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TP controversy: Prevention is better than cure

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In collaboration with tax experts from Deloitte member firms around the world, ITR’s Transfer Pricing Controversy guide provides strategies to help avoid and resolve disputes as tax authorities resume pre-pandemic levels of activity.

Heading into 2022, it was anticipated that as public health restrictions on travel and business activity eased, normal conditions would resume. The reality, unfortunately, did not align with expectations. Multinational enterprises (MNEs) have continued to experience supply chain disruptions, unpredictable fluctuations in demand, labour shortages, and associated fallout from the pandemic.

While MNEs in many sectors are still struggling to adapt, most tax authorities have now resumed pre-pandemic-level transfer pricing audits. In most countries, the mutual agreement procedure (MAP) and advance pricing agreement (APA) programmes have also been revived, although taxpayers face long cycle times due to large case inventories.

The BEPS project imposed an expanded array of documentation and reporting requirements regarding cross-border transactions (for example, a local file, a master file, and country-by-country reports, often in addition to existing transfer pricing documentation requirements). Most tax authorities have become more proficient at using these resources to identify taxpayers that are deemed to pose an elevated risk of non-arm’s-length pricing practices and profit outcomes.

Insights from Deloitte experts

Against this backdrop, in this guide professionals from several Deloitte member firms bring their extensive experience to bear, suggesting potential strategies to reduce the chances of controversy and efficiently resolve any controversies that may arise.

Chapter 2 focuses on transfer pricing documentation. The authors note that despite broader documentation requirements in recent years, the volume of transfer pricing controversy cases has remained steady or even increased. Documentation should be sufficiently robust to conclusively demonstrate that a taxpayer’s transfer prices are consistent with the arm’s-length principle. When the documentation provided is deemed to be insufficient, the likelihood of challenge sharply increases.

Chapter 3 considers the impact of BEPS-related guidance regarding profit split methods, financial transactions, and other issues. The authors signal that rather than align with the BEPS guidance, some countries continue to pursue their long-held views on certain issues. However, most countries have made effective use of the extensive documentation available as a result of the BEPS project, which will hopefully lead to a more harmonised approach among key jurisdictions.

Chapter 4 addresses the critical role of APAs in preventing transfer pricing controversy. Special emphasis is given to the APA programmes in India and China. Although each of these programmes faces challenges, both countries have expanded the availability of unilateral and bilateral APAs, which is a positive development.

Chapter 5 reviews the transfer pricing controversy environment in two key sectors: automotive and media. These sectors, like many others, underwent significant changes due to the COVID-19 pandemic, as well as broader societal conditions. The authors note that it may be necessary to rethink established paradigms and to evaluate arm’s-length results in industries that are undergoing fundamental transformation (for example, a shift to electric cars, and a shift from theatrical release of films to streaming).

Chapter 6 takes a deeper dive on several key aspects of the post-COVID-19 environment: the proliferation of hybrid or remote work, the increased availability and importance of data, and the rapid evolution of business models. Taxpayers are under pressure to revisit value chains and business models, transfer pricing practices, and supporting documentation to reflect current economic and political conditions.

Chapter 7 explores the relationship between transfer pricing compliance and the broader environmental, social, and governance (ESG) agenda. Pointing to initiatives by the EU, the OECD, and other groups, the authors note an emerging view that transfer pricing is one of the more important risks facing many MNEs. It remains unclear, however, whether mounting pressure for transparency and disclosure by taxpayers has the potential to reduce the amount of transfer pricing controversy.

In Chapter 8, the authors identify several emerging trends regarding audits and litigation in transfer pricing. They observe that information requests in audits have become increasingly sophisticated and comprehensive, as auditors often request detailed information concerning the motivation behind specific transactions. A growing body of transfer pricing case law is developing, much of it based on multilateral standards. Several recent decisions have applied a ‘commercial rationality’ analysis to complement and augment the arm’s-length principle. These developments point to the importance of documentation and contracts that are comprehensive and pragmatic. In today’s environment, documentation that meets a minimum standard is not sufficient and will often lead to requests for additional, highly detailed information.

Chapter 9 provides insights regarding the arbitration of tax treaty disputes, including transfer pricing cases under the MAP article. As arbitration becomes more widely available, it holds the prospect of facilitating timely and principled resolution of difficult disputes. At the same time, the procedural and conceptual aspects of adopting binding arbitration have proven to be more substantial than anticipated.

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