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consequences of a risk; and which from risk assumption and intangible
entities have the financial capacity to ownership. The OECD Guidelines
It is crucial to assume the risk; are open to differing interpretation by
determine the entity ■ Step 4: Determine whether the tax authorities, leaving taxpayers with
or entities within an contractual allocation of risk is the challenge of determining the ap-
consistent with the parties’ conduct
propriate level of substance to satisfy the
MNE group that are by analyzing: functional requirements for earning the
ultimately entitled to ● Whether the parties follow the rewards of risk assumption and intan-
contractual terms, and
gible ownership.
share in the returns ● Whether the party assuming the
derived by the group risk under the contractual terms DEMPE and the US
from exploiting exercises control over the risk Several countries around the world have
and has the financial capacity to
expressly incorporated the DEMPE
intangibles. assume the risk; concept and its analytical framework
■ Step 5: If, under Step 4, the party into their own domestic law, but that is
assuming the contractual risk lacks not the case for the United States. In
often used to determine entitlement to the requisite financial capacity or public pronouncements, U.S. govern-
returns from the exploitation of intan- control, apply the OECD Guidelines’ ment officials have said that the Sec.
gibles. Therefore, for example, an MNE risk allocation guidance (paragraphs 482 regulations are consistent with
could register its trademarks in a low-tax 1.98–1.99) and allocate the risk to the OECD Guidelines. However, the
jurisdiction and take the position that the entity that controls the risk and ambiguous language in the OECD
the intellectual property (IP) owner has the financial capacity to assume Guidelines can trigger differences in
could charge royalties to related entities it; and interpretation between the United States
in other jurisdictions, allowing the IP ■ Step 6: Price the transaction in and other tax authorities.
owner in the low-tax jurisdiction to be question, taking into account the Although the OECD Guidelines
entitled to the income effectively gener- consequences of risk assumption as and the DEMPE rules are occasionally
ated in other jurisdictions. appropriately allocated and appropri- referred to by the IRS in bilateral ad-
In addition to the DEMPE rules, ately compensating risk management vance pricing agreements and competent
the 2015 Final Report on Actions functions. authority cases as a common reference
8–10 introduced updated guidance on Now, after the base-erosion and point for negotiation and resolution,
the analysis of risk for transfer-pricing profit-shifting initiative, it is clear they do not constitute binding authority
purposes. Historically, contractual ar- under the OECD rules that contractual for interpreting Sec. 482. However, as
rangements between related parties were arrangements or funding alone does a member of the OECD, the United
often used to determine which party not entitle an entity to returns from States seeks to follow OECD recom-
bore relevant risks for transfer-pricing intangibles or risk assumption. To earn mendations in interpreting its treaties
purposes. Under the updated guidance, returns from assuming risk or owning with other member countries. In 2019,
the contractual allocation of risk remains intangibles, an entity must have “sub- the IRS issued a memorandum titled
relevant, but it will be respected only stance,” in the form of decision-makers’ “Interim Guidance on Mandatory Issue
if it is consistent with the enterprises’ controlling the risks or performing Team Consultations With APMA for
conduct. Paragraph 1.60 of the OECD important DEMPE functions. Enti- Examination of Transfer Pricing Issues
Guidelines provides an overview of the ties funding intangible development or Involving Treaty Countries,” which re-
required risk analysis: contractually assuming risks but with no quires Large Business and International
■ Step 1: Identify the economically significant people functions would not (LB&I) exam teams to consult with
significant risks; be entitled to the returns from economi- the IRS Advance Pricing and Mutual
■ Step 2: Determine how the risks are cally significant risks and intangibles. Agreement program (APMA) when au-
contractually allocated by the parties; Even though the OECD Guide- diting transfer-pricing transactions that
■ Step 3: Based on a functional analy- lines are clear that legal ownership or involve counterparties in jurisdictions
sis, determine which entities perform contractual terms alone do not entitle that are U.S. treaty partners.
risk control and risk-mitigation an entity to returns, the guidelines are This consultation requirement al-
functions; which entities are exposed less clear on the degree of substance lows APMA to provide early input
to the upside and downside; the required for an entity to earn the returns into transfer-pricing audits that could

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