2018 outlook for landmark transfer pricing disputes
TP Week rounds up some of the most influential transfer pricing disputes from the past year, and explores how they could evolve this year or what repercussions they could have for similar cases.
Companies are under more audit scrutiny than ever before, and it shows. Heightened transparency and pressure for revenue collection has meant tax authorities are increasingly requesting additional information from multinationals to defend their transfer pricing. The past year saw its fair share of disagreements between companies and tax authorities, and headlines accusing multinationals of tax dodging have become a familiar sight. However, some disputes became more important than others, setting precedents for pending and potential future cases.
IRS re-evaluating TP approach after losses
The Medtronic case quickly became one of the most talked-about transfer pricing disputes in the US when it won against the US Tax Court in June 2016. Among other things, the case revolved around a Puerto Rican subsidiary of medical technology company Medtronic, the royalty rate payable by this subsidiary, and Medtronic’s use of the comparable profits method.
In July 2017, the Internal Revenue Service (IRS) decided to file an appeal in the dispute – an “uphill battle” for the IRS, said Jim Fuller and Larissa Neumann, partners at Fenwick & West in California. The IRS said its grounds for appeal was based on an error by the Tax Court in using Medtronic’s Pacesetter transaction as a comparable uncontrolled transaction.
Fuller and Neumann said the appeal was surprising, and did not have much faith in the appeal being successful. “The case is highly factual and the IRS lost. To prove the court was guilty of factual errors is a heavy burden in an appeal, thus the IRS tries to frame its appeal as focused on errors of law, an easier standard. Transfer pricing, however, always involves factual questions,” they told TP Week.
The US Tax Court dealt a blow to the IRS also in the Amazon case from March 2017, which concerned a Luxembourg unit’s transactions from 2005 and 2006. Amazon had in 2005 entered into a cost-sharing agreement with this unit, and the IRS sought to make adjustments relating to a buy-in payment of pre-existing intangibles. The IRS used the discounted cash flow method to recalculate this buy-in payment.
The IRS argued that Amazon’s transactions were not all at arm’s length, but Amazon said the IRS had overestimated the value of intangible assets it had transferred to the Luxembourg unit.
The US Tax Court said the IRS had on several occasions abused its discretion or acted arbitrarily or capriciously and found that the comparable uncontrolled transaction method was the most appropriate for calculating the buy-in payment. Nonetheless, the IRS announced in October 2017 that it was appealing. Neumann told TP Week that also this appeal would be a difficult one for the IRS. “The IRS really does need to reevaluate its approach to transfer pricing. At least one IRS official seems to agree,” Neumann said.
Following these losses, Kirsten Wielobob, deputy commissioner for services and enforcement at the IRS, said during a conference sponsored by George Washington University Law School in November that the IRS would be reassessing its transfer pricing strategy. Wielobob said the IRS would look at how it selects transfer pricing cases and reaches conclusions.
Tax authority victories
In Australia, the Chevron case set a precedent for other multinationals after a lengthy battle in court that ended with a loss for the oil and gas company. Chevron’s case revolved around underpaid taxes between 2004 and 2008. The court agreed with the Australian Taxation Office (ATO) that Chevron had used a series of intercompany loans and related-party payments to lower its tax bill by around A$300 million ($230 million).
Chevron appealed, but lost the appeal in April 2017, and then decided to appeal again. In August 2017, the company admitted defeat and withdrew the appeal in a major victory for the ATO. The case created waves among multinationals operating in Australia as it cleared the way for the tax authority to pursue other similar cases.
The Chevron case gives the ATO significant firepower to pursue other multinationals, Miles Dean, founder of Milestone International Tax, told TP Week, while Jock McCormack, head of tax at DLA Piper in Sydney, said the ATO is very active in reviewing cross-border financing arrangements.
India’s tax authority also secured a big win this year in the Formula One case from May 2017 regarding permanent establishments. The Supreme Court held that Formula One championship circuit constitutes a fixed place of business, a permanent establishment, in India, and will be taxed accordingly.
Although this case was tried before the Supreme Court, meaning the case cannot go further, it is widely regarded as a very important ruling with implications for other companies operating in India. The principles held in the case were also reinforced in another transfer pricing dispute in November.
Finland and France
In Europe, taxpayers had a better track record over the past year. In July 2017, Google France won a dispute regarding a potential permanent establishment against the French tax authorities, sparing the company of a €1.1 billion tax bill. The French tax authorities claimed Google owed taxes for the period 2005-2010 because the company had been selling an online advertisement service through its search engine.
But a Paris court ruled in Google’s favour, saying the company did not have the technical means or human resources necessary to allow the advertising services to be carried out on its own. The court stated that Google did not have a permanent establishment in France and was not liable for any tax.
This ruling will provide a safer environment to foreign groups, and “prevent the authorities from using all sorts of evidence to support a commercial activity in France,” said Sandra Hazan, partner at Dentons in Paris.
In October 2017, Finland had two important transfer pricing rulings that set precedents in taxpayers’ favour. Transfer pricing rulings are scarce in Finland, so the rulings were very welcome and provided more security for companies. The cases involved enterprise resource planning and intra-group services arrangements.
One of the rulings confirmed that the Finnish transfer pricing adjustment provision does not authorise the re-characterisation of a transaction.
The decisions could have an impact for around 20 pending cases involving major financial interests, Janne Juusela, partner at Finnish law firm Borenius, told TP Week. The decisions in these cases are final, but the has Finnish tax administration acknowledged the rulings and stated that it will comply with these, said Sami Tuominen, partner at Bird & Bird.
"The tax administration also informed that it will change its policy in determining the market-based mark-up rates of service charges to reflect the new ruling. If the services provided consist mainly of administrative services designed to coordinate and standardise group company's functions, the acceptable market-based mark-up rate is a low, at the most a 3% rate. The new policy is implemented from now on when a Finnish company is selling or buying services. The policy is only to be used in low value-adding intra-group services described in OECD Transfer Pricing Guidelines chapter 7. In other cases the market-based mark-up rates of service charges need to be examined on case-by-case basis, as previously done,” Tuominen told TP Week.
Among the state aid cases, Swedish Ikea is latest high-profile dispute on Margarethe Vestager’s desk. In December 2017, the European Commission announced it had opened an in-depth investigation into the Netherlands’ tax treatment of the furniture retailer. The commission said it was concerned that two Dutch tax rulings had given IKEA an unfair advantage over other companies and allowed it to pay less tax.
Meanwhile, an EU court also rejected a US government request to support Apple in its $15 billion Irish state case, for which Ireland is being sued in the European Court of Justice for refusing to collect the sum.
The controversial case has engaged other parties too. The US and Irish Business and Employers Confederation (IBEC) both tried to intervene by applying for an annulment of the commission’s decision, with the US arguing the decision would harm its efforts to develop transfer pricing rules within the OECD framework and reduce the capacity of EU member states to honour their obligations related to tax agreements with the US. But the European Court of Justice rejected the applications on December 15 2017 as there was no proof of the US and IBEC having a “direct and established interest” in the result of the case. The order by the General Court also said there was no apparent link between the contested decision and the development of transfer pricing rules by the US within the OECD regime as these rules are established collectively and not by one single state.
The sovereignty of Ireland over its taxation regime is tested in this dispute and is expected to set a major precedent for European Commission influence on sovereign tax decisions in the EU.