If those commenting on this blog were to be believed (and they should not be) the OECD's preferred method of allocating profits between states allocates 100% of group profits to jurisdictions and no more or less, and does so in an environment of mutual cooperation where outcomes are assured and fair tax is paid.
That's not true. As Patrick Love has written on the OECD's own blog:
There is no simple method for calculating a transfer price, so the final value is the result of a negotiation between the company and the tax authority. Ideally, this would be based on equal access to information, a shared objective and a “zero sum game” where an exemption in one jurisdiction is offset by tax in another. It's not. International business consultancies have more people working on transfer pricing than any national tax authority. Prem Sikka of Essex Business School, co-author of a paper on The Dark Side of Transfer Pricing, claims that “Ernst & Young alone employs over 900 professionals to sell transfer pricing schemes. The US tax authorities employ about 500 full-time inspectors to pursue transfer pricing issues and Kenya can only afford between three and five tax investigators for the whole country.
So let's be clear about why transfer pricing is not the neat zero-sum game its apologists would like to suggest it is.
First, there is no guarantee a company will send matching information to each tax authority.
Second, there is no reason why the tax authorities need agree.
Third, the tax authorities may not know they disagree and there is no obligation on a taxpayer to tell them if that outcome is in their favour, as it can be.
Fourth, there are insufficient resources, as noted above giving asymmetric power to companies.
Fifth, there are insufficient double tax agreements. Developing countries have few and there are almost none with tax havens. by definition then there is no reciprocity in much of the system.
Sixth, as I have noted, all transfer pricing adjustments are to a wholly artificial standard - intended to tax the profit that would arise if companies were not related, but as a matter of fact they are. This results in under-taxation because companies are only related and under common control because more money is made as a result - but that excess is not taxed under OECD rules - meaning some profit always falls out of tax under existing TP rules.
I could go on - but you get my point. Current OECD transfer pricing rules 1) invariably under tax and 2) do not result in reciprocal tax adjustments. Those claiming otherwise are a) not aware of the facts b) misrepresenting the truth c) deliberately misinforming for the promotion of self interest. I am not sure what else I could reasonably conclude from any such claim. (a) is of course quite common. I am afraid I hear (b) and (c) too often.
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“……….b) misrepresenting the truth c) deliberately misinforming for the promotion of self interest.”
I couldn’t agree more with the last statement and I’ll leave it at that, because…..
I would think that the biggest problem with arm’s length pricing is that nobody really knows exactly what it should be because there will always be a range of possible prices. We know this is true from our experience as individual consumers. I can always find varying prices for identical items. Normally I aim to buy products at the lowest possible price, but when I built an extension I actually paid near enough the highest price because I wanted the job done properly. As such the arm’s length value of a transaction is in fact a range of values, not a specific amount.
As a company should you sit and think, what is the most I could pay, or are you required to wonder what the least you could pay is? It is clear that the two parts of a business can’t be simultaneously paying the minimum and charging the maximum. Ideally you shouldn’t be aiming to identify the price that will create the largest or smallest tax bill, although each tax authority may want you to do so. It is of course worth saying that the right figure isn’t necessarily the one that moves the maximum amount of profit being into the highest tax jurisdiction.
Arm’s length pricing is a poor systems because it creates massive uncertainty for everybody. When calculating taxes you should have certainty, not speculation and guess work. It is little surprise that when there is uncertainty people will tend to err on the side that gives them an advantage, but the real problem is a lack of a definitive answer that anybody can rely upon.
Speculation on the value of goods, services and even houses should be taken out of the tax system and replaced with something that can be easily calculated. Tax bills should be easily quantifiable by everybody.
You’re quite right about the fact that with the various jurisdictions acting independently there’s no guarantee that all profits will be taxed somewhere precisely once.
In my experience all authorities are keen to get as much attributed to their own jurisdiction as possible, and despite mutual agreement etc I’ve come across quite a few cases where transfer pricing discussions have ended up with more profit being taxed overall than was actually made.
That tends to be in situations where the jurisdiction receiving the income is happy to tax the full amount, but the one paying out denies a full deduction. Interest is a typical case – I’ve seen more cases of a deduction being denied for income taxable elsewhere than of a hybrid instrument getting a deduction without being taxed.
I don’t see that unitary taxation could do any better where jurisdictions are using their own formulas. A single world tax authority could, as I’ve long argued.
The moral is do not use a hybrid instrument….isn’t that obvious?
Richard, Pellinor is not advocating using hybrid instrument. He is talking about plain vanilla debt.
Well I could have sworn I read hybrid in there…..
I think Pellinor was saying there are more examples in their experience of taxpayers being denied deductions for interest paid on plain vanilla debt than hybrid instruments generating a deduction without interest being paid.
Richard ,
Are you aware of any of the big consultancies like Ernst and Young having specific divisions and consultants dedicated to providing bail-out expertise to customers looking to get their hands on Government handouts ?
Call me naive but I can’t imagine the big consultancies not wishing to get their slice of the action of what seems to have become a lucrative growth industry .
Sorry it’s off topic . Am genuinely interested if the consultancies have put together teams to conspire against the rest of us in this way .
Securing grants is a major part of the ‘location advice’ such firms provide
And if you read John Kay in FT today, the whole concept of ONE market price seems to be at least questionable. So if you cannot mark-to-market in a sensible way when putting together the balance sheet of one company, how on earth is that price supposed to be calculated when transfering the same asset between related parties?
‘fair’ is the wrong term to use. What is legally allowed and most efficient for the firm is the standard. A word like ‘fair’ (due to hyper-over use/abuse) is one of those terms which no longer have a definition.
I respectfully disagree
We just do not agree on what fair is
“Second, there is no reason why the tax authorities need agree.
Third, the tax authorities may not know they disagree and there is no obligation on a taxpayer to tell them if that outcome is in their favour, as it can be.”
Admittedly it was some years ago but when I did the transfer pricing part of my HMIT tax Inspector training, the chap at the Transfer Pricing unit said that they always copied in the other country’s tax authorities to any decision they reached and had a disputes arrangement in the case of disagreemnt.
Has HMRC abandoned such practices?
Since when was copying agreeing?
But remember – that’s only true when there is an agreement
Those remain limited in number
I made that point, I thought
“I don’t see that unitary taxation could do any better where jurisdictions are using their own formulas. A single world tax authority could, as I’ve long argued.” – Pellinor
Ah, but whose model should it follow, this unitary world-wide tax authority? The UK’s? The USA’s? Monaco’s? Hong Kong’s?
Similar tax rates would achieve little unless the tax rules were the same and how could differing economies, at different stages of development, with differing socio-economic outlooks and wildly differing resources possibly arrive at a tax code that was ‘fair’ to all?
I admire the Quixotic outlook but it always pre-supposes that morally, economically and ethically that you are right and most of the world wrong.
We do not need one – see latest blog for why