The TP Directive’s stated goal is to increase tax certainty, reduce compliance costs, and mitigate the risk of double-taxation and litigation for cross-border intra-group transactions within the EU. The TP Directive would apply as of 1 January 2026, if adopted unanimously in the EU Council.
Main takeaways
Status of the OECD TP Guidelines: Firstly, the TP Directive incorporates the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, as amended as of 20 January 2022, as the binding standard for the interpretation and application of the arm’s length principle within the EU.
Harmonised definition of an “associated enterprise”: The TP Directive then provides for a definition of an “associated enterprise” as a person (legal or natural) who is related to another person in any of the following ways:
- significant influence on their management;
- a holding of over 25% of their voting rights;
- a direct or indirect ownership of over 25% of their capital; or
- a right to over 25% of their profits.
This is good news as the definition of associated enterprise is not at all harmonised across Member States. However, that 25% threshold is a different way of defining a group compared to the criteria defined in BEFIT and Pillar Two, which could cause difficulties in coordinating the different regulations.
Finally, the TP Directive clarifies that a permanent establishment is an associated enterprise, which is not the case under the national tax laws of some Member States.
Corresponding and compensating adjustments: The TP Directive also provides for mechanisms to enable corresponding and compensating adjustments.
- Corresponding adjustment: To avoid double taxation when a primary adjustment is made by a tax authority in the course of an audit, the other Member State shall make a corresponding adjustment (subject to identified circumstances). As before, the double taxation can still be relieved through a mutual agreement procedure but the TP Directive would also introduce a new fast track procedure, whereby any double taxation that follows from TP adjustments made by an EU Member State will be resolved within 180 days. By introducing this mechanism, the TP Directive could make a significant difference, as more frequent interactions between tax authorities should in the long term result in the arm’s length principle being applied more consistently across the Member States.
In addition, under the TP Directive, tax authorities can also choose to lower the profit of an associated enterprise that is overstated due to transfer pricing, in the absence of a primary adjustment. However, this is only possible if the associated enterprise in the other country agrees to increase its profit by the same amount and informs its tax authorities of the downward adjustment.
- Compensating adjustment: When associated enterprises set a price for their intra-group transactions that is different from the market price, they may need to perform a year-end adjustment to avoid double taxation. Such practice is not currently allowed in some EU countries and the Commission has proposed the introduction of provisions allowing for this, defined as “compensating adjustments”. In that respect, the TP Directive sets out clear rules for when Member States should accept such an adjustment.
TP methods and the most appropriate method rule: The five common TP methods in the OECD TP Guidelines must be used to determine the arm’s length price. It is only if none of these methods can be reasonably applied that other valuation methods or techniques are permitted, but they must produce a result that is consistent with what third parties would achieve and this has to be demonstrated by the taxpayers. This is a stricter requirement than under the OECD TP Guidelines.
Determination of the arm’s length range: The interquartile range is the arm’s length range and the TP Directive does not allow for any flexibility in that respect (for instance, the full range). Tax authorities are generally not allowed to adjust a result that is within the interquartile range – unless a specific different positioning in the range can be justified. A pricing outside the interquartile range must be adjusted by tax authorities to the median. However, either the taxpayer or the tax authority can argue that a different result in the range is more suitable based on the specific facts and circumstances.
TP documentation: To prove that their intra-group transactions have been carried out on an arm’s length basis, taxpayers should have sufficient information and analyses in place. The Commission will clarify the requirements in relation to the TP documentation later, in particular by producing common templates and setting rules relating to linguistic requirements. The exact scope of the transactions (nature, threshold…) and the taxpayers (any revenue or balance sheet limit) in scope of the documentation requirements remains to be clarified.
The Commission's ambition clearly is to have more say in future TP matters. The TP Directive follows the Commission’s defeat in most transfer pricing state aid cases in front of the EU Courts. If adopted, the TP Directive would enable the EU to take additional measures in respect of various intra-group transactions such as intra-group services, cost contribution arrangements, intangibles, business restructurings, financial transactions and dealings between a permanent establishment and the head office, following the Commission's recommendations. Member States may have to change their national laws to follow the TP Directive and tax authorities may have to adjust their practices. The EU Courts will finally have the final say on how to apply the arm’s length principle in the EU as defined in the TP Directive. That said, the TP Directive is still a quite theoretical framework and it will take time to achieve a harmonised implementation of the arm's length principle across the Member States.
