The OECD’s base erosion and profit shifting (BEPS) initiative was born of necessity. Globalization and competition between tax jurisdictions in a “race to the bottom” on tax rates and rules created an environment where governments were finding it difficult to collect their fair share of taxes. The global financial crisis of 2008 and 2009 left tax jurisdictions without enough revenue to maintain social spending at a moment when it was critical to do so.
Transfer pricing is a threat to tax jurisdictions because it makes it relatively easy to manipulate profits so that they appeared to be generated in countries with lower tax rates. Abusive transfer pricing was also difficult to detect. If a multinational enterprise (MNE) made a product in five countries, it could make it appear that the entity that was responsible for the most added-value, and therefore was responsible for the bulk of the margin on that product as well as liable for the most tax, was in the country with the lowest tax rates, the most favorable rules or a favorable tax treaty. Tax planning managers in MNEs routinely manipulated transfer prices between entities in the group to avoid taxes.
Indeed, the OECD recognized the primacy of BEPS transfer pricing risk and tax erosion by issuing no less than four Actions – out of a total of 15 Actions — in response to widespread transfer pricing abuse. Greater scrutiny and enforcement greatly increased the attention paid to the practice among MNEs.
However, there are several advantages to the development of an agreement on what constitutes transfer pricing abuse and how to mitigate it, particularly for small-to-midsized multinational groups:
- Clear rules arguably provide more certainty, and allow for better planning, that ultimately assists MNEs meet their obligations in all the jurisdictions in which they operate.
- MNEs will benefit from the precision and thoroughness of the economic information requirements of the new transfer pricing regime.
- Complying with the new regime will help mitigate double taxation.
- The new rules are accompanied by an improved dispute resolution process if a company is double-taxed.
For small-to-midsized international MNEs, transfer pricing abuse does carry risks, not least because unfavorable rulings from tax jurisdictions can be retroactive and result in significant tax bills many years after the offense. Global corporations can hire large accounting firms to direct their compliance with the new transfer pricing regime, but small-to-midsized groups often depend on law firms with expertise in transfer pricing.
THEVOZ Attorneys will prepare a Transfer Pricing Ruling for any multinational company group. This document, properly prepared, can protect the MNE from legal exposure and double taxation that result transfer pricing disputes with taxing authorities. The process for developing a Transfer Pricing Ruling, and coming to agreement with the taxing authorities in the jurisdictions in which you operate, is as follows:
- Describe the company and identify business lines that operate across borders.
- Review which transfer pricing rules are most appropriate for the cross-border businesses. The MNE generally prefers transfer pricing rules that are most favorable to their potential tax liability, but taxing authorities prefer rules that offer “substance over form” when developing a transfer price. In other words, each respective taxing authority wants to collect the appropriate amount of taxes for the value creation within their jurisdiction and does not want to have any company manipulate the transfer price so that profit is shifted to lower-tax jurisdictions. The guiding principle is to develop a transfer price that resembles an “arm’s length” transaction between two unrelated entities. That is to say, the transfer price charged within the group is similar to the price charged by a company outside the group.
- Choose which rules are to be applied to different activities within the MNE. Which method will be used to create a supportable transfer price for each value-added activity? Often the chosen method is a form of “cost-plus,” but there are several options that are simpler or more complex depending upon the application.
- Draft a Transfer Pricing Ruling that explains and justifies the transfer price policy for various value-added activities in the business lines of the MNE.
- Negotiate with the respective taxing authorities to come to agreement about an effective transfer price structure for the MNE.
- If there subsequently is a dispute arising from transfer pricing, defend the MNE to the taxing authorities. The Transfer Pricing Ruling, if the MNE adhered to its provisions, will be the basis for a successful defense since the taxing authority signed off on it.
- Revisit and update the Transfer Pricing Ruling regularly. New products and services, new production and development technology, marketing initiatives, changes to distribution and other factors– all can require a refashioning of the Transfer Pricing Ruling. It does not necessarily need to be completely rewritten, but any substantive changes in the cross-border business should be reflected in the Transfer Pricing Ruling. Additionally, every change to the Ruling must be explained to the MNE’s accountants so that it is incorporated accurately in the MNE’s tax return. Any oversight or miscommunication could potentially result in large fines and tax adjustments.
While economists and accountants will sometimes be involved in the development of a Transfer Pricing Ruling, in THEVOZ Attorney’s experience, lawyers with a thorough understanding of the rules governing transfer pricing are critical to a successful process. Economists have an abstract understanding of macro forces that influence cross-border economies, and accountants’ “price of everything, value of nothing” framework is not well suited to negotiating with taxing authorities. Knowing the rules and how they have historically been applied, staying up-to-date with new rules; these are the central components of transfer pricing services. They are the purview of the international tax attorney. If the goal is to develop a supportable transfer price that everyone can agree upon, and the guiding principle is to develop a price that reflects a series of “arm’s length transactions,” then the tax lawyer’s understanding of the rules and their enforcement is paramount.