Can transfer pricing contribute to base erosion?
The OECD lists six key pressure areas that need to be considered. Transfer pricing is one such pressure area.
From a transfer pricing perspective, the OECD arm’s length principle starts from the premise that the different entities that make up a multinational group act independently from another. However, this is not an accurate portrayal of how MNCs operate. In reality, these “independent” entities act as a whole under an overall business strategy.
It is recognised that the arm’s length principle is focused on the identification of the location of functions, assets and risks. The OECD notes that it is difficult to shift underlying functions. Regardless, the OECD recognises that it is easier to shift the allocation of assets (in particular intangibles) and risks to low-tax jurisdictions.
This could pose genuine concerns in the relatively higher tax countries, especially when there is no real substance in the lower-tax jurisdiction to support the allocation of assets and risks.
Clearly companies relocate their businesses for many reasons, and corporate tax is likely to feature in a location decision. Governments across the world work hard to incentivise businesses to set-up (or remain) in their countries, and taxation can be a key feature of such incentives.
When implemented properly, MNCs should not be penalised for making legitimate business location decisions. However, the OECD has recognised that not all such structures are commercially driven.
Governments should have the necessary tools to tackle an artificial allocation of functions, assets or risks which deprive them of their fair share of tax revenue.