Taxpayers should design a TP policy to bridge different practices of OECD and developing countries

The updated UN Practical Manual on Transfer Pricing for Developing Countries was officially launched last month. It included new guidelines for developing governments setting up transfer pricing programmes and conducting audits as well as four country-specific chapters explaining the transfer pricing preferences for Brazil, China, India and South Africa.

The UN manual states that location specific advantages, such as government subsidies and low cost materials, are unique to a company doing business in that market. Therefore the local entity should reflect the benefit of these advantages through remuneration.

The UN also shows more detailed comparable transaction data is required by tax administrations in developing countries when compared with guidance given by the OECD to member countries.

More detailed requirements can push a taxpayer to using a different method to compute their transfer pricing, such as the profit split method preferred by the Chinese and Indian tax authorities, according to Stephen Labrum, head of transfer pricing at Alvarez and Marsal – Taxand.

However the OECD advises that adjustments should be made if transfer pricing differs from the comparables used by a taxpayer.

Paul Morton, head of tax at Reed Elsevier said the UN transfer pricing manual is helpful because it enables readers to draw out the key areas where differences can arise. The specific views of four important countries set out in Chapter 10 are particularly informative.

“The existence of quite profound differences between countries is certainly a major issue for multinationals and does make it very difficult to establish policies which are universally applicable,” said Morton. “Every multinational is likely to suffer some degree of double taxation, which is a clear obstacle to trade and investment.”

Formulating policy

Labrum said these differences create a double taxation risk for taxpayers if they do not design transfer pricing policies that recognise the differing approaches taken by developing countries, particularly India and China.

“Advance pricing agreements can be helpful and a collaborative approach can work well in some jurisdictions,” said Morton. “Sometimes, however, differences are very hard to bridge and in some cases bilateral processes may be the only answer.”

Efforts by the OECD to include developing countries in its initiatives are very helpful so some of the harder areas, particularly concerning intangible assets, can be addressed by the widest possible group of tax policy makers , he added.

“Taxpayers need to be aware of the two transfer pricing systems,” said Labrum. “Don’t assume one size fits all based on the OECD principles.”

Taxpayers should pay special attention to location specific advantages when designing their transfer pricing policies, Labrum said.

They should consider how the requirements of countries like India could be compensated for in their transfer pricing policy and reconcile this with the practices of OECD member countries, he said.

Labrum also pointed out the UN manual is a work in progress and taxpayers and practitioners will need to see what guidance is given for services and intangibles to appreciate whether a double taxation risk exists.