BEPS Actions 8 to 10: National interpretations of TP guidance

The arm’s-length principle has existed in Swedish legislation for 90 years

Transfer pricing legislation has historically been very limited in Sweden. The arm's-length principle was implemented in Swedish tax law in 1928 (today Swedish Income Tax Act (SITA), chapter 14, section 19) and has since been the only available regulation in relation to the arm's-length principle. This paragraph broadly states that if the result of a business, conducting transactions with cross-border related parties is of a lesser value due to the fact that the agreed terms deviate from those that would have applied between unrelated parties, then the result must be adjusted accordingly as if those terms had not existed. Consequently, the level of uncertainty on how to interpret this paragraph is high, and limited support is available in Swedish law on how to price cross-border intra-group transactions. In addition, the amount of case law available has been limited, although the number of cases has started to increase in recent years.

Transfer pricing documentation regulation regarding cross-border transactions between group companies was enacted in Sweden as of January 1 2007. The new documentation rules increased the focus on TP issues, but the regulation was still brief and lacking in detail. Since then, following the BEPS project, Swedish law has been complemented with new documentation rules and the level of detail is much greater. However, this has not had any spillover effect on the legislation related to the arm's-length principle and how to actually determine an arm's-length price.

When it comes to the arm's-length principle, BEPS Actions 8 to 10 are very much what it is all about and, as such, it is highly relevant how the actions are implemented in local law. In Sweden, the assumed source of law practice is as follows: law, precedents, legislative history, and doctrine. The OECD material does not really fit into these categories. However, in cases where no direct guidance can be found in legislative history, both the Administrative Court of Appeal and the Supreme Administrative Court of Appeal (HFD) refer to the OECD (the OECD Model Tax Convention and commentary and the OECD transfer pricing guidelines for multinational enterprises and tax administrations [OECD guidelines]) for guidance on the interpretation of Swedish domestic legislation.

In the first and most important case law in Sweden concerning a number of cases for Shell from 1991 (RÅ 1991 reference 107), the HFD stated that the OECD guidelines were not binding for the Swedish tax authorities, but that they were not contradictive to the law and also gave a balanced view of the issue at stake. Further, the statements in the report were therefore relevant to use as guidance when interpreting the law in relation to the arm's-length principle. Since then, the Swedish Tax Agency (STA), the courts, TP practitioners and taxpayers have, to a great extent, relied on the OECD guidelines.

Even though the OECD guidelines provide a lot more detail than what is to be found in Swedish legislation, uncertainty and gaps in information have remained. This is especially the case concerning issues like substance over form, legal and economic ownership of intangible assets, intangible assets valuations, and so on. Therefore, the news that the BEPS project would address these specific TP issues was very well received in the TP community and many had very high expectations.

When the final reports were presented in late 2015, it was clear that some of the historic uncertainties had been clarified, but that there was still a lot of work to be done. For taxpayers and TP practitioners it was clear that the reports and clarifications would provide better guidance for the future on how to structure business and price transactions in order to minimise TP risks. What most did not expect was that the new guidelines would be applied retroactively.

At the STA's seminar for taxpayers held on December 1 2015, the STA clearly stated that all changes and additions contained in the OECD guidelines were merely clarifications of the meaning of the arm's-length principle. This meant that these updates could be used immediately. This statement might have been regarded as quite provocative given the uncertainty and the issues that both taxpayers and the STA had been struggling with for the previous decade or longer. In any circumstance, one would expect the STA to use the new guidelines carefully and in a balanced way, considering that the 'clarifications' in many instances were completely new interpretations.

There are still limited examples of how the guidelines will be used in Sweden. Although there have not been many completed court cases that have followed Actions 8 to 10 and 13, there have been two interesting tax agency decisions that clearly show the intentions of the STA to withhold their opinion on direct application. These cases will be presented below.

The first case concerns the period of 2013 to 2015 and relates to the profit split method applied within a multinational enterprise (MNE). The MNE in question provides entertainment through internet applications. In this case, the MNE had a company (Company A) in a European low-tax jurisdiction, which had the legal IP ownership and also, through intra-group agreements, financed all software development and other common services provided within the group. Besides Company A, the group consisted of a number of group companies providing contract development and other group functions in relation to, for example, certain key accounts, shared services and customer support, human resources, and so on. The group also consisted of the two 'founder' companies – Company B and Company C – one being located in Sweden and the other in another European country. Within these two companies, most of the strategic personnel in relation to software development and marketing were employed. The TP model was designed so that routine functions were remunerated through a cost plus method, with the residual being split between Companies A, B and C following a particular allocation model. For the years under review, the outcome of the model split the profit between these three entities quite evenly, although with some added benefit for Companies B and C.

The STA conducted its analysis by focusing on the DEMPE (development, enhancement, maintenance, protection and exploitation: OECD guidelines, chapter VI, section B) functions within the MNE and put special focus on the main decision makers, that is, the CCO, CEO, CMO, CTO, and so on. The STA came to the conclusion that all the important decision makers had been employed by either Company B or Company C and that Company A only had a few employees working within the capacity of finance and administration. In Company A, a management board had been responsible for all strategic and important decisions in the group. None of the participants in the management board were employed in company A, except for a company secretary, and none of them were resident in the country in which Company A was located. Instead, all members were employed by Company B or Company C. The members participated in the board meetings either in person or by phone or video.

The STA concluded that even if Company A, through its pricing model and terms in the intra-group agreements, bore the group development and commercial risks, it did not have the ability to assume those risks. The reason for this was that it did not have the relevant employees that could control the risks. In order to control risk it is not enough, according to the STA, to hold management board meetings a couple of times a year. The board may decide upon what level of risk the group is willing to take on, but in order to control the risk, it is necessary to deal with it in the course of daily business. The outcome of the audit was, therefore, that Company A did not have any entitlement to any of the residual profit and that instead it should be remunerated through a cost plus method for its limited finance and administration functions, and should receive no remuneration for its legal ownership of the intangible property.

The other case to be discussed concerns the valuation of intangible property (IP) in an IP transfer that took place in 2014. The case relates to two MNEs with global operations. In 2013 one MNE (Group A) acquired the shares in a Swedish MNE (Group B). In connection with the acquisition, a purchase price allocation (PPA) analysis was conducted in order to determine the financial allocation of assets in the acquisition. The PPA analysis concluded that a substantial goodwill value could be identified.

About eight months after the acquisition, an internal reorganisation was conducted. This entailed one Swedish group company in Group B selling some IP rights to another Swedish group company based on the value of this specific IP as had been determined in the PPA analysis. In the PPA analysis, all IP was valued separately and it was therefore considered appropriate to apply this value in the internal IP transfer. Right after the first transfer, the IP rights were sold to an overseas group company in Group A, at book value. In this case it is worth mentioning that the IP in question constituted a very limited part of the total IP in Group B.

The STA claimed that the goodwill value identified in the PPA analysis in the external deal, should be allocated to the IP and be included in the price of the IP transfer to the overseas group company. The taxpayer on the other hand claimed that the goodwill could not be allocated to the specific IP, but rather it was related to group synergies and group management.

When it comes to the arm’s-length principle, BEPS Actions 8 to 10 are very much what it is all about, and as such it is highly relevant how the actions are implemented in local law

The STA decision stated that it was appropriate to use the price in the external acquisition as a basis for determining the price of the intra-group IP transfer. The STA referred to examples from the OECD guidelines to support its opinion. It is also stated that the external price could be used as a reference even if the external and internal transactions were not conducted within a close time frame. What the STA had not considered in its OECD analysis was how the goodwill value should be treated in cases where only a limited part of the IP was transferred, compared to cases where all IP is transferred. The OECD examples refer to the latter case.

The OECD guidelines state that valuations made for accounting purposes should be used with care since they likely do not consider the assumptions that are important from a TP perspective. In this case, the STA claimed that the correct assumptions had been made in the PPA analysis and since it had been used by the taxpayer itself to determine the price of the IP transfer, it should also be used for this purpose. The consequence of the case was, therefore, that the price of the IP transfer was adjusted with a proportion of the goodwill that the STA considered related to the transferred IP.

Both these cases related to years before the BEPS reports were issued. Hence, at the time of the transactions, it was not clear to taxpayers how they should have priced the transactions. The taxpayers argued that they had acted in accordance with the OECD guidelines and followed the arm's-length principle. Despite that, the STA used support based on guidelines that were issued after the time of the transaction, saying that they were just clarifications of what had always been the case.

In many cases, legal agreements have been used as the basis for reviews by the STA, however it is clear from the first case that substance has precedence over form. This is not an uncommon approach in Sweden, since we do not have a demand for formal agreements. However, neither the OECD guidelines nor the Swedish regulations have clearly defined substance in terms of value creating functions and decision making. It remains to be seen how the courts will rule in this case. In the second case, the Administrative Court of Appeal later ruled in the STA's favour. Interestingly, the court referred to the examples included in the OECD guidelines, which could be argued is a clarification and explanation on how to interpret the new guidelines. The OECD guidelines are clear that a PPA should not generally be used in order to determine a value, but rather it would be more appropriate to use a discounted cash flow method if a severable intangible related return could be identified. However, this section was disregarded by the court. If this transaction had occurred later in time and had not been preceded by the external acquisition, the relief from royalty method would have been acceptable. Consequently, no consideration would have been given to synergies or potential goodwill. Moreover, example 26, to which the court referred, states that a purchase price premium should not be taken into account if it is not attributable to the specific intangible that is being transferred. Neither the company nor the STA have presented any relevant or sufficient evidence that the premium value was attributable to the transferred asset. Consequently, there is no indication that the value of the transferred asset should be increased with a purchase price premium.

In light of this it will be interesting to see how the court will rule in cases related to hard-to-value intangibles (HTVI). According to the OECD transfer pricing guidelines for multinational enterprises and tax administrations (6.189, July 2017), HTVIs "cover intangible or rights in intangibles for which at the time of their transfer between associated enterprises: i) no reliable comparable exists; and ii) at the time the transactions were entered into, the projection of future cash flow income expected to be derived from the transferred intangible, or assumptions used in valuing the intangible, were highly uncertain, making it difficult to value the ultimate success of the intangible at the time of the transfer".

In our view, it would be impossible to claim that the conclusions and recommendations contained in the HTVI section have always applied and are something that taxpayers should have known about. This would imply an element of hindsight, taking into consideration facts that were not known at the time of the transaction. The approach of reassessing a company based on facts that occurred several years after the transaction, has historically not been used by the STA in a tax audit. In general, taxpayers, practitioners, courts and the STA have taken the view that the arm's-length price should be based on relevant, best estimates and known facts at the time of the transaction. We have to hope that the courts will be more balanced in their rulings and consider the fact that many of the guidelines were not known at the time of the transaction. If this is the case, it will be possible to use the OECD guidelines as guidance on how to price intra-group transactions, rather than how they would have been priced historically.

Annika Lindström

Partner KPMG Stockholm, Sweden Mobile: +46 70 377 61 71 annika.lindstrom@kpmg.se Annika Lindström is the national practice leader for global transfer pricing services in Sweden. She has more than 20 years of experience within the financial area, including auditing, accounting, process development, project management and transfer pricing. Annika has a master's degree in economics and business administration, and is a tax adviser certified by FAR, Sweden's professional institute for authorised public accountants. She has broad experience of working with major clients in various sectors and particularly specialises in: restructurings, advance pricing agreements (APAs), mutual agreement procedures (MAPs), tax audits, establishing defensible BEPS-compliant pricing models, and transfer pricing documentation.

Maria Andersson

Partner KPMG Stockholm, Sweden Mobile: +46 73 327 21 26 maria.andersson@kpmg.se Maria Andersson joined the Swedish transfer pricing practice in 2005 and started up the transfer pricing practice in Gothenburg in 2008. She has an MBA in finance and is a tax adviser certified by FAR, Sweden's professional institute for authorised public accountants. Maria headed the Swedish transfer pricing practice from 2010 to 2013, and has also headed the international tax practice. As of 2017 Maria has been responsible for the business restructuring service. Maria also practises international corporate tax and works together with other service lines within KPMG to provide the best solutions for clients as regards restructurings. Maria has experience in many different areas and sectors of international tax and transfer pricing, and is specialised in business restructurings, establishing BEPS-compliant pricing models, intangible property valuations and transfer pricing documentation.