Harmonized TP framework for the EU
On 12 September 2023, the European Commission (“EC”) introduced a proposal for a Directive on transfer pricing (the “TP Directive”).
This proposal follows the EC communication “Business Taxation for the 21st Century” on 18 May 2021 and has been issued together with the EC proposal for Directive on Business in Europe: Framework for Income Taxation.
As per the Explanatory Memorandum, the proposal stems from the fact that the arm’s length principle, the internationally recognized standard for the pricing of cross border transactions between related parties as enshrined in article 9 of the OECD Model Convention and detailed in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (“OECD TPG”), is not uniformly applied and interpreted in the EU.
As a result, taxpayers face greater uncertainty (potential double taxation, over-taxation, and high compliance costs) and tax authorities face increased risk of profit shifting and tax avoidance.
The TP Directive puts forward certain remedies notably by incorporating the arm’s length principle and key transfer pricing rules, clarifying the role and status of the OECD TPG and easing the process for cross-border TP adjustments.
Harmonized framework
The TP Directive would introduce in EU Member States’ domestic legislations:
- The obligation to apply the arm’s length principle to cross-border intragroup transactions, restate arm’s length conditions if not applied and tax profits accordingly.
- The application of the TP Directive rules consistently with the 2022 version of OECD TPG. The TP Directive shall be amended upon update of the OECD TPG which “should be the new binding reference framework”.
- A common definition of associated enterprises which would include:
- a person participating in the management of another person by being in a position to exercise a significant influence over the other person;
- a person participating in the control of another person through a holding that exceeds 25 % of the voting rights;
- a person participating in the capital of another person through a right of ownership that, directly or indirectly, exceeds 25 % of the capital;
- a person entitled to 25 % or more of the profits of another person;
- a permanent establishment (“PE”) would be treated as an associated enterprise. PE is defined by reference to applicable double tax treaty or absent such treaty, by reference to domestic legislation. As a result, transactions between a head office and its PE would be subject to the arm’s length principle.
- The proposal also allows the Council to issue binding rules through implementing acts notably with respect to certain transactions and safe harbours.
Dealing with cross-border tp adjustments
Where tax authorities of one EU jurisdiction increase the taxable basis of a taxpayer in restating arm’s length conditions (i.e., a primary adjustment), the tax authorities where the counterparty is located should proceed to a corresponding adjustment to eliminate potential double taxation. EU Member States shall grant a corresponding adjustment where (i) they agree that the primary adjustment is in line with the arm’s length principle, (ii) the primary adjustment resulted in the taxation of profits in another jurisdiction in which the EU located associated enterprise has already been subject to tax and (iii) in case a non-EU jurisdiction is involved, there is a double tax treaty with such jurisdiction.
The TP Directive provides for a so-called “fast track” procedure. Within 30 days EU Member States shall notify the taxpayer of the request’s receivability or missing information and, if the primary adjustment took place within the EU, the procedure must be concluded and motivated within 180 days. Mutual agreement procedures remain applicable in the context of the Arbitration Convention, Directive on tax dispute resolution or joint audits.
Absent any primary adjustment, a Member States may still perform a downward adjustment to the extent (i) it is consistent with the arm’s length principle, (ii) an equivalent amount is included in the profits of both associated enterprises triggering a double taxation and (iii) the Member State granting the downward adjustment informs the tax authorities of the other jurisdiction involved.
An adjustment performed by a taxpayer for tax purposes to reflect an arm’s length price (i.e., a compensating adjustment), shall be accepted by the relevant EU Member State where (i) the taxpayer initially made reasonable efforts to achieve an arm’s length outcome, (ii) a symmetrical adjustment is made in the accounts of all EU parties involved, (iii) the same approach is consistently applied over time, (iv) the adjustment takes place before filing of the tax returns and (v) the taxpayer can explain the difference between the forecast and the result.
Choice of the TP method and arm’s length range
The TP Directive relies on the methods provided by the OECD TPG and the taxpayer must chose the most appropriate method under the selection process provided by the TP Directive. Other methods are allowed where it can be demonstrated that the OECD methods are not appropriate or workable and the alternative valuation method or technique results in a more reliable arm’s length result.
With the stated objective to reduce dispute and ensure a common approach, where the TP methods produce a range of results, the arm’s length result is determined using the interquartile range and, in such case, taxpayer should not be subject to adjustments (unless a different positioning in the range is justified by specific facts and circumstances). Tax authorities can adjust the results to the median of all results where the results of a controlled transaction fall outside of the arm’s length range (unless specific circumstances justify other positioning in the range).
Documentation
Taxpayers must maintain appropriate information and analysis proving that transactions with associated enterprises are at arm’s length and at least (i) identifying the commercial or financial relations, (ii) determination of the most appropriate method, (iii) comparability analysis and (iv) determination of the arm’s length range.
The Commission will further issue a standard template, rules on content and linguistic arrangements, timeframes and taxpayers in scope considering chapter V of the OECD TPG and the Code of conduct on transfer pricing documentation for associated enterprises in the European Union.
Conclusion
Based on the current proposal, EU Member States shall transpose these rules by 31 December 2025 and apply them as from 1 January 2026.
The TP Directive constitutes a first step in the harmonization of the TP rules in the EU, as further binding rules should be issued with respect to specific transactions and the interpretation of the arm’s length principle would be shifted from domestic to EU courts.
