Risks are of critical importance in the context of business restructurings. Usually, in the open market, the assumption of risk associated with a commercial opportunity affects the profit potential of that opportunity, and the allocation of risk assumed between the parties to the arrangement affects how profits or losses resulting from the transaction are allocated through the arm’s length pricing of the transaction. Business restructurings often result in local operations being converted into low risk operations (e.g. “low risk distributors”, or “low risk contract manufacturers”) and being remunerated with a relatively low (but generally stable) return on the grounds that the economically significant risks are assumed by another party to which the profits or losses associated with those risks are allocated. For this reason, an examination of the allocation of risks between associated enterprises before and after the restructuring is an essential part of the functional analysis. Such analysis should allow tax administrations to assess the transfer of the economically significant risks of the business that is restructured and the consequences of that transfer for the application of the arm’s length principle to the restructuring itself and to the post-restructuring transactions.
TPG2022 Chapter IX paragraph 9.19
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By OECD
Category: Limited Risk Distributor, OECD Transfer Pricing Guidelines (2022), TPG2022 Chapter IX: Transfer Pricing Aspects of Business Restructurings | Tag: Assumption of risk, Business restructuring, Conversion of full-fledged distributors, Delineation of business restructurings, Limited Risk Distributors (LRD), Risk return trade off
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- TPG2022 Chapter IX paragraph 9.46At 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...
- TPG2022 Chapter IX paragraph 9.108The selection and application of a transfer pricing method to post-restructuring controlled transactions must derive from the analysis of the economically relevant characteristics of the controlled transaction as accurately delineated. It is essential to understand what the functions, assets and risks involved in the post-restructuring transactions are, and what party...
- TPG2022 Chapter IX paragraph 9.106Where a restructuring involves a transfer to a foreign associated enterprise of risks that were previously assumed by a taxpayer, it may be important to examine whether the transfer of risks only concerns the future risks that will arise from the post-restructuring activities or also the risks existing at the...
- TPG2022 Chapter IX paragraph 9.105When one compares a situation where a long-established full-fledged distributor is converted into a limited risk distributor with a situation where a limited risk distributor has been in existence in the market for the same duration, there might also be differences because the full-fledged distributor may have performed some functions,...
- TPG2022 Chapter IX paragraph 9.104Some differences in the starting position of the restructured entity compared to the position of a newly set up operation can relate to the established presence of the operation. For instance, if one compares a situation where a long-established full-fledged distributor is converted into a limited risk distributor with a...
- TPG2022 Chapter IX paragraph 9.102Where an arrangement between associated enterprises replaces an existing arrangement (restructuring), there may be factual differences in the starting position of the restructured entity compared to the position of a newly set up operation. Sometimes, the post-restructuring arrangement is negotiated between parties that have had prior contractual and commercial relationships....
- TPG2022 Chapter IX paragraph 9.65In particular, in the case of the conversion of a full-fledged distributor into, for example, a limited risk distributor or commissionnaire, it may be important to examine whether the distributor has developed local marketing intangibles over the years prior to its being restructured and if so, what the nature and...
- TPG2022 Chapter IX paragraph 9.64Where a local full-fledged operation is converted into an operation assuming limited risk, using limited intangibles and receiving low remuneration, the questions arise of whether this conversion entails the transfer by the restructured local entity to a foreign associated enterprise of valuable intangibles or rights in intangibles and whether there...
- TPG2022 Chapter IX paragraph 9.23For instance, where a full-fledged distributor is converted into a limited-risk distributor or commissionnaire resulting in the reduction or elimination of risks relating to inventory in the restructured enterprise, in order to determine whether such risk is economically significant the tax administration may want to analyse: The role of inventory...
- TPG2022 Chapter IX paragraph 9.22In any analysis of risks in controlled transactions, one important issue is to assess whether a risk is economically significant, i.e. it carries significant profit potential, and, as a consequence, whether that risk may explain a significant reallocation of profit potential. The significance of a risk will depend on the...