Transfer pricing: Methodologies: OECD Guidelines: Cost contribution arrangements
The OECD devotes the entirety of Chapter VIII of the OECD Transfer Pricing Guidelines to ‘cost contribution arrangements’ (“CCAs”). These may sometimes be referred to loosely as ‘cost sharing arrangements’ but the principles in Chapter VIII will still apply to them.
As noted in Paragraph 8.3 of the Guidelines, a CCA is a contractual arrangement for enterprises ‘to share the contributions and risks involved in the joint development, production or the obtaining of intangibles, tangible assets or services with the understanding that such intangibles, tangible assets or services are expected to create benefits for the individual businesses of each of the participants.’ Key features of the CCA concept are that:
- its participants have the expectation of mutual benefit from the activity and agree to share the contributions to that activity in proportion to the benefits each expects to obtain; and
- each participant may exploit the interests, rights or entitlement resulting from the activity which it can exploit separately in its own interests without payment of consideration other than the contributions it makes as a participant and any balancing payments made to other participants within the CCA.
However, it is important to note that there is no difference in the approach for analysing transfer prices for CCAs from that for analysing any other transaction and, in particular, that parties performing activities under similar economic circumstances should receive the same expected return whether those activities are carried out within the contractual framework of a CCA or not
The guidance in other Chapters of the OECD Guidelines is equally applicable to the analysis and pricing of transactions between associated enterprises carried out through a CCA as to those carried out in any other circumstances. CCAs between unrelated enterprises are not common in most sectors of industry perhaps because independents tend to favour other structures for sharing costs or pooling resources. That is no reason to question the bona fides of a CCA between associated enterprises as there are often good commercial reasons for them to seek to share costs including
- spreading the risk and thus reducing the potential for large losses from an activity, e.g. on long-term, capital intensive R&D projects with a high chance of failure
- utilising the different skills and resources of separate entities within an MNE to make possible a venture that might otherwise be beyond any single one of them
- achieving savings through economies of scale and removing duplication, e.g. by obtaining services in common
- avoiding a complicated web of intra-group agreements charging royalties or service fees
Accordingly, CCAs can be viewed as an alternative mechanism for establishing the sort of collaborative arrangements for the sharing of costs and pooling resources that are commonly seen, though perhaps in different form, between third parties.
It is nevertheless important, if the level of tax risk warrants it and subject to the transfer pricing governance at INTM481000 onwards, to consider a CCA carefully to ensure that the methods employed to share contributions amongst its participants do not differ from those that would have been agreed between independents in similar circumstances.
It is also important to note that, as with any transfer pricing analysis, although the contractual agreements and arrangements form the starting point for delineation of the actual transaction or transactions, it is necessary undertake a full comparability analysis including consideration of the conduct of the parties and particularly the control of risk to accurately delineate the actual transaction(s). See INTM485022 – INTM485024
Types of CCAs
Paragraph 8.10 of the Guidelines refers to the two types of CCAs commonly encountered. These are:
1. Development CCAs
These are CCAs established for the joint development, production or obtaining of intangible or tangible assets. Generally these would be expected to create ongoing future benefits for participants. They often involve significant risks arising from the uncertainty of the outcome of the development and hence of the benefits.
2. Services CCAs
These are CCAs established for obtaining services for the participants. A significant difference from development CCAs is that they will generally create only current benefits for participants.
Participants in a CCA
A participant in a CCA should have a reasonable expectation that it will benefit from the objectives of the CCA (for example, use of the services to be obtained or exploitation of rights in the intangible to be developed) rather than just from performing part of the subject activity. Where it does not have such an expectation but carries out the activity which is the subject of the CCA, it should be appropriately rewarded for that activity but will not be considered a participant in the CCA. Thus, for example, where a CCA is established with the objective of developing an intangible, a party that carries out research activities with regard to that development but is not assigned an interest in any intangible that results will not be a participant within the CCA.
Expected benefits from the CCA
The expected proportionate share of the total benefits from the CCA that each participant anticipates receiving should be estimated using an appropriate form of measurement. In the case of a services CCA this might typically be by means of an allocation key such as sales, profits, number of employees etc. For the participants in a development CCA projected profits arising from exploitation of the participants rights in the asset might be the most appropriate measure. The guidance on hard to value intangibles (INTM441130) may be applicable in determining the expected benefits to the participants from a CCA whose objective is the development of intangibles.
Value of contributions to the CCA
If contributions are not in line with those that independents would have agreed in similar circumstances, they should be adjusted in line with paragraph 8.34 of the Guidelines. Paragraph 8.37 advises that, generally, adjustments based on evidence from a single year should be avoided in the case of development CCAs. That is because development CCAs are often long-term projects where costs and benefits may need to be measured over a period of years.
The guidance on hard to value intangibles (INTM441130) may also be applicable in determining the value of each participant’s contribution.
Where the respective contributions of the participants to a CCA are not proportionate to their respective shares in the expected benefits from the objectives of that CCA, balancing payments should be made by the participant(s) whose shares of contributions are inadequate to the participant(s) whose shares of contributions are excessive to rectify the imbalance. Detailed guidance on this process is provided at paragraphs 8.34 to 8.38 of the Guidelines.