The pricing of intra-group services constitutes one of the leading issues in transfer pricing examinations.Tax authorities around the world investigate the allocation of costs relating to services provided within a group of affiliated multinational companies.However, documentation and guidelines on international compliance regulations are still rather vague in many areas.
With the goal of providing clear guidelines for transfer pricing within the EU, in June 2002, the European Commission established the EU Joint Transfer Pricing Forum (JTPF). In 2008, JTPF then created a sub-division with the mandate of establishing guidelines specifically for transfer pricing concerning intra-group services.The Pan-European transfer pricing regulations issued by JTPF are generally based on the 1995 OECD guidelines.JTPF aims at setting clear standards, which can help advance the goal of unifying the economic market within the union, encourage mergers and acquisitions, and set up Pan-European entities.
So far, the treatment of intra-group services falls under the domestic law of the EU member countries.It is also national law which determines the deductibility of expenses related to intra-group services.Since national statutes have different approaches to these issues, increased compliance cost for multinational companies or double taxation are often the result for companies working in several member countries.
Chapter VII of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines) is dedicated to Special Considerations for Intra-Group Services. This recent update of the 1995 OECD Guidelines examines the value of services provided from one member of a multinational associated group to another group member and provides means to establish a transfer price for intra-group services.
Paragraph 7.5 of the OECD Guidelines discusses (i) when intra-group services have been provided, and (ii) what the appropriate price would be under the arm’s-length principle. Paragraph 7.6 answers these questions by stating that a service is considered being provided if the recipient would have been willing to pay for it at arm’s-length price. These guidelines form the basis for JTPF’s examination of intra-group services.
On 4 February 2010, the JTPF supplemented OECD’s Guidelines on intra-group services by publishing new guidelines.These new guidelines on the transfer pricing treatment of low value-adding intragroup services, and their inclusion in the calculation of arm’s-length prices as required in a proper transfer pricing policy.
The JTPF report focuses on services that "although low value-adding, could still generate a high turnover”.It is thereby assumed that the services performed meet the OECD arm’s-length standard, especially if they provide economic or commercial value for the recipient as defined in the OECD guidelines.
Examples of potential low value-adding services are provided in Annex 1 to the JTPF Report.It includes services in the areas of IT, HR, marketing, legal, tax, accounting, administration, etc.Low value-adding services are basically services that are provided by a non-core structure of the company, but which still can be attributed to a cost pool and specific allocation keys.For explanatory benefits, the JTPF report concentrates on low value-adding services which are provided by a single contract.
Nothing but the routine character of a low value-adding service can be considered a proof that an actual service has been provided for the economic and commercial benefit of the recipient.Therefore, the requirements of the OECD Guidelines Paragraph 7.5 and 7.6 can be considered as met.Given the basic nature of a low value-adding service, the extent of such a routine action’s narrative in a review will stay relatively short and the provided documents will stay limited to the potential compliance requirement.The JTPF report recommends, however: (i) that the narrative still provides information on potential costs for the intra-group services; (ii) that those costs are compared to overall operating expenses of the company; and (iii) that reasons be given for the low value-adding services in the context of the company’s business.It is indicated that basic narrative information is given in writing.As for regular intra-company services, the goal of a narrative is to demonstrate the reasoning behind a specific service provision.
The JTFP report further advises that the narrative can be extended as needed over time with additional details.In case of a review, it may sometimes be crucial to be able to prove that a service has been provided to the economic and commercial advantage of the recipient and for which the recipient would have been willing to pay.As for all other intra-group services, the allocation of the cost connected to the low value-adding service has to be determined.Since the specific type of service is explained in the narrative, the question whether the arm’s-length standard provision was respected should not be contentious.
The attribution of low value-adding services to a specific cost pool has to meet the same standards as regular intra-group services.The allocated costs may consist of direct or indirect costs and, as far as appropriate, operating expenses for the business as a whole. Inappropriate costs – for example, shareholder costs – have to be excluded from the calculation.For multi- service provision centers, a description of how costs are dealt with may be required.Especially where worldwide service costs are attributed to individual group members, a detailed analysis of the costs allocated may be necessary.Generally, invoices for services provided do not exist where the costs attributed to those services are internally apportioned.Here, an explanation of the method of attributing costs is crucial.As a rule for the allocation of costs for intra-group services, the OECD provides in Paragraph 7.23 and 7.24 of its guidelines that the allocation has to respect the specific circumstances of a given situation.Also, the result of the transaction must be consistent with what independent companies would have obtained under similar circumstances.
Once the identified allocation key for specific services has been justified on this basis, it should be used consistently.In determining the value of intra-group services, the internal comparable uncontrolled transaction (CUT) method can be used where similar services are also provided to independent companies.If reliable third-party data is available on comparable transactions by unrelated parties, other methods – for example, an external CUT, the Comparable Profits Method or the Profit Split Method may be chosen as most adequate to determine the arm’s-length price.
Per definition, low value-adding services only give a modest mark-up to the main product or service.Therefore, it is important to first determine an appropriate cost base for the main product itself.Once the cost basis is calculated, a mark-up on those costs can be considered.The JTFP report refers to OECD Guidelines Paragraph 7.33 and 7.36, which provide that a mark-up does not always have to be applied in the case of low value-adding services.
In determining the value of services in regular intra-group transactions, the service provider ordinarily has to perform a complete functional, economical, financial and risk analysis.For low value-adding services, however, the JTPF report recommends that when determining a mark-up, the service providing entity should mainly concentrate on being able to prove that the arm’s-length principle was applied in determining the price of the service. Hereby, the service provider has to be able to explain the method used in establishing the mark-up.Sometimes the same mark-up and mark-up calculation can be used for several services provided under one contract.
The issue of required documentation for transfer pricing process has been addressed by JTPF in its Code of Conduct on Transfer Pricing Documentation for Associated Enterprises in the European Union (EU TPD).This code of conduct provides rules for standardised documentation that multinationals must provide to tax authorities on their pricing of cross-border intra-group transactions.It was adopted by the European Commission in November 2005.
The EU TPD report dedicates Chapter 2.3 to the required content of an effective documentation package.Special emphasis is put on the necessity of establishing evidence that the transaction satisfies the arm’s-length principle.The JTPF report also refers to Chapter 5 of the OECD guidelines and the mentioned "prudent business management principle”.Here, the OECD guidelines acknowledge that there might be a big difference between documenting material required for justifying pricing methods in a major transaction and documents required for a small transaction.This specifically applies to transactions involving low value-adding services.
Since, however, any type of controlled transaction is investigated thoroughly by tax authorities, the JTPF report suggests the taxpayer follow the "prudent business management principle” and prepares written material for tax considerations that it would otherwise not prepare.
Although the JTPF report is specifically geared to provide guidance on the treatment of low value adding services, many of the principles discussed are equally applicable to more complex intra-group services.If national tax authorities in the EU member states and EU taxpayers adopt the precepts provided in the JTPF report, the consequences of transfer pricing decisions will be foreseeable for Europe’s multinational companies.The report provides a grid to rely on.
Source: By Diana Herskovitz (TaxTALK)