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In a significant development, the European Parliament has endorsed amendments proposed by the Economic and Monetary Affairs Committee (ECON) to the Transfer Pricing Directive (TPD). These amendments, aimed at refining transfer pricing regulations within the European Union (EU), signal a pivotal step towards harmonizing transfer pricing practices and promoting fairness in cross-border transactions. 

The prevailing view across the globe advocates adherence to the Arm’s Length Standard in transfer pricing matters, a principle that ensures transactions between associated enterprises are conducted at prices comparable to those between unrelated parties. However, concerns have mounted regarding the abuse of transfer pricing rulings by multinational enterprises (MNEs), prompting the EU Commission to scrutinize such rulings for any indications of prohibited state aid. 

Recent judicial rulings, such as the Fiat Case C-885/19 and Amazon Case C-457/21, have underscored the complexity surrounding the application of the Arm’s Length Principle within the EU. While the Commission has sought to establish a uniform interpretation of the principle, courts have often ruled against its position, emphasizing the need for recognition by national laws and adherence to detailed rules defined therein. 

The lack of harmonization in transfer pricing regulations has given rise to various challenges, including profit shifting, tax avoidance, litigation, double taxation, and high compliance costs. Recognizing the need to address these issues and enhance the competitiveness of the Single Market, the EU Parliament has approved amendments to the TPD proposed by the ECON. 

The initial proposal (issued on 12th September 2023) contemplated 2 different options as to how this directive enters into force. The preferred option, which was ultimately transposed via this Directive, opts to include the OECD arm’s length principle and TP Guidelines in EU law alongside a gradual development of common approaches vis-à-vis TP approaches. The Directive proposed had some notable adjustments from the initial option, including the omission of TP anti-abuse rules and the introduction of binding regulations (‘safe harbours’) for certain transactions, aimed at fostering coherence and consistency in transfer pricing practices.  

The below covers the key salient points of the amended TP Directive:  

Harmonisation of the definition of associated enterprises 

Currently, there is no common definition of associated enterprises within the European Union. The TPD introduces a standardised definition for related parties, integrating a criterion associated with exerting substantial influence in another entity’s management. It also incorporates the 25% threshold, whether relating to voting rights, capital ownership, or entitlement to 25% or more of another entity’s profits. This initiative seeks to synchronise regulations across nations currently employing varying thresholds. Additionally, the TPD specifies that a permanent establishment shall be deemed an associated enterprise of the enterprise it belongs to. Moreover, it is yet uncertain if the existing definition of permanent establishment, characterised as a “fixed place of business”, will be expanded to accommodate Agency PEs or Service PEs.  

Corresponding & Compensating Adjustments 

The EU TPD includes provisions to streamline corresponding and compensating adjustments. As per the proposal’s wording, when a Member State enacts a primary adjustment, the reciprocal Member State must affect a corresponding adjustment, subject to certain conditions. Originally, the proposal’s initial draft stipulated a 30-day admissibility period for Member States, with a 180-day window to reach a final decision regarding the corresponding adjustment. Following amendments by ECON, this timeframe has been extended to a 40-day admissibility period and a 200-day timeframe for final deliberations. Additionally, it allows Member States, with agreement from all involved parties (Member States and taxpayers), a one-time extension of 100 days. This measure aims to prevent cases of double taxation or ensure its mitigation where it occurs.  

Regarding compensating adjustments, paragraph 4.39 of the OECD Transfer Pricing guidelines currently recognizes that not all member countries endorse these adjustments. While Article 7 of the TPD requires further clarification, the acknowledgement of compensating adjustments in this directive is a positive development. 

Transfer Pricing Methods 

The TPD mandates the utilisation of the five established transfer pricing methods delineated in the OECD TP Guidelines, underscoring the determination of the arm’s length price by employing the most appropriate transfer pricing method. Additionally, the TPD proposal introduces a concept known as the “sixth method”. According to the provisions of the TPD, an alternative valuation method or technique may be employed under the following conditions: 

  1. None of the five approved methods can be reasonably applied, and 
  2. The alternative method yields a result consistent with what independent enterprises would achieve. 

The burden of demonstrating that these requirements are met falls upon the taxpayer or tax administration advocating for the use of the sixth method. 

Arm’s Length Range 

As outlined in the EU TPD proposal, the determination of the arm’s length range is proposed to rely solely on the interquartile range, spanning from the 25th to the 75th percentiles of outcomes from uncontrolled comparables. This proposition comes as somewhat unexpected. Conversely, the current OECD guidelines not only allow for the use of the interquartile range but also endorse various other statistical methods for establishing the arm’s length standard of a transaction. For instance, under point 3.62 of the OECD Guidelines, it is permissible to consider all points in the range as being at arm’s length in situations where comparable data is relatively equal and exhibits a high level of reliability.  

The role and status of the OECD Transfer Pricing Guidelines 

The TPD aims to change the legal status of the OECD Guidelines by emphasizing a provision that requires Member States to incorporate provisions consistent with the OECD Transfer Pricing Guidelines into their national regulations. While this alignment is proposed to ensure consistent application of transfer pricing rules outlined in the TP Directive, acknowledging the latest edition of the OECD TP Guidelines as an authorised interpretation of transfer pricing rules may present a significant legislative challenge for Member States. Furthermore, through the ECON Amendments, an obligation has been created on the Commission to introduce, by way of implementing acts, the latest internationally recommended Transfer Pricing Guidelines be it from the OECD or the United Nations. The ECON Amendments also recognise the need for creating safe harbours for certain transactions on intangibles, services & cost allocation.  

Re-establishment of the EU Joint Transfer Pricing Forum 

The ECON amendment suggest the re-establishment of the EU Joint Transfer Pricing Forum, originally established to bolster the European Commission, whose operations ceased in 2019. The proposal involves broadening its engagement to encompass representatives from the business and academic sectors, thereby enhancing its scope and effectiveness in addressing transfer pricing matters within the European Union.  

Target Implementation Date & Amendments to the Directive 

Originally, the TPD was drafted with the expectation that Member States would transpose it into national law by 31 December 2025. However, discussions at ECON level have accelerated the implementation timeline by one year. Pending European Council approval, Member States now have until the end of the current year to enact the Directive into their national legislation. Moreover, the ECON Amendments recognise the necessity for periodic reassessment of the Directive, proposing a review every three years instead of the initially proposed five years. The first scheduled review date is now established for 31 December 2029, with further adjustments anticipated should the BEFIT directive receive approval from the European Parliament. 

Sunset clause 

Interestingly, while ECON recognises the importance of a harmonised approach regarding the arm’s length principle, it introduces the concept of a “sunset clause”. This clause acknowledges the significant limitations of the arm’s length principle and the OECD Transfer Pricing Guidelines. The concept of a formulary apportionment, a well-known alternative to the arm’s length principle, is now being advocated as a “long-term solution to effectively combat tax avoidance and ensure a minimum level of effective taxation”. Consequently, a prospective timeline is set for the directive’s eventual cessation, signalling the intended phase out of the arm’s length principle. 

Way Forward 

After the ECON report was approved during the plenary session on April 10th, the next crucial step is the final vote at the European Council level. For the Directive to come into effect and be transposed into national law, it necessitates unanimous agreement from all Member States. Notably, countries like Netherlands and Sweden have expressed mixed or unfavourable support toward this Directive, thus casting uncertainty on the likelihood of achieving unanimous approval. 

From a Maltese standpoint, given the recent introduction of formal transfer pricing rules, it becomes imperative to gauge the potential impact of this Directive. Considering Malta’s planned gradual approach, taxpayers and practitioners must reevaluate the implications of the Directive and ensure continued transfer pricing compliance with intra-group transactions. 

Luke Aquilina

Tax & Transfer Pricing Senior Team Leader

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