The number of transfer pricing disputes is increasing. GE, Starbucks, Apple, Facebook and Nike are just a few examples of the many MNEs that are, or have been, subject to disputes around the world. Moreover, the counter-parties of these disputes are not just tax authorities, but also supranational organizations, such as the European Union. And it is not just large-listed MNEs that face scrutiny. Smaller MNEs are subjected to the same legislation after all.
This short article first discusses the nature of transfer pricing disputes. It then lists the most common dispute areas, before moving on to a few basic measures you can take to limit your risk on a transfer pricing dispute.
Nature of disputes
Most transfer pricing disputes stem from different positions regarding the terms and conditions for controlled transactions. If the tax authorities do not accept the agreed terms and conditions, they will try to amend them to be in line with their own transfer pricing analysis, thus affecting the taxable profits of the associated enterprises involved (= more taxes). Taxpayers, on the other hand, may object to the amended terms and conditions.
The way disputes are settled depends on local legislation. In some countries, such as the Netherlands, there are formal objection procedures that need to be followed before a case can be filed to a court. In other countries, going to court is the only way to solve a dispute.
A dispute on a domestic controlled transaction is normally not a big deal. In such a case, an adjustment to the terms and conditions at the level of one associated enterprise, is easily mirrored by a corresponding adjustment at the level of the other associated enterprise. This does not apply to an international controlled transaction however, where an adjustment made by one tax authority can result in a discussion with another tax authority. If that discussion does not result in a corresponding adjustment, double taxation can arise.
Common dispute areas
In theory, every transfer price is open for debate; thus a dispute is always a possibility. Certain business practices and controlled transactions however bear a higher risk of disputes than others.
Restructuring customarily involves the transfer of assets, functions and risks from one associated entity to another. A restructuring can thus result in “visible,” and “invisible” controlled transactions. In both cases, there can be consequences for the transfer pricing, and thus an increased risk of a dispute.
When performing centralized functions, MNEs incur huge costs. Transfer pricing rules ordinarily allow the recharging of these costs (except for costs for so-called “shareholder activities”) to the operational entities of the MNE as “management fees” or “service fees”. Accordingly, operational entities are confronted with significant management fees, affecting their financial performance.
Tax authorities in certain countries are reluctant in allowing operational entities a deduction in fees, as this lowers their taxable profit and according tax collection. Brazil, China and India are among the countries known to have a critical attitude towards the deduction of management fees.
Controlled transactions involving intangible assets receive a lot of scrutiny from tax authorities. And this is not without reason. As opposed to fixed assets such as factories and inventory, intangible assets can be easily transferred within a MNE. Hence, it is easier to allocate revenues of these types of assets to an associated entity in a low-tax country. This form of profit shifting is something tax administrations do not want, and disputes are a common occurrence.
Besides lawyers, no one likes transfer pricing disputes. Disputes create uncertainty, cost money, and take time to resolve. So we all try our best to avoid them. But there is no way to ensure you won’t run into them. Transfer pricing really is a “Battle of Opinions,” and the outcome is always open to interpretation. Moreover, there are too many factors out of your control, such as the evolving transfer pricing policies of local tax authorities, or the CFO’s appetite for risk.
Thus, you can only try to reduce the risk of a dispute; And there are a few basic measures you can take to do so:
- Prepare solid transfer pricing documentation
- Comply with transfer pricing rules and deadlines on time
- Develop a good relationship with the tax authorities
- Don’t take (too) aggressive positions
- Consider Advance Pricing Agreements for sizeable controlled transactions
These measures are fairly simple and can be implemented in a cost-efficient manner. A successful implementation can significantly reduce the risk of transfer pricing disputes.
We hope you have enjoyed reading the article. If you want to learn more about transfer pricing disputes, how to avoid them, and transfer pricing in general, you can buy our Course Module with detailed examples on disputes, strategies and case law.