those results would be accepted in both countries agreeing to the MOU concerned. A commonly cited precedent for this type of approach is the agreement between the United States and Mexico regarding safe harbour profit ranges for maquiladora operations. A bilateral approach to the development of safe harbours would have a number of advantages over unilateral transfer pricing safe harbours: A bilateral approach executed through competent authority MOUs could increase the likelihood that safe harbour provisions do not result in double taxation or double non-taxation. Bilateral safe harbours could be tailored to the economics of a particular market and circumstances, and thus be compatible with the arm’s length principle. Bilateral safe harbours could be entered into on a selective basis with countries having similar tax rates, thus minimising the possibility that the safe harbour provision itself would create opportunities for transfer pricing manipulation and providing a means for limiting the application of the safe harbour to situations where transfer pricing risk is quite low. If the relevant countries desire, bilateral safe harbours could initially be limited to small taxpayers and/or small transactions in order to limit exposures to government tax revenue that might otherwise be created by the safe harbour. Safe harbours adopted by means of a competent authority MOU could be reviewed and modified from time to time by competent authority agreement, thus assuring that the provisions stay up to date and reflect developments in the broader economy. For developing countries with serious resource constraints, bilateral MOUs entered into with a number of treaty partners could provide a means of protecting the local tax base in common transfer pricing fact patterns without an inordinate enforcement effort. The following elements may be of relevance in the negotiation and conclusion of an MOU. 1)    Description of and criteria to be fulfilled by the ...

Country tax administrations should carefully weigh the benefits of and concerns regarding safe harbours, making use of such provisions where they deem it appropriate ...

For more complex and higher risk transfer pricing matters, it is unlikely that safe harbours will provide a workable alternative to a rigorous, case by case application of the arm’s length principle under the provisions of these Guidelines ...

It should be clearly recognised that a safe harbour, whether adopted on a unilateral or bilateral basis, is in no way binding on or precedential for countries which have not themselves adopted the safe harbour ...

Where safe harbours can be negotiated on a bilateral or multilateral basis, they may provide significant relief from compliance burdens and administrative complexity without creating problems of double taxation or double non-taxation. Therefore, the use of bilateral or multilateral safe harbours under the right circumstances should be encouraged ...

However, in cases involving smaller taxpayers or less complex transactions, the benefits of safe harbours may outweigh the problems raised by such provisions. Making such safe harbours elective to taxpayers can further limit the divergence from arm’s length pricing. Where countries adopt safe harbours, willingness to modify safe-harbour outcomes in mutual agreement proceedings to limit the potential risk of double taxation is advisable ...

Safe harbour provisions may raise issues such as potentially having perverse effects on the pricing decisions of enterprises engaged in controlled transactions and a negative impact on the tax revenues of the country implementing the safe harbour as well as on the countries whose associated enterprises engage in controlled transactions with taxpayers electing a safe harbour. Further, unilateral safe harbours may lead to the potential for double taxation or double non-taxation ...

Transfer pricing compliance and administration is often complex, time consuming and costly. Properly designed safe harbour provisions, applied in appropriate circumstances, can help to relieve some of these burdens and provide taxpayers with greater certainty ...

Safe harbours may raise equity and uniformity issues. By implementing a safe harbour, one would create two distinct sets of rules in the transfer pricing area. Clearly and carefully designed criteria are required to differentiate those taxpayers or transactions eligible for the safe harbour to minimise the possibility of similar and possibly competing taxpayers finding themselves on opposite sides of the safe harbour threshold or, conversely, of allowing application of the safe harbour to unintended taxpayers or transactions. Insufficiently precise criteria could result in similar taxpayers receiving different tax treatment: one being permitted to meet the safe harbour rules and thus to be relieved from general transfer pricing compliance provisions, and the other being obliged to price its transactions in conformity with the general transfer pricing compliance provisions. Preferential tax treatment under safe harbour regimes for a specific category of taxpayers could potentially entail discrimination and competitive distortions. The adoption of bilateral or multilateral safe harbours could, in some circumstances, increase the potential of a divergence in tax treatment, not merely between different but similar taxpayers but also between similar transactions carried out by the same taxpayer with associated enterprises in different jurisdictions ...

Whether a country is prepared to possibly suffer some erosion of its own tax base in implementing a safe harbour is for that country to decide. The basic trade-off in making such a policy decision is between the certainty and administrative simplicity of the safe harbour for taxpayers and tax administrations on the one hand, and the possibility of tax revenue erosion on the other ...

This concern may largely be avoided by the solution noted in paragraph 4.119 of adopting safe harbours on a bilateral or multilateral basis, thus limiting application of safe harbours to transactions involving countries with similar transfer pricing concerns. In adopting bilateral and multilateral safe harbours, tax administrations would need to be aware that the establishment of an extensive network of such arrangements could potentially encourage “safe harbour shopping” via the routing of transactions through territories with more favourable safe harbours and take appropriate steps to avoid that possibility. Similarly, countries adopting bilateral safe harbours would be well advised to target fairly narrow ranges of acceptable results and to require consistent reporting of income in each country that is a party to the safe harbour arrangement. Treaty exchange of information provisions could be used by countries where necessary to confirm the use of consistent reporting under such a bilateral safe harbour ...

If a safe harbour were based on an industry average, tax planning opportunities might exist for taxpayers with better than average profitability. For example, a cost-efficient company selling at the arm’s length price may be earning a mark-up of 15% on controlled sales. If a country adopts a safe harbour requiring a 10% mark-up, the company might have an incentive to comply with the safe harbour and shift the remaining 5% to a lower tax jurisdiction. Consequently, taxable income would be shifted out of the country. When applied on a large scale, this could mean significant revenue loss for the country offering the safe harbour ...

Safe harbours may also provide taxpayers with tax planning opportunities. Enterprises may have an incentive to modify their transfer prices in order to shift taxable income to other jurisdictions. This may also possibly induce tax avoidance, to the extent that artificial arrangements are entered into for the purpose of exploiting the safe harbour provisions. For instance, if safe harbours apply to “simple” or “small” transactions, taxpayers may be tempted to break transactions up into parts to make them seem simple or small ...

The Annex I to Chapter IV of these Guidelines contains sample memoranda of understanding that country competent authorities might use to establish bilateral or multilateral safe harbours in appropriate situations for common classes of transfer pricing cases. The use of these sample memoranda of understanding should not be considered as either mandatory or prescriptive in establishing bilateral or multilateral safe harbours. Rather, they are intended to provide a possible framework for adaptation to the particular needs of the tax authorities of the countries concerned ...

The rigor of having two or more countries with potentially divergent interests agree to such a safe harbour should serve to limit some of the arbitrariness that otherwise might characterise a unilateral safe harbour and would largely eliminate safe harbour-created double taxation and double non-taxation concerns. Particularly for some smaller taxpayers and/or less complex transactions, creation of bilateral or multilateral safe harbours by competent authority agreement may provide a worthwhile approach to transfer pricing simplification that would avoid some of the potential pitfalls of unilateral safe harbour regimes ...

It is important to observe that the problems of non-arm’s length results and potential double taxation and double non-taxation arising under safe harbours could be largely eliminated if safe harbours were adopted on a bilateral or multilateral basis by means of competent authority agreements between countries. Under such a procedure, two or more countries could, by agreement, define a category of taxpayers and/or transactions to which a safe harbour provision would apply and by agreement establish pricing parameters that would be accepted by each of the contracting countries if consistently applied in each of the countries. Such agreements could be published in advance and taxpayers could consistently report results in each of the affected countries in accordance with the agreement ...

On the other hand, if a unilateral safe harbour permits taxpayers to report income below arm’s length levels in the country providing the safe harbour, taxpayers would have an incentive to elect application of the safe harbour. In such a case, there would be no assurance that the taxpayer would report income in other countries on a consistent basis or at levels above arm’s length levels based on the safe harbour. Moreover it is unlikely that other tax administrations would have the authority to require that income be reported above arm’s length levels. While the burden of under-taxation in such situations would fall exclusively upon the country adopting the safe harbour provision, and should not adversely affect the ability of other countries to tax arm’s length amounts of income, double non-taxation would be unavoidable and could result in distortions of investment and trade ...

Where safe harbours are adopted unilaterally, care should be taken in setting safe harbour parameters to avoid double taxation, and the country adopting the safe harbour should generally be prepared to consider modification of the safe-harbour outcome in individual cases under mutual agreement procedures to mitigate the risk of double taxation. At a minimum, in order to ensure that taxpayers make decisions on a fully informed basis, the country offering the safe harbour would need to make it explicit in advance whether or not it would attempt to alleviate any eventual double taxation resulting from the use of the safe harbour. Obviously, if a safe harbour is not elective and if the country in question refuses to consider double tax relief, the risk of double taxation arising from the safe harbour would be unacceptably high and inconsistent with double tax relief provisions of treaties ...

In cases involving smaller taxpayers or less complex transactions, the benefits of safe harbours may outweigh the problems raised by such provisions. Provided the safe harbour is elective, taxpayers may consider that a moderate level of double taxation, if any arises because of the safe harbour, is an acceptable price to be paid in order to obtain relief from the necessity of complying with complex transfer pricing rules. One may argue that the taxpayer is capable of making its own decision in electing the safe harbour as to whether the possibility of double taxation is acceptable or not ...

If the safe harbour causes taxpayers to report income above arm’s length levels, it would work to the benefit of the tax administration providing the safe harbour, as more taxable income would be reported by such domestic taxpayers. On the other hand, the safe harbour may lead to less taxable income being reported in the tax jurisdiction of the foreign associated enterprise that is the other party to the transaction. The other tax administrations may then challenge prices derived from the application of a safe harbour, with the result that the taxpayer would face the prospect of double taxation. Accordingly, any administrative benefits gained by the tax administration of the safe harbour country would potentially be obtained at the expense of other countries which, in order to protect their own tax base, would have to determine systematically whether the prices or results permitted under the safe harbour are consistent with what would be obtained by the application of their own transfer pricing rules. The administrative burden saved by the country offering the safe harbour would therefore be shifted to the foreign jurisdictions ...

One major concern raised by a safe harbour is that it may increase the risk of double taxation. If a tax administration sets safe harbour parameters at levels either above or below arm’s length prices in order to increase reported profits in its country, it may induce taxpayers to modify the prices that they would otherwise have charged or paid to controlled parties, in order to avoid transfer pricing scrutiny in the safe harbour country. The concern of possible overstatement of taxable income in the country providing the safe harbour is greater where that country imposes significant penalties for understatement of tax or failure to meet documentation requirements, with the result that there may be added incentives to ensure that the transfer pricing is accepted in that country without further review ...

Any potential disadvantages to taxpayers from safe harbours diverging from arm’s length pricing are avoided when taxpayers have the option to either elect the safe harbour or price transactions in accordance with the arm’s length principle. With such an approach, taxpayers that believe the safe harbour would require them to report an amount of income exceeding the arm’s length amount could apply the general transfer pricing rules. While such an approach can limit the divergence from arm’s length pricing under a safe harbour regime, it would also limit the administrative benefits of the safe harbour to the tax administration. Moreover, tax administrations would need to consider the potential loss of tax revenue from such an approach where taxpayers will pay tax only on the lesser of the safe harbour amount or the arm’s length amount. Countries may also be concerned over the ability of taxpayers to opt in and out of a safe harbour, depending on whether the use of the safe harbour is favourable to the taxpayer in a particular year. Countries may be able to gain greater comfort regarding this risk by controlling the conditions under which a taxpayer can be eligible for the safe harbour, for example by requiring taxpayers to notify the tax authority in advance of using the safe harbour or to commit to its use for a certain number of years ...

Safe harbours involve a trade-off between strict compliance with the arm’s length principle and administrability. They are not tailored to fit exactly the varying facts and circumstances of individual taxpayers and transactions. The degree of approximation of prices determined under the safe harbour with prices determined in accordance with the arm’s length principle could be improved by collecting, collating, and frequently updating a pool of information regarding prices and pricing developments in respect of the relevant types of transactions between uncontrolled parties of the relevant nature. However, such efforts to set safe harbour parameters accurately enough to satisfy the arm’s length principle could erode the administrative simplicity of the safe harbour ...

Where a safe harbour provides a simplified transfer pricing approach, it may not correspond in all cases to the most appropriate method applicable to the facts and circumstances of the taxpayer under the general transfer pricing provisions. For example, a safe harbour might require the use of a particular method when the taxpayer could otherwise have determined that another method was the most appropriate method under the facts and circumstances. Such an occurrence could be considered as inconsistent with the arm’s length principle, which requires the use of the most appropriate method ...

The availability of safe harbours for a given category of taxpayers or transactions may have adverse consequences. These concerns stem from the fact that: The implementation of a safe harbour in a given country may lead to taxable income being reported that is not in accordance with the arm’s length principle; Safe harbours may increase the risk of double taxation or double non-taxation when adopted unilaterally; Safe harbours potentially open avenues for inappropriate tax planning, and Safe harbours may raise issues of equity and uniformity ...

A safe harbour would result in a degree of administrative simplicity for the tax administration. Although the eligibility of particular taxpayers or transactions for the safe harbour would need to be carefully evaluated, depending on the specific safe harbour provision, such evaluations would not necessarily have to be performed by auditors with transfer pricing expertise. Once eligibility for the safe harbour has been established, qualifying taxpayers would require minimal examination with respect to the transfer prices of controlled transactions qualifying for the safe harbour. This would enable tax administrations to secure tax revenues in low risk situations with a limited commitment of administrative resources and to concentrate their efforts on the examination of more complex or higher risk transactions and taxpayers. A safe harbour may also increase the level of compliance among small taxpayers that may otherwise believe their transfer pricing practices will escape scrutiny ...

Another advantage provided by a safe harbour is the certainty that the taxpayer’s transfer prices will be accepted by the tax administration providing the safe harbour, provided they have met the eligibility conditions of, and complied with, the safe harbour provisions. The tax administration would accept, with limited or no scrutiny, transfer prices within the safe harbour parameters. Taxpayers could be provided with relevant parameters which would provide a transfer price deemed appropriate by the tax administration for the qualifying transaction ...

Properly designed safe harbours may significantly ease compliance burdens by eliminating data collection and associated documentation requirements in exchange for the taxpayer pricing qualifying transactions within the parameters set by the safe harbour. Especially in areas where transfer pricing risks are small, and the burden of compliance and documentation is disproportionate to the transfer pricing exposure, such a trade-off may be mutually advantageous to taxpayers and tax administrations. Under a safe harbour, taxpayers would be able to establish transfer prices which will not be challenged by tax administrations providing the safe harbour without being obligated to search for comparable transactions or expend resources to demonstrate transfer pricing compliance to such tax administrations ...

Application of the arm’s length principle may require collection and analysis of data that may be difficult or costly to obtain and/or evaluate. In certain cases, such compliance burdens may be disproportionate to the size of the taxpayer, its functions performed, and the transfer pricing risks inherent in its controlled transactions ...

The basic benefits of safe harbours are as follows: Simplifying compliance and reducing compliance costs for eligible taxpayers in determining and documenting appropriate conditions for qualifying controlled transactions; Providing certainty to eligible taxpayers that the price charged or paid on qualifying controlled transactions will be accepted by the tax administrations that have adopted the safe harbour with a limited audit or without an audit beyond ensuring the taxpayer has met the eligibility conditions of, and complied with, the safe harbour provisions; Permitting tax administrations to redirect their administrative resources from the examination of lower risk transactions to examinations of more complex or higher risk transactions and taxpayers ...

Although they would not fully meet the foregoing description of a safe harbour, it may be the case that some countries adopt other administrative simplification measures that use presumptions to realise some of the benefits discussed in this Section. For example, a rebuttable presumption might be established under which a mandatory pricing target would be established by a tax authority, subject to a taxpayer’s right to demonstrate that its transfer price is consistent with the arm’s length principle. Under such a system, it would be essential that the taxpayer does not bear a higher burden to demonstrate its price is consistent with the arm’s length principle than it would if no such system were in place. In any such system, it would be essential to permit resolution of cases of double taxation arising from application of the mandatory presumption through the mutual agreement process ...

For purposes of the discussion in this Section, safe harbours do not include administrative simplification measures which do not directly involve determination of arm’s length prices, e.g. simplified, or exemption from, documentation requirements (in the absence of a pricing determination), and procedures whereby a tax administration and a taxpayer agree on transfer pricing in advance of the controlled transactions (advance pricing arrangements), which are discussed in Section F of this chapter. The discussion in this section also does not extend to tax provisions designed to prevent “excessive” debt in a foreign subsidiary (“thin capitalisation” rules) ...

A safe harbour in a transfer pricing regime is a provision that applies to a defined category of taxpayers or transactions and that relieves eligible taxpayers from certain obligations otherwise imposed by a country’s general transfer pricing rules. A safe harbour substitutes simpler obligations for those under the general transfer pricing regime. Such a provision could, for example, allow taxpayers to establish transfer prices in a specific way, e.g. by applying a simplified transfer pricing approach provided by the tax administration. Alternatively, a safe harbour could exempt a defined category of taxpayers or transactions from the application of all or part of the general transfer pricing rules. Often, eligible taxpayers complying with the safe harbour provision will be relieved from burdensome compliance obligations, including some or all associated transfer pricing documentation requirements ...

Some of the difficulties that arise in applying the arm’s length principle may be avoided by providing circumstances in which eligible taxpayers may elect to follow a simple set of prescribed transfer pricing rules in connection with clearly and carefully defined transactions, or may be exempted from the application of the general transfer pricing rules. In the former case, prices established under such rules would be automatically accepted by the tax administrations that have expressly adopted such rules. These elective provisions are often referred to as “safe harbours” ...

The following discussion considers the benefits of, and concerns regarding, safe harbour provisions and provides guidance regarding the circumstances in which safe harbours may be applied in a transfer pricing system based on the arm’s length principle ...

Although safe harbours primarily benefit taxpayers, by providing for a more optimal use of resources, they can benefit tax administrations as well. Tax administrations can shift audit and examination resources from smaller taxpayers and less complex transactions (which may typically be resolved in practice on a consistent basis as to both transfer pricing methodology and actual results) to more complex, higher-risk cases. At the same time, taxpayers can price eligible transactions and file their tax returns with more certainty and with lower compliance burdens. However, the design of safe harbours requires careful attention to concerns about the degree of approximation to arm’s length prices that would be permitted in determining transfer prices under safe harbour rules for eligible taxpayers, the potential for creating inappropriate tax planning opportunities including double non-taxation of income, equitable treatment of similarly situated taxpayers, and the potential for double taxation resulting from the possible incompatibility of the safe harbours with the arm’s length principle or with the practices of other countries ...

The appropriateness of safe harbours can be expected to be most apparent when they are directed at taxpayers and/or transactions which involve low transfer pricing risks and when they are adopted on a bilateral or multilateral basis. It should be recognised that a safe harbour provision does not bind or limit in any way any tax administration other than the tax administration that has expressly adopted the safe harbour ...

Despite these generally negative conclusions, a number of countries have adopted safe harbour rules. Those rules have generally been applied to smaller taxpayers and/or less complex transactions. They are generally evaluated favourably by both tax administrations and taxpayers, who indicate that the benefits of safe harbours outweigh the related concerns when such rules are carefully targeted and prescribed and when efforts are made to avoid the problems that could arise from poorly considered safe harbour regimes ...

When these Guidelines were adopted in 1995, the view expressed regarding safe harbour rules was generally negative. It was suggested that while safe harbours could simplify transfer pricing compliance and administration, safe harbour rules may raise fundamental problems that could potentially have perverse effects on the pricing decisions of enterprises engaged in controlled transactions. It was suggested that unilateral safe harbours may have a negative impact on the tax revenues of the country implementing the safe harbour, as well as on the tax revenues of countries whose associated enterprises engage in controlled transactions with taxpayers electing a safe harbour. It was further suggested that safe harbours may not be compatible with the arm’s length principle. Therefore, it was concluded that transfer pricing safe harbours are not generally advisable, and consequently the use of safe harbours was not recommended ...

Applying the arm’s length principle can be a resource-intensive process. It may impose a heavy administrative burden on taxpayers and tax administrations that can be exacerbated by both complex rules and resulting compliance demands. These facts have led OECD member countries to consider whether and when safe harbour rules would be appropriate in the transfer pricing area ...

Intra group services (treasury, administration, accounting etc) were performed and charged to a Swiss resident A AG. The payment for these services had been determined by application of the CUP method. The tax authorities found that the payment for the services had been to high and instead applied a cost-plus method which resulted in lower service fees. Judgement of the Supreme Court The court decided in favor of the tax authorities. A cost-plus method was more appropriate as The taxpayer had been unable to provide evidence of any third party pricing of comparable services The services provided were of a low-value-adding nature, for which the cost-plus method is more appropriate. Click here for English translation Click here for other translation ...

Annex I to Chapter IV Sample Memoranda of Understanding for Competent Authorities to Establish Bilateral Safe Harbours Introduction This Annex contains sample Memoranda of Understanding (MOUs) for use by Competent Authorities in negotiating bilateral safe harbours for common categories of transfer pricing cases involving low risk distribution functions, low risk manufacturing functions, and low risk research and development functions. It is intended to provide countries with a tool to adapt and use in addressing, through bilateral safe harbours, important classes of transfer pricing cases that now take up a great deal of time and effort when processed on a case by case basis. Competent authorities are of course free to modify, add or delete any provision of the sample agreement when concluding their own bilateral agreements. Reasons for Concluding a Bilateral Safe Harbour MOU As described in Chapter IV, Section E.4 of these Guidelines, one of the potential problems arising from the use of unilateral transfer pricing safe harbours is that they may increase the risk of double taxation and double non-taxation. This can occur if the country granting the unilateral safe harbour shades the safe harbour towards the high end of an acceptable arm’s length profit range, while a treaty partner on the other end of the transaction disagrees with the assertion that the defined safe harbour profit level reflects arm’s length dealing. Some critics contend that there is a tendency for safe harbour profit ranges to increase over time, exacerbating this potential problem. It is also sometimes suggested that unilateral safe harbours can tend to force taxpayers into reporting higher than arm’s length levels of income, and to incur some resulting double taxation, as the price to be paid for administrative convenience and simplicity. Finally, unilateral safe harbours can, at times, provide a windfall to taxpayers whose specific facts might suggest that income above the safe harbour level would be more consistent with arm’s length dealing. These double tax and windfall issues would likely be quite pronounced in connection with safe harbours directed at some of the most common types of transfer pricing transactions. Transactions such as sales of goods to a local distribution affiliate for resale on a limited risk basis in the local market, contract manufacturing arrangements, and contract research arrangements could clearly raise these issues. It is perhaps for this reason that few countries, if any, have developed functioning safe harbours for dealing with these common types of transfer pricing issues. Distribution margins and manufacturing mark-ups can sometimes be quite consistent across geographies and across many industries. Therefore guidance on normal settlement ranges for these types of cases could have the effect of reducing the number of transfer pricing audits and reducing competent authority dockets and other transfer pricing controversy by a substantial margin if reasonable ranges of results could be agreed bilaterally and published. These types of cases could potentially be addressed through bilateral MOUs adopted and publicised by competent authorities. Some countries have adopted such arrangements on a bilateral basis. The general view of such countries is that treaty provisions based on Article 25(3) of the OECD Model Tax Convention provide sufficient authority to support a bilateral competent authority agreement on a safe harbour rule that would apply to numerous similarly situated taxpayers. Article 25(3) provides: “The competent authorities of the Contracting States shall endeavour to resolve by mutual agreement any difficulties or doubts arising as to the interpretation or application of the Convention. They may also consult together for the elimination of double taxation in cases not provided for in the Convention.” A competent authority agreement on a bilateral transfer pricing safe harbour should properly be characterised as a “mutual agreement” that “resolves difficulties or doubts arising as to the interpretation or application” of Article 9 of the Treaty. Although nothing would prevent the countries’ competent authorities from adopting safe harbour provisions under Article 25(3) on a multilateral basis if the conditions and circumstances so allow, the particular types of transactions described above are such that countries will often adopt a bilateral approach. If such MOUs existed, qualifying taxpayers would be able to manage their financial results to fall within the agreed safe harbour range, secure in the understanding that those results would be accepted in both countries agreeing to the MOU concerned. A commonly cited precedent for this type of approach is the agreement between the United States and Mexico regarding safe harbour profit ranges for maquiladora operations. A bilateral approach to the development of safe harbours would have a number of advantages over unilateral transfer pricing safe harbours: A bilateral approach executed through competent authority MOUs could increase the likelihood that safe harbour provisions do not result in double taxation or double non-taxation. Bilateral safe harbours could be tailored to the economics of a particular market and circumstances, and thus be compatible with the arm’s length principle. Bilateral safe harbours could be entered into on a selective basis with countries having similar tax rates, thus minimising the possibility that the safe harbour provision itself would create opportunities for transfer pricing manipulation and providing a means for limiting the application of the safe harbour to situations where transfer pricing risk is quite low. If the relevant countries desire, bilateral safe harbours could initially be limited to small taxpayers and/or small transactions in order to limit exposures to government tax revenue that might otherwise be created by the safe harbour. Safe harbours adopted by means of a competent authority MOU could be reviewed and modified from time to time by competent authority agreement, thus assuring that the provisions stay up to date and reflect developments in the broader economy. For developing countries with serious resource constraints, bilateral MOUs entered into with a number of treaty partners could provide a means of protecting the local tax base in common transfer pricing fact patterns without an inordinate enforcement effort. The following elements may be of relevance in the negotiation and conclusion of an MOU. 1)    Description of and criteria to be fulfilled by the ...

Country tax administrations should carefully weigh the benefits of and concerns regarding safe harbours, making use of such provisions where they deem it appropriate ...

For more complex and higher risk transfer pricing matters, it is unlikely that safe harbours will provide a workable alternative to a rigorous, case by case application of the arm’s length principle under the provisions of these Guidelines ...

It should be clearly recognised that a safe harbour, whether adopted on a unilateral or bilateral basis, is in no way binding on or precedential for countries which have not themselves adopted the safe harbour ...

Where safe harbours can be negotiated on a bilateral or multilateral basis, they may provide significant relief from compliance burdens and administrative complexity without creating problems of double taxation or double non-taxation. Therefore, the use of bilateral or multilateral safe harbours under the right circumstances should be encouraged ...

However, in cases involving smaller taxpayers or less complex transactions, the benefits of safe harbours may outweigh the problems raised by such provisions. Making such safe harbours elective to taxpayers can further limit the divergence from arm’s length pricing. Where countries adopt safe harbours, willingness to modify safe-harbour outcomes in mutual agreement proceedings to limit the potential risk of double taxation is advisable ...

Safe harbour provisions may raise issues such as potentially having perverse effects on the pricing decisions of enterprises engaged in controlled transactions and a negative impact on the tax revenues of the country implementing the safe harbour as well as on the countries whose associated enterprises engage in controlled transactions with taxpayers electing a safe harbour. Further, unilateral safe harbours may lead to the potential for double taxation or double non-taxation ...

Transfer pricing compliance and administration is often complex, time consuming and costly. Properly designed safe harbour provisions, applied in appropriate circumstances, can help to relieve some of these burdens and provide taxpayers with greater certainty ...

Safe harbours may raise equity and uniformity issues. By implementing a safe harbour, one would create two distinct sets of rules in the transfer pricing area. Clearly and carefully designed criteria are required to differentiate those taxpayers or transactions eligible for the safe harbour to minimise the possibility of similar and possibly competing taxpayers finding themselves on opposite sides of the safe harbour threshold or, conversely, of allowing application of the safe harbour to unintended taxpayers or transactions. Insufficiently precise criteria could result in similar taxpayers receiving different tax treatment: one being permitted to meet the safe harbour rules and thus to be relieved from general transfer pricing compliance provisions, and the other being obliged to price its transactions in conformity with the general transfer pricing compliance provisions. Preferential tax treatment under safe harbour regimes for a specific category of taxpayers could potentially entail discrimination and competitive distortions. The adoption of bilateral or multilateral safe harbours could, in some circumstances, increase the potential of a divergence in tax treatment, not merely between different but similar taxpayers but also between similar transactions carried out by the same taxpayer with associated enterprises in different jurisdictions ...

Whether a country is prepared to possibly suffer some erosion of its own tax base in implementing a safe harbour is for that country to decide. The basic trade-off in making such a policy decision is between the certainty and administrative simplicity of the safe harbour for taxpayers and tax administrations on the one hand, and the possibility of tax revenue erosion on the other ...

This concern may largely be avoided by the solution noted in paragraph 4.119 of adopting safe harbours on a bilateral or multilateral basis, thus limiting application of safe harbours to transactions involving countries with similar transfer pricing concerns. In adopting bilateral and multilateral safe harbours, tax administrations would need to be aware that the establishment of an extensive network of such arrangements could potentially encourage “safe harbour shopping” via the routing of transactions through territories with more favourable safe harbours and take appropriate steps to avoid that possibility. Similarly, countries adopting bilateral safe harbours would be well advised to target fairly narrow ranges of acceptable results and to require consistent reporting of income in each country that is a party to the safe harbour arrangement. Treaty exchange of information provisions could be used by countries where necessary to confirm the use of consistent reporting under such a bilateral safe harbour ...

If a safe harbour were based on an industry average, tax planning opportunities might exist for taxpayers with better than average profitability. For example, a cost-efficient company selling at the arm’s length price may be earning a mark-up of 15% on controlled sales. If a country adopts a safe harbour requiring a 10% mark-up, the company might have an incentive to comply with the safe harbour and shift the remaining 5% to a lower tax jurisdiction. Consequently, taxable income would be shifted out of the country. When applied on a large scale, this could mean significant revenue loss for the country offering the safe harbour ...

Safe harbours may also provide taxpayers with tax planning opportunities. Enterprises may have an incentive to modify their transfer prices in order to shift taxable income to other jurisdictions. This may also possibly induce tax avoidance, to the extent that artificial arrangements are entered into for the purpose of exploiting the safe harbour provisions. For instance, if safe harbours apply to “simple” or “small” transactions, taxpayers may be tempted to break transactions up into parts to make them seem simple or small ...

The Annex I to Chapter IV of these Guidelines contains sample memoranda of understanding that country competent authorities might use to establish bilateral or multilateral safe harbours in appropriate situations for common classes of transfer pricing cases. The use of these sample memoranda of understanding should not be considered as either mandatory or prescriptive in establishing bilateral or multilateral safe harbours. Rather, they are intended to provide a possible framework for adaptation to the particular needs of the tax authorities of the countries concerned ...

The rigor of having two or more countries with potentially divergent interests agree to such a safe harbour should serve to limit some of the arbitrariness that otherwise might characterise a unilateral safe harbour and would largely eliminate safe harbour-created double taxation and double non-taxation concerns. Particularly for some smaller taxpayers and/or less complex transactions, creation of bilateral or multilateral safe harbours by competent authority agreement may provide a worthwhile approach to transfer pricing simplification that would avoid some of the potential pitfalls of unilateral safe harbour regimes ...

It is important to observe that the problems of non-arm’s length results and potential double taxation and double non-taxation arising under safe harbours could be largely eliminated if safe harbours were adopted on a bilateral or multilateral basis by means of competent authority agreements between countries. Under such a procedure, two or more countries could, by agreement, define a category of taxpayers and/or transactions to which a safe harbour provision would apply and by agreement establish pricing parameters that would be accepted by each of the contracting countries if consistently applied in each of the countries. Such agreements could be published in advance and taxpayers could consistently report results in each of the affected countries in accordance with the agreement ...

On the other hand, if a unilateral safe harbour permits taxpayers to report income below arm’s length levels in the country providing the safe harbour, taxpayers would have an incentive to elect application of the safe harbour. In such a case, there would be no assurance that the taxpayer would report income in other countries on a consistent basis or at levels above arm’s length levels based on the safe harbour. Moreover it is unlikely that other tax administrations would have the authority to require that income be reported above arm’s length levels. While the burden of under-taxation in such situations would fall exclusively upon the country adopting the safe harbour provision, and should not adversely affect the ability of other countries to tax arm’s length amounts of income, double non-taxation would be unavoidable and could result in distortions of investment and trade ...

Where safe harbours are adopted unilaterally, care should be taken in setting safe harbour parameters to avoid double taxation, and the country adopting the safe harbour should generally be prepared to consider modification of the safe-harbour outcome in individual cases under mutual agreement procedures to mitigate the risk of double taxation. At a minimum, in order to ensure that taxpayers make decisions on a fully informed basis, the country offering the safe harbour would need to make it explicit in advance whether or not it would attempt to alleviate any eventual double taxation resulting from the use of the safe harbour. Obviously, if a safe harbour is not elective and if the country in question refuses to consider double tax relief, the risk of double taxation arising from the safe harbour would be unacceptably high and inconsistent with double tax relief provisions of treaties ...

In cases involving smaller taxpayers or less complex transactions, the benefits of safe harbours may outweigh the problems raised by such provisions. Provided the safe harbour is elective, taxpayers may consider that a moderate level of double taxation, if any arises because of the safe harbour, is an acceptable price to be paid in order to obtain relief from the necessity of complying with complex transfer pricing rules. One may argue that the taxpayer is capable of making its own decision in electing the safe harbour as to whether the possibility of double taxation is acceptable or not ...

If the safe harbour causes taxpayers to report income above arm’s length levels, it would work to the benefit of the tax administration providing the safe harbour, as more taxable income would be reported by such domestic taxpayers. On the other hand, the safe harbour may lead to less taxable income being reported in the tax jurisdiction of the foreign associated enterprise that is the other party to the transaction. The other tax administrations may then challenge prices derived from the application of a safe harbour, with the result that the taxpayer would face the prospect of double taxation. Accordingly, any administrative benefits gained by the tax administration of the safe harbour country would potentially be obtained at the expense of other countries which, in order to protect their own tax base, would have to determine systematically whether the prices or results permitted under the safe harbour are consistent with what would be obtained by the application of their own transfer pricing rules. The administrative burden saved by the country offering the safe harbour would therefore be shifted to the foreign jurisdictions ...

One major concern raised by a safe harbour is that it may increase the risk of double taxation. If a tax administration sets safe harbour parameters at levels either above or below arm’s length prices in order to increase reported profits in its country, it may induce taxpayers to modify the prices that they would otherwise have charged or paid to controlled parties, in order to avoid transfer pricing scrutiny in the safe harbour country. The concern of possible overstatement of taxable income in the country providing the safe harbour is greater where that country imposes significant penalties for understatement of tax or failure to meet documentation requirements, with the result that there may be added incentives to ensure that the transfer pricing is accepted in that country without further review ...

Any potential disadvantages to taxpayers from safe harbours diverging from arm’s length pricing are avoided when taxpayers have the option to either elect the safe harbour or price transactions in accordance with the arm’s length principle. With such an approach, taxpayers that believe the safe harbour would require them to report an amount of income exceeding the arm’s length amount could apply the general transfer pricing rules. While such an approach can limit the divergence from arm’s length pricing under a safe harbour regime, it would also limit the administrative benefits of the safe harbour to the tax administration. Moreover, tax administrations would need to consider the potential loss of tax revenue from such an approach where taxpayers will pay tax only on the lesser of the safe harbour amount or the arm’s length amount. Countries may also be concerned over the ability of taxpayers to opt in and out of a safe harbour, depending on whether the use of the safe harbour is favourable to the taxpayer in a particular year. Countries may be able to gain greater comfort regarding this risk by controlling the conditions under which a taxpayer can be eligible for the safe harbour, for example by requiring taxpayers to notify the tax authority in advance of using the safe harbour or to commit to its use for a certain number of years ...

Safe harbours involve a trade-off between strict compliance with the arm’s length principle and administrability. They are not tailored to fit exactly the varying facts and circumstances of individual taxpayers and transactions. The degree of approximation of prices determined under the safe harbour with prices determined in accordance with the arm’s length principle could be improved by collecting, collating, and frequently updating a pool of information regarding prices and pricing developments in respect of the relevant types of transactions between uncontrolled parties of the relevant nature. However, such efforts to set safe harbour parameters accurately enough to satisfy the arm’s length principle could erode the administrative simplicity of the safe harbour ...

Where a safe harbour provides a simplified transfer pricing approach, it may not correspond in all cases to the most appropriate method applicable to the facts and circumstances of the taxpayer under the general transfer pricing provisions. For example, a safe harbour might require the use of a particular method when the taxpayer could otherwise have determined that another method was the most appropriate method under the facts and circumstances. Such an occurrence could be considered as inconsistent with the arm’s length principle, which requires the use of the most appropriate method ...

The availability of safe harbours for a given category of taxpayers or transactions may have adverse consequences. These concerns stem from the fact that: The implementation of a safe harbour in a given country may lead to taxable income being reported that is not in accordance with the arm’s length principle; Safe harbours may increase the risk of double taxation or double non-taxation when adopted unilaterally; Safe harbours potentially open avenues for inappropriate tax planning, and Safe harbours may raise issues of equity and uniformity ...

A safe harbour would result in a degree of administrative simplicity for the tax administration. Although the eligibility of particular taxpayers or transactions for the safe harbour would need to be carefully evaluated, depending on the specific safe harbour provision, such evaluations would not necessarily have to be performed by auditors with transfer pricing expertise. Once eligibility for the safe harbour has been established, qualifying taxpayers would require minimal examination with respect to the transfer prices of controlled transactions qualifying for the safe harbour. This would enable tax administrations to secure tax revenues in low risk situations with a limited commitment of administrative resources and to concentrate their efforts on the examination of more complex or higher risk transactions and taxpayers. A safe harbour may also increase the level of compliance among small taxpayers that may otherwise believe their transfer pricing practices will escape scrutiny ...

Another advantage provided by a safe harbour is the certainty that the taxpayer’s transfer prices will be accepted by the tax administration providing the safe harbour, provided they have met the eligibility conditions of, and complied with, the safe harbour provisions. The tax administration would accept, with limited or no scrutiny, transfer prices within the safe harbour parameters. Taxpayers could be provided with relevant parameters which would provide a transfer price deemed appropriate by the tax administration for the qualifying transaction ...

Properly designed safe harbours may significantly ease compliance burdens by eliminating data collection and associated documentation requirements in exchange for the taxpayer pricing qualifying transactions within the parameters set by the safe harbour. Especially in areas where transfer pricing risks are small, and the burden of compliance and documentation is disproportionate to the transfer pricing exposure, such a trade-off may be mutually advantageous to taxpayers and tax administrations. Under a safe harbour, taxpayers would be able to establish transfer prices which will not be challenged by tax administrations providing the safe harbour without being obligated to search for comparable transactions or expend resources to demonstrate transfer pricing compliance to such tax administrations ...

Application of the arm’s length principle may require collection and analysis of data that may be difficult or costly to obtain and/or evaluate. In certain cases, such compliance burdens may be disproportionate to the size of the taxpayer, its functions performed, and the transfer pricing risks inherent in its controlled transactions ...

The basic benefits of safe harbours are as follows: Simplifying compliance and reducing compliance costs for eligible taxpayers in determining and documenting appropriate conditions for qualifying controlled transactions; Providing certainty to eligible taxpayers that the price charged or paid on qualifying controlled transactions will be accepted by the tax administrations that have adopted the safe harbour with a limited audit or without an audit beyond ensuring the taxpayer has met the eligibility conditions of, and complied with, the safe harbour provisions; Permitting tax administrations to redirect their administrative resources from the examination of lower risk transactions to examinations of more complex or higher risk transactions and taxpayers ...

Although they would not fully meet the foregoing description of a safe harbour, it may be the case that some countries adopt other administrative simplification measures that use presumptions to realise some of the benefits discussed in this Section. For example, a rebuttable presumption might be established under which a mandatory pricing target would be established by a tax authority, subject to a taxpayer’s right to demonstrate that its transfer price is consistent with the arm’s length principle. Under such a system, it would be essential that the taxpayer does not bear a higher burden to demonstrate its price is consistent with the arm’s length principle than it would if no such system were in place. In any such system, it would be essential to permit resolution of cases of double taxation arising from application of the mandatory presumption through the mutual agreement process ...

For purposes of the discussion in this Section, safe harbours do not include administrative simplification measures which do not directly involve determination of arm’s length prices, e.g. simplified, or exemption from, documentation requirements (in the absence of a pricing determination), and procedures whereby a tax administration and a taxpayer agree on transfer pricing in advance of the controlled transactions (advance pricing arrangements), which are discussed in Section F of this chapter. The discussion in this section also does not extend to tax provisions designed to prevent “excessive” debt in a foreign subsidiary (“thin capitalisation” rules) ...

A safe harbour in a transfer pricing regime is a provision that applies to a defined category of taxpayers or transactions and that relieves eligible taxpayers from certain obligations otherwise imposed by a country’s general transfer pricing rules. A safe harbour substitutes simpler obligations for those under the general transfer pricing regime. Such a provision could, for example, allow taxpayers to establish transfer prices in a specific way, e.g. by applying a simplified transfer pricing approach provided by the tax administration. Alternatively, a safe harbour could exempt a defined category of taxpayers or transactions from the application of all or part of the general transfer pricing rules. Often, eligible taxpayers complying with the safe harbour provision will be relieved from burdensome compliance obligations, including some or all associated transfer pricing documentation requirements ...

Some of the difficulties that arise in applying the arm’s length principle may be avoided by providing circumstances in which eligible taxpayers may elect to follow a simple set of prescribed transfer pricing rules in connection with clearly and carefully defined transactions, or may be exempted from the application of the general transfer pricing rules. In the former case, prices established under such rules would be automatically accepted by the tax administrations that have expressly adopted such rules. These elective provisions are often referred to as “safe harbours” ...

The following discussion considers the benefits of, and concerns regarding, safe harbour provisions and provides guidance regarding the circumstances in which safe harbours may be applied in a transfer pricing system based on the arm’s length principle ...

Although safe harbours primarily benefit taxpayers, by providing for a more optimal use of resources, they can benefit tax administrations as well. Tax administrations can shift audit and examination resources from smaller taxpayers and less complex transactions (which may typically be resolved in practice on a consistent basis as to both transfer pricing methodology and actual results) to more complex, higher-risk cases. At the same time, taxpayers can price eligible transactions and file their tax returns with more certainty and with lower compliance burdens. However, the design of safe harbours requires careful attention to concerns about the degree of approximation to arm’s length prices that would be permitted in determining transfer prices under safe harbour rules for eligible taxpayers, the potential for creating inappropriate tax planning opportunities including double non-taxation of income, equitable treatment of similarly situated taxpayers, and the potential for double taxation resulting from the possible incompatibility of the safe harbours with the arm’s length principle or with the practices of other countries ...

The appropriateness of safe harbours can be expected to be most apparent when they are directed at taxpayers and/or transactions which involve low transfer pricing risks and when they are adopted on a bilateral or multilateral basis. It should be recognised that a safe harbour provision does not bind or limit in any way any tax administration other than the tax administration that has expressly adopted the safe harbour ...

Despite these generally negative conclusions, a number of countries have adopted safe harbour rules. Those rules have generally been applied to smaller taxpayers and/or less complex transactions. They are generally evaluated favourably by both tax administrations and taxpayers, who indicate that the benefits of safe harbours outweigh the related concerns when such rules are carefully targeted and prescribed and when efforts are made to avoid the problems that could arise from poorly considered safe harbour regimes ...

When these Guidelines were adopted in 1995, the view expressed regarding safe harbour rules was generally negative. It was suggested that while safe harbours could simplify transfer pricing compliance and administration, safe harbour rules may raise fundamental problems that could potentially have perverse effects on the pricing decisions of enterprises engaged in controlled transactions. It was suggested that unilateral safe harbours may have a negative impact on the tax revenues of the country implementing the safe harbour, as well as on the tax revenues of countries whose associated enterprises engage in controlled transactions with taxpayers electing a safe harbour. It was further suggested that safe harbours may not be compatible with the arm’s length principle. Therefore, it was concluded that transfer pricing safe harbours are not generally advisable, and consequently the use of safe harbours was not recommended ...

Applying the arm’s length principle can be a resource-intensive process. It may impose a heavy administrative burden on taxpayers and tax administrations that can be exacerbated by both complex rules and resulting compliance demands. These facts have led OECD member countries to consider whether and when safe harbour rules would be appropriate in the transfer pricing area ...

On the other hand, tax administrations have considerable flexibility in administering tax law. They can choose to concentrate more resources on cases involving large taxpayers or an important proportion of controlled transactions and show more tolerance towards smaller taxpayers. While more flexible administrative practices towards smaller taxpayers are not a substitute for a formal safe harbour, they may achieve, to a lesser extent, the same objectives pursued by safe harbours. In view of the above considerations, special statutory derogations for categories of taxpayers in the determination of transfer pricing are not generally considered advisable, and consequently the use of safe harbours is not recommended ...

Under the normal administration of tax laws, certainty cannot be guaranteed for the taxpayer, because administrations must retain the ability to review any aspect of a taxpayer’s income tax assessment, including the area of transfer pricing. Fundamentally, the introduction of a safe harbour means that the tax administration surrenders a portion of its discretionary power in favour of automatic rules. Tax administrations may not be prepared to go that far, and may consider it essential to retain the ability to verify the accuracy of a taxpayer’s self-assessed tax liability and its basis. Compliance simplicity may also often be subordinated to other tax policy objectives such as reasonable and adequate documentation and reporting and the prevention of tax avoidance ...

The foregoing analysis suggests that while safe harbours could accomplish a number of objectives relating to the compliance with and administration of transfer pricing provisions, they raise fundamental problems. They could potentially have perverse effects on the pricing decisions of enterprises engaged in controlled transactions. They may also have a negative impact on the tax revenues of the country implementing the safe harbour as well as on the countries whose associated enterprises engage in controlled transactions with taxpayers electing a safe harbour. More importantly, safe harbours are generally not compatible with the enforcement of transfer prices consistent with the arm’s length principle. These drawbacks must be measured against the expected benefits of safe harbours, certainty, and compliance simplicity on the taxpayer’s side and relief from administrative burden on the tax administration’s side ...

Finally, safe harbours raise equity and uniformity issues. By implementing a safe harbour, one would create two distinct sets of rules in the transfer pricing area, one requiring conformity of prices with the arm’s length principle and another requiring conformity with a different and simplified set of conditions. Since criteria would necessarily be required to differentiate those taxpayers eligible for the safe harbour, similar and possibly competing taxpayers could, in some circumstances, find themselves on opposite sides of the safe harbour threshold, thus resulting in similar taxpayers enjoying different tax treatment: one meeting the safe harbour rules and thus being relieved from regular compliance provisions and the other being obliged to do business exclusively in conformity with the arm’s length principle (either because the enterprise in fact deals at arm’s length or because it is subject to transfer pricing legislation that is based on the arm’s length principle). Preferential tax treatment under safe harbour regimes for a specific category of taxpayers could entail discrimination and competitive distortions ...

Whether a country is prepared possibly to suffer some erosion of its own tax base in implementing a safe harbour is for that country to decide. The basic trade-off in making such a policy decision is between the scope and attractiveness of the safe harbour for taxpayers on the one hand, and tax revenue erosion on the other. The more attractive a safe harbour is for a taxpayer, the more taxpayers will elect to use it, thereby reducing the taxation authority’s administrative burden. On the other hand, the more attractive the safe harbour is, the more tax revenue is likely to be lost due to under-reporting of income. However, the magnitude of the respective costs and benefits of such a trade-off is irrelevant if the tax administration is not prepared, as a matter of principle, to surrender any discretionary power with respect to the assessment of a taxpayer’s liability ...

Safe harbours may potentially result in the international under- taxation of income, to the extent that they result in prices or profits not approximating the arm’s length principle and allow taxable income to be shifted to low tax countries or tax havens ...

If a safe harbour were based on an industry average, tax planning opportunities might exist for taxpayers with better than average profitability. For example, a cost-efficient company selling at the arm’s length price may be earning a mark-up of 15 percent on controlled sales. This corporation would have an incentive to elect a safe harbour providing for a 10 percent mark up. The company would, under the safe harbour, be taxed on a scaled- down profits figure, notwithstanding the fact that the underlying transfer prices on controlled transactions would be significantly below the arm’s length prices. Consequently, taxable income would be shifted out of the country. When applied on a large scale, this could mean significant revenue lost for the country offering the safe harbour. By design, the tax administration would have no recourse to counter such instances of profit shifting ...

Safe harbours would also provide taxpayers with tax planning opportunities. Enterprises may have an incentive to modify their transfer prices in order to shift taxable income to other jurisdictions. This may also possibly induce tax avoidance, to the extent that artificial arrangements are entered into for the purpose of exploiting the safe harbour provisions ...

Double taxation possibilities would exist not only where a single country adopts a safe harbour. Adoption of a safe harbour by more than one country would not avoid double taxation if each taxing jurisdiction were to adopt conflicting approaches and methods. The parameters of two countries’ safe harbours for specific industry segments are likely to deviate since both countries would want to safeguard their revenues. In theory, international coordination could achieve the degree of harmonisation among national systems that would be required to prevent double taxation. However, in practice, it is most unlikely that two jurisdictions could harmonise conflicting safe harbours that would eliminate double taxation ...

The adoption of safe harbour regimes in one country may require that the other countries’ tax administrations examine the transfer pricing policy of all companies associated with enterprises that have elected a safe harbour in order to identify all cases of potential inconsistency with the arm’s length principle. Failure to do so could amount to a transfer of tax revenue from those countries to the country providing the safe harbour. Consequently, any administrative simplicity gained by the tax administration of the safe harbour country would be obtained at the expense of other countries, which, in order to protect their own tax base, would have to determine systematically whether the prices or results permitted under the safe harbour are consistent with what would be obtained by the application of their own transfer pricing rules. The administrative burden saved by the country offering the safe harbour would therefore be shifted to the foreign jurisdictions ...

However, transfer pricing adjustments of foreign tax administrations will be complicated when the MNE has chosen a safe harbour in another country, because the taxpayer is likely to dispute the adjustment to prevent double taxation. The prospect that mutual agreement procedures are generally not available to adjust prices or results downwards that have been set under a safe harbour regime may therefore have a detrimental effect on the tax administration in the foreign countries ...

It follows that double taxation may not, in itself, be a disqualifying factor against safe harbours. One may argue that the taxpayer alone should be required to make its own decision if the possibility of double taxation is acceptable in electing the safe harbour or not. However, in order to ensure that taxpayers make such a decision clearly on the basis of this trade-off, the country offering the safe harbour would need to make it explicit whether or not it would attempt to alleviate any eventual double taxation resulting from the use of the safe harbour. Since the safe harbour provides taxpayers with the privilege of avoiding any subsequent review or audit of their transfer prices resulting from the application of a safe harbour and given the nature of safe harbours, whose prices or results are, by design, only a proxy for those obtained under the arm’s length principle, it is only appropriate that the taxpayer should equally be prepared, in electing the safe harbour, to bear any ensuing international double taxation resulting from the non-acceptance by a foreign tax administration of the transfer prices reported under the safe harbour. This would logically imply that taxpayers electing the safe harbour should generally be prohibited from bringing double taxation issues before the competent authorities should the use of the safe harbour result in international double taxation. Tax relief from double taxation attributable to a taxpayer’s election of a safe harbour should be granted in the foreign country only if the taxpayer can prove that the results of meeting the safe harbour are consistent with the arm’s length principle ...

At the outset, one would argue that the possibility of double taxation would nullify the objectives of certainty and simplicity originally pursued by the taxpayer in electing the safe harbour. However, taxpayers may consider that a moderate level of double taxation is an acceptable price to be paid in order to obtain relief from the necessity of complying with complex transfer pricing rules ...

Indeed, in such cases, the tax administration of the jurisdiction adversely affected may not be in a position to accept the prices charged to their taxpayers in connection with transactions with associated enterprises in the safe harbour country. The prices may differ from those obtained in these jurisdictions by the application of transfer pricing methods consistent with the arm’s length principle. It would be expected that foreign tax administrations would challenge prices derived from the application of a safe harbour, with the result that the taxpayer would face the prospect of double taxation ...

Taxpayers may value the certainty provided by the safe harbour to the point where they would raise the prices charged to associated enterprises for the purpose of qualifying for the safe harbour, notwithstanding the fact that those transfer prices would be above the relevant taxpayer’s arm’s length prices taking into account its specific circumstances. In that case, the safe harbour would work to the benefit of the tax administration providing the safe harbour, as more taxable income would be reported by such domestic taxpayers. On the other hand, the safe harbour would penalise both the foreign associated enterprises and their tax administrations, since less profits and taxable income would be reported in their respective jurisdictions. This would create an issue with respect to the proper sharing of tax revenue between tax jurisdictions ...

From a practical point of view, the most important concern raised by a safe harbour is its international impact. Safe harbours could affect the pricing strategy of corporations. The existence of safe harbour “targets” may induce taxpayers to modify the prices that they would otherwise have charged to controlled parties, in order to increase profits to meet the targets and thereby avoid transfer pricing scrutiny on audit. The concern of possible overstatement of taxable income in the country providing the safe harbour is greater where that country imposes significant penalties for understatement of tax or failure to meet documentation requirements, with the result that there may be added incentive to ensure that the transfer pricing is accepted without further review ...

Safe harbours are likely to be arbitrary since they rarely fit exactly the varying facts and circumstances even of enterprises in the same trade or business. This arbitrariness could be minimised only with great difficulty by devoting a considerable amount of skilled labour to collecting, collating, and continuously revising a pool of information about prices and pricing developments. Obtaining relevant information for establishing and monitoring safe harbour parameters may therefore impose administrative burdens on tax administrations, because such information may not be readily available and may be accessible only through in-depth transfer pricing inquiries. Therefore, the extensive research necessary to set the safe harbour parameters accurately enough to satisfy the arm’s length principle would jeopardise one of the purposes of a safe harbour, that of administrative simplicity ...

Even assuming that the pricing method imposed under a specific safe harbour is appropriate to the facts and circumstances of particular cases, the application of the safe harbour would nonetheless sacrifice accuracy in the reporting of transfer prices. This is inherent in safe harbours, under which transfer prices are predominantly established by reference to a standard target as opposed to the individual facts and circumstances of the transaction, as under the arm’s length principle. It follows that the prices or results that produce compliance with the standard target may not be arm’s length prices or results ...

Such an occurrence could be considered as inconsistent with the arm’s length principle, which requires the use of a pricing method that is consistent with the conditions that independent parties engaged in comparable transactions under comparable conditions would have agreed upon in the open market. Some sectors where goods, commodities or services are standard and market prices are widely publicised such as, for example, the oil and mining industries and the financial services sector could conceivably apply a safe harbour with a higher degree of precision and, thus, a lesser departure from the arm’s length principle. But even these industry segments produce a wide range of results which a safe harbour would be unlikely to be able to accommodate to the satisfaction of the tax administrations. And the existence of published market prices would presumably also facilitate the use of transaction-based methods, in which case there may be no need for a safe harbour ...

Under a safe harbour, taxpayers may not be required to follow a specific pricing method, or even have a pricing method for tax purposes. Where a safe harbour imposes a simplified transfer pricing method, it would be unlikely to correspond in all cases to the most appropriate method applicable to the facts and circumstances of the taxpayer under the regular transfer pricing provisions. For example, a safe harbour may impose a minimum profit percentage under a profit method when the taxpayer could have used the comparable uncontrolled price method or other transaction- based methods ...

“The availability of safe harbours for a given category of taxpayers would have a number of adverse consequences which must carefully be weighed by tax administrations against the expected benefits. These concerns stem from the facts that: 1. The implementation of a safe harbour in a given country would not only affect tax calculations within that jurisdiction, but would also impinge on the tax calculations of associated enterprises in other jurisdictions; and 2. It is difficult to establish satisfactory criteria for defining safe harbours, and accordingly they can potentially produce prices or results that may not be consistent with the arm’s length principle. The issue can be examined from several perspectives.” ...

A safe harbour would result in a degree of administrative simplicity for the tax administration. Once the eligibility of certain taxpayers to the safe harbour has been established, those taxpayers would require minimal examination with respect to transfer prices or results of controlled transactions. Tax administrations could then allocate more resources to the examination of other transactions and taxpayers ...

Another advantage provided by a safe harbour would be the certainty that the taxpayer’s transfer prices will be accepted by the tax administration. Qualifying taxpayers would have the assurance that they would not be subject to an audit or reassessment in connection with their transfer prices. The tax administration would accept without any further scrutiny any price or result exceeding a minimum threshold or falling within a predetermined range. For that purpose, taxpayers could be provided with relevant parameters which would provide a transfer price or a result deemed appropriate to the tax administration. This could be, for example, a series of sector-specific mark-ups or profit indicators ...

Safe harbours could significantly ease compliance by exempting taxpayers from such provisions. Designed as a comfort mechanism, they allow greater flexibility especially in the areas where there are no matching or comparable arm’s length prices. Under a safe harbour, taxpayers would know in advance the range of prices or profit rates within which the corporation must fall in order to qualify for the safe harbour. Meeting such conditions would merely require the application of a simplified method, predominantly a measure of profitability, which would spare the taxpayer the search for comparables, thus saving time and resources which would otherwise be devoted to determining transfer prices ...

Application of the arm’s length principle may require collection and analysis of data that may be difficult to obtain and/or evaluate. In certain cases, such complexity may be disproportionate to the size of the corporation or its level of controlled transactions ...

The basic objectives of safe harbours are as follows: simplifying compliance for eligible taxpayers in determining arm’s length conditions for controlled transactions; providing assurance to a category of taxpayers that the price charged or received on controlled transactions will be accepted by the tax administration without further review; and relieving the tax administration from the task of conducting further examination and audits of such taxpayers with respect to their transfer pricing ...

The provision of safe harbours raises significant questions about the degree of arbitrariness that would be created in determining transfer prices by eligible taxpayers, tax planning opportunities, and the potential for double taxation resulting from the possible incompatibility of the safe harbours with the arm’s length principle ...

A safe harbour may have two variants regarding the taxpayer’s conditions of controlled transactions: certain transactions are excluded from the scope of application of transfer pricing provisions (in particular by setting thresholds), or the rules applying to them are simplified (for example by designating ranges within which prices or profits must fall). Both safe harbour targets may need to be revised and published periodically by the tax authorities. Safe harbours do not include procedures whereby a tax administration and a taxpayer agree on transfer pricing in advance of the controlled transactions (advance pricing arrangements), which are discussed in Section F of this chapter. The discussion in this section does not extend to tax provisions designed to prevent “excessive” debt in a foreign subsidiary (“thin capitalisation” rules), which will be the subject of subsequent work ...

The difficulties in applying the arm’s length principle may be ameliorated by providing circumstances in which taxpayers could follow a simple set of rules under which transfer prices would be automatically accepted by the national tax administration. Such provisions would be referred to as a “safe harbour” or “safe haven”. Formally, in the context of taxation, a safe harbour is a statutory provision that applies to a given category of taxpayers and that relieves eligible taxpayers from certain obligations otherwise imposed by the tax code by substituting exceptional, usually simpler obligations. In the specific instance of transfer pricing, the administrative requirements of a safe harbour may vary from a total relief of targeted taxpayers from the obligation to conform with a country’s transfer pricing legislation and regulations to the obligation to comply with various procedural rules as a condition for qualifying for the safe harbour. These rules could, for example, require taxpayers to establish transfer prices or results in a specific way, e.g. by applying a simplified transfer pricing method provided by the tax administration, or satisfy specific information reporting and record maintenance provisions with regard to controlled transactions. Such an approach requires a more substantial involvement from the tax administration, since the taxpayer’s compliance with the procedural rules may need to be monitored ...

Applying the arm’s length principle can be a fact-intensive process and can require proper judgment. It may present uncertainty and may impose a heavy administrative burden on taxpayers and tax administrations that can be exacerbated by both legislative and compliance complexity. These facts have lead OECD member countries to consider whether safe harbour rules would be appropriate in the transfer pricing area ...

On the other hand, tax administrations have considerable flexibility in administering tax law. They can choose to concentrate more resources on cases involving large taxpayers or an important proportion of controlled transactions and show more tolerance towards smaller taxpayers. While more flexible administrative practices towards smaller taxpayers are not a substitute for a formal safe harbour, they may achieve, to a lesser extent, the same objectives pursued by safe harbours. In view of the above considerations, special statutory derogations for categories of taxpayers in the determination of transfer pricing are not generally considered advisable, and consequently the use of safe harbours is not recommended ...

Under the normal administration of tax laws, certainty cannot be guaranteed for the taxpayer, because administrations must retain the ability to review any aspect of a taxpayer’s income tax assessment, including the area of transfer pricing. Fundamentally, the introduction of a safe harbour means that the tax administration surrenders a portion of its discretionary power in favour of automatic rules. Tax administrations may not be prepared to go that far, and may consider it essential to retain the ability to verify the accuracy of a taxpayer’s self- assessed tax liability and its basis. Compliance simplicity may also often be subordinated to other tax policy objectives such as reasonable and adequate documentation and reporting and the prevention of tax avoidance ...

The foregoing analysis suggests that while safe harbours could accomplish a number of objectives relating to the compliance with and administration of transfer pricing provisions, they raise fundamental problems. They could potentially have perverse effects on the pricing decisions of enterprises engaged in controlled transactions. They may also have a negative impact on the tax revenues of the country implementing the safe harbour as well as on the countries whose associated enterprises engage in controlled transactions with taxpayers electing a safe harbour. More importantly, safe harbours are generally not compatible with the enforcement of transfer prices consistent with the arm’s length principle. These drawbacks must be measured against the expected benefits of safe harbours, certainty, and compliance simplicity on the taxpayer’s side and relief from administrative burden on the tax administration’s side ...

Finally, safe harbours raise equity and uniformity issues. By implementing a safe harbour, one would create two distinct sets of rules in the transfer pricing area, one requiring conformity of prices with the arm’s length principle and another requiring conformity with a different and simplified set of conditions. Since criteria would necessarily be required to differentiate those taxpayers eligible for the safe harbour, similar and possibly competing taxpayers could, in some circumstances, find themselves on opposite sides of the safe harbour threshold, thus resulting in similar taxpayers enjoying different tax treatment: one meeting the safe harbour rules and thus being relieved from regular compliance provisions and the other being obliged to do business exclusively in conformity with the arm’s length principle (either because the enterprise in fact deals at arm’s length or because it is subject to transfer pricing legislation that is based on the arm’s length principle). Preferential tax treatment under safe harbour regimes for a specific category of taxpayers could entail discrimination and competitive distortions ...

Whether a country is prepared possibly to suffer some erosion of its own tax base in implementing a safe harbour is for that country to decide. The basic trade-off in making such a policy decision is between the scope and attractiveness of the safe harbour for taxpayers on the one hand, and tax revenue erosion on the other. The more attractive a safe harbour is for a taxpayer, the more taxpayers will elect to use it, thereby reducing the taxation authority’s administrative burden. On the other hand, the more attractive the safe harbour is, the more tax revenue is likely to be lost due to under-reporting of income. However, the magnitude of the respective costs and benefits of such a trade-off is irrelevant if the tax administration is not prepared, as a matter of principle, to surrender any discretionary power with respect to the assessment of a taxpayer’s liability ...

Safe harbours may potentially result in the international under-taxation of income, to the extent that they result in prices or profits not approximating the arm’s length principle and allow taxable income to be shifted to low tax countries or tax havens ...

If a safe harbour were based on an industry average, tax planning opportunities might exist for taxpayers with better than average profitability. For example, a cost-efficient company selling at the arm’s length price may be earning a mark up of 15 percent on controlled sales. This corporation would have an incentive to elect a safe harbour providing for a 10 percent mark up. The company would, under the safe harbour, be taxed on a scaled-down profits figure, notwithstanding the fact that the underlying transfer prices on controlled transactions would be significantly below the arm’s length prices. Consequently, taxable income would be shifted out of the country. When applied on a large scale, this could mean significant revenue lost for the country offering the safe harbour. By design, the tax administration would have no recourse to counter such instances of profit shifting ...

Safe harbours would also provide taxpayers with tax planning opportunities. Enterprises may have an incentive to modify their transfer prices in order to shift taxable income to other jurisdictions. This may also possibly induce tax avoidance, to the extent that artificial arrangements are entered into for the purpose of exploiting the safe harbour provisions ...

Double taxation possibilities would exist not only where a single country adopts a safe harbour. Adoption of a safe harbour by more than one country would not avoid double taxation if each taxing jurisdiction were to adopt conflicting approaches and methods. The parameters of two countries’ safe harbours for specific industry segments are likely to deviate since both countries would want to safeguard their revenues. In theory, international coordination could achieve the degree of harmonization among national systems that would be required to prevent double taxation. However, in practice, it is most unlikely that two jurisdictions could harmonize conflicting safe harbours that would eliminate double taxation ...

The adoption of safe harbour regimes in one country may require that the other countries’ tax administrations examine the transfer pricing policy of all companies associated with enterprises that have elected a safe harbour in order to identify all cases of potential inconsistency with the arm’s length principle. Failure to do so could amount to a transfer of tax revenue from those countries to the country providing the safe harbour. Consequently, any administrative simplicity gained by the tax administration of the safe harbour country would be obtained at the expense of other countries, which, in order to protect their own tax base, would have to determine systematically whether the prices or results permitted under the safe harbour are consistent with what would be obtained by the application of their own transfer pricing rules. The administrative burden saved by the country offering the safe harbour would therefore be shifted to the foreign jurisdictions ...

However, transfer pricing adjustments of foreign tax administrations will be complicated when the MNE has chosen a safe harbour in another country, because the taxpayer is likely to dispute the adjustment to prevent double taxation. The prospect that mutual agreement procedures are generally not available to adjust prices or results downwards that have been set under a safe harbour regime may therefore have a detrimental effect on the tax administration in the foreign countries ...

It follows that double taxation may not, in itself, be a disqualifying factor against safe harbours. One may argue that the taxpayer alone should be required to make its own decision if the possibility of double taxation is acceptable in electing the safe harbour or not. However, in order to ensure that taxpayers make such a decision clearly on the basis of this trade-off, the country offering the safe harbour would need to make it explicit whether or not it would attempt to alleviate any eventual double taxation resulting from the use of the safe harbour. Since the safe harbour provides taxpayers with the privilege of avoiding any subsequent review or audit of their transfer prices resulting from the application of a safe harbour and given the nature of safe harbours, whose prices or results are, by design, only a proxy for those obtained under the arm’s length principle, it is only appropriate that the taxpayer should equally be prepared, in electing the safe harbour, to bear any ensuing international double taxation resulting from the non-acceptance by a foreign tax administration of the transfer prices reported under the safe harbour. This would logically imply that taxpayers electing the safe harbour should generally be prohibited from bringing double taxation issues before the competent authorities should the use of the safe harbour result in international double taxation. Tax relief from double taxation attributable to a taxpayer’s election of a safe harbour should be granted in the foreign country only if the taxpayer can prove that the results of meeting the safe harbour are consistent with the arm’s length principle ...

At the outset, one would argue that the possibility of double taxation would nullify the objectives of certainty and simplicity originally pursued by the taxpayer in electing the safe harbour. However, taxpayers may consider that a moderate level of double taxation is an acceptable price to be paid in order to obtain relief from the necessity of complying with complex transfer pricing rules ...

Indeed, in such cases, the tax administration of the jurisdiction adversely affected may not be in a position to accept the prices charged to their taxpayers in connection with transactions with associated enterprises in the safe harbour country. The prices may differ from those obtained in these jurisdictions by the application of transfer pricing methods consistent with the arm’s length principle. It would be expected that foreign tax administrations would challenge prices derived from the application of a safe harbour, with the result that the taxpayer would face the prospect of double taxation ...

Taxpayers may value the certainty provided by the safe harbour to the point where they would raise the prices charged to associated enterprises for the purpose of qualifying for the safe harbour, notwithstanding the fact that those transfer prices would be above the relevant taxpayer’s arm’s length prices taking into account its specific circumstances. In that case, the safe harbour would work to the benefit of the tax administration providing the safe harbour, as more taxable income would be reported by such domestic taxpayers. On the other hand, the safe harbour would penalize both the foreign associated enterprises and their tax administrations, since less profits and taxable income would be reported in their respective jurisdictions. This would create an issue with respect to the proper sharing of tax revenue between tax jurisdictions ...

From a practical point of view, the most important concern raised by a safe harbour is its international impact. Safe harbours could affect the pricing strategy of corporations. The existence of safe harbour “targets” may induce taxpayers to modify the prices that they would otherwise have charged to controlled parties, in order to increase profits to meet the targets and thereby avoid transfer pricing scrutiny on audit. The concern of possible overstatement of taxable income in the country providing the safe harbour is greater where that country imposes significant penalties for understatement of tax or failure to meet documentation requirements, with the result that there may be added incentive to ensure that the transfer pricing is accepted without further review ...

Safe harbours are likely to be arbitrary since they rarely fit exactly the varying facts and circumstances even of enterprises in the same trade or business. This arbitrariness could be minimized only with great difficulty by devoting a considerable amount of skilled labour to collecting, collating, and continuously revising a pool of information about prices and pricing developments. Obtaining relevant information for establishing and monitoring safe harbour parameters may therefore impose administrative burdens on tax administrations, because such information may not be readily available and may be accessible only through in-depth transfer pricing inquiries. Therefore, the extensive research necessary to set the safe harbour parameters accurately enough to satisfy the arm’s length principle would jeopardize one of the purposes of a safe harbour, that of administrative simplicity ...

Even assuming that the pricing method imposed under a specific safe harbour is appropriate to the facts and circumstances of particular cases, the application of the safe harbour would nonetheless sacrifice accuracy in the reporting of transfer prices. This is inherent in safe harbours, under which transfer prices are predominantly established by reference to a standard target as opposed to the individual facts and circumstances of the transaction, as under the arm’s length principle. It follows that the prices or results that produce compliance with the standard target may not be arm’s length prices or results ...

Such an occurrence could be considered as inconsistent with the arm’s length principle, which requires the use of a pricing method that is consistent with the conditions that independent parties engaged in comparable transactions under comparable conditions would have agreed upon in the open market. Some sectors where goods, commodities or services are standard and market prices are widely publicised such as, for example, the oil and mining industries and the financial services sector could conceivably apply a safe harbour with a higher degree of precision and, thus, a lesser departure from the arm’s length principle. But even these industry segments produce a wide range of results which a safe harbour would be unlikely to be able to accommodate to the satisfaction of the tax administrations. And the existence of published market prices would presumably also facilitate the use of transaction-based methods, in which case there may be no need for a safe harbour ...

Under a safe harbour, taxpayers may not be required to follow a specific pricing method, or even have a pricing method for tax purposes. Where a safe harbour imposes a simplified transfer pricing method, it would be unlikely to correspond in all cases to the most appropriate method applicable to the facts and circumstances of the taxpayer under the regular transfer pricing provisions. For example, a safe harbour may impose a minimum profit percentage under a profit method when the taxpayer could have used the comparable uncontrolled price method or other transaction-based methods ...

The availability of safe harbours for a given category of taxpayers would have a number of adverse consequences which must carefully be weighed by tax administrations against the expected benefits. These concerns stem from the facts that:a) the implementation of a safe harbour in a given country would not only affect tax calculations within that jurisdiction, but would also impinge on the tax calculations of associated enterprises in other jurisdictions, andb) it is difficult to establish satisfactory criteria for defining safe harbours, and accordingly they can potentially produce prices or results that may not be consistent with the arm’s length principle.The issue can be examined from several perspectives ...

A safe harbour would result in a degree of administrative simplicity for the tax administration. Once the eligibility of certain taxpayers to the safe harbour has been established, those taxpayers would require minimal examination with respect to transfer prices or results of controlled transactions. Tax administrations could then allocate more resources to the examination of other transactions and taxpayers ...

Another advantage provided by a safe harbour would be the certainty that the taxpayer’s transfer prices will be accepted by the tax administration. Qualifying taxpayers would have the assurance that they would not be subject to an audit or reassessment in connection with their transfer prices. The tax administration would accept without any further scrutiny any price or result exceeding a minimum threshold or falling within a predetermined range. For that purpose, taxpayers could be provided with relevant parameters which would provide a transfer price or a result deemed appropriate to the tax administration. This could be, for example, a series of sector-specific mark-ups or profit indicators ...

Safe harbours could significantly ease compliance by exempting taxpayers from such provisions. Designed as a comfort mechanism, they allow greater flexibility especially in the areas where there are no matching or comparable arm’s length prices. Under a safe harbour, taxpayers would know in advance the range of prices or profit rates within which the corporation must fall in order to qualify for the safe harbour. Meeting such conditions would merely require the application of a simplified method, predominantly a measure of profitability, which would spare the taxpayer the search for comparables, thus saving time and resources which would otherwise be devoted to determining transfer prices ...

Application of the arm’s length principle may require collection and analysis of data that may be difficult to obtain and/or evaluate. In certain cases, such complexity may be disproportionate to the size of the corporation or its level of controlled transactions ...

The basic objectives of safe harbours are as follows: simplifying compliance for eligible taxpayers in determining arm’s length conditions for controlled transactions; providing assurance to a category of taxpayers that the price charged or received on controlled transactions will be accepted by the tax administration without further review; and relieving the tax administration from the task of conducting further examination and audits of such taxpayers with respect to their transfer pricing ...

The provision of safe harbours raises significant questions about the degree of arbitrariness that would be created in determining transfer prices by eligible taxpayers, tax planning opportunities, and the potential for double taxation resulting from the possible incompatibility of the safe harbours with the arm’s length principle ...

A safe harbour may have two variants regarding the taxpayer’s conditions of controlled transactions: certain transactions are excluded from the scope of application of transfer pricing provisions (in particular by setting thresholds), or the rules applying to them are simplified (for example by designating ranges within which prices or profits must fall). Both safe harbour targets may need to be revised and published periodically by the tax authorities. Safe harbours do not include procedures whereby a tax administration and a taxpayer agree on transfer pricing in advance of the controlled transactions (advance pricing arrangements), which are discussed in Section F of this chapter. The discussion in this section does not extend to tax provisions designed to prevent “excessive” debt in a foreign subsidiary (“thin capitalisation” rules), which will be the subject of subsequent work ...

The difficulties in applying the arm’s length principle may be ameliorated by providing circumstances in which taxpayers could follow a simple set of rules under which transfer prices would be automatically accepted by the national tax administration. Such provisions would be referred to as a “safe harbour” or “safe haven”. Formally, in the context of taxation, a safe harbour is a statutory provision that applies to a given category of taxpayers and that relieves eligible taxpayers from certain obligations otherwise imposed by the tax code by substituting exceptional, usually simpler obligations. In the specific instance of transfer pricing, the administrative requirements of a safe harbour may vary from a total relief of targeted taxpayers from the obligation to conform with a country’s transfer pricing legislation and regulations to the obligation to comply with various procedural rules as a condition for qualifying for the safe harbour. These rules could, for example, require taxpayers to establish transfer prices or results in a specific way, e.g. by applying a simplified transfer pricing method provided by the tax administration, or satisfy specific information reporting and record maintenance provisions with regard to controlled transactions. Such an approach requires a more substantial involvement from the tax administration, since the taxpayer’s compliance with the procedural rules may need to be monitored ...

Applying the arm’s length principle can be a fact-intensive process and can require proper judgment. It may present uncertainty and may impose a heavy administrative burden on taxpayers and tax administrations that can be exacerbated by both legislative and compliance complexity. These facts have lead OECD Member countries to consider whether safe harbour rules would be appropriate in the transfer pricing area ...