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BEPS Action 10

BEPS (Base Erosion and Profit Shifting) Action 10 is part of the OECD’s BEPS initiative, which seeks to align transfer pricing outcomes with value creation and prevent tax avoidance through manipulative practices. Specifically, Action 10 addresses the use of high-risk transactions between multinational enterprise (MNE) group members that may not align with the arm’s length principle. It aims to limit the opportunities for base erosion through transactions that would otherwise be priced inappropriately, such as management fees, low-value-adding intra-group services, and the use of intangible assets.

Primary Goal

The key objective of BEPS Action 10 is to ensure that profit allocations within MNEs are consistent with the economic activities generating those profits. It focuses on aligning transfer pricing rules with value creation to curb the artificial shifting of profits. The guidance under Action 10 strengthens the requirements for demonstrating the commercial rationale and economic substance of intra-group transactions.

Key Components of BEPS Action 10

  1. Transfer Pricing Adjustments: Action 10 provides specific guidance on addressing the pricing of transactions that may not meet the arm’s length standard.
  2. Low-Value Intra-Group Services: One significant focus is on low-value-adding services, where Action 10 offers simplified approaches to reduce compliance burdens while ensuring appropriate profit allocations.
  3. Risk and Capital Considerations: The OECD emphasises the appropriate allocation of risks and capital, ensuring that risks assumed by an entity correspond to its ability to control and manage those risks.
  4. Transactional Profit Split Method: In complex scenarios involving intangible assets, Action 10 highlights the use of profit split methods to reflect the contributions of multiple group entities.

Examples of BEPS Action 10 in Practice

Allocation of Management Fees in MNEs

A multinational corporation allocates management fees from a head office in Country A to various subsidiaries in different jurisdictions. Before the implementation of BEPS Action 10, these fees might have been set arbitrarily, reducing taxable income in higher-tax jurisdictions. Under Action 10, MNEs must provide robust evidence that these fees are consistent with the arm’s length principle. For instance, documentation must detail the services provided, their economic benefit to the subsidiaries, and comparable market prices for such services. If an MNE cannot justify the economic substance of these charges, tax authorities may disallow deductions, increasing the MNE’s taxable base.

Use of Intangible Assets

Consider a case where an MNE transfers the rights to a valuable brand or patent to a low-tax jurisdiction. The subsidiary in the low-tax jurisdiction collects substantial royalty payments from related entities using the brand. Under BEPS Action 10, tax authorities examine whether the subsidiary has the economic substance to own and manage the intangible asset. For instance, does it have the technical staff, decision-making capacity, and infrastructure to control the risk associated with the brand? If not, tax authorities may allocate profits back to the jurisdictions where the development and management of the intangible asset occur. This approach prevents artificial profit shifting to low-tax jurisdictions.

Low-Value-Adding Intra-Group Services

A scenario involves an MNE that provides low-value-adding services, such as IT support or administrative functions, across its global entities. Action 10 allows the use of a simplified approach for these services, limiting the markup to a specified range (e.g., 5%). For instance, a European subsidiary that receives IT support from a central service provider within the MNE must document the cost allocation methodology. If the markup exceeds the acceptable range or lacks justification, tax authorities may challenge the transfer pricing arrangements and enforce adjustments to reflect the arm’s length standard.

Cases/Judgments Involving BEPS Action 10

Coca-Cola Company v. Commissioner (United States)

In this landmark case, the IRS challenged Coca-Cola’s profit allocations between its US and foreign subsidiaries. The IRS argued that the pricing arrangements violated the arm’s length principle, particularly concerning intangible property royalties. The court highlighted the importance of economic substance, which is central to BEPS Action 10, reinforcing that profit allocations must correspond with the value creation activities of the MNE.

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GlaxoSmithKline (Canada) Transfer Pricing Dispute

This case revolved around the arm’s length pricing of pharmaceutical products sold between related entities in Canada and Europe. The Canadian Revenue Agency questioned the markups applied, and although the case predated BEPS Action 10, it emphasised the need for proper documentation and justification for related-party transactions. Action 10 builds on these principles to ensure such disputes are mitigated in the future.

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Amazon EU S.à r.l. v. Commission (European Union)

Amazon’s transfer pricing practices involving intangible assets held in Luxembourg came under scrutiny for state aid violations. Although not directly under BEPS Action 10, the case illustrates the growing importance of ensuring that profits associated with intangibles align with value creation activities, a principle reinforced by BEPS Action 10. The case demonstrates how tax authorities are increasingly using BEPS guidelines to address profit-shifting strategies.

CLICK HERE TO READ THE FULL CASE SUMMARY