On 11 May 2018, the Netherlands published a new Transfer Pricing Decree ("Decree"). This new Decree is an updated version of the 2013 Transfer Pricing Decree and clarifies the implementation and application of the arm’s length principle in the Netherlands.
In this Alert, we summarize the main points included in the Decree, including the most important changes as compared to the 2013 Transfer Pricing Decree.
Introduction & scope
At a time when transfer pricing is at the forefront of the international tax debate, the Dutch Ministry of Finance published a new Transfer Pricing Decree (no. 2018-6865) on 11 May 2018. The Decree provides further guidance on the application of the arm's length principle in the Netherlands, especially areas where the OECD Transfer Pricing Guidelines (the "OECD Guidelines") do not provide a clear position or where there is room for different interpretations.
With the Decree, the Ministry of Finance now confirms that the OECD Guidelines are an appropriate explanation and clarification of the arm’s length principle based on Dutch law. At the same time, the Decree provides assurance that Dutch transfer pricing practice is in line with the BEPS project undertaken by the OECD to ensure that transfer pricing outcomes are aligned with value creation within a multinational enterprise (“MNE”). With regard to changes that further clarify the application of the arm’s length principle, the Decree also applies to the years prior to its publication.
Characterisation of a transaction
The Decree acknowledges the importance of a detailed functional analysis for the characterisation of an intercompany transaction and adopts the OECD "control over risk framework". While it confirms that the starting point of the characterisation should be the contractual arrangements between parties, it also provides additional guidance on re-characterisation. Furthermore, the Decree states that the Transactional Profit Split method can be applied in case more than one party performs the "control over risk" function.
The Decree provides specific guidance regarding the composition of the cost base to be used for cost-based remunerations. First, the Decree specifies which costs can be considered as costs in the nature of a ‘disbursement’. Per the Decree, costs qualify as disbursements if the relevant costs are not a relevant indicator of the value of the functions performed and are to remain outside the cost base subject to a mark-up. Added examples of ‘disbursement’ costs include situations where one party acts as an intermediary for the purchase of services. Where the costs of the purchased services are not considered a relevant indicator of the functions performed by the intermediary, the intermediary is only entitled to a mark-up on the relevant operating expenses. The Decree further illustrates this concept in the context of toll manufacturers.
The Decree also specifies that in case of the sale of goods through a Dutch intermediary, where the intermediary does not perform any relevant sales activities, the remuneration for the intermediary should in principle be based on the relevant operational expenses (rather than revenue-based remuneration).
The Decree builds on the expanded guidance on the use of valuation techniques included in the 2017 OECD Guidelines (e.g., hard-to-value intangible assets). The Decree specifically states that the valuation should take into perspective the tax consequences of the transaction for both the seller and the buyer. Furthermore, the Decree provides additional guidance on the choice of the correct discount factor.
The Decree describes business restructurings specifically in the context of the post-acquisition restructuring of a recently acquired business. In these situations, "acquisition files" provide an essential part of the transfer pricing documentation for a business restructuring that should be submitted to the Dutch Tax Authorities ("DTA"), that is, unless a taxpayer can substantiate that certain aspects of these acquisition files are irrelevant for tax purposes.
If the business restructuring involves de-risking of an entity to the extent that only routine functions remain in the restructured entity, the DTA will take the position that a valuation of the routine functions should not be performed on the basis of routine cash flows that can be expected in perpetuity. Instead, a shorter time frame may need to be considered.
Remuneration for intangible assets
External CUP method
The Decree explains that the CUP method is generally difficult to apply to tested transactions that relate to the use of intangible assets. In practice, the compensation for the use of such intangible assets is sometimes determined through the use of available databases to identify comparable transactions between two unrelated parties (i.e., application of the “external CUP method”). According to the Decree, since the CUP method is sensitive to differences between the tested transaction and the identified comparable transactions, it is typically difficult to find good comparable transactions in these databases. The Ministry of Finance therefore clarifies that the use of such databases will be critically reviewed by the DTA.
Residual profit for the use of intangible assets
The Decree specifies that the use of one-sided methods (e.g., the resale price method, cost-plus method or TNMM) is not appropriate for determining the value of an intangible asset. However, these methods can, under certain circumstances, be used to determine compensation for the use of intangible assets without determining the value of the intangible asset per se.
More specifically, the Decree describes that one-sided methods can be used in case the party with the least complex functions that does not use any intangible assets is selected as the tested party. If in such cases the (routine) functions are compensated properly, the residual profits will be an acceptable basis to determine the compensation for the use of the intangible assets.
Adoption guidance for low value adding services
The Decree provides that the simplified method to determine arm’s length compensation for low-value adding intra-group services, as described in the OECD Guidelines, may be used in the Netherlands. As a result, the DTA will consider recharges of the costs incurred with these low value adding services, increased by a mark-up of 5% and using an appropriate allocation key, to be at arm’s length.
In case the described simplified method is not used by the taxpayer, the DTA indicates that with reference to the cost-benefit analysis as described in the OECD Guidelines, the DTA will not apply a correction or adjustment if the relevant actual costs for these low value adding services are cross-charged without a mark-up. In these cases, it is noted that the financing costs should also be taken into account when determining the actual costs.
Cost contribution arrangements (CCAs)
The Decree confirms that the updated guidance provided in relation to transfer pricing analyses also applies specifically to CCAs. This means that in determining whether CCAs were entered into based on arm’s length conditions, it should be established whether a party that contractually assumes risks according to a CCA should also be able to control the risks and have the financial ability to assume these risks. A party to a CCA that only provides financial means and does not manage or is unable to manage operational risks can therefore only be allocated a compensation for the financing provided.
TP documentation requirements
Dutch legislation provides for two types of TP documentation: 1) based on Article 8b of the Dutch Corporate Income Tax Act (“CITA”), which was introduced in 2002; and 2) based on Article 29g Dutch CITA, which was introduced in 2016 and applies to MNEs that generated consolidated revenues of EUR 50 million or more in the prior fiscal year.
The Decree confirms that Article 8b documentation requirements apply to both domestic and cross-border transactions, whereas Article 29b documentation requirements apply only to cross-border transactions entered into between related parties, as well as to the allocation of profits to permanent establishments.
The Decree provides insights on three additional areas of transfer pricing. First, the Decree confirms the DTA's current view on one-sided unilateral adjustments (i.e., the “infocap”). Therefore, the Decree implicitly acknowledges that the “infocap” as such is still part of Dutch transfer pricing policy.
Second, whereas prior decrees solely referenced the avoidance of transfer pricing abuse, the new Decree includes an explicit statement on penalties. More specifically, the Decree states that the DTA may impose penalties for transfer pricing matters depending on the facts and circumstances.
Third, the Decree states that within the context of a DEMPE analysis, each DEMPE function should be weighed in order to determine its relative importance. In general, Development and Enhancement functions are allocated greater weights.