137962763 Multinational Transfer Pricing and International Taxation What Why How and Reporting...

8/15/2019 137962763 Multinational Transfer Pricing and International Taxation What Why How and Reporting Challenges

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A+rican esearch e7ie2 Vol. 3 (5), October, !!". p. %C5-%%

Introuction *oay lobalie 6ar;ets, international +orein irectin7est6ent, an 2orl2ie procure6ent co6bine to create a co6ple,interate an yna6ic business en7iron6ent. *rans+er prices are the 7alueassine to inter6eiate oos, 2hich 6o7e bet2een the i7isions o+ a7ertically interate +ir6. *he trans+er or 6o7e6ent o+ ra2 6aterials, parts,or partially +inishe oos 6ay occur in the contet o+ either national orinternational prouction process. Intra-+ir6 trae 2hich inclues ser7ices,technoloy, capital oos, inter6eiate oos, an +inishe oos +or resale,constitutes a sini+icant portion o+ 2orl trae. In eneral, o7ern6entsconstrain trans+er pricin ecision choices throuh trae policy, +oreinirect in7est6ent incenti7es, labor la2s, +orein echane rates, currencyreulations, local content reIt isclear that the potential +or ta arbitrae that results +ro6 lobalisation createsa consierable an continuin incenti7e +or o6estic co6panies tointernationalie their business (lener an #i6on, !!&)=> . #incetrans+er prices are the 7alue assine to inter6eiate oos, 2hich 6o7e

bet2een the i7isions o+ a 7ertically interate +ir6, the +act that they are,relate party transactions bet2een oraniational units can reuce theepecte 6acroecono6ic bene+its. Intra+ir6 trae i++ers +ro6 basic ar6slenth transactions bet2een unrelate parties because it is shape by thelobal parent=>?s stratey to control upstrea6 supplies an o2nstrea6

6ar;ets (Encarnation, %""&F Een, %""&). lener an #i6on=>?s (!!&)in7estiation suests trans+er pricin threatens lobal ta re7enues, theyconclue the =>ta authorities +ace substantial i++iculties in unra7elinco6ple operations bet2een subsiiaries o+ 6ultinational roups=> . Gac;in %"'3 this ;in o+ trae accounte +or one4opyriht B IAA !!"/222.a+rre79o.co6 Inee A+rican JournalsOnline/ 222.a9ol.in+o


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branch an technically an leally a part o+ the pro+its earne by theEuropean 4o6pany. #ince the European 4o6pany is leally an +actuallysituate in er6any, the o7ern6ent o+ er6any 2ill be incline to ta the

pro+its o+ the European 4o6pany +ully an eclusi7ely (this is calle theesience *aation principle 2herein the country in 2hich the 4o6pany or ini7iual is resient applies ta on all inco6e earne by the4o6panyNini7iual). *his 2oul lea to a ouble taation in the hans o+the co6pany i+ so 6uch o+ the pro+its earne in one country are beinsub9ecte to taation in t2o countries. In orer to 6itiate this 2aste+ul costs(because ulti6ately taes are costs o+ oin business), countries are oblieto enter into ouble taation a7oiance aree6ents (D*AAs, also calleD*4s or Double *a 4on7entions) 2herein uner one o+ the countries

+oroes its riht to ta an there+ore ta is e++ecti7ely le7ie only in one 9urisiction, 2hich 2oul be eter6ine uner the D*AA ($iec;les, %"'C).ner the D*AA, enerally one only country can ta. 1o2e7er 2hat is noteter6ine here is the rate at 2hich the country 2oul ta. *here+ore espitethe D*AA, countries re6ain +ree to chare the rate o+ ta 2hich theyenerally 2oul be charin in other international ta situations. orillustration, the rate o+ ta in er6any is hiher than that i6pose unerEuropean nion (E). 1ere, since the ob9ecti7e o+ the business is to reucethe costs (an ta bein a cost to the business), the transactions souht to beone bet2een the t2o 2oul see; to be one in a 6anner 2hich brins outthe 6ini6u6 possible ta i6plication thereon. It is in this contet that*rans+er ricin ains soli roun. 0hat is *rans+er ricinP *rans+erricin is an o++shoot o+ this tenency o+ business to install a base in t2o orcountries an try to carry out its operations in a 6anner 2hich 2oul rener6ost pro+itable acti7ities in the country 2ith lo2 ta rate. An illustration2oul clari+y the 6atter. In the iara6 belo2, 2e ha7e the case o+ t2ocountries 2hich ha7e i++erent ta rates i.e. Q an R 2ith 3!L an 5!Lrespecti7ely. In this scenario, a roup co6pany has t2o associate co6paniesoperatin in Q an R. 0hile 4o6pany A is enae in 6anu+acturin,

4o6pany G is enae in train. A sells its 6anu+acture proucts to G2hereupon G sells it to thir parties.

4opyriht B IAA !!"/222.a+rre79o.co6 Inee A+rican JournalsOnline/ 222.a9ol.in+o

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Multinational *rans+er ricin an International *aation...

In the abo7e iara6, 2e ha7e t2o situations. In the +irst situation, the Asells to G at a 6ar;-up o+ 5! (upon its 6anu+acturin cost o+ 5!) anthere+ore that 5! o+ pro+it are chareable to ta in Q, 2hich is a lo2er ta

9urisiction. G sells at a pro+it o+ &!, 2hich are chareable to ta in R at arate hiher than in country Q. In this situation, the ta payable by A an Gtoether in Q an R co6e out to be 35 units. 1o2e7er, the roup +ins that itcan sa7e a bit on those taes by 9ust chanin the price at 2hich A an Gtransact. *hus no2 A sells the sa6e prouct at a price o+ %! an thus earnsa pro+it o+ '! 2hich results into a reuction in Gs pro+its (consierin that itoes not chane its price chare to thir parties) to ! an conse?s han

R 4ountry (*aes : 5!L o+ pro+its) ro+it in G=>?s han #ellin price

ro+it in A=>?s han 5! *aes payable in Q 5!3!LS%5

#ellin price %!!

A

5!

G

&!

%&!

*aes payable in R &!5!LS!


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#ituation T% *otal ta ayable S%58!S35

4ost o+ 6anu+acturin in A=>?s han

ro+it in A=>?s han '!

#ellin price %!

ro+it in G=>?s han G !

#ellin price %&!

A

5!

*aes payable in Q '!3!LS%

*aes payable in R !5!LS%!

#ituation T *otal ta ayable S%8%!S3%


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#ource/ lener an #i6on, !!&0hy Does A 4ountry $ee *rans+er ricin ulesP nerstanin thenoo;s an crannies o+ trans+er pricin, i6plies an unerstanin o+ theirection o+ its i6pacts. It has a sini+icant e++ect on the re7enue collectiono+ the 7arious countries. Gecause o+ the 6anipulations uner the trans+er

pricin policies, countries lose out their enuine share o+ the ta they areentitle to collect on the transactions 2hich ta;e place in the country. In ouroriinal illustration, R country is losin out on a ta o+ %! units (!-%!).i7en the sie o+ operations 2hich ta;e place bet2een these a++iliate parties,these +iures ro2 in sie to i7e a consierable set-bac; to the re7enuecollection tarets o+ the countries. Each country 2oul epect a +air share o+taes to be pai by co6panies operatin in their territory as they eploit the

resources 6ae a7ailable to the6 by the country an thus they are entitle tocollect taes to re+lect the cost o+ the resources bein 6ae a7ailable.urther, the chane o+ ta collecte in the case o+ these a++iliate enterprises isnot because o+ a sini+icant chane in the 2ay business has been operatin

but only because4opyriht B IAA !!"/222.a+rre79o.co6 Inee A+rican JournalsOnline/ 222.a9ol.in+o

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conitions +or ealin ha7e been i6pose bet2een these co6panies, 2hich2oul not ha7e been eistin has the transaction been unerta;en bet2eeninepenent parties. 0hile the co6panies ta pay6ents et reuce anthus their o7erall pro+its increase, this is only because o+ an a9ust6ent in

prices an trans+er o+ pro+its (arti+icially) +ro6 one country to the other. Assho2n in iure % the 6oti7ation +or trans+er price 6anipulation ten to +allinto a +e2 eneral cateories/ pro+its, politics, an +inancial issues. Gut,7arious conitions ha7e been +oun to be particularly conuci7e to the+or6ation o+ a lobal trans+er price stratey. *he M$E can use trans+er

pricin strateies to a7oi or 6itiate local content re to another i7ision 2here (2hen) tari++ an

subsiy conitions eist. Alternately, 6ultinational enterprises (M$Es) canuse trans+er prices to i7ersi+y ris; across countries an currencies therebylo2erin the iscount pre6iu6 on cash +lo2s. is; reuction 7iai7ersi+ication i7es lobal +ir6s the ability to obtain belo2 6ar;et rates on+inancial lenin an hein lo2er cost 6a;in the6 6ore co6petiti7e ane++icient. *rans+er prices can be 6anipulate to a7oi or 6ini6ie the e++ecto+ tari++s an local content reulations. *he local o7ern6ent 6ay i6pose ahiher or lo2er ta rates (hillips, !!%) an acti7ely enae in +oreinechane speculation. E6pirically, Arpan (%"') +oun that 6anae6ent7ie2s trans+er pricin as a tool to 6ini6ie taes an 6ore i6portantly tocircu67ent +orein echane restrictions. International businessi7ersi+ication has create a nee an opportunity +or +orein echane ris;6anae6ent. ro6 a social responsibility an a 2el+are econo6ics +ocus,+ree trae i6plies all countries shoul recei7e ue bene+its. 1o2e7er, Hall(%"'3) posite, the ho6e country o+ a 6ultinational 6ay ain un+airly at theepense o+ a less e7elope host country. 1e eplains ho2 conceptuallytrans+er price 6anipulation reuces host country 2el+areF because ains +ro6+orein irect in7est6ent are less than 2oul ha7e been. *his is not tolerate

by the countries 2hich pro7ie in+rastructure an support +or the countries to

operate an thus they see; to isrear the prices 2hich are aopte bet2eenthe a++iliate parties. 0hat is souht to be one by these countries is anaoption o+ *rans+er ricin ules 2hereby they see; to eter6ine theactual prices that 2oul ha7e been chare ha the parties been inepenentan on that basis co6e to arri7e at the correct +iure o+ pro+its ue to betae in their country.4opyriht B IAA !!"/222.a+rre79o.co6 Inee A+rican Journals


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Online/ 222.a9ol.in+o

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0hat are *rans+er ricin techni


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(b) 4ost lus Metho/ In this 6etho, the ar6s lenth prices are souht to be arri7e at by startin 2ith the cost o+ inputs in the hans o+ a co6panyan ain a proportionate 6i o+ 6anu+acturin an other epenses o+

prouction, 6ar;etin an sellin epenses an a reasonable le7el o+ pro+itsan thus arri7in at a constructe ar6s lenth price. *his 6etho isenerally aopte 2herein the entity in


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an thus taable a6ounts eter6ine accorinly. *his 6etho is other2ise;no2n as the Gasic Ar6s lenth 6etho (GAHM). 1o2 *rans+er ricinules are i6ple6enteP or co6panies 2hich unerta;e transactions 2ithrelate parties, there certainly are 6echanis6s esine in place to recorthe etails o+ transaction to precise etails to pro7e be+ore the taationauthorities that the prices chare re+lect a +air 7alue (*an, %""3, Ernst URoun %""%, Gor;o2s;i %""!F #prinsteel, %""").E7en other2ise, thesetrans+er pricin rules are interate in the ta syste6s in a precise etail asthe noninteration 2oul i6ply losin out on prospecti7e re7enues anthere+ore the ta authorities 6ust eercise ue care to ensure that thinsrelatin to trans+er pricin are in orer. *a authorities 2ill no loner accepttrans+er-pricin ocu6entation as e7ience that ta returns are +ile in

accorance 2ith the ar6s lenth principle. lobally, ta authorities areincreasinly ?s calle the potentialtrans+er pricin ris; an opportunity assess6ent 6oel. Assess6ent o+otential *rans+er ricin is;s an Opportunities *he trans+er pricin ris;an opportunity assess6ent +ra6e2or; presente belo2 can be utilise bycorporate treasurers to assess i+ they ha7e either a potential trans+er pricinris; eposure, or alternati7ely an opportunity to structure their operations in

a 6ore ta-e++icient 6anner.


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As the hunters learn to shoot 2ithout 6issin, the birs are also learnin to+ly 2ithout perchin. *his is intriuin an can also be use to the a7antaeo+ the o7ern6ent. *he eportin 4hallenes *he le7el o+ the trans+er price2ill ha7e i6plications +or the unerlyin taable pro+itability o+ the i++erentleal entities. *a authorities are concerne that so6e 6ultinationals 6iht6anipulate trans+er prices to obtain un9usti+ie ta arbitrae bet2een hih-an lo2-ta countries. *o aress this concern, ta authorities re => => => => =>4ash poolin. ro7ision o+ +inancial uarantees. Asset 6anae6ent o+surplus cash. orein echane an co66oity ris; 6anae6ent. ay6entsan nettin ser7ices. actorin an +or+aitin o+ recei7ables.

4opyriht B IAA !!"/222.a+rre79o.co6 Inee A+rican Journals

Online/ 222.a9ol.in+o

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=> 4arbon train. => Arranin o+ lobal creit +acilities. => 4apti7einsurance o+ roup ris;s. i7en the increase scope o+ corporate treasuryacti7ities an the increase in inter-co6pany transactions, it is i6portant +orroups to reassess their trans+er pricin isclosures to ensure that they areconsistent 2ith the ar6s lenth principle as 6ost o+ these transactions arenot reporte or inae


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ner such a policy, the roups 6ar;e-up treasury costs are o+ten allocateto roup co6panies usin an arbitrary allocation ;ey, 2hich is o+ten notconsistent 2ith the ar6s lenth principle. Many ta authorities arechallenin this approach, an assertin that treasury ser7ices shoul only

be chare out to roup a++iliates uner a cost plus approach i+ the ser7ices bein pro7ie are lo2 7alue an routine in nature. *he inter-co6panyser7ices bein pro7ie by 6any corporate treasuries are e


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there is =>no obliation to report the split bet2een thir-party an inter-roup train=> . e+erences Anre2s, D., Ernst U Roun (!!)=>*rans+er ricin/ Are Rou ollo2in Gest racticeP=> Journal o+Accountancy, Vol. 3 $o. 3. Arpan, J. (%"'), International Intra-corporatericin/ $on-A6erican #yste6s an Vie2s, $e2 Ror;/ raer, Gobbinroup, (%""), =>*rans+er pricin auits/ it=>?s s2eaty pal6 ti6e=> ,222.+inarticles.co6., $o7e6ber. Gor;o2s;i, #. (%""!) =>En7iron6entalan Oraniational actors A++ectin *rans+er ricin/ A #ur7ey=> ,Journal o+ Manae6ent Accountin esearch, V/ (all) pp. '-"". 4arter,0.@., (%"") =>*he proble6 o+ trans+er pricin/ 2hen you ha7e +acilitiesin 6ore than one 9urisiction=> , Journal o+ Accountancy(222.+inarticles.co6.), July. Een, H. (%""&), Multinationals in $orth

A6erica, 4alary/ ni7ersity o+ 4alary ress. Encarnation, D., (%""&),Intra-+ir6 trae in $orth A6erica an the European 4o66unity in Een, H.Multinationals in $orth A6erica, 4alary/ ni7ersity o+ 4alary ress, pp.33-3'. Ernst U Roun (%""%), International *rans+er ricin, $e2 Ror;/Gusiness International. Ernst U Roun (!!) =>*rans+er pricin as astrateic e7ice +or ecentralie 6ultinationals=> , International *a anublic inance pp. ''-"!. @out, M. (%"3). =>Enoenous trans+er

pricin an the e++ects o+ uncertain reulation=> , Jounal o+ InternationalEcono6ics &, %&'W%5'. Hall, *. (%"'3). =>On the econo6ics o+ trans+er

pricin, Journal o+ Gusiness, pp. %'-%&=> . Hopatin, M. (!!3). => GiGusiness #till Doin the *a Issue=> , *he Obser7er,


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http/NNobser7er.co.u;NbusinessNstoryN!,C"!3,'"&!,!!.ht6l, January.

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Monthly Gulletin o+ #tatistics, %"", 0ashinton D4/ # Depart6ent o+4o66erce, *able D p.C'. $iec;els, H., (%"'C) *rans+er ricin inMultinational ir6s/ A heuristic prora66in Approach an a 4ase #tuy,

$e2 Ror;/ John 0iley U #ons. O.E.4.D (%"'C). International In7est6entsan Multinational Enterprises, Oraniation +or Econo6ic 4o-operation anDe7elop6ent, aris, hillips, M. M. (!!%), =>.#. to re7ie2 role inassault on ta ha7ens=> , 0all #treet Journal, N3. lener, J an M.#i6ons (!!&), =>A bi s , inancial *i6es (Honon, Enlan) July. #ection & o+ the Internal e7enue 4oe/ Allocation o+ Inco6e anDeuctions A6on *apayers. #prinsteel, I. (%"""), =>#eparate butune , 4O the 6aaine +or senior +inancialeecuti7es, 222.+inarticles.co6. , April. *an, . (%"") =>*rans+erricin in the %""!=>?s=> , Manae6ent Accountin, ebruary, pp. =>X C. *an, . (%""3) =>*rans+er ricin in the %""!=>?s/ *a anManae6ent erspecti7es=> , Yuaro6, 0estport, 4onn. *he *aEecuti7e (!!3.), $o7e6berNDece6ber. 0illia6son, O., (%"'5), Mar;etsan 1ierarchies, $e2 Ror;/ *he ree press. K2ic;, #. (%""), =>0*O

probe is souht on local content=> , A6erican Metal Mar;et, N&222.+inarticle.co6


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137962763 Multinational Transfer Pricing and International Taxation What Why How and Reporting...

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