Transfer Pricing re-calibrated: “Value creation”. The new Dutch TP Decree.

On May 11, the Dutch Ministry of Finance published a new Transfer Pricing Decree. But don’t think this is an isolated case, applicable only to Dutch MNCs (Multinational Companies). This is a coordinated approach by Tax Authorities globally. Hence relevant for MNC’s worldwide. This article takes a closer look.

The Decree contains new sections and changes in light of the amendments to the OECD’s (Organisation for Economic Co-operation and Development) Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017. The new Decree provides additional guidance on the position of the Dutch Tax Authorities in the post-BEPS era.

By emphasizing the importance of conduct over contract, and functions to control risks, and explicitly mentioning penalties, the State Secretary conveys its message that the field of Transfer Pricing has matured and that both MNCs and Tax Authorities are actively working with the new BEPS/OECD guidance.

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By Norbert Braspenning

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How can Transfer Pricing be used by companies to erode the tax base and shift profits? Well actually, it’s quite simple, especially when transferring risks or assets involving intangibles. And this has always been something very common. In the past Transfer Pricing was a key and accepted element in “optimizing the tax position”. Nowadays arrangements are more scrutinized and in some cases deemed immoral or even illegal.

ATAD is an EU initiative in order to “Create Transfer-Pricing-outcome in line with value creation”.

Dutch Legislation

Before the new Decree was introduced, the Dutch Transfer Pricing legislation was based on Art 8b of the Corporate Income Tax Act (CITA ①), OECD Transfer Pricing Guidelines and the Dutch 2013 Transfer Pricing Decree. In the heart of the new Decree is the implementation of anti BEPS measures with a Transfer Pricing nature (BEPS actions 8-10). The stated objective of those BEPS and EU initiatives like the Anti Tax Avoidance Directive (ATAD), is to develop Transfer Pricing rules that create Transfer-Pricing-outcome in line with value creation.

Delineation of the actual transaction

To achieve the results of avoiding BEPS the new guidelines give significant importance to a newly introduced concept: “delineating the controlled transaction”. A new way to determine that a transaction should be analysed on its basic characteristics, whereby more emphasizes is given on how parties actually conduct instead of what is contractually arranged.

The delineation process requires careful identification of all economically relevant characteristics or comparability factors. This is done in order to examine if the transaction between associated enterprises is sufficiently realistic, compared with what independent enterprises would have done in similar circumstances.

The Dutch Tax Authorities (DTA) is of the opinion that in practice barely anything of this is new. The way of thinking about who controls and who assumes the risks in a transaction are already well set in the toolbox of the DTA. Therefore, and this is very clever, the new Decree is merely seen as clarification (not something new) whereby the policy outline can be applied retrospectively.

The Heart of the clarification

Firstly the new Decree clarifies that any Transfer Prising analysis should start with the contractual terms of the intercompany agreement and the conduct of the parties involved. Tests begin with basically two questions.

  1. Are the contractual terms at arm’s length by nature? Are, given the circumstances of the contract and the parties involved, the terms economically reasonable and logical? Is there a good expectation that third parties would contract themselves under the same or similar terms? For example
    • An FX risk contributed to an opco, whilst group policy prohibits that opco to conclude an FX hedge on itself.
    • An opco without any purchasing capacity that has an inventory risk.
    • An intangible that generates revenue in an entity that performs no or very limited functions regarding that intangible.
  2. Is the actual conduct of the parties in line with the contractual terms? Conduct overrides contractual situations in terms of which party has the control over significant risks. This emphasis on actual behaviour of related parties put the spotlight even more on the functional analysis of who controls which risk.

Next the analysis looks at control and financial capacity. Functions determine the success of an enterprise. Control is found in functions. Functions assume, maintain or release risk. Financial capacity has to do with whether or not a risk can be borne by a party when the risks materialize. A party with financial capacity is sufficiently financed with equity (or able to raise funding) matching the risk profile.

Based on the above, the somewhat traditional assumption that legal ownership of intangibles merits the allocation of residual income regarding that intangible (preferably in a tax friendly environment), is set straight in the new Decree.


The OECD promotes a contribution approach for intangible assets. The preferred approach for analysis is DEMPE (development, enhancement, maintenance, protection and exploitation).  The new Decree underlines the stages of development and enhancement, because that is where value creation happens.

Nearly all intangibles are of a unique nature. So benchmarking intangibles is almost a contradictio in terminis.

Only a party performing the DEMPE functions is entitled to the benefits of that specific intangible. Instead the party only paying for cost is not rewarded by means of the intangible revenue, but can be rewarded for its financing activity.  This is another example of emphasising functionality (and risk follow function).

Specific types of business restructuring

This is quite often seen when business and assets of target companies are integrated into the buyer’s structures and organization.

An example: Company B owns this attractive medical patent. Company A, a pharmaceutical company, is eager to complement its portfolio with this patent. In a share transaction A buys all the shares B has issued. A is now the owner of the shares of B, and by owning the shares, A owns the patent.

An important concept in this transaction is the one-off price versus value. Whilst the price is probably calculated within the return on investment goals of A, A is most likely of the opinion that the value of B, though unrealized, is higher. Otherwise it would make no economic sense to buy the shares of B.

The example continued: Suppose A decides to transfer the patent to its own R&D. Whilst purchasing the shares of B by A was a third party transaction, transferring the asset (the patent) occurs intercompany. As such, the transaction attracts Transfer Pricing attention, particularly on the aspect of what would be the intercompany price. Especially of the patent.

The new Decree stipulates that the purchase price allocation (the value for which the patent was on the balance sheet of B) in itself gives a good indication of the value of the patent. But because of the concept that the value is higher than the price of the asset, this is seen as a minimum price. Goodwill, as part of the purchase price, but not on the balance sheet of B, might also be factored into the value of the patent. Alternatively attributing a value to what is left is also a method, as a sort of residual approach, to establish what is actually the value of the patent that was transferred out. Assessing the value of the patent by assessing B’s – so called – routine activities. This is the value of B without the patent (using a discounted cash flow method on the basis of 5 to 10 years, not everlasting)

What are the takeaways?

A change in how Transfer Pricing is approached (and tested) can be observed. In a related party transaction, the party that has more assets, risks and functions should get a higher expected profit. In the past there used to be a focus on function and activities. The new guidelines now focus more on risks. For MNCs this means take a step back. Not only outline and describe activities, but also pay more attention to the risks the business is facing, and who is controlling those risks. Keep in mind that conduct, control and financial capacity trump legal ownership and contract. As for intangibles: development and enhancement trump financing.

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① Art 29b-29h, 34f, 34g CITA

Featured image: 15th-century “De Waag” (The Weigh-house), Amsterdam’s oldest remaining non-religious building (now a restaurant). Originally a city gate and part of the walls of Amsterdam, but re-purposed as a weigh house in 1617, i.e the place where the “value” of goods was determined (also for tax purposes).