Download The global nature of business means transfer

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april 2013 accountancy
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The global nature of business means
transfer pricing is becoming increasingly
problematic, argues Heather Self
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Unless John
Lewis sets up
a subsidiary
or PE in those
countries, the
profits are likely
to be taxed
wholly in the
UK, without
any amount
being attributed
to France
or Germany
ome of the companies investigated
have been operating in the UK for
years and have never paid a penny
to HMRC in corporation tax… many
foreign multinational corporations
are setting the transfer prices for their UK
subsidiaries too high.’
That quote is not, as you might think, from
the Public Accounts Committee in the last few
months. In fact, with the substitution of US for
UK and Internal Revenue Service for HMRC it
was the opening statement of US congressman
Jake Pickle to the House Ways and Means
Committee in Washington in 1990.
This shows that concerns about transfer
pricing and multinationals are not new. This
article looks at the background to the current
transfer pricing rules, the problems that
are causing concerns and the work of the
Organisation for Economic Cooperation and
Development (OECD), which aims to address
those problems.
The UK’s transfer pricing rules permit HMRC to
adjust, for tax purposes, the price paid for goods
and services sold or supplied between associated
persons when transactions are carried out on
a non-arm’s length basis. They seek to ensure
that connected parties apply arm’s length prices
for tax purposes, so that they are measuring
their profits on a similar basis to that used by
unconnected parties.
The UK rules must be construed in light of the
OECD transfer pricing guidelines. The current
OECD rules have their roots in the work of the
League of Nations, back in the 1920s. The latest
version was published in 2010.
Although the transfer pricing rules are antiavoidance rules, the idea that transfer pricing
is simply a technique used to shift profit from
one country to another is a myth. All global
businesses need to set the price at which goods
and services are supplied intra group for business
reasons, and must ensure that they comply with
the arm’s length principle for tax purposes.
www.accountancylive.com
Two key elements
of the rules are relevant
to current concerns.
These include the following:
Permanent establishment: The
OECD model treaty says that the profits of
a company resident in State A will only be taxed
in State B if the company has a permanent
establishment (PE) in State B. A PE is defined
as ‘a fixed place of business through which
the business of an enterprise is wholly or partly
carried on’. Certain activities, such as the
provision of a warehouse for delivery purposes,
are expressly stated not to give rise to a PE.
Once an enterprise has a PE, its PE profits will
be calculated on the arm’s length principle.
Functions, assets and risks: In determining an
appropriate transfer price, regard must be had
to the ‘functions, assets and risks’ which are
in a particular jurisdiction. A multinational will
need to evaluate the functions, assets and risks
jurisdiction in which it operates.
Current issues
The globalisation of business and particularly the
growth of e-commerce, has led to difficulties in
applying the current rules for internet sales.
For example, a business established in
Luxembourg and selling goods to customers in
the UK over the internet, will only be taxed in the
UK on any profits attributable to a UK PE. If all
that is in the UK is a delivery operation, then this
might well not constitute a PE and so there will be
no UK tax to pay. This is, in simple terms, a large
part of the perceived problem relating to Amazon.
The same is true in reverse: John Lewis
recently announced that it will expand its internet
sales to customers in France and Germany.
Unless it sets up a subsidiary or PE in those
countries, the profits are likely to be taxed wholly
in the UK, without any amount being attributed to
accountancy april 2013
tax
transfer pricing n
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improvements or clarifications to
the transfer pricing rules to address
specific areas, including intangibles;
QQ updated solutions relating to the
jurisdiction to tax, especially in relation
to digital goods and services; and
QQ more effective anti-avoidance rules
such as GAARs, controlled foreign
companies (CFC) rules and limitation
of benefit provisions in treaties.
QQ
France or Germany under current OECD rules.
The definition of a PE worked reasonably
well in situations where a physical presence was
needed in order to attract customers: it produces
results which are seen as ‘unfair’ when sales are
made electronically via a foreign website.
As global supply chains have become more
complex, the value attributed to different stages
of the process has fragmented with an increasing
emphasis on the value of intangibles.
For example, a pharmaceutical company may
carry out the initial research and development
(R&D) in one country (high value), contract out the
testing to another country (cost plus basis), the
manufacture to a third (limited risk) and the sales
and marketing to a fourth (value may be high,
depending on marketing intangibles).
It is relatively easy to move intangible assets
from one jurisdiction to another, but it is relatively
difficult for tax authorities to challenge whether
the contractual allocation of risk is matched by
economic substance.
Certain
activities, such
as the provision
of a warehouse
for delivery
purposes, are
expressly stated
not to give rise
to a PE
OECD response
In February 2013, the OECD issued its report
on Base Erosion and Profit Shifting (BEPS).
This addresses both of the issues above, as
well as a number of other areas. The intention
is for the OECD to come up with an action
plan by June 2013, which will identify the
actions needed, set deadlines for achieving
them and identify the resources needed.
The action plan is likely to include:
The way forward
The OECD timetable for publishing its action
plan is ambitious and allows little time for input
by businesses and advisers. The rules currently
in place are not perfect, but there is a great
risk of collateral damage if changes are rushed
through without careful thought. For example,
imposing tax based on sales in a country has
a number of major potential problems. In the
EU, VAT operates as a sales tax, and the EU
treaty forbids individual countries from imposing
additional sales taxes. Basing a tax on sales
would give rise to winners and losers at country
level: major capital exporting economies (such
as the US) would have to cede part of their
taxing rights to the countries in which sales are
made. Agreement to such a proposal among the
OECD seems unlikely.
Politicians need to accept that while the
current rules may give rise to problems, there is
no silver bullet which can magically deliver the
‘right amount of tax’ without a lot of hard work
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on a multinational basis.
Heather Self CTA, FCA
Partner (non-lawyer),
Pinsent Masons
www.pinsentmasons.com
www.accountancylive.com
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