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The OECD Transfer Pricing Guidelines were updated in 2018 by the OECD/G20 Revised Guidance on the Application of the Transactional Profit Split Method, Inclusive Framework on BEPS Action 10 (2018 revised guidance). In my recent Canadian Tax Journal article, I argue that the 2018 revised guidance failed to take the opportunity to move away from the use of the arm’s length principle in allocating profits within multinational enterprise (MNE) groups, and move toward the use of formulary factors. The transactional profit split method (profit split method) in the OECD Transfer Pricing Guidelines for Multinational Enterprise and Tax Administrations (OECD Guidelines) as updated by the 2018 revised guidance, is rarely used due to the significant threshold requirements for the profit split method to be the most appropriate transfer pricing method.

The heart of transfer pricing is comparing intra-group MNE transactions (controlled transactions) with comparable transactions between independent parties (uncontrolled transactions). The lack of comparable uncontrolled transactions has made transfer pricing, at times, arbitrary and created uncertainty for taxpayers and tax administrations. In 2013, the OECD’s Action Plan on Base Erosion and Profit-Shifting noted that special measures, such as formulary methods, may be required to deal with certain transfer pricing flaws. The OECD claimed in 2018 that it is agnostic on the arm’s length principle. The change in the OECD’s rhetoric on the significance of the arm’s-length principle was not reflected in the 2018 revised guidance.

The OECD’s revision of the profit split method was controversial. It was initially intended that the revision would result in the profit split method being used more frequently. The OECD 2018 revised guidance was finalized in June 2018 following three discussion drafts. A US official asserted that the 2018 revised guidance ensures that the use of the profit split method will remain infrequent. Following the release of the 2018 revised guidance, the OECD/G20’s Inclusive Framework endorsed a proposal called Pillar One of the Unified Approach which uses both formulary methods and the arm’s length principle for Base Erosion and Profit Shifting Action 1 (on measures for taxing the digital economy). Pillar One proposes the reform of profit allocation and nexus rules for consumer-facing and automated digital service MNEs. The aim is to allocate profit to market jurisdictions without requiring the MNE to have a physical presence in those jurisdictions.

Transfer pricing and the arm’s-length principle

Transfer prices are the prices that are used by members of an MNE group of companies (associated enterprises) for the intra-group transfer of assets (tangible property, intangibles and finance) and the provision of services. Transfer pricing is a normal part of intra-group transactions. The OECD Guidelines have been premised on the arm’s length principle which involves allocating profits to associated enterprises on the basis that their intra-group transactions are at arm’s length prices. The rationale underpinning the arm’s length principle is that in an open market, firms considering potential transactions are presumed to act rationally and to engage in transactions that are the most profitable. The arm’s length principle aims to reflect a market pricing system and should result in income being allocated within an MNE group to reflect the economic contributions and competitive positions of the participants. The OECD Guidelines claim that the arm’s length principle seeks to eliminate the effect of the special conditions within an MNE group on the profits arising from controlled transactions. The arm’s length principle, in theory, will result in the appropriate profit allocation for each country in which an MNE group operates.

Transfer pricing manipulation provides the opportunity for MNE groups to shift profits to low-tax jurisdictions. Prior to the OECD’s Base Erosion and Profit Shifting project which commenced in 2013, transfer pricing manipulation was used by some US MNEs to shift profits to low-tax jurisdictions. The Achilles heel of transfer pricing is the lack, at times, of comparable uncontrolled transactions. High-speed high-quality business information systems and communications systems have, inter alia, enabled MNE groups to achieve high levels of integration, which makes comparability a challenge. MNE groups are organized along business lines rather than national borders. MNE groups have the goal of profit maximization, which involves minimizing tax obligations. Moreover, these groups often enter into transactions that are not reflected in transactions between independent parties. Thus, most MNEs are unitary business operations with common management, common ownership and the same business goals. Despite the unitary nature of many MNEs, the OECD Guidelines are based on the separate entity approach and the arm’s-length principle. Each entity in a MNE group is treated as a separate enterprise seeking to maximise its profits. The profits derived from controlled transactions are required to reflect comparable uncontrolled transactions.

Transfer pricing under the OECD Guidelines involves a two-step process. The first step requires the determination of the commercial or financial relations in a controlled transaction and the ‘conditions and economically relevant circumstances’ (OECD Guidelines, para. 1.33) of the transaction to determine the accurately delineated controlled transaction. The second step is to compare the accurately delineated controlled transaction with comparable uncontrolled transactions using the five comparability factors. This step requires the selection of the most appropriate transfer pricing method.

There are five OECD transfer pricing methods. The traditional transaction methods (the comparable uncontrolled price method, the resale price method and cost plus method) involve testing individual controlled transactions. The transactional profit methods (the transactional net margin method and the transactional profit split method) are based on the net profits arising from controlled transactions. The transactional net margin method is the most widely used transfer pricing method and the transactional profit split method is rarely used. The OECD Guidelines require the selection of the most appropriate transfer pricing method.

The transactional profit split method

The profit split method aims to determine the arm’s length outcomes or to test reported outcomes for controlled transactions ‘to approximate the results that would have been achieved between independent enterprises engaging in a comparable transaction or transactions.’ (OECD Guidelines, para. 2.114) Under the profit split method the net profits from the controlled transactions are determined and then these profits are split on an economic basis to reflect the profit split that reflects the profit split that independent parties would have used. The profit split method adheres to the arm’s length principle, but the method does not require comparable transactions.

The profit split method represents an opportunity to move away from the uncertainty of the arm’s length principle. But the 2018 OECD revised guidance failed to pave the way for formulary (that is formula-based) methods, maintaining the rhetoric of the arm’s length principle. This revision was undertaken as part of the Inclusive Framework on BEPS: Action 10. Global formulary apportionment (formulary apportionment) is an alternative to the arm’s length principle. Formulary apportionment seeks to allocate the profits of an MNE on the basis of a formula. For example, formulary apportionment can be used to allocate profits on the basis of sales, assets and personnel. There is controversy over the relative merits of the arm’s length principle and formulary apportionment. The OECD Guidelines rejected formulary apportionment as being an arbitrary and inappropriate method for the allocation of profits between associated enterprises. (OECD Guidelines, paras. 1.16-1.32)

The 2018 revised guidance claims that the profit split method cannot be treated as the most appropriate method solely because comparable uncontrolled transactions are unavailable. Nevertheless, comparable uncontrolled transactions are usually unavailable in the three situations where the OECD profit split method is considered to be the most appropriate method—that is:

  1. situations involving high degrees of integration;
  2. situations involving unique and valuable contributions by the associated enterprises; and
  3. situations where the associated enterprises share the same economically significant or closely related risks.


The guidance set out high threshold requirements for the use of the profit split method, such that it is usually not viewed as the most appropriate method. Given the extent of intra-group trade and the integration of MNE groups, such comparables are often unavailable. Nevertheless, unless the integration of such groups reaches the substantial threshold requirements, the profit split method will continue to be, in practice, the method of last resort. By adopting this approach, the OECD failed to meet the expectations that the profit split method could be more widely used and could provide flexibility through the use of formulary methods.


This article is based on my paper, “The Transfer-Pricing Profit-Split Method After BEPS: Back to the Future” (2019) 67 Canadian Tax Journal pp.1077-1105.

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