Executive summary

On October 5, 2015, the Organization for Economic Co-operation and Development (OECD) released new guidance on commodity transactions in connection with Actions 8-10 on aligning transfer-pricing outcomes with value creation under its Action Plan on Base Erosion and Profit Shifting (BEPS). This guidance, together with other transfer-pricing guidance, was released in a package that included final reports on all 15 BEPS Actions.

The document on Actions 8-10, Aligning Transfer Pricing Outcomes with Value Creation (the Final Report), contains: (1) revisions to section D of Chapter I of the OECD Transfer Pricing Guidelines; (2) guidance on commodity transactions; (3) revisions to Chapter VI of the OECD transfer-pricing guidelines on intangibles; (4) revisions to Chapter VII of the OECD transfer-pricing guidelines on low value-adding, intra-group services; (5) revisions to Chapter VIII of the OECD transfer-pricing guidelines on cost contribution arrangements; and (6) scope of work for guidance on the transactional profit split method. This Alert discusses the revisions to Chapter II of the OECD transfer pricing guidelines (the TP Guidelines) on commodity transactions.

The Final Report modifies and finalizes an earlier discussion draft of guidance on commodity transactions that was released December 16, 2014.

Key features of the guidance include:

— Clarification of the existing guidance on the application of the comparable uncontrolled price (CUP) method to commodity transactions and the use of publicly quoted prices to apply the CUP.

— Recommendation that taxpayers document their price-setting policy for commodity transactions to assist tax authorities in conducting informed examinations.

— Guidance regarding the adoption of a deemed pricing date for controlled commodity transactions in the absence of evidence of the actual pricing date agreed by the parties to the transactions.

The final guidance reflects minor changes from the discussion draft, including a more specific list of the types of adjustments applicable when using a CUP method and clarification that, when using a CUP method, the functions performed by other entities in the supply chain need to be compensated properly.

EY is hosting a series of webcasts that will provide a comprehensive review of the final BEPS reports and outlook for country action. The final transfer-pricing guidance under Actions 8-10 will be addressed in the webcast on November 12 at 10 AM, EST.

Detailed discussion

Background

The final guidance consists of a brief introduction and proposed additions to Chapter II of the current TP Guidelines, which contained limited guidance on transfer pricing for commodities. The introduction states that the new guidance provides "an improved framework for the analysis of commodity transactions from a transfer pricing perspective, which should lead to greater consistency in the way that tax administrations and taxpayers determine the arm's length price for commodity transactions and should ensure that pricing reflects value creation." The new guidance will be supplemented with future work mandated by the G20 Development Working Group. The outcome of this work will provide knowledge, best practices and tools for commodity-rich countries in pricing commodity transactions for transfer-pricing purposes.

Key areas of the Chapter II additions

Using the CUP method for pricing commodity transactions and using quoted prices in applying the CUP method

The guidance clarifies that the CUP method would generally be the most appropriate transfer-pricing method for determining the arm's-length price for controlled commodity transactions, and that, under the CUP method, the arm's-length price for the controlled commodity transaction can be determined, not only by reference to comparable uncontrolled transactions, but also by reference to a quoted price. The term "quoted price" refers to the commodity price in the relevant period that is obtained from an international or domestic commodity exchange market. A quoted price also includes prices obtained from recognized and transparent price reporting, statistical agencies or governmental price-setting agencies, when those sources are used as a reference by unrelated parties to determine prices.

A relevant factor in determining the appropriateness of using a quoted price is the extent to which that price is widely and routinely used in the industry to negotiate prices between third parties.

For the CUP method to be reliably applied, the economically relevant characteristics of the controlled transactions and the third-party transactions represented by the quoted price need to be comparable. The economically relevant characteristics that need to be considered to establish comparability include:

— Physical features and quality of the commodity

— The contractual terms of the controlled transaction, such as volumes traded, period of the arrangements, timing, and terms of delivery, transportation, insurance and foreign currency terms

Certain economically relevant characteristics may lead to either a premium or a discount. In addition, if quoted prices are used as reference, the standardized contracts that define the terms based on which the commodities are traded on the exchange may be relevant too.

If there are material differences between the conditions of the controlled transaction and the conditions of the uncontrolled transaction or the conditions determining the quoted price of the commodity, reasonably accurate adjustments should be made to ensure that the economically relevant characteristics of the transactions are comparable.

The final guidance includes the very important statement that, when applying a CUP, contributions made in the form of functions performed, assets used and risks assumed by other entities in the supply chain should be compensated in accordance with the guidance provided in the TP Guidelines. Although the remuneration of other parties in the value chain in practice can be significant, limited guidance is provided on how to apply this in practice.

Documentation recommendations

In order to assist tax administrations in conducting informed examinations of taxpayers' transfer-pricing practices, as part of their transfer-pricing documentation, taxpayers should provide reliable evidence and documentation of their price-setting policy for commodity transactions. This should include information needed to justify any applicable price adjustments and any other relevant information such as:

— Pricing formulas used

— Third-party, end-customer agreements

— Premiums or discounts applied

— Pricing date

— Supply chain information

— Information prepared for non-tax purposes

Deemed pricing date for commodity transactions

When using quotations to price the commodity transaction, the pricing date is a particularly relevant factor. The final guidance defines "pricing date" as the specific time, date or time period selected (e.g., a specified range of dates over which an average price is determined) selected by the parties to determine the price for the commodity transactions. When the taxpayer can provide reliable evidence of the pricing date agreed in the controlled transaction at the time the transaction was entered and this is consistent with the actual conduct of the parties, the tax administrations should determine the price for the commodity transaction by reference to the pricing date agreed by the associated enterprises. Reliable evidence of the pricing date may include:

— Proposals and acceptances

— Contracts or registered contracts

— Other documents setting out the terms of the transaction

If the pricing date agreed by associated enterprises is inconsistent with the actual conduct of the parties or with other facts of the case, tax authorities may determine a different pricing date consistent with the evidence provided by those other facts.

In the absence of reliable evidence of the actual pricing date agreed by the associated enterprises, tax administrations may deem the pricing date for the commodity transaction to be the date of shipment as evidenced by the bill of lading or equivalent document. Nonetheless, the guidance states that it is important to permit the resolution of double taxation cases arising from the application of the deemed pricing date through access to the mutual agreement procedure under the applicable tax treaty.

Implications

The new guidance on commodities is part of a package of documents released by the OECD on Actions 8-10 of the BEPS project. These additions to Chapter II of the TP Guidelines resonate with the more general BEPS themes of improving the quality of information to facilitate tax administrations in conducting transfer-pricing audits and placing emphasis on the actual conduct of the associated enterprises rather than only their contractual arrangements.

The additions to Chapter II may contribute to an increased focus by tax authorities around the world on transactions involving commodities. Global businesses will want to evaluate their transfer-pricing policy for commodities, the comprehensiveness of their related documentation and their preparedness to respond to tax administration queries for specific information supporting the pricing of commodity transactions.

Webcasts

EY is hosting a series of eight tax webcasts that will provide a comprehensive review of the final BEPS reports and the outlook for country action:

— OECD BEPS Project Outcomes: Highlights and Next Steps — October 15, 10 AM, EDT

— New Reporting under BEPS Action 13 — October 20, 10 AM, EDT

— Digital Economy Developments and BEPS Action 1 — October 27, 12 noon, EDT

— Permanent Establishment Developments and BEPS Action 7 — November 5, 10 AM, EST

— Transfer Pricing and BEPS Actions 8-10 — November 12, 10 AM, EST

— Anti-abuse Measures under BEPS Actions 3, 5, 6 and 12 — November 19, 10 AM, EST

— Financial Payments and BEPS Actions 2 and 4 — December 3, 10 AM, EST

— Dispute Resolution and BEPS Action 14 — December 10, 10 AM, EST

For more information and to register for the webcast series, click here.

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