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Trends & Developments - June 2015 - Transfer Pricing: What Is It All About and Why Has It Become So Important for Multinational Enterprises?

Jun 16, 2015

From a global perspective, transfer pricing has become one of the most important if not the most important tax issue for multinational companies. Almost every day there are stories in the press regarding multinational companies that pay little or no tax as a result of transfer pricing practices. These stories coupled with foreign governments and the Organisation for Economic Co-operation and Development's ("OECD") increased scrutiny of transfer pricing have created the perfect storm.

As noted below, the OECD has proposed new reporting requirements which the U.S. Treasury will apparently follow regarding reporting by large multinational enterprises ("MNE"). It is not clear what congressional action is necessary to implement the reporting requirements. While the new reporting regime will primarily impact large multinationals, the impact of the reporting will certainly increase the focus of governments on all multinational enterprises.

At the core of all related intercompany pricing, regardless of whether the pricing is for tangible property, intangible property, services or financial transactions, is that all pricing must be made at arm's length; in principle, pricing with related companies should reflect a price that would be agreed upon between unrelated parties. This "arm's length" principle, which one would think is fairly straight forward, can be in practice very difficult to apply. This is due to a number of factors including a foreign jurisdiction's view on what is considered an arm's length price, data limitations, uniqueness of related party transactions, and difficulty of finding comparables.

Governments see transfer pricing as having created abuses and as an easy target with the potential to produce large tax revenues. Since there is no absolute rule for determining the right transfer price for any kind of international transaction with associated enterprises, there is huge potential for disagreement as to whether the correct amount of taxable income has been reported in a particular jurisdiction. While competent authority determination, where an adjustment in one jurisdiction will be matched by the granting of corresponding relief at the other end of the transaction, may resolve some issues, the reality is that transfer pricing controversies are expensive and time-consuming.

Conflicts between jurisdictions on the appropriate transfer price result in the following:

  • large tax assessments,
  • potential for double taxation when competent authority procedure is not available or when the statute of limitations is closed in one jurisdiction and an assessment is made in another jurisdiction,
  • expense and time of dealing with competent authority where it is available,
  • withholding taxes on constructive dividends,
  • inconsistent treatment between customs and tax authorities, and interest and penalties.

Most of the world's major trading nations now have detailed requirements for the documentation of transfer pricing matters, but even those that have not yet implemented specific requirements will expect taxpayers to be able to explain and produce support for the positions taken on local tax returns and to show that they conform to arm's-length results. However, there are significant differences in the way foreign jurisdictions require documentation.

Ways Multinational Companies Mitigate Transfer Pricing Issues

There are several ways multinational companies mitigate transfer pricing issues. The most popular and cost efficient is to obtain a transfer pricing study which has been reviewed by each jurisdiction it is designed to cover. Although transfer pricing is subject to challenge, if properly done and documented, concerns generally stand up to audit.

Another avenue is to obtain a unilateral or multilateral advance pricing agreement ("APA") with the jurisdictions involved.

A unilateral APA may be appropriate in cases where the U.S. disregards a foreign entity and a foreign jurisdiction considers the entity related to the U.S. company. In this case, from a U.S. tax perspective, all income passes through to the U.S. entity and transfer pricing is not a significant issue. From a foreign perspective, the foreign entity is respected thus transfer pricing is an important issue and an APA would be useful.

In a unilateral APA, only the jurisdiction that enters it is bound by its terms. In a multilateral APA, all jurisdictions that agree to it are bound by it. Although APAs and, in particular, bilateral APAs significantly reduce the exposure to transfer pricing, they are expensive and time consuming to obtain.

For large MNEs, the time and expense of obtaining the APA is well worth the effort. Jurisdictional tax adjustments could effectively bring down a company. Another issue which companies seeking APAs must contend with in the U.S. and other jurisdictions is the perception by governments that large companies have derived unfair benefits from APAs, thus making the process of obtaining one much more difficult.

Another issue related to transfer pricing for large MNEs is the country-by-country reporting requirement proposed by the OECD in its Base Erosion and Profit Splitting ("BEPS") project. The U.S. Treasury has indicated that it will follow country-by-country reporting.

BEPS Action 13

The BEPS project is a set of 15 action points aimed at mitigating the erosion of tax bases around the globe. Guidance under BEPS Action 13 ("Re-examine transfer pricing documentation") applies to the implementation of transfer pricing documentation and country-by-country (CbC) reporting in 2016 and a related government-to-government exchange mechanism in 2017 (guidance issued by OECD on February 6, 2015). The CbC reporting implementation package follows the September 16, 2014 OECD report "Guidance on Transfer Pricing Documentation and Country-by-Country Reporting," which included a three-tiered standardized approach to transfer pricing documentation:

  • A master file of information relevant for all MNE group members,
  • A local file specific to material transactions of the local taxpayer, and
  • A CbC report of financial and workforce data related to group members in countries where they have a presence.

The CbC report will include an MNE group's related party and unrelated party revenues, profits before taxes, taxes paid on a cash basis, current year tax accruals, stated capital, accumulated earnings, number of employees and tangible assets, also referred to as the template. 

This information will allow taxing authorities to evaluate transfer pricing risks by comparing the income reported in low tax jurisdictions relative to the number of employees they have in that jurisdiction. 

Countries have emphasized the need to protect tax information confidentiality. The guidance confirms that the primary method for sharing such reports between tax administrations is through automatic exchange of information pursuant to bilateral tax treaties, the multilateral convention on mutual agreement assistance, or tax information exchange agreements.


The guidance recommends requiring the filing of CbC reports for MNE fiscal years beginning on or after January 1, 2016. A report would have to be filed within one year of the close of the fiscal year to which the CbC report relates.  Hence, for a calendar-year-end company, the recommendation is for filing an MNE's CbC report by December 31, 2017 (or 12 months after the close of the relevant MNE fiscal year for non-calendar-year-end MNEs).

Exemption for smaller MNEs: Groups with less than €750 million (approximately $840 million) annual consolidated group revenue would not be required to file a CbC report.

What Do U.S. MNE Taxpayers Need for CbC Compliance? Most of the complimentary information in the OECD CbC template is currently reported by United States entities that are required to file Forms 5471/5472. However, the CbC template expands on the information reported in Forms 5471/5472 by reporting annual data on entities that are not controlled foreign corporations (CFCs) – for example, entities under the check-the-box rules.


All multinational companies will face increased scrutiny regarding transfer pricing. The recent news reports of transfer pricing abuses and the OECD's increased focus on transfer pricing will in effect produce an intense focus by all governments on transfer pricing. It is incumbent on all multinational organizations big and small to ensure that they have proper transfer pricing documentation in place.

Trends & Developments - June 2015

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