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Knowing when to stop may be ‘the big question’ in transfer pricing, says OECD

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Transfer pricing risks are among the largest tax risks that tax administrations face, but rates of tax recovery resulting from enquiries vary significantly, the OECD said in a new report, Dealing Effectively with the Challenges of Transfer Pricing, published last week.

The OECD found that effective risk management was an essential first step in the process; early dialogue between the tax administration and the taxpayer was increasingly common, and could be "very effective" in setting the scope of enquiry and establishing the facts; the "trend towards more real time working of cases" was positive and could encourage earlier cooperation between tax administrations; and that alternative dispute resolution techniques should be explored further.

"Tax administrations, business and advisers alike recognise that the big question in many transfer pricing audits and enquiries, particularly the most complicated, is when has the time come to stop fact finding and conclude the enquiry, whether by means of negotiation, or through litigation if that is necessary," the report said.

"This decision cannot be taken lightly because significant amounts of money can be at stake and the cost of litigation can be enormous."

In a foreword to the 110-page report Dave Hartnett, HMRC’s Permanent Secretary for Tax, said business, tax advisers and tax administrations alike saw transfer pricing as one of their biggest risks.

"Business fears double taxation when adjustments to taxable profits have to be made following a transfer pricing enquiry, tax administrations are concerned that multi-national enterprises can choose how they allocate their global profits by the way they organise their affairs and as a result they can allocate profits to low tax jurisdictions without moving the underlying economic activity," he said.

Tax campaigners argue that the arm’s length principle endorsed by the OECD favours the multinationals, and should be replaced by a system of ‘unitary taxation’ and country-by-country reporting.