Tax Journal

Transfer pricing developments

28 September 2010

For those involved in transfer pricing, this summer hardly presented an opportunity for relaxation

For those involved in transfer pricing, this summer hardly presented an opportunity for relaxation. The scope and depth of change in domestic and international regulations as well as administrative practice has generated a vast amount of material to take in for those taxpayers trying to remain compliant.

The reasons for so much change in transfer pricing are simple enough; the first is due to growing volumes of inter-company trade generated by globalisation of business under pressure to become more efficient; second is the pressure on tax authorities to raise revenue in a more constrained economic climate; and the third is that transfer pricing is the last big play in tax planning considered ripe for tax savings and tax audits by taxpayers and tax authorities respectively. Corporates that pursue opportunities for business-ed restructuring perceive that tax savings from such planning are reasonably well protected from the usual attacks of form over substance and other countermeasures. On the other hand tax authorities view transfer pricing audits as capable of generating revenues in the absence of definitive answers and the potential for corporates’ poor planning and execution.

A key area of contention in practice is the application of transfer pricing guidelines to business restructuring. There has been little or no consensus as to how to determine whether conditions made or imposed between related parties in the context of business restructurings differ from arm’s length and if so how to adjust profits for those conditions. The fundamental questions are whether a comparable restructuring transaction exists and if not how the arm’s-length principle is upheld.

In response to these challenges, on 22 July the OECD published its revised Transfer Pricing Guidelines for Multinational Enterprises including expanded and new chapters on comparability, profit methods and transfer pricing aspects of business restructurings.

The practical effects of these new guidelines will be played out over the next decade or so but one potential scenario points to a much higher standard required for taxpayer processes, documentation and quality of comparables from now on. This in turn may encourage tax authorities to reject comparables so as to move swiftly to testing transactions by reference to individual entities’ ability to control risk and applying the ‘options realistically available’ test. These concepts are highly subjective in the context of an integrated multinational corporations and so taxpayers may find themselves devoting considerably more time to defending against re-pricing and re-characterisation.

The message from the OECD is clear; prepare and document comparables analyses with great care or be prepared to defend profit allocations benchmarked against alternative arrangements on an entity by entity basis. While OECD has a done a reasonable job to focus taxpayers and tax authorities on appropriate processes and criteria to meet the arm’s-length standard, the language continues to provide scope for controversy. It is, however, up to taxpayers and tax authorities alike to make these revised guidelines work in practice.

22 July was also the day the US House Ways and Means Committee held their transfer pricing and international tax policy hearing assisted by the Joint Committee on Taxation’s pamphlet on income shifting and transfer pricing. During the hearing the adequacy of the arm’s length standard for dealing with perceived artificial US base erosion through licensing intellectual property offshore and certain cost sharing arrangements came under fire; so too did the adequacy of the IRS’ resources for enforcement of existing transfer pricing regulations. We will have to wait to see what proposals if any make it to the statute book but where the US goes others usually follow.

Following the UK’s lead, the US IRS has established a new national Transfer Pricing Practice headed by a Transfer Pricing Council and supported by a knowledge centre and more economists in order ‘to change the way it [the IRS] does business in the transfer pricing area’. More recently, the US IRS Commissioner, Douglas Shulman, announced the reorganisation of the Large and Mid Size Business team to bring greater focus on international issues including transfer pricing.

He also raised the prospect of joint tax authority audits, in order to ‘embed competent authority issues upfront’ and to accelerate resolution of potential cross-border disputes. This development is consistent with the drive towards greater information sharing between tax authorities. As an additional mechanism to mutual agreement procedures and advance pricing agreements (APAs), joint audits would be a welcome development if it served to eliminate double taxation and was backed up by a broader application of accessible, fast-acting, mandatory binding arbitration.

Of course, the rest of the world is not standing still regarding demands for transfer pricing documentation, audit activity and offering access to APAs. As business’ attention turns to emerging markets including China, Brazil, Mexico, India, Turkey and Russia for growth, so must those responsible for transfer pricing respond to construct appropriate frameworks and processes for managing compliance demands and audit activity. These less familiar and, to some extent, more volatile territories require increasing focus and a rebalancing of in-house and external resources to ensure tax risks are identified and mitigated.

So far from lazing around in the sun this summer, transfer pricing specialists will have had to digest a pile of new materials aimed at making transfer pricing clearer for all stakeholders. We will have to see whether the latest developments achieve the overriding goal of securing certainty of single incidence taxation in shorter time frames.


Ian Brimicombe, Head of Tax, AstraZeneca


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