Diane Hay: The way we deal with transfer pricing has got to change

What were the main changes you made while heading the transfer pricing effort at HMRC?

When I took the role in 2004, one thing that was very obvious was that we were still working transfer pricing cases in much the same way as we had done for the last 20 years. That was very much on an individual basis, so we would only have one inspector doing a case and they wouldn't have access to any experts. These enquiries took a long time because they were so fact intensive. By 2004, the amounts at stake were much bigger and also the companies and their advisers were much more skilled and professional than we were and consequently we felt we were having to settle cases for inadequate amounts and really hadn't got the firepower that we needed.

So the main thing I did starting in 2005 was fundamentally change the way in which we did transfer pricing for most of the largest and most challenging cases. That was about building up a new team inside the Revenue and for the first time bringing in our own economists, something never really done before, but also building up contacts and working with external experts, like some of the boutique economists, industry specialists and also going to the very best legal counsel. I was very lucky that I got funding to do this. It was part of an initiative whereby trying to prove that if we had access to the amount and level of skilled resource that a company or its advisers would have, then we could actually improve on our results and do the work better.

Did you reach your goals?

Oh yes, we saw the results. We started on a small number of cases and we wanted to settle these and bring in what we thought was a much more realistic outcome, obviously the companies didn't necessarily agree with that, but we achieved everything we wanted to achieve.

What did you do next?

We were able to take many of the lessons from that and apply those across the whole of transfer pricing in HMRC and that really is the foundation for the Transfer Pricing Group that we set up in 2008.

What we took from the compliance activity was the improvement in skills and understanding and knowledge and how you best work cases. We put that together with a much more rigorous procedure and decision making process that was aimed at ensuring that the right cases were selected in the first place and that we worked with business to resolve the cases as quickly as possible. We were set the objective of trying to settle typical cases within 18 months, which is very challenging.

How are cases chosen now?

Every case is selected under a rigorous risk assessment. Three levels of risk are looked at; first, the fiscal risk, how much tax is at stake; second, what sort of transaction it is, whether it involves intellectual property which is a complex transaction usually or has difficult valuation issues in it, or whether it is something more straightforward like the cost of goods; third we look at the behavioural approach of the company, what is their attitude to transfer pricing or to tax measures generally.

So the local inspector will look at how risky they think a particular case is on its facts and if he or she thinks that there is a problem with transfer pricing that should be investigated, they will put together a business case to do that. That then has to be approved by members of the Transfer Pricing Group before resources are allocated to take it up as a proper case.

How does that differ to the old method?

What happened in the past was that a lot of cases were being taken up on not very good evidence. It's one of those facts of life that if someone takes up an enquiry, they can find it quite hard to stop, they get dug into it and these things unfortunately can then go on for years and years. Companies get very frustrated and it is a waste of government and taxpayer money if the job is not done properly.

What happens once a problem is identified?

If we investigated and we got to the point where there was an issue with transfer pricing then obviously we tried to come to an agreement with the company at a point within the arm's-length range that both HMRC and the company were accepted. If we both within the range then there was plenty of opportunity for accommodation.

The difficulty is if HMRC's view of the arm's-length range is nowhere near the company's view, then you have got to think about what steps you take next.

What is the next step?

Within the UK, we haven't got much else at the moment other than proceeding towards litigation, which would be listing the case for a hearing initially by the tax tribunal.

When HMRC looks at litigation it follows the overall strategy called the Litigation and Settlement Strategy. What it will be looking at is how much is at stake compared to the cost of litigation. Litigation is extremely expensive in this area, especially for a revenue authority.

And also, [HMRC will look at] what precedent this sets, how important this is in terms of establishing a principle or an outcome that is going to influence other cases or behaviour going forward. If you wanted to show that you were going to be very aggressive for example, you might list several cases quite quickly.

Is litigation a last resort?

Oh yes, very much so.

Are there any methods of alternative dispute resolution available to taxpayers?

Within HMRC there isn't a great deal. You have got negotiation. And really both sides ought to continue to negotiate until the moment you go into the courtroom. It is very difficult once you are in the middle of preparing a case for litigation, but you have to almost have two teams working, one dealing with the litigation and one that is still prepared to negotiate. Other than that we haven't got much else in the UK to avoid litigation.

Do you think that is right?

One or two people have been thinking about alternative dispute resolution such as mediation, but that really hasn't got off the ground yet in transfer pricing. It is difficult to see what this would add to the process, to be honest. It might be useful in cases where there is a real dispute about whether or not there is an issue but when the dispute is about the amount rather than whether there is an issue, it is very difficult to see a route other than agreeing something around a table or taking it to a tribunal.

What about outside the UK?

Once you get into the bilateral realm then other alternatives do exist. You then have the possibility of the mutual agreement procedure and then if that doesn't work you have increasingly the option of arbitration.

Would you recommend the use of the MAP?

I think it is very much a facts and circumstance thing. It depends very much on what the issue is, the amounts at stake and also what other countries are involved. There are some countries where you might feel quite confident about invoking the mutual agreement procedure and would have some hope that this would be resolved amicably, without double tax within a reasonable length of time. There would be other countries where you would not think that was going to happen and not want to make things worse. This is why there are a lot of companies that suffer double tax because the dispute resolution procedures aren't good enough.

Is this an area where HMRC needs to improve?

I think HMRC is pretty good at its end of dispute resolution. We have got some very experienced people working cases and we devote some resource to it. While I think there could be more resource devoted to it here, compared to what other countries do, we are head and shoulders above what they do in terms of dedicating resource to this and having a commitment to try and deal with cases quickly.

A lot of the frustration that HMRC has and that companies have comes about because the response of other countries is so slow. Constantly having to chase people to try and get responses from them is a real problem.

What results did you see from the move to the risk assessment initiative?

This is still a fairly new game. I think the proof will come over the next few years as to whether or not this has generally worked in the sense that by building a good relationship and better understanding with business actually leads to better compliance. I think the difficulty with all this is going to be that the goalposts have moved so rapidly in the last six months, that it is going to be very difficult to make that judgment. The next two to three years is going to be a very interesting period.

What do you mean?

I can see that there is very likely going to be a fight over tax money in the years to come. It will be difficult for the UK to retain its rightful share of income because if other countries become more aggressive, and I think they will, then business finds itself in a very difficult position and wants to avoid disputes and costly controversy. The temptation is it will over-reward the more aggressive countries and under-reward the ones who aren't taking such an upfront stance. That is my concern. I have seen this already with some cases with countries like the US and Japan.

What do you see as the future of transfer pricing?

You could interpret this question as being about the future of the arm's-length principle as opposed to formulary apportionment. Increasingly you are getting commentators saying the arm's-length principle is dead, that we have to accept that and move on to something like formulary apportionment. I don't think I will ever be able to do that. I have always thought that formulary apportionment has just as much difficulty as the arm's-length principle, but in addition, its major problem is that there is no international consensus around it.

The way that we deal with transfer pricing has got to change. We have to develop new ways and adapt to an environment that is very different now to the environment we had when we were last doing to the revision of the OECD Guidelines up to 1995. The future of transfer pricing is, I think, uncertain, but one thing I would say is it has got to still be centred around the arm's-length principle.

Why did you decide to leave HMRC now?

Building the international consensus and the issues surrounding the arm's-length process are matters that I feel quite passionate about and there is only so much you can do from within a government. That inevitably comes with constraints, there are policies you have to follow, decisions you have to live with, so what I think I am interested now in doing is finding a role that is working more across governments, with a greater involvement with the business community too.

Companies and their advisers are the biggest users of the arm's-length standard and domestic transfer pricing rules and yet they don't have, I think, enough of a say in the overall agenda of the development of international guidelines and rules. There isn't enough of a debate around the policy and what we are trying to achieve and I would somehow like to stimulate that and try to develop from both sides new behaviours and understanding.

Given the added pressures of the global recession, there has got to be even more incentive to do this. There will be a fight for tax revenue if we are not careful, there will be some very aggressive positions taken by governments because they will need tax revenue over the next few years. There will similarly be a lot of problems in dealing with losses because companies will obviously want to try to utilise losses as best they can. Unless there is a better understanding between the two groups then the conflicts that we've got now are just going to be exacerbated in the future.

I am now exploring a number of roles that would enable me to do that.

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