The Functional Fallacy

The transfer pricing methods established by the transfer pricing rules and practices of many countries (generally modelled after the OECD Transfer Pricing Guidelines) are not only complex to implement, but also fraught with challenges such as the lack of availability of comparables for benchmarking purposes, low accessibility of databases and the failed capacity of tax authorities to implement them. For tax authorities in African countries, these challenges are further amplified, for example, by lack of resources, especially human and capital, and a shortage of experience in applying transfer pricing rules. As a result of these challenges, achieving arm’s length prices for transactions between related entities has posed a significant burden and cost to both taxpayers and tax authorities. The OECD and the G20 initiated the Base Erosion and Profit Shifting (BEPS) project to ameliorate some of the challenges listed above and to address the erosion of tax bases and shifting of profit to low-tax jurisdictions—challenges ultimately tied to the limitations of the arm’s-length standard and application of transfer pricing methodologies. However, tax authorities in some jurisdictions already apply safe harbors and other simplified measures to mitigate the challenges of applying transfer pricing rules and practices. These measures reduce the need for taxpayers to prepare detailed transfer pricing documentation in justifying the arm’s-length price fixed for goods and services transferred among related entities. They also remove the need for tax authorities to audit the books of taxpayers where they act within approved margins. In some cases, they exempt taxpayers from applying transfer pricing rules to related-party transactions. Historically, the OECD discouraged the use of safe harbors by tax jurisdictions, claiming that they conflict with the arm’s length standard. In recent times, the OECD has changed its views on the use of safe harbors. The Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalization of the Economy recommends the use of safe harbors, including those in the GloBE rules, in determining marketing and distribution profits. Given the positive recommendation by the OECD on the use of safe harbors in recent times, this Article analyzes the adoption and application of safe harbor regimes by certain countries and discusses how they should be designed. It recommends the cautious adoption and application of safe harbor regimes by tax authorities in African countries to achieve increased revenue collection, tax efficiency, certainty, simplicity and convenience, and to circumvent the complicated comparability analysis.

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.

Transnational corporations (TNCs) have long considered transfer pricing as a key tax concern. If stability in transfer pricing is a necessary condition for dynamic cross-border trading, then recent financial reporting changes, updated transfer pricing guidelines, and new reporting requirements for uncertain tax positions are destabilizing influences that must be addressed by companies in order to mitigate their transfer pricing-related exposures and risk. This study reports the results of a survey of tax executives from the four countries comprising the Pacific Association of Tax Administrators (PATA), three of which have transfer pricing regulations based on Organisation for Economic Co-operation and Development (OECD) guidelines. The study seeks to explain how TNCs are managing their transfer pricing risks proactively in today's volatile environment, and if their actions are successful. Findings include contradictory evidence regarding audit risk reduction strategies recommended by tax authorities and the utility of those strategies in actually reducing corporate audit risk. These were surprising results, given that tax authorities and transfer pricing consulting firms tout certain transfer pricing agreements as the best way to mitigate transfer pricing audit risk. At best, are these agreements neutral relative to audit risk? At worst, are tax authorities using these agreements as a source of confidential data for possible future use in both transfer pricing and non-transfer pricing audits?

Indonesian tax authorities currently encounter a lack of cooperative compliance among companies engaged in transfer pricing practices with their affiliated entities across borders. Transfer pricing is commonly associated with tax purposes, such as tax planning or avoidance, which is considered standard practice for business entities. Hence, there is a significant necessity to assess and evaluate the prevalence of tax planning or avoidance through transfer pricing in multinational enterprises operating in Indonesia. To gauge the extent of transfer pricing used for tax avoidance purposes, this study examines the perspective of tax authorities on companies' transfer pricing optimization behavior. Employing a qualitative approach, the study aims to comprehend the utilization of transfer pricing and its implications. The findings provide insights into transfer pricing behavior within companies over time. According to tax authorities, companies are motivated by the benefits of transfer pricing, including revenue optimization, corporate profit allocation, and cost optimization. However, these practices are influenced by various factors that facilitate or constrain transfer pricing activities. Multinational enterprises demonstrate limited awareness of normative beliefs regarding international and domestic transfer pricing regulations. Notably, companies affiliated with large multinational enterprises, possessing a strong understanding of transfer pricing, exhibit a high potential for tax planning or avoidance through transfer pricing arrangements with related parties. These findings contribute to the existing body of research on transfer pricing practices from the perspective of tax authorities as part of the Indonesian government.

The OECD project against BEPS has brought and initiated many changes – among others, in the OECD Transfer Pricing Guidelines. To react and respond to changes in the current business environment, a new chapter for transfer pricing in financial transactions has also been introduced (namely chapter X). This step can be considered beneficial. However, meeting all the requirements for setting a transfer price for financial transactions seems to remain a very demanding and expensive task. Furthermore, the OECD Transfer Pricing Guidelines have been of a general nature rather than providing responses to all potential problems and circumstances – they provide fundamental ideas and principles. Thus, the potential to apply a simplified procedure for setting a transfer price (even for financial transactions) can be viewed as desirable, both for taxpayers and tax authorities. The aim of the paper is linked to this idea – to present the results of a comparative study dealing with the rules for safe harbours for financial transactions (namely loans) as established worldwide, providing a summary of existing concepts and systematized criteria for a safe harbour to be considered.

The paper examines the scope of related party transactions falling under the OECD Transfer Pricing Guidelines (TPG) and the transfer pricing regimes of selected tax jurisdictions. The OECD TPG does not deal with the concept of associated enterprises as used in Article 9 of the OECD Multilateral Tax Convention (MTC), while Article 9 of the OECD MTC does not define the terms used to describe associated enterprises. This gives rise to the question of what exactly was intended for under the scope of Article 9 and its consequent applicability. At the same time, many jurisdictions define related party transactions for transfer pricing purposes using the concept of “control”, but countries may perceive “control” from different perspectives. The paper discusses the practical implications arising from such differences in specific scenarios, e.g. joint ventures, family owned companies, comparability and country-by-country reporting. The “closely related” concept proposed under BEPS Action 7 is also discussed. Finally, the paper concludes with some recommendations to resolve these issues. Given the increasing focus on transfer pricing, more transfer pricing disputes are expected and correspondingly a greater use of Article 9 to eliminate economic double taxation. This intensifies the need for clarity on the scope of Article 9. It would also be timely to review the scope in light of the changes that are being made to the OECD TPG.

Tax-compliant transfer pricing of intra-group services: The soft drink case

Intercompany transactions account for more than 60% of global trade value. In this article, one can easily understand that the concept of transfer pricing is a major issue in the determination of customs valuation. However, the relationship between transfer pricing and customs valuation is not easy to grasp. Basically, there is two different approaches of transfer pricing, the first one adopted by tax agencies, based on the OECD Transfer Pricing Guidelines and the second adopted by customs agencies, based on the WTO Customs valuation Agreement (CVA). From the business perspective, the divergence between the two taxation regimes is an obstacle to the liberalization of trade and inhibits international development for companies. On another hand, the International Chamber of Commerce (ICC) strongly believes that the WTO CVA and the use of OECD guidelines are enough to settle the issue of customs valuation and transfer pricing. However, ICC specifies that tax and customs approaches of intercompany transactions should converge to the same value. In this goal, ICC published a policy statement in 2012, which has been integrated in the WCO guidelines. This statement, based on the harmonization of the current rules, contains several additional options to derive customs value. Also we can regret that the Union Customs Code (UCC) does not contain any evolution from a transfer pricing perspective but contains some negatives changes regarding custom valuation. Also, the opportunity of the WCO Free Trade Agreement (FTA) should be taken to move forward on this issue.

In applying the international principles to the taxation of Multinational Enterprises, one of the most difficult issues that have arisen is the establishment for tax purposes of appropriate transfer prices. Transfer prices are significant for both taxpayers and tax administrations because they determine in large part the income and expenses, and therefore taxable profits, of associated enterprises in different tax jurisdictions. The Committee on Fiscal Affairs, which is the main tax policy body of the OECD, has issued a number of reports relating to the transfer pricing issues. The most important are the Transfer pricing Guidelines for multinational enterprises and tax authorities which was published in 1995. These Guidelines focus on the application of the arm’s length principle to evaluate the transfer pricing of associated enterprises, the analysis of the methods for evaluating whether the conditions of commercial and financial relations within Multinational Enterprises satisfy the arm’s length principle and discussion of the practical application of those methods. Simply, these Guidelines focus on the main issues of principle that arise in the transfer pricing area. The Committee on Fiscal Affairs continues its work in this area, on 22 July 2010 approved and released the proposed revisions to Chaps. I through III of these Guidelines and simultaneously published a new Chap. IX related to business restructuring. The revisions are the result of several years of work on comparability and the use of profit-based methods. The revised text will have a significant impact on the application of transfer pricing analysis and transfer pricing methods. The paper is focused on significant changes of newly approved Guidelines with aim to evaluate how the Czech Republic began applying the principles set out in the revised text of these Guidelines.

Rapid globalization has encouraged the expansion of multinational companies and the increasing complexity of cross-border transactions. Transfer pricing is an important issue in international taxation practices, because it has the potential to be used to shift profits to countries with lower tax rates. This study aims to analyze the effect of tax burden, exchange rate, bonus mechanism, and thin capitalization on transfer pricing. The method used in this research is quantitative using secondary data. The population in this study are all manufacturing companies listed on the Indonesia Stock Exchange (IDX) during the period 2019 - 2023, totaling 231 companies. The sample was selected using purposive sampling technique and obtained data totaling 25 manufacturing companies with 89 units of analysis which became the object of observation. The analytical technique used in this research is panel data regression analysis with the help of Eviews software version 12. The results showed that the tax burden has a significant positive effect on the company's decision to practice transfer pricing. This indicates that the greater the tax burden borne by the company, the greater the possibility of the company to practice transfer pricing. Meanwhile, the exchange rate variable, bonus mechanism, and thin capitalization have no significant effect on the company's decision to practice transfer pricing. In conclusion of this study, the company management is advised to consider the decision in conducting transfer pricing practices and be more careful in conducting transfer pricing. Meanwhile, the government and tax authorities are expected to increase and tighten supervision of companies conducting related transactions in order to minimize tax avoidance practices through transfer pricing practices. Rapid globalization has encouraged the expansion of multinational companies and the increasing complexity of cross-border transactions. Transfer pricing is an important issue in international taxation practices, because it has the potential to be used to shift profits to countries with lower tax rates. This study aims to analyze the effect of tax burden, exchange rate, bonus mechanism, and thin capitalization on transfer pricing. The method used in this research is quantitative using secondary data. The population in this study are all manufacturing companies listed on the Indonesia Stock Exchange (IDX) during the period 2019 - 2023, totaling 231 companies. The sample was selected using purposive sampling technique and obtained data totaling 25 manufacturing companies with 89 units of analysis which became the object of observation. The analytical technique used in this research is panel data regression analysis with the help of Eviews software version 12. The results showed that the tax burden has a significant positive effect on the company's decision to practice transfer pricing. This indicates that the greater the tax burden borne by the company, the greater the possibility of the company to practice transfer pricing. Meanwhile, the exchange rate variable, bonus mechanism, and thin capitalization have no significant effect on the company's decision to practice transfer pricing. In conclusion of this study, the company management is advised to consider the decision in conducting transfer pricing practices and be more careful in conducting transfer pricing. Meanwhile, the government and tax authorities are expected to increase and tighten supervision of companies conducting related transactions in order to minimize tax avoidance practices through transfer pricing practices.

This report, prepared by Deloitte Touche Tohmatsu transfer pricing specialists with the funding of the IDB, compares the transfer pricing regulations in the OECD guidelines, which constitute the international standard that OECD member countries have agreed should be used in analyzing transfer pricing issues between multinational enterprises and tax administrations, and the situation in Argentina, Brazil, Mexico, the United States, and Venezuela. It concludes that transfer pricing policies are not exclusively about taxation. Transfer pricing regulations should enable tax administrations to obtain a fair tax base at the same time they minimize the risks of double taxation for multinational enterprises. The OECD Guidelines provide the guidance on transfer pricing issues for both taxpayers and tax authorities by establishing a comparison with what would have happened between independent enterprises. However, there is no universal solution to transfer pricing issues in the OECD Guidelines. Also that the preface to the reform introducing the transfer pricing rules states that the tax administration, for purposes of computing the statutory margins for the import and export RP and cost plus methods, will take into consideration economic analysis by industry sector, branch of activity and based on the current economic situation. Adjustment will be allowed when the economic circumstances necessitate adjustment. This flexibility is different from the Brazilian rules, which provide fixed margins for all economic activities unless the taxpayer establishes a different margin with data from official publications or research carried out by a qualified firm. This report, prepared by Deloitte Touche Tohmatsu transfer pricing specialists with the funding of the IDB, compares the transfer pricing regulations in the OECD guidelines, which constitute the international standard that OECD member countries have agreed should be used in analyzing transfer pricing issues between multinational enterprises and tax administrations, and the situation in Argentina, Brazil, Mexico, the United States, and Venezuela. It concludes that transfer pricing policies are not exclusively about taxation. Transfer pricing regulations should enable tax administrations to obtain a fair tax base at the same time they minimize the risks of double taxation for multinational enterprises. The OECD Guidelines provide the guidance on transfer pricing issues for both taxpayers and tax authorities by establishing a comparison with what would have happened between independent enterprises. However, there is no universal solution to transfer pricing issues in the OECD Guidelines. Also that the preface to the reform introducing the transfer pricing rules states that the tax administration, for purposes of computing the statutory margins for the import and export RP and cost plus methods, will take into consideration economic analysis by industry sector, branch of activity and based on the current economic situation. Adjustment will be allowed when the economic circumstances necessitate adjustment. This flexibility is different from the Brazilian rules, which provide fixed margins for all economic activities unless the taxpayer establishes a different margin with data from official publications or research carried out by a qualified firm.

Transfer pricing is one of the most popular drivers of tax disputes between taxpayers and tax authorities around the world. To lessen the probability of disputes, the OECD proposes procedures for comparability analysis. These procedures help taxpayers and tax authorities to determine the arm's length values of related-party transaction, which is the main cause of many transfer pricing disputes. This study uses a case study method, focusing on PT OCI, to evaluate a firm’s comparative analysis practice and its conformity to OECD Transfer Pricing Guidelines. Data collection through interviews and documentation. The results of this study indicate that PT OCI had conducted a comparability analysis of transfer pricing transactions in conformity with the OECD guidelines, while the tax authorities have not carried out a comparability analysis in carrying out transfer pricing audits. However, specifically for trademark utilization transactions, PT OCI must accept the results of inspection corrections. Fulfillment of the arm’s length principle for transactions utilizing intangible assets must comply with two additional provisions, namely related to the existence of transactions and economic benefits from the utilization of intangible assets. With the results of the benefit test, it was concluded that the trademark used by PT OCI did not contribute to increasing the success of PT OCI's sales so that transactions for the use of intangible assets did not meet the arm’s length principles.

This document provides a review of the Argentine tax authority’s structure for dealing with transfer pricing in Argentina; a chronological review of the legislative transfer pricing framework; and a very extensive listing of the transfer pricing cases that have reached different court levels. The document also summarises some of the difficulties encountered in relation to the application of the arm’s length principle in Argentina; coordination with foreign tax authorities; and the regulatory changes expected following the reports resulting from the G20/OECD BEPS Action Plan. Argentine transfer pricing legislation has taken several turns over time, moving from a more restrictive pricing of exports and imports for income tax purposes to what is today internationally known as the Sixth Method for commodity valuation; and from an application of what is locally known as the ‘economic reality’ principle, a principle attempting to consider the economic substance over the contractual forms, to a transplantation into local legislation of the Organisation for Economic Co-operation and Development’s Transfer Pricing Guidelines based on the arm’s length principle. The consequences of these regulatory changes have been that lately more and more cases are being disputed at different court levels, and tax authorities seem to find it increasingly difficult to challenge multinational entities’ transfer pricing manipulation schemes and support their arguments in courts of law.

This paper explores the disparities existing between multinational corporations (MNCs) and tax administrations in terms of transfer pricing strategies. Because transfer pricing is actually considered the main tax issue in the international taxation, tax authorities’ regulations have an important role when it comes to transfer pricing policies. In one hand, the manipulation of transfer prices (applied by MNCs) results in important losses in a country’s tax revenue, and thus, create inequalities between nations. In another hand, transfer pricing tax adjustments (applied by tax authorities), result in significant costs for MNCs. Accordingly, these two parties are forced to work together in order to find a fair consensus. The OECD has introduced the Advance Price Agreement (APA), which can be concluded between a MNC and one or many tax administrations. It provides certainty to the MNC regarding the transfer pricing method selected. However, this process can be hard to achieve for MNCs, which need to openly collaborate with many tax authorities, and therefore, expose themselves to important risks. In this respect, this exploratory qualitative study mobilises both the Agency Theory and the Stewardship Theory when analysing this dichotomous relationship between tax administrations and MNCs in respect of transfer pricing strategies. Keywords: Transfer Pricing, Multinational Corporation, Tax Administration, Advance Price Agreement DOI: 10.7176/RJFA/11-24-11 Publication date: December 31 st 2020

PurposeIn transfer pricing (TP) methods, especially when based on margins, accounting indicators are of paramount relevance to assess the profitability of firms, and to compare such indicators to samples of similar companies. The purpose of this paper, drawing on the legal research method, is to discuss the following questions: when using the transactional net margin, quite common in TP tax reporting, does the new (IFRS-based) Portuguese financial accounting system produce profit level indicators that are closer to the underlying reality that TP aims to capture, or are these profit level indicators of a lower quality than before?Design/methodology/approachThe methodology used in the paper draws on legal research. The hermeneutical and evaluative approaches are used to answer the research question. The legal research method is often criticized by not making the empirical sciences’ type of generalizations, since many problems are, by nature, related to national legal systems and, therefore, proposed solutions are not valid outside a specific territory. However, given the nature of the accounting and tax issues identified and discussed in the paper the topic is relevant outside Portugal, given the widespread adoption of IFRS-based accounting systems and the multinational impact of TP principles’ and legislation.FindingsThe main conclusion is that the new accounting regime has a significant potential for increasing uncertainty and compliance costs in the area of TP, given the nature of operating income adopted in the new IFRS-based system. As such, taxpayers and tax authorities (TA) and tax courts will have to allocate more resources to an already complex and uncertain fiscal area. A careful analysis of non-recurrent items is now mandatory, given the increased flexibility and the amalgamation of recurring and non-recurring accounting items that can have a pernicious influence in TP tax compliance. The answer to the research question is that the new accounting system produces operating margins that, when used as profit level indicators in TP, are of lower quality.Practical implicationsTaking into account the aim of this study, the discussion of a Portuguese particular feature of corporate financial information and tax system can highlight useful policy points to a broader audience. Many OECD countries face a dire situation in budgetary terms. Therefore, given the pressure to increase tax receipts, TP issues can shed some light on solutions being applied in other countries, and enhance awareness of corporate tax policy points. Directive 2013/34/EU gives Member States some accounting flexibility (e.g. in the design of the income statement). Therefore, the authors would argue for a new design of the SNC’s income statement by the Portuguese legislators. The analysis also argues for a broader level of coordination and consultation between accounting standard setters and TA, in areas where a strong link exists between book and tax income.Originality/valueThe link between IFRS-based account systems and TP tax issues is not, to the best of the authors knowledge, a widely researched topic Thus, the paper adds value to the discussion related to book-tax relation in the specific area of transfer price profit level indicators. It finds a divergent path between the economic reality that TP tries to capture and a concept of operating margin that is affected by non-recurring and peripheral transactions.