Transfer Pricing Guidelines 2021
Almost a year after the publication of the draft Transfer Pricing Guidelines, on 7 October 2021 the Austrian Federal Ministry of Finance has finally issued the new Austrian Transfer Pricing Guidelines (ATPG 2021 or Guidelines). Being an extensive revision of the Transfer Pricing Guidelines from 2010 (TPG 2010), the ATPG 2021 aim at reflecting BEPS-project related developments on OECD level, latest jurisprudence and administration practice in Austria.
This article addresses both the most important changes compared to the draft version of the Guidelines, as well as the TPG 2010, and thereby provides a comprehensive overview of all relevant changes.
The ATPG 2021 are substantially in line with the 2017 OECD Transfer Pricing Guidelines (OECD TPG) and its amendments, such as the Revised Guidelines on the Application of Profit Split Methods from 2018 and Transfer Pricing Guidance on Financial Transactions issued in February 2020 (2020 OECD Report on Financial Transactions). However, the ATPG 2021 deviate in emphasis or interpretation in a number of important areas which may lead to tax audit disputes for MNEs operating in Austria.
The OECD TPG is acknowledged as an instrument to aid the interpretation of the Double Tax Treaties and the arm’s length principle set out in domestic law. They are to be used in their latest applicable version when interpreting the arm’s length principle, i.e., using a ‘dynamic interpretation’. Only in cases where new guidance expressly deviates from earlier statements in the OECD TPG and cannot be seen as clarifying or supplementary guidance, the version of the OECD TPG can be used which was in place when the parties entered into the transaction in question. As a result, the ATPG 2021 foresees a dynamic interpretation, which means that MNEs can expect that past periods under tax audit will be reviewed in light of subsequently issued guidance on OECD level and their interpretation in ATPG 2021.
Takeaway: Some intercompany arrangements may now become subject to tax audit scrutiny in Austria based on recent detailed guidance from the OECD that was not available at the time when the transactions were entered into.
The ATPG 2021 raise the bar with regards to the recognition of intercompany agreements. These are to be recognized only if they are properly formulated, have a clear and unambiguous content, and would have been concluded under the same terms and conditions between independent parties. However, in contrast to the draft, the ATPG 2021 mention that in case written contracts are not available, the terms and conditions should be inferred from the actual conduct of the parties involved.
The necessity of concluding contracts in advance is explicitly referred to, for example, in connection with cost contribution arrangements and cost allocation arrangements, loans and contracts in connection with the license or transfer of intangible assets. Similarly, the section dealing with the documentation requirements for companies not falling under the scope of the Transfer Pricing Documentation Act refers to written contracts concluded in advance of the transaction as well as in the context of year-end adjustments.
Takeaway: In order to avoid potential non-recognition of intercompany transaction terms or delineation of transactions not in line with the parties’ intentions, it is recommended that intercompany agreements expressly and clearly address all transfer pricing relevant terms in writing. This may, however, limit flexibility in their application over time and require that intercompany contractual terms are kept up-to-date with business practice and developments.
Transfer pricing methods
The ATPG 2021 generally follow Chapter II of the OECD TPG when addressing the transfer pricing methods that can be applied to assess the arm’s length nature of intercompany transactions. One point of deviation concerns the application of the Transactional Net Margin Method (TNMM), whereby the ATPG 2021 do not allow for pass-through expenses in the cost base for the calculation of the profit margin. This may create substantial practical difficulties when performing economic analyses since external comparable data rarely include sufficient granularity for a similar elimination of ‘flow-through’ items.
The new ATPG 2021 mention that, although certain comparable transactions may be analyzed on an aggregated basis, the TNMM method should not be applied for different business areas (e.g., manufacturing, distribution, etc.) together. No global formulaic profit allocation can be applied, either. The ATPG 2021 apply high standards to the application of the TNMM method in benchmarking analysis, i.e., in terms of comparability, and require that details of manual search steps, including financial information of accepted and rejected companies, be available.
With respect to the Profit Split method, in addition to the Revised Guidelines on the Application of Profit Split Methods from 2018 from the OECD, the ATPG 2021 also refer to the 2019 EU Joint Transfer Pricing Forum report on ‘The application of the profit split method within the EU’ as guidance for interpretation.
Arm’s length results
The TPG 2010 introduced clear guidance on tax audit adjustments, stating that prices that fall outside the arm’s length range have to be adjusted to the median. While the draft TPG maintained this approach, the final version introduced a significant modification, requiring only that results that fall outside the arm’s length range be adjusted to a point within the range. The median is mentioned as the point reflecting central tendency in this context, but the ATPG 2021 allow for the possibility that tax authorities deem a point other than the median as more appropriate. At the same time, the formulation of what constitutes the arm’s length range has been aligned with that of the OECD TPG.
Takeaway: In the past, tax authorities interpreted the ‘arm’s length range’ strictly as the interquartile range (unless there was a very limited number of comparables identified). The new Guidelines may allow room to argue for less restrictive limitations to, e.g., the inter-decile range or to using the full range. At the same time, the case-by-case approach may be used by tax authorities to argue for a more aggressive position compared to what adjustment to the median would have represented. Routine entities operating in Austria should therefore continue to carefully monitor the development of profits to avoid that actual results fall outside the arm’s length range.
The ATPG 2021 adhere to the ax-ante approach, which means that there should be support for the chosen price at the time of price setting. Year-end adjustments have to be made to a point that is within the arm’s length range and are only permissible if the following criteria are cumulatively met: (i) the ex-ante price setting is subject to significant uncertainty; (ii) reasonable efforts have been made during the year to achieve arm’s length prices (continuous monitoring); and (iii) factors that might influence the price setting were agreed in advance. The condition applied in tax audit practice in the past, that year-end adjustments are only permissible from a point outside the interquartile range, no longer apply.
Takeaway: Austrian tax audit practice in the past routinely disallowed year-end transfer pricing adjustments that moved the taxpayer’s results from a point within the interquartile range of benchmarked results to a particular target in the range. This created problems for many MNEs that steer the results of routine entities towards a consistent outcome taking advantage of year-end adjustments. The updated wording is an important change in this regard, allowing companies to target a particular result or narrow range of results within the arm’s length range. It is strongly recommended that end-year adjustments be explicitly allowed for in the contractual arrangement and that evidence is available demonstrating that prices are continuously monitored and, if necessary, adjusted during the year. In the absence of such documentation there is a risk that end-year adjustments are not recognized for tax purposes on the basis of the formal requirements included in the ATPG 2021.
The concept of low value-adding intra-group services (LVAIGS) and the related simplified documentation rules in line with the OECD TPG are introduced in the ATPG 2021. Based on this, a safe-harbor of a 5% cost-plus mark-up can be applied for LVAIGS, generally covering support services that are not part of the core business of the group, do not create or use unique and valuable intangible assets and do not relate to the management or control of economically significant risks. The list of typical activities that may and may not constitute LVAIGS as well as the specific documentation requirements reflect the relevant provisions of the OECD TPG.
Regarding ‘routine’ intercompany services, the previous guidance that such entities’ remuneration can generally be found in the range of 5% to 15% have been revised to a lower range of 3% to 10% net margin based on the 2010 EU-JTPF’s report on low-value adding services. The 5 to 15% gross margin range can still be applied for services performed before 1 January 2022. However, the new remuneration of 3 to 10% is not a safe harbor and an economic analysis should still be performed in order to support the actual mark-up applied.
ATPG 2021 specifically address ‘non-routine’ intercompany services, which utilize self-developed intangible assets or provide important contribution into the value-chain, such as research and development (R&D) services. The ATPG 2021 suggest that it has to be analyzed if the cost-plus method can be applicable at all for such services or the use of another method, such as transactional profit split, is warranted. Where the cost-plus method is applicable, a new example included in the ATPG 2021 implies that the remuneration in case of non-routine services is expected to be above the 3% to 10% range.
Action item: The lowering of the indicative range of margins for routine services is an important acknowledgement of the fact that the arm’s length margin for certain routine services may well be below 5%. At the same time, the lack of clarity with respect to what constitute non-routine services and under what circumstances can they be remunerated on a cost-plus basis may lead to tax audit disputes in the future. It is in any case likely that tax auditors will expect mark-ups above 10% for a range of intercompany services including research and development, services of senior management or those relating to entry into new markets. Preparing robust benchmarking analyses will be necessary for companies wishing to argue for a different position.
Cost contribution arrangements
In line with the update of Chapter VIII of the OECD TPG, the ATPG 2021 introduce stricter requirements with regards to the formation of and participation in cost contribution arrangements (CCA) by associated enterprises. The determination of arm’s length remuneration in the context of CCA was also revised in line with the OECD TPG, limiting the possibility to charge costs without a mark-up to activities whose arm’s length value is not materially different from the cost incurred (e.g., LVAIGS). Accurately documenting the risks, responsibilities and expected benefits of each participant to a CCA is more important than before.
Previous guidance on intercompany financial transactions has been completely revised, largely in line with the 2020 OECD Report on Financial Transactions.
Guidance on the credit rating analysis, including the need to consider the impact of group association, has been introduced, together with specific guidance on the arm’s length pricing of intercompany loans, cash-pooling, guarantees, and (captive) insurance. Substantial emphasis is placed on the concept of delineation of intercompany financing transactions based on a two-sided analysis of the lender and the borrower, considering their options realistically available.
The most important change in the ATPG 2021 is that the arm’s length principle also serves to distinguish between equity and debt; in other words, partial recharacterization of debt is now made possible. Compared to the OECD’s guidance, the ATPG 2021 place more emphasis on formal elements in this regard, such as missing contractual elements. Possible ground for non-recognition of intercompany financing as loan for tax purposes might include the borrower’s ‘difficult economic situation’ or missing or long-term repayment of the principal, however, the ATPG 2021 call for taking a holistic view of all relevant facts.
References to possible sources of external or internal comparable information for pricing of intercompany debt are generally in line with the OECD’s guidance. Previous guidance on the non-acceptability of pricing quotes from commercial banks has been revised, stating that specific pricing offers that have gone through credit committee approval may be used as comparable information. Lastly, lenders that do not control and manage the financing risks may receive only a risk-free return.
With regard to cash pooling structures, the ATPG 2021 confirm the view already set out in the TPG 2010, according to which the cash pool leader generally has a low function and risk profile and should be remunerated on the basis of the cost-plus method, whereas cash pool members are entitled to the synergy effects.
Takeaway: The inclusion of detailed guidance on intercompany financing transactions is a major step in Austria as this has increasingly been a tax audit focus area, in particular cash pooling and intercompany lending and borrowing. The new requirements mean that intercompany financial transactions will have to be documented carefully and market developments may have to be monitored continually in case of longer-term arrangements. While the guidance is substantially in line with that of the OECD, there are several differences in emphasis and formulation which may lead to tax audit disputes in the future. For instance, Austrian tax authorities may seek to recharacterize intercompany debt to equity due to missing formal elements of intercompany contracts or in cases where the borrower is in economic difficulties despite the fact that they could have received external financing in comparable situations.
Intangible assets and hard-to-value intangibles
The ATPG 2021 follow the updated Chapter VI of the OECD TPG, introducing the DEMPE-concept and the six-step analysis of intangibles-related transactions for the first time in Austrian administrative practice. The guidance relating to the valuation of intangible assets, including the consequences of transferring hard-to-value intangible assets (HTVI), is in line with the OECD TPG. This implies that intangible-related profits may have to be allocated to “routine” entities (R&D service providers or local distributors) based on the analysis of DEMPE functions and related risks, while the legal owner of intangible assets that outsources all DEMPE functions and does not exercise control over the outsourced functions is not entitled to the return from the exploitation of such intangibles but should get a routine remuneration for services provided instead. Compared to the TPG 2010, the strict limitation language on the charging of license fees to distribution entities have been revised, allowing the charging of license fees in some cases even to routine distributors.
Takeaway: In contrast to the draft TPG 2020, which foresaw that the concept would only be applicable after 1 January 2021, dynamic interpretation is applied in case of HTVI. It is important to bear in mind that transactions involving HTVI give rise to reporting obligations under the DAC-6 Directive and potentially allow tax authorities to adjust intercompany pricing with the benefit of hindsight under certain circumstances.
Guidance on business restructurings is substantially in line with Chapter IX of the OECD TPG. In general, compensation for the restructuring may be required if something of value has been transferred or contracts have been terminated or substantially renegotiated, provided in all cases that compensation would be due between independent parties under similar circumstances.
In addition to (tangible or intangible) assets, a business restructuring may involve the transfer of a business activity (“ongoing concern”). In this context, the transfer of a business activity, i.e., a functioning, economically integrated business unit, means the transfer of assets, together with the ability to perform certain functions and assume certain risks. The ATPG 2021 explicitly link the OECD concept of transfer of an ‘ongoing concern’ with the domestic definition of a ‘business’ or ‘business unit’ in the context of the application of the arm’s length principle in business restructurings.
Intra-group lease of personnel
The ATPG 2021, for the first time, make statements on the transfer pricing methodology in the case of intra-group secondments, distinguishing between ‘passive’ and ‘active’ services. If there is a genuine transfer of personnel (passive service), the arm’s length remuneration is generally to be determined on the basis of an (internal or external) CUP or the cost-plus method. Under the cost-plus method, all costs associated with the secondment and, if applicable, an arm’s length profit mark-up must be considered. From the perspective of the receiving company, it must be considered whether personnel with the same skills and knowledge are available on the local labor market and what expenditure would have to be made for this.
Action item: In the absence of specific guidance, secondments were often charged at cost in the past as opposed to intercompany services, where a mark-up was applied. Companies will now have to assess whether their current approach to employee leases for transfer pricing purposes must be adjusted to be in line with the new ATPG 2021. Recipients of high cost leased personnel may have to prepare additional documentation to justify the level of expenditure considering the availability of resources on the local market.
Group synergies and location savings
Rules regarding group synergies and location savings due to the market specific characteristics are in line with the guidance in the OECD TPG. Location savings are to be allocated in accordance with principles outlined in Chapter I of the OECD TPG. The ATPG 2021 specifically refer to the treatment of the Austrian R&D subsidies (‘Forschungsprämie’) as an example of location benefits. The cost saving represented by these subsidies received by Austrian R&D service providers cannot automatically be allocated to the principal but may have to be shared with the service provider in line with the arm’s length principle by performing a functional analysis and considering the parties’ relative negotiating positions.
When considering realistically available alternative options, intercompany parties must assess whether third parties would have passed on the cost advantage to foreign principals via more favorable transfer prices. Based on the example cited in the ATPG 2021, an R&D service provider should not reduce the cost base with R&D subsidy received for the purposes of determining the intercompany service charge if it has a strong bargaining position due to a lack of comparable competition, or in cases where the comparable companies identified do not grant a price discount due to the research premium received.
Action item: Companies acting as R&D service providers that receive R&D subsidies in Austria should review how the subsidies are considered in the service charge. Putting in place robust documentation in case the intercompany services are charged net of R&D subsidies received would be necessary. Further, it is likely that the Austrian tax authorities will treat COVID related subsidies (such as short-term work, fixed cost compensation, compensation for lost revenues) following the principles outlined above with respect to R&D subsidies.
Permanent Establishments (PEs) profit allocation
The concept of “AOA light” is introduced with respect to the profit attribution to permanent establishments. According to this, the principles of profit allocation between a head office and PEs outlined in the Authorized OECD Approach (AOA) are applicable in Austria only to the extent the updated version of Article 7 of the OECD Model Treaty has been adopted. The “AOA light” applies in case the updated version of Article 7 of the OECD Model Treaty has not been adopted. The key difference from the full applicability of the AOA is that interest and licensing fee charges are not recognized for tax purposes between a head office and a PE and costs related to services provided outside the group’s core business activities have to be allocated without a mark-up.
Since the AOA was fully implemented by some countries, it is possible that Austria’s tax treaty partner country interprets the profit determination differently from the limited interpretation applied by Austria. In this case, the ATPG 2021 refer to the possibility of resolving the taxation conflict within the framework of a mutual agreement procedure (MAP).
The Austrian Transfer Pricing Documentation Law requires that only constituent entities (including PEs) above the applicable materiality thresholds prepare transfer pricing documentation following the Local File, Master File and Country-by-Country Report structure introduced by the 2017 update of Chapter V of the OECD TPG. Until recently, no specific transfer pricing documentation framework and format have been provided for MNE group members with revenues below the EUR 50 million materiality threshold (to be considered based on the two preceding financial years) in Austria.
The ATPG 2021 set out the minimum requirements for transfer pricing documentation outside the scope of the Transfer Pricing Documentation Law requiring that documentation covering the minimum content is prepared contemporaneously. The new content requirements are largely in line with those applicable for a Local File. The minimum standard requires that the international value chain is presented and that written intercompany agreements are in place covering the documented intercompany transactions.
In addition to the requirement for the transfer pricing documentation (regardless of entity size) to be available by the time the relevant tax return is filed, the ATPG 2021 emphasize that support for the determination of arm’s length terms and pricing has to be available at the time the relevant transaction is entered into.
The Austrian Transfer Pricing Documentation Law contains a notification obligation with respect to Country-by-Country reporting. For fiscal years starting after 31 December 2021 such notification only needs to be submitted if there were changes to the notification submitted in the previous year.
Takeaway: The new minimum standard of contemporaneous documentation requirements will likely lead to more scrutiny of the transfer pricing arrangements of smaller entities operating in Austria.
The ATPG 2021 set out the primary procedural basis for a corresponding adjustment. If the statute of limitations has occurred, this can only be resolved within the framework of a MAP.
The ATPG 2021 is a major rework of the previous administrative guidance in Austria incorporating ten years of transfer pricing developments on the level of the OECD (including the BEPS project) as well as in local administrative practice and transfer pricing case law.
The guidance is largely in line with the OECD TPG, however, in some respects introduces stricter requirements or includes formulations that may give rise to conflicts of interpretation with other countries in the future. The largest impact of the new guidance is expected to be substantially higher standards with respect to the determination, documentation and monitoring of the arm’s length nature of intercompany transactions in Austria. This relates to the content of intercompany agreements as well as how intercompany transactions, especially intercompany financing arrangements and those involving intangibles are to be analyzed and documented in the future. Due to the dynamic interpretation, however, MNEs active in Austria can expect that their past arrangements will also be reviewed against these higher standards in tax audits. Finally, smaller companies will now also be facing stricter formal documentation requirements in Austria.
The only recent OECD-level development not reflected specifically in the ATPG 2021 is the Guidance on the transfer pricing implications of the COVID-19 pandemic published on 18 December 2020. It therefore remains to be seen how Austrian tax auditors will approach the impact of the pandemic on the results of MNE members from a transfer pricing perspective. In light of the general ‘dynamic’ interpretation, one may assume that the OECD’s latest guidance would also be considered relevant, provided that both the impact of the pandemic as well as how the arm’s length principle was applied is documented contemporaneously.
Action item: Businesses should assess whether their transfer pricing policies comply with the updated ATPG, especially relating to areas where the updated guidance substantially differs from what was included in the TPG 2010, such as, for example, intercompany financing, secondments, or transactions involving intangibles.