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With the topic of corporate tax avoidance receiving attention in the global news media as never before, the world's revenue authorities are paying closer attention to transfer pricing.
Survey after survey informs us that transfer pricing is now the top concern for multinationals in the area of taxation, and as Governments pour resources into policing this area taxpayers now have to be ever more vigilant to ensure that intra-group transactions meet arm's length standards set out in national transfer pricing regulations.
Ernst & Young's Transfer Pricing survey 2012 shows that since the survey began in 1995, there has been a remarkable increase in the number of countries introducing transfer pricing requirements. The latest survey found that tax authorities continue to increase their transfer pricing staffing, and nearly all of the 50 jurisdictions covered in the report have plans for further increases.
Worryingly for taxpayers, the survey also found that revenue authorities are increasing the quantity and quality of documentation required to support a taxpayer's position. And for those companies failing to achieve these new documentation benchmarks, penalties are becoming more frequent and more onerous.
Since our last feature on transfer pricing in December 2011, several important developments in the area of transfer pricing have taken place. As noted by E&Y's survey, a number of jurisdictions have reformed existing transfer pricing rules, while others have introduced them for the first time.
Australia introduced transfer pricing reforms into parliament in May 2012, and these were passed by the Senate in August last year. The new rules are, according to the Government, designed to ensure that multinationals with a presence in Australia pay their "fair share of tax" there. In 2009, related party cross-border trade was valued at approximately AUD270bn (USD280bn). This represented roughly 50% of Australia's cross border trade flows.
In September 2012, the Indian Finance Ministry outlined rules for its new advance pricing agreement regime (APA), which is being introduced in an effort to reduce transfer pricing disputes. The APA scheme entered into force from August 31 as a result of changes made to the Income Tax Rules. An APA will determine, in advance, either the arm's length price or the manner for determining an arm's length price (or both), in relation to an international transaction.
Also in September last year, Panama adopted a legislative amendment that introduces transfer pricing rules on transactions with foreign related parties irrespective of whether one of the parties is tax resident in a country that holds a convention for the avoidance of double taxation with Panama. Under previous Panamanian law, two related entities engaging in a transaction would only be subject to the application of transfer pricing rules if one was tax resident in a country that was party to a double tax agreement with Panama.
On November 26, Ireland's Revenue Commission placed details online from its Revenue Operational Manual of how the body undertakes compliance monitoring of transfer pricing rules. The manual warns that "if an expense incurred by a trader in dealings with an associated person is greater than the arm's length price, or receipts are less than the arm's length amount, the trader's profits will be understated for Irish tax purposes."
In February this year, the Philippines Department of Finance and Bureau of Internal Revenue issued Transfer Pricing Guidelines that now apply to both cross-border and domestic transactions between and among associated enterprises. The regulations have been promulgated to implement the Commissioner of Internal Revenue's authority, under the Philippines tax code, to review transactions among associated enterprises and to allocate or distribute their income and deductions in line with the arm's length principle, to ensure that taxpayers clearly reflect the appropriate income attributable to transactions, and to prevent the avoidance of taxes.
And in March 2013, the United States Internal Revenue Service (IRS) announced that it was seeking public comments regarding the development of a model memorandum of understanding between competent authorities on certain transfer pricing issues. The IRS is specifically seeking comments now in recognition that bilateral safe harbors, with regard to arm's length compensation for routine distribution functions, could support sound tax administration. Such routine distribution functions are said to be frequently an issue in transfer pricing cases.
Taxpayers will be glad to hear that tax authorities in some jurisdictions prefer to negotiate with businesses in an attempt to reach the fairest outcome for all in transfer pricing matters. One such jurisdiction is Singapore, and in a recent speech Josephine Teo, Minister of State for Finance and Transport said that if in doubt, businesses can approach the Inland Revenue Authority of Singapore (IRAS) to seek upfront tax certainty on their pricing arrangements through Advance Pricing Arrangements (APAs). Where necessary, the IRAS also helps businesses resolve cross-border transfer pricing disputes through Mutual Agreement Procedures (MAPs) with Singapore's treaty partners.
"Businesses will be pleased to know that IRAS intends to deepen its transfer pricing capability to assist businesses with cross-border transfer pricing issues," Teo concluded. "We support cross-border businesses that are engaged in activities with real economic substance. General anti-avoidance provisions in our tax regime are set up to prevent abusive business transactions, and to ensure that our corporate sector remains healthy and robust."
However, far from reducing uncertainty and conflict between taxpayers and tax authorities, the proliferation of transfer pricing rules seems to be leading to more of it, as evidenced by both the amount of cases being pursued by tax collectors and rising revenue figures.
The United Kingdom is named alongside Japan, Canada, India and Germany as one of the jurisdictions with the highest number of pending transfer pricing reviews. According to a new briefing from HM Revenue and Customs, the organization has secured GBP4.1bn (USD6.2bn) of additional tax revenue by challenging the transfer pricing arrangements of multinationals since the creation of a dedicated Transfer Pricing Group in 2008.
Research published in January by Pinsent Masons would appear to confirm that the UK's revenue agency has stepped up its crackdown on businesses it suspects are using transfer pricing to avoid taxes amid increasing criticism from parliament and the public that it is soft on corporate tax avoidance. The international law firm found that HM Revenue and Customs's (HMRC's) Large Business Service is going after GBP1bn of tax linked to transfer pricing issues. This is up 47% on last year's figure of GBP680m.
While Governments the world over have generally stepped up their oversight of transfer pricing, some are more aggressive than others. The tax authorities in India for instance seem to have kicked off a campaign of challenging the transfer pricing arrangements of large foreign companies, much to the dismay of many foreign investors already suffering from a highly uncertain fiscal environment.
In February, Vodafone confirmed that it is to challenge claims by the Indian Income Tax Department that it under-priced shares issued to a subsidiary, just days after Shell announced that it would fight a similar transfer pricing allegation. The Indian tax authorities are alleging that a share transfer between Vodafone India and Vodafone Teleservices Mauritius in 2007-8 undervalued the shares issued by as much as INR13bn (USD243.9m). A Transfer Price Order was issued by the Income Tax Department last week, detailing the claim.
Earlier that month, Royal Dutch Shell PLC's Indian unit confirmed that it was in discussions with India's tax authorities over accusations of tax evasion relating to the alleged under-pricing of share transfers, claims the firm said were "baseless." Royal Dutch Shell made the statement in response to reports claiming that Indian income-tax authorities have charged Shell India with under-pricing a share transfer by a total value of USD2.8bn, which allowed the business to underpay taxes.
Governments aren't having it all their own way however. Victories for taxpayers in transfer pricing disputes with revenue authorities are perhaps not as widely publicized as losses, but things are by no means a one way street. For instance, last October, Canada's highest court backed pharmaceuticals giant GlaxoSmithKline Plc in a landmark battle over the use of transfer pricing rules to reduce its federal tax bill. The case, heard at the Supreme Court, relates to the purchase by the Canadian subsidiary of GlaxoSmithKline of an active pharmaceutical ingredient between 1990 and 1993. Glaxo Canada's tax affairs for these years were subsequently reassessed by the Canadian Revenue Agency (CRA) on the basis that the prices Glaxo paid for ranitidine, an active pharmaceutical ingredient, were greater than would have been reasonable had they been dealing at arm's length. The result was a CAD51m (USD52m) tax bill, against which Glaxo appealed and the case went all the way to Canada's Supreme Court. The Supreme Court was unanimous in its dismissal of the Revenue's appeal, accepting the argument made by Glaxo Canada that the higher price it paid was legitimate and dictated by the licensing agreement. The saga is not completely over, however. In its judgment, the Federal Court of Appeal had declared that the case should be returned to the Tax Court, for a further re-assessment.
Another taxpayer victory came in December 2012, when an Indonesian subsidiary of an Australian South Sea pearl producer won an appeal against a tax assessment which had disputed the company's transfer pricing arrangements. The company had argued that it had "complied with transfer pricing protocols which have been historically authorised" by Indonesian tax authorities, and that the revised assessment was "inconsistent with these prior rulings." According to a statement issued by Atlas South Sea Pearl, the ruling by the Indonesian Tax Court in Jakarta on behalf of its subsidiary PT Cendana Indopearls is "a significant victory for the inter-company transfer pricing agreement and will help in future tax audits in Indonesia."
However, even though many jurisdictions follow guidance set out by the Organization for Economic Cooperation and Development (OECD) when laying down transfer pricing regulations, the situation for multinational companies seems to be getting more rather than less complicated.
Since out last transfer pricing feature, the OECD has been attempting to address the issue of complexity in transfer pricing rules. Meeting at the first OECD Global Forum on Transfer Pricing in March 2012, tax officials from 90 countries agreed on the need to simplify transfer pricing rules, strengthen the guidelines on intangible issues and improve the efficiency of dispute resolution. In his opening remarks to the Forum, OECD Secretary-General Angel Gurria emphasized that: "The time has come to simplify the rules and alleviate the compliance burden for both tax authorities and taxpayers. Complicated rules can be a barrier to cross-border trade and investment and place a heavy burden on tax administrations and businesses, we are making our approach simpler without making it arbitrary."
On June 6, 2012, the OECD released two discussion drafts and a consultation paper on proposed revisions to its transfer pricing guidelines. The documents include discussion drafts on the transfer pricing aspects of intangibles, and on proposed revisions to the safe harbours section of the Transfer Pricing Guidelines (TPG), in addition to a consultation on certain transfer pricing timing issues. According to the OECD, the current guidance in the TPG "has a somewhat negative tone regarding transfer pricing safe harbours" which does not accurately reflect the practice of OECD member countries, a number of which have adopted transfer pricing safe harbour provisions. Also, it says, the current guidance is largely silent with regard to the possibility of a bilateral agreement establishing a safe harbour, even though some countries have favourable experience with such bilateral agreements.
In November 2012, the OECD held a summit with transfer pricing experts from governments and 100 private sector representatives to consider transfer pricing issues raised in discussion drafts on Intangibles, Safe Harbors and Timing Issues published in June. Almost 1,400 pages of comments were received by the OECD on these topics, including 132 comment letters from business representatives. The OECD Committee on Fiscal Affairs intends to release final guidance on safe harbor provisions and a revised discussion draft on intangibles in 2013.
Delegates agreed that during the coming year the Global Forum would carry out a transfer pricing risk assessment, developing a detailed "how-to" manual which will establish good practices for governments when they assess transfer pricing risk at the beginning of an audit. This culminated in the release of a new draft Handbook on Transfer Pricing Risk Assessment on April 30, 2013, which aims to set out clear and detailed steps national authorities can take to assess the transfer pricing risk presented by an individual taxpayer's operations. According to the OECD, it is intended to be sufficiently detailed to serve as a manual, for both developing and developed countries, that can be followed by nations when developing their own risk assessment approaches.
So, in summary, the OECD's attempts to simplify transfer pricing rules are laudable. But with tax authorities diverting more resources into this area of compliance, it doesn't look as if things are suddenly about to get any easier for groups of companies with international operations. Indeed, tax experts are advising companies themselves to increase their own resources in this area, and engage with tax authorities as much as possible in order to avoid any nasty legal surprises.
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