The EU’s TP directive proposal: effective reform or a Hail Mary pass?
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The EU’s TP directive proposal: effective reform or a Hail Mary pass?

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Ingrid Faxing and Henri Ahtiainen of Skeppsbron Skatt analyse a proposal to incorporate the OECD Transfer Pricing Guidelines into EU law and question whether it will become a reality after several objections

The European Commission (the Commission) presented its Proposal for a Council Directive on Transfer Pricing (the TP Directive) in September 2023, as part of the BEFIT package as set forth in the Proposal for a Council Directive on Business in Europe: Framework for Income Taxation (BEFIT) (the BEFIT Directive).

The TP Directive aims at incorporating the arm’s-length principle (ALP) and the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, 2022 (the OECD Guidelines) into EU law.

The rationale for the proposal is born from the fact that although most EU member states are members of the OECD, the status, role, and interpretation of the OECD Guidelines differs between member states. The provisions described in the TP Directive must be implemented by member states by December 31 2025 and are proposed to apply from January 1 2026. Adoption of the directive requires unanimity in the European Council, where all member states are represented, as stipulated in Article 115 of the Consolidated Version of the Treaty on the Functioning of the European Union.

This article describes and analyses the implications of introducing transfer pricing (TP) rules to EU law for the balance of competences and the application of the ALP within the EU.

The EU and the arm's-length principle

The most significant impact of the TP Directive on member states is the incorporation of the ALP into EU law. The ALP and an arm's-length result are defined in Article 3 of the TP Directive, which broadly mirrors the definition in the OECD Guidelines. As mentioned above, there have been differences in the interpretation of the ALP between member states but also between member states and EU institutions.

For instance, in the Fiat Chrysler Finance Europe (FFT) state aid case, the Commission applied an ALP that deviates from the one defined in Luxembourg law by taking into account only the OECD Guidelines. According to the Court of Justice of the European Union (CJEU), this constituted a fictitious and erroneous framework for the assessment of state aid.

The court maintained that in the absence of harmonisation within the internal market, the member states retain the discretion and competence for the determination of arm’s-length pricing. The detailed principles and rules of national law must therefore be taken into account in determining the reference system for determining whether there is a selective advantage.

Although there may be some consensus among member states that intra-group transactions should be assessed for tax purposes as if they had been carried out between independent companies, only national rules are relevant for analysing whether transfer prices deviate from the ALP. Hence, parameters and rules outside the national tax system cannot be considered unless explicitly referred to in that system. This approach has since been confirmed in several judgments of the CJEU regarding state aid issues; namely, the Engie case (C 451/21 P and C 454/21 P) and the Amazon case (case C 457/21 P).

The TP Directive

As mentioned, the TP Directive incorporates the ALP and TP rules into EU law. There is no threshold linked to the rules; however, a common definition of what should be considered a controlled company has been included in the directive (Article 5). Furthermore, the TP Directive renders the latest version of the OECD Guidelines legally binding on the member states. Considering that the OECD Guidelines are updated continuously, further updates of the guidelines must be accepted through approval in the framework of the OECD Committee on Fiscal Affairs.

The Commission additionally retains the right to propose amendments to the TP Directive to reflect changes in the OECD Guidelines.

The directive contains rules on the application of comparability analysis and arm's-length ranges. According to the directive, the taxable result of a multinational entity shall not be adjusted if it falls within the interquartile range unless it can be proved that a different position within this range is justified by the facts and circumstances of individual cases.

If the result of a controlled transaction falls outside the arm's-length range, it shall be adjusted to the median of the range unless it can be proved that another position in the range provides an arm's-length price (Article 12). This contrasts with the OECD Guidelines, which state that the whole range (i.e., not just the interquartile range) can be arm's length. The application of arm's-length ranges from comparability analysis also differs between member states where, for example, in some states it is acceptable to adjust to the nearest quartile while others advocate an adjustment to the median.

Regarding TP documentation, Article 13 requires member states to ensure that taxpayers can provide information and analysis to confirm that they have applied arm’s-length pricing to their intra-group transactions. In addition, the Commission is empowered to supplement the TP documentation rules by establishing common templates, language requirements, which companies that are subject to mandatory documentation requirements and deadlines.

The TP Directive also includes rules regarding corresponding and compensating adjustments (articles 6.1 and 7).

Reactions from member states and organisations

The feedback on the TP Directive from member states has been scarce, with feedback mainly on the BEFIT Directive.

The Swedish government believes that the differences between the member states' interpretation and application of the ALP are overestimated and that disputes often arise because the member states make diverse assessments of the circumstances in specific cases rather than the application of the OECD’s recommended approaches. The government also believes that when TP rules are applied internationally, global solutions are preferable to solutions limited to the EU level.

The European Parliament presented its draft legislative resolution on the TP Directive on 14 November 2023, in which the rapporteur included a sunset clause with the aim of phasing out the application of the ALP and instead implementing an allocation mechanism of taxes according to a certain allocation key (similar to the previous common corporate tax base and common consolidated corporate tax base proposals).

Under the sunset clause, the TP Directive will cease to apply to groups subject to the BEFIT rules in 2035 and to all multinational groups operating in the EU (except for transactions with third countries) in 2040 (see page 33 and Article 19a of the Draft European Parliament Legislative Resolution on the proposal for a Council Directive on Transfer Pricing).

Notwithstanding the above, according to the European Parliament’s press release on 22 February, the directive received broad support among the members of the European parliament (MEP). Specifically, the shortened deadline for entry into force (2025 instead of 2026) was widely supported, along with re-establishment of the EU Joint Transfer Pricing Forum and close alignment of the directive to the OECD Guidelines.

Skeppsbron Skatt’s comments

Should the directives presented by the Commission in the BEFIT package be adopted by the member states, it would imply major changes for the member states and companies within the EU. The taxation rights of the member states will become more limited and the Commission and the CJEU will be given a greater mandate to assess corporate tax issues, including TP.

There are possibilities and challenges presented by the TP Directive. Adoption of the directive would entail a common definition of the ALP and a common view on the status of the OECD Guidelines. The Commission would also be given a mandate to draft rules regarding TP documentation. Joint interpretation of the ALP and a standard format within the EU for documentation is likely to help to facilitate the handling of TP issues for multinational groups within the EU. Currently, most EU member states apply the OECD standards in terms of TP documentation, but there are still differences in the type of information to be included.

The introduction of the TP Directive would also enable the EU courts to assess legal issues linked to the ALP. This could further simplify navigating local TP practices between EU jurisdictions for multinational groups.

Furthermore, the TP Directive establishes regulations for primary and corresponding, as well as compensatory, adjustments that will play a significant role in avoiding double taxation. Having an efficient system for dealing with double taxation on the internal market is, of course, of significant importance. It would, however, be welcomed if the dispute resolution mechanisms that currently exist within the EU were reviewed and improved, as they do not function optimally at present.

With regard to illegal state aid, the Commission has thus far assumed that there is a general definition of the ALP within the EU that it has applied in various cases. It is reassuring that the CJEU put an end to this, since the rules on state aid are clearly based on the national reference system. Had the CJEU not protected this principle, it would have greatly undermined the member states' fiscal sovereignty and decision-making power regarding direct taxes. The Commission would have otherwise received a ‘back-road’ opportunity to diminish the sovereignty of the member states in terms of direct taxation, which goes against EU law.

Potential application of the TP Directive by member states

Should the TP Directive be adopted, all member states will be given the opportunity to assess whether TP rules are something they are willing to give up control over. However, it is uncertain whether the TP Directive will solve the challenges regarding the ALP and state aid rules, such as in the FFT proceedings, since differences between member states may still arise after possible approval of the TP Directive.

Nonetheless, the Commission should be given the possibility to challenge national practices that clearly deviate from the OECD Guidelines. This could lead to the Commission possibly having opened ‘Pandora's box’ in terms of treaty claims against individual member states and a significant increase in the number of TP proceedings in the CJEU.

The TP Directive would entail significant changes in the national legislation for many member states. For example, from a Swedish perspective, the TP Directive would imply major changes regarding the status of the OECD Guidelines as a legal source, which has been historically debated in Swedish doctrine.

The TP Directive could also mean that certain common practices regarding adjustments to the interquartile range, the role of intra-group agreements, etc. can be deemed to deviate from the TP Directive and thus be questioned by the Commission. Considering that the OECD Guidelines are updated continuously, it would also be desirable for the TP Directive to provide clarity on whether new guidelines should be applied retroactively, to ensure consistent application between member states.

Furthermore, the TP Directive could entail that tax agencies have stronger support for the recharacterisation of intra-group transactions, which is a controversial topic in Sweden, where opinions are often divided between practitioners on whether the income adjustment rule allows recharacterisation of transactions.

The European Council has, as mentioned, proposed that the TP Directive should include a sunset clause, which would entail an evident departure from the OECD Guidelines and the principles countries have globally agreed upon. Differences in TP rules within the EU and towards third countries are detrimental, as it would have a negative effect in terms of administration for multinational groups rather than reduce such obligations. Global cooperation and reference to the OECD Guidelines should be the guiding principle for the EU in TP matters.

Next steps for the TP Directive

The final date for member states to provide their comments was 16 February 2024 and since several countries have objected to the proposals, changes can be expected. For the TP Directive to be adopted, unanimous approval is required from all member states. Following the feedback from the members of the economic and monetary affairs, the opinion of MEP will be confirmed by the Parliament’s plenary before passing it to the Council for adoption of the definitive act.

Harmonisation in TP could be positive but given the differences that exist between the member states, and the focus they have on protecting their tax base, a great deal of uncertainty remains around the likelihood of the TP Directive becoming a reality.

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