OECD Draft Handbook 

On April 30th, 2013, the OECD released the “Draft Handbook on Transfer Pricing Risk Assessment”. The handbook is a resource to develop risk assessments which assists tax authorities in the assignment of appropriate audit resources that reflects the nature and amount of taxpayers’ transfer pricing-related risks.

During the course of an audit, once a tax authority has committed significant resources and time, there are internal pressures to demonstrate results in the form of reassessments. By the nature of how transfer pricing audits proceed, there is reluctance from auditors to acknowledge clarifications of the key functions, risks and industry factors that would serve to reduce any upcoming reassessments. As a result, many reassessments have occurred that are based on factual misunderstandings. These inaccurate reassessments consume government and taxpayer resources when the misunderstandings are addressed later in the courts or by the Competent Authority. The typical end result is often immaterial or marginal changes to tax revenues. An initial transfer pricing risk assessment prior to the commencement of an audit could avoid this inefficiency by shifting tax authority resources away from lower risk taxpayers.

To identify taxpayers that may be off-side on their transfer pricing policies, specific sections of the handbook address:
 

• Comparing taxpayer profitability to industry standards;
• Comparing taxpayer profitability to comparable companies;
• Comparing taxpayer profitability to other related parties or to group results;
• Considerations on recurring losses or recurring low profits;
• Considerations on fluctuations that are contrary to market trends;
• Analyzing intra-group service transactions;
• Assessing royalty, management fees and insurance premium payments, particularly to entities in low tax jurisdictions;
• Reviewing marketing or procurement companies located outside market countries or countries where manufacturing takes place;
• Recognizing excessive debt and/or interest expenses;
• Reviewing transfer or use of intangibles to/for related parties;
• Analyzing cost contribution arrangements;
• Considerations of business restructurings; and
• Addressing substantial or disproportionate income in low-tax jurisdictions.

EMG views the handbook as a positive contribution from the OECD. Canada, in particular, has been well known to have one of the most aggressive tax authorities for transfer pricing. These resources have been frequently spent on taxpayers with a low risk of being off-side on their transfer pricing policies. Use of this handbook and increased communication between taxpayers and the Canada Revenue Agency (“CRA”) on initial risk assessments have the potential to reduce extensive audit activity on taxpayers with low transfer pricing risk.  This also allows the CRA resources to be better allocated to taxpayers with high transfer pricing risk.

EMG assists clients in the preparation of risk assessments to determine transfer pricing exposures. A risk assessment that demonstrates a taxpayer’s transfer pricing policies are of low risk of being “off-side” is a valuable tool to potentially reduce the audit burden. Referencing analytical procedures prescribed by the OECD publication would increase credibility and decrease skepticism that tax authorities may have from a taxpayer prepared risk assessment. The ideal time to share this risk assessment with the tax authority would be early in the international audit prior to any team meetings where transfer pricing documentation is typically requested.