«Arm’s Length Standard Month/Month 2013 In this issue: OECD Releases First Base Erosion and Profit Shifting Report IRS Releases 2012 MAP Statistics, ...»
Global Transfer Pricing
Arm’s Length Standard Month/Month 2013
In this issue:
OECD Releases First Base Erosion and Profit Shifting Report
IRS Releases 2012 MAP Statistics, Revealing Increase in Inventory and U.S.-Initiated Cases
Philippines Issues Long-Awaited Transfer Pricing Regulations
Korea Introduces New Rules on Cross-Border Financial Guarantees
Australia Introduces New Transfer Pricing Legislation into Parliament
India Issues Two Transfer Pricing Circulars on Research and Development Activities
Dominican Republic Passes Tax Reform Amending Transfer Pricing Regime
Italian Court Rules on Nondeductible Interest Expense for Undercapitalized Branches
Peru Issues Guidance on Transfer Pricing Documentation Requirements
OECD Releases First Base Erosion and Profit Shifting Report The Organization for Economic Cooperation and Development on February 12 released its first report on base erosion and profit shifting (BEPS). The report responds to the growing perception that governments lose substantial corporate tax revenue because profits are shifted to favorable tax locations, and that traditional international tax principles may no longer be adequate for countries to develop appropriate responses to BEPS.
URL: http://www.oecd.org/ctp/BEPSENG.pdf The 91-page report was presented at the February 15-16 meeting of G-20 finance ministers and central bank governors in Moscow.
The goal of this first report is to establish the case for action by showing the extent of base erosion and profit shifting. If the G-20 agree that a problem exists and that action is needed (which is likely) the OECD group will then consider work streams that will be undertaken to address the problem. The current plan is to present those work streams to the G20 in June 2013.
The plan will (i) identify actions needed to address BEPS, (ii) set deadlines to implement actions, and (iii) identify the resources needed and the methodology to implement these actions.
The report concludes that BEPS is a significant problem for OECD member and non-member states, and that “the international common principles drawn from national experience to share tax jurisdiction may not have kept pace with the changing business environment.” The report states that domestic rules and internationally agreed standards for sharing tax jurisdiction were developed in the early 20th century. They are grounded in a business environment typified by a lower degree of economic integration across borders, and are unsuited to current business models characterized by high intellectual property value and rapid information and communication systems.
The areas of concern for the working group are:
The report challenges governments to address this perceived problem both globally and in a holistic manner, including consideration of matters such as source-based and residence-based taxation. The report recognizes that individual governments cannot act alone to address these issues.
The goals of the OECD BEPS group are to:
Neutralize the effect of mismatches;
Improve or clarify transfer pricing rules to address specific areas where the current rules produce undesirable results from a policy perspective. The current Working Party 6 intangibles work is only a part of this;
Update solutions to the question of tax jurisdiction, particularly in relation to digital goods and services. This might require revision to the model treaty;
Propose more effective anti-avoidance measures to be included in domestic law or international guidance;
Draft rules on the treatment of intragroup finance transactions, including deductibility and withholding taxes; and Propose solutions to counter harmful regimes more effectively, taking into account transparency and substance.
IRS Releases 2012 MAP Statistics, Revealing Increase in Inventory and U.S.-Initiated Cases The Internal Revenue Service on March 13 released its mutual agreement procedure (MAP) statistics for the 2012 fiscal year.
In contrast to data presented by the IRS in prior years, the 2012 statistics include only data for double tax cases, with advance pricing agreements (APAs) now tracked separately by the IRS Advance Pricing and Mutual Agreement Program (APMA), which was formed in the first quarter of the 2012 fiscal year.1 Two key trends revealed by the IRS MAP statistics are an increase in U.S.-initiated cases presented to the IRS and Competent Authority, and a significant increase in U.S.-initiated transfer pricing cases (51 cases in 2012, compared to 25 in 2011).
These trends may be the result of increased taxpayer awareness and acceptance of MAP as an effective way to resolve double taxation, with the 2012 statistics highlighting that in over 95 percent of cases, U.S. taxpayers received full double tax relief through MAP. However, with the restructuring of the APMA in 2012 and increased U.S. transfer pricing enforcement, it is likely that the trend toward more U.S-initiated cases will accelerate in the next few years. This is consistent with public comments by senior IRS officials that indicate an expectation that the percentage of U.S.-initiated adjustments to foreigninitiated adjustments will increase going forward.
APMA Director Richard McAlonan has indicated that a significant factor in the increased inventory is the current impasse between the U.S. and Indian competent authorities, because U.S. taxpayers continue to file U.S./India double tax cases, but those cases are not currently being negotiated or resolved by the two governments. Nevertheless, the IRS is still accepting double tax cases arising from Indian-initiated adjustments and U.S. taxpayers are still required to seek competent authority assistance through the MAP process to (1) obtain double tax relief from Indian-initiated adjustments; (2) take advantage of
Highlights of the 2012 MAP statistics include the following:
Over 95 percent of the cases resolved were settled with full double tax relief: the majority of settlements resulted in relief by withdrawal of the original adjustment (63.59 percent), compared with the provision of correlative relief in
32.40 percent of cases. This is consistent with the outcomes on a five-year average basis, with 53.89 percent of cases resolved by withdrawal of the original adjustment compared with 35.74 percent of cases resulting in the provision of correlative relief.
Only 2.17 percent of cases were closed without double tax relief, with taxpayers receiving partial relief in an additional 1.84 percent of cases. The five-year average results (2008-2012) are slightly higher (6.73 percent and
3.64 percent, respectively) as a result of aberrations in prior years.
The number of transfer pricing cases received by the IRS that related to foreign-initiated adjustments decreased in 2012 (130 in 2012 compared with 141 in 2011), as did the number of cases arising from foreign-initiated adjustments that were resolved (74 in 2012 compared with 119 in 2011). The former statistic is somewhat surprising, given the recent emphasis the IRS has placed on creditability of foreign taxes arising from foreigninitiated adjustments, most recently articulated by Michael Danilack in his role as the U.S. Competent Authority.
Danilack has continued to emphasize the need for U.S. taxpayers to protect their foreign tax credit positions by taking advantage of the competent authority process in the case of foreign-initiated transfer pricing adjustments, and the authors would expect this to be reflected in current and future MAP statistics.
The processing time for transfer pricing double tax cases decreased in 2012 (from a combined average of 849 days in 2011 to 790 days in 2012) to a five-year low in the period from 2008. In particular, a significant decrease in the processing time for U.S.-initiated cases is evident from the statistics (an average processing time of 704 days in 2012 compared with 859 days in 2011). The average processing time for foreign-initiated cases decreased from 847 days in 2011 to 809 days in 2012. This increased momentum can be largely attributed to the formation of APMA and the increased staffing available to actively manage and process double tax cases. Increased coordination between APMA and the IRS field is also likely to have had an impact on the marked decrease in processing times for cases arising from U.S.-initiated adjustments.
Nonallocation, permanent establishment, and limitation on benefits cases continued to be processed quickly in 2012, with a total of 55 cases received in 2012 and 50 cases disposed of. Consistent with this, the average processing time in 2012 was 638 days. Notwithstanding these statistics, we understand that there are some withholding tax cases in which competent authority negotiations are moving slowly as a result of differences in treaty interpretation between the IRS and certain treaty partners.
Overall, the 2012 MAP statistics are very positive for U.S. taxpayers, and trends toward faster processing of cases by the APMA team are expected to continue. Looking forward, it is anticipated that cases arising from foreign-initiated transfer pricing adjustments will continue to be a significant but declining proportion of IRS inventory.
As the IRS emphasis on the creditability of foreign taxes continues, U.S. taxpayers under foreign audit should take care not to acquiesce to foreign-initiated adjustments, and in particular should be aware of certain situations that Danilack recently
indicated should be brought to the attention of the U.S. Competent Authority:
When a foreign tax authority offers to substantially reduce an adjustment on the condition that the taxpayer not seek competent authority assistance; and When a foreign authority asks for excessive documentation, such as passports of U.S. employees who performed a service, before it will allow a deduction for the U.S. charges.
With changes to the current IRS Competent Authority revenue procedure (Rev. Proc. 2006-54) expected in 2013, Danilack has indicated that under the new revenue procedure the IRS may permit cases resulting from self-initiated adjustments or taxpayer voluntary disclosure into the IRS competent authority process. This will be a welcome relief for taxpayers with transfer pricing exposures arising from genuine errors or mistakes in prior years that they cannot correct without exposure to double taxation. However, it is likely that those situations will be considered on a case-by-case basis, and taxpayers should seek advice about their specific facts before taking action that may preclude their ability to seek competent authority relief.
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Month/Month 2013 All rights reserved.
U.S. taxpayers that are under tax or transfer pricing audit in foreign jurisdictions, or that have a reasonable expectation they may be subject to a foreign tax audit, should be mindful of treaty timelines to request competent authority relief or notifications, and take all necessary protective measures to preserve their rights to seek competent authority relief.
Taxpayers do not need to wait until the conclusion of a transfer pricing audit to take such measures. Failure to notify the IRS (or foreign tax authority) within the specified time frames will likely preclude the taxpayer from seeking competent authority relief from double taxation, which could give rise to issues regarding the creditability of foreign taxes. See Procter & Gamble Co. v. U.S., (S.D. Ohio, Case No. 1:08-cv-00608, defendant’s motion for summary judgment granted 7/6/10).
Philippines Issues Long-Awaited Transfer Pricing Regulations The Philippines’ Secretary of Finance, upon the recommendation of the commissioner of Internal Revenue (CIR), has issued Revenue Regulations (RR) No. 2-2013 dated January 23, 2013. The regulations provide guidelines on the arm’s length principle for transfer pricing, which applies to both cross-border and domestic transactions between associated enterprises.
URL: ftp://ftp.bir.gov.ph/webadmin1/pdf/68122RR 2-2013.pdf The guidelines are largely based on the arm’s length methods set out under the Organization for Economic Cooperation and Development (OECD) transfer pricing guidelines and adopts the arm’s length principle as the most appropriate standard to determine transfer prices of related parties.
Arm’s Length Principle
The arm’s length principle requires that transaction with a related party be entered into under comparable conditions and circumstances as a transaction with an independent party. It is founded on the premise that when market forces drive the terms and conditions agreed to in an independent party transaction, the pricing of the transaction would reflect the true economic value of the contributions made by each party to the transaction. Essentially, this means that if two associated enterprises derive profits at a level above or below the comparable market level solely by reason of the special relationship between them, the profits will be deemed non-arm’s length. In such a case, the tax authorities may make the necessary adjustments to the taxable profit of the related parties in their jurisdiction so as to reflect the true value that would otherwise be derived on an arm’s length basis.
RR 2-2013 provides a three-step approach for the application of the arm’s length principle:
Step 1 – Conduct a comparability analysis;
Step 2 – Identify the tested party and the appropriate transfer pricing method; and Step 3 – Determine the arm’s length result.
Available Arm’s Length Methods
In determining the arm’s length result, any of the following methods may be used: