Transfer pricing: Methodologies: OECD Guidelines: Overview
Key international standards
The Organisation for Economic Co-operation and Development (OECD), based in Paris, is a forum for member countries to discuss and compare policy approaches to a wide range of issues, including taxation. In the course of its work, it has developed a number of key international standards, including:
- The Model Tax Convention on Income and on Capital (often referred to as ‘MTC’): This is a model tax treaty, devised by OECD members to form a basis for double taxation agreements between member countries. All the United Kingdom’s agreements entered into since the publication of the MTC was first published in 1992 have been based on it with appropriate variations to take account, where necessary, of the differing economic circumstances and tax and legal systems of the two countries.
- The Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (often shortened to ‘TPG’): This is a set of recommendations to assist in dealing with transfer pricing issues, either from the point of view of a business trying to devise or improve its own transfer pricing policy or that of a tax administration. It is recommended reading for those embarking on a transfer pricing review.
Interpretation of transfer pricing legislation must be consistent with Article 9 (the ‘Associated Enterprises Article’) of the OECD MTC - see INTM420010 - and in accordance with the Transfer Pricing Guidelines.
OECD Transfer Pricing Guidelines
Reference to the OECD Transfer Pricing Guidelines means:
- For corporation tax accounting periods beginning prior to 1 April 2011 or income tax years 2010-2011 or earlier, documents published by the OECD before 1 May 1998 (‘the 1995 Guidelines’).
- For corporation tax accounting periods beginning on or after 1 April 2011 or income tax years 2011-2012 or later, the Transfer Pricing Guidelines approved by the OECD on 22 July 2010 (‘the 2010 Guidelines’).
- For corporation tax accounting periods beginning on or after 1 April 2016 or income tax years 2016-17 or later, the Transfer Pricing Guidelines approved by the OECD on 22 July 2010 (‘the 2010 Guidelines’) as amended by the BEPS Final Report on Actions 8-10 published by OECD on 5 October 2015:
It is anticipated that in the vast majority of cases the application of any version should result in the same outcome given that the fundamental purpose of all is to provide guidance to assist in confirming or establishing the arm’s length price for the tested transaction. The 2010 Guidelines contain considerably expanded practical guidance on carrying out comparability analyses and the application of the transactional profit methods (see INTM421020 and INTM421070 to INTM421080). It will therefore be useful and informative to refer to them with regard to any accounting periods under consideration. The 2015 updates contain additional guidance on comparability analyses including, in particular, comparability analyses and accurate delineation of the controlled transaction (INTM485020 onwards) the use of quoted prices for commodity transactions (INTM421041) intangibles (INTM440110 onwards), intra-group services (INTM440060 onwards), and cost contribution arrangements (INTM421090). However, the strict statutory position remains that the 2010 Guidelines apply for corporation tax purposes only to accounting periods beginning on or after 1 April 2011, and for income tax purposes for the tax year 2011-2012 and subsequent tax years in accordance with TIOPA10/S164(4) and FA11/S58 and the 2015 updates apply for corporation tax purposes only to accounting periods beginning on or after 1 April 2016, and for income tax purposes for the tax year 2016-2017 and subsequent tax years in accordance with FA16/S75.
Except where otherwise stated, references in these instructions to paragraphs within the OECD Transfer Pricing Guidelines are to the 2010 version as updated and expanded by the 2015 Final BEPS Report on Actions 8-10.
Of necessity the Guidelines are written in very broad terms.
This section of the guidance is an introduction to the transfer pricing methodologies set out in the Guidelines. It is not a substitute for the Guidelines, which should always be referred to for further detail. Cross-references to the relevant section of the Guidelines appear throughout this chapter.
OECD methodologies: summary
The OECD Guidelines consider five methods for reaching the arm’s length price which are divided into traditional transactional methods and transactional profit methods. This manual covers each method in more detail as follows.
Traditional transaction methods
- Comparable uncontrolled price (CUP): see INTM421030 and INTM421040
- Resale minus: see INTM421050
- Cost plus: see INTM421060
Transactional profit methods
- Profit split: see INTM421070
- Transactional net margin method (TNMM): see INTM421080
It should also be noted that paragraph 2.9 of the Guidelines permits the use of ‘other methods’ not described in the Guidelines provided that they establish prices which satisfy the arm’s length principle (see INTM484080).
The paragraphs in the Guidelines on each method contain guidance on how to arrive at the arm’s length price. The overarching premise is that, for the purpose of establishing profits for tax purposes, the price between connected parties should be the same as would have been charged between unconnected parties.
“Most appropriate” method
The 1995 Guidelines expressed a strict hierarchy of methods with the Comparable Uncontrolled Profits method being the preferred method and transactional profit methods being termed methods of ‘last resort’. The 2010 Guidelines retain a so-called ‘natural hierarchy’ - expressing a preference for traditional transaction methods over transactional profit methods where both can be applied in an equally reliable manner and, similarly, a preference for the Comparable Uncontrolled Price method over others - but place emphasis on use of the most appropriate method for a particular case (paragraphs 2.2 and 2.3). See also INTM484070.