This page addresses difficulties in determining whether services have been provided by one company of a MNE group to another company of that group, and – if this is the case – in determining arm’s length pricing for those intra-group services. Several sources provide for guidelines on how to deal with transfer pricing related to intra-group services, such as: OECD Guidelines, national law (e.g. decrees and general tax law) and the EU Joint Transfer Pricing Forum. All these sources may provide for guidelines in determining arm’s-length prices for intra-group services. Since international interest prevails in transfer pricing, this page provides for information on intra-group services mainly provided by the OECD and the EUJTPF as these are internationally accepted.
Almost all MNE groups do require diversity of services for all of its group members, whether it is administrative, technical, financial or either commercial. These services can be related to management, coordination and control functions for the entire group. In general such services will be performed centrally – at the level of the ultimate parent company – and charged to the other group companies that require these services in order to be fully operational. Independent companies in need of certain services might obtain these services from a service provider that specializes in those types of services. Or – in some cases – this company might perform the services by itself. On the other hand, a member of an MNE group in need of such a service may obtain it directly or indirectly from independent companies, or from one or more related companies part of the same MNE group (i.e.intra-group), or may perform the service itself. If a company obtains such services from a related party, under certain conditions (provided below) these will be considered as intra-group services.
Some common intra-group services are provided below:
- Legal services
- Accounting services
- Central auditing services
- Financing advice
- Human resource management
- IT service
Note that the list above is non-exhaustive and other services can qualify as well as ‘intra-group services’.
Main issues / conditions
Prior to determining arm’s-length remuneration for intra-group services two main issues are addressed by the OECD:
- Whether intra-group services have actually been provided
- How to determine an arm’s-length remuneration for intra-group services
Has an intra-group service been provided?
This can be determined by considering whether an unrelated company in similar circumstances would have been willing to pay for the activity if performed for it by an unrelated company or would have performed the activity by itself. Additionally, the recipient of the service should gain commercial or economic value by receiving the service. If not, then it would not be considered as an intra-group service. There are some specific services that need attention that will not qualify as intra-group services. These are touched upon below.
An intra-group activity may be performed relating to group members even though those group members do not need the activity (and would not be willing to pay for it if they were unrelated companies). Such an activity would be one that a group member (usually the parent company or a regional holding company) performs solely because of its ownership interest in one or more other group members, i.e. in its capacity as shareholder. This type of activity would not justify a charge to the receiving companies. These activities are recognized as “shareholder activities”.
Some examples of shareholder activities are provided below:
- Costs of activities relating to the juridical structure of the parent company itself, such as meetings of shareholders of the parent, issuing of shares in the parent company and costs of the supervisory board
- Costs relating to reporting requirements of the parent company including the consolidation of reports
- Costs of raising funds for the acquisition of its participations
Note that the list above is non exhaustive and other services can qualify as well as ‘shareholder activities’.
In general, no intra-group service should be found for activities undertaken by one group member that merely duplicate a service that another group member is performing for itself, or that is being performed for such other group member by a third party. An exception may be where the duplication of services is only temporary, for example, where an MNE group is reorganizing to centralize its management functions. Another exception would be where the duplication is undertaken to reduce the risk of a wrong business decision (e.g. by getting a second legal opinion on a query).
On call services
There is another difficulty with respect to services provided “on call”. Is the availability of such services itself a separate service for which an arm’s length charge (in addition to any charge for services actually rendered) should be determined. A parent company or a group service center may be on hand to provide services such as financial, managerial, technical, legal or tax advice and assistance to members of the group at any time. In that case, a service may be rendered to related companies by having staff, equipment, etc., available. An intra-group service would exist to the extent that it would be reasonable to expect an independent company in comparable circumstances to incur “standby” charges to ensure the availability of the services when they are required. It is not unknown, for example, for an independent enterprise to pay an annual “retainer” fee to a firm of lawyers to ensure entitlement to legal advice and representation if litigation is brought. Another example is a service contract for priority computer network repair in the event of a breakdown. These services may be available on call and they may vary in amount and importance from year to year. It is unlikely that an independent enterprise would incur stand-by charges where the potential need for the service was remote, where the advantage of having services on-call was negligible, or where the on-call services could be obtained promptly and readily from other sources without the need for stand-by arrangements. Thus, the benefit conferred on a group company by the on-call arrangements should be considered, perhaps by looking at the extent to which the services have been used over a period of several years rather than solely for the year in which a charge is to be made, before determining that an intra-group service is being provided.
How to determine an arm’s-length remuneration for intra-group services
Once it is determined that an intra-group service has been provided, it is necessary, as for other types of intra-group transfers, to determine whether the amount of the charge is in accordance with the arm’s length principle. In other words, is the charge for an intra-group service in line with those that would have been agreed between independent companies in similar circumstances. This can either be done through the direct-charge method (preferred) or indirect-charge method (most used).
The direct-charge method is of great practical value to tax administrations because it allows the service performed and the basis for the payment to be clearly identified. Consequently, the direct-charge method eases the determination of whether the charge is consistent with the arm’s length principle. This is the preferred method by the OECD to determine an arm’s-length price for intra-group services. In practice it can be very difficult to apply the direct-charge method and therefore, the indirect-charge method is used quite often.
As mentioned, in practice it might be very difficult to apply the direct-charge method. In such cases, MNE groups may find they have few alternatives but to use cost allocation and apportionment methods which often force some degree of estimation or approximation, as a basis for calculating an arm’s length charge. Any indirect-charge method should be sensitive to the commercial features of the individual case (e.g. the allocation key makes sense under the circumstances), contain safeguards against manipulation and follow sound accounting principles, and be capable of producing charges or allocations of costs that are commensurate with the actual or reasonably expected benefits to the recipient of the service.
The allocation might be based on turnover, or staff employed, or some other basis. Whether the allocation method is appropriate depends on the nature and usage of the service.For instance, the usage or provision of payroll services may be more related to the number of staff than to turnover, while the allocation of the stand-by costs of priority computer back-up could be allocated in proportion to relative expenditure on computer equipment by the group members.
Some examples of allocation keys are provided below:
- IT: number of PCs
- Business management software (e.g. SAP): number of licences
- Human Resources: headcount
- Health and safety: headcount
- Management development: headcount
- Tax, Accounting, etc.: turnover or size of balance sheet
- Marketing services: turnover
- Vehicle fleet management: number of cars
Methods to determine the arm’s length price
The generally preferred method to determine an arm’s length price is the CUP method. This method can be used if there is a comparable service provided between independent enterprises in the recipient’s market, or by the associated enterprise providing the services to an independent enterprise in comparable circumstances. For instance, this might be the case where accounting, auditing, legal, or computer services are being provided to related as well as unrelated companies, if these transactions are comparable. A cost plus method is the most appropriate method in the absence of a CUP method where the nature of the activities involved, assets used, and risks assumed are comparable to those undertaken by independent companies.
As intra-group services will typically only attract a modest mark up, establishing an appropriate cost base is relatively more important. Once the cost base of an intra-group service is determined it is then appropriate to consider what mark up, if any, on those costs should be applied. The OECD acknowledges that a mark up is not always justifiable. If it is appropriate to use a mark up for intra-group services rendered, this will normally be modest and experience shows that typically agreed mark ups fall within a range of 3-10%, often around 5%. However, the facts and circumstances of the arrangement for intra-group services may support a different mark up.
WP No. 6 has developed a new simplified approach for low value-adding intra-group services – a modification of chapter VII of the Guidelines. These proposed modifications have been developed in connection with Action Point 10 of the Action Plan on Base Erosion and Profit Shifting (BEPS). The Discussion Draft reduces the scope for erosion of the tax base through excessive management fees and HQ expenses by proposing an approach which:
- Identifies numerous common intra-group services fees which require a low mark-up
- Applies a consistent allocation key for all recipients
- Provides transparency through specific reporting requirements including documentation showing the determination of the cost pool
Main aspects include:
- A standard definition of low value-adding intra-group services;
- Clarifications of the meaning of shareholder activities and duplicative costs, specifically in the context of low value-adding intra-group services
- Guidance on appropriate mark-ups for low value-adding intra-group services
- Guidance on appropriate cost allocation methodologies to be applied in the context of low value-adding intra-group services
- Guidance on the satisfaction of a simplified benefit test with regard to low value-adding services
- Guidance on documentation that taxpayers should prepare and submit in order to qualify for the simplified approach
Defining low value-adding intra-group services
Low value-adding intra-group services are services performed by one member of an MNE group on behalf of another group member which:
- Are of a supportive nature
- Are not part of the core business of the MNE group
- Do not require the use of unique and valuable intangibles and do not lead to the creation of unique and valuable intangibles
- Do not involve the assumption or control of substantial or significant risk and do not give rise to the creation of significant risk
List of low-value adding intra-group services
List of intra-group services that may fall under the definition of low value-adding intra-group services:
- Accounting and auditing
- Processing and management of accounts receivable and accounts payable etc.
- Human resources activities such as: staffing, recruitment, training, employee development, remuneration services and developing and monitoring of staff health procedures
- The monitoring and compilation of data relating to health safety
- Information technology services (which are not part of the principal activity of the group)
- Internal and external communications and public relations support
- Legal services
- Activities with regard to tax obligations
- General services of an administrative or clerical nature
List of services not being low value-adding
The following activities (specifically addressed by the OECD) are not considered as low-value adding services:
- Services constituting the core business of the MNE group
- Research and development services
- Manufacturing and production services
- Sales, marketing and distribution activities
- Financial transactions
- Extraction, exploration, or processing of natural resources
- Insurance and reinsurance
- Services of corporate senior management
The proposed approach
For qualifying low value-adding intra-group services, the OECD proposes a simplified methodology to determine an arm’s length charge. This method would be elective, and, in a case where it was elected by an MNE, would need to be applied on a consistent, group- wide basis in all countries in which the MNE operates. The proposed simplified approach contains five steps:
- Determination of the costs incurred
- Allocation of low value-adding service costs
- Profit mark- up
- Total charge for low value-adding services
- A simplified benefit test
Determination of the costs incurred
The first step is to assess the total amount – on annual basis – of all costs incurred by all members of the group in performing low value-adding intra-group services.
Secondly, shareholder costs and costs that are performed solely on behalf of one group member should be excluded from the cost pool.
Allocation of low value-adding service costs
The third step is to allocate the costs of the low value-adding intra-group services among the group members.
An appropriate allocation key needs to be determined:
“The same allocation key must be used on a consistent basis for all allocations of costs relating to the same category of services. In accordance with the guidance in 7.25, the allocation key selected with respect to costs for each relevant category of services should reasonably reflect the level of benefit expected to be received by each recipient of the particular service”
Some examples of allocation keys are provided below:
- Services related to people might employ each company’s share of total group headcount
- IT services might employ the share of total users
- Fleet management services might employ the share of total vehicles
- Accounting support services might employ the share of total relevant transactions or the share of total assets
- The share of total turnover may be the most relevant key for other cases
A balance should be struck between theoretical sophistication and practical administration, bearing in mind that the costs involved are not generating high value for the group. As such, one single allocation key may be applied if the taxpayer can substantiate that this single key can reasonably reflect the benefits.
Profit mark- up
In assessing an arm’s length charge for the low value-adding intra-group services, the service provider shall apply a mark-up to all costs in the pool irrespective of the categories of the services. The mark-up shall not be lower than 2% and not be higher than 5% of the relevant cost base. Applying such a mark-up does not have to be substantiated with a benchmark study and can therefore be considered as a safe harbour. Needles to say that the profit mark-up cannot be applied in a similar way to intra-group services that do not qualify as low value-adding intra-group services.
Total charge for low value-adding services
The total charge for low value-adding intra-group services shall be the sum of:
- The costs incurred by a group member in providing services specifically to another member, plus the selected profit mark-up
- That group member’s share in the overall pool of low value-adding intra-group services using the proper allocation key, plus the selected mark-up
A simplified benefit test
A charge for low value-adding intra-group services is only allowed under the arm’s length principle if the benefit test is satisfied.
“The activity must provide the group member expected to pay for the service with economic or commercial value to enhance or maintain its commercial position, which in turn is determined by evaluating whether an independent enterprise in comparable circumstances would have been willing to pay for the activity if performed for it by an independent enterprise or would have performed the activity in-house for itself.”
The documentation and reporting package should provide sufficient evidence that the benefits test is met given the nature of low value-adding intra-group services.
This documentation and reporting package will include:
- A description of the categories of low value value-adding intra-group services provided, the reasons justifying that each category of services constitute low value-adding intra-group services within the definition of low value-adding intra-group services; the rationale for the provision of services within the MNE; a description of the (expected) benefits of each category of services; a description of the selected allocation keys and the reasons justifying that such allocation keys produce outcomes that reasonably reflect the benefits received, and confirmation of the mark-up applied
- Written contracts or agreements
- Calculations showing the determination of the cost pool
- Calculations showing the application of the specified allocation keys