AGEFI Luxembourg, February 2017

Transfer pricing – A priority shift towards tax risk management

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As transfer pricing (TP) keeps being in the media spotlight, awareness and risk aversion is increasing among companies which are starting to see TP as key to manage the risk. This is even more important in light of the international developments which are resulting in the implementation of unprecedented transparency and anti-avoidance measures.

EY’s most recent global 2016 Transfer Pricing Survey “In the spotlight – A new era of transparency and risk” confirms two main trends identified in the 2013 EY study. With respect to the TP international environment, these survey reports that, firstly, the TP life cycle is generally shortening, thus meaning that multinationals are having less time between the moment of the implementation of the TP policy and the moment of the audit. Secondly, although risks originate more and more in the emerging markets, multinationals are still employing a significant part of their resources to mitigate uncertainty in mature jurisdictions.

These trends are even more reinforced today, due to the increasing appetite for tax revenues and the implementation of measures such as country-by-country-reporting (CbCR). CbCR, together with the updated requirements on transfer pricing documentation, will give tax authorities enormous amounts of information on how multinationals are setting up their TP strategies throughout their whole value chain.

Luxembourg seems to move in line with other jurisdictions as, on 13 December 2016, the Parliament adopted a law to implement CbCR and transpose Directive 2016/881/EU of 25 May 2016 with respect to the mandatory automatic exchange of information in the field of taxation.

In addition to these upcoming new standards in the fields of transparency and taxation, multinationals also need to start reconsidering their operating models in light of the implementation of base erosion and profit shifting (BEPS) rules. The review of the operating model should also involve intangible property and the consistency of intercompany arrangements with the level of substance behind them.

 

A new approach towards risk

In the wake of these trends, the 2016 Transfer Pricing Survey highlights an increasing awareness and risk aversion of respondents. In particular, firms are anticipating a growing level of TP disputes across more jurisdictions and concerning an increased range of matters. This pattern is clearly highlighted by the main difference between the survey of 2013 and the 2016 edition, in which 75% of firms indicate that “tax risk management” is their top transfer pricing priority (against 66% in the 2013 survey and approximately 50% in the previous editions). On a geographic base, while only 65% of those surveyed in the Americas indicate the same top TP priority, a significantly higher percentage has been registered in Europe (75%), Japan (81%) Australia and New Zealand (75%), and the rest of the Asia-Pacific region (72%).

Given the very controversial nature of transfer pricing, and because it is not a perfect science (as repeatedly defined in the TP guidelines issued by the OECD), it has become a key topic in the current international tax debate in which multiple stakeholders (like politicians, media and social justice groups) point their attention to whether multinationals are paying their fair share of tax. Because of this visibility, it is important to be reminded that the risk to be managed does not encompass only the amount of tax paid but, above all, protecting the reputation of the group.

The reputational aspect has become particularly relevant in certain jurisdictions like Luxembourg, which are more and more under the observation lens of the media, and particularly of supranational institutions.

The reputational risk makes countries and companies want to comply with the international standards. At the date of the survey, 44 countries have implemented at least some of the BEPS recommendations out of the total 80 which have committed to do so. It is increasingly necessary to meet the growing demand for transparency and show willingness to comply, not only with the letter of the rules, but also with the spirit and the intentions of the BEPS project in general, and of the TP actions in particular. This is especially true for companies operating in countries like Luxembourg, where there seems to be more international scrutiny. Also for this, multinationals in Luxembourg will now need to comply with the new article 56bis and the new circular on financing activities (both effective as from 1st January 2017) which are increasing the requirements for substance and aligning the Luxembourg practice to international standards.

 

A glance at APAs

The reputational incentive, together with the target to minimize tax audits, is pushing multinationals towards a broader disclosure, especially in advance of the controversy procedures. It is for these reasons that companies increasingly want to test their TP arrangements through advance pricing arrangements (APAs) and bilateral APAs (BAPAs). In fact, two out of three respondents (65%) to the survey declare expectations of an increase in the use of APAs in the coming years, although currently only 37% of firms are already using advance arrangements with tax authorities. This may also be due to the fact that some taxpayers see some drawbacks in the use of such instruments that they mainly identify as a “process taking too long” (69%), “bad or undesired outcome” (15%) and “onerous compliance requirements” (6%).

With respect to the use of advance pricing arrangements, the trend in Luxembourg may seem, at first glance, to be reversed compared to the outcome of the survey. In particular, according to the Luxembourg Minister of Finance, during the year 2016 (with data up to the 8 December 2016) 82 APAs have been agreed to, against 145 in 2015, and 228 in 2014. The number of APAs agreed to per year has been decreasing but in fact, such practice had already been well developed in the past and, because of the conversion towards the new post-BEPS standard, the number of APAs in Luxembourg is also converging to a new normality.

 

How to navigate the new environment?

International trends clearly show that if multinational groups want to cope with the tax risk, manage it and minimize it, they will not be able to disregard having a good TP strategy. Such strategy will need to include the implementation of TP policies, preparation of contemporaneous TP documentation according to local legislations and Action 13 report of the BEPS project while retaining all relevant documentation to support the value creation and pricing. At the date of the survey, Luxembourg does not have in place yet a dedicated legislation regarding the preparation of Master File and Local File and therefore, Luxembourg taxpayers can rely on the guidance of Action 13 to comply with the expectations of the authorities and manage their tax risk.

Part of the strategies could also involve the use of advance pricing arrangements which will contribute to the increase of cooperation between taxpayers and tax authorities by disclosing and agreeing in advance of the treatment of the intercompany transactions.