OECD Consults On Transfer Pricing Guidelines

by Jason Gorringe, Tax-News.com, London

16 March 2006

As part of its procedures for monitoring the implementation of its 1995 Transfer Pricing Guidelines, the OECD Committee on Fiscal Affairs has invited comments on the application of transactional profit methods.

The OECD is particularly concerned with comparability issues encountered when applying the transfer pricing methods authorised by the 1995 TP Guidelines (i.e. the profit split methods and the transactional net margin method which are described in Chapter III of the 1995 TP Guidelines).

It is expected that the ultimate outcome of the review of transactional profit methods should be a revision of Chapter III of the 1995 TP Guidelines.

Says the OECD: 'We believe it is essential for our work to benefit from input from the business community and from other interested non-governmental parties'.

Under the profit split method, the total profit of the transaction made between the non-arm's length parties is allocated on a fair basis to each of the parties. Profits are usually calculated before taxes and interest and some cases gross profit is used. The allocation will depend on such factors as functions performed, assets used and risks assumed by each of them, in other words, each of their contributions.

Under the transactional net margin method (TNMM), an arm's length net profit margin is determined and applied to the total cost of the transaction in order to calculate the notional net profit. Adding this notional net profit to the total cost gives the transfer price.

Says the UK's HMRC: 'TNMM is the OECD method most commonly used for justifying the transfer pricing of a company and it is also (along with cost plus) one of the most misunderstood methods. In some cases the case for a TNMM approach is based on little more than a list of supposedly comparable companies, whose results are within a range that encompasses those of the company under review . It may therefore be argued that its prices are arm's length. This is only a benchmarking method, since the results of the company under review are benchmarked by reference to other companies which are only superficially similar. This approach is in reality a comparable profits method (all it shows is that the profits of the company are comparable to those of other supposedly comparable companies), which is acceptable only to the extent that it is consistent with the OECD Transfer Pricing Guidelines.'

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