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Is the EU tide turning towards reduced transfer pricing compliance?
The conclusions drawn by JTPF demonstrate a clear direction away from burdensome legislation and refer back to EU founding principles of cohesion amongst Member States. In order to address the inconsistencies of EU Member States' approach to transfer pricing, the JTPF has focused on 3 key areas:
- Secondary adjustments
- Assessment of transfer pricing risk
- Compensating adjustments
Its message is clear: for multinationals within the EU, having a single set of rules in core areas of tax is one step closer.
In the current transfer pricing environment recently dominated by threats of crackdowns on 'tax avoiders' vilified for not paying their 'fair share', taxpayers have become used to the notion that the legislative burden of transfer pricing is increasing. With strong indications that numerous additional measures, including the oft-maligned country-by-country reporting, will soon be part of ongoing compliance requirements, the burden of maintaining a compliant transfer pricing structure is increasing. The recent (June 2014) summary of the Joint Transfer Pricing Forum (JTPF)’s recommendations and work to date in the 3 key transfer pricing areas generates some welcome relief to taxpayers. The JTPF has suggested numerous proposals to Member States’ tax authorities, all with the aim of generating a more cohesive, EU-wide framework.
Secondary adjustments are a feature of numerous tax regimes across the EU including Austria, Bulgaria, Denmark, Germany, France, Luxembourg, the Netherlands, Slovenia and Spain. They stipulate that where a transfer pricing adjustment has been made leaving “excess” profits in a territory (ie where a previous transfer price was higher than the adjusted transfer price) a further adjustment may be required to account for the excess “profit” now sitting within an entity. Typically such a secondary adjustment is accounted for via imposing a constructive dividend, constructive equity contributions or constructive loans.
Secondary adjustments have long been a problem both for tax authorities and taxpayers. Should a secondary adjustment be treated as a constructive dividend by a Member State, withholding tax may be applied, potentially without adequate corresponding relief. Alternatively it may be treated as a constructive loan whereby imputed interest (and its associated withholding tax and thin capitalisation problems) also comes to the fore. In some territories a secondary adjustment also comes with its own set of penalties in addition to the greater tax liability.
The JTPF has suggested, to the relief of many taxpayers, that where possible Member States avoid using a secondary adjustment in all circumstances. Naturally the world of transfer pricing cannot always be so simple. Where local legislation requires the use of secondary adjustments, Member States are encouraged to settle the claim via a mutual agreement procedure (MAP) ensuring that double taxation does not occur via withholding tax or other means. Further, where the secondary adjustment is between EU Member States it is recommended to ensure the adjustment is in the form of a constructive dividend making good use of the Parent Subsidiary Directive (PSD)’s elimination of withholding tax on dividends (aside from France and Bulgaria, who have unhelpfully adopted the position that the PSD does not apply in such situations).
TP risk assessment
For many territories the JTPF’s recommendations regarding risk assessment will not come as a shock. Aims are clear and noble, however, in most territories advanced in transfer pricing, they already exist.
The JTPF is advocating increased dialogue between taxpayers and tax authorities echoing a principle of HMRC in the UK (and numerous other tax authorities) of striving towards “real time discussions”, tackling problems and disagreements before an audit or tax investigation becomes necessary. Further, Member States are encouraged to adopt clear guidelines, setting out criteria they will use (ideally in harmony with other Member States) when assessing risk of incorrect transfer pricing (and associated likelihood of audit). Explicit reference is made to earlier work by the JTPF regarding “low value added services” and recommended safe harbours / thresholds at which the tax authority can consider the function appropriately rewarded. Finally a template audit map has been produced by the JTPF theoretically helping Member States draft an audit process for transfer pricing in cohesion with EU principles.
Compensating adjustments are treated and defined in numerous ways across jurisdictions although typically revolve around the core theme of remedying a transfer price which is subsequently deemed to be non-arm’s length. The difficulty, as with all transfer pricing adjustments, comes when the treatment of the adjustment (or the adjustment itself) is uneven between territories.
Particular issues with compensating adjustments arrive when 2 territories operate either alternate systems of arm’s length pricing (eg one territory operates ex-post outcome testing and another ex-ante price setting) or both operate ex-post, only under different rules (eg a different point at which any “look back” occurs, a different point in the interquartile range required or the direction an adjustment may occur). In all of these conflicting situations, 2 separate arm’s length prices may be calculated by each territory potentially resulting in double (or double non) taxation.
Currently a taxpayer’s only recourse is via MAP. However, the JTPF provides a recommendation to tackle the problem before MAP becomes necessary. Taxpayers may, under the proposed recommendations, apply a symmetric adjustment (and such an adjustment should be accepted by the tax authorities in both territories) if certain criteria are met, essentially assessing the efforts of the taxpayer to act according to the arm’s length principle at all times.
In conclusion, in the 3 areas at least, the tide is turning away from an increased regulatory and compliance burden, instead attempting to find cohesion for taxpayers across the EU. Not only will taxpayers have recourse under MAP claims but under the proposed changes there should be clear steps to address transfer pricing risk, determine the treatment of secondary adjustments and apply consistent compensating adjustments across adopting EU Member States.
The JTPF is offering welcome relief from the increased compliance burden facing multinationals in regards to transfer pricing. While the OECD’s Base Erosion and Profit Shifting (BEPS) recommendations are gradually adding to a taxpayer’s workload, numerous proposals are put forward by the JTPF to simplify the approach of tax authorities in 3 key areas. Should these proposals be taken forward, the life of a multinational will be made that little bit easier – the EU tide does seem to be turning towards reduced transfer pricing compliance.
To prepare themselves for changes in key territories in which they operate, multinationals should:
- Consult their local Taxand contact, ensuring they are up to date with any legislative changes affecting them
- Ensure that secondary adjustments and compensating adjustments are calculated according to current regulations in relevant territories
- Consider adopting a greater level of EU substance, taking advantage of the direction the JTPF has outlined
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