Transfer pricing

February 2013  |  ROUNDTABLE  |  CORPORATE TAX

Financier Worldwide Magazine

February 2013 Issue

February 2013 Issue

Transfer pricing remains one of today’s most important taxation issues. Collaboration between global tax authorities is increasing as governments seek new sources of revenue at a time of economic difficulty. More detailed regulations and documentation requirements mean pricing arrangements have become more sophisticated and complex. However, recent landmark transfer pricing cases have gone against the authorities, and governments are now cautious about which cases they choose to pursue in the courts.

FW: How has the transfer pricing environment evolved in recent years? What impact has this had on the operations of multinational firms? 

Ben-Dov: In recent years, the Israeli Tax Authorities (ITA) and local legislators have identified the possibility of the misuse of aggressive tax planning practices and, within the scope of a broader amendment (amendment no. 132), instated in 2006, added transfer pricing legislation to the Israeli Tax Ordinance (ITO). Furthermore, in September 2010 Israel was admitted as the 32nd full member of the OECD. As part of the initiation process, Israel had to carry out numerous economic and social reforms, one of which was the adoption of the arm’s length principle with regard to international transactions between related parties. There is no doubt that the impact of ongoing economic instability as well as Israel’s initiation to the OECD will have significant ramifications for Israeli international tax policy in general, and the enforcement of transfer pricing rules in particular. 

Hollis: In recent years, the IRS has put forth numerous proposals, and suggested numerous operational changes regarding the handling and enforcement of transfer pricing examinations. Many of these changes came to fruition in the last year, including substantial increases in the level of personnel dedicated to transfer pricing audits and significant organisational changes within the IRS designed to allow more efficient reviews of transfer pricing audits and cases. Specifically, the IRS realigned its APA program, Mutual Agreement program, and Competent Authority programs all under a single program − the Advanced Pricing and Mutual Agreement (APMA) program – which now operates under the IRS’s Large Business & International Treaty Assistance and Interpretation team. Additionally, during 2012 the IRS focused on training local field auditors in transfer pricing audit strategies and developing new guidelines for examinations to increase consistency and reduce time to resolution.

Alajbegu: In today’s global tax environment, companies look at the entire globe when deciding where to make and sell products. It is not unusual for a product to be made in one country, using designs and technology developed in a second country, directed by executives located in a third country, and sold to customers in a fourth country. Accordingly, multinational firms are under increasing pressure to manage transfer pricing risks with greater precision. Transfer pricing has become one of the most important issues in today’s tax department.

Tolia: The rapid growth of international trade, coupled with the economic slowdown and the shift of economic power, have led to tax authorities and multinationals across the globe viewing transfer pricing as an area of utmost priority. With uncertainty and complexity in the transfer pricing environment increasing manifold, and with tax authorities becoming more aggressive, multinationals need to be able to cope with legislation that is growing by the day across jurisdictions, and have a transfer pricing framework that is responsive to an increasingly dynamic and turbulent business environment. 

Carden: Governments are looking to transfer pricing as an area that can potentially help bring in revenue at a time when broader economic difficulties have limited options for generating tax revenue. While tax authorities have shifted their focus to enforcement efforts involving transfer pricing, other government bodies − including committees of the UK Parliament and the US Senate − have made very public inquiries of senior executives regarding their companies’ transfer pricing. In addition to stepped up pressure from governments, transfer pricing has received significant coverage in mainstream media outlets, resulting in a ‘headline risk’ that poses a new challenge for many multinationals. These changes in the transfer pricing landscape have sensitised multinationals to the importance of ensuring their transfer pricing is correct and documented as such. 

FW: Have governments and tax authorities stepped up transfer pricing enforcement in recent years, and if so, in what ways?

Hollis: The total number of transfer pricing audits rose considerably in 2012 due to the IRS’s increased hiring of transfer pricing specific personnel. Additionally, given the IRS’s estimate of six to eight months from the hiring of a field examiner and the beginning of audits, we fully expect the number of transfer pricing exams to continue to increase through 2013. Regarding the selection of audits, it is generally agreed that the IRS will be taking a more strategic approach by looking at particular industries and focusing very specifically on the issue of IP migration. Due to the perceived abuses of off-shoring intellectual property (IP), we expect the technology industry will likely be a priority target for the IRS in 2013.

Alajbegu: Tax authorities have increased enforcement of transfer pricing issues tremendously in recent years. Tax authorities clearly consider intercompany transfer prices an area to probe for revenue that otherwise might be lost to low-tax jurisdictions or to more aggressive transfer pricing regimes. In the US, an audit of a US multinational will always be accompanied by an information document request of its transfer pricing documentation. Transfer pricing penalties in the US are significant − either 20 percent or 40 percent of additional tax resulting from adjustments exceeding objective thresholds. The US recognises that it is a significant market for the majority of multinational enterprises, and therefore enforcement of compliance with US rules is a significant issue for multinationals. Not only in the US, but around the globe, tax authorities are adding resources through additional training to create transfer pricing specialists. In addition to added resources, expansive regulation packages are coming into force in many nations.

Tolia: With the ever-growing number of cross-border transactions between group affiliates, transfer pricing is a key area of focus for tax authorities of most jurisdictions. Information exchange between taxing authorities is happening more frequently and they are keeping themselves connected with developments by participating in seminars, tax forums, and training conducted by the OECD and the like. India has the dubious reputation of having one of the toughest transfer pricing regimes in the world in terms of onerous documentation and reporting requirements, stringent penalty provisions, ever increasing litigation and conflicting judicial rulings. It has been a decade since TP regulations were introduced in the Indian Income-Tax Act and the number of cases that have been picked up for TP audits and the proportion in which adjustments are made have risen dramatically over the years. Further, the Union Budget 2012 has broadened the scope of TP regulations by including specific domestic transactions in the scope of transfer pricing and also introducing new penalty provisions for not reporting transactions.

Carden: As revenue challenges have intensified, governments have redoubled their transfer pricing enforcement efforts, making changes both organisationally and in terms of audit practice. In the US, for example, the IRS has actively sought to attract private sector transfer pricing talent to the government and has created a single, integrated operational transfer pricing division, rather than leaving personnel in different divisions throughout the agency. Accompanying this change has been more aggressive review of significant transfer pricing issues during audit and prior to settlement with taxpayers. Other tax authorities seem to be taking more aggressive approaches in audit as well, including issuing document requests that are broader than the requests taxpayers have been accustomed to receiving in the past. 

Ben-Dov: ITA officials have expressed their intention to step up the enforcement of transfer pricing transactions. However, they have not as yet executed this. Furthermore, the Israeli legislation has no specific monetary penalties associated with non-compliance with transfer pricing requirements. However, if the ITA finds that the prices were not transacted at arm’s length, criminal charges could be brought against the company and its senior officials. However general penalties and criminal ramifications are stipulated in the ITO, including monetary fines, upward adjustments of taxable amounts, adjustments to prior years, and even incarceration for up to seven years for conducting tax avoidance schemes. 

FW: Has there been an increase in the appetite of governments and tax authorities to enter into litigation against multinational firms? Are countries strategically selecting cases for litigation as a means of managing future court precedents? 

Alajbegu: Governments and tax authorities are treading carefully over which cases they are choosing to pursue in litigation. Key landmark transfer pricing cases have not always gone in favour of the government, as evidenced by Veritas Software Corp., Xilinx, and General Electric Capital Canada, Inc. However, governments have responded through legislative change.

Tolia: Since the global financial crisis, several governments, reeling under the effects of recession and resulting budget deficits, have been reassessing the manner in which they evaluate transfer pricing, with the objective of intensifying enforcement. This is being achieved through a variety of measures such as allocating more resources and hiring more specialised staff, updating TP regulations, and increasing aggression in challenging TP arrangements, especially with low tax jurisdictions.

Carden: Governments seem to be willing to litigate major cases against multinationals. 2012 brought decisions in major cases like Vodafone in India − regarding jurisdiction to tax a transaction involving Indian assets but entered into by non-Indian parties − and GlaxoSmithKline in Canada − involving the transfer pricing used in transactions between Glaxo’s Canadian and Swiss affiliates. In the US, several cases pertaining to issues including corporate reorganisations and related-party transfers of foreign goodwill are currently being litigated in the tax court. In one of these cases, the IRS has cancelled the taxpayer’s APAs and asserted transfer pricing adjustments. Tax authorities have become more strategic regarding the cases brought to litigation, both in terms of allocation of government resources and the likelihood of success on the merits. This is especially true in the US, where the tax authorities have lost several high profile recent cases.

Ben-Dov: At present, several transfer pricing administrative assessments have been publicised, however the details of those cases have yet to be disclosed. In light of ever-growing worldwide and local attention to the importance of transfer pricing regulation, we would expect some level of similarity to increasing global public interest in the tax policies of large multinational firms.

Hollis: Currently, the IRS appears to be in a holding pattern regarding initiating transfer pricing litigation. In late 2012, there were less than six ongoing transfer pricing disputes where the tax administration had completed assessment, communicated the order and was involved in active litigation. In recent years, however, the IRS litigated two major cases in the US Tax Court, both dealing with transfer pricing related cost-sharing arrangements. In what was widely considered a victory for taxpayers, the IRS lost both cases. In the Veritas case, the IRS, using an income method, claimed the cost-sharing arrangement undervalued royalties by $2.4bn. The court, however, upheld the taxpayer’s use of comparable uncontrolled transactions as support for the royalties. While the IRS lost the case, in 2012 it reiterated its position that the income method remains the IRS’s preferred valuation method for the transfer of intangibles.

FW: To what extent are tax authorities placing a greater focus on cross-jurisdictional joint audits? How does this approach aid participating countries and what challenges does it raise for multinationals? 

Tolia: Information exchange and collaboration between revenue authorities across the globe has increased in recent times. The fallout of this is the new emerging trend of tax authorities pursuing joint audits, where a taxpayer is subject to a coordinated audit using a single audit team comprising representatives from two or more jurisdictions. The beneficial aspects of such joint audits include reduction in duplication of efforts, the curbing of tax avoidance and at the same time reduction in risk of double taxation. The Indian TP regime currently does not provide for the conduct of such cross jurisdictional joint audits. 

Carden: The use of joint audits can be helpful to tax authorities in a number of ways, including increased access to information, sharing of audit strategies and best practices for approaching certain tax positions, and an ability to resolve double taxation issues early and cooperatively rather than through competent authority proceedings. Although joint audits may provide some benefits to multinationals − for example, early resolution of cross-border issues rather than lengthy competent authority proceedings − challenges to multinationals include requirements to respond to broader information requests, a heavier burden on tax departments when faced with two audit teams, and unfamiliarity with foreign audit procedures and standards.

Ben-Dov: The concept of joint audits are quite new in Israel; nevertheless the ITA has participated in a number of OECD and US summits in this regard, so we expect to see more of it in the near future.

Hollis: The IRS has not historically focused on cross-jurisdictional joint audits. Rather, the IRS determines its focus on transfer pricing exams based upon risk assessments. As part of these risk assessments, local tax rates and tax treaty elements can be considered factors which make doing business in certain jurisdictions more likely to draw IRS scrutiny. Based on the IRS’s current caseload of transfer pricing exams, the counterpart countries most likely to be under exam are Canada, Japan, Germany, India, and the UK. 

Alajbegu: Tax authorities continue heightened scrutiny of intercompany transactions with information sharing through the Joint International Tax Shelter Information Centre (JITSIC). The message from tax authorities is for the need for transparency across jurisdictions. Accordingly, we can expect to see a greater number of cross-jurisdictional audits in the near future. Joint audits will be the norm, not the exception. Joint audits aid participating countries to gain a much better understanding of taxpayer behaviour and give tax authorities a global overview of a multinational global transfer pricing policy and its effect on the tax liability of a particular country. Cross-jurisdictional audits will also lead to shortcutting the MAP and competent authority route for both revenue agencies and taxpayers, which would be a benefit to taxpayers, as the MAP and competent authority process can be quite lengthy and arduous. 

FW: Has regulatory change made understanding potential tax liabilities a greater challenge for multinational firms, or does it reduce uncertainty concerning risks and opportunities within a company’s tax structure?

Carden: Although the past couple of years have not brought significant US regulatory change to speak of, there are indications that major regulatory change – and uncertainty associated with new rules and audit standards − could be on the horizon. Multinationals will be watching closely as tax reform proposals are introduced and considered by the legislatures of key high-tax countries, including the US and UK, where the goal of keeping a larger portion of multinationals’ income as part of a country’s tax base is one that is likely to garner widespread support transcending political party affiliation. On a global scale, regulatory change resulting from future adoption of new OECD regulations regarding intangibles seems likely and will almost certainly present challenges at the beginning. And, as the UN undertakes transfer pricing initiatives geared toward developing countries, multinationals can expect to encounter new challenges as developing countries become increasingly sensitive to transfer pricing. 

Ben-Dov: Transfer pricing regulation has had an enormous effect. Although it binds multinational firms to the arm’s length principle, and hence they are required to adopt ‘free market behaviour’, it is possible for multinational firms to minimise their liability for corporation tax by transfer pricing. In addition, since the results of market research are, for the most part, within the price range, having discussions with a firm about price setting and the results of market research provides an opportunity for the company to evaluate ways to achieve even more efficient tax planning.

Hollis: The IRS’s continued scrutiny of transfer pricing has definitely increased the amount of uncertainty surrounding companies’ tax structures. Intangible property, cost-sharing arrangements, stock-based compensation, and outbound transfers have all been raised to critical priorities for the IRS. For a company trying to reduce its global effective tax rate, the traditional methods of reorganisation, and commonly used structures, all pose risks. Due to the changing regulations and scepticism applied to foreign tax structures, companies need to continually evaluate their exposures and focus on documenting these higher risk areas. In addition to documentation, companies need to understand their structure and respect the legal agreements in place, and be sure to continually demonstrate the economic substance of the organisation and the related party transfers.

Alajbegu: Regulatory change has not only made understanding a company’s tax exposure a greater challenge, it has also led to increased uncertainty concerning risks and opportunities. Non-US tax authorities have tended to be critical of the level of detail included in US regulations and procedures. This has placed a huge burden on taxpayers and resulted in additional compliance costs. Regulatory change is adding to this burden.

Tolia: Given that legislative reforms are usually carried out on a piecemeal basis, often they create more ambiguity and challenges rather than reduce uncertainty. Having said that, of late, several countries, as well as forums such as the OECD and the UN, have attempted to amend tax legislation with a view to simplifying it and improving tax compliance. Countries that are adopting approaches based on guidance from global developments − such as the OECD Discussion Draft on Intangibles − need to be careful that the interpretation of the issue at hand is based on the finalised recommendations.

FW: What are the main methods used by companies and tax authorities to calculate appropriate transfer prices, both for tangible and intangible assets? 

Ben-Dov: The main directives for the application of the arm’s length standard are stipulated in the Income Tax Regulations (the Regulations), and Circular 03/2008. Israeli legislation is based on both the OECD and US approaches towards transfer pricing methodology. As such, while no official ‘best method’ hierarchy exists, the Regulations indicate that a preference should be given. The primary methods to be utilised by the taxpayer, in accordance with Section 2(a)(1) of the Regulations, are those based on the comparison between the organisation’s transactions with unrelated and related parties. These methods are similar to the Comparable Uncontrolled Price (CUP) and Comparable Uncontrolled Transaction (CUT) methods. If this method cannot be applied, companies must provide a clear reason explaining why.

Hollis: The two predominate methods of valuing tangible property in the US are the Comparable Profits method − which in practice is similar to the OECD’s Transactional Net Margin method − and the Comparable Uncontrolled Price method. Neither method has had significant regulatory changes within the past year. Intangible valuations, specifically intellectual property (IP) transfers and cost-sharing arrangements, continue to be a high priority for the IRS. In late 2011, the IRS issued final cost-sharing regulations which retained the ‘investor model’ of valuing intangible buy-in payments. The investor model takes into account useful lives, uncertainty of outcomes, profit potential, allocation of intangible development, and exploitation risks. It is believed by most transfer pricing professionals that the investor model will increase the cost of buy-in payments, making cost-sharing a less appealing option in certain circumstances. Finally, the IRS has taken the position that any goodwill, including going concern value and workforce-in-place, that is transferred from the US can be taxed to the US company. 

Alajbegu: For tangible property, the comparable uncontrolled price method, resale price method, cost plus method, comparable profits method, and profit split method are the main methods used. For intangible property, comparable uncontrolled transaction method, comparable profits method, and profit split method are the main methods used. For services, the services cost method, comparable uncontrolled services price method, gross services margin method, cost of services plus method, comparable profits method, and profit split method are the main methods used. For buy-ins, comparable uncontrolled transaction method, income method, acquisition price method, market capitalisation method, and residual profit split method are the main methods used.

Tolia: The TP methods prescribed in the Indian Regulations are consistent with the methodology prescribed in the OECD Guidelines. The Regulations accord no order of priority and require taxpayers to select the method that is best suited to the facts and circumstances of a transaction and results in a reliable determination of arm’s length pricing. The Transactional Net Margin method has been applied as the most appropriate method in the majority of cases, especially where taxpayers have multiple transactions which are tested on an aggregated basis at an operating level. However, tax authorities have also shown a preference for applying traditional transaction methods such as CUP and the RPM when comparable data is available.

Carden: Calculating transfer prices for tangible property involves a comparison between the controlled transaction and uncontrolled transactions, either by reference to the price charged in an uncontrolled transaction or the amount of profit earned by a functionally-similar unrelated entity. Intangible transfer pricing is typically determined using one of three approaches. One is to compare the controlled transaction to comparable arm’s length transactions involving similar intangibles − often difficult with high value, core intangibles. Another is to determine intangible value by subtracting the value of tangible and other ‘routine’ assets and functions from the business’ total value, with the remaining amount representing the total value of the intangibles − which is then allocated to specific assets. The third approach is to value intangible property using a ‘rule of thumb’ − for example, a 75-25 split of profit between licensor and licensee − though the use of rules of thumb to value intangibles has recently been called into question.

FW: What transfer pricing challenges arise in unique situations, such as M&A or other significant changes in company structure? 

Hollis: International business restructuring has become an integral part of the IRS’s focus in recent years. Of most concern to the IRS is the proper valuation of the intangibles being off-shored. In recent releases, the IRS has taken the position that transferred intangibles include ‘going concern value’ and ‘workforce-in-place’ value. In these cases, the mere movement of services from the US to an offshore location could trigger significant taxes due to the IRS from the US company. Incorporating an existing branch could also trigger unexpected taxes related to the off-shoring of these goodwill items. Additionally, cost-sharing arrangements have come under significant scrutiny by the IRS, making even common sharing of services subject to possible attack as offshore transfers of goodwill.

Alajbegu: Transfer pricing is critical in various other areas of a multinational’s strategic growth plan. In the area of M&A, due diligence on a company’s transfer pricing policies are of critical importance. Transfer pricing is also the most critical element when reviewing a company’s supply chain, logistics, and sourcing operations.

Tolia: One of the bigger challenges in India has been the sale of business units on account of global M&A deals. Say, for instance, X Co., US sells one of its business to Y Co., US at say, $100. As a part of the agreement, X Co. India − a captive service provider in India which is a subsidiary at X Co., US − sells its business to Y Co. India − a subsidiary at Y Co., US − based on an independent valuation of such business, at $40. Despite independent valuation, tax authorities are challenging the pricing of the India leg of such transactions. One needs to understand that under the current global economic environment, multiple cross-border M&A deals cannot be ruled out. In order to mitigate litigation in this area, tax authorities should frame clear guidelines for valuation methods − based on prevalent practice in their country − to mitigate litigation in this area. At the same time, taxpayers should go the extra mile to maintain robust documentation to support their pricing. In this context, one could look at alternate methods to corroborate an independent valuation.

Carden: Company reorganisations and M&A activity can be challenging from a transfer pricing perspective in a number of ways. In the case of an acquisition, the target’s intercompany licence and transfer pricing structure now becomes the acquirer’s structure. One obvious consequence is that tax authorities may seek to use the legacy transfer pricing practices of one of the entities involved in the M&A transaction as evidence that the legacy transfer pricing of the other entity is deficient. Other challenges include difficulties associated with ongoing application of divergent legacy transfer pricing policies and non-tax problems including, for example, IP enforcement issues that can arise from the failure to properly integrate acquired products into the acquirer’s transfer pricing structure. The process of establishing a new transfer pricing policy for a company, whether in response to an M&A transaction or an internal reorganisation, can require significant corporate resources and may result in increased scrutiny from tax authorities.

Ben-Dov: Unique situations, such as M&A, may involve the termination or relocation of employees, lease terminations, intercompany transfers of assets, and so on. Given the fact such transactions may include the transfer of tangible and intangible property, the arm’s length principle should be taken into account. Each unique situation will be followed by the business impacts of reorganisation. Notwithstanding this, there are no specific tax regulations in Israel on business restructurings. However, following Israel’s recent initiation into the OECD, the ITA have emphasised the fact that Section 85A of the ITO – Israel’s main transfer pricing legislation – and the regulations thereunder, apply to business restructuring transactions. Furthermore, ITA officials have expressed their intention to publish a directive that will exclusively deal with business restructuring from both the general taxation and transfer pricing perspectives.

FW: How difficult is it, in your opinion, for multinational companies to maximise tax efficiencies while maintaining compliance with transfer pricing regulations? What external factors can impact upon compliance? 

Alajbegu: The US is a significant market for the majority of multinational enterprises. Therefore, compliance with US rules, which remain arguably the toughest and most comprehensive in the world, is a significant issue. As such, it is extremely difficult for multinational companies to maximise tax efficiencies while meeting compliance regulations. Increased scrutiny on a local country level is adding to these difficulties. Tax departments do not have the resources internally to address local country disputes.

Tolia: With transfer pricing now one of the prime issues for any multinational firm’s tax compliance requirements, one could say that the concept of what was once considered tax efficiency has now changed. Substance over form is the clear direction and this must be taken into consideration by a taxpayer structuring any aspect of its operations. In essence, maintaining compliance with transfer pricing regulations is an integral part of maximising tax efficiency and the two issues should not be viewed as mutually exclusive. On the other hand, compliance should not be so burdensome as to adversely impact an organisation’s operations, and there is a need to work towards finding a middle ground which addresses both the concerns of the government and of multinationals. One of the key challenges encountered by multinationals while trying to comply with the transfer pricing norms of different countries are the differences in TP documentation expected across various tax jurisdictions. For example, the Indian TP regulations prescribe the arithmetic mean as the measure for determining arm’s length pricing whereas the OECD standard and global best practice is the inter-quartile range. Also, taxpayers must learn to cope with different legislations, which, at times, have conflicting considerations.

Carden: Undoubtedly, transfer pricing regulations affect the extent to which intercompany transactions can achieve tax-efficient results. However, compliance with transfer pricing rules does not necessarily mean that a multinational company’s transfer pricing will not provide tax-efficient results. The most significant trend in my view is that transfer pricing is becoming increasingly focused on functions, which puts pressure on companies to change their operating footprints. Many multinationals with whom I work are either relocating or hiring new management to support their transfer pricing positions. The primary compliance challenge is the reality that documented compliance with the letter of the law does not mean that a taxpayer will have a controversy-free audit. Because analyses under transfer pricing regulations are so fact-intensive, multinational taxpayers can expect a back-and-forth with tax authorities on transfer pricing issues like the taxpayer’s relied-upon transfer pricing method and the arm’s length range of results.

Ben-Dov: The economic conditions in Israel and the wider world complicate the issue of transfer pricing. The uncertainty of the future has resulted in tax authorities more closely examining companies’ transfer pricing documentation. It also creates opportunities in transfer activities. The slowdown of the world’s economy has increased the desire for tax savings, and transfer pricing can achieve this by determining the most appropriate price for the company, limited to the relevant laws applicable in each country where the company operates. 

Hollis: Faced with tight departmental budgets, most internal tax groups are focused on allocating their resources in a manner that accurately reflects the risk of the transactions being conducted. For instance, we have seen an increase in centralised transfer pricing studies for routine functions throughout regional areas. An example of this might be an OECD compliant TP study for routine distribution activities throughout the EU. Under exam, necessary local country adjustments would be made to the central study but in most cases the singular centralised study would be the primary support. This approach allows companies involved in higher risk transactions, such as IP migration or intangible licensing, to better focus their resources on documentation for these transactions. An example of this may be having a full valuation performed on intangible property and preparing full, country-specific documentation for all sides of a high risk transaction.

FW: What action should a firm take in response to a government audit, enquiry or investigation related to transfer pricing? Should firms have documentation readily available in preparation for this event? 

Tolia: Often, being overly rigid on positions − even if technically sound − can vitiate the atmosphere and ultimately be detrimental. A firm must ensure that its primary position is taken down on record, and it could then aim to provide comfort on supplementary requests for clarification. While having adequate annual documentation in place is mandatory in countries like India, it would be advisable that firms, even in locations without such established requirements, at least be aware of the documentation available. In this way, one could respond quickly and readily extract relevant details at the time of audit. Failure to plan may result in situations which may be more difficult to rectify on a retrospective basis. 

Carden: Well before an audit is initiated, companies should give thorough consideration to and document the rationale underlying intercompany transactions before execution; prepare transfer pricing studies demonstrating the arm’s-length nature of prices used; and execute intercompany agreements that accurately reflect the course of dealing between controlled parties. Any documentation that is subject to a claim of privilege should be clearly identified so that it may be withheld once an audit is initiated. Having an organised, comprehensive set of documentation ready in advance of a transfer pricing audit − including all financial data needed to support the company’s transfer prices − can help the audit run much more smoothly and can help reduce the burden on corporate resources during the course of the audit.

Ben-Dov: While there is no regulatory obligation to prepare transfer pricing documentation reports prior to a tax examination, the form 1385 – issued by ITA – declaring that prices were transacted at arm’s length, effectively requires every company with intercompany transactions to prepare a transfer pricing study. Furthermore, although the regulations do not explicitly require the annual maintenance of transfer pricing documentation by the taxpayer, proper documentation including the study of market analysis must be updated every year. Our recommendation is to include a transfer pricing study, intercompany agreements and any other material that may be deemed relevant by the taxpayer, or by the auditors of the ITA. 

Hollis: Transfer pricing documentation should be prepared with the inevitability of a governmental inquiry in mind. The documentation should not only cover the local county regulations, but should also be viewed as the taxpayer’s first and best opportunity to make its case. Not having documentation ready and available can make an examiner more suspicious of a company’s compliance with the necessary regulations, and can increase the overall amount of scrutiny applied. That said, it is appropriate to initially offer a judicious amount of information and reserve the full detail until necessary. Additionally, companies are best advised to review their transfer pricing policies and documentation sceptically, assuming that they will face an astute examiner that has full knowledge of the transactions under review. By asking tough questions internally, before an examination, a company will better be able to document their pricing positions or to adjust their policies if necessary.

Alajbegu: A firm should review its global transfer pricing policies and ensure appropriate documentation supports local management’s tax assertions prior to submitting a response to a government audit. Additionally, a strategy should be developed before submitting a response or meeting with the examination meeting. In many cases, tax authorities are looking to transfer pricing as a mechanism to make adjustments and generate additional tax revenue. While some practitioners believe that results from these audits are sometimes predetermined, it is imperative that documentation supports a company’s transfer pricing policies. In the US, contemporaneous documentation is required for penalty protections and thus should exist prior to the filing date of a company’s annual tax return. 

FW: Are you seeing Advanced Pricing Agreements (APAs) used more often to resolve disputes with tax authorities? What are the benefits and drawbacks of APAs?

Carden: While it is difficult to accurately quantify worldwide trends in the use of APAs, based on data recently released by the IRS, many taxpayers continue to view APAs as a viable option. If a multinational is seeking more certainty in connection with specific transactions or business decisions, entering into an APA with one or more tax authorities can be useful. However, the benefits of an APA may not be readily attainable given resource limitations within tax authorities and the sometimes long durations required before an agreement can be finalised between the taxpayer and tax authority. Additionally, as has been highlighted in one recent US tax court case, taxpayers should consider the extent to which an APA is binding under applicable law and the possibility that the tax authority could move to cancel an APA. 

Ben-Dov: The ITA has stated that it encourages taxpayers and tax authorities to enter into APAs. A taxpayer may, at its own discretion, file a request for an approval of an APA with regard to its intercompany transactions. Such a request should, when submitted, be backed by proper documentation, a full scale transfer pricing analysis that demonstrates the arm’s length nature of the intercompany transaction, and an applicable intercompany agreement.

Hollis: In early 2012, the IRS completed its merger of the APA program and Competent Authority program into the new Advanced Pricing and Mutual Agreement Program (APMA). The purpose of this merger was to streamline the APA process and enable a single group to take a case from start to finish. With the addition of a new director, the APMA program signed 46 total APAs in four months; a number that exceeds the total number of APAs signed in all of 2011. Signalling a potential desire to expand the APA program to more businesses, the APMA predicts that as many as 150 to 200 APA cases could be completed in 2013. The APA regime is not without risk though. The recent Eaton Corporation case, in which the IRS terminated its APA with the company three days before issuing a statutory notice of deficiency regarding the formerly APA-covered transactions, highlights risks previously unexpected from the APA regime. Eaton Corporation has submitted a tax court filing and the case is currently being heard by the tax court.

Alajbegu: While APAs have become an increasingly important mechanism for multinational enterprises to obtain prospective reassurance that their transfer pricing policies and procedures meet the requirements of the arm’s length standard, APAs are also an effective mechanism for resolving tax audits involving transfer pricing issues. The drawbacks of APAs are the cost and time associated with obtaining one. 

Tolia: The success of an APA regime in a particular country is generally a function of a government’s interest and commitment to the process. India has of course recently introduced APA regulations which were eagerly awaited and are expected to significantly benefit taxpayers. The government appears keen to use this as a thrust area to regain investor confidence in the economy after the negative sentiment caused by retrospective tax amendments in the last budget. The benefits of APAs include the opportunity to proactively manage the risk of tax adjustments, the certainty gained over a fixed period of time, minimal compliance and documentation requirements during that period, savings in management time, and a major reduction in costs associated with litigation. However, multinationals should carefully evaluate these benefits in light of their specific needs and circumstances. Bilateral or multilateral APAs can be particularly time-consuming; more so if there are pending applications under the MAP mechanism for the same issue. Further, some countries such as India do not have roll-back provisions in their APA framework.

FW: Have there been any high profile transfer pricing disputes between multinational companies and tax authorities in the past year? What can be learned from these cases? 

Ben-Dov: A few years ago, the ITA established a transfer pricing unit (TPU) which focuses only on transfer pricing audits. The TPU has begun to audit multinationals that act in Israel and issued new assessments in millions of dollars to companies in the fields of information technology, pharmaceuticals, and communication, among others. In recent transfer pricing audits performed in Israel, the main issues under the tax authorities’ magnifying glass have been how to choose the comparable companies, as their data has a direct impact on the pricing of the intercompany transaction; compensations for services activity; and examining the methods used by the company. Accordingly, in recent years, several Israeli companies have been charged millions of dollars.

Hollis: While no significant high profile transfer pricing cases occurred in 2012, one interesting case relating to transfer pricing did progress through the US bankruptcy courts. The DeCoro USA Ltd case, in which the IRS was a claimant, was very instructive in that it revealed how the IRS might attach a typical foreign parent supplier / US subsidiary arrangement. In the audit, prior to the bankruptcy proceedings, the IRS utilised a three-pronged attack; first it attacked the parent company by asserting that the distributor was a dependant agent, next it attacked the profit margin as not being arm’s length − the distributor earned a 3.32 percent mark-up which resulted in a operating profit of less than 1 percent − and finally the IRS treated the ‘excess’ money paid to the foreign parent for product as a constructive dividend subject to 30 percent witholding. While the case was not finalised due to DeCoro’s bankruptcy filing, it does serve as a stark outline for inbound companies to contrast against their current structure and determine where it may be attacked.

Alajbegu: One high profile dispute is with Altera Corp, where the IRS is seeking $27m in tax payments. Altera is challenging the IRS rules that require stock-based pricing to be shared between a US company and a subsidiary. Altera faces an uphill battle in overturning the 2003 rules. This is an extremely important issue to many companies, especially technology-oriented companies. The transfer pricing community will keep a close eye on this case. 

Tolia: The issue around marketing intangibles – their ownership and the resultant benefit in terms of residual profit − has been a contentious issue around the globe, especially in emerging markets. With fiscal deficits growing, newer issues will be identified by tax authorities, and it will haunt taxpayers and increase litigation in the future. APA is clearly the response to this uncertain tax environment. Also, the integrated and cohesive working of the business and tax teams, in developing real-time TP documentation, will have no substitute. It will be do or die.

Carden: In Canada v. GlaxoSmithKline Inc., 2012 SCC 52, the Canadian tax authorities asserted that Glaxo Canada paid too much to its Swiss affiliate for ranitidine, the active ingredient used in the brand-name drug Zantac. The Canadian tax authorities argued that the price paid by Glaxo Canada should have been more in line with the lower prices charged by generic manufacturers of ranitidine. Remitting the case back to the Canadian tax court for further proceedings, the Supreme Court of Canada held that Glaxo Canada, which was the licensee of a bundle of rights associated with the sale of Zantac, was not similarly enough situated to purchasers of generic ranitidine to warrant the government’s use of unadjusted generic ranitidine prices to reduce the price paid by Glaxo Canada. The court’s decision in Glaxo reemphasises an elementary transfer pricing principle, namely that all significant factual circumstances surrounding a related-party transaction must be taken into account when assessing the correctness of a company’s transfer pricing practices.


Yariv Ben-Dov is the head of Bar-Zvi & Ben-Dov’s transfer pricing practice. He is a renowned expert in drafting and defending transfer pricing studies and intercompany agreements, and has won several prizes for his practice. Mr Ben-Dov counsels both small start ups and multinational conglomerates on their transfer pricing matters, including multinationals which have no activity in Israel but which have approached the firm based upon its sterling reputation in the field.

Marshall Hollis is a managing director in CBIZ MHM’s International Tax Services group where he advises clients on a broad array of transfer pricing issues, global tax planning issues, and overall tax compliance. Mr Hollis’s clients include multinational companies with operations in the US, Europe, Mexico, Canada, and numerous APAC and South American countries. He specialises in international tax and transfer pricing with a specific focus on worldwide effective rate planning and transfer pricing compliance.

Jim Alajbegu is a partner in the International Tax Services group at EisnerAmper. His experience includes over 20 years in both public and private accounting. He has been responsible for myriad assignments in the multinational tax and transfer pricing areas including foreign tax credit studies and expense allocation reviews, acquisitions and dispositions of operating units, reorganisations, tax accounting issues, and related other tax matters. Mr Alajbegu currently serves as chair of the NJSCPA’s International Tax Committee.

Sanjay Tolia is a partner at PwC, India. He leads the firm’s western region Transfer Pricing practice of 85 members. He has extensively advised leading multinational companies on regulatory issues, transfer pricing matters, domestic and international taxation for the last 20 years.

Nathaniel Carden focuses on matters of transfer pricing, operational tax planning and tax controversy. He represents corporate clients across many industries, with a particular focus on life science and health care companies. His transfer pricing and operational planning practice focuses on planning and pre-audit issues arising from cross-border intangible property, service and financing transactions. His dispute resolution practice emphasises the representation of corporate taxpayers in pre-audit, audit, and administrative appeal and litigation proceedings.

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Yariv Ben-Dov

Bar-Zvi & Ben-Dov


Marshall K Hollis



Jim Alajbegu



Sanjay Tolia      

Price Waterhouse & Co.


Nathaniel Carden

Skadden, Arps, Slate, Meagher & Flom LLP

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