Current Trends and Challenges in Transfer Pricing

Aderndorff (2019) in relation to the South African Revenue Authority while pointing out protracted legal battles expressed similar views, expensive litigation processes and unrecovered legal costs in most tax cases. One could argue that the recommendation presupposes a cordial relationship between the MNEs and tax authority, which is not the case. The challenge with arbitration is that the resolution of conflicts, the processes and procedures undertaken remain privy to participants only (Biondi, 2017), hence leaving no future legal precedence. Several studies have sought to explore challenges of transfer pricing BEPS activities in developing countries (Barrogard et al., 2018; Cobham & Janský, 2019; Janský & Palanský, 2019; Oguttu, 2016, 2017). Contemporary research has currently centred on the enactment and effectiveness of TP legislation in developing countries as well as the suitability or applicability of OECD and UN transfer pricing regulations to developing countries (Beebeejaun, 2018, 2019; Florence, 2016; Kabala & Ndulo, 2018; Mashiri, 2018). Few studies have been conducted on TP audits and effective dispute resolution as tools that can be used to minimise TP abuse (Shongwe, 2019).

She Replied by saying that the lion’s share of the taxes was paid to the country where they were headquartered. She was talking about the intellectual capital that Google owns which drives their business and it was owned outside of Australia. It says that the transfer prices set between the corporate entities should be in such a way as if they were two independent entities. There is a need to improve the capacities of the fiscal court with legal expertise in TP pricing as well as judges that hear tax cases. For example have someone experienced and well-exposed on TP issues assist the judge in dealing with TP disputes.

This article is the first in a two-part series designed to illustrate the complexity of digital business models and the challenge of applying transfer pricing analyses based on the value creation approach. In the first article we discuss the old and new firms in the digital economy, we review the OECD’s BEPS project focusing on BEPS Action Items 8-10 (value creation) and 1 (the digital economy). We argue that, given the newness and complexity of these new digital business models, we need to better understand the challenges they create for applying transfer pricing analyses based on the value creation approach in the 2017 OECD Transfer Pricing Guidelines.

  1. As tax authorities increasingly request real-time data —  something that looks to become the norm in the future — accessibility to accurate data on a timely basis is becoming increasingly important.
  2. Despite the disagreements, the OECD’s Task Force on the Digital Economy (TFDE) expects to issue a work plan by early June 2019, with the goal of producing a consensus document by 2020 (OECD 2019d).
  3. Likewise, transfer pricing also is a pertinent issue for U.S. companies with operations in low-tax foreign jurisdictions.
  4. Transfer pricing issues will continue to command attention from corporate tax executives due to the size, complexity, and subjectivity of transfer pricing determinations, the involvement of multiple countries in the dispute, and the harsh penalties and reporting requirements.
  5. Third, a transfer pricing policy servesas evidence of the company’s intent to comply with globaltransfer pricing rules and relations, which can be crucial indisputes with tax authorities.

Captain has 23 years of experience in various aspects of global transfer pricing for a diverse range of industries. Correspondingly, the percentage of oil and gas companies identifying effective tax rate optimization as their top priority fell from 50% in 2007 to 14% in the most recent survey. The 2013 GTPS identifies several factors leading to the prioritization of risk management, as further described in Figure 1. Conversely, if inadequately administered, transfer pricing can be costly for all stakeholders, leading to lengthy audits and litigation, transfer pricing adjustments, potential nondeductible penalties, and double taxation. One way to show how the underlying economics of different businesses might result in more (or less) pressure on transfer pricing is to look at the role of fixed costs in the context of lower revenues.

In reality, arm’s-length transfer pricing in its current form, when effectively managed, is a powerful mechanism for both tax authorities and corporations to reduce audit controversy while proving to apportion income fairly among multiple taxing jurisdictions worldwide. Companies are often faced with navigating a maze of transactionsacross subsidiaries and divisions that span multiple taxjurisdictions. With every country and jurisdiction having its ownrules and regulation for transfer pricing, the intricate interplayof these regulations can lead to conflicts between taxauthorities’ interpretations of transfer pricing laws,potentially resulting in double taxation or costly legaldisputes. How well do the existing transfer pricing methods measure value creation for the new business models of Industry 4.0?

Challenges for Transfer Pricing in an Economic Downturn

In affirmation interviewees, TCs 5, 6 and 8 bemoaned the lack of expertise especially at it relates to the assessment TP transaction in the extractive sector. They explained the Revenue Officers and their investigations and audit departments are not fully equipped with appropriate and sufficient expertise to fully appraise and comprehend these mining issues with only accountants, finance persons and economists in their teams. The TCs further explained that MNEs exploit this skills and knowledge deficit to continuously report losses and maximise on tax avoidance. Similar views were raised in relations to developing countries (Barrogard et al., 2018; Nakayama, 2012), African counties (Kabala & Ndulo, 2018; Shongwe, 2019) and Zimbabwe in particular (Kwaramba et al., 2016; Mashiri, 2018). Eighty percent of MINOFs and 70% OF ZIMRA officers were in agreement regarding the negative impact of poor skills and expertise on audits and dispute resolution effectiveness and indicated that efforts were made to improve training, technical expertise and capacity building. It entails that the rational decisions are taken by a rational actor such as the revenue authority, government, tax auditors and the courts, elicit equally rational responses by taxpayers (MNEs in this case), thus contributing to the challenges affecting the effectiveness of audits and dispute resolution.

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Kabala and Ndulo (2018) allude to the fact that the understanding of TP legislation is rudimentary among tax officers and auditors in developing countries. Reiterating the TP knowledge deficiency in developing countries among the administrators and enforcers of TP legislation, Mashiri (2018) established that the TP auditors faced lack of skills and limited capacity challenges. The researcher explained that most developing countries used the general tax auditors for auditing TP transactions, yet the lack of technical expertise, skills, exposure and experience crippled their effectiveness. A number of researchers studying BEPS and transfer pricing in developing countries (Barrogard et al., 2018; Kabala & Ndulo, 2018; McNair et al., 2010; Nakayama, 2012) affirmed these shortcomings. According to Mashiri (2018) this lack of skilled personnel problem is closely connected to the challenge of shortage of financial resources. Developing countries lack enough financial means to employ, train, develop and keep competent, experienced and qualified TP auditors (UN, 2017).

Transfer Pricing Audit Challenges and Dispute Resolution Effectiveness in Developing Countries with Specific Focus on Zimbabwe

Operational transfer pricing (OTP), which looks at how these policies are implemented, cuts across data, process, people and technology. In fact, according to a previous Deloitte market survey, almost 70% of Heads of Tax at over 250 multinationals believe there is room for improvement in their Group’s OTP processes. A carve-out is available for transactions where the taxpayer reasonably relied on a transfer pricing approach. Other countries have also established penalty regimes for transfer pricing — some even more severe than U.S. rules.

Savings and Investment: The Tax Treatment of Stock and Retirement Accounts in the OECD and Select EU Countries

In arranging their affairs in such a manner that they maximise their profits and wealth for their shareholder, MNEs take into account the most effective and cost-reduction methods such as tax minimisation or tax avoidance (Cooper & Nguyen, 2020). Developing countries are the hardest hit by these decisions as they depend largely on tax revenues (Bhat, 2009; Jaffer, 2019; Mashiri, 2018). The OECD (2014) and Shongwe (2019) table that the low-income countries’ over-reliance on corporate tax is under threat from MNEs’ tax avoidance tendencies. MNEs make up approximately 70% of Rwanda’s tax base and an estimated 88% of Nigeria’s tax base and more than 20% of Burundi’s total tax revenues (OECD, 2014). Due to increased TP manipulation and its impact on tax base erosion including distortions of taxing rights, the OECD and UN came up with TP legislation guidelines to curb and regulate TP and these have been adopted by some developing countries and are at different implementation levels (Mashiri, 2018; Tørsløv et al., 2020).

In general, many employees and legal entities across the world are involved in the process, while locally transfer pricing is unfortunately often viewed as a lesser priority. On a practical level we have seen organisations struggle by suffering from the uncontrollable process of Word-files being sent back and forth and excerpts from TP documentation manually being copy-pasted and shared via e-mail. This results in a high risk of non-compliance and not having all documents centrally in place in case of an audit. With increased scrutiny in cross border transactions its key to have a global transfer pricing strategy that effectively deals with the challenges of transfer pricing.

The sheer volume of transfer pricing reports required can be overwhelming for tax departments, and with the increased focus on value chain reporting, the level of financial data detail required for the analysis may not be readily available in many enterprise resource planning systems. However, if the process is effectively managed, quality transfer pricing reports serve to mitigate controversy by establishing the framework that documents the appropriateness of the transfer prices. Furthermore, a coordinated global transfer pricing policy provides consistency and reduces the administrative burden in managing an organization’s intercompany transactions. On the other hand, the lack of transfer pricing documentation, or even poor-quality transfer pricing documentation, invites tax authorities to initiate further reviews and, in worst-case scenarios, may paint a clear road map for tax authorities to identify transfer pricing exposures. A mere 24% of oil and gas survey respondents to the 2013 GTPS expect intangible transactions to be the most important area of tax controversy in the next two years, but tax authorities are thinking otherwise.

From the ZIMRA TP manual, the outline of what is considered made the subjectivity apparent, for example, strategies include risk appetite, the scope of diversification, and an assessment of political risk, innovation and development of new products. On the other hand, economic settings involve an assessment of the size of the market, consumer purchasing power, and geographic place of operation, demand and supply considerations among other factors. Just an appraisal of these two points out challenges of objectively establishing the price as well as following an audit trail for TP justification. Despite the presence of Mutual Agreement Procedures (MAPs) and Advance Pricing Agreements (APAS) and at times arbitration being considered possible ways of bringing clarity and predictability in investments and TP regulation, their effectiveness is still controversial and contested (Sundaram, 2012).

In agreement, Shongwe (2019) points out that the governance process is neither effective nor robust enough in developing countries to enable TP cases to be speedily and appropriately resolved. The researcher further contends that effective dispute resolution is linked to the availability of the right skills in the courts, strong and clear TP legislation and access to information as well as strong capacity for tax administration and audits. Despite the importance of these factors being underscored, researchers continue to highlight most African countries tend to fall short in these key areas (Barrogard et al., 2018; Cooper et al., 2017; Kabala & Ndulo, 2018; Oguttu, 2016, 2017).

Because tax cost savings could arise through transfer pricing adjustments, industries with higher fixed costs may be more likely to make those adjustments. In normal times, transfer pricing rules for profit and loss allocation are driven where the entrepreneurial risk is. In other words, business units that are innovating and investing in new products are in a much more productive (and riskier) position than a business unit simply tasked with making sure those products get to customers. Current transfer pricing rules can be insufficient when businesses generate significant losses during an economic downturn. One challenge for a business such as that in the example is determining where those net operating losses belong for tax purposes. The three-year moving average looks backward, and if the company relied on that analysis, a 2.5 percent profit margin could be taxed in Denmark in 2020 rather than a margin that is more reflective of current economic conditions.

In light of the findings discussed in Section 4, this section makes recommendations that could possibly improve the effectiveness of audits and dispute resolution processes in developing countries. This one of the biggest challenges denoted by many researchers on the effectiveness of enforcement of TP regulations (Beebeejaun, 2018; Kabala & Ndulo, 2018; Oguttu, 2016). Eighty-three percent of TCs, 60% of ZIMRA and 40% of MINOFs pointed to the lack of clarity in legislation as a challenge to effective audits and dispute resolution. Ninety-two percent of TCs, 80% of ZIMRA and 60% of MINOFs concurred on the lack of comparable information as an important constraint.


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