John Christensen ■ Submission to OECD on transfer pricing and developing countries
The BEPS Monitoring Group, which TJN took the lead in establishing last year in the wake of the OECD’s ground-breaking initiative, has just published this report: BMG Submission to OECD on Transfer Pricing Comparability Data and Developing Countries.
This report responds to the OECD Report on this subject of 11th March 2014, prepared at the request of the G20. Its findings are summarised below:
In our view, the Report is disappointing. It is inadequate and unhelpful for developing countries. The Report:
- assumes that developing countries should use transfer pricing methodologies which have been found deficient even by OECD countries, and are currently being revised, especially through the project on Base Erosion and Profit Shifting (BEPS);
- prioritizes the use of comparables, although these methods have been shown to be deficient in both theory and practice, especially for developing countries;
- obscures the real problem, which is not the absence of data but lack of appropriate comparables, due to the integrated nature of multinational firms;
- fails to provide any information about what databases are available, or an evaluation of whether or how the data that they provide is supposed to be helpful for the purposes of auditing transfer pricing;
- encourages developing countries to use methods which are likely to require case-by-case negotiation to ameliorate the fundamental deficiency of data without acknowledging the asymmetries of knowledge and power between developing country tax administrations and both tax advisers and developed country tax administrations; and
- provides only a superficial consideration of alternatives to the use of comparables.
In our view methods based on either comparable prices or comparable profits are unsuitable for developing countries, and likely to lead to either over- or under-taxation, because:
- the lack of appropriate comparables means that appropriate assessments require detailed examinations, specialist knowledge, and subjective judgment;
- such assessments are time-consuming, and require skilled specialists, who developing countries find it hard to recruit and retain;
- the subjective judgments involved leave officials open to undue pressures and temptations to corruption;
- relying on data-bases can result in the use of inappropriate comparables, which may become generalized as firms also rely on them to avoid disputes;
- conversely, the adoption of aggressive adjustments by officials, which may also result from performance incentives, resulting in counter-claims by firms, can lead to an adversarial culture, and sometimes excessive litigation;
- the subjective and often arbitrary nature of adjustments based on comparables makes it hard to resolve conflicts if they arise between states other than by equally discretionary bargaining.
Our recommendations are that developing countries should:
- learn from the mistakes of the OECD countries, and build on their own experience, for example the `sixth method’, or the Brazilian approach;
- anticipate rather than await reforms likely to result from initiatives to combat BEPS, such as country-by-country reporting;
- establish methods which are clear, transparent and easy to administer without the need for significant ad hoc investigation or subjective judgment;
- coordinate transfer price scrutiny with other anti-avoidance measures such as denial of deductions for inappropriate payments to related entities.