Certified tax advisor and dedicated tax expert with a focus on and experience in multinational group tax, transfer pricing, VAT and tax technology. Background in business, law and IT and keen to combine those fields.
The role of ICAP in transfer pricing
February 19, 2024
Experts are highlighting how the International Compliance Assurance Programme (ICAP), facilitated by the Organisation for Economic Co-operation and Development (OECD), can add value to multinational enterprises (MNEs) that are seeking to align their transfer pricing strategies with global tax administrations.
In a recent article in the International Tax Review, Martin Bonner, transfer pricing expert at Area Bollenberger and member of the Kreston Global network, sheds light on the significance of the ICAP’s role in transfer pricing.
ICAP’s role in tax compliance
ICAP represents a voluntary, multilateral framework designed to enhance early engagement, transparency, and mutual understanding between multinational enterprises (MNEs) and tax authorities, particularly regarding transfer pricing.
Understanding ICAP’s impact on transfer pricing
The programme’s value, highlighted by Martin Bonner and other experts, lies in its capacity to encourage proactive dialogue between businesses and tax administrations. It enables a coordinated assessment of tax risks, allowing companies to confidently demonstrate their compliance with tax regulations. This proactive engagement aims to preemptively resolve potential disputes, enabling MNEs to present well-substantiated transactions and foster a mutual understanding of transfer pricing methodologies.
Challenges for MNEs
MNEs encounter challenges in aligning with the diverse expectations of tax authorities across jurisdictions. ICAP aids in facilitating a multilateral dialogue to harmonise transfer pricing methodologies and practices.
The significance of ICAP in international taxation
Martin Bonner emphasises ICAP’s role in providing assurance and a mechanism for risk assessment to participating MNEs. Nonetheless, the absence of legal certainty, in contrast to Advanced Pricing Agreements (APAs), warrants careful consideration by companies.
As the global tax landscape evolves, the importance of ICAP in fostering constructive dialogue and understanding between MNEs and tax administrations is clear. The programme offers a route towards more transparent and harmonious transfer pricing practices, within its limitations and the strategic approaches of participating companies.
The future of ICAP
While ICAP has had successes, with 20 cases completed and more underway, the limited capacity of tax authorities and the programme’s voluntary nature raise concerns. Tax experts, including Martin Bonner, acknowledge ICAP’s potential in enabling MNEs to proactively demonstrate compliance and resolve disputes, yet they also highlight its limitations.
For more advice on the ICAP’s impact on transfer pricing, please get in touch.
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Mark Taylor
Head of International and Tax Director, Duncan & Toplis, Chair of Kreston Global Tax Group
Mark is a Duncan & Toplis’s Management Board member and head of tax advisory services, covering all of their 11 offices. Mark has particular expertise in international structuring and corporate and property taxes. Mark is head of international tax for the firm while also heading up their corporate and business tax group and property tax departments. He has extensive experience of tax planning and due diligence having worked on many large property transactions, corporate restructures, acquisitions and disposals. Mark thrives on adding value to his clients and having a great team culture. Mark was made Chair of the Global Tax group at Kreston in June 2020.
Mark Taylor, Chair of the Kreston Global Tax Group, provides a critical analysis for FT Adviser on the OECD’s guidance regarding “amount A of Pillar 1”. He explores the Organisation for Economic Co-operation and Development’s (OECD) guidance on a new “Multilateral convention to implement amount A of Pillar 1”. This is a component of the OECD’s wider base erosion and profit shifting (BEPS) project, specifically designed to address tax challenges from the digitalisation of the economy. Amount A aims to redistribute taxing rights to ensure multinational corporations (MNCs) pay taxes where their customers are, rather than solely where they are tax residents.
The introduction of a multilateral convention
This framework introduces a pivotal shift in international tax policy, requiring multinational corporations (MNCs) to align tax contributions with the location of economic activities and value creation. It moves away from the traditional tax residency model, placing a greater tax obligation on MNCs in the countries where they generate profits through consumer engagement.
The OECD guidance signifies progress in the desire to implement Pillar 1, although the Multilateral Convention (MLC) required for its enactment is not yet in force.
The BEPS regime: Objectives and outcomes
The BEPS initiative combats tax avoidance strategies that exploit gaps in international tax rules, which the OECD estimates to cost up to $240 billion annually in lost revenue. Pillar 1 affects the largest and most profitable MNCs, proposing to reallocate a portion of their profits to the countries where they engage in business. Meanwhile, Pillar 2 targets a broader range of companies, imposing a minimum corporate tax rate of 15%.
The commercial impact and strategic response
Taylor highlights the need for MNCs to reassess their tax strategies in light of these developments. Digital businesses, despite their lack of physical presence in some jurisdictions, must comply with the tax laws where their users are based. This evolution in tax regulation could increase tax liabilities and compliance costs, especially for small and medium-sized enterprises (SMEs) that operate internationally on tighter budgets.
Tackling avoidance and embracing compliance
The OECD’s 15 actions provide a framework to standardise compliance and empower governments to prevent tax avoidance. These include ensuring taxation in the digital economy, countering hybrid mismatch arrangements, defining controlled foreign companies (CFCs) and their taxation, targeting preferential tax regimes, closing loopholes in tax treaties, and aligning transfer pricing with value creation.
Preparing for the BEPS shift
MNCs, and the SMEs affected indirectly, must now engage with international tax advisers to navigate this complex landscape. Advisers will play an essential role in restructuring business models, assessing global tax risk, and developing transfer pricing policies that conform to OECD guidelines. Non-compliance risks severe penalties, but thorough preparation can enhance visibility into a company’s operations and effective global tax rate.
The future of international taxation
The push to reform international tax laws to reflect the modern digital and globalised economy will undoubtably affect all businesses with cross-border activities. While the full implications of these reforms are still unfolding, they signal a firm commitment from policymakers to adapt international tax frameworks to modern economic realities. These changes are not limited to the largest corporations; any business with cross-border sales must adapt. With professional guidance, businesses can position themselves advantageously for these shifts in global taxation.
If you would like to speak to one of our global tax experts, please get in touch.
Biljana Sparavolo is the Head of Transfer Pricing at Kreston MDM in Serbia. With a robust career spanning over a decade, Biljana has developed extensive expertise in transfer pricing, financial audit, financial controlling, and corporate reporting. Before her current position, she worked as Financial Controller at both Adria Media and Nexe Group.
The impact of outsourcing on transfer pricing in Eastern Europe
January 12, 2024
Businesses should be aware of the impact outsourcing can have on transfer pricing in Eastern Europe. In a post-COVID world, a remarkable shift is underway as 77% of European countries opt to outsource within the continent. This move aims to fortify the global value chain (GVC) and reduce over-reliance on traditional outsourcing partners like China and Russia.
The spotlight is now on Eastern Europe, prompting questions about its potential to capitalise on this emerging trend and the intricate transfer pricing challenges that lie on the horizon. We spoke to Biljana Sparavalo, head of transfer pricing at Kreston MDM in Serbia, to unravel the nuances of this evolving landscape.
Benefits of European outsourcing: A win-win for accountants and clients
From an accountant’s perspective, outsourcing to Eastern Europe presents an array of advantages. Primarily, it offers cost-effectiveness and enhanced profitability, as labour costs in these regions are notably lower than in Western countries. This enables accountants to access and onboard new team members with specialised skills and knowledge that might be scarce in-house. Flexibility and scalability also contribute to the allure of outsourcing, empowering accountants to navigate varying workloads and adapt to changing demands more efficiently.
For clients of accountants, the benefits are equally compelling. Outsourcing translates into potential cost savings, which can lead to reduced accountancy fees. Clients can still expect high service quality due to the access to skills and modern technologies offered by the outsourcing team. The direct infusion of expertise and diverse perspectives brought by outsourced teams can significantly enhance the client experience. Furthermore, outsourcing can usher in innovative practices and technologies, contributing to improved service delivery.
However, while the advantages are significant, the actual benefits of hiring a European outsourcing partner may vary based on factors such as compliance, data protection, quality control, and cultural and language diversities.
Signs of the shift: Businesses moving towards Eastern Europe
“Before businesses embark on outsourcing in Eastern Europe, they typically explore opportunities in the region”, notes Sparavalo. A noticeable increase in collaborations and partnerships between businesses and European outsourcing companies serves as a tangible sign of this shift. This can be observed through official announcements, press releases, and discussions at industry events.
An additional indicator is the active participation of business representatives in conferences, forums, and industry events hosted in Eastern Europe. This demonstrates a palpable interest in leveraging the local outsourcing options available. Expansion strategies, including the opening of offices or expanding existing ones in Eastern European countries, further underline a commitment to establishing a physical presence that facilitates outsourcing activities.
Strategically, businesses align their service offerings with the strengths and specialisations of outsourcing entities in Eastern Europe. This includes areas such as IT services, software development and customer support. Investment patterns may also shift as businesses allocate funds towards infrastructures that support remote collaboration, showcasing their readiness to work seamlessly with teams spread across regions.
Companies engaged in outsourcing exploration often conduct consultations and market research specifically focused on Eastern Europe. Proactive measures such as adapting business operations to incorporate languages commonly used in the region and an increased emphasis on social responsibility initiatives illustrate a commitment to understanding and navigating the local outsourcing landscape effectively.
Opportunities for Eastern European businesses
For businesses in Eastern Europe, this paradigm shift represents a golden opportunity to actively participate in the global outsourcing market. The region’s strengths lie in its multilingual workforce, shared time zone, cost-effectiveness, and highly educated talent pool. Eastern Europe has become renowned for its expertise in the IT and technology sectors, making it a hotspot for outsourcing contracts in software and web development, as well as IT support.
The potential for European businesses to excel in outsourcing is not just limited to cost-effectiveness but extends to their commitment to delivering high-quality services. To fully capitalise on this opportunity, businesses should strategically develop their expertise to align with changing client needs. A strong focus on marketing and branding to showcase achievements and unique selling points becomes paramount.
Continuous learning and improvement, coupled with staying abreast of industry practices and trends, can make businesses more competitive. Establishing an industry presence through networking is also crucial. Active participation in conferences and engagement with clients and partners contribute significantly to achieving this goal.
Infrastructure also requires attention as businesses must ensure they have the technological and physical resources to deliver high-quality services. Implementing processes that demonstrate a commitment to providing services, flexibility and customisation can further enhance the appeal of the business. Building trust is of utmost importance when handling outsourcing projects involving confidential information. Developing a culture centred around client satisfaction and long-term relationships becomes a strategic approach in this context.
Key transfer pricing regulations in Eastern Europe
“While the rules for transfer pricing in Eastern Europe generally follow the standards set by the OECD, it’s crucial to recognise that specific laws can vary from country to country within the region”, says Sparavalo. A comprehensive understanding of the common aspects and essential regulations is pivotal for businesses navigating the complexities of transfer pricing laws in European countries, she notes.
Documentation requirements: ● Country-by-Country Reporting (CbCR): Multinational enterprises (MNEs) might be required to submit CbCR based on OECD guidelines. ● Local file and Master file: Companies may need to prepare documentation, including a detailed record of transaction-level transfer pricing (local file) and an overview of global business operations (master file). Arm’s length principle Transactions between related entities should be analysed at ‘arm’s length,’ meaning that the prices should be consistent with what would be agreed upon between unrelated companies.
Pricing methods
Regulations typically allow for various methods to define the arm’s length price, such as Comparable Uncontrolled Price (CUP), Resale Price Method (RPM), Cost Plus Method, and Transactional Net Margin Method (TNMM).
Advance Pricing Agreements (APAs)
In some countries, businesses may have the opportunity to make Advanced Pricing Agreements (APAs) with tax authorities. APAs enable taxpayers and tax authorities to agree on the methodology for determining transfer pricing, avoiding disputes in the future.
Resolving disputes
Various countries have established mechanisms for resolving transfer pricing disputes, including agreement procedures (MAP) with other nations.
Consequences of non-compliance
Not adhering to transfer pricing regulations can lead to penalties. The severity of consequences depends on the nature of non-compliance.
Documentation thresholds
Certain criteria may exist to determine which entities are obligated to adhere to documentation requirements.
It’s important to note that the development stages of transfer pricing regulations still vary in Eastern European countries, and practices differ. Therefore, conducting individual assessments in each country is advisable.
Common transfer pricing challenges faced by companies in Eastern Europe
Companies operating in Eastern Europe encounter a range of transfer pricing challenges that mirror the intricacies of the business landscape and regulatory characteristics of the region. One major hurdle is the complexity and variability of regulations. Each European country having its own tax laws means that businesses must carefully align their operations with numerous jurisdictional requirements.
In terms of documentation and compliance, companies bear the responsibility of maintaining accurate records to support their transfer pricing strategies. They must navigate through reporting requirements imposed by countries, presenting an added layer of complexity. Accessing comparable data is another significant obstacle, as relevant financial information or transactions for validation purposes can be challenging to find.
Regional economic climates introduce an additional layer of complexity, as market conditions and currency fluctuations impact border transactions and the determination of transfer prices.
To successfully manage these challenges, companies should consider leveraging the expertise of transfer pricing consultants.
Investing in solutions, continuous learning, and proactive risk management tailored to their industry and the unique transfer pricing landscapes in the Eastern European jurisdictions they operate in can also be instrumental.
Adaptation and awareness: Navigating the changing landscape
In conclusion, when dealing with transfer pricing in Eastern Europe, companies need to adopt a flexible mindset and thoroughly understand how local regulations and economic conditions can affect their finances. Keeping up with updates in transfer pricing rules and engaging with tax authorities are imperative steps.
The outsourcing landscape in Eastern Europe presents not just challenges, but substantial opportunities for businesses and accountants alike. Successfully taking part in this evolving trend requires strategic planning, a commitment to learning, and a proactive approach to region-specific transfer pricing challenges.
By embracing these principles, companies can navigate the changing landscape and leverage outsourcing to their advantage.
Certified tax advisor and dedicated tax expert with a focus on and experience in multinational group tax, transfer pricing, VAT and tax technology. Background in business, law and IT and keen to combine those fields.
Nearshoring in Europe: Protecting value chains
January 11, 2024
Nearshoring in Europe has become a trend since COVID, as companies grapple with strategic shifts and challenges in the global business landscape and bring operations closer to home. Amidst the complexities of international trade, transfer pricing emerges as a critical aspect that demands careful consideration. Martin Bonner, partner at AREA Bollenberger in Austria, shares his insights into the trends, challenges, and recommendations shaping the world of transfer pricing and cross-border operations.
Supply chains and a shift towards Europe
In recent years, a notable trend has emerged among multinational corporations seeking to safeguard their value chains. Martin Bonner sheds light on this shift, “Companies are increasingly practising nearshoring where feasible. Reasons include ensuring supply chain security, compliance, and cultural aspects.”
The motivation for this move is multifaceted. Supply chain security, compliance considerations, and cultural compatibility are key drivers. However, the shift is challenging. Bonner acknowledges challenges such as the availability of European suppliers and the persistent need to source from regions like Asia due to cost considerations. “If sourcing from the Far East proves significantly cheaper, it remains a viable option,” notes Bonner, pointing to regulatory measures like the Carbon Border Adjustment Mechanism (CBAM), prompting a shift towards EU sourcing to sidestep compliance and import costs.
Transfer pricing dynamics
The relocation of production from Asia to Eastern Europe brings new opportunities and challenges in transfer pricing. Bonner explains, “Transfer pricing setups generally simplify when production shifts from Asia to Eastern Europe.”
However, the simplicity comes with a caveat. Tax audits in the Far East often deviate from understanding European transfer pricing regulations, raising the spectre of double taxation. Bonner emphasises the importance of assessing transfer pricing setups locally in all regions involved.
Bonner highlights the value of leveraging the Kreston network to mitigate this risk. “Our Kreston network is beneficial, with local transfer pricing experts reducing the risk of double taxation,” he states, underlining the significance of a global support system in navigating the intricacies of cross-border operations.
The evolving business landscape in Austria
Reflecting on the past 12 months, Bonner observes a shift in the dynamics for international clients doing business in Austria. “Compliance work has increased, and economic, geopolitical, and global political risks have led to a decreased willingness to invest,” he notes. Investments, when made, are now more strategically focused on domestic or closer markets, mirroring a trend of risk aversion and heightened scrutiny in the current geopolitical climate.
Proactive measures for international businesses: Advice for 2024
As businesses contemplate expansion into Austria in 2024, Bonner offers a comprehensive set of recommendations. “Our experience shows that even smaller companies are increasingly subject to transfer pricing audits,” he warns. Bonner stresses the importance of proactive engagement with tax aspects from day one, encompassing transfer pricing and withholding tax, VAT, customs, and the implications of regulatory measures like CBAM.
“With the extensive resources and expertise of the Kreston network at our disposal, we are well-equipped to provide top-tier services addressing all these aspects,” assures Bonner. His advice underscores the necessity for a holistic approach and strategic foresight to navigate the intricate web of cross-border business operations. As businesses chart their course through the challenges and opportunities of international trade, insights from experts like Martin Bonner offer a valuable compass, guiding enterprises towards success in an increasingly complex global landscape.
David heads the Transfer Pricing Practice at CBIZ and offers guidance on transfer pricing and tax valuation, boasting over 17 years in the domain, mainly with prominent international accounting firms. His expertise spans transfer pricing planning, intellectual property valuation, financial modelling, and more, serving industries from oil and gas to software and tax-exempt organisations.
Identifying transfer pricing risks in the digital economy
August 18, 2023
Sector:Technology, Media & Telecom
A global economy means hard borders are less visible, creating a sense of ambiguity around regulatory obligations and defining where the value of a digital product begins, subsequently identifying transfer pricing risks in global business operations even more challenging. David Whitmer, National Transfer Pricing Leader at CBIZ and Kreston Global Transfer Pricing Chair explores this emerging challenge in an article on Corporate Compliance Insights.
Understanding existing Transfer Pricing obligations
At its core, transfer pricing sets the rates charged in transactions between related enterprises, like parent companies and their subsidiaries or between different units of a business. The aim? To prevent firms from transferring profits to low-tax jurisdictions, ensuring that taxes align with the actual business activities in a given nation.
The underlying principle is the “arm’s length principle,” which means that transactions between related parties should yield a tax outcome akin to what would have been realised if unrelated parties had conducted a similar transaction.
It’s applicable to tangible transfers like physical goods, intangible transfers like intellectual property, service transactions such as R&D or marketing services, and even financial arrangements.
The impact of the digital economy on Transfer Pricing
Selling goods or offering services used to require a tangible, local presence. However, today’s digital revolution has reshaped the business model. The rise of online storefronts, centralised global warehouses, and ubiquitous smartphone apps exemplifies the shift.
With the advent of technologies like the Internet of Things (IoT), big data analytics, AI, and blockchain, significant profits are now realised from digital avenues. And with remote work and cloud technology, the very definition of service delivery and sales locations is being redefined.
Given these nuances, businesses need to be vigilant and proactive to ensure they remain on the right side of compliance.
The impact of OECD regulations
The loss of tax revenues, estimated between $100 billion and $240 billion annually from profit manipulation, has spurred the Organisation for Economic Co-operation and Development (OECD) into action. They’ve spearheaded the BEPS (base erosion and profit shifting) initiative, with a 15-point action plan and a dual-pillar framework.
Key points include:
Item 1: Targeting proper taxation of digital enterprises, even if they lack a physical presence in the profit-generating jurisdiction. Item 8: Focusing on the challenge of valuing intangible assets to deter their shifting within a corporate group.
Evolution has brought about BEPS 2.0, with Pillar 1 being particularly significant for transfer pricing. It emphasises taxing MNEs (multi-national enterprises) in the markets they operate and generate revenues, even if there’s no direct physical presence.
Though the OECD has set transfer pricing guidelines, countries might have varied interpretations. The sporadic emergence of digital service taxes (DSTs) in various nations adds another layer of complexity, raising concerns like double taxation. Yet, with the onset of Pillar 1, DSTs are predicted to phase out. Presently, over 135 countries have embraced the two-pillar plan.
Critical steps for MNEs
As the business terrain morphs, digital-first entities must comprehend their standing, anticipate the determinants of transfer pricing across their expanse, and refine their operations. Miscalculations can lead to unwanted income adjustments, tax increments, interests, and penalties. For rigorous planning, MNEs ought to:
Revisit policies and craft best practices: MNEs must question the relevance and soundness of their current transfer pricing strategies. Does the documentation justify and support the present approach? Do the inter-company deals need recalibration?
Execute a compliance cost analysis: While compliance demands financial resources, the consequences of non-compliance could be pricier. Thus, shaping transfer pricing blueprints should pivot around decisions that skillfully and economically minimize risks.
Pinpoint value creation: Recognising the ramifications of digital transformation on the company’s value chain is paramount. This ensures that profit distribution mirrors the tangible economic results of diverse business activities.
Determine IP jurisdiction: Discerning which entity within the group owns the rights to digital-born intangibles and their geographic locations can significantly influence transfer pricing. Additionally, firms should deliberate if transferring IP ownership internally is strategic.
Strategise organisational structures: Companies should consider structures like on-ground representative offices, which can facilitate local regulation compliance. Alternatively, establishing a resale entity could be beneficial in managing risks associated with permanent establishments and transfer pricing adjustments. Contemplating cost-sharing arrangements, where the expenses tied to intangible assets are divided among associated bodies, is another avenue to explore.
Beyond these considerations, numerous queries arise. How should the value contributions of remote employees, who service multiple territories, be distributed? How are innovative technologies like AI, VR, and automation influencing revenue streams? How is data acquisition shaping value delivery? The considerations are myriad.
In essence, for MNEs that offer services and goods globally, perfecting transfer pricing strategies to ensure continual compliance with both global and local regulations is vital, albeit daunting. To determine the value of intangible assets and establish apt transfer pricing approaches, extensive analysis, modelling, and benchmarking are typically essential.
What’s evident is that methodologies, which were conceptualised over a century ago for conventional businesses, now demand reinvention for the digital age. This era presents a heightened challenge for transfer pricing and companies should remain proactive and adaptable in strategising to retain resilience.
Get in touch with one of Kreston Global’s transfer pricing experts today.
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A guide to setting up a business in Italy
August 3, 2023
Kreston TDL Italy, a member of Kreston Global’s international network, has created a detailed 128-page guide to setting up a business in Italy. This guide is for anyone investing in Italy, to help you navigate the Italian business landscape.
The guide offers an in-depth analysis of various aspects integral to operating a business in Italy. It begins with an introduction to the country’s corporate and legal structures, including an exploration of different business entity forms. Subsequent sections delve into setup and liquidation procedures, the intricacies of mergers and acquisitions, and the responsibilities arising from corporate criminal liability.
Understanding taxes in Italy
Kreston TDL’s guide shines a light on Italy’s complex taxation system. Covering corporate taxes, business income, VAT, and individual income taxation, the guide provides an exhaustive exploration of main incentives, anti-avoidance measures, and withholding taxes. It also presents in-depth knowledge on VAT registration, returns, deductibility, and the mechanisms behind international supplies of goods and services.
Business laws in Italy
The guide further examines various legal aspects like customs, excise, import VAT, accounting procedures, filing requirements, and audit systems. In addition, it offers comprehensive advice on potentially challenging areas like transfer pricing, bankruptcy, reorganisation, debt restructuring procedures, and employment laws.
Local experts
The guide offers you invaluable technical insights from Kreston TDL’s team of experts, to help you make informed decisions and save time and money setting up a business in Italy correctly.
Established in 1985, Studio TDL is an independent Italian firm that specialises in tax, corporate and labour consultancy, and administrative outsourcing services. With a team of Certified Accountants, Statutory Auditors, and Labour Consultants, the firm caters to multinational companies and groups, capitalising on its long-standing relationships with major international professional firms.
The quality of Studio TDL’s services is driven by the team’s high level of expertise. They offer a wide range of services in tax, corporate, accounting, and labour matters, serving both local and international clients. This is supported by the latest methodologies and a vast network of international relations.
Studio TDL’s professionals are active contributors at conferences and trade magazines and are members of study commissions set up by relevant professional institutes in Milan. This engagement, alongside their in-house Study Centre, allows them to maintain current knowledge and develop best practices. As such, they can provide reliable support for even the most complex operations. Their in-depth understanding of the Italian business environment makes Studio TDL a go-to source for business setup and operations in Italy.
The impact of digital disruption on transfer pricing
January 26, 2023
Digital disruption and a global economy have caused a profound shift in the way companies conduct global business operations. Businesses are facing challenges in terms of transfer pricing, particularly when it comes to international transactions. David Whitmer, national transfer pricing lead at CBIZ MHM and Chair of the Kreston Global Transfer Pricing Group and Ganesh Ramaswamy, Partner at K Rangamani and Associates LLP, Global Tax Group Regional Director, Asia Pacific were invited to comment on these developments by the International Accounting Bulletin. Read the full article here, or the summary below.
Digital disruption and Big Data
The digital revolution is having a profound effect on how business enterprises function, replacing physical systems with those in cyberspace. This has completely changed the way companies interact with their customers, introducing ways to analyse their behaviour and preferences online. These insights are being used to innovate value chains and develop more appealing customer propositions and revenue streams.
Cloud computing, AI, blockchain, the Internet of Things, VAR and automations all offer organizations the potential to optimize operations, increase customer engagement, and drive cost savings with Big Data, providing valuable details regarding what is succeeding and failing in the marketplace.
Businesses have been using Artificial Intelligence as a means of improving their digital marketing strategies. By using AI for forecasting demands, customer profiling and enhancing customer experience, companies are able to generate higher brand recall rates.
Businesses that embrace digital transformation will take advantage of automation, cost efficiency and advanced safety measures.
Digital disruption and transfer pricing
The repercussions of digital transformation are far-reaching and have implications for transfer pricing. Technologies such as artificial intelligence, robotics and blockchain have changed how businesses interact and transact with one another, which has had a considerable effect on the approach to transfer pricing.
Tax regulators around the world have expressed worry about systems that fail to capture profits made through digitizing businesses. Such income is often earned in locations where firms don’t have a physical presence, leaving them free to avoid taxes. The Organization for Economic Cooperation and Development (OECD) has responded with Pillar 1, which will make multinationals pay taxes where they carry on business and bring in revenue. Various nations across Europe, Asia, Latin America and Africa have already adopted Digital Service Tax (DST), taxing the top-line of money made. It’s anticipated that implementing Pillar 1 will lead many countries to discontinue such levies gradually.
Companies from various sectors that are undergoing digital transformation should consider a few essential transfer pricing queries. Questions such as:
Who holds the rights to any valuable intangibles created through digitalisation?
What impact has digital transformation had on the group’s value chain?
The transfer pricing positions are already set up by the multinational group – are they still defensible and supported by the necessary paperwork?
Do you employ remote workers on a large scale? Consider how these individuals make their contribution in terms of services and sales across multiple tax jurisdictions.
Do you have a centralised warehouse system that allows you to serve sales from one location to multiple countries? You need to review any applicable intercompany agreements, making sure they keep up with the changing landscape.
How will you keep up with technology as it is developed within your organisation, as well as its dissemination within the commercial and supply chain networks?
Multinational companies are making use of big data analytics and AI to better their marketing efforts, as well as address and enhance quality control matters and streamline their manufacturing operations. They should record data on how these advancements helped the multinational entity’s revenues. To limit transfer pricing issues in the digital era, they need to know where they acquired this data and how it was integrated into technical progress.
In conclusion, it is clear that there is a significant enough impact on tax obligations for global and digital businesses to understand their position and what will affect transfer pricing across their business.
To speak to one of our transfer pricing experts, get in touch.
News
Kreston Global announces new Global Transfer Pricing Group
September 15, 2022
New group to be made up of specialists from across the network
LONDON – Kreston Global today announces its new Global Transfer Pricing Group, led by US-based David Whitmer. The group, which will form part of the Global Tax Group, will act as a steering group for Kreston Global’s transfer pricing services, ensuring market-leading expertise across the network and creating a network-wide focus for this critical international client service.
David Whitmer leads the National Transfer Pricing Practice at US member firm CBIZ Inc., advising multinational clients on solutions to transfer pricing and tax valuation issues. He has more than 20 years’ experience in transfer pricing consulting, in sectors including oil and gas, finance, chemicals, pharmaceuticals, software, manufacturing, multilevel marketing, service providers and tax-exempt organisations.
The new group brings a wealth of experience from across the network. It includes Jorge Oropeza of Kreston BSG in Mexico, Amit Ajmera of Kreston SNCO in India, Radhika Seth of MMJS/Kreston Menon in the UAE, Victor Matesanwa of Kreston Zimbabwe, Agnieszka Janeczek of EXCO Poland and Yiwen Ping of Zhonghui in China.
David Whitmer, Chair of the Global Transfer Pricing Group at Kreston Global said:
“The growing prominence of transfer pricing is clear to see on a global level, and the creation of the Global Transfer Pricing Group will ensure that our transfer pricing clients’ needs are met with the utmost quality and care. I welcome the opportunity to work alongside international colleagues in this field to bring the best service possible to our transfer pricing clients everywhere.”
Mark Taylor, Head of the Global Tax Group at Kreston Global said:
“The creation of a Global Transfer Pricing Group marks a key moment for the development and growth of our services in this area, which have gone from strength to strength in recent years. I would like to thank David for his work to date in spearheading our global transfer pricing practice, and to thank the wider Global Transfer Pricing Group team for their involvement in this exciting new initiative.”
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Mr Keat Heng
Audit Partner, Kreston Cambodia
KeatHeng, ACCA, CPA has more than 17 years of experience in tax & accounting consulting services with international accounting firms including transfer pricing documentation, property valuation, business risk assessment, financing arrangement, M & A engagement, and cross border tax & accounting assignment.
Ms Haing Sivtieng
Tax Director, Canadia Bank
Haing Sivtieng, MBA, CAT has been involving in tax and accounting services for more than 10 years with international tax, annual income tax, VAT, Withholding taxes, M & A and cross border assignment. She received her Certified Accounting for Technician from ACCA, UK and got a Master in Finance from the Nantes University of France. She speaks fluently in Chinese and English.
Transfer Pricing in Cambodia
September 12, 2022
In Cambodia currently, some of the most pressing corporate issues are in the area of transfer pricing risk. Those risks are mitigated through understanding, planning, and compliance with tax regulations.
Taxpayers already face problems in the areas of intra-group sale and purchase transactions, related parties’ loan, salary and rental rates which often result in tax reassessments by the tax officer.
In 2017 Ministry of Economic & Finance issued Prakas on Determination of Revenue & Expenditure of Related Parties which covered arm’s length analysis, arm’s length range, methods that apply to arm’s length transaction, intra group services, and documentation.
Kreston Cambodia can help clients with:
Developing your transfer pricing methodologies in accordance with tax regulations.
Benchmarking processes for both internal and external information.
Preparing documentation for transfer pricing to comply with tax regulations.
Performing analysis and modelling of intercompany services.
Consulting financial instruments benchmarking such as the arm’s length interest rate.
Transfer Pricing Manager with CBIZ’s National Transfer Pricing Practice.
OECD Transfer Pricing Guidelines
July 20, 2022
CBIZ Transfer Pricing experts, Srinidhi Tuppal and Ava Colocho were recently invited to share their expertise with International Accountant magazine on the most recent developments from the OECD 2022 update and the impact that has globally on transfer pricing.
OECD and the policy impact
For any multinational business, the inclusive framework and the 15-point action plan will have already had a significant impact on any existing transfer pricing/tax planning strategy. The recent article by Srinidhi and Ava gives readers an overview of the progression of the policy that impacts transfer pricing and outlines the specific impact of the new 2022 updates compared to the 2017 policy.
OECD 2022 updates
There are three main updates to the policy;
Revision to the transactional profit split method
Revision to the hard-to-value-intangibles (HTVI)
Transfer pricing guidance on financial transactions
The three new reports were developed in 2017 and the 2022 update clarifies points made in these reports, specifically;
The appropriate application of the transactional profit split method
Ex-post outcomes as presumptive evidence about the appropriateness of the ex-ante pricing arrangements, aiming to reach equitable practice of application of adjustments, to improve consistency and reduce the risk of double taxation.
OECD 2022 update takeaways
MNE should update their transfer pricing policies to reflect the new OECD policies, testing the processes used to determine the unique and valuable contributions provided by the parties and during the selection of an appropriate method. In addition, the risk of double taxation as a result of the updated HTVI policy is critical for effective tax planning.
David Whitmer has more than 20 years of experience in transfer pricing consulting services, primarily with large international accounting firms, covering transfer pricing planning, intellectual property valuation, financial modelling, and transfer-pricing disputes in a number of industries, including finance, chemicals, pharmaceuticals, software, manufacturing, services and tax-exempt organizations.
Transfer Pricing FAQs
April 22, 2022
Sector:Finance
What is transfer pricing?
In simple terms, transfer pricing is the process of setting the prices charged between associated enterprises in cross-border transactions, which can involve transfers of tangible goods, services, and intangible property, as well as financing transactions.
When a cross border transaction occurs between associated enterprises, tax administrations in the respective countries are especially interested to ensure that the taxable profits of multi-national enterprises (“MNEs”) are not artificially shifted out of their jurisdiction and that the tax base reported by MNEs in their country yield results that are consistent with the economic activity undertaken and the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances.
What are the rules?
Each country has different transfer pricing rules, so it is important to speak to a country tax specialist to make sure you are following local country requirements. With only a few exceptions, most countries’ transfer pricing rules are based on the “arms-length” principle, where pricing between associated enterprises should reflect the prices that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances
The OECD has also published transfer pricing guidelines (“OECD Guidelines”) here for member countries and cooperating non-member countries to follow. Most countries’ transfer pricing rules are based on the OECD Guidelines, though there may be certain differences in interpretation, application, and administration among countries.
If the transfer price is not arm’s length, the tax administrator has the authority under the tax jurisdiction regulations to make adjustments by reallocating items of gross income, deductions, credits, or allowances in order to properly reflect income between the entities.
What is an example of transfer pricing?
The following case illustrates various examples of transfer pricing related issues:
A MNE group, ValveCo, is in the business of designing, producing, and selling valves. ParentCo is responsible for design, manufacture, and distribution in its territory. SubCo1 operates as a licensed producer in its jurisdiction (Transaction 1). SubCo1 performs certain development work under the direction of ParentCo (Transaction 2). SubCo1 purchases components from ParentCo to be used in its manufacturing process (Transaction 3). SubCo1 relies on ParentCo for certain management and administrative functions (Transaction 4), as well as funding of its operations (Transaction 5). SubCo2 purchases products from ParentCo and SubCo1 for resale to third-party customers in its jurisdiction (Transaction 6).
Who do the transfer pricing rules apply to?
The transfer pricing rules are relevant to MNEs with controlled transactions among associated enterprises in different tax jurisdictions. Uncontrolled transactions do not fall under transfer pricing rules. A transaction is controlled or enterprises are associated if one enterprise participates in the management, control, or ownership of another enterprise, or if the same people or enterprise participates in the management, control, or ownership of two enterprises (i.e., a situation with common ownership).
Are there exemptions?
A growing number of countries are implementing contemporaneous transfer pricing documentation requirements, meaning the transfer pricing documentation has to be prepared prior to the filing of the tax return for a given accounting period. However, certain jurisdictions do provide documentation exemptions for small and medium-sized enterprises. In addition, a handful of other countries do not require contemporaneous documentation. While these exemptions exist, the burden of proof remains with the taxpayer to demonstrate arm’s-length pricing. This supporting information may still be requested during a transfer pricing examination, and the intercompany pricing may be adjusted by the examiner to reflect an arms-length outcome.
How do you calculate transfer pricing?
As noted above, associated enterprises should price transactions in the same way that uncontrolled entities would price the same transactions under similar circumstances. In short, the arm’s-length principle requires the comparison of controlled transactions with uncontrolled transactions. Hence, transfer prices are calculated through “comparability analysis” or benchmarking analysis. Valid comparables or benchmarks may exist as transactions between an associated enterprise and third parties (i.e., internal comparables). Alternatively, external comparables may be applied in the form of external comparable uncontrolled transactions (where none of the parties involved are members of the MNE group) or independent comparable companies that perform similar functions to one of the associated enterprises (i.e., the tested party). Our transfer pricing specialists can evaluate the specified transfer pricing methods and comparability criteria to identify the most reliable transfer pricing approach for a specific client. For external comparables, our transfer pricing specialists have access to specially licensed databases to conduct our benchmarking research. Please contact your nearest Kreston Global office to assist with your transfer pricing compliance needs.
Is transfer pricing tax evasion?
The objective of transfer pricing rules is to prevent MNEs from arbitrarily shifting income to avoid paying taxes. According to the OECD Guidelines, the consideration of transfer pricing should not be confused with the consideration of problems of tax fraud or tax avoidance, even though transfer pricing policies may be used for such purposes. Application of transfer pricing in accordance with the arm’s-length principle and the preparation of supporting documentation is considered to maintain tax compliance and good practice; failure to do so may result in income adjustments, potential double taxation, interest, and penalties.
How can Kreston Global help my company with transfer pricing?
Kreston firms can help support your company to adhere to country-based transfer pricing rules with the following core services:
Develop and/or optimize your transfer pricing methodologies with our planning expertise and benchmarking solutions.
Assist with transfer pricing documentation to ensure compliance with country specific regulations.
Perform analysis and modelling of intercompany services charges.
Perform benchmarking searches for royalty and license agreements, intercompany interest rates and comparable company samples.
Perform valuations of intellectual property and evaluations of migration strategies.
Please search for your nearest Kreston Global office here and they can help signpost you to the countries you need support in.
News
Transfer pricing a priority
October 13, 2021
LONDON – Transfer pricing has been impacted significantly by the pandemic and will be a priority issue for most multinational enterprise clients over the next two years, according to our senior leaders.
A recent poll of 55 international tax specialists from the network found that transfer pricing will be a priority issue for their multinational enterprise clients over the next two years, with 22% of respondents saying that transfer pricing will be their top priority, and 70% saying that it will be a priority amongst others. Only 8% of participants stated that transfer pricing would not be a priority at all and there were zero participants polled who either did not know whether it would be a priority or who did not consider it to be an issue in the first place.
In addition, the poll found that 76% of participants believed Covid-19 had impacted transfer pricing matters for their multinational enterprise clients, of which 11% stated that the pandemic had significantly impacted transfer pricing matters. Only 3% of respondents believed there to have been no impact at all.
To contrast, participants generally believed Brexit to have had substantially less of an effect, with only 5% agreeing that it had significantly impacted transfer pricing matters for their multinational enterprise clients, and 32% believing it to have had a somewhat significant impact. This is compared with 39% of participants stating that it had not very much affected their client’s transfer pricing matters, and 11% stating that there was no impact at all.
“In recent years we have seen transfer pricing matters shift to the fore of many of our multinational enterprise clients’ concerns, and these results reflect that increased prioritisation of these issues across our network. The pandemic, and to a lesser extent Brexit, have further impacted the way that our multinational clients are addressing their transfer pricing issues. All eyes will now be on the world’s progress towards a post-pandemic era, and how that progress impacts the trajectory of domestic and international tax policies.”
News
Transfer pricing issues in the changing global tax climate
The rapidly changing political climate and global tax environment are expected to affect the transfer pricing strategy of multinational entities (MNEs) with related entities worldwide.
The Covid-19 pandemic has caused operational impacts and led to practical challenges in applying the arm’s length principle.
The impact of Brexit is another issue that MNEs have to consider.
With further global corporate tax and transfer pricing changes due from the OECD’s pillar one and pillar two proposals, MNEs should adopt a robust transfer pricing policy and review them periodically to ensure compliance and manage risks.
This article was originally published in Accountancy Daily, view here.
Previously accepted comparables used for establishing a company’s transfer pricing policy might not be comparable due to the impact of the pandemic, warn David Whitmer, transfer pricing practice leader and Srinidhi Tuppal, transfer pricing manager at Kreston Global.
With only over 13% of the total world population fully vaccinated against the Covid-19 virus, the world economy is struggling to recover from the impact of the pandemic. As businesses grapple with employee retention, government restrictions, and other safety compliance issues, multinational entities have additional considerations concerning their cross-border transactions and taxes.
While ensuring the arm’s length standard is the mantra of transfer pricing, finding real-world data to support an arm’s length valuation for its related party transactions that are regional, functionally comparable, and at a similar stage in the pandemic might be challenging.
Due to the lack of comparables in similar industries, multinationals sometimes rely on companies that perform similar functions, eg, distribution, manufacturing, or sales and marketing functions, to determine the arm’s length range. Previously accepted comparables used for establishing a company’s transfer pricing policy might not be comparable due to the impact of the pandemic.
On 18 December 2020, the OECD published its guidance on the transfer pricing implications of the Covid-19 pandemic, intending to aid the tax authorities and taxpayers dealing with complexities due to economic uncertainties caused by the pandemic. The OECD guidelines provide clarifying comments and examples for comparability, losses, government assistance, and agreements.
For a tested party performing a distribution function, the transfer pricing analysis might include distributors from other industries performing similar functions in its set of comparable companies. While almost all industries faced supply chain disruptions, not all industries were negatively impacted by the pandemic.
According to an analysis by S&P Global, industries that were significantly affected include airlines, restaurants, clothing and home furnishing retailers. Construction industries were positively impacted, and steel and timber prices are at a record high. However, restaurants and other leisure hospitality industries struggle to keep their businesses open. A manufacturer tested party should factor in domestic circumstances, including shutdowns and labour availability, while considering companies for comparability analysis.
Allocating pandemic losses to limited risk distributors or contract manufacturers that are expected to earn a specific rate of return could raise a red flag to the tax authorities (since the entrepreneurial entity is typically expected to take on higher risk and reward based on their functional profile).
The OECD provides guidelines on allocating Covid-19 specific costs, and in some cases, there may be circumstances that warrant a low-risk functional entity to bear losses in the short term. Considering the impact of such loss allocations in the financials of the comparables and making relevant adjustments to ensure comparability, reviewing the transfer pricing agreement for the functions, risks and assets of the related entities, including the availability of force majeure clause, would serve in establishing the loss allocation criteria and help mitigate tax adjustments.
Although ensuring the health and safety of its citizens is the top priority, governments across the globe implemented assistance programmes, including financial and liquidity support, to ensure business continuity. Companies that took advantage of these measures, including preferential term financing and loan deferrals, must maintain proper books of accounts. These benefits affect the recipient’s market advantage and cost base, necessitating taking into account the receipt of government assistance when reviewing potential comparables.
Advanced pricing arrangements
One of the critical transfer pricing strategies affected by economic conditions resulting from the Covid-19 pandemic was the applicability of existing unilateral, bilateral, and multilateral advanced pricing arrangments (APAs). The key benefit of APAs is to provide tax certainty regarding international transactions for tax purposes.
In the absence of breach of any critical assumption, existing APAs must be respected and upheld. However, in some cases, the economic conditions resulting from the global pandemic may warrant a revision, cancellation, or revocation of APAs. Multinationals should review their existing APAs and consider renegotiating the terms of an APA if it results in a tax advantage. Further, multinationals should account for the time and cost impact of renegotiating these agreements. Companies in the process of renegotiating an APA should expect delays in the process.
The Covid-19 crisis will continue to evolve and have a material impact on business. However, the transfer pricing concept will not change. The profit and loss allocation will continue to be based on the related entities’ functions, risks, and assets. Companies should review their transfer pricing policy to ensure that the policies align with the new economic reality.
In a global context of digitalisation of economies, tariff wars, and economic uncertainties fueled by the global pandemic, transfer pricing represents a tool for multinationals to strategise business and tax planning. It has also put transfer pricing in the limelight for tax authorities looking to identify potential profit shifting. Proactively engaging the tax authorities with contemporaneous documentation of specific and extensive details regarding geography, timing, and the reasoning for the price setting are the key to avoiding tax penalties and adjustments.
About the authors
David Whitmer, CBIZ transfer pricing practice leader and transfer pricing network lead and Srinidhi Tuppal, CBIZ transfer pricing manager at Kreston Global
News
Transfer Pricing in the STA 2021 General Tax Control Plan
June 1, 2021
Transfer Pricing in the STA 2021 General Tax Control Plan
By Mario Quiliez, Mario Pires & Elena Ramirez
The 2021 publication of the Annual Tax and Customs Control Plan in early February has confirmed that the Spanish Tax Agency is looking more and more closely, in their investigations and checks for tax fraud, at issues associated with related-party transactions and transfer pricing in multi-national groups, large corporations, and medium-sized companies.
The special economic and financial conditions due to the coronavirus pandemic and the State’s response to its effects pose significant challenges for both companies and tax administrations, from a practical standpoint, in applying the arm’s length principle.
The Spanish Tax Agency, to tackle challenges from 2021 and in studies regarding transfer pricing for 2020 (the year of the outbreak and spread of Covid-19) and following years, will take into account the guidelines recently passed for the Inclusive Framework on BEPS on the application of the Organisation for Economic Co-operation and Development (“OECD”) transfer pricing guidelines, concerning several specific issues arising from or exacerbated by the Covid-19 pandemic, as well as their consistency with the general pricing policy of companies or business groups.
Specifically, the issues covered in the recent OECD guidelines, as a practical example of how the arm’s length principle should be applied to related-party transactions impacted by the Covid-19 crisis, are as follows: (i) comparability analysis; (ii) losses and the allocation of Covid-19 specific costs; (iii) government assistance programmes; and (iv) advance pricing agreements (“APAs”).
Furthermore, for 2021, STA has announced a specific campaign to verify proper compliance with obligations to report related-party transactions on form 232. It is important to note that the information reported on this form must be consistent with the transfer-pricing dossier. Likewise, failure to report operations and/or reporting inaccurate data on the 232 form is a serious tax violation, punishable with a fine of up to 2% of the value of the operations not reported or inaccurately reported.
Other priority focuses announced, regarding related-party transactions, are:
Checking deduction of financial expenses, particularly when funding comes from abroad (within a multinational group) and payment of interest and dividends.
Carrying out multilateral controls in the European Union to check intragroup payments for intangible goods.
Searching for unreported income from services provided, intangibles transferred without output tax, or undue reduction of income from said assets.
All the above confirms that Spanish companies with related-party transactions must properly document transfer pricing, which must be in line with the company’s transfer pricing policy, taking into account that studies from 2020, and for other years affected by the situation caused by the coronavirus, the OECD Guidance on the transfer pricing implications of the Covid-19 pandemic will apply.
As a final note, in recent years, the Spanish Tax Agency has been looking closely at issues related to transfer pricing and related-party transactions, as per guidance from the OECD.
News
Losses in a limited-risk entity pursuant to the OECD Guidance on the Transfer Pricing Implications of the Covid-19 Pandemic
May 19, 2021
Losses in a limited-risk entity pursuant to the OECD Guidance on the Transfer Pricing Implications ofthe Covid-19 Pandemic
By Guillermo Narvaez, Tax Partner at Kreston FLS Mexico
The OECD guidance on the transfer pricing implications of the Covid-19 pandemic (referred to as the “Guidance”) was issued in December 2020. The idea was to give light to taxpayers and tax administrations on what to do about intercompany operations and how to apply the methodology of transfer pricing determined in the OECD TP Guidelines (“OECD TPG”) due to ‘fact patterns that may arise commonly in connection with the pandemic’.
There is a permanent discussion in transfer pricing related to ‘limited risk’ distribution operations and how to deal with this kind of transaction. A point to stress is whether a limited-risk distribution business could afford losses or these businesses are not ‘entitled’ to generate them.
There is neither a rule in the OECD TPG nor the Guidance related to losses generated by limited-risk distribution operations. Moreover, the term ‘limited risk’ is not defined in the OECD TPG. However, what is expected is that distributors with low risks have profits regularly and if losses are generated these should be part of an isolated fact not frequently repeated; however, this is only convention. When a subsidiary has full support from its related parties to make the distribution of products with moderate risks, the least expected thing is to deal with risks that could finally drive operating losses.
The fact is that a limited-risk operation can indeed generate losses, and this matter should not be a concern for the taxpayer nor the tax authority as long as the risks associated with the distribution operation and borne by the distributor, including the financial risk, are assumed by the latter.
If the terms of the agreement between related parties were those that independent businesses would have agreed and the negative operating result of the distribution operation is directly coming from applying such terms, the loss will probably make sense. Note that risks during a pandemic may be exacerbated. Nonetheless, the contractual terms should not be necessarily modified because of force majeure.
The Guidance is clear when it states that ‘It is important to emphasize that in the absence of clear evidence that independent parties in comparable circumstances would have revised their existing agreements or commercial relations, the modification of existing intercompany arrangements and/or the commercial relationships of associated parties is not consistent with the arm’s-length principle’.
Each case should be analysed to understand the background and effect of the pandemic on the specific operation accurately to get conclusions on what to do when a loss is incurred by a low-risk distribution operation.
Another matter is that the pandemic does not suffice to change the transfer pricing method applied in previous years. The Guidance is clear with regard to fostering the OECD TPG aims without modifying the arm’s length principle and its rules, all of them determined in the OECD TPG.
The Guidance is focused on giving light on what is needed to do in an extraordinary event like the pandemic suffered since the beginning of 2020 but in some cases with a very general view.
News
Practical Application of the Arm’s Length Principle in the Context of the COVID-19 Pandemic
May 14, 2021
Practical application of the arm’s length principle in the context of the Covid-19 pandemic
By Carlos D’Arrigo, Transfer Pricing and Valuation Partner, Kreston BDM
In 2021 most taxpayers around the world would face an unprecedented challenge to reflect how their 2020 transactions compared to fair and open market values simply because in a crisis downturn like no other with disruptions and restrictions across almost every industry, how can you define what market conditions were fair? In the so-called phrase “business as usual”, how can you explain “usual”? We are not quite certain either but let’s try to find some answers.
On December 18, 2020, the 137 members of the Organization for Economic Co-operation and Development (“OECD”) Inclusive Framework on Base Erosion and Profit Shifting Action Plan (“BEPS”) released the Guidance on the transfer pricing implications of the COVID-19 pandemic (the “Guidance”) with the purpose of helping both taxpayers and tax administrations in reporting the financial periods affected by the pandemic in compliance with the arm’s length principle[1]. The guidance provides insights for the following four priority issues:
The Guidance recommends to first identify each specific cause that impacted taxpayers results and group them into three risk bubbles: Market Risk, Operational Risk and Financial Risk. The following chart intends to show a more comprehensive process flow:
Identify specific cause
• Drop in sales volume and/or price
• Increase in material and labour cost
• Increase in overhead expenses
• Exceptional, non-recurring, extraordinary operational cost
• Decrease in capacity utilisation or economy of scale
• Increase in days inventory and obsolescence
• Increase in days Receivable
• Increase in interest rates and bank fee charges
Once specific causes are identified, the Guidance suggests addressing each of them on a case by case basis using the following sources of contemporaneous information to support the performance of a comparability analysis applicable for Fiscal 2020:
Guidance suggested source
Our comments
Pre-COVID sales vs. 2020 actual
Be mindful when using new product/services data that could distort comparability, also marketing strategies to retain customers
Pre-COVID utilization vs 2020 actual
Economies of scales, cost structures and operating leverage, break-even analysis
Employee retention cost, rental and lease cost, tax waivers, deferral of contributions, interest
Macroeconomic data
GDP by country, sector or region, and trade association data can be helpful to confirm Pre-COVID sales vs. 2020 actual conclusions. Macroeconomics analyses might use data such as market share variation and drop in consumption, demand and other market metrics
Regressions
Regression analysis of variance analysis is more reliable to
predict variations when a large amount of data inputs are included; thus, it might be of limited help.
2020 Budget vs 2020 real
Budget data is unlikely to be considered official data for controversy or court cases.
Finally, Guidance made important remarks about comparability adjustments that are likely to be rejected by tax administrations including the following:
Guidance remarks
Our comments
Prior global crisis comparison
Since COVID-19 is an unprecedented crisis like no other, using data from other global crisis, such as the 2008/2009 financial crisis, could lead to poor and superficial conclusions
Using Loss-making comparables
Although the Arm’s Length principle does not override the inclusion or exclusion of loss-making comparables[2] as long their inclusion/exclusion satisfy the comparability criteria, extra care should be taken when performing comparability analysis for fiscal 2020 ensuring that chosen comparables assumed similar levels of risk and that have been similarly impacted by the pandemic.
Intercompany renegotiations
Related parties that renegotiated certain terms in their existing agreements are advised to identify clear evidence that independent parties in comparable circumstances would have revised their existing agreements or commercial relations, otherwise, such modification of existing intercompany arrangements and/or the commercial relationships of associated parties is deemed to be considered not consistent with the arm’s length principle. Examples of fair renegotiation might include: renegotiate a contract to support the financial survival of any of the transactional counterparties, or to retain key customers,
Limited-risk arrangements
Consistency is key to support changes in limited-risk arrangements, for instance, a “limited-risk” distributor did not assume any marketplace risk Pre-COVID and hence was only entitled to a low return, but in 2020 argues that the same distributor assumes some marketplace risk and hence should be allocated losses, is expected to keep bearing such risk in 2021 and so on.
Force majeure adjustments
Taxpayers should carefully review existing intercompany arrangements when invoking a force majeure clause to ensure that: i) the arrangement actually includes a written force majeure clause, ii) if no clause existed but one was added in 2020, such clause is also expected to remain in force after the pandemic, iii) the law governing the contract is not a civil law jurisdiction where force majeure would automatically apply, and iv) the specific related party situation actually qualifies as a force majeure.
As discussed above, reporting the financial periods affected by the pandemic in compliance with the arm’s length principle cannot be done with one single and straightforward approach, in this particular challenge, our preferred approach is to build up from a pre-COVID vs. 2020 actual comparability analysis which in fact compares the actual tested party with itself as long as the pre-COVID pricing policy was not intended to aggressively shift profits within the MNE.
[1] The foundation of transfer pricing is the arm’s length principle, which states that the price, terms and conditions charged in a controlled transaction between two related parties should be the same as that in a transaction between two unrelated parties on the open market. In other words, an arm’s length transaction refers to a business deal in which buyers and sellers act independently without one party influencing the other.
[2] It worth noting that in many cases, domestic legislation and/or tax administration ruling prescribe against the use of loss-making comparable.
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