Intra-group services with low added value – TRANSFER VALUATION

One of the most common types of controlled transactions between dependants is services. In practice, these can be a wide range of intra-group services that are provided within a group of dependants. These services may be provided as a core part of the dependent’s business but may also be in the nature of ancillary services provided to provide support activities unrelated to the core business of the group of dependants.

The OECD Transfer Pricing Guideline, which was revised and published in 2017, specifically addresses low value-added intra-group services in Chapter VII and provides that, under certain conditions, the transfer price need not be evidenced through a comparability analysis (benchmark analysis). I.e. we are talking about a simplified approach.

Content of the OECD Transfer Pricing Guidelines

Low value-added services for simplification purposes within the meaning of the OECD Directive include services provided by one or more members of a group of dependants to one or more members of that group which:

• are of a supportive nature,
• they are not part of the main business of the group of dependants (i.e. they do not generate profitable activity or do not represent an economically significant activity for the group of dependants),
• do not require the use of unique and valuable intangible assets and do not give rise to the creation of such intangible assets; and
• do not involve the assumption of significant risk by the service provider, nor do they give rise to significant risk for the service provider.

The Directive also defines activities that cannot be qualified as low value added services for simplification purposes, which are:

• services constituting the principal activity of a group of dependants,
• research and development (including software development, unless the definition of IT services below is met),
• production and manufacturing services,
• purchasing activities relating to raw materials or other materials used in production or in the production process,
• sales, marketing and distribution activities,
• financial transactions,
• extraction, exploration and processing of natural resources,
• insurance and reinsurance, and
• senior management services (other than management oversight of services that may be considered low value-added).

The fact that a service does not fall within the definition of a low value-added service does not mean that the service generates high revenues. Such a service may also generate low value added but the general transfer pricing procedure shall be used to determine the transfer price.

At the same time, the OECD Directive lists examples where activities (services) are likely to meet the definition of a low value-added service, which are:

• accounting and auditing,
• processing and management of receivables and payables,
• human resources activities, (e.g. recruitment, training and development of employees, employee compensation services, development and monitoring of employee health, safety and environmental procedures and standards related to the employment of employees,
• monitoring and data collection,
• IT services that are not part of the core business,
• internal and external communication and public relations support
• some legal services,
• certain activities related to tax compliance, and
• general administrative and clerical services

Transfer pricing method

Given the nature of the services, to determine the difference between the independent comparable price and the price in a controlled transaction, the Dependent may use the Comparable Uncontrolled Price (CUP), the Cost Plus Method (CUP), or the Transactional Net Margin Method (TNMM) as the most appropriate method.

Profit margin

If the CUP method is used, a comparable arm’s length transaction must be documented.

In applying the Cost+ method, the tax administrator should consider a mark-up on the actual direct and indirect costs associated with the transaction in the range of 5% to 10%, most commonly 5% as the mark-up that would be applied in comparable uncontrolled transactions and should be consistent with the arm’s length principle. Where the amount of the mark-up differs, the difference should be satisfactorily justified in such a way that it is clear that the amount of the mark-up is consistent with the arm’s length principle.

In applying the net margin method, the tax administrator should consider a mark-up of between 5 % and 10 %, most commonly 5 % on total costs, to be a mark-up that would be applied in normal commercial relations and is consistent with the arm’s length principle.

As mentioned above the cost base should include direct and indirect costs related to the transaction and an appropriate proportion of operating costs. It is important to note, however, that the cost base should exclude costs related to the internal activity of the dependent person and which benefit only the dependent person as a service provider, and should also exclude the so called “other costs”. shareholder costs, i.e. those which are related to the activity of the shareholder and do not benefit the dependent person, should be excluded.

Conclusion

Although the simplified approach for low value added services is not regulated in a statutory or sub-statutory standard (e.g. guidance), the OECD Directive as well as the Commentary to the OECD Model Treaty is considered as an interpretative document to Article 9[1] (of the OECD Model Treaty).

The Financial Directorate of the SR also states in its methodological instruction that “The Directive is regarded as a generally accepted supplementary means of interpretation to Article 9 of double taxation treaties within the meaning of the Vienna Convention on the Law of Treaties. The Commentary to Article 9 of the OECD Model Income and Wealth Tax Treaty states in paragraph 1 that the Directive represents internationally agreed (accepted) principles and provides guidance for the application of the arm’s length principle. It is therefore a generally accepted procedure for the application of the arm’s length principle in cross-border transactions of dependants.”

AUTHOR: Andrej Choma, transfer pricing specialist

[1] The equivalent wording of the article in question can be found in every valid double taxation treaty that the Slovak Republic has concluded.