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The Profit Split Method: Historical Evolution and BEPS Insights
This article is the first of a two-part contribution that attempts to provide an outlook on the historical development, the status quo, and the future direction of the profit split method, especially by taking into account the outcome of the OECD/G20 BEPS project.
This article particularly examines the latest OECD discussion draft, “Revised Guidance on Profit Splits”, and further discusses the direction that the discussion draft might lead to in the future, given the direct and immediate impacts the discussion draft might have on the future development of the profit split method.
1. Introduction
The profit split method, as defined by the OECD, seeks to determine the division of profits (as well as losses) that independent enterprises would have expected to agree under comparable circumstances. Despite being one of the five OECD authorized transfer pricing methods, the profit split method is slightly different from the other methods. First, the profit split method is a two-sided method: it requires a consideration of both sides (goods seller and goods purchaser, or service provider and service recipient) of the controlled transaction to assess the rel+ative contributions of each party. Consequently, it boasts of being in conformity with economics of multinational enterprises (hereinafter: “MNEs”), and it provides a more reliable proxy of MNEs’ business reality. Second, the profit split method is a profit-based method. It begins with calculating the combined profits of a transaction which are subsequently subject to a division through the arm’s length principle. For that reason, it is regarded as the least direct method; and, until 2010, it was considered (together with the transactional net margin method; hereinafter “TNMM”) a method applicable only in exceptional situations. Compared to other transfer pricing methods, the strength of the profit split method is apparent. The application does not generate extreme profit splitting results,