Secondary adjustments represent one of the most specialized and least uniform areas within the transfer pricing framework. Although they are not part of the primary adjustment, which seeks to correct the value of the transaction to bring it into line with the arm’s length principle, secondary adjustments arise to address additional economic implications, such as if undue benefits had been channeled as loans, dividends, or implicit capital contributions. Their application can completely change the taxpayer’s tax position, generating financial consequences such as double taxation, imputed interest, or additional withholdings, depending on the jurisdiction and the treatment adopted.
The OECD Transfer Pricing Guidelines (TPG 2022) devote a specific section to this subject, explaining its conceptual basis, the risks for multinational groups, and the tax policy implications for countries that decide to incorporate them into their regulations.
What are Secondary Adjustments?
A secondary adjustment arises after a primary correction, when the tax administration concludes that the part of the group that received an unremunerated benefit must recognize an additional transaction to adequately reflect the economic flow that would have occurred between independent parties.
This mechanism is based on the idea that an excess benefit derived from the adjusted transaction cannot remain “without consequence.” Therefore, the tax authority reinterprets that benefit as a form of financing, distribution, or contribution, depending on the case.
Although conceptually these adjustments seek economic consistency, they do not modify the primary adjustment, but rather add an additional tax consequence.
How are Secondary Adjustments implemented?
The Guidelines recognize three predominant forms:
1. Presumed loan.
The entity that received an undue benefit is considered a debtor to the counterparty. This scenario usually involves the allocation of arm’s length interest and a cross-border impact on withholding.
2. Deemed dividend.
The excess benefit is treated as an unrecorded distribution of profits. It may generate additional withholding taxes and affect the tax credit in the recipient’s jurisdiction.
3. Deemed capital contribution.
The authority interprets that the entity is increasing its investment in the counterparty. This treatment does not generate interest, but it does affect the valuation of equity.
The choice between these forms depends on the domestic legislation of each country and the economic substance of the transaction.
Risks and Challenges for Multinational Groups
Secondary adjustments can have profound impacts on a group’s tax position, even when the primary adjustment is limited. The main risks identified by the OECD are:
- Economic double taxation.It is possible for one jurisdiction to apply a secondary adjustment while the counterparty does not recognize it or interprets it differently. For example, one country may treat excess profit as a deemed dividend while the other considers it ordinary income, without credit entitlement.
- Additional administrative burden.Deemed flows generate recording, documentation, and reconciliation obligations that did not previously exist. In some countries, this is so burdensome that the concept is not applied for practical reasons.
- Regulatory inconsistencies between countries.The OECD does not require the application of secondary adjustments, which means that their use is uneven internationally. This increases the risk of disputes, MAP processes, and protracted litigation.
- Impact on complex transactions. Restructuring, intragroup financing, or transfers of intangibles are particularly sensitive due to the high level of subjectivity in the valuation and identification of uncompensated benefits.
OECD Criteria for the Application of Secondary Adjustments
Although the Guidelines do not require the application of this mechanism, they do establish essential guidelines:
- Consistency with the arm’s length principle. The secondary transaction must reflect what independent parties would have done in the event of an excess profit. Therefore, deemed loans and dividends are considered reasonable from an economic perspective.
- Dependence on local legislation: The OECD emphasizes that it is up to countries to decide whether or not to incorporate this mechanism into their legislation. This explains its limited use in some jurisdictions.
- Proportionality and substance: The secondary adjustment should not become an additional revenue-raising tool, but rather a mechanism to correctly reflect the economic impact of the primary adjustment.
- Methodological consistency: In cases where a deemed loan is considered, the imputed interest rate must be arm’s length and consistent with the international financial rules applicable to the group.
Implications for taxpayers and best practices
Multinational groups should adopt preventive strategies to reduce the risk of secondary adjustments:
- Robust and up-to-date documentation, especially for recurring or high-volume transactions.
- Continuous monitoring of uncompensated flows, avoiding accumulations that could be interpreted as implicit benefits.
- Pre-APA assessment in critical operations such as intangible transfers or cost-sharing arrangements.
- Periodic review of intragroup policies, considering that a small deviation in the mark-up can be amplified if it generates secondary adjustments.
- Strategic use of MAPs and double taxation agreements, particularly when practices between jurisdictions are not aligned.
These practices do not eliminate risk, but they do significantly reduce the likelihood of unexpected financial consequences.
Conclusion
Secondary adjustments, while not part of primary transfer pricing obligations, constitute an advanced area of transfer pricing that, although not mandatory, can have a significant impact on the tax burden of multinational groups. Their uneven and potentially conflicting application across jurisdictions highlights the importance of regulatory consistency and documentary transparency.
The OECD Guidelines, while not requiring their adoption, establish guidelines that seek to ensure harmonious and proportionate application. In a globalized environment, taxpayers must understand both the implications of these adjustments and the tools available—such as mutual agreement procedures (MAPs) or APAs—to mitigate risks and avoid double taxation.
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Source: OECD