The practical application of domestic transfer pricing rules and their coordination with the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations has historically resulted in different interpretations of the arm’s-length principle by tax administrations in several countries. This has led to disparities and difficulties for multinational enterprises with a significant presence in multiple jurisdictions, including instances of double taxation.
To address these concerns, the European Commission has drafted a proposal for a transfer pricing directive, presented in September 2023, with the goal of harmonising the interpretation and application of some of the main transfer pricing concepts and principles by the tax administrations of EU member states. A more coherent interpretation and application of transfer pricing legislation within the EU would provide greater certainty for multinational enterprises and reduce double taxation resulting from different interpretations of the same rules in different EU jurisdictions. The proposed directive also aims to address BEPS concerns.
The primary points of the proposed TP directive
The main proposed harmonisation features to be incorporated into the member states’ domestic laws include:
A common concept of associated enterprises for transfer pricing purposes, which includes a change of the relevant participation percentage to 25%;
The introduction of a European procedure to resolve cross-border transfer pricing adjustments within the EU space in 180 days or less, in the case of double taxation issues arising from said adjustments; and
The introduction of a uniform process for the conclusion of corresponding (or downward) adjustments, following an adjustment made by the authorities of a different EU member state.
The proposed uniform interpretation of the arm’s-length principle requires transfer pricing adjustments only if the inspected taxpayer’s profitability does not fall within an interquartile range constructed with data from comparable entities. When the taxpayer’s profitability does not fall within said range, the tax authorities should perform a transfer pricing primary adjustment to the median of the results composing the interquartile range. However, the taxpayer and the tax authorities may defend a different position in the same range by proving that such a position is a better reflection of the arm’s-length principle. This interpretation of the arm’s-length principle may reduce litigation between tax authorities and multinational enterprises regarding the application of the principle, especially when defending the position of a taxpayer’s profit level indicators in an interquartile range composed of data from independent companies.
Regarding transfer pricing documentation, the directive proposal also aims to establish the grounds for the European Commission to develop a model for uniform transfer pricing documentation in the EU in the future. This will impact the content of the documentation, the deadlines for preparation, the acceptable languages, and the entities required to prepare the documentation.
Additionally, when preparing transfer pricing documentation, multinational enterprises will have to justify in any controlled transactions the application of a transfer pricing method different from the traditional methods determined in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, by demonstrating that none of the traditional methods was adequate for this purpose and that the selected method is compliant with the arm’s-length principle, thus providing more accurate results than those that would be achieved with the traditional methods.
The proposed directive also includes common rules for determining the pricing applied in intra-group transactions entered into by multinational enterprises, as well as the criteria for determining when controlled and uncontrolled transactions should be deemed comparable. These contribute to greater uniformity in the transfer pricing policies to be adopted by multinational enterprises and in the economic analyses prepared to justify such policies.
Next steps and potential impact
The directive proposal must be negotiated by the EU member states, since it requires their unanimous approval. If approved in its current version, it would cover taxpayers registered in at least one EU member state and permanent establishments registered in EU member states, even if pertaining to companies domiciled outside the EU.
The goal is to implement and transpose the directive by the end of 2025, to enter into force in early 2026.
Since the proposed changes will have significant impacts on multinational enterprises’ intra-group policies in the EU, these entities should monitor the matter to ensure compliance with the arm’s-length principle and alignment of their transfer pricing files with the latest developments.
In the long term, the proposed changes should provide greater certainty in the application of transfer pricing legislation by tax administrations, easing the compliance burden of corporate groups.
In Portugal, the proposed directive is expected to lead tax authorities to the interpretation and application of transfer pricing regulations coordinated with other EU member states’ authorities, thus reducing litigation and local compliance costs for multinational enterprises.
