Intenational taxation report on Transfer Pricing

Exam Number: 55 University of Copenhagen International Taxation Essay Character count: 33,159 (excluding Cover page, Table of contents and bibliography)

Transfer Pricing What it is, Current regulation, Issues and Future Solutions.

BQZ372 12/11/2014

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Table of contents

1.0 Introduction……………………………………………………………………………………………………….....…….……………P2

2.0 Transfer Pricing…………………………………………………………………………………………….……………..……………P2

2.1 Case study I: Basic transfer price…………………………………………………………….…….………………P4

2.2 Case study II: SAB Miller…………………………………………………………………………….….……………..P4

2.3 Case study III: Forest Laboratories Inc…………………………………………………….…….………………P4

3.0 Tax Havens…………………………………………………………………………………………………………..…….……………..P5

4.0 Arm’s Length Principle…………………………………………………………………………………………..….………………P6

4.1 Associated Companies…………………………………………………………………………………..……………..P7

4.2 Arm’s length Pricing Methods……………………………………………………………………………………….P8

4.2.1 Comparable Uncontrolled Price Method……………………………………………………P8

4.2.2 Resale Price Method and Cost-Plus Method………………………………………………P8

4.2.3 Transactional Net Margin Method and Comparable Profits Method…….……P9

4.2.4 Profit Split Method……………………………………………………………….…….…..………..P9

4.3 Adjustments to the Arm’s Length Price…………………………………………………….……………..…P10

5.0 Issues with Arm’s Length Principle………………………………………………………………………………….……….P11

5.1 Management Fees……………………………………………………………………………………………..……….P11

5.2 Intangible Property Sale and Licencing……………………………………………………………….………P12

5.3 Cost Sharing………………………………………………………………………………………………………….…….P12

6.0 Future OECD Reforms………………………………………………………………………………………………………………P14

7.0 Alternative to Arm’s Length Principal………………………………………….………………………………..…………P15

8.0 Conclusion…………………………………………………………………………………….………………….……….……………P16

9.0 Bibliography…………………………………………………………………………………….………………...……………………P17

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1.0 Introduction

Today’s economy is more interconnected than ever before with trillions of dollars moving between

multiple countries every day. Globalisation has created the perfect circumstances for International

business opportunities and as a result hundreds of Multi National Enterprises (MNE’s) have grown

into significantly powerful international bodies with far reaching influences all over the world.

Contrasting 2012 Gross Domestic Product (GDP) data with reported revenue in annual corporate

reports shows that 37 of the world’s largest 100 economies are corporations.1

The primary goal of corporations is to act in the best interest of their shareholders by acting in good

faith and within the confines of the law, their contribution to other economies which they draw

revenue from is in the form of corporate tax. One way corporations can achieve this goal is to

reduce this required contribution. Under the current international taxation system, complex

corporate structures and techniques can be used to create loopholes allowing significant taxation

reductions which under current systems, domestic tax authorities can do little about. This report

will examine one of the most significant issues of these corporate taxation practices ‘Transfer

Pricing’.

2.0 Transfer pricing

Across separate corporate groups or Multi National Enterprises (MNE’s), the price of trades are kept

in check by negotiations and market forces such as the associated costs of the transaction, the

margin of profit and the price of competition. These factors allow the market to generate a “fair

price” which can tax by local authorities accordingly. For trades between two companies within the

same corporate group (which are ultimately the same company) it is logical that the party which

should receive the highest financial benefit should be the one which pays the least tax. The price of

the trades of goods or services between two companies in separate jurisdictions within the same

corporate group is referred to as the ‘Transfer price’. While such trades are necessary business

transactions which can occur on a daily basis, many International companies and their subsidiaries

are taking advantage of this situation by both manipulating and mispricing these transactions in

1 Forbes, International Monetary Fund & CIA World Fact book (2013) “The corporations bigger than nations”

retrieved from: http://makewealthhistory.org/2014/02/03/the-corporations-bigger-than-nations/

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order to maximise profits by reducing the payable tax, resulting in the erosion of a countries tax

base.2

Today, there are International taxation systems in place in globalised economies to regulate this

behaviour, the majority of which are based on the recommendations of the most significant and

influential international taxation body, the Organisation for Economic Co-operation and

Development (OECD). The OECD estimates up to 70% of international trades are between companies

within the same corporate group, this means that there are massive amounts capital MNE’s move

between countries and it is clear that the regulation of these transfers is a major issue for

governments. 3

There have been multiple studies, reports and estimates on the total cost of transfer pricing around

the world. A 2009 Christian Aid report “False Profits” estimated bilateral trade mispricing totalled

$1.1 Trillion USD in lost taxation in Europe and the United States alone between 2005 and 2007 .4

The scale of MNE’s overseas operations is now higher than ever, a report generated from

Bloomberg stated that between 2006 and 2010 the top 135 US companies foreign profits increased

by over 70% from $590 Billion to over $1 trillion USD which was accredited to increased productivity

and sales along with the use of transfer pricing and base erosion practices.5 A study by the United

Kingdom showed that nearly one third of UK’s 700 largest businesses paid no corporation tax in the

2005-06 financial year.6 It is clear that the use of these practices is common place for MNE’s and

taxation avoidance cases are not just isolated incidents but examples of a major problem. Below a

basic transfer pricing practice is explained in 2.1 along with two examples of major international

companies which have used transfer pricing to reduce their payable tax in 2.2 and 2.3.

2 Tax Justice Organisation (2014) “Transfer Pricing”. Retrieved from:

http://www.taxjustice.net/topics/corporate-tax/transfer-pricing/

3 Murphy, R. (2010) “70% of world trade is between multinational corporations – new OECD estimate” Tax

Research UK. Retrieved from: http://www.taxresearch.org.uk/Blog/2010/01/28/70-of-world-trade-is-between-multinational-corporations-new-oecd-estimate/#sthash.qEwfEziF.dpuf

4 Christian Aid (2009) “False Profits: robbing the poor to keep the rich tax-free”. Retrieved from:

http://www.christianaid.org.uk/Images/false-profits.pdf

5 Drucker, J (2010) “Companies dodge $60 Billion in Taxes” Bloomberg. Retrieved from:

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a7td7E8_4EeI&pos=10_;pos=10_

6 Lawrence, F & Griffiths, I (2007) “Revealed: how multinational companies avoid the taxman” The guardian.

Retrieved from: http://www.theguardian.com/business/2007/nov/06/19

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2.1 Case study I: Basic transfer price

Coffee Ltd is a US company selling coffee; it owns a subsidiary in Africa named Bean Co. where the

raw product is grown and picked before being shipped to Coffee Co for production and packaging.

Here assuming the taxation rate of 30% applies to both Africa and America, regardless of where the

profits are sent both will be taxed. However if another subsidiary Tax Co was set up in the Cayman

islands where there is 0% company tax there is the potential for abuse, if this subsidiary buys low

from Bean co and sells high to Coffee co, both companies’ profits will decrease and their taxation bill

will be lower while Tax co makes a high profit and pays no tax.

2.2 Case study II: SAB Miller

SAB Miller, the world’s second largest beer producing company reduced its African tax bill by of as

much as a fifth in 2009 using transfer pricing to tax havens and depriving poor countries of up to $31

Million In taxation revenue. Despite owning and operating a substantial production factory in Ghana,

SAB miller managed to completely avoid paying income tax. Royalties were paid to Dutch

subsidiaries from the Ghana subsidiary; ‘management service fees’ were paid to Swiss subsidiaries

where effective tax rate is substantially lower and loans were taken from the Mauritius subsidiary

with high interest payments. All of which are deducted from the African tax bill while all other

subsidiaries profit from these activities, effectively SAB Miller is paying itself and benefiting from it. 7

All of this was done in accordance with regulations in the relevant countries it operates in and in line

with the principals generated from the OECD guidelines, showing the clear inefficiencies of the

current system and its inability to prevent the use of transfer price to benefit these Multinational

companies.

2.3 Case study III: Forest Laboratories Inc.

This US pharmaceutical company, Forest laboratories purchases its most sold product, Lexapro from

a subsidiary named Forest Laboratories Ireland Ltd which employs 5% of its 5200 workers. The

revenues from this company were equivalent to 70% of the parents net sales according to company

reports, paying Irelands 12.5% company tax rate on the profits in comparison to the US tax rate of

35%, one of the highest in the world.

7 Brooks, R (2010) “How SAB Miller escapes tax in developing countries” The Guardian. Retrieved from:

http://taxjustice.blogspot.dk/2010/11/how-sab-miller-escapes-tax-in.html

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From 2005 a new subsidiary was created, Forest Laboratories Holdings Ltd registered an office in

Bermuda before transferring the groups patent licences to it. Fees are ultimately sent to the

Bermuda office via another subsidiary in the Netherlands which in 2007 reported $1.19 billion in

licencing income, paying out 99.6% of this to licencing expenses. This Dutch company allowed the

20% Irish withholding tax on patent royalties to be avoided, reducing the effective tax rate of the

Irish subsidiary from 10.3% to 2.4%. Using these subsidiaries the forest group was able to drop its tax

bill by $183 million USA boosting its net income by 31% in 2009.8

Many other US pharmaceutical and technology companies also set up operations in Ireland, along

with its low taxation rate, the Irish Department of Finance outlined further incentives such as an

educated workforce, political stability and European market access.

3.0 Tax Havens

Another party to these transfer pricing principals are ‘tax havens’. These are smaller countries with

limited local business that profit from creating opportunities within the global taxation environment

for multinational companies. While there are many ‘tax havens’ around the world for international

companies, the most commonly sought after for subsidiaries are countries such as the British virgin

islands, Ireland & Luxembourg whom are willing to enter confidential taxation deals with major

companies, allowing subsidiaries to be established in their jurisdiction and be taxed at a nominal

rate or not at all.

Luxembourg has been subject to much scrutiny for luring international companies with massive tax

breaks and promises of confidentiality. While there are only 550,000 residents in Luxembourg there

are over 50,000 holding companies registered with some paying corporate income taxes as low as

0.1%. Multinational companies move hundreds of billions of dollars in and out of Luxemburg every

year, with total foreign business investments totalling $3.2 trillion dollars in 2013, four times that

held one decade ago according to OECD data. Recently, an OECD review of Luxembourg’s tax system

concluded that it did not comply with international standards of transparency and information

exchange while Luxembourg maintains that no international laws are being broken.

.

8 Drucker, J (2010) “Companies dodge $60 Billion in Taxes” Bloomberg. Retrieved from:

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a7td7E8_4EeI&pos=10_;pos=10_

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Until economies which profit from offering such financial services are either prevented from

engaging in these practices by international laws or reform their own local taxation regulations due

to mounting pressure, there will always be an environment to facilitate tax savings. This is easier said

than done as countries such as Luxemburg and Ireland have structured their economies to facilitate

and profit from these transactions and a complete reformation of taxation regulations will come at

significant costs. For example Luxemburg’s financial services sector accounts for 36% of its GDP and

the country is able to generate 80% of its 1.5 billion euro in annual corporate tax revenue, from

corporate tax structures facilitating transfer pricing.9

The only action the OECD has for combating these tax haven economies is standardised rules to

force greater transparency from low tax countries, increasing the difficulty for companies shifting

profits. The current regulation addresses this problem via the MNE’s by applying the ‘arm’s length

principal’

4.0 Arm’s Length Principle

The Organisation for Economic Co-operation and Development (OECD) was established in 1961 with

one of its goals to “contribute to the expansion of world trade on a multilateral, non-discriminatory

basis.” For this goal to be achieved it is important that transfer pricing is controlled and regulated. 10

Major world economies such as the US began to pay considerable attention to transfer pricing in the

1960’s and 70’s but a major turning point for regulation and guidelines for transfer pricing was in

1990 where a US investigation into Japanese owned US subsidiaries showing -.02% growth found

that the Japanese holding company was profiting roughly 7% this investigation, later named the

‘Pickle Hearings’ prompted the introduction of the Comparable Profits Method in the US which later

led to the original OECD Transfer Pricing Guidelines (TPG’s) being published in 1995 which led to the

widespread adoption of the ‘arm’s length principle’.11

9 Karnitschnig, M & Daalen, R (2014) “Bueisness-friendly Bureaucrat helped build tax haven in Luxembourg”

Wall Street Journal. Retrieved from: http://www.wsj.com/articles/luxembourg-tax-deals-under-pressure-1413930593

10 See OECD, Transfer Pricing and Multinational Enterprises, 1979 & OECD, Transfer Pricing Guidelines for

Multinational Enterprises and Tax Administrations 1995/96/97.

11Price Waterhouse Coopers (2014) “International Transfer Pricing”. Retrieved from:

https://www.pwc.tw/en_GX/gx/international-transfer-pricing/assets/itp-2013-final.pdf

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The current OECD TPG’s state that the ‘Arm’s length principal’ is the recommended legislative

approach to transfer pricing issues as it serves to balance protection of domestic tax base while not

creating double taxation or uncertainties which may discourage foreign direct investment.12 This

principal requires that any intercompany transaction be priced as if it had taken place between

unrelated parties, acting independently and in their own interests within the free market.

While the principal can be stated simply, the practical application is much more difficult as the type

of the transaction and economic circumstances surrounding it can influence both the amount of

compensation and the form of payment. Today almost all countries have implemented anti-

avoidance regulations within their tax codes with respect to intercompany transactions, the majority

of which are based on the OECD arm’s length principal; however both the application of domestic

legislation and actual enforcement of regulations vary greatly.13 The OECD Transfer Pricing

Guidelines (TPGs) offer assistance for companies, tax administrators and governments on the

application and interpretation of the Arm’s length principal and possible issues which arise in its

enforcement.

4.1 Associated companies

Firstly to apply the principal the two enterprises must be ‘associated’. This is defined in section two

and requires that “one enterprise (or person) participates directly or indirectly in the management,

control or capital of the other.” Direct or indirect management is defined as owning more than 50%

of the share capital of an enterprise or possessing the practical ability to control the business

decisions of the enterprise. The wording of the recommended act ensures that companies cannot

avoid being ‘associated’ by using separate agreements with 3rd party shareholders to maintain

control of a company even without holding a 51% share capital. Not all counties implement this

definition, many choose to define a fixed percentage of capital shareholding, the lowest of which is

Poland which requires just a 5% shareholding to be a related party while many others such as China

and Germany use a 25% capital contribution threshold. 14

12 Organisation for Economic Co-operation and development (2011) “Transfer Pricing Legislation – a suggested

approach June 2011” Retrieved from: http://www.oecd.org/ctp/tax-global/3.%20TP_Legislation_Suggested_Aproach.pdf

13 Price Waterhouse Coopers (2014) “International Transfer Pricing”. Retrieved from:


14 Organisation for Economic Co-operation and development (2011) “Transfer Pricing Legislation – a suggested

approach June 2011” Retrieved from: http://www.oecd.org/ctp/tax-global/3.%20TP_Legislation_Suggested_Aproach.pdf

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4.2 The arm’s Length Pricing Methods

The OECD model convention describes five ways to determine what price would constitute an ‘arm’s

length transaction’ which are be applied to the circumstances of the particular taxation scenario. The

2010 amendments to the guidelines contained new guidance on the selection of the most

appropriate TP method for the cases circumstances as a response to the difficulty many authorities

were facing to the application of the regulation. According to the guidelines, at least one of the

pricing methods below can be applied in circumstances where others cannot.

4.2.1 Comparable uncontrolled price

The Comparable uncontrolled price (CUP) method is the most precise pricing method which

is applied to the large majority of day to day MNE transactions. The method involves using a

‘comparable’ market transaction between two unrelated multinational companies was an

example of fair price. In order to be comparable the differences between two transactions

“could not materially affect the condition being examined OR that reasonably accurate

adjustments can be made to eliminate the effect of any such differences.”15

This method is weak or inapplicable in certain situations such as a non-competitive market

or a dealing with a unique asset. Particularly for the transfer of intangible assets or

intellectual property where negotiations, contractual terms and bargaining power cannot be

observed.

4.2.2 Resale Price Method & Cost-Plus Method

The Resale Price Method (RPM) takes into account the price of product when it is resold on

the next supply chain level to a third party and deducts a gross margin in order to calculate

the arm’s length price. The gross margin is calculated with reference to transactions with

unaffiliated companies or if this data is not available, the gross margin of other distributors

of similar products is used. The Cost Plus Method (CPM) is similar to RPM but is done by

adding a mark-up to the company’s costs of production taking the perspective of a

manufacturer selling similar product.

15 King, E. (2009) Transfer Pricing and Corporate Taxation, p. 24-25.

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Both methods have been met with much criticism as it assumes the gross margins are

comparable for all products, implying that both the product and the transaction

circumstances are the same when, in reality the assumption that gross margins are

comparable across firms is not a realistic or fair assumption. 16 However the OECD generally

prefers these three transaction methods as they are more direct methods of transfer price

identification however it is often that sufficient information is not available due to complex

or unique business processes leading to the below methods being more appropriate.

4.2.3 Transactional Net Margin Method and Comparable Profits Method

Described in the OECD TPG’s as ‘transactional profit’ methods, the Transactional Net Margin

Method (TNMM) & Comparable Profits Method (TPM) concentrate on establishing an arm’s

length net profit margin rather than ‘traditional’ pricing methods above. By assessing a

group of similar, stand-alone unrelated companies to the entity to be taxed within the same

industry producing and distributing similar goods and/or services, the tax authority is able to

generate a profit level indicator based on key accounting figures such as operating

profits/sales or gross profit/ operating expenses. This Profit level indicator is then applied to

the company engaging in related transactions.

This method has also been criticised and the TPG’s acknowledge there are a number of

weaknesses to this TNMM. It is difficult to compare two companies when there is such a

range of factors which affect these profit margins, for example two companies may appear

very similar on paper but different management styles could result in substantially different

margins.17

4.2.4 Profit Split Method

Total profits from controlled transactions are identified and split between all associated

companies applying ratios utilized in an uncontrolled transaction taking into account the

circumstances of the transaction, the assets used and the risks assumed by associated

16 Lohse, T. Roedel, N & Spengel C (2012) “The Increasing Importance of Transfer Pricing Regulations – A

worldwide overview” Oxford University Centre for Business Taxation Journal. Retrived from: http://sbs.eprints.org/4388/1/WP1227.pdf

17 HM Revenue & Customs Service (2014) “INTM421080 - Transfer pricing: Methodologies: OECD Guidelines:

Transactional net margin method”. Retrieved from: http://www.hmrc.gov.uk/manuals/intmanual/intm421080.htm

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companies. 18 This method is appropriate to use for highly integrated operations for which a

one-sided method specified above would not be appropriate. The profit split method may

also be the most appropriate method in cases where both parties to the transaction make

unique and valuable contributions to the transaction.19

4.3 Adjustment of the Arm’s Length Price

The OECD outlines several factors which a tax authority should take into account when making

adjustments to the price of an arm’s length transaction to account for differences in the

circumstances between the comparable market transaction and the controlled transaction within a

MNE.

For example, Different characteristics of the property or service such as physical features, quality

and reliability and availability or volume of supply leads to differences in value of the product.

Compensation from a transaction must reflect the functions taken on by each enterprise, for

example if a longer payment period is applicable or if one subsidiary bears all product liability and

the availability of substitute goods and services.20 Price Waterhouse cooper has criticised some of

these factors such as ‘quality of products’ and ‘geographic markets’ as impossible to take into

account.21 Further criticism from Oxford academics states that by applying adjustments has the

effect of increased documentation and complexity for all parties involved. 22

18

Lang, Michael (2013) ‘Introduction to the law of double taxation conventions’ 2nd

ed pp146-148



20 Lang, Michael (2013) ‘Introduction to the law of double taxation conventions’ 2

nd ed pp146-148



22 Lohse, T. Roedel, N & Spengel C (2012) “The Increasing Importance of Transfer Pricing Regulations – A

worldwide overview” Oxford University Centre for Business Taxation Journal. Retrieved from: http://sbs.eprints.org/4388/1/WP1227.pdf

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5.0 Issues with Arm’s Length Principle

The arm’s length principal was developed with the intention of resolving transfer pricing issues and

the guidelines do offer guidance for tax authorities which can be applied to a large amount of

transactions. However statistics and effective tax rates being paid by many MNE’s clearly shows that

the system is not working. As the OECD continues to amend their guidelines which now total over

370 pages they continue to increase the complexity and difficulty of applying and understanding the

principal for both taxation authorities and corporations.23 This is a particular issue for the pricing of

Intangible property where there is simply too much ambiguity and variability applicable in the

circumstances of each case to apply the principal effectively and consistently, three major

transactions have been identified and discussed in detail below.

5.1Management Fees

An intercompany management fee is any charge by a parent or subsidiary for general administrative

services such as marketing; technical services such as management, or commercial services such as

accounting. In order to claim deductions for services paid for and avoid double taxation the tax

jurisdictions that accept these fees have extensive documentation requirements which place a

significant burden on companies to document all stages in the process providing documents such as

written descriptions of services provided with information on type and number of employees

involved, timesheets, detailed invoices or worksheets and a full analysis of costs incurred including

justification of why they were appropriate for the service.

While detailed requirements such as these reduce the likelihood of transfer price abuse it also has

the effect of increasing costs for both the companies preparing these documents and the tax

authorities which often direct large amounts of resources to auditing these transactions.

Furthermore it is still possible for companies to charge larger amounts than actual as many of these

services are unique to the interrelated companies and evaluation of the benefits received can often

be difficult to quantify.

23 Picciotto, S. (2014) “Towards Unitary Taxation of transnational corporations” Tax Justice. Retrieved from:

http://www.taxjustice.net/wp-content/uploads/2013/04/Towards-Unitary-Taxation-Picciotto-2012.pdf

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5.2 Intangible Property Sale and Licencing

Intangible Property (IP) represents between 40-80% of multinational enterprise value which can be

the subject of much conjecture between individuals, government authorities and other companies

attempting to price these assets.24 Due to this massive potential variability in IP prices the regulation

of the IP transfer price between related corporate entities is the most contentious issue with the

OECD arm’s length model today.

Under current systems the arm’s length price is determined again using a comparable transaction

between two unrelated parties, if this cannot be done then licence agreements for ‘economically

similar technology’ between unrelated parties are used.25 In theory this works well however large

multinational companies are usually dealing with new unique or revolutionary technologies/

methods which they have developed and patented and subsequently transferred to a subsidiary.

This creates significant issues for a tax authority wanting to establish an Arm’s length Price as there

are no transactions which they can base this off.

5.3 Cost sharing

Cost sharing is essentially another way of transferring Intangible Property to an international

subsidiary without having a stand-alone transaction. This involves companies sharing the associated

expenditure involved with research and development of new technology or methodology, allowing

each participant to obtain equal rights to the property regardless of their actual contribution.

Because payments under a cost sharing agreement are generally not regarded as royalties,

companies are typically able to avoid withholding taxes.

If the tax jurisdiction allows these expenses to be deductable from a company’s revenue for taxation

purposes it then the fundamental issue is whether there has been a ‘reasonably proportionate’

allocation of cost. Tax authorities will require companies to present the cost sharing agreement and

explain why the allocation between the corporate groups is reasonable. The very nature of research

and development makes this assessment extremely difficult to make as it is typically over large

periods of time often with large abortive expenses not leading to any valuable IP. Because of this if a

24 Intellectual Property Expert Group (2014) ‘Transfer Pricing and Intangibles, a continuing battlefield’.

Retrieved from: http://www.ipeg.com/transfer-pricing-and-intangibles-a-continuing-battlefield/



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tax authority wishes to dispute a company’s cost allocation they must do so without the use of

hindsight. This requires a conclusion that the agreement was not entered into in good faith and not

properly documented, a very difficult case to establish which is likely to lead to a long and difficult

process in courts to recover funds.26

These agreements have the potential to be exploited for tax purposes due to the fact that a split in

R&D costs also allows a split in profits from the intangible property generated from the agreement.

By funding a subsidiary which in turn repays costs to the parent which is in reality undertaking all

R&D, profits can later be distributed to the subsidiary commonly established in a tax haven.27 The

OECD argues that the possible benefits that can accrue from such an agreement can be balanced

against the possible losses if an R&D activity is not successful, forgoing the possible deductions in a

higher tax environment and thus preventing companies from being too aggressive when entering a

cost sharing agreement for taxation purposes. 28

However Martin Sullivan, a chief economist for ‘Tax Analysts’ a non-for profit tax organisation

specialising in international taxation argues that in fact a significant information asymmetry exists

between the multinational enterprises and the tax authorities which allows companies to allocate

costs with very little or even no risk after assessing all their available information.29 This assumption

makes sense as companies are only required to disclose limited information; the preliminary

development of a project may have already been completed prior to a cost sharing agreement being

entered which is later established under a ‘new’ project.



27 Antony Ting (2014) “itax – Apple’s International Tax Structure and the Double Non-Taxation Issue” British

Tax Review No 1. Retrieved from: ssrn.com/abstract=2411297

28 US Joint Committee on Taxation, (2010) Present Law and Background Related to Possible Income Shifting

and Transfer Pricing, 21.

29 M.A. Sullivan (2013) “The Other Problem with Cost Sharing” Worldwide Tax Daily 975

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6.0 Future OECD Reforms

The issues which have been described above are quickly gaining increased awareness and discussion

amongst the international taxation bodies which has seen transfer pricing move to the forefront of

the OECD agenda. The topic was the dominating discussions at the recent G20 financial summit in

Russia during which the OECD presented their BEPS (Base Erosion and Profit Shifting) action plan.30

This plan is aimed at implementing greater transparency through increasing co-operation between

tax authorities party to multilateral tax treaties. This can be achieved through information exchange

agreements allowing foreign tax agencies access to traditionally confidential information along with

mutual legal assistance agreements which obligate domestic tax authorities to assist foreign

agencies to prosecute tax offenders. 31

In 2010 the OECD announced a project specifically focusing on the transfer pricing of intangibles,

holding three public consultations before publishing a revised discussion draft in January 2014, the

focus is on co-ordination and simplification of documentation requirements. This is supposed to

reduce compliance costs for companies by making documentation requirements more

straightforward and to “provide taxpayers with a means and an incentive to meaningfully consider

and describe their compliance with the arm’s length principle in material transactions.”32

It Is positive that the issues of transfer pricing have been recognised and are receiving significant

attention in the international community and while the future plans of the OECD to tighten down on

documentation requirements has the potential to reduce transfer pricing incidents; it is also placing

a significant burden on corporations to justify their prices along with the taxation authorities

themselves to audit and enforce these requirements. The move towards greater international co-

operation and assistance between tax authorities across borders is a significant move against

transfer pricing practices, however this will only be effective if all countries get on board otherwise

there will always be issues with countries providing significant tax breaks for MNE’s while refusing to

co-operate or only providing limited assistance to foreign agencies.

30 Corrando, D. Hill, T. Moore, J & Yang, W (2014) “World Transfer Pricing 2014” International Tax Review.

Retrieved from: http://www.internationaltaxreview.com/pdfs/wtp/world-transfer-pricing-2014.pdf

31 Deloitte (2013) “Transfer pricing schemes and use of tax havens, is the future looking good?” Inside Tax

Issue 16 (1) Retrieved from: www.deloitte.com/multifiledownload%3FsolutionName%3Ddeloitte.com

32 OECD (2014) “Discussion draft on transfer pricing documentation and CbC reporting” p4-5 s17 retrieved

from: http://www.oecd.org/ctp/transfer-pricing/discussion-draft-transfer-pricing-documentation.pdf

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7.0 Alternative to Arm’s Length Principal

An alternative to the arm’s length principal which has received support from both governmental and

non-governmental bodies is the unitary taxation system. In simple terms this essentially involves the

taxation of total multinational group profits across all jurisdictions based on an averaged percentage

of the distribution of a company’s workforce, assets and sales in each area. Under a unitary system a

corporate group cannot take position that licensing income belongs to a tax haven holding company

because under the unitary system, intragroup transactions are ignored and licensing income is

allocated to tax jurisdictions where IP is used.33

This system has been met with fierce resistance from multinational companies as it would involve a

complete overhaul of current ‘country by country’ reporting to a system which requires a MNE

group report. MNE’s argue will come with a massive compliance cost however these statements are

most likely self-serving as it will lead to higher tax bills and transparency.34 While there have been

many issues raised such as whether a blanket formula would disadvantage certain industries such as

the transport and shipping industry where key assets are mobile these can be dealt with using

careful planning and discussion.

The main issue with this alternative is that the actual implementation of a unitary system will require

significant planning by all parties involved. The system would need to be implemented by a

substantial amount of major G20 members at the same time, something that would be extremely

difficult politically; particularly where MNE’s are able to threaten moving their businesses to more

tax friendly locations that are yet to take on the unitary approach.

The complexity of the issue of transfer pricing is such that there is no perfect answer for

multinational tax assignments however it is also clear that current systems have significant issues

which require significant reforms and international co-operation in order to move toward a fair and

administrable system that can operate multilaterally across borders and ensure that countries where

these companies are receiving benefits also are benefiting from taxation revenue, particularly

developing countries whom do not poses the resources to enforce their taxation regulations.

33Sheppard, L (201) “Transfer Pricing as Tax Avoidance” Forbes Magazine. Retrieved from:

http://www.forbes.com/2010/06/24/tax-finance-multinational-economics-opinions-columnists-lee-sheppard.html

34 Picciotto, S. (2014) “Towards Unitary Taxation of transnational corporations” Tax Justice. Retrieved from:

http://www.taxjustice.net/wp-content/uploads/2013/04/Towards-Unitary-Taxation-Picciotto-2012.pdf

16

8.0 Conclusion

It seems today that that regulation is becoming increasingly unworkable, as further amendments are

made to OECD guidelines and subsequently, taxation systems around the world; the arm’s length

principal becomes progressively difficult to apply effectively and consistently. Furthermore company

compliance and taxation authority enforcement and auditing is becoming increasingly time

consuming and costly.

The future of international taxation seems to be a ‘cat and mouse’ game of the MNE’s vs the

Taxation Authorities. Further amendments to the OECD arm’s length principal creating higher

compliance requirements and an increasingly complex system is likely to push MNE’s and major

international accounting firms to find new creative ways around these new laws. The entire system

is an outdated one which dates back to an economic environment which no longer exists today.

Patching it with amendments and updates is a quick fix solution that can eventually lead to a system

that is so complex and costly that a complete international overhaul is almost inevitable.

In the long term it seems likely that a unitary taxation approach makes the most sense, and while

there are many issues with the creation and implementation of such a system it seems possible as

governments around the world are likely to see the benefits of co-operating against both the profit

maximising MNE’s and governments willing to accommodate and subsequently profit off base

erosion strategies by providing law tax environments. Until this global unitary approach is taken,

there will always be issues with transfer pricing.

17

9.0 Bibliography

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Lang, Michael (2013) ‘Introduction to the law of double taxation conventions’ 2nd ed pp146-148

Lawrence, F & Griffiths, I (2007) “Revealed: how multinational companies avoid the taxman” The guardian. Retrieved from: http://www.theguardian.com/business/2007/nov/06/19

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OECD (2014) “Discussion draft on transfer pricing documentation and CbC reporting” p4-5 s17 retrieved from: http://www.oecd.org/ctp/transfer-pricing/discussion-draft-transfer-pricing-documentation.pdf

Organisation for Economic Co-operation and development (2011) “Transfer Pricing Legislation – a suggested approach June 2011” Retrieved from: http://www.oecd.org/ctp/tax-global/3.%20TP_Legislation_Suggested_Aproach.pdf

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US Joint Committee on Taxation, (2010) Present Law and Background Related to Possible Income Shifting and Transfer Pricing, 21.

Documents

Intenational taxation report on Transfer Pricing