methodology and the Arm’s-Length Principle
What is the way forward?
Adv LLM thesis
submitted by
Cristian Camilo Rodríguez Peña
in fulfilment of the requirements of the
'Advanced Master of Laws in International Tax Law'
degree at the University of Amsterdam
supervised by
Sjoerd Douma
co-supervised by
PERSONAL STATEMENT
Regarding the Adv LLM Thesis submitted to satisfy the requirements of the 'Advanced Master of Laws in International Tax Law' degree:
1. I hereby certify (a) that this is an original work that has been entirely prepared and written by myself
without any assistance, (b) that this thesis does not contain any materials from other sources unless these sources have been clearly identified in footnotes, and (c) that all quotations and paraphrases have been properly marked as such while full attribution has been made to the authors thereof. I accept that any violation of this certification will result in my expulsion from the Adv LLM Program or in a revocation of my Adv LLM degree. I also accept that in case of such a violation professional organizations in my home country and in countries where I may work as a tax professional, are informed of this violation.
2. I hereby authorize the University of Amsterdam and IBFD to place my thesis, of which I retain the
copyright, in its library or other repository for the use of visitors to and/or staff of said library or other repository. Access shall include, but not be limited to, the hard copy of the thesis and its digital format.
3. In articles that I may publish on the basis of my Adv LLM Thesis, I will include the following statement in
a footnote to the article’s title or to the author’s name:
“This article is based on the Adv LLM thesis the author submitted in fulfilment of the requirements of the 'Advanced Master of Laws in International Tax Law' degree at the University of Amsterdam.”
4. I hereby certify that any material in this thesis which has been accepted for a degree or diploma by any
other university or institution is identified in the text. I accept that any violation of this certification will result in my expulsion from the Adv LLM Program or in a revocation of my Adv LLM degree.
signature:
name: Cristian Camilo Rodríguez Peña
Table of Contents
Table of Contents ... III
List of Abbreviations ... IV
Executive Summary ... V
Main Findings ... VI
1.
Introduction ... 1
2.
Commensurate with Income Standard (CWIS) in the United States ... 3
2.1. Context ... 3
2.2. Commensurate with Income Standard Methodology ... 4
2.2.1. Application of the CWIS ... 4
2.2.2. Exceptions to the CWIS ... 5
3.
OECD treatment for transactions involving highly uncertain intangibles ... 7
3.1. Context ... 7
3.2. Periodic adjustments as a mechanism to mitigate the uncertainty in the valuation of intangibles ... 8
3.3. Application of the HTVI methodology ... 9
3.3.1. Examples given by the Guidance for Tax Administrations ... 11
4.
Tensions between the ALP and the HTVI approach ... 13
4.1. Main arguments for the incompatibility of the HTVIs approach with the ALP ... 13
4.1.1. The use of hindsight ... 13
4.1.2. Transactional adjustments ... 15
4.1.3. Reversal of the burden of proof ... 18
4.2. Normative conflicts due to the tensions between the ALP and the HTVI/CWIS ... 20
5.
Solutions to the incompatibility between the HTVIs approach and the ALP ... 23
6.
Conclusion ... 26
Bibliography ... 28
Literature ... 28
Case Law ... 31
List of Abbreviations
ALP Arm’s-length principle ALS Arm’s-length standard
APA Advanced Pricing Arrangement BARLM Basic Arm’s Length Return Method
CPM Cost Plus Method
CUT Comparable Uncontrolled Transaction CWIS Commensurate with Income Standard HTVI Hard-to-Value Intangibles
IRC Internal Revenue Code
IRS Internal Revenue Service MAP Mutual Agreement Procedure
MLI Multilateral Instrument to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting
MNE Multinational Enterprise
MTC Model Tax Convention
OECD Organisation for Economic Co-operation and Development S&P Standard and Poor
TP Transfer Pricing
TPG Transfer Pricing Guidelines TNMM Transactional Net Margin Method
UN United Nations
Executive Summary
The 2017 OECD TPG adopted in its section D.4 of Chapter VI a new methodology to deal with the information asymmetry problem between taxpayers and tax administrations when valuing transactions involving intangibles which valuation is highly uncertain. The so-called Hard-to-Value Intangibles (HTVIs) methodology provides tax administrations with a useful tool to deal with this issue. This new methodology permits tax administrations to perform periodic adjustments (e.g., inclusion of revision to price clauses) if the associated parties cannot rebut the presumptive evidence that the significant difference between the ex post result and ex ante valuation of an intangible was due to unforeseeable or unprovable developments or events affecting the value of the transaction.
However, this methodology as set out by the 2017 version of the TPG rivals with the ALP as enshrined in article 9 (1) of the OECD and UN MTC and, consequently, with the ALP as internalized at a domestic level within the income tax law and tax treaty network of many jurisdictions around the world. This incompatibility is due to the use of hindsight by the tax administration, the performance of almost mechanic transactional adjustments and the absence of criteria for the rebuttal of the presumptive evidence that lies over the taxpayer.
Hence, there are two possible ways to solve this incompatibility between the ALP and the HTVI approach. First, adopt the HTVI methodology at the same normative level of the ALP and amend all the tax treaties including a provision along the lines of art.9(1) of the OECD and UN MTC, which would suppose the negotiation of a new MLI including this methodology. Second, amend the HTVI approach as to make it compatible with the ALP as currently stated in art. 9(1)- This would entail increasing the information obligations on behalf of the taxpayers, providing clear criteria for the rebuttal of the presumptive evidence that relies on them and clarifying the exceptionality in the performance of transactional adjustments, including periodic adjustments to deal with intangibles which valuation is highly uncertain.
Main Findings
The new HTVI methodology adopted by the OECD in its 2017 update to the TPG is in contradiction with the ALP as enshrined in article 9 (1) of the OECD and UN MTC. This methodology aims to solve the information asymmetry problem between tax administration and taxpayer, and gives to the former the possibility of using the ex post outcomes of transactions involving HTVI as presumptive evidence that the associated parties did not take into account the events or developments foreseeable or predictable at the time the transaction took place, and therefore, the price set was not at arm’s length. However, this methodology does not solve the above-mentioned problem, issue that ultimately is transferred to the taxpayers, who find themselves in a position in which they cannot rebut the presumption that lies over them even cooperating with the tax administration.
Consequently, the incompatibility between the HTVI and the ALP is due to the reversal of the burden of proof that lies over the taxpayer because there is not guidance on how to rebut the presumptive evidence as to demonstrate that the events or developments affecting the value of the transferred intangible were not reasonably foreseeable or predicted when the transaction took place. In order to solve this problem, the HTVI methodology should be amended before its adoption at a domestic level so to avoid possible normative conflicts with the ALP. The main amendments should entail at least a trade-off between higher levels of information compliance on behalf of the taxpayer and less stringent and rather clearer possibilities for the taxpayer to rebut the presumptive evidence, not limiting to the options listed in the TPG.
1. Introduction
A significant part of the value of the economy lies in intangible assets. This is confirmed by the use of financial ratios to measure the participation of intangibles within the market value of companies. For example, a market price-to-book value (P/B) ratio1 of the Standard and Poor (S&P) 500 companies
shows that the P/B value of these companies has increased from 1.0 in 1980 to approximately 3.2 in 20202, which implies that from every 3,2 dollars of market value of a company, only 1 is reflected on its
books and the rest 2,2 represents intangible assets3.
Given the importance of the intangibles within our economy, it is crucial to value adequately transactions involving intangibles in cross-border situations. However, this task has proved to be highly uncertain, particularly for transfer pricing (TP) purposes due to the asymmetry of information between the taxpayer and the tax administration, rendering as a result the misuse of the TP rules by MNEs to shift their income to low-tax jurisdictions through transactions involving intangibles.
This information asymmetry issue arises because the foreseeability and predictability of the developments or events that might affect the value of a transaction involving intangibles might not be easily accessible for the tax administration given the intricacies of the specific industry or business where the transaction is carried out. Thus, the tax administration is dependent on the information provided by the taxpayer4. Therefore, the information asymmetry impedes the Tax Administration to challenge
whether the transaction was made at arm’s length or not and whether the difference between the ex ante valuation and ex post result is a consequence of an unanticipated result or a non-arm’s length price setting. This problem can arise in different circumstances, for example, when the intangible object of the transaction is only partially developed at the time of the transfer5 or when it is not expected to be
exploited commercially until several years following the transaction6.
This problem has been recognized and addressed by specific TP methodologies. The first time this issue was explicitly addressed by a normative rule was in the United States (US). The 1986 amendment to section 482 of the Internal Revenue Code (IRC), incorporated a Commensurate-with-Income Standard (CWIS) according to which the value of the transfer of an intangible must be commensurate or proportional with the profits that it produces. In order to achieve this result, this approach contemplates the inclusion of periodic adjustments to adjust the prices when they deviate from the actual income or profits obtained from the intangible. However, this standard has been harshly criticized as it might be considered in opposition to the ALS, which may be a reason why the Internal Revenue Service (IRS) has not actively used it.
Consequently, the OECD has recently adopted a methodology similar to the one found in the US. The 2017 update to the OECD TP Guidelines (TPG) includes a specific treatment for Hard-to-Value Intangibles (HTVI), that permits tax administrations to use ex post results of the transfer of an intangible, as presumptive evidence that the price, set at the time the transaction took place, was not at arm’s-length and might not be in accordance with what independent parties would have done. If the taxpayer cannot rebut the presumption that lies on him, the tax authority is enabled to perform an adjustment using a mechanism (e.g., a revision clause) to mitigate this uncertainty, just as independent parties
1 This ratio compares the market value of the company to the net value as recorded on its balance sheets. 2 Ycharts.com. 2020. Ycharts: S&P 500 Price to Book Ratio [online] Available at:
https://ycharts.com/indicators/sp_500_price_to_book_ratio [Accessed 25 May 2020].
3 Baruch Lev, Intangibles: Management, Measurement, and Reporting (Brookings Institution Press 2001) 8. 4 OECD, ‘Guidance for Tax Administrations on the Application of the Approach to Hard-to-Value Intangibles.
Inclusive Framework on BEPS: Action 8’ (2018) para 5.
5 OECD, ‘Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations’ (OECD TPG17) para 6.190.
would have done it. However, this approach, in the same manner as the CWIS, might be in contradiction with the ALS.
This purported tension between the HTVI methodology and the ALS is particularly important considering the adoption of the ALS in article 9 of the OECD Model Tax Convention (MTC) and in a similar fashion within the domestic law of many jurisdictions around the world.
Therefore, if the HTVI methodology is in contradiction with the ALS, and not a mere clarification or addition of the principle, this rule would not apply immediately in a domestic and treaty context. At least in the case of those countries that have adopted a provision similar to art. 9 OECD MTC, and especially if one considers that the HTVI is laid down within the TPG, a soft law instrument no binding for jurisdictions. Thus, it would be necessary to modify both the domestic legislation and the treaty provisions to avoid a normative conflict between both sets of rules or, conversely, to modify the new approach adopted by the OECD’s TPG as to make it compatible with the ALS.
This study intends to highlight this tension and determine whether the HTVI methodology is contrary to the ALS and what ways forward can be adopted to solve this tension. For that matter, the first part refers to the context in which the CWIS, as an immediate antecedent to the HTVI approach, was adopted in the US and what is the scope of this rule within the regulations to section 482 of the IRC (Chapter 2). Then, it analyses the methodology adopted by the OECD in the 2017 TPG, recurring first to the context in which this rule was adopted, the guidance already given for transactions involving intangibles which valuation is highly uncertain, and its connection with the new HTVI methodology (Chapter 3). Consequently, it analyses the tensions and normative conflicts that arise between this methodology and the ALS, particularly because its use of hindsight, performance of transactional adjustments and reversal of the burden of proof (Chapter 4). Lastly, the paper analyses possible solutions to align the HTVI approach with the ALS (Chapter 5).
2. Commensurate with Income Standard (CWIS) in the United States
The first country to address the problem regarding the uncertainty in the valuation of intangibles was the United States (US) through the adoption of the commensurate-with-income standard (CWIS). This chapter aims at explaining the reasons for the adoption of this standard, its functioning and exceptions, and whether this approach is compatible with the ALP. For that matter, in a first part the context under which this specific methodology was adopted will be explained as an important antecedent of the HTVI approach, recently adopted by the OECD. After all, the same problems that are intended to be solved with the CWIS in the US, are the ones the OECD tries to tackle with the HTVI methodology. Additionally, in a second part of this chapter, the specific methodology of the CWIS, its application and exceptions, will be explained as a first referent in relation to the approach adopted by the OECD in the 2017 TPG. 2.1. Context
The 1968 US Regulations to Section 482 intended to address the new problems that followed the expansion of MNEs in the United States and their increasing transactions with subsidiaries located in low tax jurisdictions7. One of the main issues consisted of the “outbound transfers of intangibles”8 or
“roundtrip transfers of intangible property”9 to affiliates located in these kinds of jurisdictions. Specifically,
in the case of transfers of valuable patents developed in the United States by pharmaceutical parent companies to subsidiaries located in Puerto Rico, which manufactured the drugs and sold them back to the associated American parties10. The IRS challenged this specific behaviour, and as a
countermeasure, it adopted a position according to which these transfers of intangibles should not be recognized. The subsidiaries should not be treated as owners of the intellectual property, but rather as contract manufacturers which income was determined on a cost-plus basis11. This position was struck
down by the judiciary12.
One of the main problems lying behind these transactions consisted of the transfer of intangibles that had been developed in the United States, but which value was uncertain because they had not been commercialized yet. Thus, before the deployment phase took place, the intellectual property was transferred to the associated entities located in low tax jurisdictions, which accrued the benefits of the ownership and exploitation of the intangible. The IRS wanted to use the post results to revise the ex-ante price-setting accorded between associated enterprises in transactions involving intangibles. However, the judiciary13 also struck down this approach by stating that the ex-ante conditions were the
ones that should be taken into account when assessing the transfer price of a transaction involving an intangible and not the ex post results.
As a countermeasure to the abusive behaviours of MNEs14 and the limitations imposed by the judiciary15
to the existent TP rules, section 482 was amended by the Tax Reform Act of 1986, adding the following
7 Jens Wittendorff, Transfer Pricing Arm's Length Principle International Tax Law, vol 35 (Kluwer Law International 2010) 33.
8 Michael C Durst and E Culbertson, ‘Clearing Away the Sand: Retrospective Methods and Prospective Documentation in Transfer Pricing Today’ (2003) 57 Tax Law Review 37.
9 Robert G Clark, ‘Transfer Pricing, Section 482, and International Tax Conflict: Getting Harmonized Income Allocation Measures from Multinational Cacophony’ (1993) 42 The American University Law Review 1155, 1165. 10 Reuven S Avi-Yonah, ‘The Rise and Fall of Arm’s Length: A Study in the Evolution of U.S. International Taxation’
(2007) Public Law & Legal Theory Working Paper Series 92
<https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1017524> accessed 28 December 2019. 11 Wittendorff, Transfer Pricing Arms Length Principle International Tax Law (n 7) 40.
12 ‘US: Court of Appeals, Seventh Circuit, 27 October 1988, Eli Lilly & Company and Subsidiaries v. Commissioner, Nos. 86-2911, 86-3116, Tax Treaty Case Law IBFD’.
13 ‘US: USTC, 6 September 1973, R.T. French Company v. Commissioner, No. 5026-70, Tax Treaty Case Law IBFD’.
14 Richard L. Kaplan, ‘International Tax Enforcement and the Special Challenge of Transfer Pricing’ (1990) 1990 University of Illinois Law Review 299.
15 Aitor Navarro, Transactional Adjustments in Transfer Pricing, vol 40 (2018); Jens Wittendorff, ‘Valuation of Intangibles under Income-Based Methods – Part II’ (2010) 17 International Transfer Pricing Journal 383.
sentence: "In the case of any transfer (or license) of intangible property (…), the income concerning such transfer or license shall be commensurate with the income attributable to the intangible."
Consequently, in 1988, the IRS issued a comprehensive study of intercompany pricing under Section 482, commonly known as the “White Paper”,16 and which focused on the analysis of pricing issues
concerning transactions involving intangible assets. Specifically, this study analysed the scope of the new methodology adopted by the Congress to face these kinds of problems, i.e., the commensurate with income standard and its compatibility with the arm’s length principle. Additionally, the White Paper studied the appropriate TP methods for transactions involving intangible assets, which then extended to tangible assets and services in situations lacking comparable prices or comparable transactions.17
The White Paper stressed the little or total absence of guidance within section 482, before the 1986 amendment, to deal with transactions in respect of which there were no comparables.18 Also, it
recognized as one of the main problems in the administration of this section the valuation of intangibles and how the CWIS was adopted “to ensure that each party earns the income or return from the intangible that an unrelated party would earn in an arm’s length transfer of the intangible”.19 Furthermore, the Study
underlines that the amendment “is a clarification of prior law”20 and consistent with the arm’s length
principle.21
Later, in 1992 and 1993, the US issued proposed regulations to section 482 following part of the line of reasoning fleshed out in the White Paper of 1988. These proposals received several commentaries in their discussions within the OECD, which questioned22 the compatibility of the “periodic adjustment
provision” of the regulations with the arm’s length principle, determining that this measure should be narrowed down to only exceptional cases involving abusive behaviours or scenarios where the taxpayer had failed to provide enough information about the transaction.
Ultimately this process would influence the final US Regulations adopted in 1994 and the OECD TPG of 1995, finding a compromise between both positions in several points, among other things, regarding the adoption of income-based methods23, the progeny of the initial US initiative of the Basic Arm’s Length
Return Method (BALRM); and the implicit acceptance by the OECD24 of the CWI standard as if it were
in accordance with the arm’s length principle25.
2.2. Commensurate with Income Standard Methodology
2.2.1. Application of the CWIS
When studying the inability of section 482 to tackle the problems related to the valuation of intangibles, the main concern was referred to transactions involving high-profit intangibles of US companies with associated enterprises located in low-tax jurisdictions. Nevertheless, the 1986 amendment to section 482, and its regulations, apply to all kind of transfers, regardless of whether the intangible transferred is normal or highly profitable, or whether it is transferred to a low tax jurisdiction.26 Therefore, the CWIS 16 IRS, ‘A Study of Intercompany Pricing (White Paper)’ (1988).
17 Durst and Culbertson (n 8). 18 IRS (n 16) 12.
19 ibid 47. 20 ibid 46. 21 ibid 61.
22 OECD, ‘Reports of the Task Force of the OECD Committee on Fiscal Affairs on US Transfer Pricing Proposed Regulations (1993)’ (1993) s H.
23 Comparable Profit Method -CPM- in the United States or Transactional Net Margin Method -TNMM- in the OECD and the Profit Split Method in both cases
24 OECD, ‘Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations’ (OECD TPG95) para 6.34.
25 Jens Wittendorff, ‘The Transactional Ghost of Article 9(1) of the OECD Model’ (2009) 63 Bulletin for International Taxation 107, 120–121.
applies to all kind of intangibles and the “consideration for [its] transfer […] must be commensurate with the income attributable to the intangible"27. This means that the tax administration can perform periodic
adjustments to the controlled transaction to reflect the “actual” income obtained from the intangible. Additionally, the determination in a previous year of an arm’s length price for an intangible does not impede in a successive year the performance of an adjustment.28
This standard applies equally to transactions of intangibles for lump-sum payments as it does for license agreements with periodic royalty payments. In the former case, the payment must be treated as “an advance payment of a stream of royalties over the useful life of the intangible or period covered by the agreement”, using a present value calculation for the pertinent period29 and a discount rate, which must
be commensurate with the income attributable to the intellectual property. In that sense, an equivalent rate must be determined for the equivalent royalties, which is the result of dividing the lump-sum payment by the present value of the projected sales. This equivalent royalty might be subject to periodic adjustment as a regular royalty would be and it is covered by the same exceptions as well30.
Hence, the transaction involving intangibles is revised each year, and the returns of the transferred intangible must correspond to the actual income obtained. However, it is worth questioning what is the role that the ex post outcome or the actual profit plays in the performance of the periodic adjustments and whether the periodic adjustments are based entirely on the actual profit or if this data is only used as evidence of what independent parties would have done.
According to the IRS,31 the actual outcome or profits accrued due to the transfer of the intangible should
not be “determinative”, but presumptive evidence. Therefore, adjustments should be made in accordance with the reasonably projected profits, using the ex post outcome only as a presumption of the conditions that would have been agreed upon if all the events affecting the transactions would have been taken into consideration by the related parties.
This view is challenged by Torvik,32 who estimates that the IRS “downplays the role of the actual profits
under the commensurate-with-income standard”. This author argues that the bar to challenge the presumption of the CWIS is too high, and in practice, the taxpayer could not determine a level of profits that are outside of a range from 80% to 120% of the projected income. This implies that the actual profits are almost always the ones taken into account for the performance of periodic adjustments from part of the tax administration.
2.2.2. Exceptions to the CWIS
According to the regulations33 to section 482, there are five exceptions in which no periodic adjustments
should be made according to the commensurate-with-income standard. In the opinion of Bullen,34 these
five exceptions can be grouped into three main categories. The first category includes exception A, which operates if there is an internal comparable to apply the comparable uncontrolled transaction -CUT- method (equivalent to the CUP method) in the first year in which substantial periodic consideration was required to be paid; and if that amount is at arm’s length, then there is no room to perform periodic adjustments even if the actual income is not commensurate with the projected profits of the intangible. This exception acknowledges that using comparables remains “the best way to allocate intangible
(1989) DOC 89-1612 Tax Notes. 27 ‘US Treasury Regulations’ s 1.482-4(f)(2). 28 ibid.
29 ibid 1.482-4(f)(6).
30 Oddleif Torvik, Transfer Pricing and Intangibles. US and OECD Arm’s Length Distribution of Operating Profits
from IP Value Chains, vol 45 (IBFD 2019) s 16.4.
31 IRS, ‘AM-2007-007’ 10. 32 Torvik (n 30) s 16.3.2. 33 § 1.482-4(f)(2)(ii)A-E.
income”35 and comply with the ALS.
The second category comprises exceptions B, C and E. It refers to the no application of the periodic adjustments in cases involving minor variations in intangible income36 within the range of 80 to 120%
(+/- 20%) of the projected profits, i.e., not less than 80% nor more than 120% of the prospective profits or cost savings. These exceptions apply if the amount paid in the first year is proven to be at arm’s length using the CUT method (exception B) or any other method (exception C) relying on external comparables. Additionally, these exemptions apply only if there have not been substantial changes in the functions performed by the parties under their written agreements unless these changes are due to unforeseeable events, which might diverge depending on the lifecycle of the intangible at the moment the transfer took place37. In turn, exception E prescribes that no adjustment will be performed if the
conditions for applying Exception B or C are met in each year of the subsequent five years after the first substantial periodic consideration was required to be paid.
The third and final category encompasses exception D, according to which the second category of exceptions can apply even if the outcome of the transaction falls outside the pre-established range (80 to 120%) because of “extraordinary events that were beyond the control of the controlled taxpayers and that could not reasonably have been anticipated at the time the controlled agreement was entered into”38. According to the example provided by the regulations, an extraordinary event might be an
earthquake in the jurisdiction of the subsidiary that negatively affects the projected profits envisioned by the parent at the time the transaction took place. Thus, the events dealt with in this exception must be akin to those of “force majeure occurrences.”39
On the whole, the exceptions contained within the regulations to Section 482, intend to narrow down the performance of periodic adjustments under the CWIS. To some extent, the fact that the regulations, a set of norms which counts with an administrative nature, try to limit the scope of the Section 482 of the IRC, a statute at the level of the law, could be considered contrary to law because the exceptions fleshed out within the regulations are not in accordance with the statutory language used in the IRC. Therefore, as some commentators argue, in some cases the “exception[s] ha[ve] swallowed the rule”40 and are in
conflict with the plain text of the IRC that is established in section 482 and that permits a broaden application than the one established within the regulations. However, the requisites for the exceptions to the periodic adjustments, as seen above, are very stringent, which means that only in few cases they would apply and, consequently, permitting that “the profit allocation in controlled intangibles transfers to be commensurate with the actual profits allocable to the transferred intangible” 41, i.e., permitting the
periodic adjustment under the CWIS to apply more easily.
35 IRS (n 16) 52. 36 ibid 66.
37 Torvik (n 30) s 16.3.3.3.
38 ‘US Treasury Regulations’ (n 27) s 1.482-4(f)(2)(ii)D. 39 Torvik (n 30) s 16.3.3.5.
40 Philippe Penelle, ‘The OECD Hard-to-Value Intangible Guidance’ (International Tax Review, 11 April 2017) <https://www.internationaltaxreview.com/article/b1f7n6p9rmsygd/the-oecd-hard-to-value-intangible-guidance> accessed 12 June 2020.
3. OECD treatment for transactions involving highly uncertain intangibles
This section aims to explain the new Hard-to-Value Intangibles methodology as set out by the OECD in section D4 of Chapter VI of the 2017 update to the TPG. For that matter, it is important to study first the context under which the OECD arrived at the adoption of this new methodology and how it interacts with the guidance already given by the TPG when dealing with transactions involving intangibles which valuation was highly uncertain. Then, the application of the HTVI approach will be studied as set out in the TPG and further explained by the OECD in the Guidance for Tax Administrations on the application of this approach.
3.1. Context
The OECD has addressed on several occasions the TP problems related to transactions involving intangible assets. Already in its 1979 Report on Transfer Pricing and Multinational Enterprises,42 it
contemplated the transfers of technology and trademarks between MNEs. In the short term, the valuation of intellectual property for TP purposes has become one of the most important, if not the most important one, of the problems affecting the ALS as the OECD recognizes it43. Despite the importance
of this subject, only since the 2017 update, the OECD Guidelines adopted a specific approach to deal with the uncertainty in the valuation of intangibles in a similar way as the United States did with the adoption of the CWIS. Before that, when analyzing the US proposed regulations and the CWIS, the OECD Task Force44 had posed several questions and recommendations concerning the compatibility
of the US methodology with the ALP, which implied that the OECD did not endorse such standard as drafted under the US transfer pricing regulations.
Nevertheless, in the 1995 TPG the OECD implicitly supported the compatibility of the CWIS, as postulated by the US, and the ALP, which might seem contradictory with its former position adopted just two years before with the issuance of its OECD Task Force in 1993. This assertion is founded upon the inclusion within the Guidelines45 of the “commercial rationality test” as an exceptional circumstance to
disregard the transaction as structured by the parties,46 exception which might also be a response to
the US domestic legislation.47 This point is confirmed by the example given within the guidelines to
explain this exception regarding the outstanding sale of an IP for a lump-sum payment, a scenario that had been fleshed out first in the White Paper and that recommended to make an adjustment and treat the operation as an open transaction increasing the consideration paid in commensurate with the income obtained.48
Additionally, the 1995 and 2010 OECD TPG accepted, as the CWIS in the US, the possibility to perform periodic adjustments due to the uncertainty in the valuation of transactions involving intangibles.49
However, the starting point of this rule was the negation of any adjustment except if independent parties would have insisted in the inclusion of a price adjustment clause or the following developments were so crucial as to renegotiate the agreement.50 Thus, although the Guidelines recognized the possibility to 42 OECD, ‘Report on Transfer Pricing and Multinational Enterprises’ (1979).
43 OECD, ‘Action Plan on Base Erosion and Profit Shifting’ (OECD 2013); Ulrich Schreiber and Lisa Maria Fell, ‘International Profit Allocation, Intangibles and Sales-Based Transactional Profit Split’ (2017) 9 World Tax Journal 17, 100.
44 OECD Task Force, ‘Intercompany Transfer Pricing Regulations under US Section 482 Temporary and Proposed Regulations’ (1993).
45 OECD TPG95 para 1.37.
46 Wittendorff, ‘The Transactional Ghost of Article 9(1) of the OECD Model’ (n 25) 117. 47 Bullen (n 35).
48 Emil Sunley, Edward Maguire and John Wills, ‘United States Section 482 White Paper’ (1989) 17 Intertax 45, 48.
49 OECD TPG95 para 6.34, 6.35. 50 ibid 6.33.
perform periodic adjustment similar to the CWIS, the conditions to make these adjustments were not that clear, maybe “due to the historical resistance among some OECD member countries against periodic adjustments”.51
Although the previous versions of the TPG included the possibility to perform periodic adjustments as a measure to mitigate the uncertainty in the valuation of transactions involving intangibles, there was not clear criteria of when the tax administration should make use of these kinds of adjustments to diminish such uncertainty. Thus, the 2017 update TPG included a new section D.4. dealing with hard-to-value intangibles,52 which complements the guidance already found therein regarding the performance of
periodic adjustments in section D.3. This new section D.4. is inspired to some extent in the experience of the CWIS in the US and stresses the information asymmetry problem between the taxpayer and tax administration in transactions involving intangibles. For that regard it defines what HTVIs are and in which types of transactions they could be found. Furthermore, it establishes a presumption according to which the ex post outcome, actual result of a transaction dealing with HTVIs, constitutes a presumptive evidence that the valuation made ex ante by the taxpayer is not at arm’s length.
3.2. Periodic adjustments as a mechanism to mitigate the uncertainty in the valuation of intangibles
As stated before, the 1995 and 2010 versions of the OECD TPG already acknowledged the uncertainty in the valuation of transactions involving intangibles and the difficulties that this uncertainty brings about for both taxpayers and tax administrations in determining an arm’s length price for these transfers. For that matter, the TPG emphasizes that this difficulty must be overcome “by reference to what independent enterprises would have done in comparable circumstances to take account of the valuation uncertainty”.53 In the same vein, the TPG recognizes various mechanisms that independent parties
could adopt to face the uncertainty in the valuation of intangibles (use anticipated benefits,54 short term
agreements, the inclusion of price adjustment clauses or contingent payments,55 or the renegotiation of
the contract56). If these mechanisms had been agreed on by independent parties, then the tax authority
should be allowed to determine the price of the intangible making use of such mechanisms.57 51 Torvik (n 30) s 16.5.
52 The study of a new methodology dealing with the uncertainties in the valuation of highly valued intangibles started after the 2010 update of the TPG, year in which the OECD launched a new project concerning the transfer pricing issues relating to intangibles, in particular, “on its definition, identification and valuation” OECD, ‘Transfer Pricing and Intangibles: Scope of the OECD Project’ (2011). Consequently, in 2012 the OECD issued a first Discussion Draft52 with the considerations of the revision of Chapter VI regarding intangibles and including a specific consideration for “transfers of intangibles when valuation is highly uncertain at the time of the transaction” OECD, ‘Discussion Draft. Revision of the Special Considerations for Intangibles in Chapter VI of the OECD Transfer Pricing Guidelines and Related Provisions’ (2012). In July 2013 the OECD issued its BEPS Action Plan, within the 15 actions set out by the OECD, action 8 dealt with the development of rules to prevent BEPS “by moving intangibles between group members”52 adopting, among other rules, “special measures for transfers of hard-to-value intangibles”52. The same year, the OECD issued its Revised Discussion Draft OECD, ‘Revised Discussion Draft on Transfer Pricing Aspects of Intangibles’ (2013) on TP aspects of intangibles, linking its work on the update of the TPG on intangibles for which its valuation is uncertain with the mandate received within the BEPS project regarding HTVI. In 2014 the OECD issued a new report OECD, ‘Guidance on Transfer Pricing Aspects of Intangibles. Action 8: 2014 Deliverable’ (2014) with the proposed amendments on TP aspects of intangibles, containing guidelines for hard-to-value intangible. Then, this guidance was reiterated in the 2015 OECD released of the Final Report on Actions 8 to 10 of the BEPS project OECD, ‘Aligning Transfer Pricing Outcomes with Value Creation, Actions 8-10:2015 Final Reports’ (OECD 2015).. Lastly, the proposed guidance was included within the 2017 update to the TPG, which deals with the HTVIs in section D.4. of Chapter VI.
53 OECD, TPG95 para 6.28; OECD, ‘Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations’ (OECD TPG10) 6.28; OECD, TPG17 para 6.181.
54 OECD, ‘Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations’ (n 5) para 6.182. 55 ibid 6.183.
56 ibid 6.184. 57 ibid 6.185.
The above-mentioned mechanisms intend to emulate what independent parties would do in similar circumstances depending on the foreseeability and predictability of the developments or events that might affect the value of the intellectual property object of the transaction. Therefore, at least before the 2017 update of the OECD TPG, “relying on post-transfer profitability of transferred intangibles should be permitted only in situations when independent enterprises would adopt price adjustment clauses”.58
However, the guidance up to 2010 was by no means clear as to when and under which conditions make these adjustments to mitigate the uncertainty of transactions involving intangibles. It was not until the 2017 update to the OECD TPG and its incorporation of the HTVI approach that a clear criterion was given to determine when and under which circumstances the periodic adjustments already referred to in the TPG could effectively be performed.
3.3. Application of the HTVI methodology
The HTVI approach starts defining what constitutes a hard-to-value intangible and, therefore, when this methodology is applicable in dealing with information asymmetry in the valuation of transactions involving these types of assets. According to the 2017 OECD TPG, HTVIs are those intangibles in respect of which (i) no reliable comparables exist, and (ii) the projections or assumptions used for the valuation of the intangible are highly uncertain, impeding the prediction of the level of success “of the intangible at the time of the transfer”59. Intangibles of this type portrayed certain features60 that might fall
under the definition of a HTVI and in which the intangible: (i) is only partially developed at the time of the transfer; (ii) is not expected to be exploited commercially until several years following the transaction; (iii) is not a HTVI, as defined by the TPG61, but is important for the development or enhancement of
other HTVIs; (iv) is expected to be exploited in a novel manner without suitable comparables in the market; (v) has been transferred to a related party for a lump sum payment; and, (vi) is used in connection or developed under a CCA or alike arrangement.
The above-mentioned definition presupposes various problems. First, because of its overarching scope virtually every intangible could be considered as a HTVI62, and, second, and most importantly, it does
not establish clear criteria of how to determine the level of uncertainty in the valuation of the transaction, or better, the foreseeability63 of the actual potential of the intangible as to determine that it is a HTVI. In
fact, the guidance in this point is a Catch-22 or a paradoxical situation64 because two elements of section
D4 contradict among themselves. On the one hand, the HTVI definition demands a high level of uncertainty to consider an intangible as hard-to-value and, therefore, apply this specific approach set out by the TPG. On the other hand, the guidance contained therein establishes that the substantial difference between the ex-post outcome and ex ante valuation constitutes presumptive evidence that the developments or events that occurred after the transfer of the intangible, were reasonably foreseeable65 and, thus, not uncertain. Therefore, the definition of HTVI would go against the
methodology that the TPG is adopting within the same section D4, because in principle this methodology would not be applicable to HTVI, but instead to intangibles which valuation is certain enough to be valued under the reasonably foreseeable information at the time the transaction took place, a circumstance that can only be known in an ex post scenario.
Aside from the definition of HTVI, the methodology fleshed out in section D.4. of chapter VI 2017 OECD
58 Richard Collier and Joseph L Andrus, Transfer Pricing and the Arms Length Principle After BEPS (Oxford University Press 2017) n 6.70.
59 OECD, TPG17 para 6.189. 60 ibid 6.190.
61 ibid 6.189.
62 David Ernick, ‘OECD Strays Further from Arm’s-Length Principle in Hard-to-Value Intangibles Draft’ (2017) 26 Bloomberg 4.
63 Aitor Navarro, ‘Intangibles de difícil valoración y ajustes retrospectivos en la normativa española sobre precios de transferencia’ (2019) 173 Crónica Tributaria 159, 171.
64 ibid 172, 173.
TPG, considers the ex post outcome of a transaction involving HTVIs as a pointer about the arm’s length nature of the ex-ante pricing and the existence of uncertainty at the time the transaction took place.66
The ex post outcome refers to the actual income or cash flows that are considerably higher or lower than what was projected by the taxpayer when setting the price,67 undervaluing or overvaluing the
intangible or right in the intangible.68 If that is the case, this difference is presumptive evidence69 that
foreseeable developments or events that might have affected the value of the intangible were not adequately taken into account by the parties when determining the transfer price, and that the information used ex ante for the valuation of the intangible was not reliable.70 However, the use of this
presumptive evidence, seems not to be automatic,71 as the tax administration should only use this ex
post outcome if it is necessary to determine the reliability of the information used ex ante, thus, the tax administration could by other means determine whether the information used for the ex-ante valuation is or not reliable72 and, therefore, whether the price set by the parties is or not at arm’s length, without
the need to recourse to the ex post outcome.
At this point, the new guidance of HTVI links73 the content of section D.4 with the usage of mechanisms
to mitigate the uncertainty in transactions involving intangibles already contained in section D.3. of Chapter VI OECD TPG. Thus, the ex post outcome is the trigger to perform periodic adjustments according to section D3 of the TPG in a similar way as the CWIS in the US uses the actual profits to determine the deviation from the ALP of the ex ante valuation74 and the possibility for the tax
administration to perform periodic adjustments. This means that the ex post outcome is used as presumptive evidence that independent parties would have adopted different pricing arrangements75 in
order to address the events or developments foreseeable at the time the transaction took place and that could have affected the value of the intangible transferred.
Furthermore, although the ex post outcome renders its purpose as presumptive evidence for the tax administration concerning the correspondence of the price set by the parties with the ALS, this outcome should not be used to determine the correct revised price of the transfer without “taking into account the probability, at the time of the transaction, of the income or cash flows being achieved”76. In other words,
the actual profits should not be the base under which the transfer pricing adjustments are performed, which should be determined according to the foreseeable information when the transaction took place. The taxpayer can rebut77 this presumptive evidence if it can be determined that the difference between
the ex ante valuation and ex post outcome does not affect the adequate determination of the arm’s length price. For that matter, the 2017 TPG establish four exemptions where the methodology described above does not apply.
The first exception consists of the reliability of the information that the taxpayer can provide to demonstrate that an outcome was foreseeable or not. In order to prove this, the taxpayer must provide (i) details of ex ante projections taking account of the risks of the transaction and probability of occurrence of foreseeable events; and (ii) evidence that the difference between the ex ante valuation and the ex post outcome is due to unforeseeable developments or foreseeable outcomes that were not
66 ibid.
67 OECD, ‘Guidance for Tax Administrations on the Application of the Approach to Hard-to-Value Intangibles. Inclusive Framework on BEPS: Action 8’ (n 4) para 6.
68 OECD, TPG17 para 6.191. 69 ibid 6.188. 70 ibid. 71 Navarro (n 65) s 170. 72 OECD, TPG17 para 6.192. 73 ibid 6.187, 6.192. 74 Torvik (n 30) s 16.5. 75 OECD, TPG17 para 6.187, 6.192.
76 OECD, ‘Guidance for Tax Administrations on the Application of the Approach to Hard-to-Value Intangibles. Inclusive Framework on BEPS: Action 8’ (n 4) para 6.
too probable.
The second exception occurs when a bilateral APA covers the transfer involving the HTVI. The third exception concerns the amount of the deviation between the ex ante projection and the ex post outcome, and it applies where this amount does not exceed more than 20% of the estimated profits. Lastly, the fourth exception establishes that a commercialization period of 5 years has passed with no deviation of more than 20% of the projected profits in that period.
Additionally, although not explicitly mentioned within the exceptions, it is clear, as in the US CWIS, that if a comparable transaction is found suitable to comparison with the controlled transaction, there would not be room to apply the HTVI approach78, chiefly, because the transaction would not involve in itself a
HTVI if a reliable comparable exists.
Furthermore, although the Guidelines states that the usage of ex post outcomes is just used as presumptive evidence as to the existence of uncertainties at the time of the transaction79, it is clear that
“actual profits” are going to be used if they deviate from the 20% range established in the exceptions or the exceptional circumstances mentioned therein, and this could also “encompass information that not necessarily could or should reasonably have been taken into account at the time of the transfer”80.
3.3.1. Examples given by the Guidance for Tax Administrations
Section D.4 of Chapter VI 2017 TPG does not count with examples or practical application of the HTVI methodology. Thus, the OECD issued in 2018 a guidance for tax administrations to reach a common understanding on how to apply adjustments resulting from the application of the HTVI approach. The guidance for tax administrations contains two examples81 of how the HTVI methodology can be
applied. In the first example, there is a Company A that has patented a pharmaceutical compound and has taken it through Phases I and II of chemical trials. The third phase is taken by company S after the patent is transferred to it. The parties set a price of 700 paid as a lump sum in year 0. This estimation was made based on the expected income for the exploitation of the drug over its patent period or lifetime. In this example, the parties assumed that the commercialization would start in year six after the transfer and that the sales would be of up to 1,000 per year.
Figure 1. Factual situation of the examples fleshed out within the Guidance for Tax Administrations on the Application of the Approach to Hard-to-Value Intangibles
78 Torvik (n 30) s 6.15. 79 OECD, TPG17 para 6.188. 80 Torvik (n 30) s 6.15.
81 OECD, ‘Guidance for Tax Administrations on the Application of the Approach to Hard-to-Value Intangibles. Inclusive Framework on BEPS: Action 8’ (n 4) paras 18–33.
In a first scenario, phase III is completed earlier, and the commercialization of the product starts in year 3. Thus, the ex post outcome is used by the tax administration to determine that the valuation made by the taxpayer did not take into account the possibility that sales would arise in earlier periods, making an adjustment for the anticipated arm’s length price that should have been 1.000, assessing additional profits of 300. In a second scenario, if the price had been reassessed to be 800, then no adjustment would be necessary because the outcome would fall under the exception (iii) of paragraph 6.193, i.e., a deviation of less than 20% between the ex ante price and the ex post result.
In the second example, the factual situation is the same; however, this time the projection of the sales (1.000) made by the taxpayers is less than the actual sales (1,500) obtained for the commercialization of the drug. In this case, again, the tax authority takes the ex post outcome as presumptive evidence that “the possibility of higher sales should have been taken into account in the valuation”82. Thus, the
tax administration determines that the transfer price should have been 1,300 in year 0 instead of 700, and consequently, it adjusts to include the additional profits of 600.
In the first example, a correct projection of sales per year is made, although there is a change in the time of commercialization that changes the transfer price set ex ante. In contrast, in the second one, there is an underestimation of the estimated sales per year that also affects the transfer price set by the parties. In any case, the guidance does not deal with the way in which the tax administration makes the adjustments even when it mentions, later on, that the adjustments may be implemented by re-assessing the initial price or, in a form more consistent with what unrelated parties would have done, i.e., adopting “an alternative payment structure”.83 Also, the guidance does not provide clarifications on how the
presumptive evidence can be rebutted by the taxpayer, demonstrating that the ex-ante valuation was done with the foreseeable probability of the developments or events affecting the transaction84. Instead,
the guidance obviates85 the discussion regarding the foreseeability of the events or developments that
altered the outcome from the projections made by the taxpayer and focuses on the application of the adjustments to be performed,86 without providing suitable guidance for the taxpayer, but only from the
side of the tax administration87.
82 ibid 29. 83 ibid 31.
84 Johan Hagelin, ‘Ex Post Facto Considerations in Transfer Pricing of Hard-to-Value Intangibles: Practical and Methodical Issues with the HTVI Approach’ (2018) 26 International Transfer Pricing Journal 50, 53. 85 Navarro (n 65) 172.
86 ibid.
4. Tensions between the ALP and the HTVI approach
Now that the antecedents and main features of the HTVI approach have been set out in the previous chapters, it is appropriate to analyze the tensions of this methodology with the ALP. To do so, the specific tensions between the above-mentioned approach and the ALP will be studied in section 4.1., and the normative conflicts arising from this tension within the context of different normative systems will be analyzed in section 4.2.
4.1. Main arguments for the incompatibility of the HTVIs approach with the ALP
The HTVIs approach is in contradiction with the ALS because its application is virtually automatic, i.e., it is excessively difficult for the taxpayer to rebut the presumption that lies over him as a consequence of the actual outcome of the transaction that differs significantly from the ex ante valuation. Therefore, it is hardly possible to prove that the transaction involved a HTVI and that adequate measures were not taken to mitigate the uncertainty in the valuation of the intangible because the developments or events that led to the significant difference in the outcome were not known or reasonably foreseeable at the time the transaction took place.
These reversal of the burden of proof over the taxpayer is ultimately what condemns the HTVI approach and the possibility to make periodic adjustments to its incompatibility with the ALS for two main reasons: (i) the reverse onus transforms the presumptive character of the ex-post outcomes in a prohibited use of the hindsight to assess the transaction, and (ii) it permits to the tax administration the performance of transactional adjustments not in an exceptional manner, but almost in an automatic form. This section will explain first these two disconformities of the HTVIs approach with the ALP and then it will make reference to the burden of proof.
4.1.1. The use of hindsight
The use of ex post outcomes for the application of the HTVI methodology is not in accordance with the ALP because it supposes the use of hindsight. The OECD TPG states in various paragraphs88 that care
should be exercised to avoid the use of hindsight for TP purposes and some authors even consider that its use is banned89. This means that the arm’s length conditions of transactions carried out between
associated enterprises must be assessed on an ex ante basis or with the information available at the time the transaction took place90 and not based on the actual outcome of the operation. This element or
requirement of the ALS is consequent with its rationale, according to which the transactions conducted between associated enterprises should emulate those carried out between independent parties in free market conditions91 and based on the existent situation at the time the negotiation took place92.
The ex ante valuation has been recognized by the judiciary in various countries. In the United States, the Tax Court stated in both R.T. French Co.93 and Bausch & Lomb Inc.94 that the arm’s length nature
of an agreement is determined based on the facts when the transaction took place. Similarly, in the United Kingdom95 this rule has also been acknowledged proscribing the use of hindsight and confirming
that the assessment of the transactions carried out by the parties must be done looking at the conditions made or imposed at the time of the transaction. Lastly, in India, the ITAT96 recognized the position of 88 OECD, TPG17 para 2.136, 3.73, 3.74, 8.20, 9.24.
89 Jens Wittendorff, ‘Consistency: Domestic vs. International Transfer Pricing Law’ [2012] Tax Notes International 8, 1130.
90 OECD, TPG17 para 3.69.
91 Wittendorff, ‘Consistency: Domestic vs. International Transfer Pricing Law’ (n 91) 1130. 92 Bullen (n 35) 14.2.2.1.
93 ‘US: USTC, 6 September 1973, R.T. French Company v. Commissioner, No. 5026-70, Tax Treaty Case Law IBFD’ (n 13).
94 ‘US: US Court of Appeals for the Second Circuit, 14 May 1991, No. 89-4156, Tax Treaty Case Law IBFD’. 95 ‘UK: CHRMC, 31 March 2009, DSG Retail Ltd v. Her Majesty’s Revenue and Customs, TC00001, Tax Treaty
Case Law IBFD’.
the taxpayer according to which the ex-ante valuation, based on the future revenue projections of the intangible property transferred to its foreign associated party, was in accordance to the ALP and was not susceptible to be modified by the actual revenue.
Furthermore, some commentators argue that the ex-ante valuation and the consequent proscription of hindsight should be explicitly recognized as a principle within the TPG.97 In this vein, Bullen sustains
that although the TPG just makes reference to this norm in some of their paragraphs, the ex-ante valuation should be considered as the adopted approach for the application of the ALS.98 This position
is buttressed by the Reports of the OECD’s Task Force on the US Transfer Pricing Proposed Regulations, which warned that the CWIS might be in contradiction with the ALP because it involved the application of hindsight through a “year-by-year retrospective reappraisal based on profits”.99 Therefore,
according to the OECD’s Report, the elimination of this contradiction should be made by “restricting the examination to profits which could reasonably have been foreseen given the terms of the underlying transaction”. 100 By the same token, the TPG suggests that the information that should be used for the
assessment of a transaction is that “known or reasonably foreseeable […] at the time the transaction [was] entered into”.101
Nevertheless, ex post information can have some evidential value102 and be taken into account to carry
out further inquiries by the tax administration103 in relation to a transaction, but not to assess the
foreseeability of the information surrounding the transaction and its compatibility with the ALS.104
In the HTVI methodology, the OECD explicitly states that the use of ex-post outcomes provides presumptive evidence of the uncertainty at the time of the transaction and does not constitute the use of hindsight105 because it permits the taxpayer to rebut such presumptive evidence as to demonstrate
that the developments or events affecting the actual result could not have been reasonably foreseeable.106 The methodology intends to solve the problem of information asymmetry between tax
administration and taxpayer by presuming that the latter is in a better position to determine the developments or events that might be reasonably foreseen in the valuation of a transaction involving a HTVI.107 However, the truth is that this approach does not constitute a real solution to the information
asymmetry problem because the developments affecting the market situations cannot be foreseen by neither “the taxpayer nor the tax administration”.108 In fact, the methodology is only transferring the
problem from the Administration to the taxpayer109 without the provision of clear criteria of the
requirements for a successful rebuttal of the presumptive evidence110 and establishing a presumption
that “is not based on a lack of cooperation on the side of the taxpayer, in which case it would be reasonable for him to bear the burden of proof”.111 This issue might be exacerbated when the taxpayer
ignores the ex post information used by the Authority when performing a TP adjustment.112 All in all, the
guidance creates a new legal uncertainty problem regarding the eventual performance of periodic
97 Helmut Becker, ‘The New OECD Report on Transfer Pricing - A First Overview and Comment’ (1994) 22 Intertax 356, 358.
98 Bullen (n 35) s 14.2.2.2.
99 OECD, ‘Reports of the Task Force of the OECD Committee on Fiscal Affairs on US Transfer Pricing Proposed Regulations (1993)’ (n 22) ch 3, Part I., A., (i).
100 ibid Part II., F.
101 OECD, TPG17 para 2.136.
102 Wittendorff, Transfer Pricing Arms Length Principle International Tax Law (n 7) 689. 103 Bullen (n 35) s 14.2.3.5.
104 ibid.
105 OECD, TPG17 para 6.188. 106 ibid 6.193, 6.194.
107 ibid 6.186.
108 Simon Hoffmann, ‘International Hard-To-Value Intangibles and the Pricing of Uncertainty’ 10, s 4.2. 109 Navarro (n 65) 177.
110 Hagelin (n 86) 56. 111 Navarro (n 15) s 5.3.3. 112 Navarro (n 65) 177.
adjustments, which will be borne by the taxpayer.113
Accordingly, the restrictions in the rebuttal of the presumption to demonstrate that the events or developments, occurred after the transaction took place, were not known or reasonably foreseeable, are in contradiction with the ALP.
4.1.2. Transactional adjustments
The HTVIs methodology uses ex-post outcomes as presumptive evidence to permit the tax administration to perform transactional adjustments. The performance of these adjustments under the approach adopted by the OECD in sections D.3, dealing with the measures to mitigate the difficulties in the uncertainty of intangibles, and D.4, dealing with HTVI, of chapter VI of the TPG is in contradiction with the ALP.
It is clear that article 9(1) MTC covers within its scope TP valuation adjustments, according to which it authorizes the modification of prices, profits or margins of the transaction made or imposed by the associated enterprises. However, it is debatable whether the scope of the article reaches transactional or structural adjustments, i.e., adjustments to the contractual conditions agreed upon by the parties. These kinds of adjustments might rival with the as-structured principle recognized by the OECD since its 1979 Report and according to which the transfer pricing adjustments should “recognize the actual transactions as the starting point for the tax assessment and not, in other than exceptional cases, to disregard them or substitute other transactions for them”.114 Similarly, this principle is recognized in the
2017 OECD TPG which states that “[i]n performing the analysis, the actual transaction between the parties will have been deduced from written contracts and the conduct of the parties”.115
The adoption of this principle for the purposes of transfer pricing adjustments forces to question whether article 9(1) covers these kinds of adjustments, and if that is the case, whether it authorizes them or contends them. This debate has already been recognized116 in the academic literature pointing out the
two opposing positions regarding its compatibility with the ALS. On the one hand, the provision might be interpreted as not dealing with these adjustments, which would be outside of its scope117 and which
legitimation by the OECD TPG would not be more than a response based on policy considerations and not technical principles of interpretation.118 Thus, the recharacterization of the controlled transaction
would be an issue governed entirely by domestic law119 according to domestic substance-over-form
rules in a previous moment to the application of the ALS.120 However, the treaty provision might cover
these kinds of adjustments when they do not represent a substance-over-form conflict121 and
accordingly, article 9(1) would “restrict a transactional adjustment which is triggered solely by a transfer price that deviates from the arm’s length price”.122 Hence, the domestic recharacterization would not be
authorized by the treaty in these cases123 and, in conformity with art. 3(2) MTC, the context would
113 Xaver Ditz, Sven-Eric Bärsch and Christian Engelen, ‘Comments Received on Public Discussion Draft. BEPS Action 8 Implementation Guidance on Hart-to-Value Intangibles’.
114 OECD, ‘Report on Transfer Pricing and Multinational Enterprises’ (n 43) para 23. 115 OECD, TPG17 para 1.120.
116 Amir Pichhadze, ‘The Non-Recognition and Recharacterisation of Contracts in Transfer Pricing: Exposing the Tensions with Private Contract Law’ (2017) 23 New Zealand Journal of Taxation Law and Policy 516, s 3.0. 117 Wittendorff, Transfer Pricing Arms Length Principle International Tax Law (n 7) 167.
118 ibid 169.
119 Jens Wittendorff, ‘OECD Misinterprets Controlled Transactions’ [2015] Tax Notes International 461, 470, 472. 120 Wittendorff, Transfer Pricing Arms Length Principle International Tax Law (n 7) 157.
121 ibid 159. 122 ibid.
123 Although under this position transactional adjustments might not be authorized in art. 9(1) MTC, it is possible for States to adopt them in their domestic legislation and provide them with “separate legal authority” as in the case of Germany or Canada when applying the CWIS. See Wittendorff, Transfer Pricing Arm’s Length Principle
