Heightened government scrutiny leads to rapidly evolving transfer pricing rules and regulations: KPMG International survey
Long-term growth in international trade, combined with the challenging global economic environment and growing fiscal deficits, has many governments focused on tax base protection. According to KPMG International’s Global Transfer Pricing Review, this trend has heightened government scrutiny of transfer pricing matters, including issues such as attribution of losses, business restructuring, intellectual property migration and intercompany financing transactions.
“Globally, transfer pricing is a hot button issue for regulators and companies alike,” says Steven Fortier, leader of KPMG’s Global Transfer Pricing Services (GTPS) practice. “As globalization widens the reach and ambition of multinational enterprises (MNEs), CFOs and tax directors face significant new risks in tax regimes with different rules and expanding requirements. Since every cross-border intercompany transaction impacts two or more tax jurisdictions, and the local tax authorities may treat the same transaction differently, it is impossible to eliminate transfer pricing risk entirely. However, the risk can be mitigated by sound planning and good risk management principles.”
The Americas View
Transfer pricing is one of the highest priority issues for the tax authorities in both the United States (US) and Canada. Internal Revenue Service (IRS) auditors are turning to transfer pricing enforcement as the mainstay of their investigations of Multi National Enterprises (MNEs). In the US, there is a focus on the outbound transfer of intangibles, with a particular emphasis on cost sharing arrangements. Intercompany services also continue to come under increasing scrutiny in the United States.
Canada continues to justify its reputation as one of the countries with the toughest transfer pricing audits. Canadian companies have seen audit adjustments that slash outbound royalties and require relatively high levels of operating profit based on the view that the Canadian company or market has unique characteristics that would garner substantial profits at arm’s length.
According to Fortier, “The focus must be on the end-game: resolution of double taxation. From that perspective, the recent US-Canada protocol introducing mandatory arbitration for mutual agreement procedure (MAP) cases may prove to be a big step in the right direction.”
In Latin America, a decade and a half ago, the region was a rules-free zone as far as transfer pricing was concerned. Today, many countries in the region have transfer pricing rules, mostly based on Organisation for Economic Co-operation and Development (OECD) guidelines. Brazil, however, continues to operate under a system of statutory margins that is not based on the arm’s-length standard. In light of this stance and Brazil’s importance as a trading partner in the region, MNEs must tread carefully in their intercompany transactions within Latin America.
The Asia Pacific View
Tax authorities in the Asia Pacific region continue to heighten their scrutiny with new compliance initiatives, growing budgets for investigations, and a renewed emphasis on transfer pricing. While each jurisdiction has its own story, the general trend is increased standardization of transfer pricing practices within each regime, and, to some degree, across the region.
One particularly important area of development is that of advance pricing agreements (APAs). The past decade has seen an increasing number of Asia’s tax authorities offering APAs, with several new APA programs across the region at varying stages of development. The number of APAs completed by Asia Pacific countries continues to grow, with close to 100 bilateral APAs being conducted per year by Japan and around 20 or 30 APAs per year concluded by Australia and Korea. The United States, for comparison, was concluding more than100 APAs per year in 2006 and 2007; however, this number has now fallen to around 70 per year.
According to Fortier, “Under the right circumstances APAs can be a viable way to manage transfer pricing risks. APAs can be time-consuming and expensive to complete, but they should be considered when they may create opportunities to realize an important objective such as removing uncertainty or achieving a given transfer pricing result.”
The European View
The expansion of transfer pricing rules across Europe is nearly complete. Governments in the region encourage MNEs to comply with documentation either by introducing documentation rules (e.g. France and Greece) or by introducing penalty protection schemes (e.g. Italy). Other countries are on the brink of introducing transfer pricing rules covering not only documentation, but also material transfer pricing guidelines (e.g. Ireland, Austria and Russia).
Dr. Teodora Alecu, Senior Manager of KPMG Romania Transfer Pricing Services briefly comments upon the Romanian transfer pricing legislation and highlights a simple way in which MNE’s could reduce their Romanian transfer pricing risks: “New joiners of the European Union, such as Romania, have only just introduced transfer pricing documentation guidelines a few years back. So this is still a relatively new and unclear topic to handle for Romanian companies, especially since the Romanian transfer pricing legislation tends to be quickly amended by way of strengthening rules. For example, in May 2010 the transfer pricing legislation has reinforced the obligation of Romanian companies documenting all intra-group transactions, including those carried out between Romanian related entities. Needless to say this last amendment constitutes an additional burden for any Romanian company part of an MNE.”
“Thus, in the light of the fast changing legislation requirements, CFO’s of Romanian companies are not always clear as to the extent and the level of detail required by the local tax authorities when it comes to documenting transfer prices. In this sense, MNE’s with a business presence across Europe are best advised to consider setting up “Masterfile Documentation”, to which all companies within the group can refer to for quick and reliable information to be used in complying with the local transfer pricing legislation.”
Mutual agreement procedures and APAs have increased in number, and involve more EU countries. In the past, MNEs often accepted double taxation unless the impact was material. Today, the increased level of transfer pricing audits in many countries has led to a change of policy by many taxpayers.
Keys to Managing Transfer Pricing Issues
According to KPMG’s Global Transfer Pricing team, the keys to companies confidently managing their transfer pricing issues include:
• Planning: developing economically supportable transfer pricing policies and executing forward-looking tax planning with long-term tax benefits.
• Implementation: developing and implementing effective policies, procedures, controls and systems for setting, monitoring and testing intercompany transactions.
• Compliance and documentation: managing risk within the current environment of detailed transfer pricing regulations, strict documentation requirements, sophisticated audit practices and significant penalties for noncompliance.
• Controversy: resolving transfer pricing disputes through APAs, competent authority negotiations, arbitration and litigation support.
“However, due to the fast changing economic environment of developing countries such as Romania, resolving transfer pricing disputes through APAs is not always a viable option for MNE’s. The Romanian and Eastern European business environment may usually be characterised by greater market fluctuations as compared to the more stable Western economies. For this reason, companies most often are faced with situations when they have to quickly change their business model to accommodate a new market demand. Thus, the fast changing environment does not provide much reason for APAs, which tend to take a very long time to be processed by tax authorities, by which time the company might be operating a completely different business model altogether. This is by no means to say that APAs are never a good idea for MNE’s with a business presence in developing countries; but they are, in our view, still a long way from becoming a commonly used tool for mitigating risks in countries such as Romania”, says Niculae Done, Senior Tax Partner at KPMG Romania.
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