The Organisation for Economic Co-operation and Development (OECD) at the end of last week released a discussion draft under the base erosion and profit shifting (BEPS) project under BEPS Action 8 (Revisions to Chapter VIII of the Transfer Pricing Guidelines on Cost Contribution Arrangements).
Read the BEPS Action 8 discussion draft [PDF 394 KB]
Action 8 of the BEPS project covers the transfer pricing of intangibles and requires the development of rules to prevent base erosion and profit shifting by moving intangibles among group members.
In response to this action item, the OECD first issued the Guidance on Transfer Pricing Aspects of Intangibles (2014) that provided modifications to, mainly, Chapter VI of the Transfer Pricing Guidelines (OECD Guidelines).
The recently released BEPS Action 8 discussion draft (Discussion Draft) is part of the requirement under Action 8 to update the guidance on cost contribution arrangements (CCAs) in Chapter VIII of the OECD Guidelines, and provides proposed text for an updated chapter.
The guidance in the Discussion Draft also takes into account draft guidance on Chapter I of the OECD Guidelines released December 2014 (that is, the discussion draft on risk, recharacterisation, and special measures referred to in this report as the “Chapter I Draft”). In particular, the Chapter I Draft is relevant to a CCA, as the concept of control over risks developed in the Chapter I Draft is relevant in determining participants in a CCA.
Finalizing the guidance contained in this Discussion Draft will also take into account any changes to other parts of the OECD Guidelines.
The BEPS Action 8 Discussion Draft is divided into the following sections:
The following discussion summarizes certain key elements.
The OECD defines a CCA as a:
…contractual arrangement among business enterprises to share in the contributions and risk involved in the joint development, production, or the obtaining of intangibles, tangible assets or services with the understanding that such intangibles, tangible assets or services are expected to create direct benefits for the businesses of each of the participants.
The OECD indicates that while a CCA can streamline the flows of intercompany transactions, it is not to affect the valuation of the contributions of the participants. Thus the outcome for the CCA participants is to be the same as that would have arisen out of arm’s length terms outside of a CCA. In addition, the OECD recommends that each participant’s proportionate share of the overall contributions must be consistent with the participants’ proportionate share of the overall expected benefits. The Discussion Draft describes two common types of CCA:
Development CCAs are expected to create ongoing, future benefits for participants while services CCAs are often expected to create current benefits only. The OECD specifies that each participant’s interests in the CCA are to be established upfront and for development CCAs, the rights are often to exploit intangibles in a specific geography or application.
This section of the Discussion Draft indicates that to be consistent with the arm’s length principle the value of participants’ contributions must be consistent with what independent enterprise would have agreed to contribute under comparable circumstances given their proportionate share of the total anticipated benefits.
In addition, this section also echoes themes laid out in the Chapter 1 Draft that it expects all members of the CCA to have the ability to understand, control, and make decisions around the investments that are made. In the absence of such substance, the arrangement may be disregarded.
The new proposed guidance also makes it clear that contributions to CCAs are to be based on their arm’s length value, rather than on their cost. The Discussion Draft does provide an exception to this for low value-adding services when there is a modest difference between cost and value. It also specifically states that for development CCAs cost will not generally provide a reliable basis to value contributions.
The Discussion Draft describes circumstances when “adjustments” or “balancing payments” may be necessary. These arise when the expected benefits differ from the actual benefits received by the participants.
Specifically the Discussion Draft describes that tax authorities may question the projections used when the actual results differ significantly from the actual. In addition, the OECD recommends that enterprises structure CCAs such that allocation keys used in a CCA can change over time to reflect actual benefits.
This section describes both “buy-in” and “buy-out” payments made at the inception and withdrawal / termination of a CCA. The OECD recommends that these payments be based on the value of the interest that the participant has coming in or out of the CCA.
The OECD recommends that CCAs between related parties meet six provisions. These include such criteria as participants are those enterprises that are expected to derive mutual and proportionate benefit, the CCA must specify the nature and extent of each participants’ interest and the expected share of benefits, and the CCA requires balancing payments and/or changes in the allocation of contributions after a reasonable period of time to reflect change in the expected benefits.
Also in this section, the Discussion Draft lists certain information that would be relevant in the initial terms of a CCA and over the duration of the CCA. While the information listed does not provide a “minimum compliance standard nor an exhaustive list of information that a tax authority may request,” the OECD makes the point that the relevant information will be on a facts and circumstances basis but is to include information that would be expected under “prudent business management principles.”
n the Annex, the OECD provides five examples that are intended to illustrate the general principles.
Examples 1 through 3 in the Annex are examples demonstrating that contributions to CCAs are to be based on their arms’ length value, rather than on their cost per se, except for low-value services.
The Discussion Draft includes two examples—Examples 4 and 5—that touch on “substance” and may be particularly relevant to multinationals with cost-sharing arrangements established under U.S. rules. In Example 4, Company A performs, through its own personnel, the functions associated with analyzing and making decisions regarding assumption and continuation of funding of the intangibles and the associated risk. The Discussion Draft states that in this example, Company A is entitled to a risk-adjusted anticipated rate of return on its funding but no more, and indicates that Company A’s contribution payments must be adjusted to reflect this treatment.
In Example 5, the facts are the same except that Company A does not have the substance associated with controlling funding of risk. In this case, the Discussion Draft concluded that the arrangement is to be disregarded.
The OECD is requesting comments on the Discussion Draft to be submitted by 29 May 2015 and it intends to hold further public consultation on the Discussion Draft on 6-7 July 2015 at the OECD Conference Center in Paris, France.
There are two key themes to the Discussion Draft: (1) the Discussion Draft makes it clear use of a CCA does not change arm’s length outcomes; and (2) it expects all members of the CCA to have the ability to understand, control, and make decisions around the investments that are made. In the absence of such substance, the arrangement may be disregarded. In these respects, the Discussion Draft references and reflects the prior Chapter I Draft as well as the revisions to Chapter VI of the OECD Guidelines on intangibles.
The Discussion Draft introduces a number of changes to current guidance and practice. First, the new proposed guidance makes it clear that contributions to CCAs are to be based on their arm’s length value rather than on their cost per se. The OECD Discussion Draft explicitly adopts the position (also taken in U.S. regulations on cost sharing) that an entity that makes only a financial contribution is only entitled to a “…risk adjusted rate of anticipated return on its funding commitment….” While the new proposed guidance states that costs are to be allocated based on expected benefits, it also make it clear that all participants to the CCA must have substance and the ability to exercise some form of control over their investments. Absent such substance, the CCA can be disregarded. The Discussion Draft, however, provides no guidance as to what are the implications of this position. Finally, the Discussion Draft provides suggested documentation for a CCA that is relatively specific and detailed, and would presumably be required over and above the documentation required by the OECD’s recently issued guidance on transfer pricing documentation.