The OECD is asking developing countries to tax on the basis of make believe, and that’s not good enough

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During the last week the BEPS Monitoring Group of NGOs and civil society organisations, of which I am a member, made a submission to the OECD on the Base Erosion and Profit Shifting paper on transfer pricing. The key issues within the submission were as follows:

In our view, the Report is disappointing. It is inadequate and unhelpful for developing countries. The Report:

  • assumes that developing countries should use transfer pricing methodologies which have been found deficient even by OECD countries, and are currently being revised, especially through the project on Base Erosion and Profit Shifting (BEPS);
  • prioritizes the use of comparables, although these methods have been shown to be deficient in both theory and practice, especially for developing countries;
  • obscures the real problem, which is not the absence of data but lack of appropriate comparables, due to the integrated nature of multinational firms;
  • fails to provide any information about what databases are available, or an evaluation of whether or how the data that they provide is supposed to be helpful for the purposes of auditing transfer pricing;
  • encourages developing countries to use methods which are likely to require case-by-case negotiation to ameliorate the fundamental deficiency of data without acknowledging the asymmetries of knowledge and power between developing country tax administrations and both tax advisers and developed country tax administrations; and
  • provides only a superficial consideration of alternatives to the use of comparables.

In our view methods based on either comparable prices or comparable profits are unsuitable for developing countries, and likely to lead to either over- or under-taxation, because:

  • the lack of appropriate comparables means that appropriate assessments require detailed examinations, specialist knowledge, and subjective judgment;
  • such assessments are time-consuming, and require skilled specialists, who developing countries find it hard to recruit and retain;
  • the subjective judgments involved leave officials open to undue pressures and temptations to corruption;
  • relying on data-bases can result in the use of inappropriate comparables, which may become generalized as firms also rely on them to avoid disputes;
  • conversely, the adoption of aggressive adjustments by officials, which may also result from performance incentives, resulting in counter-claims by firms, can lead to an adversarial culture, and sometimes excessive litigation;
  • the subjective and often arbitrary nature of adjustments based on comparables makes it hard to resolve conflicts if they arise between states other than by equally discretionary bargaining.

Our recommendations are that developing countries should:

  • learn from the mistakes of the OECD countries, and build on their own experience, for example the `sixth method’, or the Brazilian approach;
  • anticipate rather than await reforms likely to result from initiatives to combat BEPS, such as country-by-country reporting;
  • establish methods which are clear, transparent and easy to administer without the need for significant ad hoc investigation or subjective judgment;
  • coordinate transfer price scrutiny with other anti-avoidance measures such as denial of deductions for inappropriate payments to related entities.

Let’s not beat around the bush here: we think the OECD has got its whole approach to this issue wrong. It is absurd to ask developing countries to adopt and use a system of profit allocation between states that very obviously does not and cannot work. However well trained officials from these countries might become in this system nothing within their supposed new competence will overcome the fact that the OECD transfer pricing system assumes that companies within multinational corporations are independent of each other, when very obviously they are not, and that there are comparable free market prices available with which their trades can be compared when we very obviously know that is not the case, not least because up to 70% of all world trade is now thought to be undertaken on  an intra-group basis.

Asking people to tax on the basis of make believe is not just absurd; it’s also a recipe for abuse. That’s what we’ve got and that’s what we’ll keep whilst this system is perpetuated by the powers that be in the OECD, the Big 4 accountants and big business that has everything to gain from continuation of this abuse.