What is Substance in Transfer Pricing Context? The new international tax regime under BEPS emphasizes on actual conduct over form requiring profit allocation between jurisdictions to mirror actual distribution of functions (with risks tied to the performance of functions). The relevant profit driving functions have been termed as 'significant people functions' (also called risk-taking functions)
BEPS approach focuses on the reality of functions undertaken in the supply chain. For example, merely because there is a cost plus agreement with subsidiary it does not follow that the subsidiary is low value adding or has limited risk. The inter-company agreement shall not be conclusive of characterization but should be supported by functional profile - in other words the enquiry must focus on how the following (illustrative list) significant people' functions are performed:
Who makes strategic decisions for the Company?
Who decides on the new product/ service launch?
Who decides how much to invest, hire or expand?
Who takes call on the critical matters of the business - vision, accept reject or contracts etc?
If any or all of these 'significant people' functions are carried out by the so called low value adding subsidiary it is not a limted risk entity but a perhaps a risk bearing entity / Entrepreneur.
Therefore 'Significant People' functions is the real 'substance' for Transfer Pricing Policy Determination.
To conclude actual functions have to be first examined and documented and then agreements should be drafted to reflect those functions/ risks - not the other way round.