The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.
By Jaap Reyneveld and Eduard Sporken
The May 2018 Dutch transfer pricing decree endorses the interpretation of the arm’s-length principle set forth in the OECD transfer pricing guidelines.
The 2018 Dutch transfer pricing decree also confirms the Dutch Tax Administration’s existing policies. The 2018 TP Decree replaces the Decree of the Deputy Minister of Finance dated November 13, 2013, no. IFZ 2013/184M. Many of the changes to the 2018 TP Decree generally reflect the DTA’s views expressed in past cases.
Some of the views taken in the 2018 TP Decree are debatable. The application of the Dutch approach to valuating intangibles may lead to controversy and discussions with other tax authorities. Also, the emphasis on the “D” and “E” functions in the DEMPE—Development, Enhancement, Maintenance, Protection and Exploitation—approach may not be valid for each and every case.
The 2018 TP Decree’s adoption of the simplified approach with respect to low value added services constitutes a practical approach that will be very helpful in addressing these transactions when preparing transfer pricing documentation.
However, it is important to note that the decree reflects the policy pursued by the DTA, and therefore the decree is not necessarily prescriptive for Dutch taxpayers in all cases. In particular, if companies’ individual facts and circumstances are different from cases described in the decree, it is possible to depart from the decree, if properly documented.
This article covers the main changes made by 2018 TP Decree to the 2013 Decree.
In recent decades, the OECD guidelines have been revised several times to reflect the ‘communis opinio’ of the OECD members with respect to transfer pricing.
For the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017, see:
The most recent revisions to the OECD guidelines in July 2017 resulted from the OECD BEPS project.
Because of the 2017 update of OECD guidelines, the Netherlands updated its 2013 Transfer Pricing Decree and published the 2018 TP Decree.
In the 2018 TP Decree the Dutch secretary of Finance states that the OECD guidelines provide an internationally accepted reflection of the arm’s-length principle. Therefore, he considers the OECD guidelines as an appropriate clarification of the arm’s-length principle as codified in Article 8b of the Dutch Corporate Income Tax Act 1969. The aim of the 2018 TP Decree is to provide the Dutch point of view where the OECD guidelines leave room for interpretation or where the OECD guidelines are unclear.
The Netherlands already codified OECD BEPS Action 13, including the Country-by-Country reporting, Master File and Local File requirements regarding financial years starting as of January 1, 2016 onwards in the Dutch Corporate Income Tax Act 1969. See the Dutch Corporate Income Tax Act 1969, articles 29b – 29h.
Important changes in the 2018 TP Decree, compared to the 2013 previous decree, include:
The Dutch tax authorities (DTA) will, where necessary, assess the extent to which imposing a penalty would be appropriate given the facts and circumstances of the case at hand. The authors anticipate that for a corporate tax correction above a certain threshold, the DTA will consult their penalty/fraud coordinator.
This does not mean that deviations from the policy presented in the decree will automatically result in the imposition of penalties, according to the 2018 Dutch TP decree. In working to combat non-arm’s length profit shifting, the DTA’s Transfer Pricing Coordination Group will, if necessary, join forces with the Coordination Group on Tax Havens and Group Financing and the Coordination Group on Avoidance Schemes.
3.1 Characterization of the Transaction
Under the 2018 TP Decree, it is crucial that each transfer pricing analysis is based on a sound understanding of the role of each undertaking of the multinational enterprise and the commercial and financial relationship between these undertakings and the transactions. Before the price of a transaction between associated parties can be established, the transaction as such must be characterized. This requires an analysis of the economically relevant characteristics of the transaction, consisting of (see par. 1.36 OECD guidelines):
If the actual conduct does not correspond to the contractual structure of the transaction, the actual conduct will, in general, be decisive for characterizing the transaction, according to the 2018 TP Decree. The functions performed and the economically relevant risks associated with the transaction will also need be analyzed. As per the 2018 TP Decree, the analysis of the risks in a controlled transaction comprises all of the following steps:
Paragraph 1.65 of the OECD guidelines defines ‘control’ as: “Control over risk involves the first two elements of risk management defined in paragraph 1.61; that is (i) the capability to make decisions to take on, lay off, or decline a risk-bearing opportunity, together with the actual performance of that decision-making function and (ii) the capability to make decisions on whether and how to respond to the risks associated with the opportunity, together with the actual performance of that decision-making function.”
In the authors’ view, the weighting of the control functions is heavily dependent on the facts and circumstances of the case.
Paragraph 1.64 of the OECD guidelines defines ‘Financial Capacity’ as: “Financial capacity to assume risk can be defined as access to funding to take on the risk or to lay off the risk, to pay for the risk mitigation functions and to bear the consequences of the risk if the risk materialises.”
In the authors’ view, also this is heavily dependent on the facts and circumstances of the case.
The 2018 Decree acknowledges that it is conceivable that in certain situations multiple parties exercise control over the risks and have the financial capacity to bear these risks, although only one of those parties has contractually assumed those risks. In such cases, paragraph 1.94 of the OECD guidelines stipulates that the contractual risk allocation should be respected. This doesn’t alter the fact that the other party (or parties) should receive an arm’s-length compensation for performing the control function fulfilled by that party (or parties). According to the 2018 TP Decree, this means that the Transactional Profit Split Method may be appropriate in such cases. As per this decree, it does not seem to be at arm’s-length that a party that assumes risks on the basis of a contract, but in fact contributes only minimally to the ‘control’, is ascribed all the negative and positive consequences of the relevant risks pursuant to paragraph 1.94 of the OECD guidelines, while the other party (or parties) receive a small routine fee.
On the basis of the characterized transaction, a suitable price should be set, taking account of the arm’s-length risk allocation. Price setting should, in principle, take place on the basis of comparable transactions between independent parties identified in a comparability analysis. The economically relevant characteristics referred to above also form the elements of this comparability analysis.
3.2 Disregarding the Transaction
The 2018 TP Decree merely reiterates the OECD guidelines that allow for the transaction itself to be questioned in extreme cases. According to the OECD it is only possible to question a transaction as such if the characterized transaction (including any changes to the risk allocation), seen in its entirety, differs from what commercially rational independent parties would have agreed in comparable circumstances, so that it is not possible to set a price that is acceptable to all parties. In doing so, the perspective of both parties and the options realistically available to each of them must be taken into consideration at the time the transaction is entered into (par. 1.122 – 1.124 of the OECD guidelines). Only in this situation, the impact of such a transaction on the profit for tax purposes must be ignored as per the OECD guidelines and the 2018 TP Decree.
The 2018 TP Decree also states that the mere fact that comparable transactions between third parties are not found, does not mean that the associated transaction would thus not be at arm’s- length.
3.3 The Comparability Analysis / Benchmarking
Whereas the 2013 TP Decree identified the functional analysis as the core element of the comparability analysis, the 2018 TP Decree states that the functional analysis of the parties involved in the transaction is also an essential part of the application of the arm’s-length principle and the required comparability analysis. This does not seem to be meant as a change in the DTA’s policy.
The 2018 TP Decree notes that for Dutch taxpayers that are only required to keep transfer pricing documentation pursuant to Section 8b of the Corporate Income Tax Act 1969, the absence of an investigation or survey into the prices (in databases) that were used by independent parties in comparable situations will not lead to a reversal of the burden of proof as per the 2018 TP Decree. The authors note that this suggests that absence of an investigation or survey into the prices (in databases), as part of the Local File, that were used by independent parties in comparable situations may result in a reversal of the burden of proof
If only the price of the controlled transaction differs from the price that independent third parties would have agreed, a price adjustment can be made for tax purposes as per the 2018 TP Decree. This decree notes that this can also be a downward adjustment if it is only the shareholders of a Dutch company that receive a benefit, thus without any or in exchange for a small non-arm’s length consideration, and both the payer and the recipient of the benefit are aware of this. The authors note that the latter practice is based on Supreme Court decisions of 3 April 1957 (BNB 1957/165) and 31 May 1978 (BNB 1978/252) where the DTA was ordered to accept the informal capital concept in respect of interest free loans between related parties. Under Dutch tax law formal contributions to, or withdrawals from, equity capital do not constitute taxable profit. Similarly, informal contributions to, or withdrawals from, a Dutch company’s equity capital are not contributing to or deductible from taxable corporate income.
3.4 Applying a Range
The 2018 TP Decree stipulates that if the transfer pricing outcome is within an acceptable interquartile range, there is no need to make an adjustment. The 2018 TP Decree furthermore states that if the outcome is outside the interquartile range, an adjustment will be applied to the most appropriate point in the interquartile range. If no other specific point in the arm’s-length range be identified, then the DTA will take the position that this adjustment will need to result in an outcome equal to the median (the middle of the range).
If any another state does not accept a TP adjustment by the DTA to the median of the range, the Competent Authority in the Netherlands will, if so requested by the taxpayer, enter into discussions with the relevant state (under a Mutual Agreement Procedure) in order to reach agreement on a point within the range that is acceptable for both states.
The 2018 TP Decree notes that if shifts in the range will occur, due to an upward or downward adjustment of the initial transfer price, the taxpayer must be able to demonstrate that the changed circumstances justify the adjustment of the transfer price. Such a shift must be laid down in the agreement concluded between parties, but is also actually charged. If no change in circumstances can be identified that would justify the adjustment of the transfer price, the DTA may reject such change.
Last but not least the 2018 TP Decree notes that in a case of (partially) write-off a receivable arising from the supply of goods or service because of government interventions, the costs related to the transaction may be taken into account (considered as a tax deduction). However, the 2018 TP Decree asks the DTA to examine whether circumstances can be distinguished that should lead to the conclusion that the write off is in the non-tax deductible capital sphere under Dutch tax law.
4.1 Transfer Pricing Methods
The 2018 TP Decree notes that in many cases TNMM is the transfer pricing method used in practice. However, it is also noted that the tested party, which in view of its functions, assets and risks is considered the least complex party to the transaction, should not be entitled to the revenues that are closely related to the intangible assets in use.
The 2018 TP Decree also notes that a transfer pricing method that determines the profit related to the transaction(s) on costs is only acceptable if these costs constitute the relevant indicator for the value of the functions performed, the assets used and the risks assumed. It is remarkable that the language in the 2018 TP Decree on this subject has significantly changed compared to the 2013 TP Decree. This may be an indication that the DTA will put more emphasis on checking that a TNMM benchmark and profit level indicator are applied only to routine activities corresponding with the facts and circumstances as delineated in the functional analyses.
4.2 The Cost Base and Disbursements
The 2018 TP Decree notes that an essential element in the application of the cost-plus method and TNMM (with costs as profit level indicator) is the determination of the cost base. Like the OECD guidelines, the 2018 TP Decree does not rule out the possibility of keeping some of the costs outside the cost base if an independent party in a comparable transaction would also be prepared to forgo the realization of profit in relation to such costs. These costs of a ‘disbursement’ nature will, as per the 2018 TP Decree, remain outside the cost base over which a profit markup is calculated. Familiar examples of disbursements are costs initially paid by the contracting party providing the service, such as administrative charges, court fees and service costs. In general, these should be charged separately to the customer. The authors note that this issue frequently results in discussions with the DTA on what costs are to be included in the cost basis on which to apply a mark-up and which mark-up.
4.3 Toll Manufacturer
The 2018 TP Decree further states that also the costs of raw materials processed by a producer, whose functionality entails that it does not assume any risks on the raw materials as such, can generally remain outside the cost base in case of a toll manufacturer. In such a case, only the operating costs of this producer must be a relevant indicator for the value of the functions it performs, the assets it employs and the risks it assumes. In such cases, this producer does not perform any relevant function in respect of the purchase of raw materials nor does it assume any risks for them.
4.4 Cost-related Remuneration for the Sale of Goods via an Agent
The 2018 TP Decree refers to an associated Dutch intermediate (agent) that does not perform any relevant sales activities itself, but in effect mainly provides administrative services for the sales transactions. Sometimes the turnover realized with the sales in such cases is reported in the agent’s financial statements (income statement). The authors note that under generally accepted accounting principles, such agent may not even be allowed to record the turnover in its financial statements anyway (from FY 2018).
In line with paragraph 2.39 of the OECD guidelines such an associated agent, which:
(a) does not perform any economic function in the value chain that increases the value of the goods, or
(b) on the basis of the characterization of the transaction does not assume any risks in respect of the sales activities, should not receive a share of the profit relating to the sales transactions, because this would also not have been allocated to it in independent relationships. This agent may be remunerated with a profit markup based on its own relevant operating costs, including the costs incurred for the provision of administrative services, and not by way of a turnover-related remuneration.
4.5 Valuation Methods
The 2018 TP Decree refers to valuation methods, and in particular to section D.2.6.3 of Chapter VI of the OECD guidelines. It states that, depending on the facts and circumstances, taxpayers and the Dutch Tax and Customs Administration may use valuation methods, and in particular the discounted cash flow method, as part of the
The 2018 TP Decree does not provide further guidance other than that it refers to section D.2.6.3 and D.2.6.4 of Chapter VI of the OECD guidelines that provide guidance on the application of valuation methods and details about the various parameters.
In line with the OECD guidelines, the 2018 TP Decree does consider it important that in order to accomplish an arm’s-length price, valuations should take place from the perspective of all the parties involved in the transaction. As per the 2018 TP decree, the arm’s-length price will lie between the value of the intangible asset from the:
Based on the above perspectives, the 2018 TP Decree notes that the value resulting from the application of a valuation method is not the same as the arm’s-length price for the transaction.
The Decree further emphasizes that in determining the arm’s-length price, the Dutch corporate tax consequences of the transfer should be taken into account. In the event of an asset transaction, the seller should take account of the possibility that the capital gain for Dutch corporate tax purposes resulting from the transfer of the (intangible) asset could be taxable. The seller will require compensation. In the event of an asset transaction, the purchaser should take account of the potential Dutch corporate tax benefits of depreciating/amortizing the acquired (intangible) asset. The 2018 TP Decree explicitly refers in this respect to paragraph 6.178 of the OECD guidelines and Example 29 in Chapter VI of the OECD guidelines.
The 2018 TP Decree refers to paragraphs 6.170 through 6.173 of the OECD guidelines addressing the discount factor for the purposes of determining the cash value of the expected future cash flow. With regard to selecting the correct discount factor, the 2018 TP Decree explicitly refer as an example to the Weighted Average Cost of Capital (WACC), where one should take the risk profile of the parties involved, the asset to be valued and the activity to be valued, into full account. The authors interpret this guidance such that in determining the value of a more routine activity a lower discount rate is applied than in case of a more entrepreneurial activity.
5.1 Transactions Regarding Tangible/intangible Assets
According to the 2018 TP Decree, a transaction will not meet the criteria of the arm’s-length principle if tangible/intangible assets are transferred to a group company, while that group company does not add any value to the particular assets. This is because the necessary functionality is absent and the group company is therefore not able to manage the risks associated with the tangible/intangible assets. For sellers and purchasers, this expectation can only become fact if it involves an expected increase in the joint profit of the seller and the purchaser compared to the joint profit of both had the transaction not taken place. If there is no expected increase in the joint profit, the offer made by a potential purchaser will be less than the price asked by a potential seller. In that case, the transfer of the asset is not commercially viable. Such a transaction between associated parties does not meet the criteria of the arm’s-length principle as per the 2018 TP Decree. The authors agree that it is reasonable to assume that the buyer needs to be able to exercise the functions to be able to make the decisions to purchase the relevant assets, and are familiar with the point of view of the DTA on this matter. However, this view is debatable depending on the facts and circumstances of the case. In certain industries, e.g. music and fashion industry, such transactions are observed between independent parties.
Again the arm’s-length assessment carried out from the perspective of both the seller and purchaser must also take note of whether there are other realistic and more attractive opportunities available to the seller and/or the purchaser.
5.2 Determining the Fee for Using Intangible Assets
The 2018 TP decree is skeptical about the use of databases where a comparability analysis is performed for the use of intangible assets. The OECD guidelines state that, in the case of intangible assets, a comparability analysis will in any case often show that no comparable uncontrolled transactions can be found. This skeptical attitude is in line with the authors’ experience with the DTA, where the DTA take the position that intangible assets are by nature unique and can therefore not be measured by way of comparison using a benchmark study. The authors, however, have many times encountered reasonable Comparable Uncontrolled Price or CUPs for royalty rates in third party data bases. Moreover, tax authorities in other countries are often more receptive of benchmarking studies to support the level of remuneration for intangibles. As a consequence, in competent authority procedures, the Dutch authorities may encounter debate with other authorities during Mutual Agreement Procedures when challenging benchmarking studies regarding intangibles.
The 2018 TP decree explicitly refers to paragraph 6.141 of the OECD guidelines where it is considered that one-sided methods are by themselves not reliable methods for directly determining the value of an intangible asset. In these analyses where the resale price method, the cost plus method or TNMM is the appropriate method, the tested party will be the party with the less complex functions that does not use any of its own intangible assets. Although these one-sided methods may not be appropriate to determine the value of the intangibles assets, they may be used to determine the excess profits created in employing the intangibles assets. These residual profits then constitute the reward for the intangibles assets. This is, however, conditional on the fact that it has been established under a functional analysis that the remaining profit must be allocated to the intangible assets and that all other (Dutch) routine functions, risks and assets are already sufficiently remunerated. The authors note that such residual profit analysis requires a thorough two sided functional analysis. In the absence of CUPS, as per the 2018 TP Decree this method is therefore acceptable to determine the amount of the fee to be paid by the tested party for the use of the intangible asset, provided certain conditions are met.
5.3 Tax Haven Intellectual Property
The 2018 TP Decree refers to the case that the purchaser of a tangible/intangible asset is established in a low tax jurisdiction. The decree assumes an increase in the joint profit only if the purchaser has the relevant functionality in respect of the tangible/intangible fixed asset. Where the seller actively retains the functionality, and the purchaser will be completely dependent on the seller for any future business growth, the purchaser cannot expect any operating profit (increase). Consequently, arm’s-length conditions will not allow the purchaser to benefit from the low/lower tax rate.
The 2018 TP Decree, also refers to group companies holding the legal ownership of tangible/intangible assets and the legal owner lacking the relevant functionality. The DTA will allow the legal owner of the tangible/intangible assets, that does not perform the relevant functions in respect of the asset, to only receive a relatively small (routine) remuneration. The authors note that the DTA are expected to assume the same position if the IP is located in a high tax jurisdiction.
5.4 DEMPE Concept
The OECD guidelines often refer to ‘DEMPE functions’ when describing the relevant functions in respect of the intangible assets. These are the Development, Enhancement, Maintenance, Protection and Exploitation functions. Depending on the facts and circumstances, the DEMPE functions will have to be weighted as to their relative importance. In assessing the relevant contribution to the value of the particular intangible asset, the 2018 TP Decree takes the position that in general the Development and Enhancement functions will receive a higher weighting than the MPE functions. This is where the DTA take a different view than the OECD guidelines. They seem to have certain industries in mind, where the D and E functions are most relevant. However, there are also many cases where the M, P and E functions are as relevant as or even more important than the D and E functions. In the authors’ view, the weighting of the DEMPE functions is heavily dependent on the facts and circumstances of the case.
The authors have seen cases where the Dutch taxpayer IP owner not having sufficient DEMPE functions in the Netherlands as per the DTA, the DTA informed the taxpayer that they would spontaneously exchange information in writing with all the foreign licensee countries about the lack in Dutch DEMPE substance (triggering adverse tax consequences abroad including withholding taxes).
5.5 Contract Research
As per the 2018 TP Decree a cost-related remuneration is possible if the contract research activities are developed by group company A, while group company B manages the research activities, bears the costs and risks, and will have the economic ownership of the developed assets. However, group company B must also exercise control over the risks assumed and have the financial capacity to bear the impact of these risks.
The analysis must in any case use the specific facts and circumstances as the basis for the evaluation.
The following elements are factors in answering the DTA’s questions in this respect, same as per section 3.1 above, being in terms of R&D as follows:
In some transfers of intangibles at the moment of the transfer it is difficult to establish the value because of insufficient insight in the future proceeds and risks. In line with par. 6.185 of the OECD guidelines, the 2018 TP Decree states that independent parties would in such situation agree to an adjustment clause, which should be respected by a tax authority. Moreover, the DTA will in such situation between related parties take the position that it would not be at arm’s-length to agree to a fixed price without and an adjustment clause. The 2018 TP Decree explicitly notes that a price adjustment clause can result in both an upward and a downward adjustment of the price initially agreed. Last but not least the 2018 TP Decree notes and cites paragraph 6.185 of the OECD guidelines leaving open the possibility of renegotiating the transaction, if independent parties would also have renegotiated the transaction as a result of differing values.
The 2018 TP Decree refers to cases involving the transfer or licensing of intangible assets as described in paragraph 6.189 of the OECD guidelines, where it is difficult for the DTA to assess the value in relation to the transactions in question due to major uncertainty about the future growth in value. The DTA can use the actual results realized with the particular intangible assets to assess the arm’s-length pricing at the time the transaction took place. If there appear to be major deviations between the realized results and the expectations and resulting projections that were the basis for the pricing at the time the transaction took place, and these deviations cannot be explained by the facts and circumstances that only occurred after the date of the pricing, then the DTA can question the price as it was determined at the time of the transaction, thereby referencing the results that were actually realized. The 2018 TP Decree states that a major deviation is any deviation of more than 20% compared to the projections that were the basis for the original price setting. Furthermore, such a deviation of over 20% must appear within a period of 5 years to be regarded as ‘hard-to-value’ intangible assets (in accordance with par. 6.186 through 6.195 of the OECD guidelines).
A new paragraph 5.4 addresses that situation where an acquisition of shares in an independent company is followed by a business restructuring which entails that the intangible assets present in that company are transferred to another group company. The 2018 TP Decree explicitly refers to discussions between taxpayers and the DTA about the arm’s-length price for the transfer of the intangible assets.
The 2018 TP Decree refers explicitly to paragraph 6.147 and Example 23 of the Annex to Chapter VI of the OECD guidelines stating that the arm’s-length price of the shares of the acquired company contains useful information for valuing the business of this company. As per the 2018 TP Decree, the acquisition file which is usually held by the purchaser of the shares, is an essential part of the transfer pricing documentation to be provided by the taxpayer to substantiate the price of the transferred intangible assets. The 2018 TP Decree acknowledges that those parts of the acquisition file for which the Dutch taxpayer can substantiate that they are not relevant for taxation can be exempted from the documentation that needs to be provided by the tax payer.
The 2018 TP Decree explicitly refers to Chapters VI and IX—on business restructuring—of the OECD guidelines in determining the arm’s-length price for the transfer of the intangible assets. Both as per the OECD guidelines and as per the 2018 TP Decree attention should be paid to:
According to the 2018 TP Decree, the value of the company may be higher for the buyer than the price paid for the shares, since the buyer may only buy the shares anticipating that more value can be created than the purchase price paid. Although the share value may be a good indicator for the price to be established regarding the subsequent transfer of the intangible assets, the 2018 TP Decree suggests that the price of the assets should be higher. In view of this position of the DTA, the authors consider it crucial to take thorough notice of the purchase price allocation exercise that is often involved in a share purchase transaction when a subsequent transfer of intangibles is envisaged.
In this respect, the 2018 TP Decree notes that when transferring the intangible assets, the seller should take account of the fact that, unlike in the case of the transfer of shares, corporate income tax will have to be paid. Having consideration for this tax payable, the seller will generally wish to accomplish a sale price for the intangible assets that is at least equal to the value that it ascribed to the intangible assets plus the corporate tax payable on any capital gain.
According to the 2018 TP Decree, the DTA is sometimes faced with situations in which the entrepreneurial functions and associated intangible assets of an acquired company are transferred to another group member, whereas only a routine function remains in the Netherlands. In those types of situations, taxpayers sometimes establish the transfer price by deducting the expected ‘perpetual’ cash flow of the routine function, converted to cash based on a discount factor based on this routine function, from the expected cash flow, converted into cash, of the acquired company, had no transfer taken place. As such, the value of the entrepreneurial functions and associated intangible assets is represented by the delta between the net present value of the routine cash flows (typically with a lower risk, so subject to a lower discount factor) and the net present value of the entrepreneurial profits (subject to a higher discount factor). The DTA will generally take the position (certainly if only one (exclusive) controlled contract remains in the Netherlands) that the expected cash flow of a routine function will not be suitable to be perpetually discounted. The DTA’s argument is that such functions are relatively easy to be replaced in the market and contracts containing such functions therefore generally have a relatively short term. As a consequence of this position of the DTA, the Dutch corporate tax due upon a conversion of principal/entrepreneurial activities into routine activities in the Netherlands will trigger a higher Dutch corporate tax burden. The authors consider this point of view debatable, since it may also be argued that a routine company could still be able to continue activities after the term of a contract. The 2018 TP Decree does allow also to create a step up in a tax amortizable basis, in case a Dutch entrepreneur is set up at the expense of former entrepreneurs abroad being converted into routine activities.
8.1 Intra-group Services (Chapter VII)
According to the OECD guidelines, a group service has been rendered if an activity is performed for a group member that adds economic or commercial value to the group member and for which that group member would ordinarily be willing to pay. This does not involve shareholder activities. The transfer pricing method to be applied can be one of the OECD methods.
In practice, it appears that a cost-based payment is the preferred choice as per the 2018 TP decree. Whether this is appropriate or not needs to be established on the basis of a thorough functional analysis, showing that it concerns more routine services.
The application of this method (cost-related remuneration) will, in principle, only involve an arm’s-length fee if an appropriate profit markup was taken into account when determining the payment. Only in specific situations, where the 2018 TP Decree refers to paragraph 7.37 of the OECD guidelines, there may be reason to forgo a profit markup.
8.2 Group Services and Shareholder Activities: The Simplified Method
The OECD guidelines specifically refer to low value-adding intra-group services. As per the 2018 TP Decree, Dutch taxpayers may opt to elect the simplified approach to determine the fee for these specific services. The 2018 TP Decree also refers to the ‘Guidelines on low value-adding intra-group services’ by the EU Joint Transfer Pricing Forum (Brussels, February 2010, JTPF/020/REV3/2009/EN).
Taxpayers may elect a small fixed profit markup of 5% on the relevant costs of these services, recharge the costs plus this profit markup to the group members eligible for this, by using a suitable allocation key, provided this is substantiated with appropriate documentation. This simplified method also involves a simplified and more limited benefit test from the perspective of the recipient of the relevant services, whereby the benefit of certain categories of services only has to be generally demonstrated (the 2018 TP Decree explicitly refers to par. 7.54 and 7.55 of the OECD guidelines). These low value-adding services have the following characteristics (see also par. 7.45 of the OECD guidelines):
Paragraph 7.47 of the OECD guidelines lists activities that do not fall under the simplified approach. Paragraph 7.49 of the OECD guidelines lists the activities that in all probability will usually fall under the simplified approach.
Last but not least, this simplified approach does not apply to services that the service provider also provides to independent parties. In this way, a pragmatic approach is endorsed.
The fixed profit markup does not have to be substantiated with a comparability analysis, the 2018 TP Decree notes. The authors note that if it concerns a different service or a mark-up other than 5%, a comparability analysis will be required under the Dutch Local file requirements.
The 2018 TP Decree notes that the mark-up may be a fixed 5%, whereas the cost base includes both direct and indirect costs related to the respective support services, as well as overhead costs. Relevant costs also include exceptional expenses (such as redundancy and reorganization costs, and salary in kind). The functional analysis underlying the taxpayer’s transfer pricing system will determine which costs are relevant. The authors note that the 2018 TP Decree may accept a low 5% mark-up.
As per the 2018 TP Decree the above applies regardless of which legal entity within the group provides the support services. This means that no adjustment will be imposed in cases where the support services are performed by a separate legal entity (this could include, for example, a shared service center).
8.3 Conditions for a Cost-plus 0%
If a Dutch taxpayer does not opt for the elective simplified approach to determine the fee for these specific services no adjustment will be made if the taxpayer elects to charge all the relevant actually incurred costs for the low value-adding services, as described in paragraphs 7.43 through 7.65 of the OECD guidelines. The 2018 TP Decree observations about the relevant cost basis and the separate legal entity with regard to the elective simplified approach apply in full. However, contrary to the elective simplified method as described in the OECD guidelines, if only the relevant actually incurred costs are recharged without a profit markup, then the financing costs must also be included in these relevant costs as per the 2018 TP Decree. The authors note that Dutch taxpayers need to consider whether or not charging without a mark-up on a higher cost base is more favorable than to apply a mark-up of 5% on a lower cost base. Furthermore, the authors note that internationally there is no consensus on when a mark-up may be omitted.
8.4 Contributions to Cost Contribution Arrangements (Chapter VII)
As per the 2018 TP Decree the basic assumptions of the other chapters of the OECD guidelines (in particular Chapters I and VI) apply in full for the question whether cost contribution arrangements (CCAs) meet the arm’s-length principle. This means, for example, that a participant to a CCA that assumes risks must also exercise control in respect of these risks and have the financial capacity to bear the negative effect of these risks. For example, the participant to a CCA, which only provides the financing for the CCA and only exercises control over the risks of financing and thus not over the risks in respect of the other activities within the CCA, is generally only entitled to an arm’s-length fee for the financing, with account being taken of the financing risk (the risk adjusted rate of return).
The 2018 TP Decree further notes that if and insofar as B provides financing to A and does not exercise control over the risks in respect of this financing, B can at most only be entitled to a risk-free return.
Below we summarize the main changes in the 2018 TP Decree with respect to financial transactions. These changes are rather limited.
On July 3, 2018, the OECD released a BEPS discussion draft on the transfer pricing aspects of financial transactions. The OECD invites public comments on this draft, which deals with follow-up work in relation to Actions 8-10 ("Assure that transfer pricing outcomes are in line with value creation") of the BEPS Action Plan. This draft includes important guidance for multinationals on intercompany loans, treasury functions and cash pooling, guarantees and captive reinsurance.
Like many other countries the Netherlands are awaiting the new OECD guidance, once finalized, on related-party financial transactions, before updating the 2018 TP Decree.
9.1 Guarantees in Loan Agreements
As per the 2018 TP Decree providing guarantees for the debts of third parties will not occur very often, certainly not without demanding a high degree of certainty. The authors strongly disagree, because if the reward is sufficiently high, there is no reason why third parties will not be prepared to incur correspondingly high(er) risks.
In the case that guarantees are provided between associated enterprises, it needs to be examined whether arm’s-length conditions can nevertheless be found under which commercially rational third parties would engage in such a transaction. Whether or not a controlled transaction meets the arm’s-length principle should always be assessed from a two-sided perspective, as per the 2018 TP Decree.
9.2 Loan Transactions
The 2018 TP Decree notes that the prevailing conditions of controlled financing transactions must also be assessed for compliance with the arm’s-length principle. For a loan transaction, this means all the conditions of the transaction, including the risk allocation and the price. The end result of the loan agreement recognized as such after this assessment should be a price (interest income/interest expense) that complies with the arm’s-length conditions of Section 8b CITA.
The Supreme Court judgment rendered on November 25, 2011 (case no. 08/05323) addressed the question whether a controlled loan could be impaired in domestic situations. If a loan is considered non-business motivated, the impairment is not recognized as a tax deductible item in the books of the lender. Furthermore, for such non-business motivated loan it must be determined what part of the interest must be taken into account for tax purposes. The Supreme Court used two conditions for this: (i) the rule of thumb (Supreme Court, November 25, 2011, no. 08/05323), and (ii) the fair market value rule (Supreme Court, March 15, 2013, no. 11/02248). The lowest is the interest that has to be taken into account for tax purposes.
The rule of thumb rule determines the interest rate that would be due by the borrower on a third party loan by assuming that the lender provides a guarantee with respect to that loan to a third party (“borgstellingsanalogie” or pledge analogy). The difference between this interest obtained with the guarantee and the actual interest charged to the borrower is considered to be in the capital sphere.
The application of the fair market value rule mainly applies if the non-business motivated loan is interest-free if the interest is accumulated. According to the 2018 TP Decree, the interest to be considered is determined as the fair market value of every interest term at the moment that it becomes payable. In case the lender does not have higher credit rating than the borrower, or if the lender has a non-investment grade rating, not more than a risk free interest rate may be imputed. See Standards & Poor ratings, Moody’s uses, for example, Aaa tot Bbb.
The authors note that for taxpayers generally the rule of thumb generates a higher interest rate compared to the market rule. It then depends on whether the taxpayer is at the interest receiving or interest paying end which rule is more beneficial. The authors note that the DTA has been seen to argue for the market rule (hence lower rates) in case of interest deductions.
The transfer pricing documentation obligation is regulated in two different places in the Corporate Income Tax Act 1969 (CITA).
Firstly, there is the documentation obligation contained in Section 8b(3) CITA. This documentation must consist of a description of the five comparability factors used for the controlled transactions listed in Chapter I of the OECD guidelines, a substantiation of the transfer pricing method selected and a substantiation of the conditions, including the price, under which the transaction was entered into. When the documentation obligation was codified in Section 8b(3) CITA, the requirement that an exhaustive list of documents be provided to substantiate the arm’s-length nature of the transactions was deliberately excluded under a so-called ‘open standard’. The competent tax inspector may therefore be requested to provide certainty on whether the documentation obligation of Section 8b(3) CITA has been met. The authors note over the past 15 years, they have never have seen a case where a Dutch taxpayer asked for certainty from the DTA on the documentation without certainty under the underlying transfer prices as part of an advance pricing agreement procedure. There is also a separate decree on dealing with requests for advance pricing agreements, dated June 12, 2014, no. DGB 2014/3098.
Secondly, Section 29(b) through (h) CITA includes regulations on documentation related to taxpayers that meet certain standards. This documentation obligation covers the Country-by-Country report, the Master File and the Local File. The rules on additional transfer pricing documentation obligations dated December 30, 2015 (DB2015/462M) include rules on the form and content of the reports and files.
Section 8b(3) CITA covers both national and cross-border transactions with associated enterprises, while the obligations contained in Section 29(b) through (h) CITA cover cross-border transactions between associated group entities and the substantiation of an arm’s-length profit allocation to permanent establishments.
The 2018 TP Decree notes that Dutch entities whose documentation complies with the requirements stipulated in Section 29(g) CITA also comply with regard to the content of this documentation with the obligation as contained in Section 8b(3) CITA insofar as this concerns cross-border transactions.
If entities also apply the requirements of Section 29(g) CITA to national transactions with associated entities, then the 2018 TP decree notes that the documentation obligation of Section 8b(3) CITA has also been complied with.
This decree has taken effect the day after the publication date of the Government Gazette in which it was published, which is effectively May 13, 2018.
What may be controversial is the retroactive effect of the 2018 TP Decree. The state secretary of finance states that in as far as the revisions constitute a clarification on the application of the arm’s-length principle, he is of the opinion that these revisions are also applicable to the years in which the revisions were not published. The question is what revisions constitute a clarification. Does the additional guidance on HTVI or the views on valuations or the view that absent control over the risks in respect of this financing, one can at the most only be entitled to a risk-free return only, constitute clarifications? It needs to be seen in practice how this policy is pursued in discussions on past years.
Jaap Reyneveld is a partner and Eduard Sporken is a director with Meijburg & Co. Tax Lawyers in Amstelveen, Netherlands, specializing in KPMG’s global transfer pricing services.
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