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Transfer pricing developments in Asia

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By its very nature, transfer pricing is fraught with challenges not least of which is establishing comparables that provide a fair and reasonable means to determine the Arms Length Standard. Many would argue that the science of transfer pricing is always open to dispute given that no two independent companies operate identically even though they may be competing in the same space. This is even more apparent in Asia where the breath of economic development is very wide – from the developed first world economies of Japan/Australia to the under developed economies such as Laos and Vietnam.

While the US has taken the lead in providing the tax fraternity with fodder in the transfer pricing arena through the many landmark legal issues in Asia the Australians have been at the forefront of developing the landscape for transfer pricing. An example is the recently release ATO Ruling on Business Restructuring which among others will give guidance on what the ATO expects when characterizing international transactions between related parties and the selection of the appropriate methodology.

Given the more transparent nature of the Australian environment there is also a body of case law that can be relied on either by the ATO or the taxpayer to support positions. The decision by the Australian Federal Court in the SNF case over the use of the TNMM in dealings between a distributor and its affiliated offshore manufacturing enterprises is of particular interest as the Judge seemed to set aside the OECD guidelines in arriving at his decision and the ATO has since lodged an appeal to the Full Federal Court of Australia. The decision of the Full Federal Court will be of keen interest to all tax directors in Asia given developments in Australia especially on transfer pricing issues have a tendency to flow on to other jurisdictions.

While in the APAC region, Australia has over the last decade certainly been on the forefront of transfer pricing developments one cannot ignore the developments in other parts of Asia in the last decade certainly as those who have had dealings with the Korean NTS and Japanese NTA would attest.

Transfer pricing audits in Korea continue to generate significant heartburn for Tax Directors given that the details requested by the auditors can be onerous and prove challenging especially when having to manage internal expectations and work pressures.

Korean audits also tend to be very intensive in that they are normally slated for a finite number of weeks and given the propensity of the tax auditors to seek large adjustments, it is imperative that in-house tax directors educate quickly the key stakeholders to ensure better alignment of expectations. Given the language and cultural barriers a multinational is best advised to work closely with a advisor as this would assist in facilitating closure of the audit but be warned, the road is likely to be a steep one.

In Japan, as in many jurisdictions in Asia, the first step to any controversy management is to ensure that appropriate documentation is available at short notice as the Japanese transfer pricing auditors are empowered to undertake their own analysis of the company’s transfer pricing arrangements and use whatever data they have (perhaps even including secret comparables) to arrive at a tax adjustment if the company fails to provide documentation to the tax auditors in a timely fashion.

There have been a few cases of late that indicate the tax auditors continue to be aggressive on TP issues and focus not just on multinationals with Japanese operations but also on Japanese corporations that have significant operations overseas.

Like Korea, transfer pricing audits in Japan are time and resource intensive and tax directors should engage and align internal expectations promptly. An option to consider is seeking to do an APA but as anyone who has had to do an APA would know, these themselves can be fraught with issues.

However in getting to such a position the company would necessarily go through a very rigorous audit process and incur advisor spends as always in defending its position more so if the matter has to be litigated which in India seems to be on the uptrend.

Like Japan and Korea the Indian landscape has changed very dramatically and today one would rate India as probably one of the most important geographies to be concerned about in the event of a transfer pricing audit or dispute as a flood of transfer pricing litigation would attest. The saving grace (if one wants to call it that) is that the Indian Courts have shown great grasp of the transfer pricing issues and have given judgments that have gone in favor of the taxpayers.

Other countries in Asia such as China, ROC Taiwan, Indonesia, Malaysia, Singapore and Thailand to name a few have also introduced transfer pricing legislation and there have been instances of aggressive audits and large adjustments proposed by the tax auditors.

China in particular is a country to watch as given its arrival on the global landscape and as in other jurisdictions the Chinese tax auditors would have to better understand commercial drivers that determine transfer pricing policies adopted and move away from a more traditional view that the companies were in fact shifting profits between borders unreasonably.

The vast bank of TP guidance and literature that has been released over these last few years by the State Administration of Taxes in China (SAT) is a case in point and the SAT has indicated that the second half of 2010 will be one where policing of contemporaneous documentation and tax audits would be a key focus.

Malaysia and Indonesia also seem to have moved into the transfer pricing space and feedback from tax directors is that the audits are difficult and significant time and resources are burnt trying to get tax auditors to understand business models as a first step to avoiding large adjustments.

For in-house tax personnel in Asia, the picture is clear – be prepared for ever increasing tax audits that focus on transfer pricing issues given that, like the US and other developed economies, governments in Asia are looking for financial resources to close budget deficits.

While it may be common place to think that some of the audits in Asia are aggressive and painful due to a lack of understanding of commercial rationale by tax auditors, one only has to look to the USA to realize that transfer pricing by its very nature lends itself to potentially significant disputes and resolution of such disputes can be lengthy and very costly to say the least. Being prepared is clearly going to be a key factor in getting a “favorable” resolution – if ever there are favorable resolutions but the road in getting to such a place will be bumpy and the scenery interesting to say the least.


Subha Segaram, Group Tax Director, Pacnet Group

Categories: Analysis , Transfer pricing