Dirk Van Stappen is a partner
The EUJTPF continues to seek pragmatic, non-legislative solutions
After having celebrated its 10th anniversary at its 35th meeting held on October 25, 2012, the EU Joint Transfer Pricing Forum (EU JTPF) continued its work and met on February 14, 2013, June 6, 2013 and November 5, 2013 to discuss the outstanding issues.
The work of the EU JTPF in 2013 will result in reports on secondary adjustments, transfer pricing risk management, compensating or year-end adjustments and on the monitoring of past soft law instruments.1
It is possible that a transfer pricing adjustment is accompanied by a so-called “secondary adjustment”. The OECD defines secondary adjustments in the Glossary of the OECD Transfer Pricing Guidelines (TPG) as:
“an adjustment that arises from imposing tax on a secondary transaction in transfer pricing cases”, and a secondary transaction as “a constructive transaction that some States assert under their domestic transfer pricing legislation after having proposed a primary adjustment in order to make the actual allocation of profits consistent with the primary adjustment. Secondary transactions may take the form of constructive dividends (that is items treated as though they are dividends, even though they would not normally be regarded as such), constructive equity contributions, or constructive loans.”2
The OECD Model Tax Convention does not prevent secondary adjustments from being made insofar they are permitted under domestic law. However tax administrations are encouraged to structure these secondary adjustments in such a way that the possibility of double taxation is minimised, unless the behaviour of the taxpayer suggests an intent to disguise a dividend for the purposes of avoiding withholding tax.3
Only nine out of the 28 EU Member States seem to have regulations enabling their tax authorities to make secondary adjustments.4
In its report on secondary adjustments5 the EU JTPF advises that, where secondary adjustments are compulsory under the legislation of a EU Member State, it is recommended that EU Member States provide for ways and means to avoid double taxation (e.g. by endeavouring to solve it through a mutual agreement procedure, or by allowing the repatriation of funds at an early stage, where possible).
Furthermore it is recommended that within the EU, EU Member States characterise secondary adjustments as constructive dividends or constructive capital contributions rather than as constructive loans, as long as there is no repatriation.
When secondary adjustments are treated as hidden profit distribution/contribution and therefore considered as constructive dividends, the application of the Parent-Subsidiary Directive (Articles 4 and 5 PSD) should in principle result in no withholding tax being imposed on a distribution from a subsidiary to its parent within the EU.
However it should be noted that out of the nine EU Member States making secondary adjustments, Bulgaria and France seem to consider that the PSD is not applicable to constructive dividends and as such the levying of withholding tax may not be excluded.
On the repatriation of funds the report states that where competent authorities agree in a mutual agreement procedure (MAP) on the need to effectively put the accounts in line with the economic intent of the primary adjustment and thus reversing the funds, EU Member States consider repatriation by a direct reimbursement or through an offset of inter-company accounts as an appropriate tool for achieving this result.
Tax administrations should be aware that taxpayers would need up to 90 days from the date of the notification of the agreement to actually implement the repatriation.
When repatriation is agreed in a MAP settlement, it is recommended that the MAP agreement states that no withholding tax will be applied by the EU Member State out of which the repatriation is made and no additional taxable burden will be imposed in the EU Member State to which the repatriation is made.
Where the MAP is between EU Member States it is, on grounds of simplification, recommended in the report that EU Member States allow, as far as possible, the repatriation without an interest component and include this in the MAP agreement.
If an EU Member State considers repatriation at an early stage, for example at the stage of an audit, it is recommended to ensure that the other EU Member State is informed concurrently based on an exchange of information procedure, or by the taxpayer (if the taxpayer agrees). A repatriation agreement reached at the audit stage should not preclude a request by the taxpayer for a MAP, nor should it indicate agreement or disagreement with an audit statement.
In line with its earlier report on penalties, the EU JTPF recommends that when a secondary adjustment is required, EU Member States should refrain from imposing a penalty with respect to the secondary adjustment.6
In cases where penalties on secondary adjustments are nonetheless applied, the report states that, when the tax consequences of a secondary adjustment are eliminated or reduced in a MAP, it is recommended to eliminate or commensurately reduce the related penalty, respectively.
As taxpayers may not be aware of the fact that in certain situations a separate request needs to be made for avoiding double taxation resulting from secondary adjustments, EU Member States which do not consider that secondary adjustments can be treated under the European Arbitration Convention are encouraged to highlight in their public guidance the fact that a separate request under article 25 of the OECD Model Tax Convention may be needed to remove double taxation. For reasons of efficiency, it is recommended that taxpayers submit both requests in the same letter.
In order to make optimal use of their scarce resources (people, funds, etc), both tax authorities and business want to attribute their resources into issues which deliver value. Also in the transfer pricing domain, appropriate risk management will facilitate the optimal attribution of resources.
With its report7 issued in June 2013, the EU JTPF intends to provide best practices on effective risk management in transfer pricing with a focus on aspects specific for EU Member States and business in the EU. The best practices discussed in the report are structured according to the three phases a transfer pricing file normally follows:
i. the initial phase;
ii. the audit phase; and
iii. the resolution phase.
With the initial phase should be understood the phase covering the time before a serious commitment of a tax administration's resources is made to concretely investigate whether transfer prices are set in accordance with the arm's length principle, regardless of whether this is already considered as audit or pre-audit in the administrative practice of the EU Member State.
The objective of the initial phase is to enable the tax administration to make a well-founded judgment on whether it is, in the light of the risk identified and the resources available, appropriate to pursue with a further investigation (the audit phase) and if so, where to put the focus. In order to enable tax authorities to make this judgment appropriately, it is important to know what kind of information they should consider and also when and how. The latter may be facilitated by an appropriate administrative organisation (e.g. a co-operative compliance arrangement between tax administration and taxpayers). In case such a more formal form of organisation is not considered appropriate, EU Member States are encouraged to at least implement measures that allow communication between taxpayers and tax administrations at an early point in time.
There are situations where it would make sense that a transfer pricing risk which was identified by one tax administration is communicated to the other tax administration(s) involved. The EU Directive on Administrative Co-operation8 is considered to provide a practicable framework for exchanging such information from risk assessment in an effective manner and at an early point in time. In this initial phase, the detail of information submitted should, however, be rather limited as the aim of the exchange would be to prevent problems resulting from early and late audits or to envisage a simultaneous or joint audit.
The report considers the 'audit phase’ to start with the decision to make a serious commitment of a tax administration's resources to concretely investigate whether transfer prices were set in accordance with the arm's length principle.
Besides a well-founded result of the initial phase, setting up a work plan is considered to be one of the foundations of an effective audit process. In an annex to the report of the EU JTPF on transfer pricing risk management, an example of such a work plan is being provided.
It is recommended that the following aspects should be taken into account during the audit phase:
• The importance of first establishing a mutual understanding of the facts and circumstances underlying the transactions that were chosen for further review in the context of the business and the industry in which the taxpayer is operating before applying transfer pricing rules. For this purpose the involvement of sector or industry experts is considered to be useful;
• A high degree of co-operation between taxpayer and tax administration, e.g. by establishing an early and ongoing dialogue is regarded as beneficial for the whole process. Further, well-prepared face to face meetings are helpful. Generally, keeping the time difference between the transaction and audit as short as possible or even envisage discussing on a real time basis is regarded as beneficial;
• Furthermore all actions and requests should be well targeted and a reasonable balance should be kept between the usefulness of the information requested for the issue under consideration and the burden the request creates for both the taxpayers and the tax administration.
The EU JTPF stresses also the importance of transfer pricing documentation when assessing the transfer pricing risk. Keeping documentation consistent with the EU TPD and making it available to the tax authorities can also be regarded as an indication for a co-operative taxpayer.
When considering risk-based approaches in the context of documentation it is recommended to take the following aspects into account:
• quantitative aspects, e.g. lower documentation requirements for low amount transactions;
• qualitative aspects, e.g. lower documentation requirements for certain low risk transactions;
• time aspects, e.g. not imposing annual documentation requirements for continuous transactions where the facts and circumstances stay the same; and
• simplification for certain transactions and in accordance with the conclusions of the OECD on safe harbours in revised paragraphs 4.93 - 4.131 of the OECD TPG. In this context it is also useful to refer to the JTPF guidance on low value adding intra-group services and CCAs on service not creating intangible property.
Given the bi-and multilateral nature of transfer pricing, simultaneous and/or joint transfer pricing audits are considered beneficial to both the audit phase and the subsequent resolution phase. It is however acknowledged that at the beginning the actual performance of simultaneous and joint audits will provide legal and practical challenges. Therefore developing or improving existing legal frameworks and practical guidance on bi- or multilateral transfer pricing audits would be useful. The report suggests that the EU JTPF considers taking up this work in the future.
Even if all parties involved act in the best manner, there will be cases in which it will not be possible to come to an agreement. The disagreement may be between the taxpayer and the tax administration or, e.g. in case of simultaneous or joint audits, the tax administrations involved may come to different conclusions. In these situations it is important to decide whether the issue can be resolved within the audit phase or whether the so called resolution phase should be started. In the EU JTPF report on transfer pricing risk management, 'resolution phase’ means further proceedings (litigation or MAP) if the taxpayer claims for these proceedings.
In the report it is recommended to establish an administrative framework which ensures that the decision to enter the resolution phase is made in a timely and efficient manner. EU Member States and taxpayers should ensure the proper functioning of the European Arbitration Convention by following the guidance in the Code of Conduct. Given the high workload on MAP, EU Member States may also consider the implementation of Alternative Dispute Resolution Mechanisms.
Following the discussion on compensating adjustments that the EU JTPF had in June and November 2013, the EU JTPF report on compensating adjustments has been finalised. The report proposes guidance for a practical solution to issues arising from the application of different approaches to compensating adjustments by EU Member States.9
“an adjustment in which the taxpayer reports a transfer price for tax purposes that is, in the taxpayer's opinion, an arm's length price for a controlled transaction, even though this price differs from the amount actually charged between the associated enterprises. This adjustment would be made before the tax return is filed.”10
The responses of the EU Member States to the questionnaire on compensating adjustments indicate that they apply different approaches with respect to compensating adjustments. It is recognised that these differences are often grounded in a different understanding of more fundamental principles in transfer pricing, e.g. timing issues and the use of information relating to contemporaneous uncontrolled transactions, the availability of comparable data and the quality of benchmark studies created on the basis of commercial databases and what constitutes the inappropriate use of hindsight in transfer pricing.
The purpose of the report is to provide practical solutions to the relating issues and to increase the acceptance of compensating or year-end adjustments, but this without limiting a tax administration's ability to make an adjustment at a later stage.
Furthermore it should be noted that the recommendations in this report are only applicable to compensating adjustments which are made in the accounts and explained in the taxpayer's transfer pricing documentation.
In general, the adjustment of transfer prices set at the time of a transaction at a later point in time touches upon the important theoretical issue in transfer pricing on whether
• taxpayers should be required to establish transfer pricing documentation that demonstrates that they have made reasonable efforts to comply with the arm's length principle at the time their intra-group transactions were undertaken based on information that was reasonably available to them at that moment (ex-ante or arm's length price setting approach), or whether
• taxpayers can or should test the actual outcome of their controlled transactions to demonstrate that the conditions of these transactions were consistent with the arm's length principle (ex-post or arm's length outcome testing approach).
EU Member States which follow the reasoning of an ex-ante approach would generally require the taxpayer to make reasonable efforts to establish the transfer prices at the time of transaction. If prices were set in a way third parties would have done and with the information reasonably available to third parties at the time of transaction, these prices and the outcome thereof would be binding.
EU Member States which follow the reasoning of an ex-post approach would generally allow or even require taxpayers to test and, if necessary, to adjust their transfer prices at the end of the year, before closing the books or when filing the tax return. Following an ex-post approach may also imply that at the time of an audit the best data available (e.g. data relating to the time when the transaction was undertaken) may have to be used.
When both EU Member States apply an ex-post approach and require compensating adjustments, problems and even a risk of double or double non-taxation may arise with respect to the following:
• the point in time when such an adjustment should/can be made (year-end, closure of books, filing of the tax return);
• the data which should be used for determining the need for an adjustment and the adjustment itself;
• whether an adjustment can be made in both directions (upwards and downwards); and
• to which price the adjustment should be made (in case of ranges e.g. nearest quartile, median, etc.).
If the transactions under review are between two related parties which are situated in two EU Member States, one of which follows an ex-ante while the other follows an ex-post approach with an obligation to reflect the adjustments in the books, a conflict arises on whether such an adjustment can be made at all.
The guidance in the OECD TPG on those issues is currently rather limited. Both the arm's length price setting approach and the arm's length outcome-testing approach are recognised as being applied by EU Member States and in case of dispute, the OECD refers to the Mutual Agreement Procedure (MAP).11
However, a MAP may not yet be available or may not yet provide a solution for the conflict at an early stage, e.g. at the time when the taxpayer is obliged to file his tax return.
To address these or related practical issues, EU Member States agree on conditions under which taxpayer-initiated compensating adjustments should be accepted for the tax return. The decision whether to oblige the taxpayer to make such an adjustment is left to the discretion of the EU Member States.
To address the practical issues arising from the situation described above, EU Member States agree that:
i. the profits of the related enterprises with respect to the commercial or financial relations between them need to be calculated symmetrically, i.e. enterprises participating in a transaction use the same price for the respective transactions, and that
ii. a compensating adjustment initiated by the taxpayer should be acceptable if the conditions listed below are fulfilled. This means that if the EU Member States involved have less prescriptive rules on compensating adjustments, these less prescriptive rules apply.
Furthermore the EU JTPF report on compensating adjustments does not encourage EU Member States to introduce more conditions for compensating adjustments than currently applied.
The conditions referred to above are the following:
• before the relevant transaction or series of transactions, the taxpayer made reasonable efforts to achieve an arm's length outcome. This would normally be described in the transfer pricing documentation of the taxpayer;
• the taxpayer makes the adjustment symmetrically in both MS involved;
• the taxpayer applies the same approach consistently over time;
• the taxpayer makes the adjustment before filing the tax return; and
• the taxpayer is able to explain the reasons why his forecast did not match the result achieved, when it is required by internal legislation in at least one of the EU Member States involved.
Where the actual result is outside the range of arm's length results targeted when setting the price at the time of the transaction, the adjustment should be made to the most appropriate point in an arm's length range. Upward as well as downward adjustments should be accepted.
Accepting an adjustment in the aforementioned manner should be regarded as a practical solution to issues arising from the application compensating adjustments.
An important part of the work of the EU JTPF consists of monitoring the state of play on the working in practice of the various soft law instruments previously issued by the European Commission on the basis of the work of the EU JTPF. In particular the purpose of this monitoring exercise is to evaluate their effectiveness and to consider how improvements might be made.
With respect to the European Arbitration Convention (EAC), the (2006 - revised in 2009) Code of Conduct on the effective implementation of the EAC might have already contributed to an improved working of the EAC. Despite the issuance of the (revised) Code of Conduct, practice shows however that things can still be improved. Since 2004 the number of cases has tripled. The estimated number of cases older than two years has more or less doubled in absolute figures over the period 2004-2011. Notwithstanding the fact that the relative number of cases older than two years has decreased from approximately 40 percent in 2004 to 20 percent in 2011, business and its advisers report that they are still facing practical problems. The EU JTPF has considered a significant number of the issues being reported and will provide practical guidance to remediate them insofar possible.
Regarding transfer pricing documentation, the survey made by EU Member States and private sector member of the EU JTPF in 2008 came too early. Therefore the monitoring exercise carried out by the EU JTPF in 2013 is crucial to assess the implementation of the EU TPD/Master file-concept by both the tax authorities of the EU Member States and the tax payers. The answers to the questionnaires given by both the EU Member States and the private sector members were quite interesting. The outcome thereof was already going to be reported orally on the OECD Working Party 6 meetings and once the summary report had been approved as being final by all EU JTPF members, the report will be published and used to determine possible future work of the EUJTPF on the EU TPD.
In the field of Advance Pricing Agreements (APAs), numbers are clearly on the rise. Since the issuance of the EU APA Guidelines in 2007, the number of EU Member States disposing of an APA programme has increased and subsequently the number of APAs requested and granted has gone up as well. On the reporting side, EU Member States can still do better by making a clear distinction between unilateral, bilateral and multilateral APAs.
The EU IGS Guidelines, the report on non-EU triangular cases, SMEs and CCAs on services not creating IP are too recent to already monitor now. They are scheduled to be monitored in 2014 and 2015.
The European Commission Communication on the work of the EU JTPF containing the reports on secondary adjustments and on transfer pricing risk management is envisaged for the beginning of 2014. Depending on the envisaged timing it could include the report on compensating adjustments as well.
Furthermore the publication of the outcome of the monitoring exercise of past soft law instruments, in particular on the EAC and on the EU TPD, may be expected in 2014.
All this work will further contribute to the goal for which the EU JTPF has been established in 2002: finding pragmatic, non-legislative solutions to transfer pricing problems within the EU.
Dirk Van Stappen is a partner of KPMG Tax Advisers and
heads the Belgian firm's Corporate Tax and Global Transfer Pricing Services
(GTPS) practice. He specialises in international tax and transfer pricing.
Dirk is also a professor at the University of Antwerp (Belgium) and a faculty
member at the University of Leiden (The Netherlands). He is one of the 16
private sector experts appointed by the European Commission and has
participated in the EU Joint Transfer Pricing Forum since its establishment in
2002. He may be contacted at:
1 For earlier updates on the activities of the EU Joint Transfer Pricing Forum see e.g.: Van Stappen, Dirk, “Transfer pricing developments within the European Commission - a state of play of the achievements and future work of the EU Joint Transfer Pricing Forum”, Handbuch Verrechnungspreise, Bernegger Rosenberger Zöchling, Linde, 2008, p. 33-57; Van Stappen, Dirk, “EU Joint Transfer Pricing Forum”, Bloomberg BNA Transfer Pricing International Journal, January 2010, p. 18-21, Van Stappen, Dirk, “ EU Joint Transfer Pricing Forum”, Bloomberg BNATransfer Pricing International Journal, January 2011, p. 10-12, Van Stappen, Dirk, “ EU Joint Transfer Pricing Forum”, Bloomberg BNATransfer Pricing International Journal, January 2012, p. 9-11, Van Stappen, Dirk, “EU Joint Transfer Pricing Forum”, Bloomberg BNATransfer Pricing International Journal, January 2013, p. 17-22.
2 OECD Transfer Pricing Guidelines, July 22, 2010, Glossary.
3 OECD Transfer Pricing Guidelines, July 22, 2010, 4.71.
4 Austria, Bulgaria, Denmark, Germany, France, Luxembourg, the Netherlands, Slovenia and Spain.
5 JTPF/017/FINAL/2012/EN of January 18, 2013.
6 EU JTPF Summary report on Penalties accompanying the communication on the work of the JTPF in the period March 2007 to March 2009 (COM(2009)472 final).
9 The contribution below is based on and quotes explicitly from the EU JTPF report Doc: JTPF/009/FINAL/2013/EN.
10 OECD Transfer Pricing Guidelines, 22 July 2010, Glossary.
11 OECD Transfer Pricing Guidelines, 22 July 2010, 3.71 and 4.39.
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