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Base Erosion & Profit Shifting (BEPS) – Is Transfer Pricing the Problem or the Solution?

Base Erosion & Profit Shifting (BEPS) – Is Transfer Pricing the Problem or the Solution?
Multinational companies (MNCs) engaging in tax planning have come under significant scrutiny in the last 12-18 months, despite the fact that this planning is acceptable under tax law.

Transfer pricing has been raised as a key issue with companies shifting functions and risks to low tax locations.

The OECD tax policy division stepped into the debate in February 2013 to try to identify the sorts of transactions that are seen as aggressive or unacceptable (eg hybrid instruments creating an artificial mismatch that seeks to take advantage of tax rate arbitrage). The OECD is also seeking to highlight the significant amount of commercially based planning that should be permitted to continue, unencumbered by changes in the law. Examples include Coca-Cola Hellenic who announced a move to Switzerland due to reasons wholly related to access to finance, and the requirement to leave behind a troubled environment.

The OECD paper confirms that resources should look to "artificial" shifting of profits, and therefore a commercial shift is acceptable. It is clear that more guidance in relation to what is commercially acceptable under law will facilitate planning going forward, and there are a number of discussion drafts in the transfer pricing arena that could be updated to help achieve this.

Taxand's Global TP & Business Restructuring team investigates this issue further, and looks at whether transfer pricing is the problem or the solution.

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The BEPS paper covers a number of tax issues, one of which is transfer pricing. However, transfer pricing regulations the world over have always sought to challenge artificial shifting of profits as tax adjustments will be levied where the economic reality does not match pricing. The challenges raised against MNCs (and tax administrations) are in relation to whether the current regulations are not strict enough, and whether they have kept pace with changes in certain industries (eg e-commerce). The solution may be to further improve transfer pricing guidance to minimise disputes, and it is for this reason that the OECD has entered the debate. There are a number of ways in which clarity may be achieved and all of these relate to ongoing consultations for updating the transfer pricing guidance.

The intangibles discussion draft has looked long and hard at substance requirements and sets out a plethora of 'dos and don'ts'. This can be extended to procurement, manufacturing and other supply chain areas to provide additional clarity. Certain jurisdictions (eg Singapore) set out exact numbers of employees that are expected to be on the ground, for example, which may contribute some clarity to the process.

The BEPS report also includes examples of typical structures (referred to as "tax-planning structures"), which are not particularly, or necessarily, aggressive. These include (a) early transfer of intangible assets to low taxation countries; (b) supply chain structure with the principal situated in a low taxation country; or (c) leveraged acquisitions, using a hybrid instrument between companies in the same group.

The OECD's aim, therefore, is apparently to eliminate any use of tax law or transfer pricing that does not match a rigorous vision of what is fair in tax and TP matters. This approach could lead to very interesting debates on the concept of fairness and on the regulatory ability of the national legislative powers.

Safe harbours
Purists do not like safe harbours; however, many jurisdictions are introducing these to help minimise disputes. These would certainly temper aggressive pricing structures from being put into place but it may limit commercially acceptable structures if the harbours are not carefully thought through by transaction type.

The last OECD consultation in this area was in 2005. Now, with increased speed and mobility of business activities, combined with cross-border transactions resulting from internet usage, there are particular implications for applying transfer pricing methods and for taxing business profits. It is necessary to ensure that this initiative is updated in line with BEPS.

The above initiatives are likely to assist with some of the subjectivity. However, a more unified voice is required between administrations and MNCs to silence the critics. This could stop the low level debate that compares sales with tax payable and ignores the whole concept of value creations and people functions that are fundamental to transfer pricing.

Balance of intentions
Tax law has not kept up to date with the economy; MNCs are not to blame for this, however. Most of the concepts in the BEPS paper are not new, and have been debated for a number of years. The economic crisis has of course changed the debate, but international cooperation will be necessary. Countries are still competing on attracting foreign investments through implementation of beneficial tax rules. The current mismatch between what countries say they want and what they actually do is illustrated by the UK Government, which is being very vocal on these subjects while at the same time trying to become an attractive tax country.

Your Taxand contacts for further queries are:
Antoine Glaize, TP & Business Restructuring SL Co-Leader
T. +33 623 088 006

Tom McFarlane, TP & Business Restructuring SL Co-Leader
T. +44 207 072 3201

Marc Sanders
T. +31 61 136 7769

Mario Ortega Calle
T. +34 91 5145 200

Shiv Mahalingham
T. +44 207 715 5234

Taxand's Take

MNCs are arguing that the lawmakers should act if they are unhappy - however, tax administrations face a conflict of interest with a desire to encourage investment with a favourable tax regime. It is at odds with the desire to stop other jurisdictions attracting investment and eroding domestic tax base.

Transfer pricing guidance could be extended in the following ways to provide clarity to the issue of profit shifting:

  • Introduce additional clarity around commercial substance requirements to support pricing structures. We are often asked how many people are required to support a principal structure and of course the unhelpful answer is that it depends. The EDB in Singapore provide rulings which speak to exact numbers of people they expect to see on the ground, and in what fields of expertise and functions. Other locations may wish to follow suit.
  • Introduce statutory safe harbours (eg 1-3% return on sales for limited risk distributers). This would reduce a significant amount of disputes and stop overly aggressive structures from being implemented.
  • An update of the 2005 e-commerce transfer pricing review.

MNCs and tax administrations are agreed that more clarity is better than less, but (some) of the above may be seen as drastic measures. The alternative may be to replace the whole transfer pricing system with one of formulary apportionment. That is a topic which will no doubt appear as this particular debate progresses.

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Taxand's Take Author