Transfer pricing is a mechanism to determine the pricing of transactions between companies that are part of the same group. A significant volume of global trade consists of international transfers of goods and services, capital and intangibles, such as intellectual property, within a multinational group. These are called intra-group transactions. According to the current international standards - the OECD's arm's length principle - transactions between related entities of a multinational group must be priced on the same basis as transactions between third parties under comparable circumstances. This arm's length principle is further elaborated in the OECD's Transfer Pricing Guidelines.
To apply the arm's length principle, it is necessary to identify the commercial or financial relations between the associated enterprises and to compare the conditions and economically relevant circumstances of transactions between associated enterprises, called controlled transactions, with those of comparable transactions between independent enterprises, which are called comparable uncontrolled transactions.
Why do we need to harmonise transfer pricing rules in the EU?
At European Union level, transfer pricing rules are currently not harmonised through legislative acts. While all Member States have in place domestic legislation that provides for some degree of a common approach by following the arm's length principle, even if its application is not identical across Member States, the definition of associated enterprises and the notion of control, which are pre-conditions to applying transfer pricing, differ between Member States. Certain Member States apply a threshold of 25% while others apply a threshold of 50% shareholding when it comes to determining whether the control criterion is met. The complexity of the transfer pricing rules also causes a number of other problems, such as:
- Profit shifting and tax avoidance, as transfer prices can be easily manipulated to shift profit and be used in the context of aggressive tax planning schemes.
- Litigation and double-taxation, as transfer pricing is more subjective than other areas of taxation and, for this reason, is sensitive to disputes, with tax administrations not always sharing a common interpretation.
- High compliance costs, resulting from businesses having to determine what prices could be regarded as arm's length, conducting studies, as well as compiling, maintaining and updating the related documentation.
A common approach to transfer pricing rules in the EU?
The European Commission’s proposal for harmonised transfer pricing rules within the EU and ensuring a common approach to transfer pricing problems. It incorporates the arm's length principle and key transfer pricing rules into EU law, clarifies the role and status of the OECD Transfer Pricing Guidelines and creates the possibility to establish common binding rules on specific aspects of the rules within the Union.
The proposal will increase tax certainty and mitigate the risk of litigation and double taxation. Moreover, it will also reduce the opportunities for companies to use transfer pricing for aggressive tax planning purposes.
Next steps
The Commission’s proposal must be agreed unanimously by all EU Member States in the Council before it can become law.