Transfer Pricing Times: Volume XII, Issue 7
In this Edition:OECD Holds Final Public Consultation for BEPS Project.
On July 6 and 7, 2015, the Organization for Economic Cooperation and Development (OECD) held its final public consultation related to the Base Erosion and Profit Shifting (BEPS) Project. The first day included consultation on the discussion drafts for cost contribution arrangements (CCAs) and hard to value intangibles (HTVI). On the second day, the OECD provided status updates on various action items, with a particular focus on the status of the modifications to Chapter I of the transfer pricing guidance related the discussion draft on Risk, Recharacterization, and Special Measures.
Public comments on the CCAs discussion draft covered a number of areas, including:
- Commentators raised concerns that the existing draft language potentially created unnecessarily high requirements for participation in CCAs and that the language needs to respect the concept of delegation within multinational enterprises. Astra Zeneca, for instance, asked that the language be clarified such that participants have the capability to assess and control risks at a strategic and operational level, but not necessarily for every participant to control every decision.
- With regards to the cost vs. value issue, there was agreement that pre-existing contributions to development CCAs should be paid for on a value basis. There was concern, however, that the existing language could lead to circumstances where ongoing cost sharing transactions would need to be valued on a basis other than costs. Commentators pointed to typical sharing arrangements between third parties and argued that such arrangements generally measure ongoing contributions on a cost rather than value basis.
- Commentators addressed concerns about the potential for tax authorities to use hindsight to make adjustments to CCA transactions – a topic that overlaps with HTVI-related topics.
The HTVI draft introduced the potential for the tax authorities to make adjustments to intangible transfer prices under certain conditions when actual results were different than projected results. Top areas of discussion included:
- Concern that the HTVI draft opened the door for tax administrations to question the payment forms of transactions and to recharacterize the payment form to contingent consideration when it was in their interest to do so.
- Concern that exemptions in the discussion draft that intend to reflect respect for the transfer price when appropriate projections were made and relied upon are too vague. The discussion draft provides exemptions when the difference between actual and projected results were due to unforeseeable or extraordinary events, but that language and the associated examples are potentially overly restrictive with respect to the appropriate application of this framework.
- Commentators asked that additional exemptions be considered, including consideration of time and quantitative-based boundaries (similar to the 80 percent/120 percent bounds incorporated in the US commensurate with income provisions).
- Commentators requested that the apparent “optionality” of the HTVI treatment in the discussion draft be removed so that tax administrations on both sides of a transaction are required to follow the guidance rather than it being elective. They also argued that taxpayers should be able to apply similar adjustments in order to preserve fairness and symmetry.
- It was requested that the OECD provide guidance on what the consequences of the HTVI approach would be (i.e., how adjustments would be determined under the HTVI approach when it was determined to apply). The OECD said that work related to implementation of the HTVI framework would largely be undertaken in 2016.
In regards to changes in Chapter I of the OECD guidelines, the OECD stressed that the information conveyed during the status update was still very much a work in progress and subject to change as they moved towards finalization. Some highlights include:
- Clarification that contracts would form the starting point of a transfer pricing analysis, and specific conduct would be used to verify that the contract was followed (with any gaps addressed when interpreting the contract).
- References to moral hazard as a consideration for risk allocation have been removed, and risk-return tradeoffs are recognized.
- An “analytical framework” for risk is being contemplated where economically significant risks are first identified, and contractual allocations of those risks are then recognized and ultimately verified through the functional analysis. Risk allocations will be respected if the party that has allocated the risk (and which bears the risk based upon the contractual and factual analysis) has the financial capacity to bear the risk and exercise control. If the party that is assuming the risk does not have both financial capacity and control, the risk will be allocated to the party that best meets these criteria. It seemed clear, from the discussion, that there was still substantial work being done in this area, and that consensus still needed to be reached on some aspects of this framework.
- With respect to exercising control, the OECD said that there would be greater recognition that risk mitigation and preparatory work related to risk management can be outsourced without sacrificing control.
- Entities determined to be minimally functional entities (or “cash boxes”) will not be allocated risk. They should only be entitled to risk free returns for their capital contributions. This is another area where further work will be done and guidance may be subject to change in order to reach consensus.
Final guidance related to the formal BEPS project should be published in early October. Certain additional work streams (including those on profit attribution to permanent establishments, guidance on profit splits, additional guidance on financial transactions, and guidance on HTVI implementation) will be undertaken in 2016.
WCO Releases Guide on Customs and Transfer Pricing
On June 24, 2015, the World Customs Organization (WCO) published the WCO Guide to Customs Valuation and Transfer Pricing (the Guide). The Guide provides an overview of customs and transfer pricing rules, highlights the linkages between transfer pricing and customs valuation, and discusses the role of transfer pricing in customs valuation.
This release is part of the WCO’s continued efforts to encourage customs and tax administrations to exchange information so that each authority may have an accurate and consistent understanding of related party transactions amongst multi-national enterprises.
Currently, customs authorities evaluate transactions related to imported goods using methodologies contained in the WTO (World Trade Organization) Valuation Agreement to determine whether the relationship of the buyer and seller has impacted the terms of the transaction. On the other hand, tax administrations examine the same transactions, using transfer pricing methodologies, to ensure that conditions are consistent with the arm’s length principle. The WCO Technical Committee on Customs Valuation has confirmed that the examination of transfer pricing studies may be of use to customs officials when examining certain related party transactions for customs valuation purposes and is preparing examples of such situations.
For additional information, please click here.
Developing Countries Push for a New Global Tax Body
Developing nations and advocacy groups pushed for a new global body to tackle tax avoidance by companies during a United Nations (UN) global summit held earlier this month in Ethiopia. According to a position paper endorsed by 142 civil-society groups, poor countries lose more money to tax havens – an estimated $190 billion in tax revenue – than they receive in aid. The paper argues that responsibility for tax standards should be moved to a new agency at the UN, which would address issues such as profit shifting and increasing transparency in multinational corporations. According to Adriano Campolina, CEO of ActionAid International, the current tax system will otherwise continue to work “only in the interests of rich countries, rich individuals, and rich companies for the foreseeable future.”
On the other hand, the 34 countries comprising the OECD oppose the establishment of a new agency. The EU Commissioner for International Cooperation and Development has stated that the focus should be on ensuring compliance with existing organizations rather than creating new ones.
The final text of the summit suggests that the developing nations drop their demands for a global tax body and that the UN's Economic and Social Council (ECOSOC) handle the matter. However, this issue is likely to remain contentious.
More information on the UN summit is available here.
European Parliament Votes for Public Country-by-Country Reporting
The European parliament voted in favor of measures to increase transparency in the operations of multinational corporations (MNCs), including a requirement for MNCs to publicly report financial information on a country-by-country basis. This would require MNCs to disclose information such as amount of profit made, taxes paid, revenue generated, and number of employees for each country where a subsidiary operates (see Transfer Pricing Times, Volume XII, Issue 6). Although the OECD has recommended its members adopt country-by-country reporting, it has not recommended that such information be made public, due to pressure from MNCs. The OECD argues that the government can be transparent without sharing information with the public as long as the tax administrations from each country exchange information. However, the European parliament maintains that the public should be allowed to know where multinational corporations do business, how much they pay in taxes, and whether any tax deals with other countries have been made.
The renewed public focus on corporate transparency and tax deals comes in the wake of the LuxLeaks scandal, in which hundreds of MNCs were found to have signed secret tax deals with the government of Luxembourg. However, public dissemination of country-by-country data would likely amplify the tendency to draw incomplete conclusions about an MNC’s tax and transfer pricing circumstances, furthering the need for a comprehensive and consistent documentation strategy.
In that vein, Karen Cate, a senior international tax law specialist in the office of the US Competent Authority, recently indicated that the US is planning to place strict limits on the information that can be shared under country-by-country reporting, specifically limiting sharing to only partners in treaties and in tax information exchange agreements. She notes that this will not only ensure the confidentiality of commercial data, but ensure that it is only used for its intended purpose – assessing high-level transfer pricing risks, and not as a substitute for a detailed transfer pricing analysis.