The tax administrations of the four PATA (Pacific Area Tax Administrations) countries - Australia, Canada, Japan and the US - recently issued a request for comments regarding a draft transfer pricing documentation package. The PATA members' objectives were to streamline the complex transfer pricing documentation process by eliminating the need to prepare different packages in each jurisdiction, and to provide taxpayers with certainty that transfer pricing penalties would not be imposed if their documentation met a certain quality standard.
The PATA Transfer Pricing Documentation Package (PATA Package) is available on the IRS website (http://www.irs.gov). The document briefly discusses three operative principles necessary to avoid the imposition of penalties: reasonable efforts, contemporaneous documentation of the efforts and timely production of the documentation. The focus of the PATA Package is, however, on a collective list of documents that PATA members have identified as necessary to avoid the transfer pricing penalties, with no detail regarding the steps and decisions required to determine an arm's-length price.
Deloitte & Touche assembled a coalition of large multinational corporations interested in responding to this request for comments, and drafted, in cooperation with its Deloitte & Touche colleagues in Australia, Japan and the US, one set of uniform comments that were sent to the four tax administrations simultaneously.
The PATA member countries have made significant efforts towards developing a one-size-fits-all approach to transfer pricing documentation; however, the task is much more complex than one would first expect. Three interrelated factors contribute to the complexity, and in turn, increase the burden of transfer pricing compliance:
differences in substantive transfer pricing laws;
differences in transfer pricing documentation requirements and penalties; and
differences in the administrative practices of the various tax authorities.
The interrelationship of these factors requires an integrated approach that addresses all three factors if substantial relief from the web of transfer pricing compliance burdens is to be achieved.
The PATA Package addresses only documentation requirements and penalties. While it certainly provides a comprehensive list of documents, it provides little by way of guidance regarding the underlying effort required to establish appropriate transfer prices. The limited scope of the PATA Package undoubtedly reflects the practical limitations of the PATA member countries to change domestic legislation and policy.
The absence of uniformity in the substantive transfer pricing rules and practices in each PATA jurisdiction presents a substantial obstacle to creating truly uniform documentation. The reality is that tax authorities would still be able to audit and challenge the underlying methodologies, data and computation of prices, and would still be empowered to impose penalties if their respective domestic transfer pricing rules are not followed.
In addition to substantive transfer pricing laws, each jurisdiction differs in its transfer pricing enforcement activities. An illustration of these differences is found in the use of so-called secret comparables by some PATA members in support of proposed adjustments. It is self-evident that any effective analysis of an asserted comparable uncontrolled transaction requires, as a threshold matter, comparing the relevant circumstances of the controlled transaction to those of the asserted comparable uncontrolled transaction. At a minimum, given the efforts that taxpayers will be required to exert, the PATA members should agree that secret comparables should not be used when the taxpayer has made reasonable efforts to establish transfer prices, as eventually contemplated by the PATA Package.
DETAILED COMMENTS ON THE DOCUMENTION PACKAGE
Overview
The stated goal of the PATA Package is to enable taxpayers to create uniform transfer pricing documentation that will satisfy the respective transfer pricing documentation requirements of all four PATA member countries. To accomplish this goal, the PATA Package enumerates three broad principles that must be satisfied for taxpayers to avoid transfer pricing penalties:
taxpayers must make reasonable efforts to set transfer prices that are in accordance with the arm's-length principle;
the documentation must be contemporaneous; and
upon request, documentation must be provided in a timely manner to the tax authorities.
As discussed below, the PATA Package merely provides uniform principles while leaving the interpretation of the principles subject to the local laws of the individual PATA member countries. This will undoubtedly lead to inconsistent application of the broad principles, which will effectively increase taxpayers' transfer pricing compliance burdens.
Insufficient protection against penalties
The PATA Package provides only limited protection against the imposition of penalties. It is intended to allow taxpayers to prepare one transfer pricing documentation report that will protect taxpayers from penalties related to transfer pricing documentation in all PATA jurisdictions. Only Canada and the US, however, have specific transfer pricing documentation-related penalties. Australia has specific penalty rules for transfer pricing adjustments that operate in conjunction with powers of penalty abatement which may be exercised by the commissioner. However, the existence and quality of transfer pricing documentation are factors that may determine the extent to which penalties may be imposed. Notably, a taxpayer's compliance with the type of reasonable efforts that we recommend be adopted by the PATA Package, is grounds for a waiver of penalties. Japan does not have transfer pricing documentation-related penalties. Consequently, the penalty protection afforded by the PATA Package, which is limited to documentation-related penalties, would seem to have benefits that are limited to taxpayers in Canada and the US.
As a result, it would be preferable if compliance with the requirements of the PATA Package were sufficient to avoid all discretionary penalties (both specific transfer pricing penalties and general tax penalties) that can be imposed by any PATA member country. Further, the PATA Package should include a list of the specific penalties that it is intended to cover in each jurisdiction.
Need to revise the "reasonable efforts" standard
Non-uniform standards increase compliance costs
It is unclear what level of certainty the PATA Package affords taxpayers regarding transfer pricing penalties. The preamble to the list of documents contained in the PATA Package states: "To avoid the imposition of PATA member transfer pricing documentation-related penalties, the taxpayer needs to maintain and timely produce upon written request documentation of sufficient quality so as to accurately and completely describe the transfer pricing analysis conducted by the taxpayer and the efforts to comply with the arm's length principle, covering:...."
This statement does not describe the level of effort required by taxpayers. The term "sufficient quality" is unclear as is its relationship (if any) to "reasonable efforts". However, in paragraph IIA, the PATA Package states: "The first principle is that taxpayers need to make reasonable efforts to establish their transfer pricing in accordance with the arm's length principle. Such efforts include, but are not limited to, analysis of controlled transactions, searches for comparable transactions between independent enterprises dealing at arm's length, and the selection and application of transfer pricing methods that are reasonably concluded to produce arm's length results in accordance with applicable PATA member transfer pricing rules, consistent with the OECD Guidelines."
Given the obvious differences in the substantive transfer pricing rules and administrative practices of the PATA members, their interpretations of the reasonable steps necessary to establish a transfer price may be very different.
The PATA Package states that the individual PATA members have retained the right to assess penalties based on the lack of reasonable efforts, subject to their individual local interpretation. Since the PATA Package offers no guidance on the fundamental differences in substantive transfer pricing rules, it is unclear how one set of documents can satisfy each of the respective PATA members' expectations of the efforts required, or how the PATA Package offers any additional certainty with respect to penalties. This lack of uniformity will effectively require taxpayers to comply with the requirements of the jurisdiction that imposes the highest requirements, and in some instances cause taxpayers to prepare separate documentation reports for each jurisdiction.
Ideally, a uniform standard of "reasonable efforts" should be adopted. However, a truly uniform standard is probably unrealistic given the fact that the respective PATA members have explicitly retained the right to impose penalties based on the lack of reasonable efforts, subject to their individual local interpretation. It would be preferable if the PATA Package would provide that if documentation satisfies the reasonable efforts standard of one PATA member (ie documentation is in accordance with the substantive transfer pricing rules of one PATA member), it should satisfy the reasonable efforts standard of all other PATA members for purposes of imposing a penalty.
It would also be preferable if issues concerning compliance with the reasonable efforts requirement (including whether or not a penalty should be imposed) be resolved through the mutual agreement/competent authority process. Although the competent authorities traditionally have not been vested with the authority to discuss and negotiate these issues, the granting of such authority would be a necessary prerequisite to achieving the PATA goal of reducing transfer pricing documentation-related compliance costs.
The list of required documents should be omitted or substantially revised and reduced to give due regard to relevance, materiality and proportionality.
The PATA Package contains a list of documents that the taxpayer may be required to maintain to avoid transfer pricing documentation-related penalties. This list appears to be an amalgamation of the various pieces of information that at times are requested by the various tax authorities when actually conducting an audit or other transfer pricing examination. As such, the PATA list of required transfer pricing documentation will probably increase a taxpayer's compliance burden - a result inconsistent with PATA's goals.
In evaluating the PATA documentation list, the historical rationale for imposing transfer pricing documentation requirements cannot be ignored. The maintenance and production of documentation generally has been intended to serve as a point of departure for the design of a potential in-depth transfer pricing audit. In addition, the contemporaneous documentation requirement was intended to change historical behaviour by encouraging corporate decision makers to establish the company's transfer pricing based on some form of comparables or contemporaneous information that would have the effect of reducing audit controversy between the taxpayer and the local tax authorities through the avoidance of post hoc analyses of the arm's-length nature of controlled transactions.
The ultimate purpose of transfer pricing documentation is to reduce the time and expense incurred by both the taxpayer and the tax authorities in determining whether transactions between related parties are carried out on arm's-length terms by providing a threshold explanation of how a taxpayer establishes its intercompany prices. Documentation requirements were never intended to force a taxpayer to fully document a self-initiated transfer pricing examination prior to a possible audit by a tax administration. Nor was it ever contemplated that documentation requirements would include the necessity of identifying and reconciling the differing and frequently conflicting interpretations of various jurisdictions regarding substantive transfer pricing laws, including:
acceptable transfer pricing methodologies (ie transactional methods v profit-based methods);
priority of transfer pricing methodologies (ie best method rule v hierarchy of methods);
the recommended process for the selection of comparables and determination of an acceptable range;
acceptance of post-year-end adjustments; and
use of the commensurate with income standard.
To achieve the meaningful documentation reform contemplated by, and central to the PATA Package, a taxpayer should not have to assume the burden of creating documentation that reconciles these differences and conflicts merely for the purpose of avoiding the imposition of a penalty. Indeed, responsibility for the reconciliation of differing and conflicting transfer pricing regimes ultimately rests with the offices that negotiate tax treaties to alleviate double taxation, and as a last resort, with the competent authorities of the various competing treaty jurisdictions.
While the importance of contemporaneous documentation is acknowledged, it is notable that tax authorities have recognized that these purposes are not absolute, and therefore have mitigated the burden of transfer pricing documentation compliance by introducing the concepts of relevance, materiality and proportionality. Under this approach, the creation or maintenance of documents and analyses must be relevant, material and proportionate to the goal of documenting arm's-length pricing.
It appears that the list of documents included in the PATA Package is overly broad and fails to give due regard to relevance, materiality and proportionality. One notable example, among many others, is that the PATA Package requires "a description of internal procedures and controls in place at the time of the related party dealings". In addition to lacking a clear definition of what this item is intended to include, the emphasis on such information seems to contradict the principle applied in several countries that transfer pricing examinations should determine whether the results of controlled transactions are arm's length, and therefore, would be only of limited relevance to a transfer pricing examination.
Because the list of documents is overly broad, the list should be omitted. Alternatively, if a list of documents is necessary, the list should be revised substantially and reduced to adhere to the following principles:
the list of information is not mandatory and must be individually tailored to the unique facts and circumstances of each case;
the list of information is not a substitute for an examination-related information request and should not include items that are ordinarily requested during an examination;
the information should be limited to the specific tax years, transactions and countries involved;
the information must be relevant, material and proportionate to the transactions being analyzed; and
the information must not include trade secrets or other similar proprietary and confidential information.
The PATA Package should recognize and adhere to general requirements of relevance, materiality and proportionality, and the avoidance of any redundancy.
Finally, to the extent the Package requires the preparation, maintenance and possible production of documentation of a type that is not otherwise required by a PATA member, the taxpayer should have the alternative of preparing the transfer pricing documentation in accordance with the standards of that PATA member.
Is PATA documentation equivalent to non-PATA documentation?
It is the authors' understanding that the PATA Package is not intended to replace the documentation requirements set out under the local laws of the PATA member countries. Consequently, the issue of whether documentation prepared pursuant to the PATA Package will be treated as equivalent to transfer pricing documentation prepared under local law must be addressed. Without an explicit statement of equivalence, we believe that taxpayers could decide not to prepare uniform documentation out of the concern that local tax examiners would hold up such documentation to a higher level of scrutiny compared to documentation prepared pursuant to local requirements.
Therefore, the PATA Package should include an explicit statement that documentation prepared thereunder will be treated as equivalent to documentation prepared under local law for examination purposes. Furthermore, taxpayers should be instructed to disclose whether their documentation has been prepared pursuant to the PATA Package, so as to inform local examiners as to why the documentation may not appear to be consistent with local requirements.
Contemporaneous and timely production requirements
The PATA Package states that documentation is contemporaneous if it exists or is brought into existence no later than the due date, under each PATA member's respective rules, of a timely filed tax return and includes relevant information up to that date. However, since tax return due dates vary across PATA jurisdiction, documentation created pursuant to the PATA Package cannot be uniform because of the requirement that the documentation must include information that is readily available up to the time that the documentation is prepared (the deadline for which is generally the tax return due date). This issue is exacerbated in situations where the controlled parties have different tax year-ends. To eliminate the difficulties of complying with this requirement, the contemporaneous requirement should be considered satisfied if documentation is existing or is brought into existence by the latest tax return due date of the controlled parties.
SUMMARY OF RECOMMENDATIONS
The authors commend PATA's efforts to reduce transfer pricing compliance costs. While the PATA Package only addresses transfer pricing documentation-related compliance burdens, it is a positive first step toward reducing overall compliance burdens.
However, the authors believe a number of improvements can be made, and would recommend that the Pata Package should:
state that compliance with the requirements of the PATA Package is sufficient to avoid all discretionary penalties (both transfer pricing-specific penalties and general tax penalties) that can be imposed by any PATA member country. The PATA Package should also include a description of the specific penalties that the PATA Package is intended to cover in each jurisdiction;
provide that if documentation is in accordance with the reasonable efforts requirement of one PATA member, it should satisfy the reasonable efforts requirement of all other PATA members for purposes of imposing a penalty;
provide that issues concerning compliance with the reasonable efforts requirement (including whether or not a penalty should be imposed) be resolved through the mutual agreement/competent authority process;
not include a list of required transfer pricing documentation information. Alternatively, if a list is deemed necessary, the current list should be revised substantially to reduce the amount and type of required information;
adopt and define the concepts of uniformity, relevance and proportionality as a necessary prerequisite to the imposition of a penalty on the basis that a taxpayer has failed to make reasonable efforts;
provide that, to the extent it would require the preparation, maintenance and possible production of documentation of a type that is not otherwise required in respect of a relevant taxpayer, the transfer pricing documentation may be prepared in accordance with the standards of that PATA member;
contain an explicit statement of equivalence between documentation prepared pursuant to the PATA Package and documentation prepared pursuant to local law. Furthermore, taxpayers should be instructed to disclose whether their documentation has been prepared pursuant to the PATA Package so as to inform local examiners as to why the documentation may not appear to be consistent with local rules; and
the PATA Package should provide that the contemporaneous requirement is satisfied if documentation exists or is brought into existence by the latest tax return due date of the controlled parties.
CONCLUSION
As a whole, the recommendations discussed above would require wholesale changes to the PATA Package, as well as changes to the members' transfer pricing legislation and policies. Obviously, any legislative changes would be beyond the scope of the PATA members' mandate, although their recommendations would of course be of relevance to the legislators.
One can reasonably assume that, as PATA members have made no attempt to address the differences in their views on reasonable efforts and were, in fact, careful to indicate that the issue would be subject to local interpretation, they have fully understood the energy and resources that would be required to reach a consensus. In the end, they simply did not have the appetite to take on such a daunting task. However, in the authors' view, until the fundamental differences in policies and approaches are reconciled, the PATA Package can do little to reduce the burden of preparing different documentation packages tailored to the rules within the respective jurisdictions.
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