Quantera Global: A price to pay for accountability - Richard Slimmen
With corporate tax avoidance rarely out of the headlines, multinationals are coming in for much tighter scrutiny over their transfer pricing activities. As the OECD continues work on its action plan to clamp down on base erosion and profit shifting (BEPS), Richard Slimmen, managing director at transfer pricing specialists Quantera Global, lays out his hopes for better cross-border collaboration between revenue authorities.
Does corporation tax constitute a moral duty? Or is it, as Microsoft founder Bill Gates argues, a matter that falls firmly within the legal bracket?
Wherever one's personal convictions may sit, multinationals now find themselves firmly in the crosshairs regarding their tax activities. The naming and shaming of Apple, Google and Starbucks - accused of shirking local tax responsibilities through the exploitation of legal loopholes - has certainly contributed to an aura of wariness over big businesses' overseas activities.
In particular, the practice of transfer pricing - whereby separate parts of a single multinational enterprise, operating in different jurisdictions, set the price for the trading of products and services between them - has garnered an impressive number of column inches.
Tool of the trade
With cross-border intercompany transactions occurring hand over fist, transfer pricing has become a commonplace tool in international taxation and a means of evaluating interdivisional performance. Current legislation is underpinned by the 'arm's length' principle, under which the fee set by connected entities should be the same as what is accepted to be the market price.
In other words, the transaction should be treated as if it were between two independent enterprises. But while it has been the standard recommended by the Organisation for Economic Co-operation and Development (OECD) for the last 30 years, the practical application of the concept - as has been evidenced by recent headlines - is generally considered to be complex and subject to arbitrary interpretations of international regulations.
In effect, multinationals are required to use their own discretion as to the interpretation of the arm's length principle. And, in the event that transfer pricing is abused for the funnelling of profits into low-tax jurisdictions - a practice known as base erosion and profit shifting (BEPS) - it is commonly described as a tax-avoidance instrument.
Misuse and malpractice
The negative press around transfer pricing in recent years has almost overshadowed the fact that applying the arm's length principle by using transfer pricing is a legal requirement. In the eyes of Richard Slimmen, managing director at transfer pricing specialists Quantera Global, it is the malpractice and misapplication of the tool that should be condemned, rather than the tool itself.
"I am of the opinion that the press has created this idea among the public that transfer pricing is the root of all evil," he says. "I can understand why this may be the case, but I don't think it is accurate. Given the globalised nature of multinationals, it would be difficult to imagine the world today without transfer pricing; it is a vital instrument for allocating profits among the countries involved.
It's the abusive application of it that is behind the public's outrage."
Last year saw the OECD publish its BEPS action plan, which was officially endorsed by G20 leaders and finance ministers. The goal of the proposal - due to be completed by the end of 2015 - is to address situations where profits are deemed to be geographically divorced from action.
While Slimmen reserves praise for the OECD's renewed focus on stamping out corporate tax avoidance ("an unprecedented effort with huge scope"), he repeats his concerns that transfer pricing is at risk of receiving further unfavourable scrutiny due to its mere association with BEPS.
"Transfer pricing is never black and white," he says. "It's all about interpretation of facts and circumstances. What I'm afraid of is that the focus on BEPS will continue to create the mindset that transfer pricing must be wrong by default. It's a risk."
Cooperate and communicate
With transparency being the new watchword, the OECD has also vowed to tackle the problem of double non-taxation, exacerbated by poor interaction between tax authorities in different jurisdictions. To remedy this, and create a more level playing field, the organisation has revamped its promotion of tax information exchange agreements - bilateral agreements between regions to cooperate in tax matters.
"Things have definitely improved in this area," says Slimmen. "If you look back at the international tax scene of ten years ago, there wasn't half as much information exchanged between countries. With the huge focus on the exchange of information agreements between countries, tax authorities can certainly benefit from greater transparency and a better availability of data."
However, while high-economy OECD countries - generally speaking - have high levels of expertise in the analysis of transfer pricing fact patterns, revenue authorities in developing nations are still divested of the necessary resources. How much of a problem does this disparity pose when it comes to the sharing of information between jurisdictions?
"It's a big challenge," says Slimmen. "There's still a big knowledge gap between some countries and officials. It's not something that you can just solve by data exchange. Data will need to be evaluated and interpreted. Without the proper expertise to evaluate, a data overload may result in unwarranted adjustments and create unnecessary disputes. This could be a real risk to the distribution of data as provided in the country-by-country reporting as agreed by the OECD. It will require some educational efforts from parties with less expertise. We are seeing a lot of countries expanding their efforts to manage transfer pricing issues, but it's going to take time."
As Slimmen rightly points out, the analysis of transfer pricing within multinationals is concerned with interpretation. Given this subjective nature, and the number of different authorities involved in the process, disagreements are inevitable. On the back of the OECD's new BEPS agenda, dispute resolution is set to become an even more sought-after service.
"There's bound to be a steep increase in cases of dispute resolution, as a result of different interpretations by different tax authorities," he argues. "This also creates more of a focus on mutual agreement procedures between countries, as they negotiate with each other over how to solve cases. In practice, however, this can take a lot of time, especially with all the formal paperwork involved."
Slimmen proposes instead that jurisdictions engage in greater levels of cross-border dialogue in order to facilitate more flexible and pragmatic mutual agreement. Proper documentation will be required, but may be more like a joint write-up of the agreement reached, instead of individual positions."
"Traditionally, the mutual agreement procedure begins with drafting each party's position in writing," he says. "The result is that each party is forced to take its own entrenched stance and is not easily convinced to move from that position. Once things are put in writing, it tends to result in less flexibility of the parties involved. Many times disputes are about facts and circumstances and how to interpret them. I have experienced in practice that when countries start with discussions and obtaining a joint understanding of the facts without digging into their individual positions by writing formal position papers, it could substantially shorten the turnaround time of the mutual-agreement procedure."
Keep it clean
For the MNEs, the clamour for accountability cannot be ignored; transfer pricing needs to be conducted legitimately. Anything less could lead to not only fiscal punishment, but also reputational damage - Apple, Google and Starbucks can attest to this - as a consequence of public ire.
It will certainly be interesting to see how multinationals react to the OECD's BEPS action plan. Slimmen believes they would do well to revaluate their transfer pricing models from a more external vantage point.
"In my eyes, the BEPS discussions are a wake-up call for MNEs," he says. "There is still a significant number of MNEs that have the same structure of operations as they did ten years ago. Because they haven't had any issues so far, they don't see the need to alter their transfer pricing model.
"That's far too passive a mindset. They need to understand that it's not only about what's happening within the company that could provide cause for concern; it's also about what's happening in the world around them. If they don't adjust to this, many MNEs might be in for some unwelcome surprises."