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US and OECD harmonise approaches to arm's-length principle

Tax specialists are praising the OECD’s decision to equalise the methods for allocating income and expenses between controlled entities under the arm’s length principle.

In September 2009, the OECD released draft proposed revisions to Chapters one through three of their 1995 guidelines.

One of the most important proposed changes included the abandonment of the traditional hierarchy of transfer pricing methods.

The proposed guidelines suggested that taxpayers should instead use the method that provided the most reliable measurements.

One potential reason behind the change is that a growing number of tax authorities may have realised the difficulty multinationals face in trying to get reliable data to apply to the traditional methods.

Tax practitioners and specialists welcome the change.

“This will simplify the process of doing global documentation for large multinationals, and over time will potentially reduce the number of disputes,” said Paul Burns, counsel at DLA Piper.

“These are sensible changes that would bring the two main promulgators of the arm’s length standard, the US and the OECD, into closer harmony in the application of that principle,” said Richard Boykin, principal economist at Baker & McKenzie.

Though there is no definite date for the finalisation of these guidelines, the US Department of Treasury (Treasury) has confirmed that the proposals do abandon a strict hierarchy of methods in favour of an approach that is more similar to the one now in place at the Treasury and IRS.

The US Treasury adopted its own version of the “best method rules” in 1994.

“Tax authorities outside the US now have the benefit of 15 years of US experience with the best methods rule,” said Burns. “My sense is that they have reached a certain comfort level with this.”

“This is one area where it seems that the US is out in front leading and the OECD guidance sort of converged later to get there,” said David Ernick, associate international counsel at the Treasury, at a BNA Tax Management International Luncheon on March 31.

The proposed guidelines also contained a helpful discussion about issues of comparability. Recognising that reasonably comparable controlled transactions are often unavailable for complex multinational transactions, especially those involving intangibles, the guidelines allow for use of profit-based methods, as long as the allocation method is reliable and consistent.

This explanation about comparability will also help to bridge differences between the application of the US and OECD methods.

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