Transfer pricing issues faced by multinational businesses have been exacerbated in recent years by the introduction of new legislation and a legion of global transfer pricing disputes with tax administrations. However, significant savings can be achieved with effective tax planning involving transfer pricing design supported by economic analysis.
In this issue of Tax Advisor Update, George Koutouras sets out some expected global transfer pricing trends for 2011.
(Excerpts from an article on economic substance by George Koutouras, which appeared in the December edition of Transfer Pricing from BNA International, have been reproduced in this issue of Tax Advisor Update).
Tax Planning in 2011
Business restructurings have been applied extensively in recent years by multinational businesses to achieve financial benefits and this will be facilitated in 2011 by the finalisation of the OECD’s guidance (consultation commenced in September 2008) in this area. These restructurings typically involve the cross-border redeployment or centralisation of functionality between associated enterprises in the group, with consequent effects on the profit and loss position in each jurisdiction; in this manner, businesses are able to achieve commercially based tax savings.
Increased service levels and profitability are typically associated with an increase in supply chain costs (e.g., recruitment of a senior procurement director). However, operational efficiencies can be achieved by centralising functions to achieve an increase in profitability AND reduction in costs.
The OECD consultation paper referred to above considers the examination of functions, assets and risks with reference to the contractual terms between the parties, as those generally define how risks are to be divided between the parties. The paper is clear that the contractual allocation of risk between associated enterprises is respected only to the extent that it has economic substance. Therefore, the review of contractual terms in isolation is not sufficient and has to be completed by a review of whether the related parties actually conform to the contractual allocation of risks in practice. It is also necessary to consider whether the contractual terms provide for an arm’s length allocation of risks and whether the risk is economically significant.
The paper also highlights the fact that where economic substance differs from form, it is both appropriate and legitimate for tax administrations to, exceptionally, consider disregarding a structure adopted by a taxpayer in entering into a controlled transaction. In such a case, the tax administration may disregard the parties’ characterisation of the transaction and re-characterise it in accordance with its substance. This would have significant impact on the tax position of the taxpayer and highlights the importance of approaching this type of planning with robust economic support.
Drivers of Supply Chain Planning
Increase in Disputes and Litigation
Transfer pricing disputes continue to attract headlines due to the volume of tax adjustments. With 40 jurisdictions now applying transfer pricing legislation, disputes and litigation have been increasing at an alarming rate with multi-million pound settlements resetting the transfer pricing environment. Expect to see the introduction of – or the extension of – legislation in 2011 in a number of key jurisdictions (including but not limited to Ireland and Russia). Thin capitalisation – transfer pricing relating to funding structures – is also increasing in importance in many jurisdictions due to an increase in funding activity.
Businesses spend a significant amount of management time in relation to transfer pricing, often engaging advisors to prepare extensive transfer pricing reviews in an attempt to mitigate the impact of a potential transfer pricing audit. However, given the subjective nature of transfer pricing, adjustments may still be sought by tax administrations.
Many tax administrations continue to offer Advance Pricing Agreements (APAs) to help address this problem; these agreements can prevent unexpected transfer pricing adjustments, interest and penalties. Audit sign off, tax provisioning and projections form an important part of the reporting process and we are finding that many clients are responding favourably to the possibility of APAs in relation to intra-group transactions. Certainty rulings of this nature will be a viable option for businesses that are not engaged in aggressive tax planning structures. Some of the benefits include assisting in controlling tax spend, reducing unexpected adjustments, and improving working relationships with tax administrations.
We are already seeing a significant global increase in requests for APA applications in 2011 which demonstrates the importance of transfer pricing certainty.
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