Many global trends in the transfer pricing landscape have emerged, including the growth of the digital economy, challenges to the arm’s length standard, increasing tax authority and taxpayer use of “big data” and discussions on the compensable value of data, and the increasing “popularity” of the profit split method. This article focuses on the following trends:
- Globally converging corporate income tax (“CIT”) rates and rules to diminish tax base erosion;
- Changing treatment of intangibles by tax authorities;
- Increasing compliance and risk management burden; and
- Efforts by multinational companies to improve their global transfer pricing processes.
Globally Converging CIT Rates and Rules
Globally converging CIT rates and rules to diminish tax base erosion are evidenced by changes to the CIT rate under the United States Tax Cuts and Jobs Act 2017 (“TCJA”), which was a response by the U.S. to more closely align its CIT rates to other OECD countries. The TCJA has adopted provisions that resemble other countries’ dual-rate innovation box regimes (e.g., the UK has a regular rate of 19 percent and 10 percent for patent boxes). Since the TCJA, additional OECD countries have taken steps to more closely align CIT rates – and tax rule structures to strengthen anti-BEPS measures – with emerging “global norms.”
Globally, tax competition among countries continues, with the majority of OECD countries now having corporate tax rates in the 20 to 25 percent range. After the TCJA, Belgium, Luxembourg, Japan and Norway all reduced their CIT rates. Conversely, Switzerland recently announced a CIT increase effective in 2020, along with patent box incentives including full deductions for Swiss-based R&D expenses. The convergence of global tax rates is increasing the focus on transfer pricing risk management – to mitigate the risks of controversy, double taxation and penalties – and decreasing the focus by multinational enterprises (“MNEs”) on tax rate arbitrage-based transfer pricing planning.
Treatment of Intangibles
The passage of the TCJA resulted in a new provision in IRC 482 that unambiguously allows for the aggregation of intangible property (“IP”) transactions (required when aggregation is the most reliable means of valuation), and an expanded definition of intangible property under IRC 936
Motivated by recurring controversies involving transfers of IP for purposes of Treasury Regulations 482, both of which used the statutory definition of IP in IRC 936(h)(3)(B), Congress utilized the TCJA and the Budget Fiscal Year, 2018 (PL 115-97) to add a new, third sentence to IRC 482. This sentence reads, “For purposes of this section, the Secretary shall require the valuation of transfers of intangible property (including intangible property transferred with other property or services) on an aggregate basis or the valuation of such a transfer on the basis of the realistic alternatives to such a transfer, if the Secretary determines that such basis is the most reliable means of valuation of such transfers.” PL 115-97 also added the same content of the new last sentence of IRC 482 to IRC 367(d)(2) as the new subparagraph (D).
IRS efforts to aggregate transactions for transfer pricing purposes have been repeatedly addressed by the Tax Court, most recently in Amazon.com, Inc. v. Commissioner, 148 T.C. No. 8 (2017). In these cases, the Tax Court has held that aggregation of transactions is appropriate if an aggregated approach produces the most reliable means of determining the arm’s length consideration for the controlled transactions.
The 2017 edition of the OECD Transfer Pricing Guidelines (“OECD Guidelines”) state (Chapter III: Comparability Analysis, paragraph 3.9) “there are often situations where separate transactions are so closely linked or continuous that they cannot be evaluated adequately on a separate basis. Examples may include: … b) rights to use intangible property … when it is impractical to determine pricing for each individual product or transaction.” Also, Chapter VI: Intangibles (paragraph 6.12) discusses the importance of: identifying relevant intangibles with specificity, the functional analysis and DEMPE functions, the manner in which intangibles under analysis interact with other intangibles, and the appropriateness of aggregating intangibles for the purpose of determining arm’s length conditions for the use or transfer of intangibles in certain cases.
The TCJA also resulted in an expansion of the definition of intangible property under the IRC. In addition to the intangible property specified in IRC 367(d)(4)(A – E), goodwill, going concern value, and workforce in place (including its composition and terms and conditions of employment) are now defined as intangible property within the meaning of IRC 367(d)(4)(F) for purposes of Treasury Regulations 482 as is the residual category of “other item the value or potential value of which is not attributable to tangible property or the services of any individual.” However, it is not the case that all aspects of the accounting value of goodwill, going concern value and workforce in place are necessarily compensable.
The OECD Guidelines’ Chapter VI: Intangibles also treats goodwill and ongoing concern as intangibles (paragraph 6.13), while the general definition of intangibles is widely-encompassing and does not necessarily preclude “workforce in place” as an intangible, stating in paragraph 6.6 “In these Guidelines, therefore, the word “intangible” is intended to address something which is not a physical asset or a financial asset, which is capable of being owned or controlled for use in commercial activities, and whose use or transfer would be compensated had it occurred in a transaction between independent parties in comparable circumstances.”
Global Compliance and Risk Management Burden
The BEPS initiative has considerably increased the transfer pricing compliance burden (i.e., master file, local files and country-by-country reports) for MNEs under Action 13. The resulting increased transparency requires MNEs to carefully consider the appropriate location of high-value activities, intangible property, and intercompany financing. Also, since tax authorities now have more information about taxpayers than they have ever had before (for example, via the Country-by Country (“CbC”) Multilateral Competent Authority Agreement), expectations are for increased controversy as tax authorities utilize relatively large amounts of taxpayer data. MNEs face the risk that tax authorities will misuse this information taken out of context to justify aggressive adjustments to taxable income.
In addition to Action 13 and the related automatic exchanges of taxpayer transfer pricing information, the sixth European Union (“EU”) Directive on Administration Cooperation (the “Directive”) introduces a new mandatory reporting regime in respect of certain “reportable cross-border arrangements.” The Directive is intended to increase transparency to tackle what it sees as aggressive cross-border tax planning. It requires “intermediaries” such as tax advisors that design and/or promote tax planning arrangements to report cross-border arrangements that are considered by the EU to be potentially aggressive. Cross-border reportable arrangements where the implementation started on or after 25 June 2018 will need to be reported by 31 August 2020. A few examples of reportable cross-border arrangements include: fees contingent on tax advantages derived, “standardized” (e.g., boilerplate or generic) documentation and structures, the acquisition of a loss-making company to reduce tax liability, and transfers of hard-to-value intangibles (when a main benefit of the arrangement is to obtain a tax advantage). In addition to these specific examples of reportable arrangements, reporting obligations in respect of IP sales or transfers will likely result for companies active in the EU. Under the Directive, reported information about the arrangements will be automatically exchanged between EU Member States. As such, it is more important than ever to carefully and thoroughly document the business case for these transactions.
Global Transfer Pricing Management Solutions
One of the main challenges MNEs face is developing streamlined, well-organized transfer pricing processes. Companies are looking for cost effective approaches to achieving compliance and addressing their risks. At the same time, MNEs must balance global consistency while concurrently achieving compliance with specific country requirements.
Transfer pricing technology solutions have evolved in form, content and usability. Early offerings were CD-ROM databases of company information with minimal user interfaces, and not necessarily specific to transfer pricing practitioners. The next technological step brought software applications that integrated company databases with user interfaces designed to research, perform analysis and generate reports. Today, there are more than a dozen technology offerings, including SaaS platforms and applications.
Transfer pricing technology solutions have primarily consisted of software designed to enable MNEs to create transfer pricing documentation in-house. These technology offerings have often fallen short because of their rigidity and their inability to address many of the nuances that require attention in global transfer pricing. Tax authorities become skeptical when they see reports with generic, boilerplate language – concluding that the MNE has taken a lack of care.
While certain software products focus on limited aspects of transfer pricing, such as the analysis of financial transactions or the automation of CbC reporting compliance, MNEs need to solve the challenges they face within their in-house global transfer pricing management capabilities, including:
- Limited resources and time to complete large numbers of documentation reports
- Inefficiencies with gathering and sharing information across departments and entities
- Difficulties organizing and tracking the status of projects
- Lack of an effective process to measure risk and prioritize transactions and reports
- Monitoring and adjusting transfer prices during the fiscal year to achieve target levels of profitability in accordance with transfer pricing policies
- Tracking the location of global IP owners and mapping them to the associated functions (i.e., DEMPE functions)
- Maintaining a state of readiness for transfer pricing audits in various countries
In response to these challenges, WTP Advisors has introduced a global transfer pricing management platform. Trans-Portal is designed to address the above “pain points” and provide a comprehensive solution to organize global documentation, automate data collection, perform research, analyze risks, efficiently update master and local files, collaborate with colleagues, and validate results and documentation.