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OECD Restructuring Discussion Draft

Issue Notes challenge the “pragmatism and appropriateness” commercial rationale for the transactions and appear to revise the tenets of the established arm's-length standard.

February 26, 2009
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* From Journal of International Taxation (February 2009).

This article was prepared by the Baker & McKenzie Global Transfer Pricing Steering Committee members, including Richard Fletcher (London); Marc M. Levey, Chair (New York); Cyril Maucour (France); Stephan Schnorberger (Dusseldorf); and Monique van Herksen (Amsterdam).

The OECD released a 56-page discussion draft on business restructurings (“Restructuring Draft”) on September 19, 2008. Generally, business restructurings involve cross-border redeployment by multinational corporations (MNCs) of functions, assets and risks. Typically, the OECD provides that MNCs have restructured their global-business models from vertically-integrated business models with full-fledged manufacturing and distribution activities and associated services through locally-incorporated enterprises to a centrally-controlled supply-chain model. The focus of tax administrations thus far is on these transactions but, as noted in passing, the Restructuring Draft defines “business restructuring” far more broadly in an introductory statement that suggests that a business restructuring may include any cross-border transfer of assets and/or risks and/or functions. The OECD should clarify that this broader interpretation is not intended. These centrally-controlled models are often located in a tax-benefited jurisdiction, structured with appropriate economic substance, and act as the risk-taking entrepreneur who oversees limited-risk distributors or commissionaires and contract manufacturers typically located in high-tax environments with reduced profitability commensurate with their limited-risk profit.

The Restructuring Draft is composed of four Issue Notes that consider various issues related to restructurings and, among other things, challenge the “pragmatism and appropriateness” commercial rationale for the transactions and appear to revise the tenets of the established arm's-length standard:

  • Issue Note No. 1 (Special Considerations for Risk).
  • Issue Note No. 2 (Arm's-Length Compensation for the Restructuring).
  • Issue Note No. 3 (Transfer Pricing Aspects of Post-Business Restructurings).
  • Issue Note No. 4 (Recognition of the Actual Transaction Undertaken).

Generally, the Issue Notes address (1) general guidance in the allocation of risks by and among the related parties to the restructuring; (2) application of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (“OECD Transfer Pricing Guidelines”) to the restructuring with compensation or indemnifications for any terminations or “buy-ins”; (3) application of the arm's-length principle to “post-restructurings”; and (4) exceptional circumstances where a restructuring may be disregarded by a tax authority.

Focusing largely on risk transfer and the centralizing of functions, the OECD seems to establish presumptions that adopt the skepticism and adverse attitudes of many tax authorities and challenge the business judgment of MNCs through a “commercial rationale” standard.

The Restructuring Draft sets out many issues involved in business restructurings that are not new or novel, and there is no indication that the existing OECD Transfer Pricing Guidelines cannot address these concerns. Accordingly, one questions the Draft's underlying premise. Is it to highlight sensitivity to tax administrators? If so, more balance may be required and the focus should be more to issues not already considered under the existing rules. Further, does this create an overriding blanket for all restructurings that the arm's-length principle must be perused more vigorously? Is there simply a presumption of distrust that gives rise to this seemingly unnecessary detail and review?

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