A Practical Analysis of Transfer Pricing Methodologies for Bilateral Advance Pricing Arrangements

Abstract

I was previously Director of Mutual Agreement Procedures, National Tax Agency (‘NTA’), in Japan. This paper was written during my stay at Columbia University as senior visiting research scholar. I hope that this paper will lead to further discussion of practical aspects of Transfer Pricing Methodologies for Bilateral Advance Pricing Arrangements. The opinions expressed herein are my personal views and do not necessarily reflect organizational or state positions. It is desirable for multinational enterprises to minimize the risk of economic double taxation arising as a result of transfer pricing adjustments. Such economic double taxation should be, if at all possible, addressed under the condition of rational income allocation between countries. For this purpose we need practicable transfer pricing methodologies. Furthermore, it is better if we have an efficient bilateral framework in which to settle transfer pricing disputes. There is some possibility that Bilateral Advance Pricing Arrangements (‘BAPA’), where Transfer Pricing Methodologies (‘TPMs’) are mainly based on profit methods, can be a reliable way of resolving these disputes. Looking to the past, actual results of BAPA between Japan and the United States may be viewed as a successful model whereby tax authorities have reached agreement in a considerable number of cases of various types related to both inbound and outbound transactions. In this paper, which is intended to be highly supportive of the BAPA, I enumerate the practical points at issue, after taking note of world currents in transfer pricing taxation. I also express some important items for development of the BAPA. I. Currents in Transfer Pricing Taxation The present international standard of transfer pricing taxation is the 1995 Transfer Pricing Guidelines (‘Guidelines’) published by the Organisation for Economic Co-operation and Development as a sort of “soft law.” The world current of transfer pricing taxation since 1995 has three aspects,: the proliferation of countries taking serious interest in such taxation, the trend toward profit methods, and the increase in use of BAPA. First, as relatedparty transactions have spread quantitatively and geographically, European countries have seemed to strengthen their policies regarding transfer pricing since the late 1990’s. And many Asian and Latin America countries have introduced transfer pricing legislation and adopted policies toward transfer pricing. Most of these countries, reflecting both the OECD’s outreach activities and tax practitioners’ guidance, have developed transfer pricing regimes that include profit methods as TPMs and the framework of BAPA as an administrative approach for resolving transfer pricing disputes. Second, with regard to the hierarchy of TPMs in each country’s regime, most countries prioritize the three traditional transactional methods over profit methods. In the United States, however, there is no fixed hierarchy among TPMs and regulations require use of the best method. There seems to be some tendency toward profit methods gradually becoming mainstream in practice because, in many cases, there has been difficulty in identifying comparable transactions allowing use of the traditional methods. Furthermore, considerable experience with practical applications of profit methods has developed, mainly in the United States, including discussions of intangibles, income from services, and cost sharing arrangements.