In line with the OECD Transfer Pricing Guidelines, the tax administration must begin a transfer pricing examination from the perspective of the method selected by the taxpayer. Nonetheless, the taxpayer must be able to substantiate why the chosen method is appropriate in view of the relevant facts and circumstances. It is explicitly not intended to prescribe a ‘best method rule’. The Transfer Pricing Decree refers directly to the OECD Transfer Pricing Guidelines. In Chapter II of these guidelines the following methods are described, which can be used to substantiate arm’s-length pricing between associated enterprises.
The following traditional methods are regarded as the most suitable and direct means of establishing a transfer price, as the price can be traced directly.
The comparable uncontrolled price (CUP) method compares the price charged for transactions between associated enterprises with the price charged for comparable transactions under comparable circumstances between unrelated parties. The CUP method is particularly reliable where an independent enterprise sells the same products in the same quantity and in the same market under the same conditions as those sold between associated enterprises. A disadvantage is that an external CUP is often hard to find, since relevant information is frequently unavailable. An internal CUP can be used when a taxpayer sells products to an associated enterprise as well as to an independent enterprise. The CUP can be quite strict in its application. If products, quantities or parties involved in the transaction are not comparable from a two-sided perspective, this will possibly lead to non-acceptance. The advantage is that it is the most direct and reliable way to find a comparable price. The CUP method is mainly applied to financial transactions.
The cost-plus method increases the relevant costs incurred with an appropriate mark-up. The cost-plus method is a gross compensation, since it is in most cases not applied to all the costs incurred by the taxpayer. Based on the OECD Transfer Pricing Guidelines, the cost-plus method is considered most useful where:
- semi-finished goods are sold between associated enterprises;
- the associated parties have concluded joint facility agreements or long-term buy-and-supply arrangements; or
- the controlled transaction is the provision of services.
In the Netherlands, in practice, the costs that are included in the cost base for applying the cost-plus method can be subjected to close scrutiny.
The resale price method deducts an appropriate margin from the resale price to an independent third party to determine the intercompany price for a product purchased from an associated party. The margin is set in a way that enables the reseller to cover its selling and operating expenses and make an appropriate profit. According to the OECD Transfer Pricing Guidelines, the resale price method is most useful where it is applied to marketing operations. In practice, it is important to compare the selling and other operating expenses of the comparables, as this will be a good indicator of the comparability of the functions and risk profiles. It can also be useful to perform a sanity check on operating profit level, as the tax authorities can argue that the resale price method is a one-sided method and the tested party should then be entitled to a routine profit.
The following transactional methods examine the profits that arise from transactions between associated enterprises.
The most frequently used method is the transactional net margin method (TNMM). The TNMM compares the profits that comparable independent entities realise while performing comparable functions. The TNMM measures the profit relative to a profit level indicator (eg, costs, sales or assets). Compared with the cost-plus method, the TNMM on costs remunerates a percentage over all costs. The TNMM has the advantage that it compares the functional profile of an entity instead of specific transactions. Therefore, it can be easier to find comparables. Another advantage is that it is easier to determine the annual corporate income tax due. In practice, this can also cause the TNMM to be a preferred method for the tax authorities when the choice of this method is in line with the functions and risk profile of the entity. To apply this method, the tested party should be considered as the least complex entity.
The transactional profit split method divides the combined profit realised from transactions between associated enterprises based on an economically valid key on which unrelated parties could have agreed. This method is used when both entities make unique and valuable contributions, or where operations are highly integrated and a one-sided approach would not be appropriate. An advantage of applying this method is that the allocation of profits may be based on the division of functions between the entities, especially when there is no more direct evidence of how independent parties would split the profit in comparable circumstances. This means that internal company data can be used to determine an allocation key. The transactional profit split method is mostly used in bilateral or multilateral situations, as more countries then have to agree with the applied allocation key.
Multinational enterprises can also use methods not described in the OECD Transfer Pricing Guidelines, although it should then be explained why such a method is considered more appropriate.
Tangible property transactions
For tangible property transactions generally a fair market value should be determined, which means that the CUP method is the preferred method.
Intangible property transactions
For intangible property transactions the DTA prefers that the less complex functions are compensated first and that the residual profit is then allocated to the intangibles or key value drivers. This approach only works provided that all other functions, risks and assets receive an arm’s-length compensation.
Like the OECD in BEPS, the TP decree also refers to the development, enhancement, maintenance, protection and exploitation of intangibles (DEMPE) functions. It is stated in the decree that development and enhancement will generally be given more weight.
The hard-to-value intangibles doctrine, which was developed by the OECD, is also implemented in the Dutch TP Decree. According to the Dutch TP Decree, if a hard-to-value intangible is transferred to a related party, and the actuals deviate by 20 per cent or more from the forecasted figures, the tax inspector of the DTA may retroactively challenge the transfer price on this basis. This is itself not a justification for a transfer pricing adjustment, but de facto postpones the assessment to a later time.
For intragroup services the TNMM on cost method is generally accepted, provided that the service provider does not create or maintain any intangibles relating to the transactions.
Loans and advances
Generally the CUP method is applied for loans. This is because a large number of financial transactions are available in databases.
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