Transfer pricing, like its broader parent the international tax system, is in the emergency room. As the readers surely have noted, the system has been diagnosed to be a sick man to whom the doctors (OECD under the guidance of G20) are now mixing increasing doses of medicine at increasing pace. The BEPS project is making efforts to fix things and create a transfer pricing framework which would better align the outcomes with the true value creation contribution of the various parties and create more transparency and standardisation for transfer pricing documentation (as previous medicine has been too diverse and localised). As the disease is widespread, further measures, such as guidance on financing transactions, are expected on the second stage of the project.
While the big debate on whether arm's-length will survive or be replaced by formulary apportionment has somewhat faded, the medicine mix seems to suggest that this question is still implicitly present. For example, both the latest intangibles draft and the recent country-by-country reporting (CBC) initiative could give tax authoritie potential ammunition for wider application of formulaic profit split methods. And there are abstract statements on how certain difficult areas may have to be resolved by solutions outside of the arm's-length standard.
An absolute key for BEPS initiative will be the ability of jurisdictions to reach a broad enough consensus on the framework to be implemented, resulting ultimately in a level playing field. In this respect, the fact that BEPS is now really a G20 initiative may help to get all major global economies on board and this would in the course of time create pressure for any outliers to also join. However, the G20 aspect will also reinforce the views and demands of the big non-OECD developing countries in this process, potentially making consensus more difficult.
One fundamental challenge is the true level of harmonisation for transfer pricing which realistically can be achieved under any regulatory solution. To remind ourselves, transfer pricing, perhaps more than any other area in tax, is a principles based, inexact science and any level of regulation cannot exhaustively resolve the myriad real life transfer pricing permutations. BEPS may be further compromised in this sense because of the urgency vested to the project by the politicians. Given these inherent limitations, success will heavily depend on what happens to BEPS at national implementation and interpretation level. The big question here is whether the governments would really backtrack from their existing, divergent practices towards a more unified position or whether they would use BEPS just as a means to top up their existing regimes with new obligations and approaches.
Finally, additional challenges to the success arise from the unabashed stance of countries to use fiscal incentives to attract foreign investment. Political and peer pressure is now expected to eliminate the most abusive schemes but jurisdiction to tax will prevail and even in a post-BEPS world, there will be incentivised regimes as long these are based on robust substance and transparency. So the schizophrenic behavior, where some countries mix right hand posturing against aggressive tax planning with left hand introduction of tax incentives, will likely not disappear. Analogous to stock market and trader behaviour, whenever the government brain is inflicted with a prospect of future FDI dollars, rationality may break down, compromising any pre-agreed principles on profit and tax allocation. One wonders if governments can really stick to unified, BEPS compatible standards in the future when they compete over the mobile resources of the MNES.
In terms of Asia, transfer pricing has been on a Silk Road between West and East for years and the road has also become a two-way one. BEPS has already built a presence in Asia and is hence nothing new to the region. Obvious examples come from China and India who have for years pursued innovative, less conventional approaches, seeking to account for the true value generation occurring in these countries. Location savings, market premiums and other unique attributes are such attempts to align profits with value creation, however, rather than being about eliminating double non-taxation, they have created a sticky, double taxation prone deadlock between developing and developed economies. These factors are now being codified as comparability factors in the revised OECD intangibles chapter, perhaps partially as a practical solution to provide oxygen to the continuous application of the TNMM and avoid developing country tax authorities converting to profit splits as a default.
Looking at Asia further, one can note that also some of region's most developed countries, such as Australia, are living and breathing BEPS. For years, the Australian Taxation Office (ATO) has placed an increasing emphasis on the transaction characterisation (rather than the mere price), hence going back to the heart of the arm's-length principle. The ATO is now already pursuing unilaterally its own BEPS implementation process which has features akin to CBC. The broader pattern in the developed Asian inbound jurisdictions has been for tax authorities to move, once having taken their battles on local distributor margins, on to push hard against any profit stripping business restructurings and intra-group funding arrangements.
Asian countries are a very diverse mix and in some of them, particularly in South East Asia, transfer pricing developments were momentarily stagnated over the past few years. However, there is now momentum again and the common threads are increasing activity and ramp up of rules, compliance obligations, enforcement and resulting disputes. Financial and trading hubs like Hong Kong and Singapore are also gearing up their actions, as they are now very focused on preserving their fairly recently achieved status as white-listed, transparent jurisdictions with proper transfer pricing regimes.
Across the board, the conventional, problematic transfer pricing issues in Asia continue to be ever present. To name a few, managing self initiated true-ups and related customs issues continues to be very challenging and there are the eternally lasting disputes on service/headquarter charges where taxpayers are expected to present two truckloads of information to evidence the benefits. Many have faced a slow death in the sun in these battles and it seems BEPS may now reinforce this trend, unless action 10 truly manages to strike a balance against the excessive demands of many tax authorities.
So, from a substance standpoint BEPS is and has been, to variable degree, already present in Asia. What we have not really seen in Asia is the media attention and reactions from the public. This is natural given that the region is not undergoing any real austerity and the public in most countries is likely to be focused on more fundamental political issues.
What will one make out of all this? The heading provokes that there is little prospect for the sick man to heal, if not even to survive. BEPS will seek to modernise the transfer pricing system and eliminate some of the loopholes and perceived weaknesses. It is also expected to materially increase transparency and information access, while simplifying the vastly proliferated compliance landscape. But for BEPS to succeed it will have to achieve all these ambitious objectives without generating a framework for increased disputes and double taxation.
While we hope that this future perfect world will materialise, a pinch of realism is necessary. Governments will still always choose the particular transfer pricing strategies and approaches which fit into their proprietary position in the global economy and trade flows. Tax authorities at a practical level will also forever disagree where value is created, at least as soon as the stakes of any case get high enough. Developed countries likely will continue to emphasise brands, technology, capital and strategic management as key value creators whereas developed countries will pursue their anti-colonial transfer pricing, claiming that labour, infrastructure and consumption power are the real sources of value. Modern transfer pricing is a fluid escort, conveniently lending arguments from both capitalist and socialist economic theories and going where the money is. Given all this, the moderated global economic growth levels and the fiscal tightness, it is fair to say that pressure on dispute resolution mechanisms will not fade away.
It is not all doom and gloom though. Once finalised, BEPS will presumably offer more unified and better guidance on concepts like substance and push taxpayers undergoing business transformations to link up tax more effectively to such initiatives. Typically this results in additional savings and shareholder value.
And the advice to taxpayers?
The risk and opportunity landscape is changing materially so this is not the time to stand in the water. However, while take-the-money-and-run is not really an option, run-for-the-money may be. Running meaning, developing a much deeper understanding of the transfer pricing risks involved, better and more business integrated planning (which will now carry on opportunity premium) and seeking even more upfront certainty.
To be a winner, one needs to run like hell.
KPMG in Hong Kong
Kari is the Asia Pacific Leader of KPMG's global transfer pricing services, leading more than 600 KPMG transfer pricing professionals across the region. Kari has more than 15 years of experience in tax and economic advisory in relation to transfer pricing, valuations, value chain management and international taxation.
Kari works both with global MNEs and new emerging market champion across a wide range of industries ranging from retail and consumer markets, energy and natural resources, financial services, industrial markets, transport and logistics to information, communication and telecoms. As a member of KPMG's global value chain management team, Kari has extensive experience in conducting large scale business transformations and tax value chain management projects across an integrated suite of tax services. He also regularly works on engagements covering discrete transfer pricing planning, global or regional documentation and dispute resolution.
He is a frequent public speaker and regularly publishes in international and regional journals.
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