Profit Split Method Research Articles

Recent Case Law on the Application of the Profit Split Method

Is it possible for MNEs to achieve tax certainty when using the profit split method? Recent case law demonstrates a growing controversy surrounding the profit split method application, with tax authorities becoming more proficient at challenging its use.

Supreme Administrative Court Decision on Intra-Group Services Involving the Stock Spirit Group

This article provides some insights into the methodological approach of the Czech judiciary in the example of the Stock Spirits Group case involving intra-group services, including consulting services remunerated with a feature resembling a profit split method, charges made for support services and the recharge of services from third parties related to the refinancing of the loan. The key issue of dispute was the burden of proof on the taxpayer to establish that the services can be deducted for tax purposes, rather than the specific transfer pricing methodology.

Analysis of PSM after implementation of CbCR policy in Indonesia

The Country-by-Country Reporting (CbCR) policy requires that multinational enterprises report financial information of all of their business group members globally. The presence of the information within such policy framework should be reviewed as to whether it will be useful for the Profit Split Method (PSM) implementation. This research used a qualitative approach with data collection techniques including indepth interview. The results indicate that in the future, the PSM will grow in urgency with the development of multinational enterprises and the Anti-BEPS (Base Erosion and Profit Shifting) project. However, the PSM implementation in Indonesia at the present time is still rare due to particular difficulties encountered by both taxpayers and tax authorities. CbCR data alone is not sufficient to be used as a basis for the PSM implementation. Nevertheless, CbCR can still be used by taxpayers as a basis for the PSM implementation in collaboration with other data and information.

The Transformation in BEPS Mechanism and Tax Evaluation from Global Digitalization and Tax Competition

With the advent of the globalization, it was witnessed that there was a growth of communication system within the companies and the services were more intangible in nature. Therefore, the initiative of the OECD Base Erosion and Profit Shifting (BEPS), 2013 was the one of the most significant effort to eradicate the problem of shifting tax profit. Further, the misalignment of the national tax laws benefitted the companies in shifting their profits to the less tax jurisdiction. This imbedded the basis for the arm’s length principle acting as a guidance for comparison of associated enterprises with the independent one. The OECD/G20 Addressing the Tax Challenges of the Digital Economy, 2014 articulated a structural shift towards the profit-split method which is more suitable for intangible transactions. However, the 2018 Revised Guidance on the Application of the Transactional Profit Split Method: action 10 prescribed a revision of the above consideration. Consequently, Inclusive Framework’s 2019 asserted a need to address a more appropriate transfer pricing method that would be allow the evaluation of profits to go beyond the basic arm’s length principle. As a result, there is an unlikeliness with a stable tax system that can be adhered too. Therefore, I evaluate alternative proposals including the value created method or the residual profit-split method to re-examine the loopholes of the existing residence-source paradigm.

Profit Allocation within MNEs in Light of the Ongoing Digital Debate on Pillar I – A “2020 Compromise”?

The current profit allocation framework, i.e. the arm’s length standard, is mainly based on a facts and circumstances analysis. In particular, depending on the situation, facts and circumstances-related allocation keys are used to allocate profits among various entities within a multinational enterprise (MNE). Nevertheless, there are situations wherein predetermined formulas and/or allocation keys are also used within the standard. The purpose of this article is to show that predetermined approaches will quickly infiltrate the profit allocation framework, although a facts and circumstances analysis and/or allocation keys will continue to be used. The authors support this proposition by analysing the current debate on profit allocation with respect to the digitalization of the economy. They conclude that the use of predetermined approaches is inevitable if the objective is to develop a simplified solution with respect to the profit allocation debate made in the context of Pillar 1 of the digital debate. A simplified solution would be to apply a formulary approach at the MNE group level and an arm’s length principle (ALP) approach at a separate-entity level. More specifically, a predetermined formulary approach in the form of a simplified but modified residual profit split method could be applied at the MNE group level to reallocate residual profits (the so-called Amount A). Simultaneously, a predetermined formula based on the arm’s length approach could be applied at a separate-entity level, that is, to routine distribution and/or marketing activities (the so-called Amount B). This latter approach will be complemented and backed up by a facts and circumstances arm’s length analysis (the so-called Amount C, which, in some respects, would seem to be more of a process, rather than a separate amount). In this context, the authors address their view on a few key questions that arise in the “new” profit allocation context for Amounts A, B and C. For Amount A, the authors express their view on determination of the MNE tax base, determination of losses, revenue sourcing rules, information reporting, collection of taxes as well as stabilization of the MNE group approach. For Amount B, they provide their view on issues such as the determination of the scope of application, the determination of the fixed return, its legal qualification and its possible stabilization. The need to introduce a more robust dispute resolution institutional framework is also addressed with specific regard to Amount C. Finally, they analyse the impact of the new profit allocation mechanisms on selected business models used by MNEs. It should be noted that the present contribution does not address, as far as necessary to provide adequate context, the normative debate on a new scope, new nexus or new relief rules but rather focuses on the challenges arising from profit allocation.

Does the Profit Split Method Apply to Principal Structures?

The purpose of this article is to address whether the profit split method (PSM), in particular, the transactional PSM (TPSM) applies to principal structures in multinational enterprises (MNEs). It takes into account the shift in focus of the post-BEPS amendments, especially the 2017 OECD Guidelines and the 2018 Revised Guidance on the Application of the Transactional Profit Split Method. The main focus is on the possible departure from the arm’s length principle in the 2019 consultation document of the OECD on a unified approach to profit allocation under Pillar One. Will this unified approach (deemed “PSM” on consolidated MNE level) improve the world order between global MNEs and local tax authorities and lead to less disputes and less double taxation?

Allocating Multinational Income Generated by Intangible Assets: An Industry Perspective

This study develops a model in which a multinational firm creates a brand that generates income in multiple countries. Many firms attempt to develop a brand, but only one firm succeeds. The firm that creates the brand earns positive residual profits. The industry as a whole does not, as the residual profits are competed away by firms trying to create the brand. There is a unique allocation of taxable income among countries that is distributionally neutral at the industry level. This allocation can be achieved using the comparable profit method, but not by using other methods such as the residual profit-split method or formulary apportionment methods based on relative sales or residual profits. The message of the study is that any analysis of the taxation of residual profits is incomplete if it does not consider all the investments, including failed investments, associated with the creation of those residual profits.

The Transfer-Pricing Profit-Split Method After BEPS: Back to the Future

In 2018, the Organisation for Economic Co-operation and Development/Group of Twenty (OECD/G20) Inclusive Framework on base erosion and profit shifting (BEPS): action 10 issued revised guidance on the transactional profit-split method. Regrettably, the revised guidance failed to provide the opportunity for the profit-split method to be more often the most appropriate transfer-pricing method. The revised guidance expressly states that the lack of comparable uncontrolled transactions, by itself, is not a basis for the use of the profit-split method. Under the former guidance, the profit-split method was used infrequently. In the revised guidance, the threshold requirements for the use of the profit-split method are still restrictive. Consequently, it is likely that the profit-split method will rarely be the most appropriate transfer-pricing method. Nevertheless, the residual profit-split method is being considered for BEPS action 1, on the taxation of the digital economy. Two of the proposals under pillar 1 of the Inclusive Framework's 2019 short policy note involve the use of the residual profit-split method to allocate profits. These proposals involve new profit allocation rules that go beyond the arm's-length principle.

Allocation of Taxing Rights in the Digitalized Economy: Assessment of Potential Policy Solutions and Recommendation for a Simplified Residual Profit Split Method

In 2019, the OECD released a public consultation document and its work program that address the tax challenges raised by the digitalization of the economy. These documents essentially discuss proposals that either address the allocation of taxing rights (Pillar I) or unresolved Base Erosion of Profit Shifting issues (Pillar II). Regarding Pillar I, three solutions were proposed: user participation, significant economic presence, as well as the marketing intangibles approach. The purpose of this contribution is to assess the Pillar I proposals considering their policy rationale and the broadly agreed tax policy principles by tax administrations. In light of the assessment, the author takes the view that the marketing intangible proposal, which seems to apply to consumer (or user) facing businesses, could be the most appropriate solution to address the issue of the allocation of taxing rights. However, that proposal incites several issues concerning its profit allocation mechanism. Thus, in order to achieve tax certainty, the contribution offers a potential solution for implementing the consumer (or user) facing proposal, that is, to resort to a simplified residual profit split method that is based on operating profit margins of a MNE Group . The article provides a high-level overview of the design of the mechanism and briefly addresses issues related to scope and nexus as well as rules that deal with elimination of double taxation.

Revised Guidance on the Application of the Transactional Profit Split Method: Evolution or Revolution?

The OECD, in response to the mandate under the BEPS Project of developing rules in order to ensure allocation of profits in line with the actual value creation, recently revised the guidelines provided for the application of the transactional profit split method. This article analyses the new provisions contained in the Revised Guidance 2018 and discusses practical approaches which can be taken in order to apply the method in a reliable manner, and to some extent elucidates the OECD’s thoughts on some particular issues.

Landmark Ruling on the Tax Administration’s Duty to Respect the Taxpayers’ Choices

The Supreme Administrative Court found in case SAC 2018:173 that the Finnish tax administration did not have the legal right to disregard a taxpayer’s benchmarks and to make reassessments for the years 2006-2008 by applying the transactional profit split method. The taxpayer had not filed incorrect tax returns because it would have been possible for the tax authority to test the arm’s length profitability of intra-group transactions with the transfer pricing methods that the taxpayer had actually used and documented.

Basic Concept and Conditions for Recognition of Combined Profits under the Residual Profit Split Method

Basic Concept and Conditions for Recognition of Combined Profits under the Residual Profit Split Method

Digital Economy and Profit Allocation: The Application of the Profit Split Method to the Value Created by a “Significant Digital Presence”

The European Commission recently released a comprehensive legislative proposal laying down a new set of tax rules applicable to the digital economy. The proposal at issue also provides a set of rules concerning profit attribution to a “significant digital presence” (a new concept of permanent establishment intended to establish a digital taxable nexus in the European jurisdictions). The EU legislator opted for the profit split method (adapted in a consistent manner to reflect the way value is created in digital activities). The aim of this article is to understand how the new proposed EU rules concerning profit attribution to a “significant digital presence” will work and then try to evaluate their suitability and efficiency. To this end, the article studies and compares three highly digitalized business models. Based on such analysis, the author proposes both theoretical and practical solutions aimed at making the proposed EU provision on profit attribution to a “significant digital presence” applicable and efficient.

Profit Split Method: Time for Countries to Apply a Standardized Approach

With the OECD issuance in June 2018 of its final guidance on the profit split method, individual countries must determine how they might consider and apply the profit split method (PSM) going forward. The OECD guidance issued reflects a consensus view that included input from the very large number of countries. The need for consensus means that guidance can only reflect the lowest common denominator of country positions. Hence, it is not surprising that the final guidance does not include innovative proposals for simplification of the PSM or any effort to expand its use. In previous comments to the OECD concerning the PSM, the BEPS Monitoring Group recommended making the PSM truly easy to apply by taxpayers and tax authorities alike by establishing standardized concrete allocation keys and weightings for common business models. This article calls for individual countries and regional groups to now consider adopting this approach. It also suggests that countries that choose to do so could not only establish standardized concrete allocation keys and weightings for common business models, but such countries could require that any groups whose businesses reflect these common business models must use the PSM and these required keys and weightings. Another method or the use of alternative keys and weightings could only be used where a taxpayer group establishes to the satisfaction of the relevant tax authorities that some other transfer pricing method or key and weighting approach is, in fact, more appropriate. Countries should also consider encouraging the Platform for Collaboration on Tax to take on the challenge of further developing this approach so that it could more easily be adopted by many countries.

The Use of Value Chain Analysis in a Profit Split

This article provides an introduction to the profit split method (PSM), giving a quick look into its evolution throughout time and explaining how it shall be identified and applied as the most appropriate transfer pricing method, while demystifying the terms “value creation” and “value chain analysis” (VCA) and explaining why they were introduced by the OECD in the Action Plan on Base Erosion and Profit Shifting (hereinafter BEPS Actions). This article elaborates on what a VCA should consider, how it should be conducted and what should be the outcome, and addresses the practical aspects of the use of the PSM in a VCA, based on a numerical example in the light of the OECD’s recommendations in, inter alia, the OECD Model Tax Convention, the OECD Transfer Pricing Guidelines, the BEPS Actions, discussion drafts and public consultations on the application of the PSM.

The Use of the Profit Split Method in Highly Integrated Transactions

Given the increased significance of the transactional profit split method, the author provides a critical analysis of this transfer pricing method related to highly integrated transactions within multinational enterprises in light of the recently published discussion drafts on profit splits by the OECD. Particularly, this article addresses different aspects of these discussion drafts and gives a real-life example of a profit split in the construction industry in the context of highly integrated transactions.

Intangible Assets and Customs Valuation

This paper focuses on determining the customs value of intangible assets by using a transactional profit split method. In this paper we explain how to determine the customs value of related inter-company transactions; summarise the relationship between the arm’s length principle and customs valuation; explain how the customs value of intangible assets can be determined by using a profit split method; and discuss the developments related to reconciliation of customs valuation with transfer pricing and the proposed solutions.

Profit Split Method: Is It Becoming the Most Appropriate “Alternate” Method?

In this article, the authors highlight the increasing move by the Indian tax authorities towards adoption of the profit split method of allocating profits of multinational enterprises which undertake operations in India, particularly in relation to marketing intangibles, permanent establishments and contract research and development centres. The article canvasses recent Income Tax Appellate Tribunal decisions and highlights the need for multinational enterprises to protect themselves from the tax authority’s newfound thirst for the profit split method by carrying out detailed functional analyses, which are comprehensively documented.

Submission (To OECD Task Force on the Digital Economy) Concerning Tax Challenges of Digitalization

Profit shifting has been on steroids. Despite this, at the initiation of the BEPS project in 2013, a decision was made to limit the project’s scope by accepting the separate entity concept and the arm’s length principle. It is now time to think more broadly. Considering this, in this submission I suggest four concrete approaches to dealing with BEPS behavior within the context of the digital economy. Certain of these approaches are new and presumably have not been previously considered by the Task Force. The first three may be initiated immediately. The fourth is a long-term approach. These four approaches are: • Identification of PEs in BEPS Structures and Applying Taxation to Them—Many BEPS structures involve the recording of profits in a principal company where the management and conduct of the business takes place in the MNEs home country or a third country. Such cases will involve undeclared PEs that would be appropriately taxable in the countries where the business is managed and actually conducted. I suggest in this submission various steps that would lead to taxation of such BEPS structures. This in turn would lead to the unwinding of some existing structures and discouraging new structures. (Note that this is a focus on the country where the principal company’s business is run and is not a focus on the BEPS project’s expansion of Article 5, which expands the PE definition for countries from which a non-resident is earning revenue.) • Expanded Use of the Profit Split Method and Development of Concrete Allocation Keys and Weightings—Broader use of the profits split method along with the creation of concrete allocation keys and weightings for common business models would ease compliance for taxpayers and significantly facilitate reviews by tax authorities. It would also greatly increase certainty for both taxpayers and tax authorities alike. • Abandonment of Territorial Tax Systems in Favor of Something Better—Territorial tax systems have significantly contributed to the BEPS contagion by strongly motivating MNEs to shift profits out of home countries, source/host countries, and the countries into which they sell products or provide services. Transfer pricing and CFC rules have been insufficient to protect home country tax bases. A typical goal of MNEs is to be taxable nowhere. The Task Force on the Digital Economy could recommend that the relatively few countries that are home countries to MNEs should abandon their territorial systems and adopt residency-based full-inclusion systems. Under full-inclusion systems, the home countries of MNEs would tax currently at home country tax rates the worldwide income of their MNEs irrespective of which group member recorded the income. This is a very practical approach that could be instituted in the short term since its adoption only requires participation by the relatively few countries that are home countries to MNEs. In addition, there is no need for uniformity with each country being able to define its own tax base, tax rates, sourcing rules, etc. This full-inclusion approach stands on its own as an approach that would provide an environment with much less motivation for BEPS behavior. If the longer term formulary apportionment dialogue recommended below is successful, this full-inclusion approach could be an effective interim approach. • Formulary Apportionment—Initiation of a dialogue amongst all nations with a long-term goal of developing agreement for the implementation of a formulary apportionment taxation system.

Submission (To OECD Task Force on the Digital Economy) Concerning Tax Challenges of Digitalization

Profit shifting has been on steroids. Despite this, at the initiation of the BEPS project in 2013, a decision was made to limit the project’s scope by accepting the separate entity concept and the arm’s length principle. It is now time to think more broadly. Considering this, in this submission I suggest four concrete approaches to dealing with BEPS behavior within the context of the digital economy. Certain of these approaches are new and presumably have not been previously considered by the Task Force. The first three may be initiated immediately. The fourth is a long-term approach. These four approaches are: • Identification of PEs in BEPS Structures and Applying Taxation to Them—Many BEPS structures involve the recording of profits in a principal company where the management and conduct of the business takes place in the MNEs home country or a third country. Such cases will involve undeclared PEs that would be appropriately taxable in the countries where the business is managed and actually conducted. I suggest in this submission various steps that would lead to taxation of such BEPS structures. This in turn would lead to the unwinding of some existing structures and discouraging new structures. (Note that this is a focus on the country where the principal company’s business is run and is not a focus on the BEPS project’s expansion of Article 5, which expands the PE definition for countries from which a non-resident is earning revenue.) • Expanded Use of the Profit Split Method and Development of Concrete Allocation Keys and Weightings—Broader use of the profits split method along with the creation of concrete allocation keys and weightings for common business models would ease compliance for taxpayers and significantly facilitate reviews by tax authorities. It would also greatly increase certainty for both taxpayers and tax authorities alike. • Abandonment of Territorial Tax Systems in Favor of Something Better—Territorial tax systems have significantly contributed to the BEPS contagion by strongly motivating MNEs to shift profits out of home countries, source/host countries, and the countries into which they sell products or provide services. Transfer pricing and CFC rules have been insufficient to protect home country tax bases. A typical goal of MNEs is to be taxable nowhere. The Task Force on the Digital Economy could recommend that the relatively few countries that are home countries to MNEs should abandon their territorial systems and adopt residency-based full-inclusion systems. Under full-inclusion systems, the home countries of MNEs would tax currently at home country tax rates the worldwide income of their MNEs irrespective of which group member recorded the income. This is a very practical approach that could be instituted in the short term since its adoption only requires participation by the relatively few countries that are home countries to MNEs. In addition, there is no need for uniformity with each country being able to define its own tax base, tax rates, sourcing rules, etc. This full-inclusion approach stands on its own as an approach that would provide an environment with much less motivation for BEPS behavior. If the longer term formulary apportionment dialogue recommended below is successful, this full-inclusion approach could be an effective interim approach. • Formulary Apportionment—Initiation of a dialogue amongst all nations with a long-term goal of developing agreement for the implementation of a formulary apportionment taxation system.