Specialising in economic analysis

It isn't just corporate bombast. It's a reality many US businesses have already witnessed. For many corporates, transfer pricing is the most important issue any large global has to face up to during the next five years. Tax authorities – including Her Majesty's Revenue & Customers (HMRC) – are getting tough with any company which may have pushed the envelope when it comes to clearly explaining their transfer pricing regime. But it's also an environment where tough, intellectual rigour is increasingly valued says Dr Ted Keen of Ballentine Barbera, the US-based transfer pricing boutique specialist. “A lot of countries have already adopted the OECD Guidelines and the arm's length principle into law, but though that gives countries the same basic rules, each country interprets the rules slightly differently. And you've got to remember that the OECD guidelines are just that – guidelines: there is no one correct transfer price! Producing economic evidence and analysis in support of your transfer pricing policy is critically important.”

Know your way in a changing landscape
The issue has certainly been underscored by Sir David Varney, former executive chairman of HM Revenue & Customs (HMRC). HMRC has taken a much tougher line with business, especially large operations. Varney repeatedly underlined that more resources were being ploughed into transfer pricing enquiries and would follow a clear action plan when not enough information is offered. “We're expecting to see a lot more recourse to litigation generally,” says Keen, “especially in the UK. We've already seen a lot of action in the US, Canada and Australia. Certain types of companies, such as the largest drug companies, are being targeted. So the government isn't wasting time on small fry. There's a huge amount of money at stake.”

Litigation of transfer pricing matters is also quite a change in culture too. Tax authorities traditionally have had a close with accounting firms – many tax partners in UK accounting firms got their start as tax inspectors. “So when taxpayers and their accountants go into negotiation with HMRC, they're dealing with people who already know each other.” But with increasing prospects of litigation, lawyers are now starting to challenge the accounting firms' dominance in the transfer pricing arena says Keen. ‘Law firms traditionally have been much more involved in the transfer pricing area in the US than in the UK. We're now seeing law firms in the UK and Continental Europe getting more involved in transfer pricing. That has to give multinationals an advantage when it comes to litigation. Lawyers know the litigation process better. So the landscape is definitely changing.”

A more positive message
However, Ballentine Barbera's Gerben Weistra says the EU is gradually developing a more consensual view on transfer pricing issues to prevent double taxation via the EUTP forum. In addition, “the OECD recently issued a paper suggesting changes to the 1995 guidelines. What they've done is incorporate some of the practices in the guidelines. You could say that there will likely still be differences in interpretation of transfer pricing regulations between countries, of course, but it's becoming more about being less dissimilar than different, I'd say. In terms of transfer pricing, the EU has focused on the free flow of capital growth, taking away practical barriers to growth. . So it's really about overcoming the differences at the theoretical side now.”

He says it's useful to remember that many European countries are still working out their own transfer pricing initiatives. “Still, even if the now suggested changes are implemented some countries, of course, will interpret it to the letter, while others will be trying to find their own way with it.”

Weistra also says he is surprised some companies are still – within varying degrees – not aware of the huge financial ramifications as they should be. “Some companies still say things like ‘oh, our transfer pricing is audited out', or they ‘don't consider it a material issue'. Frankly, that surprises me.” He says some operations remain preoccupied with the process of transfer pricing issues, rather than the technical side and implementation of their policy. “Since Sarbanes Oxley, we see more people again who are interested about pricing procedures, and who is involved therein. They're less interested in the technical side and implementation of a policy. But the process, actually, is not that different to what it was 10 years ago, although there are obviously new reporting rules for audit purposes. The key question however is about whether you have in fact a proper and consistent transfer pricing policy, how it is applied and communicated and what deviations might lie inside it. That is where possible transfer pricing corrections would arise.”

It's also about getting a sense of where the legal argument really lies. For example, Greg Ballentine, a founder of Ballentine Barbera, has been involved in many landmark transfer pricing court cases helping build Ballentine Barbera's reputation and invigorating debate on all the issues. Plainly it's not about following tried-and-tested formulas that may have worked a few years ago. Something more demanding is now needed.

Imagining the future
So how will the role of transfer pricing develop? Dr Ted Keen thinks that Europe, including the UK, will need to get used to a great deal more transfer pricing litigation. “In the past, HMRC, for example, would have been quite reluctant to penalise tax payers and they would often give them the benefit of the doubt. But we're seeing a lot more pressure from a variety of special interest groups who are interested in governance and how companies make their money. Just read the front page of The Guardian newspaper. You'll see frequent challenges to multinationals' transfer pricing practices to avoid paying UK taxes.”

Is there any way to avoid the expensive and lengthy litigation process? Some companies will certainly want to explore the use of advance pricing agreements (APAs) in greater detail. The advantages of APAs are simply certainty and consistency, especially useful for companies with less predictable audit cycles. Keen says the French government, for example, are increasingly looking hard at such arrangements. “There's a lot of APA activity in France right now and certainly the French government seem quite eager to enter into APAs. The bigger you are, the easier it is to bear the fixed cost in terms of money and time. But others still prefer to handle transfer pricing issues if and when they arise under audit.” The Germans, on the other hand says Keen, have changed their transfer pricing rules slightly but significantly. “Germany is a very high tax country for business so many companies have attempted to scale back their operations there. The Germans don't like this, of courses, so have implemented new rules on how they will look at supply chain reorganisation and disposals of business.”

Of course, it's always quite a judgement call when considering your taxable footprint in one country compared to another. And a change your transfer pricing policy will inevitably upset at least one tax authority. But a rigorous examination of the facts and a thorough knowledge of your industry and market will help to support your case.

No right way
What are the key issues for transfer pricing going forward? Much of the real debate says Keen remains focused on intangible property and just where and how those after-tax profits are declared. “Much of the issue arises from licences to use intangible property, like patents or brands, to develop, manufacture and/or distribute goods or services. Where you incurred the costs and risks of developing your valuable intangible property will dictate where profits arising from those intangibles should be recorded. Multinationals who have a clear and well-documented strategy and policy for funding the development of their intangibles will be in much better shape than those who don't. There is no one right way to do this, and what's right for one might be completely wrong for another. It's up to each multi-national to work with their economic and legal advisors to figure out the best strategy for them within the bounds of the OECD Guidelines. This will help them avoid costly litigation down the road.”

In other words, each case is different, and the OECD guidelines are just that – guidelines. “That's why you need very tight economic analysis of your own operation and circumstances – that's our specialty.”

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