In their constant quest for efficiency, multinational corporations often relocate their production or service centers to jurisdictions with significantly lower operating costs. This phenomenon, known as Location Savings, is analyzed in detail in Chapter I of the OECD Guidelines (2022).
The tax dilemma is clear: when a company saves millions on labor or infrastructure by operating in a local market, should those savings increase the local subsidiary’s profit, or should they be transferred to the parent company through Transfer Pricing?
What Are Location Savings?
Location savings are the net benefits a corporate group obtains by conducting operations in a low-cost market. These include not only cheaper labor but also lower costs for land, utilities, transportation, or specific tax incentives.
However, the OECD notes that these savings do not always translate into greater “extra” profit. In highly competitive markets, the savings may be passed directly on to the end customer through lower prices to gain market share.
The OECD’s Analysis: Who Retains the Benefit?
To determine how these savings should be allocated among related parties, tax authorities evaluate two critical factors:
- Existence of local comparables: If there are independent companies in the local market performing similar functions and earning standard profit margins, it is assumed that the “savings” are already implicit in the market and do not require a special adjustment.
- Specific location advantages: If the savings are extraordinary and stem from a country-specific advantage (such as a free trade zone or unique access to resources), the OECD analyzes whether that advantage belongs to the local entity or whether it was the parent company that, through its strategy and assets, made it possible to capture that value.
Tax audit risks for subsidiaries
Tax authorities in developing countries often argue that Location Savings belong to the jurisdiction where the savings are generated. If a parent company absorbs all the profit, leaving the local subsidiary with minimal (“routine”) profitability, the local tax administration could make an adjustment, claiming that part of those savings should be taxed in its territory.
A robust functional analysis is the only tool to demonstrate whether the subsidiary has sufficient economic substance to retain those savings or whether it simply acts as a low-risk service provider.
Conclusion
Location savings represent a legitimate competitive advantage, but their treatment in transfer pricing requires absolute technical precision. Failure to properly document the allocation of these benefits can lead to double taxation disputes, where two countries claim the right to tax the same profit derived from operational efficiency.
Does your Transfer Pricing policy correctly capture location advantages?
At TPC Group, we help multinational groups identify and document the allocation of Location Savings under the most recent international standards. We ensure that your operational structure and technical documentation are consistent with the creation of real value, mitigating audit risks and optimizing the group’s global tax position.
Source: OECD – Chapter I