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Transfer Pricing Has Become Most Important Tax Issue For Multinationals

by Mike Godfrey,, Washington

07 November 2003

According to a new survey undertaken by accounting firm Ernst & Young, transfer pricing has become the most important international tax issue identified by multinational enterprises (MNE’s) located around the world.

The Transfer Pricing 2003 Global Survey found that 86% of MNE parent companies and 93% of subsidiaries considered the issue the most pressing international tax matter they were currently dealing with and reported that audits by the tax authorities are becoming increasingly common.

Transfer pricing involves the price at which transactions between units of multinational companies take place, including the inter-company transfer of goods, property, services, loans and leases.

The E&Y survey revealed that 59% of all MNEs with revenues of more than $5 billion and 71% of all US-based MNEs regardless of revenues have been the subject of a transfer pricing audit at some point within their organizations since 1999. Meanwhile, 76% of respondents envisaged being the subject of an audit inside the next two years.

One of the conclusions reached by Ernst & Young to explain this growing trend is the increase in transfer pricing legislation in many countries, whilst those that already have the legislation in place are increasing their enforcement efforts.

Should a tax authority enforce an adjustment on an MNE as a result of a transfer pricing audit, the survey found there is a one in three chance that a firm will be threatened with a penalty, with a one in seven chance that this will eventually be imposed, though E&Y anticipates an increase in these figures as countries step up their enforcement campaigns.

Furthermore, the survey revealed that 40% of the reported transfer pricing adjustments resulted in double taxation. "This figure is alarmingly high, but perhaps lower than might be expected, given that only 19 percent of reported cases with adjustments were appealed," said Robert D. M. Turner, Global CEO of Ernst & Young's Transfer Pricing Services. "Of the appeals actually made by parent MNEs, 51 percent involved the competent authority process, 26 percent went to court and 7 percent sought arbitration," said Mr. Turner.

Whilst the survey found that MNE experiences of the competent authority process in which two governments resolve an issue using a tax treaty process varied, in general firms seemed to report favourable results from the process, and there were many instances where the authorities reduced or eliminated the double taxation.

The survey also found that the most commonly audited transactions remain the sale of tangible goods, though the number of such audits appears to be on the decline, whilst audits of services and intangible goods were on the increase.

Mr. Turner observed that "intercompany services are becoming a much larger part of the 'services economy' and we are seeing services transactions with larger monetary value. Despite this, MNEs tend to shy away from documenting these types of transactions, as they consider administrative or managerial services and financing transactions to be de minimis. With no or minimal documentation, these transactions appear to be the weakest link in an MNE's transfer pricing armor, giving revenue investigators more room to propose an adjustment."

The Survey, conducted by an independent research firm, polled 641 multinational parent companies and 200 subsidiary corporations in 22 countries. In addition, Ernst & Young interviewed tax authorities and transfer pricing specialists in the 22 survey countries and in 22 other countries with developing transfer pricing regimes.

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