Tax AdvisoryAugust 17, 2023by fiecon

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

Transfer pricing

Energy and Resource (ER) Transfer Pricing Considerations

Trading Hub: In the present BEPS landscape, the focal point regarding trading hubs revolves around a crucial transfer pricing (TP) consideration. It involves ensuring a harmonious correlation between two key factors:

  • Strategic Decision-Making and Risk Control: This entails verifying that the geographic location where pivotal decision-makers exert authority over the fundamental business risks and possess the financial capability to manage these risks in the event they materialize is in alignment with the place where the residual profits originating from the trading operations are officially recorded.
  • Application of Accepted Pricing Indexes: Additionally, the existence and acceptance of universally recognized pricing indexes serving as benchmarks for specific commodities’ trading activities must be taken into account. These indexes should be duly factored into the intercompany sales pricing, while any essential adjustments should be incorporated to account for disparities in quality or blend, geographic location, storage, insurance, and trade volumes.

These considerations highlight the intricate interplay between decision-making, risk management, and profit allocation within the context of trading hubs. Adhering to these principles ensures that transfer pricing practices align with global standards and regulations, enhancing transparency and compliance in a rapidly evolving business environment.

Centralized Procurement Hubs: In the realm of Exploration and Resources (E&R), it is customary to employ centralized procurement hubs, often organized under a procurement principal framework. These hubs generally acquire goods or resources from suppliers or manufacturers, assuming complete ownership for subsequent distribution to affiliated entities. Much like trading hubs, maintaining the strength of the procurement principal framework requires careful attention to ensure its proper economic foundation.

Intragroup Services: In the E&R value chain, intra-group services play a crucial role across all stages. Notably, distinct differences exist in the types of intra-group services offered during the upstream, midstream, and downstream phases of the value chain.

In this regard, it is key for companies to ensure:

  • The nature of the services is clearly identified
  • The recipient has derived a benefit from the transaction
  • There are no activities to which the service charge relates to that only benefit the shareholder and not the recipient of the charge
  • The cost base and the allocation keys derive an economic reasonable amount correspondent to the benefit obtained from the services.
  • The possible profit element is market-related.

It is imperative to have comprehensive documentation of this process, which should undergo regular reviews to guarantee alignment between the stipulated charging methodology and its actual execution.

Use of Intangible Property: Intellectual property (IP) presents significant challenges across various industries, and the utilization of IP in the E&R sector is no exception. Particularly in the upstream phase of the value chain, a notable instance is evident in the research and development endeavors that led to advancements in hydraulic fracturing (fracking), enabling the extraction of shale oil which was previously unattainable. This progress resulted in the patenting of related technologies, currently generating substantial revenues and profits due to continuous technological and procedural enhancements.

Similarly, in the upstream phase, multinational enterprises (MNEs) are granted rights for the exploration of oil and gas or mining fields. Transitioning to the midstream phase, significant MNEs have patented refining techniques and technologies, including design configurations such as fluid catalytic cracking. Shifting to the downstream phase, another instance emerges with the incorporation of well-established global brand names in the retail sale of fuels. The pivotal question revolves around whether these intangible assets should be financially compensated, and if so, how the allocation of residual profits to their proprietors should be managed. Furthermore, a critical assessment is warranted to determine if the legal holders of these intangible assets are indeed their economic proprietors deserving of the residual profit allocation.

Hence, it becomes essential to identify the relevant entities involved in these scenarios through:

  • Performing the DEMPE (Development, Enhancement, Maintenance, Protection and Exploitation) Function Analysis in connection to the intangible assets
  • Making the key decisions relating to the control over the risks
  • Which have the financial capacity to bear those risks in the case they materialize

Leasing of Equipment: Within the offshore services sector, the leasing of vessels and/or rigs presents distinct transfer pricing (TP) challenges that are particularly pertinent to the upstream phase of the value chain. In the domain of Exploration and Resources (E&R), primarily focused on Oil and Gas (O&G), the arrangement of vessel charters involving affiliated entities frequently pertains to services such as offshore construction, subsea equipment and pipeline installation, servicing, and contract drilling.

Offshore and oilfield service companies play a pivotal role in the E&R sector by possessing equipment and vessels essential for aiding major corporations in the processes of offshore oil and gas exploration, drilling, and production. Despite this, these service providers do not extract and vend the resources under their own name. Consequently, the operational models employed by vessel or rig charter firms can raise concerns related to the establishment of a permanent presence in the countries where the vessels are deployed. Determining the allocation of profits to these entities can be intricate, especially considering that functions are performed and risks are overseen both within and outside the nation where the vessel operates.

Given these circumstances, TP concerns may arise, exemplified by the need to appropriately compensate various parties involved in the process. This encompasses the shipowner, charterer, and service provider (e.g., contract drilling company). A meticulous approach is essential to accurately define the roles and attributes of each entity, alongside discerning the geographical location of key personnel responsible for managing risk associated with these transactions. Additionally, it is crucial to ascertain the entities possessing the financial capability to bear such risks if they materialize.

Moreover, the practice of vessel chartering remains prominent throughout the midstream phase of the value chain, particularly in the realm of transportation activities. Furthermore, the leasing of heavy earth-moving and construction equipment is a recurring practice within natural resource mining endeavors.

Intra-group Funding: The E&R sector commonly employs internal funding, often originating from the parent company and directed towards subsidiaries or branches. This practice is pervasive due to the capital-intensive character of the industry and its associated commercial uncertainties. Internal financing is prevalent across diverse phases of the value chain, encompassing exploration and discovery, project development, transportation (for acquiring transportation assets), refining/production, and downstream distribution (to support various distribution operations).

From a transfer pricing (TP) standpoint, several crucial aspects merit consideration. These include verifying the adherence to arm’s length principles in relation to interest rates on loans and other forms of intra-group financing, ensuring the appropriate valuation of risk in financial and performance-related guarantee fee payments, overseeing hedging endeavors designed to mitigate the Group’s exposure to future price fluctuations, and adhering to regulations surrounding thin capitalization and interest limitation.

In essence, managing intra-group funding in the E&R sector necessitates careful attention to these multifaceted TP dynamics to ensure fairness and compliance throughout the value chain.

To summarize, transfer pricing considerations hold significant significance within the Energy and Resources sector. Enterprises engaged in this industry must be cognizant of the distinctive hurdles inherent to their field and must establish transfer pricing structures that align with pertinent laws and guidelines. This proactive approach enables companies to mitigate potential risks, enhance compliance measures, and sustain their competitive edge within the intricate and ever-evolving global business landscape.


Author: Eddie Opiyo