FTI Consulting’s response to the draft guidance and updates from the public consultation
“What is missing from the draft, however, is a clear statement that:
1) None of these factors standing alone dictates the mandatory use of a Profit Split Method methodology; and
2) that the absence of any one or more of these factors does not prevent the use of a Profit Split approach if all the circumstances of a particular case suggest that such an approach is the most useful method.”
Chair, WP6, 12th October 2016, quoting from one of the received responses
Transactional Profit Split of Anticipated Profit
One of the major changes proposed by the discussion draft was the introduction of the transactional profit split of anticipated profit as an addition to the profit split commentary. The transactional profit split of actual profit is applicable in transactions with highly integrated activities, focused on a shared business objective. The newly introduced method, in contrast, would be most appropriate for transactions which are integrated, but one party has a lower level of involvement in the on-going business activities and, therefore, less able to influence the expected outcome.
The key difference between the two alternatives of the profit split method is that the transactional profit split of anticipated profits requires the ability to accurately predict the future cash flows generated from the combined efforts. This, in our opinion, adds an additional layer of complexity and uncertainty above the transactional profit split of actual profits. Additional weakness of the method results from how a tax-payer evidences that the profit splitting factors were determined ex ante hence should not be subject to challenge post ante. There is a perceived heightened risk when actual results differ greatly from the anticipated results.
We believe, if to be retained at all, that the transactional profit split of anticipated profits should be clearly outlined as an additional method and not a variant of the traditional profit split method. Furthermore, we welcome that the guidance emphasised that the applicability of either of these methods depends on the specific facts of the transaction and that they are only used when determined as the most appropriate method, and not in situations of perceived lack of reliable data under another method, for which adjustments may be possible.
Sharing of Significant Risks
The discussion draft contains new commentary on the sharing of significant risks and the link with integration of business activities in order to assess the appropriateness of the application of the transactional profit split of actual profit to the transaction in question. In our response, we argued that a clearer definition of “sharing” of risk is required, such that it is not seen as interchangeable with “controlling” of significant risks. In our opinion, parties do not need to control the same risks in relation to the transaction, but rather a portion of the risks associated with the overall business objective in question.
We recommended, therefore, that when determining the transactional profit split of actual profits as the most appropriate method, the focus should remain on what independent parties in comparable situations would do. Therefore, the attention should be on whether multiple parties are contributing towards a shared business objective, manage significant risks relating to achieving that business objective and either (i) contribute unique intangibles; or (ii) contribute key assets.
Public Consultation Update
The participants invited to speak at the public consultation covered topics surrounding anticipated versus actual profits, integration and risk sharing. We spoke on integration and using a business objective as an additional test for the applicability of the profit split as the most appropriate method.
The use of formulaic apportionment or mandatory profits splits are not in line with the ALP which remains the standard to be applied.
The majority of the day was spent on the concept of risk sharing, and the requirement for it to be present in order to use the profit split method. Additionally, there was considerable debate on whether economically significant risks could exist in isolation of functions and how the profit split concept of risk and control interacts with the description in Chapter 1. There was a lack of unanimity on the role risk sharing plays in the profit split of anticipated profits. However, overall a greater consensus was reached on the sharing of economically significant risks as a requirement for the use of the profit split of actual profits.
The concepts of integration and Value Chain Analysis are tools for the Functional Analysis and likely sit better in Chapter 1 than Chapter 2.
Concerns were raised that the added concept of integration was confusing and added little value. Equally, the inclusion of the Value Chain Analysis (VCA) concept into the profit split guidance was considered misleading and unnecessary. The consensus amongst advisors was that if either had a place, it was in Chapter 1 as a tool for conducting the functional analysis. When questioned on the reason for including the VCA, WP6 Chair stated that they had been mandated to consider whether it could be a useful tool and the inclusion therefore was an open question.
Several parties requested acknowledgement that the use of a profit split method did not mandate inclusion of global profits and could equally be applied to the profit of one party or one product. A NGO (BEPS Monitoring Group) called for global profit splits as the starting point for all MNCs and the use of formulaic apportionment to determine global profits. However, it was confirmed that the mandate of WP6 is not to reconsider the arm’s length principal. A revised draft is expected towards the end of the year.
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November 10, 2016