On 6 June 2012, the Organisation for Economic Co-operation and Development (OECD) released a discussion draft entitled “Revision of the Special Considerations for Intangibles in Chapter VI of the OECD Transfer Pricing Guidelines and Related Provisions” (DDI). In it, the OECD proposes changes to long-standing principles that determine for income tax purposes the “arm’s length” compensation that related parties, such as entities within a corporate group, should pay each other for the transfer or use of intangibles.
The OECD’s request for public comments on the DDI resulted in a record volume of responses from the multinational business community and its advisors. Among the matters at issue is what constitutes “intangible property”. Historically, intangible property has included items such as patents and trade marks. Some tax authorities would like “intangibles” to include other items as well, such as a work force in place.
The DDI’s most direct attack on international business concerns the standards used to evaluate which affiliate within the multinational group is considered to be the “tax owner” of intangibles. It is the tax owner that is entitled to the financial returns generated by intangible assets and that will be taxed on the income they generate. The proposals, in essence, would provide intangible-related returns to an affiliate within the group only if it develops, enhances, maintains and protects the intangible assets. In a highly controversial move, the DDI would require that such activities be carried out in many cases by the employees of the affiliate that would like to claim the intangible-related returns for income tax purposes. In other words, outsourcing functions such as research, whether through affiliates or even through third parties (although including the latter may have been an error), would get in the way of the affiliate’s entitlement to intangible-related returns.
These proposals are intended partly to safeguard against multinational groups allegedly placing in tax havens affiliates with few, if any, business activities in order to claim intangible-related returns there and thereby reduce the group’s world-wide tax liability. However, the proposals would also affect affiliates outside tax havens that have substantial business activities and bear the costs and risks of the discovery, development, enhancement, maintenance and protection of intangibles. If adopted largely in their current form, the proposals would cause multinational groups to rethink current international tax and business strategies.
Fortunately, the DDI is only a preliminary discussion document. Industry and tax advisors have already pushed back on the extreme position against outsourcing and made recommendations in their comment letters. Certain tax authorities are also resisting aspects of the proposals, e.g., the US Department of the Treasury has already expressed strong reservations about the outsourcing attacks in the DDI. At the same time, however, other tax administrations are taking aggressive positions in tax audits and will be urging the OECD to adopt tough and unorthodox measures to correct perceived international tax abuses involving transfer pricing of intangibles.
The OECD will issue revisions to the DDI in the near future, following its November 2012 business consultation. Whatever the outcome, there will continue to be opportunities for effective business and tax planning in this important area.
McDermott Will & Emery submitted a comment letter on behalf of the Transfer Pricing Discussion Group that discusses numerous aspects of the OECD proposals. The letter is in the 28 September 2012 OECD compilation of comment letters, available at www.oecd.org.