On 4 July 2016, the OECD issued a Public Discussion Draft relating to BEPS Actions 8-10, providing draft Revised Guidance on Profit Splits. The revised guidance seeks to provide further clarity on the circumstances under which a Transactional Profit Split method is the ‘most appropriate method’ and further guidance on the application of the method. Comments should be submitted by 5 September 2016. The guidance makes a distinction between the transactional profit* split of ‘anticipated profits’ and ‘actual profits’. The primary focus of the document is the application of the transactional profit split method to actual profits. However, the guidance is clear that the basis on which combined profits are to be calculated and split must be determined ex ante, that is, before risk outcomes are known.
The application of a transactional profit split of actual profits reflects a relationship where the parties either share the same economically significant risks associated with the business opportunity or separately assume closely related risks associated with the business opportunity, and consequently should share the resulting profits or losses.
The division of combined actual profits under a transactional profit split of actual profits requires that the parties share in the outcome of the business activities and risks associated with those outcomes. Each of the parties involved remains exposed to the effects of the risks associated with the business activities of the other. The outcome for each party will depend on the overall performance of the businesses (including the performance of each party) in relation to those risks. Transactional profit splits sharing the combined actual profits of the parties contributing to the arrangement have the effect of sharing the impact of the risks associated with the business activities of the parties. In accordance with the OECD Guidelines, this outcome would only be appropriate where the economically significant risks associated with the outcomes of the business activities are controlled, either separately or collectively, by the parties sharing the actual profits, and each party has the financial capacity to assume its share of the risks.
It would be contrary to the OECD Guidelines to apply a transactional profit split of actual profits where the functional analysis demonstrates that one of the parties does not exercise any degree of control over the risks.
The revised guidance provides further detail and examples to illustrate how a transactional profit split should be performed and in which circumstances this is the most appropriate method. The guidance, as expected, is in line with existing OECD Guidelines and BEPS principles, with a significant focus on the sharing of risks being a key indicator that a transactional profit split may be appropriate.
The revised guidance also provides some helpful comments around the purpose of a value chain analysis and how it should be used in the context of a transactional profit split.
The revised guidance provides that a value chain analysis may be useful in helping to identify when the transactional profit split method may be appropriate. A value chain analysis does not indicate that the transactional profit split method is the most appropriate method, since all parties to a transaction can be expected to make some contributions to value creation.
A value chain analysis contributes to:
However, a value chain analysis is simply a tool to assist in accurately delineating the transaction; it is not a method in and of itself for applying a transactional profit split.
* All references to ‘profits’ should be taken as applying equally to losses.
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