AGEFI Luxembourg, June 2014
Transfer pricing – the importance of considering intercompany transactions in their entirety
EY’s 2013 global transfer pricing survey, “Navigating the choppy waters of international tax”, leaves very little doubt that companies having important intercompany transactions across various different countries are struggling to meet their heightened obligations in a rapidly changing world. It is likely that the current environment will remain difficult for the next few years and those companies should take some steps to prepare.
Recent OECD developments, such as the BEPS project, the White Paper on Transfer Pricing and the OECD Intangibles Discussion Draft, indicate that Tax Authorities around the Globe will increasingly wish to review transfer pricing based on the totality of intercompany transactions and not simply on a transaction by transaction basis any longer. As a result, soon it will no longer be enough to simply make sure that individual intercompany transactions satisfy a checklist of technical requirements. Tax authorities across the Globe are reporting that they will be taking a holistic view of taxpayers’ intercompany transactions to assess the total profit shifted from their jurisdictions, without specific regard to the individual transactions that caused the shift. Tax authorities are also using non-transfer pricing provisions, such as permanent establishment and general anti-avoidance rules, to supplement their transfer pricing review powers.
In order to mitigate their risks, taxpayers having important intercompany transactions will have to consider the following actions:
- Make sure their systems are up to the challenge of handling transfer pricing processes. Year-end or post-year-end adjustments can create indirect tax exposures. These challenges can be particularly severe if the taxpayer operates in an industry where tangible assets are a significant portion of the value chain. As attention begins to shift to how taxpayers implement and adjust prices, taxpayers in all industries should make sure that they have the people and systems in place to undertake frequent reviews and adjustments to transfer prices in order to eliminate uncertainty of outcomes. The inability to evaluate the system profit and a product-by-product or intangible-by-intangible basis may limit the ability of the taxpayers to assess how profits are currently allocated across the business and leave the taxpayer open to a challenge by the tax authority.
- Consider the perspectives of the rapid-growth markets. In the past, the main considerations in relation to intangibles may have started out from the value given to the intangibles from the developed markets’ position. That issue is in sharper focus than ever, but tax authorities in developing countries may also conclude that intangibles have been developed locally that taxpayers haven’t acknowledged, much less compensated. Only a rigorous and current analysis of functions, risks and intangibles across taxpayers’ organization can assist in uncovering where those risks may lie.
- Risk assessment may need updating. Increasingly detailed documentation requirements at local level, combined with increased scrutiny by tax authorities, will require companies to adjust their approach to documentation globally. Documentation requirements are in place in markets that may never have been on our radar screen in the past. And the requirements in those jurisdictions may be more onerous and individualistic than what taxpayers are accustomed to in mature markets.
Finally, the most important risk that taxpayers may face is not just the risk of additional tax, penalties and interest, but real damage to their company’s overall reputation. Transfer pricing is in the media spotlight and is likely to remain there for some time. Transfer pricing has become a hot topic for journalists, antipoverty and social justice organizations and political leaders around the world who are challenging international tax rules they feel do not fairly deliver the revenue they were intended to capture. Many of the headlines and activist protests, as well as much of the political rhetoric, betray a lack of technical knowledge about how transfer pricing works. But the coverage has created a number of reputation risk challenges for companies looking to reconcile legally compliant tax positions with public perceptions about them. These concerns are magnified when accusations of tax avoidance are amplified by social media. The media has focused its coverage heavily on the mobility of intangible assets which appears to reflect the concern of tax authorities. It also appears to help explain an increase in the percentage of companies predicting intangible property will be their most important area of transfer pricing controversy in the future. Companies will have to struggle with the burdens of complying with an increasingly onerous worldwide regulatory framework. The need to consider how the public at large has come to perceive transfer pricing only makes that task more complex.
Luxembourg-based companies having intragroup transactions across various countries will also have to consider the evolution of transfer pricing rules in order to avoid potential challenges from foreign tax authorities. The government underlined in its program the need to have a comprehensive Transfer Pricing legislation in line with international standards. Hence, additional Transfer Pricing requirements are expected to be introduced in Luxembourg in a near future, thus enhancing its regulatory framework and aligning its TP rules to international standards.
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