17 November 2023 — Publication
The European Commission (EC) has proposed a legislation on transfer pricing to reduce tax compliance costs for SMEs that engage in cross border business using a permanent establishment. This Directive is part of the EC’s BEFIT package released on 12 September. It aims to harmonise EU transfer pricing rules and tax treatment of intra-group transactions. Accountants should consider the proposal’s impacts on clients that have cross border transactions with associated enterprises.
This webpage provides the key features of the proposal. For more details, please refer the proposed Directive full text.
As this is a proposed Directive, all details and timelines are subject to change during the legislative process.
Transfer pricing rules are not harmonised in the EU. Member States have a considerable discretion in interpreting and applying the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (‘OECD Guidelines). This “gives rise to complexity and an uneven playing field for businesses” according to the EC.
The EC specifically mentions differences between Member States’ definitions of ‘associated enterprises’, the thresholds for which can vary between a 25 and 50%. This creates barriers to cross border operations and leads to the risk of double or over-taxation.
The EC also highlights additional issues from non-harmonised transfer pricing rules such as profit shifting and tax avoidance by cross-border businesses, increased litigation, and high compliance costs.
The proposal has four objectives:
Member States are required to ensure that businesses engaged in cross-border commercial or financial transactions with an associated enterprise use the arm’s length principle.
Where transactions are not conducted on an arm’s length basis, Member States are required to include the appropriate amount of profit that would have been included had the transaction been conducted at arm’s length in the tax assessment and tax the additional profits. This is the primary adjustment.
Associated enterprises are broadly defined as those over which significant influence or common control is exercised or where direct or indirect holding of over 25% of the share capital, right to profits etc. exist (see Article 5). Associated enterprises includes permanent establishments.
Where a primary adjustment has been made, Member States must ensure that they make a corresponding adjustment to prevent double taxation, subject to all the following conditions:
Corresponding adjustments can also be granted under mutual agreement procedures (MAP). Taxpayers can also request them, provided that the taxpayer’s request contains all of the following information:
If double taxation has occurred, Member States are obliged to conclude the corresponding adjustment within 180 days of receipt of the taxpayer’s request irrespective of whether the request has been accepted or rejected.
Member States are also obliged to accept a compensating adjustment requested by a taxpayer in the form of a year-end adjustment if certain conditions are met (Article 7).
Member States are obliged to ensure that their transfer pricing rules are applied in a manner consistent with the OECD Guidelines. This is part of the transposition of the proposed Directive into national law.
As the OECD Guidelines are periodically updated, a mechanism will need to be introduced so that updates to the Guidelines are also reflected in EU and national law.
Member States must ensure that the arm’s length price is determined by applying the most appropriate transfer pricing method to the circumstances of the case, by default by ensuring that one of the five transfer pricing methods listed in Article 9 is used.
However, Member States must also permit businesses to use an alternative to the five prescribed methods if it can be demonstrated that:
Member States must evaluate whether a transaction is at arm’s length by comparing its conditions with the conditions that would have existed for a comparable transaction under comparable circumstances had the associated enterprise been independent.
Such factors as legal terms, functions performed and business strategies must be compared (the full list of factors is in Article 11 2.). The transactions are comparable if material differences do not exist or if reasonably accurate adjustments can be made to eliminate any material differences.
Where the application of a transfer pricing method produces a range of values, Member States must ensure that the arm’s length range is determined between the 25th to the 75th percentile of the results obtained between unconnected enterprises.
Member States are obliged to ensure that affected enterprises have ‘sufficient information and analysis’ available to verify the assessment of:
The proposed Directive gives the right to the EC to adopt delegated acts in the future to further harmonise documentation – such as common templates, setting linguistic requirements and specifying which types of taxpayers would be obliged to use such templates and timelines.
The proposed Directive gives the right to the Council to lay down further rules specifying how the arm’s length principles are to be applied to specific transactions, such as transfers of intangible or hard to value assets, financial transactions etc.
Any such specific rules must be consistent with the OECD Guidelines.
The proposals would be applied to all taxpayers that are registered in, or subject to, corporate income tax in one or more Member States, including permanent establishments. It is proposed that the rules would come into effect on 1 January 2026.
The proposals should provide significant benefits for businesses that have cross border transactions with associated enterprises.
In particular, there should be a reduction in administrative costs from Member States taking a common approach and for faster corresponding adjustments would be very useful.
The commitment to remain as close as possible to the OECD Guidelines will be beneficial for those businesses that also have transactions with associated enterprises in third countries.
However, it will not completely remove all differences in the treatment of transfer pricing between Member States as, for example, considerable divergences exist at a more granular level – for example, how Member States’ tax authorities believe that specific transfer pricing methods should be applied. The proposals do not contain any provisions to force Member States to agree on such issues or propose additional forms of dispute resolution other than the MAP or that contained in the tax dispute resolution Directive.
The proposal will follow the normal legislative process for a tax file, meaning unanimity decision by all EU Member States in the Council, and a non-binding opinion by the European Parliament.
[1] “‘arm’s length principle’ means the international standard that prescribes that associated enterprises must transact with each other as if they were independent third parties”.
