OECD BEPS Action #8 - Thoughts on the Guidance on TransferPricingAspectof Intangibles (3)

So from now on, the overall trend will dictate that we accept this new OECD definition as the new "ordinary meaning" in every transfer pricing disputes involving intangibles.

And in doing so, we should also remind ourselves that this definition is an offspring of the OECD's notorious BEPS action plan, implying that in "inventing" this definition, the emphasis was on protecting (and perhaps expanding) the member states' tax base and relatively little attention has been paid to preventing double taxation, which is the traditional conviction of the OECD when it comes to the matters of international taxation.

Hence, with the advent of this new definition, I fear that the incidence of double taxation may rise. As I indicated in my previous post, what seems really controversial is the arm's length compensibility feature within the definition. One must now rely on a "mere fiction" to decide whether something should be considered an "intangible." Not only is this radical deviation from the traditional meaning given to intangibles with which everyone has felt comfortable, such undue reliance on fictions create rooms for conflicts/disputes, not only between tax authorities and taxpayers, but also between different tax jurisdictions.

The scenario below is a rough demonstration of what would most likely happen within the next four to five years if the new definition becomes an international convention:

• Companies A and B are controlled parties. During the tax audit, Company A is found to have let Company B use a non-physical or non-financial "things" which could be both owned/controlled and, most importantly, compensable (1). The tax authority identifies them as intangibles for transfer pricing purposes and recognizes several inter-company transactions where compensation-free use of the identified intangibles allegedly occurred (2) and then applies the arm's length principle to determine the compensations that should have been charged to Company B(3), resulting in significant tax assessment to Company A.

• Having learned a painful lesson from country A, Companies A and B immediately enter into a new arrangement whereby the intangibles so identified are subject to the arm's length compensation in the event of transfer or use. Hence, Company B starts paying royalty-like payments to Company A for the use of the intangibles identified by the tax authority in Country A.  

• After some time, seeing the size of inter-company charges made and the nature of the intangibles used, the tax authority in country B challenges the arrangement and denies deductibility of the royalty-like payments (5) on the grounds that, according to their own viewpoint, the intangible identified as compensable in country A are found to be non-compensable (4) if the same transactions were undertaken between highly comparable independent third parties. This denial of deductibility also results in a sizable tax assessment to Company B(6),  not to mention the company may also be subject to a secondary adjustment by virtue of re-characterization of the adjusted income as dividend.

Hence, double taxation seems inevitable because the states will have hard time agreeing on the extent of the arm's length fiction suggested by one state to the other in regards to a related party transaction involving intangibles. 

So MNEs must make due preparations for this potential conflicts of different "fictions" conjured up by different taxing jurisdictions. What would be the "things" that could be captured along the MNEs' value chains as constituting "intangibles" under the new OECD definition? How do we go about measuring the transfer pricing risk accordingly? My next post will be discussing specifically the nature of the arm's length compensability requirement within the new definition and the "things" that could most likely be considered as "intangibles" by virtue of the OECD definition.