What is this all about?
Multinational groups of companies (MNEs) use transfer pricing between group entities in different jurisdictions to divide their global profit and to minimise their worldwide tax. They try to erode their tax base in high-tax countries by shifting profits to low- or zero-tax countries. There is only one important restriction with which they must comply − MNEs must take into account the arm’s length principle, which means that the conditions for transactions between related entities have to be the same as for the identical or similar transaction between mutually independent entities. MNEs have to provide evidence and document their compliance with this principle in the great majority of jurisdictions around the world in order to avoid the imposition by their local tax authorities of unilateral adjustments leading to tax increases (giving rise to double taxation).
However, due both to the revised OECD transfer-pricing guidelines (by which most nations abide) and to the European Anti-Tax Avoidance Directive (ATAD), tax planning, and certainly transfer-pricing planning will never be the same again. We can seriously talk about a pre-BEPS and post-BEPS period in the tax world.
The action plan against base erosion and profit shifting (‘the BEPS Action Plan’), which was completed at the end of 2016, has resulted in 15 reports. However, these can broadly be summarised in three basic principles: coherence, substance and transparency. Coherence aims to align more closely the various laws of individual countries in order to close loopholes and gaps. The importance of substance can be stated as the fact that profits (and corresponding profit taxes) have to be attributed to the location and jurisdiction where the added value is effectively created. Finally, more transparency at the international level will enable national governments to make a better analysis of MNEs’ facts and figures, allowing them to make companies pay their ‘fair share’ of tax in each country.
The transparency aspect contains a complete chapter (Action Plan 13), dedicated to transfer-pricing documentation. It makes recommendations to tax authorities and multinational enterprises on how to document the way that they have arrived at the arm’s length prices of their intercompany transactions, using a master file and a local file. For groups of companies exceeding the turnover threshold of EUR 750 million, there has been the introduction of mandatory country-by-country (CbC) reporting. The CbC report has to contain information such as aggregated profit, taxes paid and accrued, cash flow, group investments and the number of employees in each country where the group does business. Moreover, the most important functions of each legal entity or permanent establishment must be explained. Additional information concerning the group’s activity and the interaction between group members is also required. This three-tier set of documentation has to be provided to the local tax authorities of the ultimate parent company. These local tax authorities are then supposed to share this information with the other countries where the group has legal entities. Over 100 tax authorities have already signed an agreement committing them to exchange this type of information.
Disclosure of this information will also mean that national governments will gather a great deal of additional information, giving them a very good insight into where profits are made and taxes are paid. Each concerned government will inevitably try to have its own piece of the cake, and taxpayers will have to defend their transfer-pricing strategy on various fronts. Taxpayers will have to ensure that these three sets of documents (local file, master file and CbC report) tell a consistent story – thorough preparation on a global scale preparation will be crucial to avoid problems with local tax audits and reduce the compliance cost.
Action Plans 8, 9 and 10, for their part, are completely dedicated to the technique of transfer pricing. The transfer-pricing guidelines have been refined, partially rewritten, and supplemented with many examples. As a Belgian tax inspector has recently commented, tax authorities have been given a strong weapon against profit shifting and base erosion in their countries.
Action Plans 8, 9 and 10, for their part, are completely dedicated to the technique of transfer pricing. The transfer-pricing guidelines have been refined, partially rewritten, and supplemented with many examples. As a Belgian tax inspector has recently commented, tax authorities have been given a strong weapon against profit shifting and base erosion in their countries.
Another point concerns risk identification. Entities bearing greater risks expect greater profit and in fact are entitled to all residual profit in excess of routine profits. A complete chapter is dedicated to an approach for risk analysis, referring to the importance of people functions, the financial capacity for assuming the risks and the detection of who is responsible for the consequences of functions and capacity.
Consideration is given to specific subjects such as ‘location savings’, ‘group synergies’ and ‘commodity transactions’. Even with recent clarifications in the guidelines, however, all these items continue to be difficult to apply, often come into dispute and will continue to add to uncertainty.
However, the part of the action plan describing how to deal with intangibles is much clearer and is punctuated with plenty of examples. Intangibles are a frequent means of profit shifting to low-tax jurisdictions and the new guidelines are aimed at tightening or even rewriting the rules of the game drastically. Under the guidelines, mere legal ownership should give the legal entity concerned no rights to any profits from the intellectual property, but the entity that performs the DEMPE functions (development, enhancement, maintenance, protection and exploitation), the entity that controls the important economic risks (and has the financial power to assume this risk) and the entity that effectively embeds the assets, should be entitled to a return in proportion to their contribution to the value of the property. Hard-to-value intangibles (are there any other?) whose valuation is based on financial projections that are uncertain at the time they are made, may under certain conditions and circumstances be challenged ex post by tax auditors. It is at this juncture also that one may expect further disputes between taxpayers and the tax authorities.
Finally, the OECD’s point of view on low-value-added intragroup services, proposing cost plus 5% as a safe harbour, seems at first sight a relief from the hundreds of pages of technical descriptions. However, taxpayers had better be on their guard since it is quite likely that many countries will have their own differing opinions on the deductibility of management fees and HQ expenses.
Initially the BEPS Action Plan was intended to attack the big players such as the Apples, Googles, and Starbuckses of this world. It served to analyse and disclose the international structures MNEs used to minimise tax (considered as a cost) using ingenious and creative techniques, only accessible for groups of a critical size. However, pressure from public opinion, NGOs and tax authorities has led to a great increase in its scope so that all MNEs are now facing a new corporate social responsibility, in particular of paying their ‘fair share of tax’, however that may be determined.
As a worldwide network of consultants, mainly advising small and medium-sized companies, we are well placed to guide you how to behave in this post-BEPS world. We are convinced that mid-tier groups operating internationally may also benefit from optimising their structures and transfer-pricing policies within the framework of this new reality. As the documentation for an international group has to be in proportion to its size, Moore Europe offers its clients a ‘hands on’ and customised transfer-pricing solution.
We hope you will find the contents of this Transfer Pricing Brief useful.
