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January 21, 2013

2013 - Issue 4—The OECD consultation on intangible property and transfer pricing has received a great deal of press. This issue of Tax Advisor Weekly looks at two lesser-known consultations ongoing with the OECD Transfer Pricing Group that can have a significant impact on businesses: safe harbors and timing issues.

Safe Harbors

Safe harbors in transfer pricing consist of acceptable intra-group prices, margins, markups, or other parameters that are specified in an administration’s regulations. Reliance one of these safe harbors absolves the need for an economic transfer pricing review of the relevant intra-group transaction, saving fees and resources. The purist view is that a set price cannot be arm’s length, as every transaction is subject to specific and distinct economic pressures.

The OECD has noted that, notwithstanding the language in Chapter IV of the OECD Transfer Pricing Guidelines rejecting the use of safe harbors, there are in effect many safe harbors, both statutory and non-statutory.

The OECD report Multi-Country Analysis of Existing Transfer Pricing Simplification Measures, first issued in June 2011, was updated in June 2012. The updated report found that 33 out of 41 countries surveyed have transfer pricing simplification measures in effect, many of which would be considered to be safe harbors.  

In practice, non-statutory safe harbors (essentially observed enforcement practices by tax authorities) also operate as an effective tool to assess risk and to ensure that sufficient resources are allocated by tax administrations and multinational enterprises. Readers will have encountered non-statutory safe harbors such as:

  • 1:1 Debt equity for intra-group funding;
  • 25/75 Rule of thumb for licensee/licensor; and
  • Cost plus 5-10 percent for routine head office services.

Reliance on parameters such as these may be considered reasonable in many situations (and mitigate penalties in the event of an arm’s length challenge and adjustment). However, complex transactions will always require a more detailed assessment of the economic situation.

The OECD discussion draft isolates some key areas that tax departments should consider:

1. Operation in practice and concerns over the arm’s length principle

Concerns raised about safe harbors not being arm’s length are going to be relevant in many situations, and will be the price paid for the benefits of introducing safe harbors. In many ways, the operation of safe harbors in practice is commensurate with exemptions already provided in many jurisdictions, such as small company exemptions or de-minimis exemptions. The effect is to take the relevant transactions out of the arm’s length requirement and replace this with a basic price (zero in the case of the exemptions). Therefore, the introduction of safe harbors should be possible in practice with minimal disruption to the existing legislation, as these transactions would be freed from the arm’s length requirement.

2. One-sided adjustments

In many jurisdictions, transfer pricing adjustments can only occur where tax has been underpaid, and there is limited recourse if a company has a transaction that is below an introduced safe harbor (save for re-stating accounts, which is a difficult process). A grandfathering period should assist with such situations.

3. Tax arbitrage opportunities

The discussion draft raises concerns about safe harbors creating “inappropriate tax planning opportunities.” However, if a safe harbor is introduced in a particular jurisdiction, businesses should be able to seek tax arbitrage opportunities where they exist in commercial transactions.

Given these concerns, the OECD concludes that the emerging system of operating both statutory and non-statutory safe harbors is not the optimal result, largely because the safe harbors operate unilaterally. As an alternative, the draft proposes that many of the concerns raised about unilateral safe harbors could be addressed if tax authorities were to use the competent authority process to negotiate and implement a network of bilateral or multilateral safe harbor agreements. 

To facilitate this process, the draft contains three pro forma bilateral agreements covering low-risk manufacturing, low-risk distribution and low-risk research and development. The OECD hopes and advocates that countries decide on the relevant pricing metrics and use the template agreements to expedite the implementation of the recommendations.

Timing Issues

Timing issues in transfer pricing can arise as a result of the following:

  • Constraints on the availability of information;
  • Differences due to adjustments at year-end;
  • Information that becomes apparent after the date of transaction; and
  • Uncertainty as to the date a transaction takes place.

The impact of these differences can be material. Recognizing this, the OECD discussion draft on timing issues has called for comments relating to the above. This article discusses our experience in relation to the four key issues:

1. Availability of information

In practice, many businesses (in an ex post transfer pricing regime) will wait until after the end of the financial year before embarking on a transfer pricing review. Software and websites that collate third-party comparable information must also wait until after accounts are finalized before posting the information. Therefore, the advantage of an ex post approach is one of administrative ease and availability of information. The proposed changes (to paragraphs 3.67 and 3.68 of the OECD Transfer Pricing Guidelines) address this in part; however, it is important to recognize that materiality/significance can ease the burden on administrations and business.

2. Adjustments made at year-end

Adjustments made at year-end may be one of the following:

  • Year-end financial adjustments (recognizing that interim adjustments were provisional and seeking to finalize transactions with data available at the year-end); or
  • Year-end tax return adjustments (made on tax returns and not reflected in accounts).

Clearly an ex post regime is consistent with the former type of adjustment as it seeks to wait until such accounts are finalized. Exceptional items and material differences between financial and tax accounts will need to be explained in transfer pricing reviews, including the economic reasons for adopting one set of results in preference for another. Whether all administrations respect the adjustments made is of concern, as set out in the discussion draft. However, the system of tax treaties and the competent authority process exists to address these inconsistencies (and do so in the majority of practical cases). 

3. Ability to consider information post-transaction date

It is uncommon for businesses to go back and change pricing after the end of the financial year to “contemporaneous third-party outcomes” unless something material occurs after the end of the year that would require such an adjustment. The reason for this is twofold: (i) many tax administrations take a balanced approach to materiality, and the requirement for changes after accounts are finalized would be arduous if the adjustments were not material; and (ii) many tax administrations apply a non-ambulatory approach in transfer pricing legislation whereby the key date for assessing arm’s length transactions is that date at which the transaction took place. Information becoming available subsequent to that date is arguably not relevant for the purposes of the legislation; so-called “hindsight” cases have tested this point in many jurisdictions, including the U.S. and the U.K., and set out a number of specific situations when hindsight cannot be applied under the relevant legislation and more limited situations in which hindsight may be relevant. A recent U.K. tax case (Erdal v. HMRC [2011] UKFTT 87) held:

“It is also an accepted principle of valuation that the valuer stands at the valuation date looking forward into the future with reasonable foresight, rather than looking back today with hindsight at the valuation date. However, regard may be had to later events for the purpose only of deciding what forecasts could reasonably have been made... The question of reasonable foresight is of particular importance in this appeal when coupled with the statutory direction to assume that the prospective purchaser has all the information which a prudent prospective purchaser might reasonably require if he were proposing to buy from a willing seller by private bargain at arm’s length.”

4.     Considerations for intangible property and uncertainty as to the date a transaction occurs

We have significant experience of this situation whereby an intangible is transferred (e.g., into a cost-sharing agreement) on a particular date, but the dates of intent and completion may be different and can lead to different valuation results. Legal and accounting principles should be relevant here for consistency and to ensure that the test is not overly cumbersome for administrations and businesses. In addition, a natural migration of intangible value can occur over time. It is necessary to take a balanced and consistent view of the date of any transfer (we will often look at both dates if intent/expression and completion and raise any material differences). Most material intangible transactions of this nature will be reviewed on an ongoing basis (either annually or when a significant event occurs) to ensure that the pricing is still relevant; however, we refer to the comments made above about transfer pricing legislation following a non-ambulatory approach in many jurisdictions. 

Alvarez & Marsal Taxand Says:

Safe Harbors

In the current environment, many multinational enterprises have already started to reduce the amount of economic support in place for low-risk transactions and are adopting reasonable non-statutory safe harbor positions to mitigate penalties in the event of a challenge. Recognizing this, the OECD is considering how best to apply safe harbors (if at all).

It is clear that:

  • Safe harbors can reduce the administrative burden on multinational enterprises and tax administrations;
  • The appropriateness of safe harbors is most apparent when directed at low-risk situations; and
  • Many tax administrations apply safe harbors in practice with success.

The OECD considers that unilateral safe harbors are not the best long-term solution and, therefore, encourages tax authorities to negotiate and implement a series of bilateral or multilateral safe harbor agreements.

From the perspective of tax-paying companies, the potential administrative relief that a network of safe harbors might offer is clearly beneficial. The key questions will be how quickly tax authorities will act on these recommendations, and whether global consistency will emerge on the pricing levels embedded in the body of agreements.

Timing Issues

Timing issues in transfer pricing can lead to materially different arm’s length results. It is important to ensure that:

  • Transfer pricing reviews and risk assessments identify contentious timing issues that may be relevant and attempt to explain these issues;
  • A certainty ruling (advance pricing agreement) is considered, where timing issues are material and complex; and 
  • A consistent policy is applied with due regard to materiality.


For more information, contact:

Laurie Dicker
Managing Director, Washington DC
+1 202 688 4215

Senior Director, London
+ 44 207 072 3278

Other Related Issues

Survey of Transfer Pricing Issues in U.S. Business Restructurings

Intangible Property Planning Opportunities for High-Tech and Other Startups

Transfer Pricing Changes in Foreign Jurisdictions


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The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.

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