Transfer pricing is currently a headline story. The OECD consultation on chapter VI of its Transfer Pricing Guidelines covering intangibles tends to an anti-avoidance tone. The OECD has assured business otherwise but only the next draft of the consultation document will show whether concerns over a loose definition of intangibles and an emphasis on the profit split method will be addressed.
Transfer pricing is currently one of the hottest topics in tax. With the widely reported suggestion that some corporates have used international structures to avoid corporation tax by abusing the arm’s length principle, public attention is focused on an issue of which few were previously aware. Some overseas groups have even had their finance chiefs summoned to the public accounts committee to explain their transfer pricing arrangements. Clearly, transfer pricing is no longer merely a tax risk but a risk that goes to the heart of a group’s corporate reputation. It is therefore not surprising that the OECD’s work on developing its transfer pricing guidelines is being followed closely by international businesses.
The growing involvement of the United Nations is also a factor. The UN is often more sympathetic to the government position in developing countries, many of which have challenged multinationals on their taxable profits, with some suffering significant double taxation. It is against this backdrop that OECD Working Party 6 gathered in Paris from 12–14 November to hear concerns raised by commentators on the discussion draft it issued earlier this year (Discussion draft: Revision of the special consideration for intangibles in chapter VI of the OECD transfer pricing guidelines and related provisions, dated 6 June 2012) proposing changes to the treatment of intangibles in its transfer pricing guidelines. This article considers some of the points raised and examines the technical issues from a practical standpoint.
Fundamental to guidance in this area must surely be a clear understanding of what is meant by the term ‘intangibles’ for transfer pricing purposes. This is where the meeting started, with a discussion on the general definitional approach for intangibles. Most commentators feel that the definition in the discussion draft is too vague. The concern is that a definition open to wide differences in interpretation will lead to unrelieved double taxation. Intangibles will be deemed to exist in some countries but not recognised in others. It is possible that OECD member governments are under pressure from the developing economic powers to broaden the definition to include concepts such as location savings and workforce in place, along with widening the concept of marketing intangibles. But if the cost of international consensus is a vague and subjective orientation, then this is not in anyone’s interest. It is suggested that the guidelines need to be clear in order to be effective. If they cannot be used to determine whether or not an intangible exists for transfer pricing, with reasonable certainty, then they are not fit for purpose.
The existing categories of intangibles in the current chapter VI have been dropped. According to the OECD, and some governments, this is because terms such as ‘trade intangible’ and ‘marketing intangible’ add nothing unless one can say precisely what they mean. While this is probably true it is an argument for more clarity not the contrary. For example most business commentators argue that a workforce in place is not an intangible because it cannot be owned, transferred and controlled. It should be viewed as a comparability factor not as an intangible asset capable of being transferred for a price. It certainly cannot be both and, in any event, specific guidance is needed. Furthermore there is little international support for the idea that goodwill can be separately defined and identified in applying a transfer pricing method.
One of the most significant concerns is that the discussion draft focuses too heavily on restraining abusive behaviour. If the general tone of the transfer pricing guidelines becomes one of ‘guilty until proven innocent’, then it adds to a trend of taking double taxation too lightly. A practical consequence of this anti-abusive approach is that it sets the documentation burden too high. If the guidelines are read as requiring an enhanced level of analysis, whether in fact this is actually needed, this raises compliance costs which are already too high for many businesses. Again the discussion draft appears to place too much emphasis on the profit-split method, but it should not be necessary to use a two sided method when intangibles are normal to the function being priced. Similarly a suggestion that comparability adjustments should be seldom used is unwelcome as it marginalises the arm’s length principle. To argue that the process of making adjustments for comparability differences is not sufficiently distinct from a recharacterisation ignores the fact that a good functional and economic analysis can establish whether adjustments are appropriate and proportionate. It is also important not to set the bar too high regarding the degree of similarity required in a comparability analysis, otherwise the comparable uncontrolled price method, with or without adjustments, is practically ruled out. This is not in the spirit of chapters I–III of the guidelines.
Encouragingly, the OECD Secretariat and some Working Party members stated that third party behaviour is the real test and that there should have been more references to the arm’s length principle in the discussion draft. It remains to be seen if this will be conveyed to the next draft, but if it does, this may go a long way to addressing the concerns of business. However, if the outcome is to institutionalise double taxation and reduce international trade, then this will be a high price to pay.
Transfer pricing is currently a headline story. The OECD consultation on chapter VI of its Transfer Pricing Guidelines covering intangibles tends to an anti-avoidance tone. The OECD has assured business otherwise but only the next draft of the consultation document will show whether concerns over a loose definition of intangibles and an emphasis on the profit split method will be addressed.
Transfer pricing is currently one of the hottest topics in tax. With the widely reported suggestion that some corporates have used international structures to avoid corporation tax by abusing the arm’s length principle, public attention is focused on an issue of which few were previously aware. Some overseas groups have even had their finance chiefs summoned to the public accounts committee to explain their transfer pricing arrangements. Clearly, transfer pricing is no longer merely a tax risk but a risk that goes to the heart of a group’s corporate reputation. It is therefore not surprising that the OECD’s work on developing its transfer pricing guidelines is being followed closely by international businesses.
The growing involvement of the United Nations is also a factor. The UN is often more sympathetic to the government position in developing countries, many of which have challenged multinationals on their taxable profits, with some suffering significant double taxation. It is against this backdrop that OECD Working Party 6 gathered in Paris from 12–14 November to hear concerns raised by commentators on the discussion draft it issued earlier this year (Discussion draft: Revision of the special consideration for intangibles in chapter VI of the OECD transfer pricing guidelines and related provisions, dated 6 June 2012) proposing changes to the treatment of intangibles in its transfer pricing guidelines. This article considers some of the points raised and examines the technical issues from a practical standpoint.
Fundamental to guidance in this area must surely be a clear understanding of what is meant by the term ‘intangibles’ for transfer pricing purposes. This is where the meeting started, with a discussion on the general definitional approach for intangibles. Most commentators feel that the definition in the discussion draft is too vague. The concern is that a definition open to wide differences in interpretation will lead to unrelieved double taxation. Intangibles will be deemed to exist in some countries but not recognised in others. It is possible that OECD member governments are under pressure from the developing economic powers to broaden the definition to include concepts such as location savings and workforce in place, along with widening the concept of marketing intangibles. But if the cost of international consensus is a vague and subjective orientation, then this is not in anyone’s interest. It is suggested that the guidelines need to be clear in order to be effective. If they cannot be used to determine whether or not an intangible exists for transfer pricing, with reasonable certainty, then they are not fit for purpose.
The existing categories of intangibles in the current chapter VI have been dropped. According to the OECD, and some governments, this is because terms such as ‘trade intangible’ and ‘marketing intangible’ add nothing unless one can say precisely what they mean. While this is probably true it is an argument for more clarity not the contrary. For example most business commentators argue that a workforce in place is not an intangible because it cannot be owned, transferred and controlled. It should be viewed as a comparability factor not as an intangible asset capable of being transferred for a price. It certainly cannot be both and, in any event, specific guidance is needed. Furthermore there is little international support for the idea that goodwill can be separately defined and identified in applying a transfer pricing method.
One of the most significant concerns is that the discussion draft focuses too heavily on restraining abusive behaviour. If the general tone of the transfer pricing guidelines becomes one of ‘guilty until proven innocent’, then it adds to a trend of taking double taxation too lightly. A practical consequence of this anti-abusive approach is that it sets the documentation burden too high. If the guidelines are read as requiring an enhanced level of analysis, whether in fact this is actually needed, this raises compliance costs which are already too high for many businesses. Again the discussion draft appears to place too much emphasis on the profit-split method, but it should not be necessary to use a two sided method when intangibles are normal to the function being priced. Similarly a suggestion that comparability adjustments should be seldom used is unwelcome as it marginalises the arm’s length principle. To argue that the process of making adjustments for comparability differences is not sufficiently distinct from a recharacterisation ignores the fact that a good functional and economic analysis can establish whether adjustments are appropriate and proportionate. It is also important not to set the bar too high regarding the degree of similarity required in a comparability analysis, otherwise the comparable uncontrolled price method, with or without adjustments, is practically ruled out. This is not in the spirit of chapters I–III of the guidelines.
Encouragingly, the OECD Secretariat and some Working Party members stated that third party behaviour is the real test and that there should have been more references to the arm’s length principle in the discussion draft. It remains to be seen if this will be conveyed to the next draft, but if it does, this may go a long way to addressing the concerns of business. However, if the outcome is to institutionalise double taxation and reduce international trade, then this will be a high price to pay.
Transfer pricing is currently a headline story. The OECD consultation on chapter VI of its Transfer Pricing Guidelines covering intangibles tends to an anti-avoidance tone. The OECD has assured business otherwise but only the next draft of the consultation document will show whether concerns over a loose definition of intangibles and an emphasis on the profit split method will be addressed.
