Volume No. 14-06
As part of its work on Action 10 of the OECD/G20 Base Erosion and Profit Shifting (BEPS) Action Plan, the OECD released a draft revision to Chapter VII of its Transfer Pricing Guidelines on November 3.
The draft revision broadly aims to limit deductions for management fees and head office expenses in receiving jurisdictions. Management and headquarters services are viewed by the OECD to be problematic from a pricing information standpoint, given such transactions are viewed to occur rarely between independent parties. Using an approach reminiscent of the IRS services regulations re-write in 2009 and implementation through IRB 2007-3, the draft introduces a new category of services termed “low value adding”.
Meeting the “low value adding” definition is accomplished by the service type either being on one list or not being on another. Other measures proposed, such as determination of cost pools, demonstrating benefit, specific services, drafting service contracts, and allocation methods or “keys”, have been good transfer pricing practice worldwide among practitioners for many years and are simply written down for all to see.
The significant development in the draft is the proposal of a safe harbour profit mark-up of strictly between 2% and 5% on low value-adding services costs. This guidance does alleviate the need to research a services mark-up, and the trade-off with other proposed compliance steps seems on balance to benefit taxpayers in the long-run. How to pick a point in the range of 2% to 5% is left unexplained.
Some structural inconsistencies with other jurisdiction rules will need to be managed, however. The U.S. 482-9 Regs that use a 7% low mark-up threshold instead of 5%, and service centers or service hubs in low-cost jurisdictions (i.e. India, Poland, and the Phillipines) that charge arm’s length mark-ups greater that 5% by reference to local market conditions are examples of areas of conflict to watch.
Like the whales swimming free in modern harbours in the Stan Rogers tune, will simple or ‘low value adding’ services be accepted by the CRA if priced under the draft Chapter VII and spared the traditional harpoon of Section 247(2)(a) of the Act?
The CRA has been clear that transfer pricing safe harbours are not crossing our borders any time soon, and that a ‘facts and circumstances, case-by-case’ approach is the way to go. As Canada is a net importer of service fees, it will be interesting to hear CRA’s views on the Chapter VII draft. A profit safe harbour would simplify compliance and lead to less disputes over the reasonableness of a mark-up on basic service fees, and this may well provide an efficiency benefit to tax authorities like the CRA. Efficiency gains may however be limited in practice given service fee disputes often center around the benefit received from the service, and what services were actually rendered. CRA’s position has traditionally been that a mark-up should not apply on support or management services.
In case you were wondering, “Giving advice on tax matters” is listed as an example of a low value adding service. Comments are due from interested parties and their tax advisors in January 2015.
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