On 9 March 2011, the Organisation for Economic Co-operation and Development (OECD) Committee on Fiscal Affairs (CFA) launched a project on the administrative aspects of transfer pricing, including a review of practices that may be implemented by countries to optimise the use of taxpayers’ and tax administrations’ resources. The CFA invited comments on various issues including experience with extant forms of transfer pricing administrative simplification measures and their effectiveness; the different types of “safe harbours” and how best to describe and differentiate among them; and the advantages and disadvantages of safe harbour rules and other forms of transfer pricing administrative simplification, from both practical and policy perspectives. On behalf of Tax Executives Institute, I am pleased to respond to the OECD’s request for comments.
TEI Background
Tax Executives Institute was founded in 1944 to serve the professional needs of business tax professionals. Today, the organisation has 56 chapters in North America, Europe, and Asia. As the preeminent international association of business tax professionals worldwide, TEI has a significant interest in promoting tax policy, as well as the fair and efficient administration of the tax laws, at all levels of government. Our 7,000 members represent 3,000 of the largest companies in the United States, Canada, Europe, and Asia.
Project Background and Objectives
The OECD Transfer Pricing Guidelines (TPG) for Multinational Enterprises and Tax Administrations provide internationally accepted guidance on the application of the arm’s length principle set out in
Article 9 of the OECD and UN Model Tax Conventions. The TPG were originally approved in 1995 and substantially revised in 2010. With the approval of the updated guidelines, the CFA launched this project on the administrative aspects of transfer pricing, which includes a review of techniques that have been implemented by countries to optimise the use of taxpayers’ and tax administrations’ resources. In connection with the project, the OECD surveyed Member and Observer countries on their use of safe harbours. The results of the survey were recently published.[1]
Paragraph 2 of that survey notes that “while there is a need for the development of increasingly sophisticated guidance for complex transactions, it is also essential to promote a cost-effective use of taxpayers’ and tax administrations’ resources for improved compliance and enforcement processes. In effect, countries often have scarce administrative resources to enforce transfer pricing rules. At the same time, taxpayers face increasing compliance requirements and transfer pricing audit activities worldwide.” TEI concurs and believes that governments should direct compliance requirements and enforcement efforts to the transactions they deem to be the riskiest, largest, and most complex.
TEI commends the OECD for undertaking this project. For multinational enterprises of any scope, compliance with myriad transfer pricing requirements, especially documentation rules, is one of, if not, the most burdensome compliance challenge faced. The multiple, highly nuanced, and sometimes conflicting interpretations of the arm’s length standard reflected in the substantive transfer-pricing rules and administrative requirements of various jurisdictions impose significant and inconsistent compliance burdens on taxpayers. TEI supports the development of uniform, multilateral guidance for taxpayers and tax administrators. To the extent that OECD Member States can agree upon safe harbour rules, especially harmonised substantive rules, taxpayer compliance burdens will be reduced. The development of harmonised standards for substantive transfer pricing rules will require careful balancing. On one hand, the Member States would likely reject proposals to standardise the rules based on the lowest common denominator among the respective rules. On the other hand, the standards cannot be so high that compliance is excessively burdensome and unattainable. In other words, the most stringent elements of the various countries’ transfer-pricing rules should not be combined and characterised as the “harmonised” rule. True harmonisation may require a compromise among the respective countries’ requirements based on complexity and risk.
Hence, the OECD should reconsider its guidance on safe harbours at paragraphs 4.95 to 4.123 of the current TP guidelines, especially the recommendations in paragraphs 4.121 to 4.123. Paragraphs 4.95 to 4.120 of the guidelines review the pros and cons of safe harbours, but paragraph 4.121 regrettably states that “safe harbours are generally not compatible with the enforcement of transfer prices consistent with the arm’s length principle.” We disagree and recommend deleting that statement. Taxpayer and tax administrator experience with the imprecise process for determining an arm’s length price suggests that there is room within the arm’s length principle for administrative tolerance for all taxpayers — large MNCs as well as smaller taxpayers. Finally, the OECD should strive to ensure that Member State documentation rules are proportionate, consistent, and streamlined.
Discussion
A. General Principles. The OECD’s survey of Member State transfer pricing simplification measures provides useful data. The summary notes that 27 of 33 OECD countries provide some form of transfer pricing simplification, with measures benefitting “small and medium-sized enterprises” (SMEs) accounting for more than one-third of the available simplification measures, and measures benefitting “small transactions” accounting for a quarter. With the exceptions discussed below, many of the simplification measures are irrelevant to larger enterprises. As a general matter we encourage the OECD to work toward simplification measures that will apply to all taxpayers and to more transactions.
A root cause of compliance burdens encountered by multinational enterprises is inconsistency among various jurisdictions either in the substantive transfer-pricing rules or in their administration, especially in respect of how the taxpayer’s compliance with the arm’s length standard is evaluated. Thus, to simplify the administration of transfer pricing, the OECD member countries would have to agree upon and implement uniform substantive safe harbour rules. To the extent that two countries have safe harbour rules but the substantive rules and documentation requirements differ, the administrative relief afforded by the safe harbour may be attenuated. For example, if two countries have safe harbour rules prescribing a methodology for determining an acceptable “interest rate” on intercompany loans, but the methodology for setting the interest rate or the loans to which the safe harbour interest rates may be applied are different, a taxpayer structuring a loan between the two countries must still comply with two different sets of rules. Hence, the documentation and compliance burdens are only minimally reduced by the safe harbours. The analysis would be similar, though far more complex, where safe harbour rules are applied to sales of products, performance of services, or licenses or transfers of intangible products.
In addition, where the safe harbour rules of different countries differ, taxpayers may still need to resort to competent authority proceedings to resolve double taxation issues. Even though paragraph 38 of the OECD survey referenced in footnote 1 states that there have been no reported cases of double taxation as a result of taxpayers complying with different countries’ safe harbour rules, we question how long that that will continue.[2] Hence, unilateral safe harbours may not be effective in providing relief unless they are reasonably consistent and harmonised among the OECD countries.
B. Useful Safe Harbours. There are several substantive safe harbour rules in use in various countries that TEI commends to the OECD for its consideration.
1. Low-cost services. Most large multinational companies are familiar with and beneficially employ the safe harbour rules promulgated by the United States for the Services Cost Method (SCM) and Associated Shared Services Arrangement (SSA) for SCM transactions. Transactions covered by these rules for low-margin services include services that have a median comparable mark-up of seven percent or less or are listed in Rev. Proc. 2007-13;[3] services that are not listed as excluded activities; services that do not contribute significantly to key competitive advantages, core capabilities, or fundamental risks of success or failure; and services for which certain documentation requirements are satisfied. Although taxpayers’ experience with the IRS’s administration of the rules as safe harbours has not been wholly satisfactory, the rules are theoretically sound and we encourage the OECD to promote the adoption of similar rules by other Member States.[4] Such safe harbour rules will be successful insofar as they are consistently implemented and administered by tax authorities. Moreover, taxpayers’ documentation burdens under the safe harbour should be no more rigorous — and should preferably be less rigorous — than would be required in the absence of the safe harbour. Thus, taxpayers and tax authorities would benefit greatly from a coordinated, consistent approach of using the costs of providing “low-cost services” as a safe harbour proxy for the arm’s length price.
2. Establish a safe harbour range for tangible products based on a pricing differential between arm’s length and non-arm’s length parties. Some countries have established a safe harbour range for prices of tangible products based on an acceptable percentage differential between the price to controlled parties (inside price) and the price to arm’s length customers (outside price). For example, where the price of tangible goods to the non-arm’s length party is within a range of no less than 80 percent and no more than 120 percent of the price charged to an arm’s length party, the price is considered arm’s length. The 20-percent differential above or below the price to the arm’s length party is considered within an acceptable safe harbour range.
3. Setting interest rates on loans between associated companies. Several countries have established safe harbours for setting interest rates on loans between associated nonfinancial companies. We believe there is a clear benefit in avoiding costly but unproductive audits of loans that do not involve taxpayers in the lending business and encourage the OECD to work toward establishing Member State safe harbour guidelines. The commercial loan market in most countries is generally deep enough to provide a market-based benchmark that would permit countries to publish and periodically update a range of acceptable safe harbour interest rates, even for large loans. Alternatively, countries might provide an optional safe harbour range based on government borrowing rates, for example 100 to 130 percent of the interest rate on government debt securities of comparable term to maturity.
C. Distinguish “Minimum”/”Maximum” Transfer Pricing Rules from “Safe Harbours.” Some non-OECD countries have adopted minimum transfer pricing rules for inbound goods, especially for goods that compete with domestic goods, and maximum prices for services. In many cases, the “safe harbour” or minimum transfer pricing rules for goods are designed, together with excessive tariffs and discriminatory VAT rates, to render the foreign goods uncompetitive with domestically produced goods. In the case of maximum prices for services, the rules may not be set with a view for recovery of costs let alone a small markup. TEI urges the OECD to differentiate safe harbour rules that promote ease of compliance and administration with transfer pricing requirements and rules that operate as protectionist legislation. We have no quarrel with countries establishing a range of arm’s length results as an acceptable safe harbour for transfers of goods or services — indeed we encourage countries to do so — but the range should not be set in a discriminatory fashion with a view to favouring domestic companies over foreign competitors in the production of goods or minimising the cost contributions that affiliates should bear for shared services.
D. Ensure that Safe Harbours Are Not Absolute Rules or Minimum Requirements. Safe harbours are intended to minimise taxpayer documentation and compliance burdens as well as minimise the resources that tax administrations must expend to monitor compliance. A safe harbour thus is different from a substantive rule. Where a taxpayer’s transactional results fall outside of a safe harbour range, the failure to satisfy the safe harbour should not be deemed per se evidence of noncompliance. Rather, the taxpayer should be permitted to establish through the regularly applicable documentation rules that its transactions satisfy the arm’s length principle.
E. Documentation and Administrative Burdens. The TPG, especially at paragraphs 3.80-3.83, 5.6-5.7 and 5.28, emphasise that documentation requirements should be reasonable and should not impose costs and burdens disproportionate to the circumstances. Under paragraph 5.4 of the TPG, “prudent business management principles” require a taxpayer to document the arm’s length nature of its transactions. Section 5.16 of the TPG also confirms that the amount and type of documentation relevant to any particular intercompany transaction depends on the facts and circumstances of each case. Consequently, under the current standards, taxpayers are not required to prepare or retain documents that they would not otherwise prepare or retain in the ordinary course of managing their business. This principle affords taxpayers flexibility in managing their affairs. Regrettably, some Member States request transfer-pricing information from local affiliates about transactions occurring wholly outside of the Member State jurisdiction. Such information is not maintained in the ordinary course of the local affiliates’ business and should not be relevant to the determination of the prices in the local affiliates’ transactions.
TEI encourages the OECD to keep these principles in mind as this consultation progresses. All too frequently, tax administrators conclude that every shortcoming or challenge in the administration of transfer pricing rules is attributable to insufficient taxpayer records or documentation and have responded by imposing additional and ever-more onerous rules or requests for more information on examination. The ever-growing, overlapping, and increasingly divergent documentation guidelines of the Member States in respect of transfer pricing is a severe administrative burden on companies. TEI urges the OECD to re-affirm that taxpayers are permitted to tailor the scope of the required documentation to (1) the information reasonably available in the ordinary course of its business and (2) the materiality of the cross-border controlled transaction.
Specific recommendations for documentation safe harbours are, as follows:
1. Regional harmonisation of documentation requirements. Global harmonisation of transfer pricing documentation requirements would be ideal. To the extent that global harmonisation is not attainable, regional harmonisation of such requirements may be an achievable alternative.[5] A helpful analogy is the EU Master File system developed by the EU Joint Transfer Pricing Forum[6] and adopted by many pan-European multinationals. The combination of taxpayer input in setting up the system, uniform guidelines across multiple countries, and the promise of an exemption from documentation related penalties will make the Master File system a success. As with all safe harbours, however, the documentation rules should be voluntary and should not become de facto minimum requirements.
2. Practical language and translation requirements. For taxpayers operating in multiple jurisdictions, the need for local language translations of transfer-pricing documentation can be very burdensome. TEI encourages the OECD to recommend that Member States accept documentation in “major” languages and to require translation into local languages only upon audit request and for relevant and limited extracts from such documentation.[7] Guidance about what constitutes a “major” language can be found in most country rules permitting MNEs to file local accounts in one of several “major” languages.
3. No annual renewal of transfer-pricing studies where there are no significant changes. Finally, we recommend that the OECD clarify its current documentation guidelines to provide that, where there are no material changes to the underlying facts of the taxpayer’s functional analysis, risks assumed, or the market conditions governing controlled transactions, taxpayers are not required to undertake a painstaking transfer pricing study to update their comparables data. Only when there are material changes should a wholly new transfer pricing study be required. In addition, where documentation developed for one period provides evidence of arm’s length pricing and remains relevant, taxpayers should be permitted to incorporate the earlier documentation by reference rather than repeat the data in a new study.
E. Summary. Overall, TEI believes that the development of consistent, fair, and reasonable substantive transfer-pricing rules and administrative practices will not only minimise taxpayer burdens but also generally reduce transfer-pricing controversies. A reduction in controversies, in turn, will diminish the resources that both taxpayers and tax administrators, including the competent authorities of the OECD countries, devote to the resolution of such cases. Thus, we urge the OECD to provide balanced and harmonised guidance on substantive safe harbour transfer-pricing rules as well as documentation requirements.
Conclusion
TEI appreciates this opportunity to present its views on the OECD’s project on the administrative aspects of transfer pricing. These comments were prepared under the aegis of TEI’s European Direct Tax Committee whose Chair is Anna M. L. Theeuwes. If you have any questions about the submission please contact either Ms. Theeuwes at +31 70 377 3199 (or An.M.L.Theeuwes@shell.com), Johann Müller at +45 6120 2911 (or johann.muller@maersk.com), or Jeffery P. Rasmussen of TEI’s legal staff at +1 202 638 5601 (or jrasmussen@tei.org).
TAX EXECUTIVES INSTITUTE, INC.
Paul O’Connor
International President
[1] Multi-Country Analysis Of Existing Transfer Pricing Simplification Measures, Centre for Tax Policy and Administration, Organisation for Economic Co-operation and Development (10 June 2011). The document is available at http://www.oecd.org/dataoecd/55/41/48131481.pdf.
[2] Some taxpayers reported transfer-pricing adjustments between countries with differing safe harbors that created double taxation, but the amounts involved were insufficient to warrant the cost of undertaking competent authority proceedings.
[3] 2007-3 I.R.B. 295 (January 16, 2007).
[4] Australia, Austria, and New Zealand also have safe harbour pricing rules for non-core services, but there are differences from the U.S. rules. Other countries provide safe harbour rules for services, but impose limits on the value of the cross-border services that will qualify for the safe harbour relief. Hence, they may be beneficial only for small associated companies within large multinational enterprises.
[5] For example, as noted in previous OECD consultations, tax administrations often require taxpayers to find and use local country comparables. Worldwide or regional benchmarks and comparables, however, should, in many or most circumstances, be acceptable, especially in global markets or in highly integrated regional markets such as Europe or North America.
[6] Another example is the transfer pricing documentation package created by the Pacific Association of Tax Administrators (PATA) whose laudable goal is to establish principles under which taxpayers can create uniform transfer pricing documentation so that one set of documentation can meet their respective transfer pricing documentation provisions and thus avoid the imposition of the PATA members’ transfer pricing penalties. That said, TEI is very concerned with the package’s stringent documentation requirements, which regrettably represent an aggregation of the requirements from each member jurisdiction.
[7] Thus, transfer pricing studies in “major” languages should always be deemed to satisfy requirements for “contemporaneous” documentation requirements.