Tag: Reallocation of profit potential

TPG2022 Chapter IX paragraph 9.47

In scenario no. 1, the distributor is surrendering a profit potential with significant uncertainties for a relatively low but stable rate of profitability. Whether an independent party would be willing to do so would depend on its anticipated return under both scenarios, on its level of risk tolerance, on its options realistically available and on possible compensation for the restructuring itself. In case scenario no. 2, it is unlikely that independent parties in the distributor’s situation would agree to relocate the risks and associated profit potential for no additional compensation if they had the option to do otherwise. Scenario no. 3 illustrates the fact that the analysis should take account of the profit potential going forward and that, where there is a significant change in the commercial or economic environment, relying on historical data alone will not be sufficient ... Read more
TPG2022 Chapter IX paragraph 9.46

TPG2022 Chapter IX paragraph 9.46

At arm’s length, the response is likely to depend on the rights and other assets of the parties, on the profit potential of the distributor and of its associated enterprise in relation to both business models (full-fledged and low risk distributor) as well as the expected duration of the new arrangement. In particular, in evaluating profit potential, it is necessary to evaluate whether historic profits (determined in accordance with the arm’s length principle) are an indicator of future profit potential, or whether there have been changes in the business environment around the time of the restructuring that mean that past performance is not an indicator of profit potential. For example, competing products could have the effect of eroding profitability, and new technology or consumer preferences could render the products less attractive. The consideration of these factors from perspective of the distributor can be illustrated with the following example ... Read more

TPG2022 Chapter IX paragraph 9.45

As another example, assume a full-fledged distributor is operating under a long term contractual arrangement for a given type of transaction. Assume that, based on its rights under the long term contract with respect to these transactions, it has the option realistically available to it to accept or refuse being converted into a limited risk distributor operating for a foreign associated enterprise, and that an arm’s length remuneration for such a low risk distribution activity is estimated to be a stable profit of +2% per year while the excess profit potential associated with the risks would now be attributed to the foreign associated enterprise. Assume for the purpose of this example that the restructuring leads to the renegotiation of the existing contractual arrangements, but it does not entail the transfer of assets other than its rights under the long term contract. From the perspective of the distributor, the question arises as to whether the new arrangement (taking into account both ... Read more

TPG2022 Chapter IX paragraph 9.44

Take the example of a conversion of a full-fledged manufacturer into a contract manufacturer. In such a case, while a cost plus reward might be an arm’s length remuneration for undertaking the post-restructuring contract manufacturing operations, a different question is whether there should be indemnification at arm’s length for the change in the existing arrangements which results in the surrender of the riskier profit potential by the manufacturer, taking into account its rights, other assets and economically relevant characteristics. Indemnification is discussed in Section F ... Read more

TPG2022 Chapter IX paragraph 9.43

General guidance on the transfer pricing aspects of risks is found in Section D. 1.2.1 of Chapter I, and the reallocation of risk following a business restructuring should be analysed under the framework set out in that Section in order to determine whether the party allocated risk following the restructuring controls the risk and has the financial capacity to assume the risk ... Read more

TPG2022 Chapter IX paragraph 9.42

In order to determine whether at arm’s length the restructuring itself would give rise to a form of compensation, it is essential to understand the restructuring, including the changes that have taken place, how they have affected the functional analysis of the parties, what the business reasons for and the anticipated benefits from the restructuring were, and what options would have been realistically available to the parties, as discussed in Section B ... Read more

TPG2022 Chapter IX paragraph 9.41

In the context of business restructurings, profit potential should not be interpreted as simply the profits/losses that would occur if the pre-restructuring arrangement were to continue indefinitely. On the one hand, if an entity has no discernible rights or other assets at the time of the restructuring, then it has no compensable profit potential. On the other hand, an entity with considerable rights or other assets at the time of the restructuring may have considerable profit potential, which must ultimately be appropriately remunerated in order to justify the sacrifice of such profit potential ... Read more

TPG2022 Chapter IX paragraph 9.40

In these Guidelines, “profit potential” means “expected future profits”. In some cases it may encompass losses. The notion of “profit potential” is often used for valuation purposes, in the determination of an arm’s length compensation for a transfer of intangibles or of an ongoing concern, or in the determination of an arm’s length indemnification for the termination or substantial renegotiation of existing arrangements, once it is found that such compensation or indemnification would have taken place between independent parties in comparable circumstances ... Read more

TPG2022 Chapter IX paragraph 9.39

An independent enterprise does not necessarily receive compensation when a change in its business arrangements results in a reduction in its profit potential or expected future profits. The arm’s length principle does not require compensation for a mere decrease in the expectation of an entity’s future profits. When applying the arm’s length principle to business restructurings, the question is whether there is a transfer of something of value (an asset or an ongoing concern) or a termination or substantial renegotiation of existing arrangements and that transfer, termination or substantial renegotiation would be compensated between independent parties in comparable circumstances. These two situations are discussed in Sections E and F below ... Read more

TPG2022 Chapter IX paragraph 9.6

Business restructurings are typically accompanied by a reallocation of profit potential among the members of the MNE group, either immediately after the restructuring or over a few years. One major objective of this chapter in relation to Article 9 is to discuss the extent to which such a reallocation of profit potential is consistent with the arm’s length principle and more generally how the arm’s length principle applies to business restructurings. The implementation of integrated business models and the development of global organisations may complicate the application of the arm’s length principle, which determines the profit of members of an MNE group by reference to the conditions which would have been made between independent enterprises in comparable transactions and comparable circumstances. This complexity in applying the arm’s length principle in practice is acknowledged in these Guidelines (see paragraphs 1.10-1.11). Notwithstanding this issue, these Guidelines reflect the OECD Member countries’ strong support for the arm’s length principle and for efforts to ... Read more

TPG2017 Chapter IX paragraph 9.47

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TPG2017 Chapter IX paragraph 9.45

As another example, assume a full-fledged distributor is operating under a long term contractual arrangement for a given type of transaction. Assume that, based on its rights under the long term contract with respect to these transactions, it has the option realistically available to it to accept or refuse being converted into a limited risk distributor operating for a foreign associated enterprise, and that an arm’s length remuneration for such a low risk distribution activity is estimated to be a stable profit of +2% per year while the excess profit potential associated with the risks would now be attributed to the foreign associated enterprise. Assume for the purpose of this example that the restructuring leads to the renegotiation of the existing contractual arrangements, but it does not entail the transfer of assets other than its rights under the long term contract. From the perspective of the distributor, the question arises as to whether the new arrangement (taking into account both ... Read more

TPG2017 Chapter IX paragraph 9.44

Take the example of a conversion of a full-fledged manufacturer into a contract manufacturer. In such a case, while a cost plus reward might be an arm’s length remuneration for undertaking the post-restructuring contract manufacturing operations, a different question is whether there should be indemnification at arm’s length for the change in the existing arrangements which results in the surrender of the riskier profit potential by the manufacturer, taking into account its rights, other assets and economically relevant characteristics. Indemnification is discussed in Section F ... Read more

TPG2017 Chapter IX paragraph 9.43

General guidance on the transfer pricing aspects of risks is found in Section D. 1.2.1 of Chapter I, and the reallocation of risk following a business restructuring should be analysed under the framework set out in that Section in order to determine whether the party allocated risk following the restructuring controls the risk and has the financial capacity to assume the risk ... Read more

TPG2017 Chapter IX paragraph 9.42

In order to determine whether at arm’s length the restructuring itself would give rise to a form of compensation, it is essential to understand the restructuring, including the changes that have taken place, how they have affected the functional analysis of the parties, what the business reasons for and the anticipated benefits from the restructuring were, and what options would have been realistically available to the parties, as discussed in Section B ... Read more

TPG2017 Chapter IX paragraph 9.41

In the context of business restructurings, profit potential should not be interpreted as simply the profits/losses that would occur if the pre-restructuring arrangement were to continue indefinitely. On the one hand, if an entity has no discernible rights or other assets at the time of the restructuring, then it has no compensable profit potential. On the other hand, an entity with considerable rights or other assets at the time of the restructuring may have considerable profit potential, which must ultimately be appropriately remunerated in order to justify the sacrifice of such profit potential ... Read more

TPG2017 Chapter IX paragraph 9.40

In these Guidelines, “profit potential” means “expected future profits”. In some cases it may encompass losses. The notion of “profit potential” is often used for valuation purposes, in the determination of an arm’s length compensation for a transfer of intangibles or of an ongoing concern, or in the determination of an arm’s length indemnification for the termination or substantial renegotiation of existing arrangements, once it is found that such compensation or indemnification would have taken place between independent parties in comparable circumstances ... Read more

TPG2017 Chapter IX paragraph 9.39

An independent enterprise does not necessarily receive compensation when a change in its business arrangements results in a reduction in its profit potential or expected future profits. The arm’s length principle does not require compensation for a mere decrease in the expectation of an entity’s future profits. When applying the arm’s length principle to business restructurings, the question is whether there is a transfer of something of value (an asset or an ongoing concern) or a termination or substantial renegotiation of existing arrangements and that transfer, termination or substantial renegotiation would be compensated between independent parties in comparable circumstances. These two situations are discussed in Sections E and F below ... Read more

TPG2017 Chapter IX paragraph 9.6

Business restructurings are typically accompanied by a reallocation of profit potential among the members of the MNE group, either immediately after the restructuring or over a few years. One major objective of this chapter in relation to Article 9 is to discuss the extent to which such a reallocation of profit potential is consistent with the arm’s length principle and more generally how the arm’s length principle applies to business restructurings. The implementation of integrated business models and the development of global organisations may complicate the application of the arm’s length principle, which determines the profit of members of an MNE group by reference to the conditions which would have been made between independent enterprises in comparable transactions and comparable circumstances. This complexity in applying the arm’s length principle in practice is acknowledged in these Guidelines (see paragraphs 1.10-1.11). Notwithstanding this issue, these Guidelines reflect the OECD Member countries’ strong support for the arm’s length principle and for efforts to ... Read more