Transfer Pricing Times: Volume XI, Issue 6

Inside this Edition: OECD Provides an Update to the BEPS Project.  

On May 26, 2014, the Centre for Tax Policy and Administration, part of the Organization for Economic Cooperation and Development (OECD), held a webcast to provide the latest updates on the OECD Base Erosion and Profit Shifting (BEPS) Project. The OECD reiterated the purpose of the BEPS Action Plan, which is to help set tax standards that increase coherence, substance, and transparency across OECD member and non-member countries. The group reported that the timeline and deliverables listed in the BEPS Action Plan are operating as scheduled. They also indicated that the planned deliverables are expected to be approved by the OECD Committee on Fiscal Affairs in time to be presented to the G20 Finance Ministers in September 2014, followed by the full G20 during their Summit in November 2014. These deliverables aim to 1) address the challenges of the digital economy, 2) neutralize the effects of hybrid mismatch arrangements, 3) prevent tax treaty abuse, 4) encourage transfer pricing documentation and country by country (CbC) reporting, and 5) advocate use of multilateral instruments. The OECD also discussed progress on the transfer pricing aspects of intangibles, including delivery of another discussion draft in December 2014.

For each of the planned 2014 deliverables, the OECD walked through the steps taken to date, including public releases, public consultations, and task force/working party meetings. The group also emphasized that they carefully considered and modified draft documents based on commentary and consultations with stakeholders. This included review of the 462 comments totaling over 3,500 pages that were submitted to the OECD on these topics. Responses were primarily related to CbC and came from a variety of stakeholders, including businesses/lobbies (41%), law firms (40%), multinational corporations (10%), non-governmental organizations (5%), and academia (4%).

Key considerations and priorities received from developing countries related to the BEPS Project were also discussed. 

The consultation was broadcast live online and the full recording can be found here.

Considerations for Sales Principal Reorganizations

Many companies are considering operational reorganization in light of changing business and operational and tax environments. One such value chain reorganization is the relocation of an existing sales principal (also referred to as an existing distributor) from one country to another. This type of reorganization has become more common as companies choose to locate operations in countries that are more beneficial from an operational and/or tax perspective. At first pass, this type of change might seem relatively mundane; however, there are a number of considerations that need to be addressed.

Operational Considerations

The first set of considerations are operational, including (i) the ability to hire and retain personnel capable of managing the region and the related business risks of the principal; (ii) the need to minimize disruption to existing customer relationships; and (iii) the desire to maintain a smooth flow of products or services to customers. Changes in contracts can also provide opportunities for customers to renegotiate terms (e.g., pricing) and other aspects of the relationship. In addition, warehousing, product delivery, customs, information technology and systems, and all other mechanisms of the supply chain may need to be reoriented. As a result of these changes, customers may want operational and other guarantees if they are asked to transact with an entity or country with which they are unfamiliar. Consumer-facing companies, in particular, face significant problems if the changes are viewed unfavorably or require explicit customer approval. Clearly, a change in sales principal needs to be managed very carefully from an operational perspective so as to not disturb ongoing business operations.

Structure of the Change

Implementing a change in sales principal may be effected through a number of means, including (i) termination of the existing distribution agreements and establishment of new distribution agreements with the new entity; (ii) assignment of the distribution agreements from the existing distribution principal to the new one; (iii) re-domicile of the existing distributor into the new country of choice; or, (iv) legal entity reorganizations and mergers. Each of these mechanisms presents unique challenges based on the specific facts and circumstances of the case, with operational, legal, tax, transfer pricing, and valuation issues generally present. Some of the key issues are discussed below.

Legal Framework

The structure of the reorganization significantly affects the applicable legal framework. For this reason, contractual terms shaping the reorganization should be clearly laid out in the form of an intercompany agreement. Such terms may include governing jurisdiction and termination provisions, which will generally be respected by the courts / tax authorities if such terms meet the following criteria: (i) are consistent with local laws, (ii) have business purpose and economic substance, and (iii) the actions of the parties have been consistent with the agreements.1  

In this respect, it should be noted that some countries have local statutory provisions that serve to protect local interests or vulnerable parties. One of note for sales-related reorganizations is the European Council Directive EC/86/653 (EU Directive), which offers guidance to EU Member States on the protection of commercial sales agents through compensation upon termination of such agreements in many circumstances. 2 While this EU Directive is directly applicable to agency agreements, some EU Member States, such as Italy, Germany, Belgium, and Switzerland, apply similar concepts and protections to distributors in their domestic laws or courts in certain circumstances. Non-EU countries may also have similar statutory elements on their books.

Re-domicile and legal entity reorganization transactions are interesting alternatives to termination or assignment that may avoid the need to change existing customer or supplier agreements. They may also avoid a separate transfer of any valuable local marketing and operating intangibles that were developed and are beneficially owned by the existing sales principal. On the other hand, these arrangements need to tread a path through the relevant commercial and tax laws of the existing sales principal country, the new sales principal country, and the parent country. These types of transactions may also have other consequences, such as a deemed liquidation of assets at market value. Checking the legal and tax consequences of the alternatives is therefore critical step in deciding how best to proceed.

Ownership or Development of Distribution Intangibles

Another primary issue to consider is whether there are any intangibles that were developed and are beneficially owned by the existing sales principal. Any such assets may need to be considered either as a transfer under the transfer pricing rules or examined within a business or asset valuation context. Such intangibles might include customer lists, customer contracts, local brand names, other marketing intangibles, or service-related intangibles that may or may not include related goodwill depending upon the relevant countries’ rules and regulations.

The facts and circumstances behind the development of the existing distributor’s business are very important for this determination. Even if local sales and marketing intangibles clearly exist, how they were developed will have a strong bearing on whether any compensation for their transfer or assignment is required under the arm’s length standard, consistent with or beyond any statutory provisions or exit charges that might exist.

The OECD Transfer Pricing Guidelines for Tax Authorities and Multinational Enterprises (OECD Guidelines) provide some guidance relevant to the restructuring of the sales principal as a result of a realignment of the Company’s operations in Chapter VI – Special Considerations for Intangibles; and, Chapter IX – Transfer Pricing Aspects for Business Restructuring. This guidance recognizes the need for a thorough evaluation of the facts and requires compensation or an exit charge consistent with the arm’s length standard. It also questions whether compensation is required in situations where an existing distributor inherited the local business, bore little risk, or made no non-routine investments to the development of the market and any related marketing and distribution intangibles.
If some form of transfer compensation or exit charge is likely due, consideration then needs to be given to (i) its value; (ii) the ultimate transferee and transferor; and (iii) the form of consideration, for example a sale or commission, which may also affect its tax treatment in the jurisdictions of the payee and payor.

The OECD Guidelines and many other country transfer pricing regimes have evolving rules and guidance around the valuation of intangibles that in many cases are not entirely clear; the U.S. regulations and OECD “Discussion Draft on Considerations for Intangibles” (July 2013) are no exception. Given these uncertainties and those inherent in any intangible valuation, it is advisable to use multiple methods when performing a valuation, and take into account the viewpoints of both the transferor and the transferee. Ideally, there will be convergence and overlap in the results that support the value and positions taken. Depending on the relevant tax law and/or valuation standards being used, the valuation exercise may also need to take positions on the relevance of the economic life of the intangibles to the compensation payment, as well as the relevance of the pre-tax and post-tax positions of the parties. Some helpful guidance may be gleaned from the EU Directive and its interpretation in local laws and courts for the compensation or indemnity payments to sales agent agreement terminations.

Cost of Reorganization

Generally there will be transition costs incurred by all parties in any reorganization, whether the change involves a contract termination, an assignment, a re-domicile, or other legal entity restructuring. These costs can sometimes be significant and consideration must be taken to ensure the appropriate party bears those transition costs based on the characterization of the new arrangements that the company seeks to portray. In most cases, it is customary to compensate an existing distributor for any transition costs it incurs in an orderly transfer of the distribution activity, business, or assets.

It is clear, in conclusion, that a change of sales principal from one country to another is a potentially complex transaction requiring careful diligence, planning, and sound documentation in order to be successful operationally and avoid potential tax controversies.

Multistate Tax Commission (MTC) Launches Transfer Pricing Effort

On June 2, 2014, the Arm’s Length Advisory Group within the MTC met in St. Louis to begin the process of developing a multistate solution to effectively conduct transfer pricing audits at the state level. This was the first meeting since the project was announced by the MTC earlier this year. Participating states included Alabama, Florida, Georgia, Iowa, Kentucky, New Jersey, and North Carolina, as well as the District of Colombia. The immediate goal of the Arm’s Length Advisory Group is to develop an operational model by July 2015.

The initial meeting focused on the kinds of services MTC can provide to assist states with audits. Two potential solutions were discussed:

1) The MTC would develop institutional knowledge and economic expertise (potentially including staff economists) that could be utilized by each of the participating states in determining the value of intangible assets transferred intercompany. Questions did arise surrounding the usefulness of such expertise without access to taxpayer financial data required to perform a reliable calculation.

2) The MTC would establish a joint audit function for transfer pricing to facilitate the development of institutional knowledge, among other benefits. Open questions include how the joint audit function for transfer pricing would fit within the context of existing MTA joint audit framework (e.g., corporate income, sales and use, franchise, gross receipts tax audits), and which states, if any, would be interested in participating.

The group will meet throughout the summer, with their next meetings scheduled for June 25th and July 28th (during the 2014 Annual MTC Conference and Committee Meetings), to further discuss these issues. Both meetings will be open to the public.

For additional information on the MTC and its transfer pricing issues, see our previous article here.

Maruca Discusses the IRS Transfer Pricing Audit Roadmap

On February 14, 2014, the Internal Revenue Service (IRS) released its Transfer Pricing Audit Roadmap. The Roadmap was developed to provide guidance to IRS practitioners, including audit techniques and tools to assist with the planning, execution, and resolution of transfer pricing examinations. The Roadmap is intended as a practical, user-friendly toolkit that is organized around a basic audit timeline and provides advice and links to useful reference material. With the release of the Roadmap, the IRS is also providing taxpayers with insight into what to expect during a transfer pricing audit, intending to improve communications and efficiency for both the IRS and taxpayers. As part of this effort, Samuel Maruca, the head of the IRS Transfer Pricing Operations division, participated in a question and answer session on the Roadmap on May 27, 2014.

A key theme throughout the Q&A was the limited resources of the IRS and how the Roadmap can guide the IRS to more efficiently use these resources. Specifically, the Roadmap is intended to not only guide examiners in an audit, but also help them identify the most relevant issues upfront. This is part of an ongoing IRS effort to have field teams assess the facts and determine when and if there are relevant/meaningful issues on which the assistance of the national resources are warranted. Specifically, Maruca explained that by following the process prescribed by the Roadmap, field teams will be expected to develop all cases with the thoroughness of preparing for litigation, rather than taking an underdeveloped, aggressive position such as sending a case to appeals without full understanding of the underlying issues. To that end, taxpayers confident in their transfer pricing and aiming to get through an audit with as little friction as possible should lay out their case fully during examination, making it incumbent on the IRS to identify any remaining issues.

In closing the session, Maruca stressed that the Roadmap is an evolving document and taxpayer feedback is encouraged, as the IRS plans to release an updated document about every six months. A copy of the Transfer Pricing Audit Roadmap is available here.


1As set out in the Economic Substance Doctrine under Section 7701(o) of the US Health Care and Education Reconciliation Act of 2010 (Act), Pub. L. No. 111-152. Under section 7701(o), a transaction is treated as having economic substance only if it passes a conjunctive, two-prong test. Please refer to the IRS website at:

 2The EU Directive allows a choice between using the indemnity system or the compensation system. The Commission of the European Communities issued a report (COM(96) 364) on the differences in these two systems. Please refer to the European Commission’s website at:

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