THE APPLICATION OF THE PROFIT SPLIT METHOD WITHIN THE EU (2019)

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The profit split method (PSM) is one of the five transfer pricing methods in Chapter II of the OECD Transfer Pricing Guidelines. These methods can be used to establish whether the conditions imposed on the commercial or financial relations between associated enterprises are consistent with the arm’s length principle.

The OECD guidelines of 1995 referred to the PSM as a method of “last resortâ€, to be used when other methods could not be reliably applied (para. 3.50). Yet, since the revision of the OECD Guidelines in 2010, the PSM is considered a pricing method to be applied in an equally reliable manner as the other methods in accordance with the “most appropriate method†criterion.

Due to the increased integration of multinational enterprises and the globalization of national economies and markets, the clarification of the PSM was one of the priorities identified in the action plan against Base Erosion and Profit Shifting (BEPS). Indeed, in order to develop rules that can prevent BEPS resulting from engaging in transactions which would not, or would only very rarely, occur between third parties, Action 10 called for clarification of the application of transfer pricing methods, in particular of the transactional profit split method, in the context of global value chains.

In June 2018 the OECD published a Report containing Revised Guidelines on the application of PSM that clarifies and significantly expands the Guidelines on when a profit split may be the most appropriate method. The Guidelines also note that the basic premise that the transactional profit split method is applicable where it is found to be the most appropriate method is unchanged.

In addition, the programme of work 2015-2019 of the Joint Transfer Pricing Forum (JTPF) referred to the PSM as one of the topics on which the JTPF should provide output in order to address the problems in the practical application of the PSM. A particular reference is made to the high degree of subjectivity encountered when stakeholders determine how to share the profit.

As pointed out in the OECD Guidelines, the main advantage of the PSM is that it can offer solutions in cases where all relevant parties make unique and valuable contributions and/or there is a high degree of integration. In such cases, it is frequent that the reliable information on comparables is insufficient for applying another transfer pricing method although as pointed out by the OECD, lack of external comparable per se should not lead to default use of PSM (para 2.128 and 2.143 of the OECD Guidelines). Secondly, when parties share the assumption of economically significant risks or assume closely related risks, its flexibility allows the determination of an arm’s length profit for the parties according to the actual assumption of the risks.

The analysis of the economically relevant characteristics of the transaction and in particular, the functional analysis, supported by the information in the MNE group’s transfer pricing documentation, should reveal: (i) how value is generated by the group as a whole; (ii) the interdependencies between the functions performed by the associated enterprises; and (iii) the contribution that each of the associated enterprises makes to that value creation. In particular, the analysis of risks and the determination of which group entities take the key decisions related to control over risk as well as which of these entities have the financial capacity to assume the risk should help identify the most appropriate way of splitting the relevant profit from the transaction under review.

 

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