New OECD Country Profiles made Available

On 9 June, the OECD published four new Transfer Pricing Country Profiles (“Country Profiles”).  They cover Egypt, Liberia, Saudi Arabia, and Sri Lanka.  The OECD prepares its Country Profiles based on a survey, replied to by the respective local authorities.  It covers a wide area of transfer pricing (“TP”) questions.  Examples are the status of the OECD’s transfer pricing guidelines (“OECD TPG”), the local approach to TP analysis, and documentation.  In the following, we summarize certain aspects that are relevant for TP valuation.

Status of International Guidelines

All four countries follow the OECD’s transfer pricing guidelines (“OECD TPG”).  Egypt and Sri Lanka even clarify that their local guidelines are based on the OECD TPG.  In this regard, Sri Lanka also mentions the UN practical TP manual.  While Saudi Arabian regulations follow the OECD, Liberia explicitly mentions that it applies local regulations consistent with international guidelines.

Comparability Analysis

All four countries state that their comparability analysis follows the OECD TPG.  This would be in line to their relies on the status of international guidelines.  Both Egypt and Saudi Arabia mention that local comparable transactions (“Comparables”) are strongly preferred.  Nevertheless, Saudi Arabia acknowledges the use of foreign Comparables when local ones are not available.  All four countries allow using an arm’s-length range, but Saudi Arabia and Sri Lanka require using the interquartile range (“IQR”) instead of a full range.

Comparability adjustments are made to the raw data to account for certain differences in the relevant comparability factors.  Here, Egypt explicitly requires such adjustments, while Saudi Arabia and Sri Lanka allow them.  For Sri Lanka, such adjustments need to be reliable and accurate, which is the general requirement under the OECD TPG.  Saudi Arabia, however, limits comparability adjustments to such situations, where they do not make a material impact.  In other words, Saudi Arabia only allows adjustments for smaller differences.

Intra-Group Restructurings

Unfortunately, the OECD-survey does not foresee a section on intra-group business restructuring.  Such restructurings involve the cross-border transfer of whole businesses, thus of going concerns instead of isolated tangible or intangible properties.  Very few jurisdictions have explicit regulations addressing this topic with Germany being the main exception.  Accordingly, we assume that the four covered countries too, lack such explicit guidance in their domestic regulations.  The local tax administration will likely follow the basic guidance provided by Chapter IX of the OECD TPG.  In the case of Sri Lanka, Chapter 8 of the UN manual can and should also be considered.

Our Findings

From our perspective, the approach to the application of the IQR taken in Saudi Arabia is highly problematic.  Typically, tax administrations tend to apply this mechanical range-narrowing tool even if the necessary preconditions do not exist.  In principle, the IQR is a possible means to reduce scattering due to non-systematic distortions.  Nevertheless, as a purely descriptive tool the IQR requires a large number of observations.  Otherwise, it cannot provide a necessary a minimum of accuracy.  The OECD TPG do acknowledge this explicitly (para. 3.57).  Rather than statistical analyses, the OECD prioritizes close comparability.

However, a following such a proper approach will necessarily deliver relative narrow range of the Comparables’ financial results.  An additional application of the IQR will further narrow it unduly, typically to about the half.  This increases the risk of tax adjustments, albeit relatively small, in situation where the taxpayer transacted at arm’s length.  Taxpayers and economic consultants therefore face the difficulty of finding ways to allow for a sufficiently broad range that even after inappropriate narrowing provides the taxpayer with a sufficient cover.

Another troubling result from reviewing the Country Profile of Saudi Arabia is the approach towards comparability adjustments.  As mentioned above, Saudi Arabia limits their application to cases where the raw data only changes slightly.  Such a “fine-tuning” approach directly contradicts the OECD TPG which only recommend adjustments for material differences.  Comparability adjustments with only minor quantitative effects are explicitly discouraged.  For this, see especially paragraphs 2.2, 2.11, and 2.15 of the OECD TPG.  This approach makes sense to avoid spurious accuracy.  It is also in line with general valuation principles.

Conclusion

Saudi Arabia here also illustrates a more general issue that practitioners regularly face in discussions with tax administrations:  While they claim to follow the OECD TPG, individual views are sometimes clearly contradicting explicit statements of the OECD.  In some cases, this may be an honest mistake caused by a lack of deeper understanding of valuation principles.  However, in other cases goal-orientation of the examiner may motivate such inconsistencies.  In any case, a valuation professional should be involved early when setting and documenting transfer prices.

Sources

All Country Profiles of the OECD, including the four new ones can be found on the website of the OECD here: https://www.oecd.org/tax/transfer-pricing/transfer-pricing-country-profiles.htm

Please note that these Country Profiles can only serve for general information purposes.  They do not provide a reliable opinion about local laws.  For reliable advice in specific cases taxpayers should consult a locally qualified legal expert while valuation experts can help with the economic aspects.