Substance over form in transfer pricing – a common misconception

It is often said that the OECD Transfer Pricing Guidelines emphasize substance over form, when it comes to delineating controlled transactions. This is true insofar as it goes, but it gives rise to a common misconception that functional analysis trumps legal agreements.

It’s true that if an intercompany agreement (put in place in advance, or ‘ex ante’, if you like a bit of Latin) doesn’t match what the group actually does, then the written agreement will carry little weight.

But the same would apply to functional analysis underlying a group’s transfer pricing policy, if that functional analysis did not reflect what actually happened. Or if TP documentation prepared ex post facto contained an inaccurate description of how the group operated.

Functional analysis will only take you so far in delineating a controlled transaction. For example, the analysis of a value chain as regards the role of a procurement hub may be consistent with a number of different legal scenarios: the hub may act as principal in buying and selling goods, or it may simply provide services to other associated entities which do the buying and selling. The actual legal reality as regards the role of the procurement hub will have very different implications as to the nature of the controlled transactions involved, and the treatment of those transactions from the perspective of VAT/GST, liability risks, credit risks and so on.

This is presumably why the OECD Transfer Pricing Guidelines contain extensive commentary on the role of intercompany agreements.

As always, our collective task as professionals in this area is to design a system or framework within which the group can operate, and which meets the needs of the groups key stakeholders… and then actually implement that framework in legal and operational reality.

If you and your colleagues would benefit from a private training webinar on the legal implementation of transfer pricing, and the basics of intercompany agreements, please let us know by emailing us. We’ve run similar sessions for teams in countries including Australia, China, Malaysia, New Zealand, Singapore, South Africa, Switzerland, Russia and the United States, and we would be delighted to arrange one for you too. You can find a copy of slides we’ve used recently here.

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