The European Commission on 12 September 2023 published a “Proposal for a council directive on transfer pricing“ that would harmonise transfer pricing rules within the EU as part of its Business in Europe: Framework for Income Taxation (BEFIT) package.
The package includes, in addition to the transfer pricing proposal that would integrate key transfer pricing principles into EU law with the aim of putting forward certain common approaches for member states, a second separate proposal that lays down a common set of rules for computing the tax base of large groups of companies in the EU.
If adopted, the new rules would be implemented by 31 December 2025 and would apply from 1 January 2026. The proposed directive would apply to all companies resident in an EU member state, and to permanent establishments located within the EU.
The complexity of the transfer pricing rules and their different implementation in the domestic law of member states gives rise to a number of other problems: profit shifting and tax avoidance, litigation and double taxation, and high compliance costs.
To achieve the objective of providing certainty for taxpayers, the Commission proposes establishing common binding rules in the area of transfer pricing by way of implementing acts. These implementing acts would provide taxpayers with a clear understanding of what tax authorities in the EU would consider acceptable to be used for specified transactions. They would also provide safe harbours that would reduce multinational entities’ compliance burden and the number of transfer pricing disputes.
Associated enterprises. The explanatory memorandum accompanying the proposed directive provides an example where the lack of common rules has led to tax uncertainty, high compliance costs, and time-consuming legal disputes leading. The domestic legislations of member states include differences in the definition of “associated enterprises,”’ particularly on the notion of “control,” which is usually the precondition for the application of transfer pricing rules. Some member states apply a 25% shareholding threshold to determine whether the control criterion has been met, whereas others apply a 50% threshold.
The proposed directive would introduce a common definition of associated enterprises (and therefore the transactions covered by transfer pricing regimes) across EU member states. Under the directive, an “associated enterprise” is a person who is related to another person in any of the following ways:
Transfer pricing methods. In line with the OECD Transfer Pricing Guidelines, the proposed directive refers to the following five transfer pricing methods:
The arm’s length range. The directive, unlike the Transfer Pricing Guidelines, provides that when the application of the most appropriate method produces a range of figures, the arm’s length range must be determined using the interquartile range. Moreover, according to the proposal, a taxpayer should not be subjected to adjustment when its results fall within the interquartile range, unless the tax administration or the taxpayer prove that a specific different position in the range is justified by the facts and circumstances of the specific case.
The package includes, in addition to the transfer pricing proposal that would integrate key transfer pricing principles into EU law with the aim of putting forward certain common approaches for member states, a second separate proposal that lays down a common set of rules for computing the tax base of large groups of companies in the EU.
If adopted, the new rules would be implemented by 31 December 2025 and would apply from 1 January 2026. The proposed directive would apply to all companies resident in an EU member state, and to permanent establishments located within the EU.
Background
The rationale for this proposal focuses on the status and role of the OECD Transfer Pricing Guidelines, which, according to the Commission, currently varies among member states. Moreover, transfer pricing rules are currently not harmonised through legislative acts, although all member states have in place domestic legislation that provides for a common approach to the basic transfer pricing principles. According to the Commission, “The fact that each Member State enjoys large discretion in interpreting and applying the OECD Transfer Pricing Guidelines gives rise to complexity and an uneven playing field for businesses.”The complexity of the transfer pricing rules and their different implementation in the domestic law of member states gives rise to a number of other problems: profit shifting and tax avoidance, litigation and double taxation, and high compliance costs.
Specific Proposals
The proposal focuses on three areas:- The arm’s length principle and possible consequences of applying this principle;
- Core elements that are relevant for applying the arm’s length principle; and
- A mechanism for establishing further common rules covering a limited set of subjects that will provide simplification and tax certainty for taxpayers on the interpretation and application of the arm’s length principle.
To achieve the objective of providing certainty for taxpayers, the Commission proposes establishing common binding rules in the area of transfer pricing by way of implementing acts. These implementing acts would provide taxpayers with a clear understanding of what tax authorities in the EU would consider acceptable to be used for specified transactions. They would also provide safe harbours that would reduce multinational entities’ compliance burden and the number of transfer pricing disputes.
Associated enterprises. The explanatory memorandum accompanying the proposed directive provides an example where the lack of common rules has led to tax uncertainty, high compliance costs, and time-consuming legal disputes leading. The domestic legislations of member states include differences in the definition of “associated enterprises,”’ particularly on the notion of “control,” which is usually the precondition for the application of transfer pricing rules. Some member states apply a 25% shareholding threshold to determine whether the control criterion has been met, whereas others apply a 50% threshold.
The proposed directive would introduce a common definition of associated enterprises (and therefore the transactions covered by transfer pricing regimes) across EU member states. Under the directive, an “associated enterprise” is a person who is related to another person in any of the following ways:
- The person participates in the management of another person by being in a position to exercise a significant influence over the other person;
- The person participates in the control of another person through a holding that exceeds 25% of the voting rights;
- The person participates in the capital of another person through a right of ownership that, directly or indirectly, exceeds 25% of the capital; or
- The person Is entitled to 25% or more of the profits of another person.
Transfer pricing methods. In line with the OECD Transfer Pricing Guidelines, the proposed directive refers to the following five transfer pricing methods:
- The comparable uncontrolled price method;
- The resale price method;
- The cost plus method;
- The transactional net margin method; and
- The profit split method.
The arm’s length range. The directive, unlike the Transfer Pricing Guidelines, provides that when the application of the most appropriate method produces a range of figures, the arm’s length range must be determined using the interquartile range. Moreover, according to the proposal, a taxpayer should not be subjected to adjustment when its results fall within the interquartile range, unless the tax administration or the taxpayer prove that a specific different position in the range is justified by the facts and circumstances of the specific case.
Next steps
The proposed directive is subject to the European Council’s unanimity requirement for adoption; thus, the next step will be for the 27 EU member states to discuss the proposal. During that negotiation process, changes to the current version of the proposal are likely.
If unanimity is achieved, the final version of the directives would be published in the Official Journal of the European Union, and member states would adopt the directive into their domestic legislation. The Commission has proposed that the member states finalise that process by 31 December 2025 and apply the directive’s provisions from 1 January 2026.
Betty Fernandez
BDO Global