The Transfer Pricing Directive - Round 2 for an EU ALP?

Richard Collier (Oxford University Centre for Business Taxation)

The Draft Directive

The Proposal for A Council Directive on Transfer Pricing,¹ proposes to include both the arm’s length principle (“ALP”) (as reflected in Article 9 of the OECD Model Tax Treaty) and the OECD Transfer Pricing Guidelines in EU law. It is intended to be applied from 1 January 2026.

The stated goal of the Directive is to create more certainty for taxpayers through common binding rules for transfer pricing, thereby replacing the administrative guidance and the laws and regulations (and the discretion in interpreting the ALP) that vary from state to state.  The initiative is intended to lead to a reduction in: tax avoidance based on transfer pricing; transfer pricing litigation; double taxation caused by non-symmetrical application of the transfer pricing rules; and high compliance costs. 

The concern to reduce tax avoidance based on the ALP might also suggest a different motivation following on from the attempts by the European Commission to utilise the ALP in state aid cases. Given that the judgement of the European Court of Justice in the case of Fiat² has now rejected the European Commission theory of the ALP, one possible interpretation of the appearance of this proposal for a Directive is that the European Commission is now moving to deal with its concerns about the lack of harmonised transfer pricing rules by “fixing” Member States’ relevant national law applying the ALP. 

The Directive includes the basic rules concerning transfer pricing adjustments and corresponding adjustments. Also included in the Directive are certain “core elements” of the Transfer Pricing Guidelines such as the guidance on the delineation of transactions, transfer pricing methods, the most appropriate method rule, comparability analysis, the arm’s length range and transfer pricing documentation. There is also a separate provision that allows the European Council to lay down specific rules within the framework of the OECD Transfer Pricing Guidelines on how transfer pricing rules are to be applied in specific transactions. 

The Directive also empowers the European Commission to introduce transfer pricing documentation requirements and envisages the creation of an expert group to discuss and agree on the interpretation of the arm’s length principle and ensure a coordinated interpretation. 

Commentary

There are aspects of the Directive that are certainly welcome – such as the effort to get greater consistency in transfer pricing practice. However, there are some major challenges facing the Directive and a core concern is that, following the state aid cases involving the ALP, the Directive is another attempt to create an ALP in the form desired by the European Commission (which may not be the form of the ALP that currently exists). 

The Directive seems to assume that its requirement that the transfer pricing rules enacted in Member States are to be applied in a manner consistent with the OECD Transfer Pricing Guidelines will transform the way the ALP is applied. However, contrary to the optimism expressed in the Explanatory Memorandum in the Directive, the goal of a uniform application of the Guidelines will not be so straight forward. This is because the Transfer Pricing Guidelines are in parts ambiguous, imprecise, or unclear, meaning that they allow for different (and sometimes very different) interpretations of the guidance they contain (as can be seen from the differences in the way the BEPS transfer pricing rules on risk are being applied in practice).³ 

Included in the Directive is a mechanism of “implementing acts” (based on specific proposals from the European Commission, drawing on the advice of an expert group) for establishing common binding rules for transfer pricing to “provide further simplification and tax certainty for taxpayers on the interpretation and application of the arm’s length principle”. These are very ambitious (and optimistic) proposals. It is stated in the Directive that any common binding rules would cover “a limited set of subjects” but in fact within the scoping are the rules on intangibles, intra group services, cost contribution arrangements, business restructurings, financial transactions and dealings between the head office and its PEs. These are complex – and highly controversial – topics on which it has proved very difficult to secure consensus in the past. In the absence of a colossal dedication of resources, further progress on these issues is likely to be very limited. 

The Directive includes the “core elements which are relevant for applying the arm’s length principle”. However, the emphasis in the Directive on the “core” elements needed to apply the arm’s length principle, together with the selective drawing on material from the Guidelines, creates the possibility of controversy about whether there is a different standard to be applied under the Directive as compared with the Transfer Pricing Guidelines. Indeed, some of the detailed points covered in the Directive (such as in relation to the application of the arm’s length range) already indicate such a divergence in standards.

The scheme of the Directive is to treat PEs in the same way as associated enterprises. The mechanism by which the Directive seeks to bring PEs within the transfer pricing rules operates in a very simple way: specifically, that goal is delivered by the provision in the Directive’s Article 5 definition of Associated enterprises which provides that a PE shall be considered to be an associated enterprise of the enterprise of which it is part. Unfortunately for the Directive, the simple mechanism adopted is very unlikely to deliver the intended result of treating PEs in the same way as associated enterprises for the purposes of the arm’s length transfer pricing rule. Rather, a raft of additional guidance will be necessary to achieve that result (this will be required to, for example, determine the assets and risks that are to be attributed to the PE for the purposes of applying the Directive, determine how the capital of the PE is to be calculated, determine how “transactions” (dealings) between the head office of the enterprise and one or more PEs are to be construed and recognised, etc).  In short, the Directive’s goal of treating PEs in the same way as associated enterprises is only going to have any chance of working if, as well as the Transfer Pricing Guidelines, the Directive also incorporates the 2010 PE Report. Even then, material problems at both a technical level and policy level will remain. 

The Explanatory Memorandum included in the Directive refers to the intention to reduce abuse, but no such anti-abuse provisions are included in the Directive as it stands. It is not clear if it is contemplated that specific anti-abuse rules might at a later stage be included in the Directive or in rules developed pursuant to powers in the Directive. The difficulty here would be that the ALP as reflected in the OECD’s Transfer Pricing Guidelines is not concerned with (and so does not take account of) tax avoidance motives. Thus, if the Directive is true to its stated goal of having Member States apply transfer pricing rules “in a manner consistent with the OECD transfer Pricing Guidelines”, any scope for additional anti-abuse measures may be extremely limited. 

If, the ambition of the Directive is successfully realised and its various measures enacted and implemented, then this would seem to have significant potential to create differences between what would then be an EU version of the transfer pricing rules and the OECD’s Transfer Pricing Guidelines. 

A fuller discussion of the Transfer Pricing Directive is contained in Richard S. Collier, The Transfer Pricing Directive, British Tax Review, Issue 5, 2023, at 556 – 563.

¹ Proposal for A Council Directive on Transfer Pricing, {SWD(2023) 308-309 final}, Strasbourg, 12.9.2023 COM(2023) 529 final, 2023/0322 (CNS), hereafter “the Directive” or “the Transfer Pricing Directive”. 
² Fiat Chrysler Finance Europe and Ireland v Commission, Joined Cases C-885/19P and C-898/19P, Judgement of 8 November 2022. 
³ See for example Richard S Collier and Ian Dykes, The Virus in the ALP, Critique of the Transfer Pricing Guidance on Risk and Capital in the light of the covid-19 pandemic, Bulletin for International Taxation, 2020 (Volume 74), No 12.