The EU Transfer Pricing Directive: Harmonizing Regulations

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On 12 September 2023, the European Commission released a proposal for The EU Transfer Pricing Directive (TP Directive), which seeks to guarantee that all Member States implement consistent transfer pricing legislation and procedures for overseeing transfer pricing and resolving instances of double taxation. If unanimously accepted by the EU Council, the TP Directive is set to take effect from January 1, 2026.

In the European Union, transfer pricing regulations vary due to the autonomy of each Member State in establishing its own domestic principles and guidelines. While these domestic laws of member states are generally based on the application of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, their specific textual details may differ across countries. Although these differences are typically not significant, they can pose challenges for businesses and taxpayers, introducing issues related to compliance and the application of regulations.

The proposal of the TP Directive aims to standardize key transfer pricing regulations and set forth binding guidelines on transfer pricing issues, aligning them with the principles outlined in the OECD Transfer Pricing Guidelines. This proposal is part of the package known as ‘Business in Europe: Framework for Income Taxation’ (BEFIT).

The TP Directive suggests in particular:

  1. Harmonizing the definition of associated enterprises.

Currently, there is no common definition of associated enterprises within the European Union framework. The TP Directive puts forth a standardized definition for related parties, incorporating a criterion linked to exerting significant influence in the management of another entity, along with the inclusion of the 25% threshold—whether it pertains to voting rights, ownership in the capital, or entitlement to 25% or more of the profits of another entity. This solution aims to harmonize regulations among countries that presently employ diverse thresholds. The Directive also makes it clear that a permanent establishment shall be considered to be an associated enterprise of the enterprise of which it is part.

  1. Determination of the arm’s length range

As proposed in the EU Transfer Pricing Directive, the determination of the arm’s length range is to be exclusively based on the interquartile range, covering the 25th to the 75th percentiles of outcomes from uncontrolled comparables. This proposal is quite surprising. In contrast, the current OECD guidelines permit not only the use of the interquartile range but also 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.

  1. Transfer pricing methods

The TP Directive mandates the application of the five established transfer pricing methods outlined in the OECD TP Guidelines, emphasizing the determination of the arm’s length price through the use of the most appropriate transfer pricing method. But also the TP Directive proposal introduces a concept referred to as the “sixth method.” According to the stipulations of the TP Directive, an alternative valuation method or technique may be utilized provided that (i) none of the five approved methods can be reasonably applied, and (ii) the alternative method produces a result consistent with what would be achieved by independent enterprises. The taxpayer or tax administration asserting the use of the sixth method bears the burden of demonstrating that these requirements have been met.

  1. Corresponding and compensating adjustments

The EU Transfer Pricing Directive incorporates mechanisms to facilitate corresponding and compensating adjustments. According to the text of a proposal, if a Member State implements a primary adjustment, the counterpart Member State is required to carry out a corresponding adjustment, except under specified circumstances (this is aimed at preventing instances of double taxation or, ensuring that double taxation can be alleviated).

  1. Clarifying the role and status of the OECD Transfer Pricing Guidelines

As of today, it should be noted that the OECD Transfer Pricing Guidelines lack legal binding force on member countries within the European Union (EU). Instead, these guidelines function as recommendations and principles intended for member countries to consider while formulating their individual transfer pricing regulations. In this context, each EU member state retains the autonomy to establish and enforce its own national laws and regulations, including those pertaining to transfer pricing.

The TP Directive seeks to alter the legal nature of the OECD Guidelines by highlighting a provision that obliges Member States to include in their national regulations provisions consistent with the OECD Transfer Pricing Guidelines.

While such an alignment is proposed to ensure consistent application of the transfer pricing rules outlined in the TP Directive, recognizing the most recent edition of the OECD TP Guidelines as an authorized interpretation of transfer pricing rules may pose quite a legislative challenge for Member States.

Next steps

Transfer pricing poses a significant challenge for taxpayers across various jurisdictions, being an international, regional, and local concern. The absence of uniform transfer pricing rules at the European Union level creates ongoing complexities for multinational corporations. The EU Transfer Pricing Directive proposal represents a substantial advancement in simplifying tax regulations and diminishing compliance burdens for large cross-border companies.

Moving forward, the TP Directive draft is set to enter the negotiation phase among Member States, seeking unanimous agreement. Following unanimous approval, the subsequent step involves the publication of the Directives in the Official Journal of the European Union. Upon formal approval by the European Union, Member States will be required to incorporate the provisions of the TP Directive into their national legislation.

Currently, the final wording of the TP Directive remains uncertain. During the negotiation phase, countries will need to reach a consensus on addressing more ambiguous issues, including the legal implications of OECD Guidelines and the specific determination of the arm’s length range. As of today, the suggestions and concepts articulated in the proposal provide a robust basis for a comprehensive directive, although there are issues there that may raise a number of debates. Once implemented, this directive is expected to bring about harmonization and facilitate smoother cross-border transactions in the context of transfer pricing, as well as increase tax certainty and reduce cases of double taxation and double non-taxation.

Maghdalena Dymkowska
Partner, MDDP
E: [email protected]