Exclusive Q&A On Transfer Pricing
With Nate Carden
Posted: 13th June 2014 09:21Q) What benefits does a firm receive in hiring a transfer pricing specialist?
Practitioners focused on transfer pricing typically serve many clients in similar industries, which means the specialist's advice to one taxpayer is informed by how other taxpayers approach transfer pricing. Possessing the ability to assess how one taxpayer's approach compares with another's is important because navigating the transfer pricing rules involves many judgment calls and being an outlier company could result in an unfavorable result. Additionally, many transfer pricing specialists are intimately familiar with all stages of a controlled transaction's lifecycle, from planning to audit to litigation, as well as how transfer pricing structures may affect M&A transactions and other corporate initiatives (e.g., reductions or realignments of staff). Former government officials in private practice can provide additional perspective on how rules are intended to operate and how to handle a controversy. Finally, in my experience tax authorities are likely to assign more weight to transfer pricing documentation prepared by an outside advisor than documentation prepared internally.
Q) Can you talk us through the current transfer pricing landscape?
In the United States, MNEs find their transfer pricing under pressure from many sides. For U.S.-based multinationals, U.S. tax authorities are often focused on transfer pricing with respect to intangibles. This focus, which is reflected in the pronouncements of senior U.S. officials as well as the cases that the U.S. government has chosen to litigate, is based on a concern that U.S. companies inappropriately shift income outside of the U.S. tax net through the use of intangible transfers and licenses. At the same time, other jurisdictions—especially European countries—have focused on the income attributable to sales and distribution activities that these multinationals report in local markets. Adding to this, countries in which multinationals have substantial research, engineering, or support service functions, such as India, maintain that local service affiliates should receive greater returns than have traditionally been associated with these functions. Consequently, all parts of these multinationals’ value chains may be under transfer pricing pressure. Finally, in addition to pressure from tax authorities, multinationals face criticism from both elected officials in the U.S. Congress and U.K. parliament, as well as U.S. media.
Q) Have there been any recent regulatory changes, tax treaties or interesting developments in your jurisdiction?
In the U.S, recent legislative changes and other developments have focused on other parts of MNCs’ international tax policies. Some of these changes have been legislative—including rules governing the availability of foreign tax credits for international operations (the so-called “anti-splitter” rules). Others have been regulatory—including guidance regarding corporate transactions that allow companies to more efficiently deploy offshore earnings (the 2012 Notice governing crossborder reorganizations). Finally, the increasing number of corporate mergers that result in U.S. multinationals being acquired by non-U.S. entities have drawn legislative proposals intended to stop or slow such combinations. These changes do not directly affect transfer pricing, but can dramatically impact the overall global tax effect of an MNC’s transfer pricing policies.
There has not been significant legislative change specific to transfer pricing in the United States yet, but several developments suggest it may be coming. Transfer pricing has taken center stage in tax reform debates in Congress. The Senate has conducted high profile investigations on the tax strategies of multinationals, resulting in many of those strategies becoming front-page news in mainstream newspapers. In addition, the OECD continues its pro base erosion and profit shifting initiative, which could result in legislative changes in some countries.
Q) Are there any attractive incentives for multinational corporations (“MNCs”) in your jurisdiction?
While there has been significant discussion of preferential treatment for certain types of intangible-related income (especially where the intangibles are used outside of the U.S. market), there are not now any material incentives in the U.S. that are specifically related to transfer pricing. That said, the U.S. will often continue to allow the use of other incentives and helpful provisions (such as the credit for research and development and flexibility with respect to entity classification, or “check the box”) notwithstanding a company’s transfer pricing policies. These rules at least generally allow MNCs to maintain the structures and incentives that they have irrespective of their transfer pricing policies.
Q) Is it better to manage transfer pricing documentation locally, regionally or globally?
In my experience, this tends to be very company-specific and many MNCs often take a hybrid approach. The ideal structure for managing documentation depends largely on a company’s operating footprint, available resources and overall transfer pricing approach. For companies with business models under which most affiliates are acting solely as distributors in their local markets, it is often simpler to have a global policy (e.g., a range of arm’s length returns) that is supported by a general functional and industry analysis, as well as potentially a common set of comparable companies, but with a locally prepared analysis of the affiliate’s performance, often relying on local statutory financials. This approach is particularly appropriate for companies that have significant differences between local financials and the parent company’s GAAP, since local expertise may be required to identify and understand these differences. It also requires significant local finance resources, so it is of course more appropriate for companies with substantial global footprints.
That said, in my experience the trend among MNCs is toward global documentation with local tailoring as required. This will often involve a global “master file,” which contains the basic financial information, accounting rules, and transfer pricing policies necessary to determine tentative results in each market. The master file information is often used for making in-period transfer pricing adjustments as well. Local tailoring can then occur after the year is over. The advantage to this approach is that it ensures that each affiliate is using financial information that reflects its taxable income (sometimes required and almost always preferable for local purposes), while at the same time ensuring that policies are applied consistently worldwide. Consistent application is particularly important both for MNC rate forecasting and because of increasing international audit cooperation and information exchange; it also often alleviates local country concerns to know that policies are applied consistently worldwide.
Q) How much of a factor do custom duties, royalties and withholding taxes have on the way firms work?
I usually see customs and withholding issues arise in connection with (often very contentious) audits, so I strongly encourage MNCs to try to reconcile, to the extent possible, the prices charged for customs and transfer pricing purposes. From my perspective, this avoids having to explain inconsistent positions to authorities within the same jurisdiction. Moreover, it often promotes better internal controls, since one set of policies can be used in companies’ ERP and other IT systems. This can ensure that local customs and finance teams understand the transfer pricing policies and that those responsible for setting and monitoring those policies are synchronized with customs requirements. The resulting product-level invoicing usually ends up being more reliable as well.
That said, many MNCs separately manage tax and customs, which can make coordination difficult. Also, where transfer pricing policies are intended to produce targeted returns for entities that serve multiple markets (e.g., regional contract manufacturers that sell at a markup on total costs), it may not be possible to have policies that meet the customs rules of each market, which may depend on local market third party prices. Finally, there are certain instances where customs valuation rules explicitly do not follow the arm’s length standard or local transfer pricing rules. However, in my experience it is often relatively easy to reconcile the approaches and the differences tend to be more a matter of terminology and method than result.
Q) What are the transfer pricing implications of cloud computing?
Cloud computing raises many of the same transfer pricing challenges that other MNCs face, but with the added complication of underdeveloped principles governing the location to which income should be attributed and the returns that should flow to different functions. As with other businesses, this has led to competing pressures on cloud computing business models from different jurisdictions. Some locations focus heavily on developed intangibles and software engineering, while others are increasingly focused on their residents’ use of cloud services and “free” service offerings that cloud providers make available in order to increase advertising or other third party revenue earned in other jurisdictions.
Nate Carden is a tax partner focusing on matters of transfer pricing, operational tax planning and tax controversy. He represents corporate clients across many industries, with a particular focus on life science and health care companies.
Mr. Carden’s transfer pricing and operational planning practice focuses on planning and pre-audit issues arising from cross-border intangible property, service and financing transactions.
His dispute resolution practice emphasizes the representation of corporate taxpayers in pre-audit, audit, administrative appeal and litigation proceedings and involves resolving substantive tax disputes and addressing discovery and evidentiary privilege issues arising from financial audits, IRS examination and litigation.