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Transfer Pricing Disputes « Back
Matt Atkins, April 2011
Transfer pricing is one of the key challenges facing multinational enterprises (MNEs) today as the frequency of disputes has increased markedly. While most MNEs have transfer pricing policies and documentation in place, globalisation has changed the playing field and transfer pricing arrangements have become more sophisticated and complex. Not only are large companies falling under the watchful eye of regulators, mid-sized multinationals are also being audited with greater frequency. As this activity intensifies, we can expect more transfer pricing related disputes to emerge between international companies and tax authorities globally. In addition, since regulatory reforms do not occur in a harmonised fashion around the world, companies with operations in various jurisdictions face an uphill battle to maintain compliance.

Fertile ground for disputes

With the global economy in slow recovery, and deficits at record levels, governments have focused on raising revenue through taxation.

More and more jurisdictions are boosting their tax monitoring and enforcement efforts, providing greater opportunities for disputes to arise, according to Claudia Kühnlein, a partner at PwC Germany. “The main driver is certainly the government’s everlasting need for a higher tax income – further fuelled by the economic downturn. This has in recent years resulted in lower business profits and thus, lower tax bills, and the need to inject money into the economy. As a consequence, many countries have introduced more challenging transfer pricing legislation, including documentation requirements. In addition, compared to five or 10 years ago, tax auditors have gained transfer pricing knowledge and experience, and have been encouraged to focus on this area during an audit.”

Tax authorities have upgraded and increased their workforce while at the same time placing greater demands on corporations. The US Internal Revenue Service (IRS) added 1200 employees in 2009, and a further 800 in 2010. In the UK, Her Majesty’s Revenue and Customs (HMRC) has made similar efforts and reported that approximately 100 new transfer pricing inquiries have been initiated annually since 2008. “HMRC have built a strong centre of expertise,” says Liesl Fichardt, a partner at Berwin Leighton Paisner LLP. “In addition, they have sought actively to engage with MNEs in an open manner, which enabled them to acquire an appreciation of the relevant business issues concerned. HMRC are also actively expanding the scope of their powers: they do not merely look at pricing or percentages but they consider comparables and methodologies and attempt actively to engage earlier closed years by issuing discovery assessments, even alleging careless conduct on the part of the taxpayer.”

This trend toward more assertive enforcement is not limited to developed nations, but is also observed in emerging markets. In 2009, China issued new transfer pricing regulations and tax authorities there have begun to establish a several hundred-strong transfer pricing team. Similarly, Indian tax authorities have substantially increased the size of their transfer pricing team over the last two years. Since the introduction of transfer pricing legislation in 2001 the law has developed further and tax officers have become increasingly inquisitive. A surge in transfer pricing disputes is the inevitable result, helped by a regulatory framework which is relatively vague. Pranay Bhatia, an associate partner at Economic Laws Practice, explains that so far six rounds of transfer pricing audits have been concluded in India. “The cumulative transfer pricing adjustments in these six rounds have been close to $9bn, which is a clear indicator of an extremely aggressive approach being adopted by tax authorities in transfer pricing audits. Transfer pricing regulations, as provided under Indian Tax Law, are brief compared to OECD guidelines, US 482 regulations and regulations adopted by other western jurisdictions. There is a lack of clarity which is one of the core reasons for an increase in disputes,” he adds.

These developments come at a time when competitive pressures on MNEs are at a high. Corporations are compelled to operate more efficiently, by adjusting corporate structures and functions, and searching for low-cost raw materials, labour and suppliers. Part of this drive is to identify attractive and competitive, but ultimately defensible, global tax rates. Considering this combination of factors, it is unsurprising that the incidence of transfer pricing disputes is on the rise.

Legislative and regulatory change

At the same time that tax jurisdictions are placing increased emphasis on transfer pricing, rules and regulations are in a state of flux. MNEs are facing a new era of regulations, penalties, transparency and disclosure. In July 2010 the Organisation for Economic Co-operation and Development (OECD) approved a revised version of its Model Tax Convention, with revisions to chapters one to three, covering profit methods, and a new ninth chapter which considers the transfer pricing aspects of business restructuring. A key aspect of the 2010 update is the replacement of Article 7.

The new version takes into account the results of work by the Committee on Fiscal Affairs on the attribution of profits to permanent establishments, and a 2010 version of the Report on the Attribution of Profits to Permanent Establishments. These alterations have implications for all OECD member countries. “Following the recently amended Article 7 of the OECD Model Convention, the Dutch Ministry of Finance published a decree on the attribution of profits to permanent establishments in January 2011,” says Patrick Van Oppen, a partner at Loyens & Loeff. “Preferences expressed in the decree include the application of the dynamic approach to the interpretation of treaties and changes to the OECD Commentary; and the application of the ‘capital allocation approach’ for the attribution of a minimum equity of a PE. Transparency of the Dutch views should result in fewer disputes with the Dutch tax authorities.”
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