Taking care of business cross-border | PLANT
How OECD's new guidelines will impact base erosion and profit splitting.
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New developments in transfer pricing and international tax planning have increased tax authorities’ scrutiny in Canada and foreign jurisdictions.
A significant volume of today’s global trade involves international transfers of goods and services, capital and intangibles within multinational enterprise (MNE) groups. But plans by the Organisation for Economic Cooperation and Development (OECD) to revise the attribution of profits to different countries will have a significant impact on transfer pricing, international tax planning and business restructuring on a cross-border basis for years to come.
Evidence shows such “intra-group” trade is growing steadily and accounts for more than 30% of all international transactions, according to United Nations Practical Manual on Transfer Pricing for Developing Countries. Given that the structure of transactions within an MNE group is determined by a combination of market and intra-group forces that can differ from the market conditions operating between independent entities, it’s important to establish the appropriate transfer price for intra-group, cross-border transactions.
Transfer prices serve to determine the income of both parties involved in a cross-border transaction and such internal pricing also forms the tax base for the countries involved. Base Erosion and Profit Shifting (BEPS) issues have resulted from the need for austerity measures by tax authorities in light of the global economic crisis and increased scrutiny by the public, non-governmental organizations and media.
One factor that poses significant challenges for the international tax regime is the digital economy. An initial report from the OECD explained that a holistic approach was necessary to properly address the BEPS issue. Key pressure areas include:
• Mismatches in entity and instrument characterization, typically referring to hybrid mismatch arrangements (transactions that take advantage of different tax treatments among jurisdictions) of financial instruments, entities or transfers. They generally arise in double deduction transactions, deduction/no inclusion transactions, or foreign tax credit generator transactions.
• Application of tax treaty concepts to profits derived from the delivery of digital goods and services.
• Tax treatment of related-party debt-financing, captive insurance, and other intra-group financing.
• Transfer pricing, particularly related to the shifting of risk and intangibles, and the artificial splitting of ownership of assets.
• The effectiveness of anti-avoidance measures such as General Anti-Avoidance Rules (GAAR), Controlled Foreign Corporation (CFC) regimes, thin capitalization rules, and rules to prevent tax treaty abuse.
• The availability of harmful preferential tax regimes.
A joint OECD-G20 project calls for greater disclosure of aggressive tax planning arrangements and treaty changes to neutralize hybrid mismatches. The OECD has proposed a plan to revise the basis for attribution of profits to different countries for businesses with high value intangible assets, and those with supply chains that deliver goods and services across multiple jurisdictions. Over the next two years, the project will attempt to produce 15 major international tax reforms, four of which address transfer pricing. Any of the following circumstances may trigger possible business impacts:
• High value intangible assets and transactions with overseas markets.
• Business in the digital economy.
• Distribution channels that include remote delivery of goods or services.
• Distribution structures that include local distributors with limited substance including commissionaires.
• Local headquarter executive teams with larger overseas operations.
Information exchanges between tax authorities around the world are increasing to a degree never seen before, creating new challenges relating to ensuring transparency and consistency across country lines. An important consideration of the OECD is the significance of a ‘big picture’ analysis of the corporate value chain and where profits are reported globally compared to where employees, assets or sales are located. This foreshadows the introduction of country-by-country reporting requirements to combat BEPS.
Although each country’s approach to documentation varies significantly, the number of those requiring preparation of transfer pricing documentation increases every year. The proliferation documentation requirements, combined with a dramatic increase in the volume and complexity of international intra-group trade and the heightened scrutiny of transfer pricing issues by tax authorities, makes transfer pricing documentation a top tax compliance priority for tax authorities and businesses.
When there are international tax disputes and cases of double taxation, bilateral tax conventions generally include a mutual agreement procedure (MAP) article as a form of dispute resolution mechanism. Residents in either country may formally request assistance from the “competent authority” to resolve a particular tax issue. The MAP reporting framework requires co-operation from taxpayers and regular communication between the tax administrations to resolve these cases.
According to OECD statistics released in September, member countries reported 4,061 open cases at the end of 2012 – the highest number in any year on record and a 5.8% increase over the 3,838 cases recorded for 2011. The average completion time for a MAP case last year was 23 months.
With increased enforcement by tax authorities, more companies are reviewing their transfer pricing plans. Effective planning and administration also reveals previously unknown information, including opportunities for driving value through transfer pricing, and where current weaknesses lie.
For supply chain and distribution businesses, transfer pricing moves cash between affiliates in different countries and minimizes cash taxes, maintains liquidity and manages cash more efficiently. Updating transfer pricing policies potentially increases profits and cash flow in desired locations.
Canadian manufacturers looking at or are currently managing an extended supply chain involving activities carried out in foreign jurisdictions need to understand more clearly the new developments in international tax planning and transfer pricing that are evolving to avoid putting the financial integrity of their cross-border activities at risk.
MNP is a chartered accountancy and business advisory firm with offices across Canada. Angeline Zioulas is a partner and national transfer pricing leader based in MNP’s Vancouver office. Joyce Cheung, is a senior associate, National Transfer Pricing Services.
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This article appears in the Nov./Dec. 2013 issue of PLANT.