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Discussion draft, BEPS Action 10 revised guidance on profit splits

OECD’s discussion draft on profit splits

The Organisation for Economic Co-operation and Development (OECD) last week released a discussion draft related to the base erosion and profit shifting (BEPS) Action 10.


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Read the BEPS Action 10 discussion draft on profit splits [PDF 1.6 MB] referred to below as the “2017 discussion draft.”

The 2017 discussion draft follows a 2016 discussion draft on profit splits [PDF 330 KB] and proposes revised guidance on the application of the transactional profit split method.

 The 2017 discussion draft  considers revisions to be included in Chapter II of the OECD Transfer Pricing Guidelines and is not intended to imply changes to the broader framework of accurately delineating the actual transaction discussed in revised Chapter I or evaluating intangibles discussed in revised Chapter VI.

Overview of 2017 discussion draft

The 2017 discussion draft considers several key issues related to the application of the transactional profit split method, addresses certain comments provided on the 2016 discussion draft, and poses some questions for public discussion.

Some of the key issues addressed by the 2017 discussion draft are:

  • When the transactional profit split method is likely to be the most appropriate method—The 2017 discussion draft considers strengths and weaknesses of the transactional profit split method; the nature of transactions for which the transactional profit split method may be appropriate; and the availability of reliable information. 
  • Approaches for splitting profits—The 2017 discussion draft proposes two commonly used approaches to the transactional profit split method: (1) a contribution analysis that divides total profits between the parties  based on the division of profits that would be expected between independent enterprises; and (2) a residual analysis that first assigns profits to the routine contributions of each party and then allocates the remaining combined profits between the parties based on the relative value of their contribution to the residual profit.  
  • Measures of profits—The 2017 discussion draft provides guidance on the specific measure of profits—gross profits or operating profits, actual or anticipated profits—to be split. 
  • Profit splitting factors—Asset/capital-based factors (such as operating assets, intangibles, capital employed), cost-based factors (such as R&D spend, marketing spend), and other factors (such as incremental sales, headcount) are discussed as measures that may be used to capture the relative contributions of the parties. The 2017 discussion draft notes that cost-based factors need to consider several issues, such as differences in timing of the expenditures by each party. 

Key changes from the 2016 discussion draft

The 2017 discussion draft includes significant revisions to the 2016 discussion draft.  Some of the key revisions are discussed below:

  • The 2016 discussion draft included an extensive discussion upfront on splitting anticipated or actual profits.  While the 2017 discussion draft includes a section on splitting anticipated or actual profits under the measure of profits to be split, most of the discussion on actual versus anticipated profit has been deleted. 
  • The discussion on situations when the transactional profit split method may be the most appropriate method is revised to focus the discussion of three situations: (1) when each party to the transaction makes unique and valuable contributions; (2) highly integrated transactions; and (3) transactions with the shared assumption of economically significant risks or the separate assumption of closely related risks. While these topics were discussed in the 2016 discussion draft, the discussion has been reorganized and edited in the 2017 discussion draft. For instance, there is no longer a discussion of parallel versus sequential integration. Further, the sections on group synergies and value chain analyses have been deleted. 
  • The 2017 discussion draft further clarifies that the transactional profit split method must not be automatically selected on the basis of one or more of the listed indicators in the discussion draft. For instance, it clarifies that the most appropriate method is to take into account the relative reliability of the selected method compared to the other methods. 
  • The 2017 discussion draft includes explicit reference to the Master file, in addition to the Local file, as a source of information for profit-splitting factors, noting in particular information on the important drivers of business profit, the principal contributions to value creation by entities within the group, and key group intangibles included in the Master file. 
  • The 2017 discussion draft includes a new annex with 10 examples illustrating the guidance on the transactional profit split method. 

Specific questions for commentators

The 2017 discussion draft includes three questions in the preamble on which the OECD is specifically requesting comments. These relate to:

  • Factors to be taken into account in determining whether a profit split of anticipated profits or a profit split of actual profits is to be used
  • Profit-splitting factors—the relevance of capital or capital employed, headcount of similarly skilled and competent employees, adjustments for purchasing power parity, and other profit-splitting factors to be included in the guidance
  • Additional examples of scenarios in which a transactional profit split is found to be the most appropriate method due to the high level of integration of the business operations

Next steps

The OECD invites public comments on the 2017 discussion draft, that are to be submitted by 15 September 2017.  

KPMG observation

The 2017 discussion draft has been significantly revised from the 2016 discussion draft. The 2016 discussion draft elicited numerous comments from the public, and it is clear that the 2017 discussion draft has tried to incorporate some of those comments. For instance, the discussion on parallel and sequential integration, which many commentators had questioned, is excluded from the 2017 discussion draft.  

The 2017 discussion draft takes a more balanced view of the transactional profit split method—for instance, emphasizing the relative reliability of the selected method over other methods and including examples illustrating the selection of the transactional profit split method as the most appropriate method, as well as examples illustrating the rejection of the transactional profit split method as the most appropriate method. The 2017 discussion draft suggests that public comments have the potential to shape regulatory guidance. Given that the OECD is soliciting input on the discussion draft, respondents appear to have additional opportunity to shape the future guidance on profit splits.

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