'Special Measures' and the Arm's-Length Principle

By Gary D. Sprague, Esq.  

Baker & McKenzie LLP, Palo Alto, CA

The OECD held a public consultation on November 12-13, 2013, on
the revised Discussion Draft to replace Chapter VI of the OECD's
Transfer Pricing Guidelines.1 Chapter VI sets
forth additional specific guidance to be applied to transactions
that involve the use or transfer of intangible property. The
revised Chapter VI includes significant new guidance for taxpayers
and tax administrators, including detailed guidance as to when an
entity may be entitled to an "intangible related return." In very
broad terms, the revised Discussion Draft in its current form
apparently is intended to support a shift toward allocating a
greater return from intangibles being allocated to entities
performing specified business activities relating to the relevant
intangible, and less to entities that may own the intangible, fund
the acquisition or further development of the intangible, or bear
commercial risk with respect to business activities relating to the
development or exploitation of the intangible, but which do not
perform the specified business activities themselves.2

At the conclusion of the consultation, noting that the process
has benefited from several public consultations, the Secretariat
indicated that Working Party 6 now intends to prepare and publish a
final version of the revised Chapter VI. This project indeed has
been underway for a considerable period of time. The project was
first announced in 2010, although the first complete discussion
draft was not released until June 2012. The OECD has held several
consultations with interested business commentators, both before
and after the publication of the discussion drafts. The
Secretariat's comments signal that Working Party 6 has received the
public input it desires and is now prepared to proceed to a final

This march toward completion, however, must maneuver around,
alongside, or through the OECD/G20 Base Erosion and Profit Shifting
comprehensive action plan (BEPS Action Plan). The BEPS Action Plan
was released on July 19, 2013, and contains several Actions
relating to transfer pricing matters.3 The three core
transfer pricing Actions, in fact, address issues also at the core
of the Chapter VI revision project. The BEPS Action Plan includes a
very aggressive timetable for completion of all Actions; the core
transfer pricing ones have deadlines of September 2014 and
September 2015. The overlap between the two projects means that
Working Party 6 will need to make some critical decisions about the
nature of interpretative guidance under the arm's-length principle
as they proceed to put Chapter VI in final form.

The three core transfer pricing Actions (8, 9, and 10) are all
presented under the goal to "assure that transfer pricing outcomes
are in line with value creation." The three core transfer pricing
Actions are as follows:

Action 8 - Intangibles  

Develop rules to prevent BEPS by moving intangibles among group
members. This will involve: (i) adopting a broad and clearly
delineated definition of intangibles; (ii) ensuring that profits
associated with the transfer and use of intangibles are
appropriately allocated in accordance with (rather than divorced
from) value creation; (iii) developing transfer pricing rules or
special measures for transfers of hard-to-value intangibles; and
(iv) updating the guidance on cost contribution arrangements.

Action 9 - Risks and capital  

Develop rules to prevent BEPS by transferring risks among, or
allocating excessive capital to, group members. This will involve
adopting transfer pricing rules or special measures to ensure that
inappropriate returns willnot accrue to an entity solely because it
has contractually assumed risks or has provided capital. The rules
to be developed will also require alignment of returns with value
creation. This work will be co-ordinated with the work on interest
expense deductions and other financial payments.

Action 10 - Other high-risk

Develop rules to prevent BEPS by engaging in transactions which
would not, or would only very rarely, occur between third parties.
This will involve adopting transfer pricing rules or special
measures to: (i) clarify the circumstances in which transactions
can be recharacterised; (ii) clarify the application of transfer
pricing methods, in particular profit splits, in the context of
global value chains; and (iii) provide protection against common
types of base eroding payments, such as management fees and head
office expenses.

Action 8 most directly overlaps with the Chapter VI revision
project; the first three elements of Action 8 are integral parts of
Chapter VI. Actions 9 and 10 also have close connections to the
Chapter VI project.

The most actively debated issue in the Chapter VI project is the
determination of which portion of the "intangible related return"
should be allocated to the enterprise that owns the intangible and
funds the acquisition and further development of the intangible,
but that does not itself perform or control any or only some of
those business activities identified in the revised Discussion
Draft as indicating the entity which should participate in the
intangible related return. The ultimate resolution of that issue
presumably will involve consideration of the same issues the
OECD/G20 delegates will consider under Action 8 as to how profits
from intangibles are "appropriately" allocated to value creation,
and under Action 9 as to what returns to capital or risk-bearing
would be "inappropriate."

Another actively debated topic in the Chapter VI work is the
appropriate approach to setting a price for transactions involving
"hard to value" intangibles, particularly the transfer of partially
developed intangibles. These transactions generally are regarded as
encompassed in the reference to "high-risk transactions" in Action
10, and the question of when such transactions could be
recharacterized is a central element of the Chapter VI
discussions.  Again, the direction the delegates choose for
resolving this issue in the Chapter VI work presumably will be
influenced, if not directed, by the emerging thinking on Action

Each of the core transfer pricing Actions refers to the
possibility of promulgating "special measures" to address a variety
of situations, including: (1) the circumstances in which a
transaction might be recharacterized; (2) protections against
"inappropriate" returns accruing to an entity solely due to risk
assumption or capital provision; and (3) providing guidance on the
transfer of a hard to value intangible.

I believe that the most significant decision now facing the
OECD/G20 delegates is whether "special measures" will be considered
as applications of, and therefore consistent with, the arm's-length
principle, or rather as rules which operate outside the
arm's-length principle. The BEPS Action Plan states that "special
measures, either within or beyond the arm's length principle, may
be required…."4 Public statements by
OECD officials to date have been noncommittal on this point.
Perhaps that means that this decision has not yet been made.

The overlap between the BEPS transfer pricing Actions and the
Chapter VI work means that the Working Party 6 delegates likely
will need to face the question of the nature of "special measures"
immediately. As noted above, the transfer pricing Actions have
deliverable dates as early as September 2014, which presumably
points to the release of a final revised Chapter VI. In order to
deliver on that promise, the delegates will need to make some
decisions soon on whether to propose "special measures."

Based on the public comments at the recent consultation, the
delegates understand the choice in front of them. A delegate from a
major jurisdiction put the point succinctly in the context of a
discussion of when a transaction could be recharacterized. The
delegate noted that one of the important elements of the revised
Discussion Draft still to be finalized is when a taxpayer's
allocation of commercial risk should be respected, and when a tax
administration should have the authority to recharacterize the
transaction as something other than that as structured by the
taxpayer. The delegate noted that one approach would be to provide
further guidance within the framework of the Transfer Pricing
Guidelines, with the additional guidance presumably being regarded
by the delegates as an appropriate and defensible interpretation of
the arm's-length principle. The delegate also noted that the
alternative would be to identify some purported risk allocations as
presumptively subject to recharacterization. This approach would
seem to be a "special measure" as contemplated by the text of
Actions 8-10. While the delegate did not express this
interpretation, it would seem that such a prescriptive rule would
not necessarily be justified as an application of the arm's-length
principle, but rather would be a special measure "beyond" the
arm's-length principle.

This will be a momentous decision. Tax administrations clearly
are struggling to find approaches to challenge outcomes that they
regard as "inappropriate." Any approach that attempts to establish
a prescriptive rule "beyond" the arm's-length principle, however,
faces serious jurisprudential challenges.

The arm's-length principle is a feature of the domestic law of
many countries. In the United States, §482 itself does not speak
directly in terms of "arm's-length" dealings, but the Treasury
regulations interpreting §482 state that "the standard to be
applied in every case is that of a taxpayer dealing at arm's length
with an uncontrolled taxpayer."5 The domestic law
of other countries include similar provisions. Finally, the current
international tax treaty network uniformly is based on the
arm's-length principle.6

Any "special measure" that is not expressly designed to be
consistent with the arm's-length principle thus will be subject to
challenge under existing domestic law and treaty obligations. It is
hard to see how a tax administration could prevail in asserting an
adjustment under a "special measure" that is not designed to be
consistent with the arm's-length principle.  Perhaps the
OECD/G20 will suggest including "special measures" in the
multilateral instrument contemplated under the BEPS Action Plan to
achieve quick adoption of resolutions coming out of the BEPS
project, but that would seem to be a hugely controversial endeavor
if the point is to implement rules not in conformity with the
arm's-length principle.

In the end, the OECD/G20 delegates probably don't have a choice.
If the intention is to promulgate guidance that stands a chance of
being accepted by most courts around the world, any "special
measures" will need to be consistent with the arm's-length

This commentary also will appear in the January 2014 issue
of the
 Tax Management International Journal. For
more information, in the Tax Management Portfolios, see Maruca and
Warner, 886 T.M.
, Transfer Pricing: The Code, the Regulations,
and Selected Case Law, Culbertson, Durst, and Bailey, 894
, Transfer Pricing: OECD Transfer Pricing Rules and
Guidelines, and in Tax Practice Series, see ¶3600, Section 482
- Allocation of Income and Deductions Between Related



  1 The revised Discussion Draft was issued July 30,

  2 The Discussion Draft proposes to change the title
of Chapter VI from "Special Considerations for Intangible Property"
to "Special Considerations for Intangibles." It is a small, but
telling, detail reflecting the expanded scope of the revised
Chapter VI.


  4 BEPS Action Plan, p. 20.

  5 Regs. §1.482-1(b)(1).

  6 See, e.g., OECD Model Tax Convention,
Art. 9; OECD Transfer Pricing Guidelines, Ch. I, ¶1.6; Technical
Explanation, U.S. Model Treaty, Article 9.