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Recently, the Organization for Economic Co-operation and Development (OECD) issued the 2022 edition of the OECD Transfer Pricing Guidelines, which has mainly updated the following aspects:
• Guidance on the application of the profit split method.
• Guidance on the application of the approach to Hard-to-Value Intangibles.
• Guidance on financial transactions.
1. Application of the Profit Split Method (PSM)
The new Transfer Pricing Guidelines clarify when the PSM may be the appropriate transfer pricing method.
OECD specifies that the PSM could be considered as an appropriate transfer pricing method in the following scenarios:
(i) Each party of the transaction makes a unique and valuable contribution (a unique and valuable contribution includes not only the assets used, such as intangible assets, but also the functions performed);
(ii) The business operations are highly integrated, i.e. there is an inter-connection of the functions, risks and assets used undertaken by the parties to the transaction, so that the contribution of each party cannot be reliably measured separately;
(iii) The parties to the transaction share significant economic risks or each party bears closely related risks separately.
2. Approaches to Hard-to-Value Intangibles
According to the new Transfer Pricing Guidelines, the tax authorities may resort to asset valuation technology and expertise to evaluate the reasonableness of transfer pricing arrangement for Hard-to-Value Intangibles (HTVI).
Tax management related to intangible assets that are difficult to be valued and measured remain a complex and controversial point in transfer pricing. With the release of the OECD's 2022 Transfer Pricing Guidelines, it is likely that the Chinese tax authorities may pay more attention to the transaction of intangibles.
3. Guidance on Financial Transactions
The new Transfer Pricing Guidelines provide guidance on cross-border intra-group financial transactions (e.g. fund lending, guarantees, etc.), The determination of whether a financing arrangement is characterized as debt or capital may become a focus of international tax and transfer pricing analysis, and only interest arising from a debt-based financing arrangement could be eligible for pre-tax deduction/s.
In the absence of relevant regulations in China, the new OECD Transfer Pricing Guidelines may provide a more comprehensive reference and basis for the Chinese tax authorities and taxpayers alike in the future.
Our Observations
The new OECD Transfer Pricing Guidelines reflect a new potential focus for the tax authorities on multinational companies.
Considering the content of this update have not yet been promulgated in China, multinational companies are recommended to contact tax professionals and their overseas headquarters to discuss how to make reasonable arrangements in China in order to prevent potential transfer pricing risks.
If you would like to know more about the most recent tax and financial developments in China, or about the services mentioned above, please contact us at info@phcadvisory.com.
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