Standardization of Transfer Pricing Practices in the European Union

February 15, 2024

Introduction to Transfer Pricing Standardization

Simplifying and harmonizing taxation within the European Union to promote competitiveness and efficiency are the goals of the legislative proposals included in the package called BEFIT (Business in Europe: Framework for Income Taxation), issued by the European Commission on September 12, 2023. This package addresses the following issues: (i) A framework for income tax to analyze the complexity and high costs faced by multinational companies in their European transactions, and (ii) A Directive on Transfer Pricing proposing the introduction of a common approach in the EU for the application of the Arm’s Length Principle.

Current Transfer Pricing Challenges

All States members of the Organization for Economic Co-operation and Development have committed to follow its principles and recommendations; conversely, even with a political commitment, the status and role of its Guidelines on Transfer Pricing currently differ among member states.

Need for Harmonization

On the other hand, although the Transfer Pricing regulations are partially aligned, through regulating acts, the member states have national legislation providing a common approach to basic principles. Hence, due to the singular interpretation of each member State to apply the OECD Guidelines, “complexity” and unfair competitive conditions for companies are given.

Therefore, the Commission intends to harmonize the Transfer Pricing rules of the member states to ensure a common application for the potential problems encountered.

Proposal of the Directive on Transfer Pricing

This proposal aims to codify the OECD principles and guidelines into the internal laws of the member states, clarifying and proceeding to ensure an aligned administration. This would increase tax certainty for multinational companies in the EU by minimizing the risk of Transfer Pricing controversies and double taxation, as well as reducing tax evasion through the use of “aggressive tax planning” systems.

The Key Aspects of the Proposal of the Directive on Transfer Pricing

Therefore, the proposed Directive applies to all taxpayers registered or subject to taxes in a member state to include the Arm’s Length Principle and the interpretation of the OECD Transfer Pricing Guidelines in the legislations of all the EU member states, providing: (i) A common definition of the related enterprise (ii) A process to apply the corresponding adjustments to cross-border transactions (iii) a framework through which year-end adjustments on associated transactions within the EU are recognized both by the member state where the upward adjustment is made and by the member state where the downward adjustment is made (compensatory adjustments).

Concerning the first issue, this will not have any substantial change due to the 25% percentage above which an entity related to another one somehow will be considered a “related company,” both legal and natural persons. Regarding the methods of valuation at market price, the proposed Directive does not suggest a specific order to apply one of the five methods but establishes the most appropriate method.

Implementation and Deadlines

According to the proposal, the Transfer Pricing Directive will be implemented on December 31, 2025, coming into force from January 1, 2026. It should be noted that these deadlines may be modified until their approval and entry into force due to political and economic factors affecting the European Union economy.