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The last decade in transfer pricing: nothing has changed but everything

The last decade in transfer pricing: nothing has changed but everything
1 Apr 2015

10 years ago, transfer pricing was esoteric area for an isolated group of practitioners. It was perceived as an obscure technical matter only required for tax departments of multinationals. Taxand's global transfer pricing & business restructuring service line examines how 10 years later transfer pricing has become one of the most important and controversial tax areas. It has provoked many public comments from politicians, including public (and “bare knuckled”) hearings of tier-one MNCs summoned to disclose their alleged deviations from the norm in this field.

What happened to create such a furor? Strangely, almost nothing - technically. But in practice, transfer pricing practice has changed dramatically and will continue to do so.
First, from a technical standpoint, the transfer pricing tool box is largely the same as it was 10 years ago (and more):

  • Despite transfer pricing and valuation techniques improving, and both authorities and experts exploring new paths, the foundations of transfer pricing are still what they were in the late 90s  and beginning of the 2000s: OECD and EU recommendations have not fundamentally changed, even as the “universal” arm’s length principle has been consistently re-defined and adapted, in a positive way, to better fit the challenges faced by authorities and enterprises  in working from the Financial public databases which, though are imperfect, are still the only source recognised by all stakeholders to support transfer pricing policies
  • Transfer pricing documentation requirements have increased dramatically worldwide, but they continue to be designed in the same manner. These requirements apply the same historic methods resulting in an increasingly formalistic, administrative burden for MNCs, rather than being a true analytical demonstration of transfer pricing policies

Second, areas of transfer pricing controversy between tax authorities and taxpayers remain the same in 2015 as they were in 2005 - with practitioners on both sides recognising the same discussions are taking place around the existence and valuation of intangibles, such as marketing intangibles, clientele, R&D contribution or the consequences of business structuring operations. 

Third, relationships with tax authorities are mostly unchanged: transfer pricing is still top of most administrations’ priority lists, resulting in increased scrutiny of the behaviour of MNCs and systematic review of their operations. And even though we’ve seen the development of alternative options such advanced pricing agreements and notable improvement of mutual agreement procedures, the relationship remains largely driven by mutual suspicion and conflicting arguments. Basically, rather than looking for a common understanding and reasonable position, tax authorities and taxpayers continue to support positions on facts and circumstances they often recognised as the same but interpret in complete different ways.  And transfer pricing litigation is far too often driven as a matter of belief: “whatever your method is, I should get more”, rather than a matter of science: “tell me what method you use, I will tell you who you are”.

Notwithstanding the above, the transfer pricing arena has nevertheless evolved in the most part because of the exposure to the public of transfer pricing in recent years. Although a highly technical area, it has nevertheless become a major topic of (often less than well informed and sometimes hyperbolic) political posturing and media discussion.
Transfer pricing, by its very nature, generates some of the fantasies about tax evasion. Most of the highest profile cases have been overly simplified as transfer pricing cases while they relate more to “substance over form” analysis. 

Consequently, the legislative and administrative framework surrounding transfer pricing policies of MNCs has been substantially strengthened, particularly documentation requirements and related penalties. Numerous governments have also endorsed TP related objectives for their tax administrations with instructions to proceed with more transfer pricing audits and implementing dedicated expert teams. As a result of the public debate around transfer pricing, it has now become a public component of governments’ tax policies. MNCs today now not only face tax risks but  reputational risk – the risk feared most of all -  with the result that transfer pricing has moved the  desk of the corporate tax department exclusively, to the office of the CEO, CFO, General Counsel, and even the public relations department. 

The OECD and the EU, as well as the Pacific Association of Tax Administrators, have made considerable efforts to better design rules that were originally ambiguous and sometimes confusing or not adapted to concrete situations. They have succeeded, at least in one regard, by improving the certainty afforded by tools such as APAs and MAPs. 

The list of work issued by theses bodies would be too long to outline here, but enormous work has been achieved for the benefit of all stakeholders, including, among others, in the areas of business structuring, intangibles valuation and arbitrage procedure.

Possibly, the major change that occurred in the last decade is still to be achieved: transparency. All MNCs are seeing increasing transparency requirements, particularly in the management of transfer pricing. First we saw the publication by the OECD of its list of non-cooperative states, followed by the on-going implementation of a wide scale automatic exchange of information, and then by country-by-country reporting, currently being discussed in the BEPS  forum.

Such initiatives have changed considerably the framework in which MNCs must operate, with the upcoming decade promising continued development.  MNCs must face the enlargement of their interlocutors in this field: from the mid to late 20th century the OECD was, more or less, the only body issuing recommendations. Then the EU jumped in. Nowadays, jurisdictions that were not particularly advanced in these matters have declared themselves to be major players. Emerging countries are seeking their own path and tend to defend their interests in ways that are often divergent from the approaches taken by developed countries. Meanwhile, the UN has also come back in the game and the G20, as a political representation, has now intervened in the international tax field stating objectives, defining actions plans and setting deadlines for other stakeholders. This makes a yet more complicated and challenging environment for all companies worldwide.

Tax administrations have enhanced and sharpened the grounds for re-assessment: not only from a pure transfer pricing standpoint but also using indirect ways to address situations such as adapting traditional notions like permanent establishment to new challenges, identifying transfer of assets in business restructuring situations, or recharacterising legal agreements. 

What next?

Even though the historic arm’s length principle is still the foundation of transfer pricing and will likely remain for a significant period of time, international organisations and tax authorities have traced the path to new approaches.
Increased opportunities appear for the use of profit split methods that may better reflect economic patterns than traditionally transactional methods. 

The nature of economics has deeply evolved and the old equivalence between location of (human) resources and value creation is being overwhelmed by new types of organisational structures facilitated, and caused by, new technologies. This is the case of course for the actors in the digital economy, but also for established industrial groups in which executive teams are more and more fragmented even in the most strategic functions. The traditional functional analysis grid that has applied for decades of transfer pricing becomes more and more inapplicable and inappropriate. 

The BEPS work will dramatically change the transfer pricing arena. Not only because of the magnitude of the decisions that may arise from these discussions but also because it creates a new pattern and approach.

For many authorities, their role is not only driven by the application of law and tax treaties, but also a post-financial crisis requirement to generate revenue. The BEPS work will endorse the fact that previous rules have not been sufficient to prevent a tremendous tension from arising  between a smart – but proper – application of rules by MNCs and the need for public resources.

BEPS reports and related local legislations will result in major changes in international tax and transfer pricing that will modify dramatically  the tax landscape within which MNCs operate and will increase, at least short term,  uncertainty, including: the potential for new transfer pricing approaches, stricter regulations related to legal arrangements transferring business risks among group entities, new interpretations of permanent establishment rules, and the enforcement of the country-by-country reporting.
What is certain is that increasing levels of transparency will be imposed – potentially the most impactful evolution in the global tax landscape. Inefficiencies in cross-border exchanges of information will be reduced; on-demand transparency and country-by-country reporting are just the beginning.

Your Taxand contact for further queries is:
Antoine Glaize
Taxand global transfer pricing & business restructuring service line leader
T. + 33 1 70 38 88 28

Quality tax advice, globally

Also published in Thomson Reuters' TaxNet Pro

Taxand's Take

Does this mean that MNCs must give up efficient tax strategies? Certainly not, but such strategies will go have to be implemented through  more sophisticated tools which are closer to the economic reality and  better reflect  value creation within MNEs. Unfortunately however, we are on the cusp of an unstable period of transition as these new tools will have to coexist initially with remaining traditional principles.

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