Determining an Arm’s Length Remuneration for intra-group services

It is not in the interests of an MNE group to incur costs unnecessarily, and it is in the interest of an MNE group to provide intra-group services efficiently, thus an MNE group should ensure that services are appropriately identified and associated costs appropriately allocated within the MNE Group in accordance with the arm’s length principle.

• Application of the benefit test

According to the OECD Guidelines, under arm’s length principle, services provided by a group member to another group member are chargeable only when there is a demonstrable benefit being derived by the service recipient.

• Identifying the category of the service

When determining the charges for intra-group services, the first step involves identifying the costs incurred by the provider of the service in the service provision itself. The costs are classified into four types of cost pools:

• Non-allocable costs;
• Pass-through costs;
• Low value-adding service costs; and
• Other services cost where a markup applies.

• Identifying the costs to be allocated through a direct or indirect method, depending on the circumstances of the case.

In allocating and charging out the service costs to the related parties receiving the services, two charging methods may be applied, a direct or indirect charge method. The direct charge method can be applied in cases where the benefit from the intra-group service can be readily identified to associated enterprises, which are charged for such specific services. This approach has great practical convenience, especially for the tax authorities since a clear identification of the service performed and of the basis for the charge easily allows for the determination of whether the arm’s length principle has been met.

Where it is difficult to establish a specific charge for each identifiable service, the indirect charge method may be applied. Under the indirect charge method, the costs of a service provided to more than one entity are allocated to a particular entity with reference to a basis or allocation key that indicates the share of the total value of the service attributable to the particular entity.

• Determining appropriate markups

MNEs essentially have three options to justify their selected markup(s) depending on the selected cost pool. The first one is to perform a benchmark study and apply an appropriate measure from the study. The second approach is to apply the markup that the MNE service provider applies in cases where the intra-group service is provided to independent parties as well, and where the contractual circumstances are the same or can be adjusted without distorting reliability. Finally, in the case of low value adding services,  the OECD Guidelines propose the option (to be adopted on a national basis)  to apply a 5% markup.

Concluding remarks

MNEs spend a significant amount of time debating markup levels on different kinds of services within their group. However, the reality is that the main tax risk for intra-group services lies in the specific pooling of cost, as the cost base determination comprises by far the most significant component of a cost-plus based transfer price. The  determination of the  appropriate markups should not take place at the cost  of the time that should be devoted to the  cost pooling exercise.

How can BDO help

Discover how BDO can assist your multinational enterprise (MNE) in navigating the complexities of intra-group service cost allocation. With our expertise in transfer pricing and international tax regulations, we provide tailored solutions and reliable guidance to ensure compliance with the arm's length principle. 

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