When is the transfer pricing (TP) of a transaction
considered final? The key feature of TP as a discipline is its
subjective nature. This is recognised by the OECD's approval of
a range of possible prices in any TP transaction. By
definition, TP is a study of facts and analysis of comparable
economic circumstances to assess arm's-length pricing.
Businesses and their circumstances change over time, and in
turn, TP guidance also changes, as seen by the many updates to
TP guidelines that were introduced through the G20/OECD's BEPS
process, which ultimately led to the modification of domestic
TP laws and practices.
Transfer pricing needs to be right when a tax return is
filed. A subsequent adjustment by a tax administration creates
a new price (that is right at that time). The new post-audit TP
adjustment can then be subject to a mutual agreement procedure
(MAP), and as a result, a third TP outcome is agreed upon in
The subjective nature of TP rules can often mean that no tax
penalty is levied on a TP adjustment. Many TP regimes focus on
the effort the taxpayer has made, or its behaviour, rather than
the TP reported. This implicitly recognises the genuine
difficulty in adopting appropriate transfer prices.
One may conclude that no transfer price is final until two
competent authorities (CAs) have agreed together on that price,
since there is no further arena in which that price can be
changed (absent developments such as state aid). Alternatively,
the available time for a tax administration audit may have
passed, and therefore, the TP arrangement becomes final by
default. It is thus no surprise that TP disputes are numerous
and may take considerable time to resolve. Viewing the dispute
in its full cycle (the time it takes to finalise an audit and
resolve any double taxation), will render the true cost of a TP
The rise of the MAP
The OECD's MAP statistics remain the most empirical guide to
the level of ongoing TP controversy. These statistics, however
differently presented since records began in 2006, have
consistently shown that the number of MAPs are increasing.
Experience has reinforced the conclusion that the number of
disputes involving TP (and the attribution of profits to
permanent establishments) have increased.
It is important to note that the actual number of
controversies may be much higher than the number of MAP cases
reported. Ongoing 'risk assessment' interactions with a tax
administration can resemble a full audit in everything but
name. Furthermore, many full TP audits end without any
adjustments, and are often just as burdensome and
resource-intensive as those that do give rise to an adjustment.
Even in situations where audits end in an adjustment, some
cases are not taken forward into a MAP (sometimes by choice,
but sometimes because of more formal factors, such as the
taxpayer running out of time or being ineligible for some other
Improvements in dispute resolution processes (essential in a
MAP itself) are a part of the BEPS project, and a recognition
(tacit or otherwise) that increased powers for tax
administrations would mean more controversy. BEPS outcomes were
designed to ensure that single taxation was allocated to the
appropriate jurisdiction, not to increase double taxation. The
Multilateral Convention to Implement Tax Treaty Related
Measures to Prevent BEPS (BEPS multilateral instrument, or MLI)
contains text designed to improve access, resolution and
implementation of a MAP.
The MAP remains the sole path to eliminate double taxation
caused by TP rules. That is universally accepted as the proper
approach. There are few, if any instances, in which
multinational enterprises (MNEs) can legitimately address
double taxation caused by a tax administration adjustment.
Therefore, a MAP process that works is crucial.
Reforming the MAP
The three areas of concern identified by the OECD's
2005/2006 dispute resolution work that led to the manual for
effective mutual agreement procedures (MEMAP) and the
subsequent insertion of an arbitration clause into Article 25
of the Model Tax Convention (MTC) remain relevant.
1) Accessing a MAP;
2) Resolving a MAP; and
3) Implementing a MAP.
The consensus remains that the MAP works when available
(availability depends on a number of factors, not all of them
technical or legal), but it does not always work quickly
The sheer number of disputes reported by the OECD has
ramifications for the speed of resolution. Resolution times are
not improving, while the changing nature of disputes is already
impacting the resolution time frames for MAPs. The probability
of a resolution based only on best endeavours has also been
impacted. The latter underlines the importance of binding
Traditionally, MAP cases in which the only issue was price
was relatively easy to resolve. This may no longer be the case
when the amount at stake is objectively large. Following the
introduction of Chapter 9 into the OECD's TP guidelines, there
are now more binary adjustments based on one tax
administration's view of what an MNE would have done (had its
constituent parts been independent).
Adjustments that have arisen from re-characterisation are
difficult to resolve as it can be difficult for CAs to find
common ground (or a point on which to make a principled
compromise). A different arm's-length price to the one in a tax
return or imposed on audit can be agreed more easily than
whether intellectual property would (or would not) have been
sold by unrelated parties in similar circumstances, given a tax
administration's view of what the realistically available
option would have been.
Increased openness during the MAP process is welcomed and is
paying dividends in terms of resolving complex double taxation
issues. In most countries, it is now easier to determine the
name and address of the relevant person (the CA) who should
receive the MAP. For the country receiving the TP adjustment
(the country that did not conduct the audit), questions around
access are often narrower, and tend to focus on whether a case
can be made in time and whether enough information has been
made available to the CA. The main concerns around accessing
the MAP continue to be in the country where the TP adjustment
has been made.
Some tax administrations are open about having a policy that
allows the audit to close with a lower adjustment if the
taxpayer agrees not to open a subsequent MAP. The OECD may
frown on this, but from a cost-saving perspective, one can see
the point. However, MNEs should carefully weigh the
consequences of settling for double taxation in this
Barriers to the MAP
The biggest single issue to take into account is the
interaction between the audit settlement stage and the
impending (or desired) MAP. Strategic thinking in this area
remains critical. For instance, it is vital that any adjustment
to the price of a transaction with an affiliate (or denial of
relief for tax purposes) is clearly agreed to be a TP
adjustment. Adjustments denying deductibility under non-TP
rules can result in a denial of entry into a MAP for taxpayers
without considerable (and not always successful) effort.
Another barrier to MAP entry that often needs to be overcome
occurs at the end of the audit. In any negotiated settlement,
the taxpayer may feel persuaded to agree that no MAP case will
be made. In effect, that would mean agreeing to double
All of the above practices that seek to deny access to a MAP
are not in line with the minimum standards developed by the
OECD. If relief is available "at the other end of the
transaction" through a MAP, deciding to forgo a MAP should not
be done lightly.
The OECD's statistics, as well as the MLI and BEPS minimum
standards improvements, reveal some ground for optimism. For
example, unilateral relief is granted in 20% of cases. This
figure is not analysed further to distinguish between TP and
non-TP cases, and it seems likely that a significant portion of
these unilateral resolutions are for non-TP cases.
Notwithstanding, the inclination of CAs to grant relief without
the need to enter into bilateral negotiations is welcomed.
After all, the notion is articulated in paragraph 2, Article 25
of the MTC.
Competent authority independence from the audit arm of the
tax administration remains crucial in allowing for a principled
resolution of MAPs. As the internal governance of TP audits by
tax administrations increases, MAP agreements fleshed out
between CAs are also coming under increased scrutiny to
determine whether they should be ratified by the tax
If a pause is reached after a potential agreement, that can
be a good thing, as it can be used to inform or consult with
the taxpayers involved. However, subjecting a MAP agreement to
the same (or essentially similar) internal governance as TP
audits may lead to an increased focus on the tax-raising (or
tax-base defence) aspects of the tax adjustments involved in
the MAP. This would be an unwelcome development.
The OECD was rightfully clear during the first round of
dispute resolution improvement work when the arbitration clause
was inserted into the MTC, noting that the CA's own performance
should not be impacted by tax yield. This was to maintain that
the MAP is about determining TP in terms of Article 9, rather
than on narrower national self-interest. This philosophy is
increasingly under threat.
Independence under the MAP
A longstanding 'separation of the powers' concept for MAPs
has helped to sustain principled outcomes in a MAP. But that
concept is under threat in various ways, and the MAP outcomes
may move away from treaty concepts and become mired in tax
raising efforts. Irrespective of whether the CA is a function
of the finance ministry or a government's treasury department,
having independence from the audit/tax division is vital to the
non-partisan conclusion of a MAP.
When the auditor or tax inspector effectively sits in the
room with the CA during any negotiation in a MAP, a
non-partisan conclusion becomes less likely. Influence over the
MAP process by the audit arm of the tax authority often hinders
the conclusion of a MAP.
However, influence can be exerted in other, less apparent
ways. Subjecting MAP outcomes to the same, or similar
governance as audit outcomes, or having substantially the same
people within a tax administration carrying out such governance
or internal audit, is essentially limiting the ability of the
CAs to operate as impartial 'officers of the treaty'.
Tax administrations that impose adjustments during an audit
that can be seen as the more extreme end of the arm's-length
position may emerge from a subsequent MAP with a higher agreed
adjustment. This places a commensurately higher burden on the
CAs charged with eliminating double taxation, and may create
expectations within the tax administration that a significant
amount of tax remains to be collected.
Taking all this into account, it comes as no surprise that
arbitration mechanisms are becoming increasingly important and,
in theory, increasingly available. The groundwork was laid by
the EU's Arbitration Convention in 1990. The OECD took the most
effective parts of this document, and 17 years later introduced
a far-reaching arbitration article into the MTC. Approximately
a decade later, we have the arbitration potential in the
Multilateral Instrument, and in the EU at least, in the Dispute
All these developments bode well for the potential
availability of arbitration to resolve TP disputes between tax
administrations. For example, the arbitration article has been
incorporated regularly and consistently into tax treaties.
However, there has been no great increase in TP cases that have
actually gone to arbitration panels. In fact, such cases have
been few and far between.
The availability of arbitration has traditionally been seen
as a good thing for dispute resolution. But if this were
universally true, there would have been an uplift in the
numbers of cases being settled in proportion to the number of
MAP cases being brought forward. However, this has not
occurred. Given that the number of cases to proceed into formal
arbitration have not increased, one conclusion is that cases
are being kept out of the arbitration stage by a combination of
tax administration or taxpayer action (or inaction).
However, it is likely that reality is more nuanced. For
example, cases are being settled shortly before arbitration
deadlines fall due. On the whole, arbitration is having its
intended result: deterrence. The quid pro quo of having
mandatory binding arbitration governing the eventual outcome of
a MAP has been an increase in the barriers to entry of a MAP.
Time limits, information requirements, and domestic legal
proceedings must be taken into account if actual arbitration is
going to be relied upon. It is more important than ever to take
a strategic view of TP dispute resolution.
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Edward Morris of Deloitte UK specialises in transfer
pricing dispute prevention and resolution. He has been
instrumental in setting up Deloitte's global TP
controversy team, consisting of former tax
administration personnel and in particular former
government competent authorities. This network has a
global reach and expertise and helps clients with
mutual agreement procedures, advance pricing agreements
and transfer pricing enquiry resolution.
Previously, Edward worked for the HMRC as a tax
inspector and as a UK competent authority, at the EU
Commission and at the various OECD working parties
concerned with tax treaties, transfer pricing and
Edward helps clients across all industry sectors
deal with the increasingly complex world of tax
disputes. Since joining Deloitte, he has appeared
consistently in Euromoney's Transfer Pricing Expert