The European Union has recently proposed the introduction of a council directive on Transfer Pricing. The proposed directive would incorporate the arm’s length principle and key transfer pricing rules into the EU legal framework. It is intended to clarify the role and status of the OECD Transfer Pricing Guidelines across the European Union and would create the possibility of establishing common binding transfer pricing rules on specific aspects of transfer pricing. The Directive on transfer pricing is part of the Business in Europe: Framework for Income Taxation (BEFIT) package.
Article 4 of the proposed directive lays down the general rule on the application of the arm’s length principle by obliging all EU Member States to ensure that, where an enterprise engages in one or more commercial or financial cross-border transactions with an associated enterprise, such enterprise determines the amount of its taxable profits in a manner that is consistent with the arm’s length principle.
Associated Enterprises The directive aims to introduce a common definition of “Associated Enterprise”.
An enterprise will be classified as an associated enterprise if it satisfies one of the following conditions:
- A person participates in the management of another person by being in a position to exercise a significant influence over the other person.
- A person participates in the control of another person through a holding that exceeds 25 % of the voting rights.
- A person participates in the capital of another person through a right of ownership that, directly or indirectly, exceeds 25% of the capital.
- A person is entitled to 25% or more of the profits of another person.
Transfer pricing methods
Article 9 of the Directive proposes the use of one of the following transfer pricing methods to determine the arm’s length price:
- Comparable uncontrolled price method
- Resale price method
- Cost plus method
- Transactional net margin method
- Profit split method.
Other valuation methods
Member States shall still be allowed to use other techniques to arrive at the arm’s length price where:
- None of the methods mentioned is appropriate or workable in the circumstances of the case; and
- the selected valuation method or technique is consistent with the arm’s length principle and provides a more reliable estimate of the arm’s length result.
The proposed Directive is expected to regulate the following issues arising in the context of transfer pricing:
- The most appropriate method rule
- Identification of commercial or financial transactions
- Compensation and corresponding adjustments
- Comparability analysis
- Transfer pricing documentation
- Determination of the arm’s length range
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