Nature of OECD Transfer Pricing Guidelines

The OECD Transfer Pricing Guidelines provide guidance for applying transfer pricing principles to transactions between related enterprises. These guidelines are voluntary for OECD member countries. However, several countries have adopted the OECD Guidelines almost without modification.

The terminology used in transfer pricing rules may differ between countries. Therefore, a country adopting the OECD Guidelines may use different terms while applying broadly similar transfer pricing principles.

Preference for Transactional Methods

The OECD Guidelines generally give preference to transactional transfer pricing methods because these methods are considered the most direct way of establishing comparability between controlled and uncontrolled transactions.

Transactional methods examine actual transactions and compare the conditions or prices of related-party transactions with those of transactions between independent enterprises.

The Transactional Net Margin Method (TNMM) and Profit Split Method are generally used when traditional transactional methods cannot be applied reliably or as methods of last resort.

The OECD Guidelines do not give automatic priority to the Comparable Uncontrolled Price (CUP) Method over other transactional methods.

The Guidelines recognize that it may be difficult to identify a transaction between independent enterprises that is sufficiently similar to a controlled transaction. Differences between transactions may materially affect the price. Therefore, adjustments may be required to the tested transaction or the uncontrolled comparable transaction to improve comparability.

Comparability Standards under OECD Guidelines

The OECD Guidelines permit consideration of business strategies while determining whether transactions or financial results are comparable.

Such business strategies may include market penetration, expansion of market share, cost savings, and location savings. These strategies may influence the pricing and profitability of an enterprise and should therefore be considered in a transfer pricing analysis.

Other important comparability factors include the contractual terms of the transaction, characteristics of the goods or services, and the overall economic circumstances of the parties.

Therefore, transfer pricing comparability under OECD rules requires an examination of both the transaction and the broader business and economic environment in which the transaction takes place.

Transactional Net Margin Method (TNMM)

The Transactional Net Margin Method (TNMM) compares the net profitability of a transaction or a group of transactions with the net profitability of another comparable transaction or group of transactions.

Under TNMM, preference is given to the use of actual and verifiable transactions. Reliable transactional information improves the quality of the transfer pricing analysis.

However, in practice, TNMM may also be applied to company-level aggregates of transactions. Therefore, in certain circumstances, TNMM may operate in a manner similar to the Comparable Profits Method (CPM) used under U.S. transfer pricing rules.

The main focus of TNMM is on comparing net profit margins or net profitability rather than directly comparing the price of individual transactions.

Contractual Terms and Actual Transactions

Under the OECD Guidelines, the contractual terms and transactions agreed between related parties should generally be respected.

However, contractual terms may not be followed where the economic substance of the transaction differs materially from the contractual terms and following those terms would create difficulties in tax administration.

Therefore, contracts are generally respected, but the actual economic substance of a transaction remains important in transfer pricing analysis.

Transfer Pricing Adjustments under OECD Rules

Under OECD transfer pricing principles, tax authorities generally should not make an adjustment when the price charged between related enterprises falls within the Arm’s-Length Range.

If the transfer price falls outside the arm’s-length range, the tax authority may adjust the price to the most appropriate point within the range.

The burden of proving that a transfer pricing adjustment is appropriate generally rests with the tax authority.

This approach differs from certain transfer pricing systems where the taxpayer may have a greater burden of proving that an adjustment is incorrect.

Transfer Pricing Documentation under OECD Guidelines

The OECD Transfer Pricing Guidelines do not prescribe detailed or specific rules regarding the exact nature of transfer pricing documentation that taxpayers must maintain.

Documentation requirements are generally left to individual OECD member countries. Therefore, the nature, format, timing, and extent of transfer pricing documentation may differ between jurisdictions.

Companies must therefore comply with the specific documentation requirements prescribed under the domestic tax laws of the country in which they operate.

European Union and Transfer Pricing

In 2002, the European Union established the EU Joint Transfer Pricing Forum. The Forum was created in relation to transfer pricing matters within the European Union.

The European Union has also emphasized the importance of supporting developing countries in improving their ability to mobilize domestic financial resources for development and promoting good governance in taxation.

The EU Communication titled “Tax and Development – Cooperating with Developing Countries in Promoting Good Governance in Tax Matters” highlighted this objective.

In this context, PwC prepared a report titled “Transfer Pricing and Developing Countries.”

Many European Union countries currently apply the OECD Transfer Pricing Guidelines. Cyprus was identified as a recent adopter and issued a ruling in 2017 relating to financial arrangements.

Key Exam Points

The OECD Transfer Pricing Guidelines are voluntary for member countries, although several countries have adopted them almost without modification.

The OECD generally gives preference to transactional methods because they are considered the most direct way of establishing comparability.

The TNMM and Profit Split Method may be used where traditional transactional methods cannot be reliably applied.

The OECD Guidelines do not give automatic priority to the CUP Method among transactional methods.

OECD comparability analysis may consider business strategies, market penetration, market share expansion, cost savings, location savings, contractual terms, characteristics of goods or services, and economic circumstances.

The TNMM compares net profitability of transactions or groups of transactions and may sometimes operate similarly to the U.S. Comparable Profits Method.

Contractual terms are generally respected unless the economic substance of the transaction materially differs from the contractual terms and following the terms would impede tax administration.

Tax authorities generally cannot adjust prices within the Arm’s-Length Range. Prices outside the range may be adjusted to the most appropriate point.

The burden of proving the appropriateness of an adjustment generally rests with the tax authority.

OECD Guidelines do not prescribe detailed transfer pricing documentation rules. Such requirements are determined by individual member countries.

The EU Joint Transfer Pricing Forum was established in 2002, and many EU countries apply the OECD Transfer Pricing Guidelines.