The European Commission has broadly confirmed guidance on transfer pricing covering a range of matters. This is helpful in dealing with some of the problems that can arise from transfer pricing issues. We highlight three areas covered in their guidance.

Secondary adjustments

These are required in some member states to allocate profits in line with the original adjustment. They can have tax consequences, so double taxation can arise in certain circumstances. The guidance suggests that states should avoid imposing penalties on secondary adjustments. However, here are some possible methods of limiting double taxation.

  • Avoid the use of secondary adjustments if possible (nine EU states currently apply secondary adjustments - Austria, Bulgaria, Denmark, Germany, France, Luxembourg, the Netherlands, Slovenia and Spain).
  • If secondary adjustments cannot be avoided, make them as constructive dividends or constructive capital contributions.
  • Apply the Parent Subsidiary Directive so no withholding tax is applied on a transaction between a parent and its subsidiary (Bulgaria and France do not currently apply the directive); or
  • Repatriate funds within an agreed timeframe, free of withholding tax in line with the economic intent of the primary transfer pricing adjustment.

Double taxation can be avoided via a mutual agreement procedure or by the Arbitration Convention, though this is recognised as complicated and time consuming.

Transfer pricing risk management

This covers the legal and practical tools available to assess transfer pricing risks, address those risks and allow for dispute resolution. Suggested methods of managing risk cost effectively were to use:

  • common audit working procedures
  • common documentation standards; and
  • dispute resolution (using mutual agreement procedures and the arbitration convention).

The report also advises that resources should be allocated to matters which carry a high risk. Joint cross-border audits of companies are regarded as useful, including those initiated by the taxpayer.

Compensating adjustments

Compensating adjustments are transfer pricing adjustments, where the price reported for tax purposes is consistent with an arm's length price; in spite of the price actually charged in the transaction.

Some states adopt an ex-ante approach – taxpayers must demonstrate that they made reasonable efforts to comply with the arm's length principle at the time of the intragroup transaction.

Other states apply an ex-post approach, i.e. taxpayers review the outcome of transactions to demonstrate they were in accordance with the arm's length principle.

It has been recommended that each of the enterprises participating in a transaction should use the same price for respective transactions, and compensating adjustments should generally be accepted if certain conditions are fulfilled.

The statement by the Commission is welcome and essential to make the approach more consistent across states and fairer to taxpayers.

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