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Challenges of Transfer Pricing & ‘The Cloud’
As businesses increasingly rely on rapidly evolving remote or outsourced information technology accessed via the internet 'The Cloud', tax planning in general enters into relatively new territory as well. Setting transfer prices for related-party transactions that have the effect of allocating profits among competing taxing jurisdictions is no exception. Taxand US examines the challenges that face multinationals in Transfer Pricing planning for 'The Cloud'.
Two main challenges have emerged in the transfer pricing arena as a result of this business trend. First, new valuation methods must be meshed with recently reissued regulations that have been less frequently used (and debated) than the methods typically used before The Cloud became prevalent. Second, isolating exactly what drives value and therefore profit; in the services offered through and by The Cloud is not always clear, and this lack of clarity is bound to create confusion and disagreements between taxpayers and taxing authorities when new valuation methods are applied.
It is extremely difficult to distill a direct financial relationship between expenditures to refine the user interface and site features of a social network and the income that can be derived from, and split with, merchants seeking access to those users attracted to a site by those enhanced features. The exercise involves predicting (i) user behavior as a result of the site-enhancing expenditures, (ii) the value third-party merchants will find in that user behavior, (iii) how that value compares with alternatives for third-party merchant expenditures, and (iv) the extent that value will be shared among the market participants.
How can these attenuated, indirect and difficult to distill projections be molded into the related-party transfer pricing methods required by the IRS for electronic services? At least initially, this can only be done with great uncertainty until a body of experience between taxpayers and the government emerges with relatively new rules being applied to extremely new and rapidly evolving business facts. But the chances of success will increase, and the chances of disputes will decrease, to the extent that the economic analysis has been done with rigorous focus on the true value drivers of the electronic service, and rigorous analysis of which pricing methods best approximate those value drivers. In this, the new and evolving Cloud is no different from more traditional business models; a successful transfer pricing analysis will be critically dependent on an understanding of all aspects of the taxpayer's business and on a careful application of economic and transfer pricing models.
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