New proposed EU directive on transfer pricing

On this page, you can read about some of the key points of the proposed directive on transfer pricing (the “TP Directive”), which the Commission proposes to adopt first - independently of the BEFIT Directive, which we will discuss in a later article.

Although the arm's length principle is codified in Article 9 of the OECD Model Tax Convention and almost all EU member states are also members of the OECD, the arm's length principle is not interpreted in the same way in all member states. Furthermore, the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines), which provide detailed guidance on the application of the arm's length principle, are not uniformly applied in the domestic law of the Member States.

This results in unpredictability.

The TP Directive proposal aims to change this by harmonising the Member States' application of the arm's length principle through a uniform application of the OECD Guidelines. The intention is to make the arm's length principle part of EU law and harmonise key transfer pricing rules, and to clarify the status of the OECD Guidelines - and not least to establish common EU law rules in the field of transfer pricing, but still within the framework of the OECD Guidelines.

On this page you can read about the following key messages from the proposed TP Directive:

• The threshold for when a dominant influence exists
• Arm’s length range and adjustment range
• Payment corrections according to the fast-track procedure.

The proposed TP Directive proposes a very significant change to the threshold for determining the existence of a dominant influence. This affects when the transfer pricing rules apply, including the arm's length principle and disclosure and documentation requirements. In Danish law, a dominant influence is defined as ownership of at least 50% of the share capital or control of at least 50% of the voting rights.

The proposed TP Directive suggests, among other things, changing this limit to 25%.

This is a significant change that will result in far more companies being subject to section 2 of the Danish Tax Assessment Act (the arm's length principle) and the requirement for transfer pricing documentation, see section 39 of the Danish Tax Control Act.

Another significant change is that it is proposed to make the interquartile range the only proper position measure. This follows from the proposed TP Directive, Article 12(1) that "Member states shall ensure that, when the application of the transfer pricing methods produces a range of values, the arm's length range is determined using the interquartile range of the results of the uncontrolled comparables". At the same time, it is proposed to adjust to the median if a taxpayer's actual result is outside the interquartile range.

The proposal appears to be in line with the Danish Tax Agency's practice. "If the earnings or price of the controlled transaction is outside the interquartile range, an adjustment is made," states, for example, Legal Guidance section C.D.11.5.9, which continues: "Generally, the adjustment is made so that the earnings or price of the controlled transaction is set at the point in the middle range that is most comparable to the controlled transaction." But: "If there is insufficient information to assess whether one point in the range is more comparable than another, adjustment is made to the median".

However, this is a proposal that goes far beyond what follows from the OECD Guidelines, and it may therefore entail major differences in income adjustment.

The use of the interquartile range as the sole measure of position is, in our opinion, wrong in two ways. Firstly, we do not believe it is consistent with the OECD Guidelines in general to use only the middle range as a starting point. The entire range should be at least the starting point, and it should not be given that the right position target is always the interquartile range. Other percentiles that do not automatically exclude half of a dataset are also relevant to at least consider. Secondly, we believe it is disproportionate and also nor in line with the OECD Guidelines to automatically adjust to the median if there is insufficient information to assess whether one point in the range is more comparable than another. Thus, adjustments should be made to the nearest point in the relevant range.

It is not only a technical discussion. Recently, we saw that the profit margin of a Danish taxpayer's subsidiary abroad was adjusted down to the median instead of the third quartile, even though the actual realised profit margin was only less than one percentage point higher than the third quartile observation. Specifically, it meant a difference in payable tax of approximately DKK 1.5 million if the adjustment was to be made to the median or the third quartile.

The proposed TP Directive will - if adopted - seek to significantly reduce the processing time for existing Mutual Agreements Procedures (MAP) cases.

It is proposed that Member States must ensure mechanisms to ensure a corresponding adjustment when a primary adjustment has been made in another Member State or in a third country. In particular, Member States should have the possibility of making corresponding adjustments unilaterally and not limit the possibility of adjustments to cases processed under the MAP rules.

This also applies to cases arising from (i) a fast-track procedure to be completed within 180 days without the need to initiate a MAP when there is no doubt that the primary adjustment is well-founded, or (ii) joint reviews or other forms of international cooperation such as multilateral risk assessment programmes.

If adopted, the proposed TP Directive aims to be implemented by Member States by the end of 2025 at the latest, for the purpose of entering into force as part of national law in Member States on 1 January 2026.

The proposed TP Directive was published together with the proposed BEFIT Directive (Business in Europe: Framework for Income Taxation) which is a proposal for a common European tax base for certain companies, which in the long term (re)introduces formula allocation as an alternative allocation standard for certain taxpayers and in parallel with the arm's length principle.