Tax AdvisoryAugust 17, 2023by fiecon

Transfer Pricing Considerations in the Energy & Resources Sector: Part One

Transfer pricing

Transfer price is the price of a transaction between two entities that are part of the same economic group of companies. The price transacted between the two related entities is the “transfer price” and the process for setting the price is referred to as “transfer pricing.” Whereas commercial transactions between independent enterprises are generally determined by market forces, transactions between associated enterprises may not be, giving rise to concerns about the potential for “transfer mispricing” and posing significant challenges for tax authorities in monitoring and assessing such transactions.

In the Energy and Resources sector, transfer pricing can be particularly important, given the significant volumes and values of cross-border transactions in this industry. As such, companies operating in this sector need to be aware of transfer pricing considerations to ensure that their pricing arrangements are in line with relevant regulations and standards.

The Energy and Resources sector is characterized by complex supply chains, long-term contracts, and substantial investments in assets such as infrastructure and equipment. This complexity is compounded by the fact that many companies in this sector operate across multiple jurisdictions, each with its own tax and regulatory regime. In this context, transfer pricing can be a challenging area to navigate, as companies need to balance competing considerations such as compliance with tax laws, competitiveness, and managing risks.

Shifting Dynamics in Worldwide Taxation

In recent times, there has been a substantial surge in the enactment of laws by national governments aimed at safeguarding their existing tax revenue, coupled with the advancement of more intricate regulatory structures tailored to taxing corporate earnings. This movement has been propelled by the evolving global economic landscape, wherein the focus has transitioned from predominantly tangible goods to digital products and services. Consequently, these substantial matters of international taxation have taken a central role in domestic political discussions. This economic transformation has exerted additional pressure on governments to reevaluate their tax regulatory frameworks. As a response, the OECD introduced the BEPS framework, which aims to establish fresh guidelines in the domain of international taxation and transfer pricing, intending to bridge perceived gaps between local tax statutes

While oil and gas (O&G) companies continue to expand their intricate global supply chains, which now encompass intangible elements, it’s important to note that the BEPS initiative initially centered around addressing the transformation brought about by technology giants in the digital economy, rather than O&G multinationals. Nonetheless, due to the interplay of worldwide expansion and the increasing reliance on intangible assets, the BEPS initiative has emerged as a critical consideration within the O&G sector.

Specifically, the BEPS effort concentrated on bolstering worldwide transparency by means of transfer pricing (TP) compliance mechanisms such as the master file, local files, and country-by-country reporting (CbCR). Additionally, BEPS sought to tackle concerns related to the substantial aspects of intangible asset management. This was achieved through an in-depth analysis of various functional components, including development, enhancement, maintenance, protection, and exploitation activities. Furthermore, the initiative delved into the geographical location of these intangibles and the decision-making capacities associated with them.

Moreover, the BEPS final reports introduced a comprehensive framework for addressing risk allocation. This framework was particularly oriented toward the substance and delineation of activities related to risk management, moving beyond mere contractual risk allocation. As a result of BEPS, there was a significant surge in TP compliance requirements, prompting multinational entities to reevaluate their supply chain structures and assess the alignment of value creation and decision-making capabilities.

An Overview of the Energy and Resource (ER) Value Chain

Many enterprises within the Energy and Resource (E&R) sector manage intricate cross-border value chains, encompassing a multitude of operations spanning their upstream, midstream, and downstream activities. These operations involve a diverse range of processes that can be conducted by distinct entities within the same corporate group, resulting in a complex network of transactions among related parties and giving rise to transfer pricing considerations. The E&R sector comprises various segments, each with its own distinct characteristics, yet generally follows a tripartite structure across three main phases: Upstream (encompassing Exploration, Field/Mine Development, and Extraction or Mining and Concentration), Midstream (covering Transport, Refining, and Storage), and Downstream (encompassing Distribution, Marketing, and Trading). Within each of these phases, critical functions are performed, each posing distinct challenges for multinational corporations’ tax departments as they approach transfer pricing matters.

In particular, the Upstream phase involves activities such as exploration, field or mine development, and extraction or mining and concentration. The Midstream phase includes processes like transportation, refining, and storage. Lastly, the Downstream phase comprises distribution, marketing, and trading. Across these phases, multinationals operating in the E&R sector encounter diverse transfer pricing complexities unique to each activity, requiring careful navigation and compliance with relevant tax regulations.

Hence, the typical intercompany transactions that fall under the purview of Transfer Pricing encompass;

Trading Hubs: These entities engage in the purchase and sale of products at different stages of the value chain

Procurement Hubs: Centralized units responsible for managing the acquisition of products, equipment, and services across the entire corporate group

Intragroup Services: Diverse services provided within the group, covering administrative, management, field development, transportation, storage, refining, separation, research and development (R&D), and marketing activities.

Use of Intangible Property (IP): Involves the utilization of various forms of intangible assets, such as exploration rights, trademarks, brands, designs, know-how, trade secrets, patents, and customer lists.

Leasing of Equipment: Encompasses the leasing of various types of equipment like vessels, drilling rigs, heavy earth-moving and construction machinery, oil tankers, and storage facilities.

Intragroup Financial Support: Involves financial transactions within the group, including loans, issuance of financial and performance guarantees, and hedging activities.

The extensive array of business functions inherent to the Energy and Resource (E&R) value chain, coupled with the intricacies of the integrated business models that multinational corporations adopt in this sector, result in a wide spectrum of areas of focus for tax authorities when considering taxation and transfer pricing matters. The multifaceted nature of these transactions demands careful attention to compliance and alignment with relevant tax regulations.

Author: Eddie Opiyo