Already a top priority, high-profile victories by both the US and European tax authorities are causing multinational businesses to re-examine their transfer pricing strategies, positions and documentation. The additional transparency requirements mandated by the OECD/G20 Base Erosion and Profit Shifting project will embolden tax authorities around the world to pursue transfer pricing adjustments with even greater vigor. Taxpayers must be proactive to avoid the consequences.
ValueScope is uniquely positioned to assist companies in accurately valuing, documenting and defending transfer prices between related taxpayers. Our team of international tax professionals, Phd Economists and financial analysts have the technical knowledge and industry experience to analyze transactions ranging from the simple transfer of tangible goods or provision of services to the most unique transfers of intellectual property.
Pick up the paper almost any day of the week and you can read about huge transfer pricing cases docketed for US Tax Court and about US multinationals settling equally huge European transfer pricing cases. Every country seems to have placed transfer pricing as a top tax priority. With the magnitude of the adjustments (Coca Cola proposed adjustment of $3.3 billion, Google’s $181 million settlement with the UK and possible similar adjustments in other large Euro countries, and Apple’s settlement with Italian tax authorities for $350 million), transfer pricing will maintain a top tax priority for many years to come.
In the pages that follow, we highlight some of the top reasons taxpayers find themselves in transfer pricing controversy, the potential consequences of that controversy and how ValueScope protects and defends taxpayers from adjustment.
Waiting for the Shoe to Drop (Playing the Audit Lottery) – Some taxpayers have taken the position that they will simply wait for the IRS to challenge them before addressing their transfer pricing issues. However, the benefit of proactively determining the arm’s length price between related members of the controlled group is at least two-fold. First, it is always more cost effective to get it right the first time vs. defending a transfer price against challenge. But even more importantly, taxpayers have the opportunity to control the narrative by allocating profits to entity and jurisdiction where they can be supported by sound functional and economic analysis.
Shoddy Functional Analysis (“Let us do the functional analysis to save costs.”) – Functional analysis is a methodology that is used to explain the workings of a complex system. Unless you have experience with the specific challenges that tax authorities bring in the transfer pricing area, it is difficult to know the right questions to ask.
Common errors in the functional analysis process include:
failure to identify value-creating intangibles
giving inappropriate weight to non-value added asset and functions
over reliance on the contractual allocation of risks.
Uncomparable Comparables –The economic analysis found in transfer pricing reports selected for examination is many times inadequate and sometimes just plain wrong. Comparable transactions and/or profits may miss the mark because they are ultimately not comparable.
Often this is due to:
a faulty functional analysis
an incorrect database search
an ignoring of potential comparability adjustments
The consequence of bad economic analysis is a meaningless and unsupportable transfer price.
Unilaterally Ignoring the Other Country – By nature, there are a minimum of two tax jurisdictions impacted by cross-border transfer prices. Failure to address the issues under both sets of rules will more often than not lead to challenge by the other jurisdiction.
Selecting the Wrong Best Method – Both the IRS regulations and OECD guidelines list a number of proscribed methods for establishing an arm’s length price. Taxpayers not only have the burden of selecting the best or most appropriate method, but also documenting why other methods were not selected.
Skimping on the Documentation (Can’t we wait to document our answer after we get the IDR?) – In an effort to save money, rather than use IRC Sections 482 and 6662 compliant documentation, taxpayers will often document their transfer pricing methodology in one of the following ways:
not at all
back of the envelope
benchmarking with functional analysis.
Anything less than IRC Sections 482 and 6662 compliant documentation subjects the taxpayer to one or more of the consequences listed below.
Penalties – Taxpayers with substantial, or worse, gross transfer pricing misstatements will be subject 20% or 40% penalties in addition to the tax adjustment and interest, unless … the taxpayer is deemed to have met the transfer pricing method selection and documentation requirements of IRC Sections 482 and 6662. Meeting the standard for selection of the appropriate method can be met most easily by relying on the analysis of a qualified professional such as the professional at ValueScope.
Meeting the documentation standard requires that the transfer pricing report contain a discussion of:
business overview which includes the economic and legal environment in which the taxpayer operates
taxpayer’s organizational structure
method selected and why
methods not selected and why
comparables and any adjustments
explanation of the economic analysis
Adjustments and Secondary Adjustments – When taxpayers get transfer pricing wrong, they are required to adjust the price on the books of each of the affected parties. This will lead to tax adjustments in at least two jurisdictions. This may also lead to deemed transfers of property (dividends, notes, etc.) to reflect the movement of cash. These secondary adjustments could attract other taxes such a withholding taxes.
Customs Audits – Income taxes are not the only taxes that are assessed on the related party transfer of tangible and intangible property and services. For example, transfer of tangible property between related parties across borders can also attract customs duties. Taxpayers can most certainly expect better coordination between income tax and customs authorities in the years to come.
BEPS/Form 5471/UTP/Fin 48 – Pick up the SEC Form 10-K of almost any multinational and you will see disclosure of transfer pricing controversy and the potential financial statement impact. The OECD and G20 leaders have been successful in requiring disclosure by large multinationals of how and where profits are allocated. The IRS requires annual disclosure of related party transactions and uncertain tax positions. Bottom line, getting the transfer price wrong will have cash and financial statement impact.
International Tax professionals + Phd Economists + Financial Analysts – The combination of these three disciplines (along with other specialists such as engineers) gives ValueScope a huge advantage over most of our competitors. From the most straightforward documentation engagement to the most complex intangible transfer, we have the skills and experience.
The Best Data – We have invested significant resources to ensure that we have access to all the data we need to accomplish our economic analysis. These include Thompson Reuters EIKON, Bloomberg/BNA, IBIS World, kt MINE and many other data resources.
Right Pricing – Our expertise compares to the global firms but our prices compare to that of a regional/local. Our clients get maximum value from us.
Extensive IRS and Taxpayer experience – In addition to our extensive experience in planning, preparing, and defending taxpayer’s transfer prices, we are frequently hired as experts by the IRS in the largest (read billions of dollars in adjustments) transfer pricing controversies. This relationship with the IRS provided our clients with two advantages.
First, we know exactly how the IRS and Treasury approach transfer pricing controversy cases.
Second, we are known within the IRS as reliable and trusted advisors such that our transfer pricing studies have never been adjusted upon exam.
In December of 2015, the US issued proposed regulations related to the implementation of OECD/G20 Base Erosion and Profit Shifting (BEPS) Project, Action 8-10 – Aligning Transfer Pricing Outcomes with Value Creation. (Have we lost you yet?) These proposed regulations would require US Multi-National Enterprises (MNEs) with annual revenues of $850 million (Now have you checked out?) to report, on a country by country (CbC) basis, detailed information on its business activities, revenues, profits, taxes, capital, assets, and employees.
Reporting will be required in the year following the year the regulations are finalized. Meaning, not this fiscal year, but next, at the earliest. (By now, surely you have stopped reading.) Finally, the US tax authorities have indicated that they will not require companies to comply with BEPS Master File and Local File reporting as they believe existing tax forms (Form 1120 Schedule UTP, Form 5471 Schedule M, and Form 5472) already collect the same information. (Done, Checked out, Why are you bothering me?)
But wait. Are small and mid-size US MNEs in the clear? The answer, unfortunately is no. While it is true that US MNEs will not be subject to CbC reporting even after the regulations are finalized due to the $850 million trhreshold, and it is true that the US tax authorities have no plans to require Master File and Local File reporting, small and mid-size US MNE may still have a significant compliance burden beginning in the 2016 tax year.
The Master File is a document that provides a blueprint of the entire MNE with specific detailed information on the following 5 categories:
The Master File is to be prepared by the parent of the MNE and filed with the parent’s home country tax authority. OECD and non OECD countries alike are currently implanting Master File and Local File reporting requirements, most with a consolidated revenue threshold of euro 50 million.
OK, so the first bit of good news is that most US MNEs will not have a Master File filing responsibility.
Now for the bad news. The Local File is a document that provides detailed information to the taxing authority in the local entity’s tax jurisdiction. This information includes:
Local Files can be required by the local taxing jurisdiction regardless of whether a Master File is required of or prepared by the parent of MNE. The same threshold of MNE consolidated revenue of euro 50 million applies to the Local File. To date, a number of countries have adopted Master File and Local file requirements for the 2016 tax year. One such country is the Netherlands. Dutch penalties for failure to file the Local File include a fine of euro 8,100 (unintentional) and euro 20,250 (intentional). However, Dutch penalties also include criminal penalties of up to 6 months in prison (unintentional) and up to 4 years (intentional). Other countries that have adopted CbC, Master File and Local File reporting requirements include France, Italy, Japan, and Mexico among others.
US MNEs should immediately determine if they have a requirement to file a Local File for one or more of their foreign operations. If a filing requirement is identified, the US MNE should ensure that its transfer pricing documentation is sufficient to comply with those filing requirements.
Tags: OECD Aligning Transfer Pricing
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