On 20 January 2022, the Organisation for Economic Co-operation and Development (OECD) released a new version of the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the OECD Guidelines). These guidelines provide guidance on the application of the "arm's length principle" for the valuation of cross-border transactions between associated enterprises. The OECD Guidelines give taxpayers a framework for their transfer pricing analysis and are followed by many tax administrations, including the Luxembourg tax authorities.
The new version of the OECD Guidelines replaces the 2017 edition of the guidelines. The 2022 version does not provide any new features as such; however, it consolidates into a single publication all changes that have been made since 2017.
Three important pieces of guidance have been incorporated:
- The new guidance on financial transactions,(1) which was the first OECD guidance to address transfer pricing aspects and the application of the arm's length principle to financial transactions. This guidance is now included in Chapter I and in the new Chapter X of the OECD Guidelines.
- The 2018 revised guidance on the transactional profit split method,(2) providing clarifications on when and how the profit split methods might be applied, as well as a number of examples to illustrate its application in practice. This revised guidance can now be found in Chapter II and Annex II to Chapter II of the OECD Guidelines.
- The 2018 guidance on the treatment of hard-to-value intangibles,(3) intended to provide a common understanding and practice among tax administrations on the application of adjustments under the hard-to-value-intangibles approach. This guidance is incorporated in a new Annex II to Chapter VI of the OECD Guidelines.
Moreover, the new version incorporates consistency changes that have been made to the rest of the guidelines.
Although the new the OECD Guidelines do not introduce major changes to the transfer pricing principles, taxpayers should be aware of them and should continue to monitor future changes to these guidelines in order to ensure their compliance with the arm's length principle.
The adoption of the new guidance on financial transactions is particularly relevant for companies operating in Luxembourg, especially for those involved in financing activities such as investment funds, or banking activities, as they may often be involved in transactions falling under the scope of the new guidance. In this context, the arm's length principle applies to determine what should be treated as debt for tax purposes, as opposed to equity. Intra-group loans should be analysed considering both lenders' and borrowers' perspective. Special consideration should be given to the creditworthiness of the borrowing entities by applying credit ratings either on a standalone basis or a group credit rating if the standalone rating is not available.
Although these provisions are not considered binding law, Luxembourg tax authorities follow and apply the OECD Guidelines. Therefore, the application of these provisions gives opportunity to tax administrations to recharacterise intra-group loans into equity, deny interest deductions and apply withholding tax where relevant. It is, therefore, strongly recommended that taxpayers ensure the alignment of their intercompany financial transactions to the arm's length principle.
On the other hand, Luxembourg companies should also be aware of the revised guidance on the transactional profit split method, especially if they are involved in highly integrated business operations. This method will typically be relevant for companies dealing with intangible assets such as intellectual property, involved in the provision of research and development (R&D) services or marketing services.
However, the profit split method is also relevant in the context of fund management services where highly specialised management services are provided by various parties in such an integrated manner that it is not possible to remunerate them separately.
Finally, the revised OECD approach on hard-to-value intangibles (HTVI) may be particularly relevant for companies involved in the transfer of intangibles or rights in intangibles for which no comparable exists at the time of the valuation, such as highly innovative or first-of-its kind products, developed by companies performing R&D activities. When determining the arm's length ex ante value of a so-called HTVI, the OECD Guidelines allow the use of ex post results of the use of an intangible. This approach can be used by taxpayers and tax administrations.
For further information on this topic please contact Frédéric Feyten or Imelda Navarro Arroyo at CMS Luxembourg by telephone (+352 26 27 53-1) or email ([email protected] or [email protected]). The CMS Luxembourg website can be accessed at www.cms.law.
(1) OECD report "Transfer Pricing Guidance on Financial Transactions" released on 11 February 2020.
(2) OECD report "Revised Guidance on the Application of the Transactional Profit Split Method" released on 21 June 2018.
(3) OECD report "Guidance for Tax Administrations on the Application of the Approach to Hard-to-Value Intangibles" released on 21 June 2018.