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TII EDIT
Universalisation of the OECD transfer pricing guidelines
By D P Sengupta
Apr 23, 2018

THE OECD has recently (on9thApril, 2018) released what it calls Transfer Pricing Country Profile in respect of 14 additional countries including China and India. The total country profiles now available is 44.

As has been clarified, these country profiles focus on countries' domestic legislation regarding key transfer pricing principles, including the arm's length principle, transfer pricing methods, comparability analysis, intangible property, intra-group services, cost contribution agreements, transfer pricing documentation, administrative approaches to avoiding and resolving disputes, safe harbours and other implementation measures. "The information contained in these profiles is intended to clearly reflect the current state of countries' legislation and to indicate to what extent their rules follow the  OECD Transfer Pricing Guidelines."

The country profiles contain answers (presumably prepared by the tax administrations of the countries concerned) to certain questions designed by the OECD Secretariat. What is the purpose of such an exercise? Presumably again, the efforts seem to be to show that most of the countries follow the OECD transfer pricing guidelines. It is not very difficult to arrive at that conclusion since most of the countries jumped on to the complex transfer pricing bandwagon at the prodding of the OECD itself. One notable exception is Brazil that used to openly declare that it did not follow the OECD transfer pricing guidelines. But, Brazil now wants to become a full-time member of the OECD and efforts are on to make it shed some of its opposition.

Before proceeding further a few words about the business of transfer pricing would be in order. Transfer pricing by multinationals is real. It is through transfer pricing that large corporate groups are able to park most of their overall profits in tax havens. But the solution used by the OECD in its transfer pricing guidelines is based on the extremely flawed Arm's length principle that is horrendously complex and generates staggering business for the large accountancy firms. In the context of tax avoidance and transfer pricing, the following remarks of the UK PAC is interesting. " … we have seen what look like cases of poacher, turned gamekeeper, turned poacher again, whereby individuals who advise government go back to their firms and advise their clients on how they can use those laws to reduce the amount of tax they pay…." (UK PAC report 944 th report of session 2012-13 on tax avoidance: the role of large accountancy firms.)(https://publications.parliament.uk/pa/cm201213/cmselect/cmpubacc/870/870.pdf)

The same report also points out the asymmetry in the allocation of resources between the government of the UK and the tax authorities. "…There is a large market for advising companies on how to take advantage of international tax law, and on the tax implications of different global structures. The four firms employ nearly 9,000 people and earn £2 billion from their tax work in the UK, and earn around $25 billion from this work globally. HMRC has far fewer resources. In the area of transfer pricing alone there are four times as many staff working for the four firms than for HMRC…."

Theoretically attractive, the lynchpin of the OECD transfer pricing guidelines is the concept of arm's length. Transactions between related parties should be the same as two unrelated parties would have dealt with each other. Thus the guidelines are based on the separate entity concept and not on the reality of the various entities belonging to the group being controlled by one common interest.

Transfer pricing is essentially a matter of domestic legislation. Article 9 merely authorizes adjustments in case there are transactions between related parties. But how these adjustments are to be done is a matter of domestic law. Even before the advent of treaties, transfer pricing legislation was introduced in the domestic law of the UK in the year 1915 and in the year 1917 in the USA. The issue however became prominent only after the expansion of international trade in the 1960s and has attracted added attention after the process of globalization.

Since the issue surfaced in the developed countries and the OECD represented such countries, it developed a consensus amongst its members in respect of the domestic regulations in the form of a Transfer Pricing Guidelines in the year 1995. There was no other standard available and soon it became the standard for all countries that wanted to have transfer pricing legislations. India also adopted transfer pricing legislation in 2001 and arm's length concept is again the fulcrum of the same. In fact, it seems that while drafting the Indian transfer pricing legislation, experts from the OECD had helped. Thus it is true that the Indian legislation on the subject is more or less on the same lines as the OECD TP guidelines with only some peculiarities like the adoption of arithmetical means in place of the range concept. This has also been subsequently changed. The guidelines also provided for several methods for resolution of disputes- like APAs and safe harbours. Initially, these were not adopted by India. However, of late, the APAs are going great guns and the numbers of cases settled by APAs in India is quite impressive.

Notwithstanding the ubiquitous prevalence of the Arm's length principle, the concept came in under severe criticism primarily from the academic community that pointed out the inherent contradictions in that multinationals are formed primarily to take advantage of the synergies of the various entities in a group and it becomes impossible to find comparable in almost all major transactions.

Transfer pricing also has the effect of allocating profits between the different entities. The FAR (Functions, Assets and Risk) analysis is prescribed by the OECD for this purpose. Till recently, these elements could easily be manipulated by contractual means and putting most of the risks and functions in paper companies floated in low tax jurisdictions. It could then be argued that these companies owned the relevant assets and performed the relevant functions as well.

In course of time, the developed countries themselves found out that their MNCs were eroding their own tax base by the simple expedience of forming paper companies in tax havens and by misutilizing the arm's length concept. The BEPS project that arose out of these considerations had action plans 8-10 to deal with and correct some of the aberrations of the current practice.

As a result, certain changes were proposed to be incorporated in the rules. The most significant of the changes is the adoption of country by country reporting by the MNCs. This would theoretically allow the tax administration to have an idea of where the multinationals put their profits. Thus, if most of the profits are parked in some jurisdiction with nil profit and no employees, it should attract the attention of the tax authorities. No doubt, this was one of the positive developments of the entire BEPS project and owes its origin entirely to the efforts of civil society group.

Intangibles being the most valuable assets of an MNC in the current world environment, it was obvious that the treatment of intangibles would also come for scrutiny. As a result, some rules were also formed that would derogate from the strict principles of separate accounting and the Arm's length standard. All these recommendations are in various stages of implementation in different countries.

Developing countries are however not satisfied with the actual implementation of the OECD guidelines. But the UN Model also uses the same arm's length standard. In 2013, the UN however came up with a Practical Manual on transfer pricing for developing countries. It chose to concentrate on the practical aspects of transfer pricing. In fact, the 2013 Practical Manual in its Foreword specifically mentioned: "Consistency with the OECD Transfer Pricing Guidelineshas been sought , as provided for in the Subcommittee's mandate and in accordance with the widespread reliance on those Guidelines by developing as well as developed countries." It may be noted that in 2017 the UN has come up with another practical manual but the reference to the consistency between OECD TP guidelines is not found although the 2013 Foreword is also reproduced.

Nevertheless, the 2013 UN practical manual introduced a separate chapter-X that signalled the dissatisfaction of the emerging economies with the actual working of the OECD standard and contained the experience of the emerging countries - Brazil, China, India and South Africa and the views adopted by the tax administrations in these countries in respect of transfer pricing even though UN did not endorse the practices per se. It mentioned: "Chapter 10 is different from other chapters in its conception, however. It represents an outline of particular country administrative practices as described in some detail by representatives from those countries, and it was not considered feasible or appropriate to seek a consensus on how such country practices were described. Chapter 10 should be read with that difference in mind."

Very briefly, Brazil states that in respect of the Cost Plus and Resale Price Method, instead of making use of comparable transactions, it follows fixed margins for gross profits and mark-up. This is indeed simple for developing country tax administrations to follow. Both China and India emphasized the role of location savings, the importance of the market where products are sold in the development of intangibles, amongst others. In the 2017 version, chapter-X has become Part-D and Mexican practice is also included. There are also some nuanced changes in the positions. However, broadly they remain the same.

It is in this context that one should examine the recently published country positions. The positions are in in the form of answers to certain questions. There are 29 questions in all. What is most interesting is the following question and the answer to the same from some selected OECD and non-OECD countries: "What is the role of the OECD Transfer Pricing Guidelines under your domestic legislation?"

The answers are interesting and there are variations even amongst the OECD members. Thus, Australia says that its transfer pricing legislation specifically makes reference to the OECD Transfer Pricing Guidelines (TPG). It provides that for the purposes of determining the effect the legislation has in relation to an entity, the arm's length conditions should be identified so as best to achieve consistency with the following relevant guidance materials. Similarly, Austria mentions that according to para 2 of the Austrian Transfer Pricing Guidelines 2010, the arm's length principle of Austrian Double Taxation Conventions has to be interpreted in the light of the principles of the OECD and under consideration of the OECD TPG, as they may be revised from time to time. UK also states its transfer pricing legislation incorporates a specific requirement that it be interpreted as "best secures consistency" with the OECD Transfer Pricing Guidelines. France says that the OECD Transfer Pricing Guidelines are not prescriptive under the French domestic law or regulation. However, administrative doctrine makes expressly references to them.

Germany, however, says that the TPG can be seen as interpretation aid if the specific topic is not governed by its domestic legislation or by administrative order. Similarly, Canada mentions that as a member of the OECD it endorses the OECD Transfer Pricing Guidelines. However, it adds that The TPG provide guidance but are not law in Canada. "This distinction was mentioned in a Supreme Court of Canada decision (Canada v GlaxoSmithKline Inc., 2012 SCC 52)"

The USA asserts: "Our transfer pricing regulations are consistent with the TPG . Neither our domestic legislation nor our regulations mention the TPG."

Amongst the non-OECD, non-European countries, Malaysia seems to endorse the TPG stating that its Guidelines are largely based on the governing standard for transfer pricing which is the arm's length principle as set out under the Organization for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines. However, while stating that its domestic rules are consistent with the OECD TPG, adds that " by the provisions of Regulation 12, where any inconsistency exist between the provisions of any applicable laws, rules, regulations, UN practical manual on Transfer pricing and the OECD TPG referred to in Regulation 11, the provisions of the relevant tax laws, shall prevail."

Considering the history of the dissatisfaction amongst the emerging economies, it will be interesting to note in detail the responses of the BRIC. (Comments from South Africa are not available as yet)

As mentioned earlier, Brazil follows its own method in transfer pricing. Its response assumes significance: "The TPG can be used as a subsidiary interpretation guidance, whenever it does not contradict the Brazilian transfer pricing legislation and the national legal system ."It may however be noted that Brazil is the only country that had ticked no against the earlier question: Does your domestic legislation or regulation make reference to the Arm's Length Principle?

"The Arm's Length Principle is a principle that governs the Brazilian Transfer Pricing legislation. However, there is no direct reference to the arm's length principle or its Portuguese translation in the transfer pricing legislation in Brazil. For example, the Explanatory Statement of the Law 9430/1996 which introduced the Transfer Pricing Rules in Brazil says the law conforms rules adopted by OCDE member countries."

China, economically the most important of the BRCIS, states that it respects OECD TPG and incorporates the basic aspects of OECD TPG in the domestic legislation. Russia specifically mentions that not being a member of the OECD, it is not legally obliged to follow OECD documents. However, it adds that the OECD Transfer Pricing Guidelines are used as recommendations. "Generally, OECD transfer pricing principles are the basis for the Russian transfer pricing legislation ."

That leaves us with the response from India that has been carrying some sort of challenge to the OECD dominance in this area. Its response is more nuanced. "OECD Transfer Pricing Guidelines are a useful reference for carrying out transfer pricing studies by taxpayers and audits by Indian transfer pricing officers (TPO). Indian law does not explicitly recognise the direct applicability of the OECD TPG. However, India has framed its own rules and guidance on transfer pricing, which are broadly in line with the OECD TPG as well as the UN TP Manual . The guidance flowing from what has been agreed to in the BEPS Final Reports on Actions 8, 9, 10 and 13 – except the guidance pertaining to low value adding intragroup services – would, nonetheless, be adhered to."

The answers given by the countries concerned may imply that broadly speaking there is acceptance of the OECD TP guidelines. This is to be expected if the concept of arm's length standard is adopted for the purpose of making adjustment. As stated earlier, the ALP concept is part of the separate entity concept that is an artificial construct in the context of the multinationals. However, the concept itself is under challenge although it has also to be admitted that there is no viable alternative to the same as yet. The EU is again trying the CCCTB concept which adopts formulary apportionment but its reach will be limited to the EU alone.

The more difficult outcome will be if the advanced countries, having established the supremacy of the arm's length standard in the context of transfer pricing between related entities, then try to force the more controversial OECD proposal of applying the same methodology for allocation of profits to permanent establishment. That is what OECD has proposed and in that direction, it has formulated the Authorized OECD approach (AOA). Developing countries have so far stoutly opposed the adoption of the AOA since the separate entity concept allows tax base of developing countries to be easily eroded by adopting this approach. Tax administrations of these countries need to be on their guard.

 
 
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