‘It is hard to describe the international transfer pricing rules as they operate in practice except as an exercise in documentation’ The aim of transfer pricing rules is to determine the price of goods, services or use of property in situations of cross border international transactions between related enterprises. The two main stakeholders are multinational firms (taxpayers) and the tax administrations but governments and politicians are also concerned.
Because of globalization, the rise of the multinational corporations and the role of the “transfer price” in allocating profits from one tax jurisdiction to another one, this issue is becoming increasingly important for its stakeholders. Firms willing to play with the rules could use it to shift profits into low tax jurisdictions even if they carry out little business activity in that jurisdiction but they face huge penalties and firms willing to be taxed at a fair level may be the collateral within a tax administration battle.
OECD and US guidelines as well as many others permit related parties to set prices within an arm’s length range, that is to say within a range of prices that would be charged for the same item, under the same conditions, by independent parties dealing at arm’s length.
But there are some clear practical difficulties in implementing the arm’s length standard: We have the problem of identical item – this may not exist – but also that the terms of sale may vary from one transaction to another. Market and other conditions may also vary geographically or over time. Administrations have thus defined an obligation for multinational to disclose documentation to make them able to understand the method chosen and to assess whether it is an acceptable transfer pride or not.
Because of the factors described above, but also due to the current recession that urge administration to protect their tax bases, the documentation requirements have increased and spread in an uncorrelated and divergent way, increasing the burden of the multinationals. Meeting these compliance requirements is complex, costly and time-consuming for firms but they face huge threats as they are taxed twice on the same profits by two different administrations in the case of tax adjustments and they also faces huge penalties.
But they are not willing to disclose unnecessarily burdensome information as it could also be used by the administration to reassess other tax bases. While the arm’s length principle should guaranty the fair allocation of profits to each and every jurisdiction, it is reduced, from a taxpayer’s point of view, to a pros and cons analysis on to the content and extent of the documentation to be provided and tend to be solved by advanced pricing agreements for large multinational enterprises.
But if it is problematic in practice, a standard based approach has the main advantage to be recognized by nearly all administrations while the only other alternative method based on a formula is not likely to be approved by all administration because it is easier to play with and will never content all administrations.