Quantera Global: The progress of transfer pricing regulations – Richard Slimmen
In the wake of the final recommendations of the OECD's 'Base Erosion and Profit Shifting' project, multinationals are sailing into uncharted waters when it comes to determining new transfer pricing policies. Chief Executive Officer talks to Richard Slimmen, managing director at Quantera Global, about how the company is helping companies prepare for greater uncertainty in the years ahead.
On 15 December 2011, Western Union announced in a letter to its shareholders that, after a long-running legal battle, it had finally reached a settlement with the US Internal Revenue Service (IRS). The company would pay $470 million in unpaid taxes related to a series of illegal pricing policies and intangible asset transfers made in from 2003 to 2011 between it and its former parent, First Data Corporation. Although this was less than 40% of the total financial benefit the self-described "global leader in international money transfer" accrued during the period, it was nevertheless one of the largest settlements reached between a public tax authority and a multinational over the abuse of transfer pricing mechanisms.
The term 'transfer pricing' refers to the legal practice whereby multinational companies, insofar that they operate in two or more national tax jurisdictions, purchase goods and services from each other. The pricing applied in these transactions should be appropriate. Historically, however, the practice is vulnerable to abuse. Through collusion between the buyer and seller, prices may be maintained at an artificial level for the purpose of avoiding tax that would be levied if the good or service were bought or sold at its price on the open market.
Cases range from the overpricing of pharmaceutical imports by the foreign parents of their subsidiaries in Latin America at rates of up to 155% of the original market value in the 1970s to claims that, between 1995 and 1999, the artificial discounting of 25 different types of export from Russia to the US resulted in up to $8.92 billion in capital flight from the source country.
The need for regulation
It is for this reason that transfer pricing is a practice regulated by national public tax authorities across the globe. For the most part, each of them have looked to recommendations issued by the Organisation for Economic Cooperation and Development (OECD) for guidance on the scope of regulation and the zeal to which they should apply themselves in adjusting their corporate tax returns. Since the mid-1990s, these points have generally conformed to what is known as the "arm's-length principle", by which the price of a good or service subject to transfer pricing is judged according to its value on the open market.
However, within the past decade, increased international scrutiny has been brought to bear on something that, before the global financial crisis, was often regarded simply as an internal accounting matter. This year, after extensive consultations with private stakeholders, taxpayers and public financial regulatory authorities, the OECD published a new set of recommendations in its 'Action Plan on Base Erosion and Profit Shifting' (BEPS).
Within its final set of reports, the international body recommended member states pass laws that would force multinationals to publish 'country-by-country' (CbC) reports on their activities in individual jurisdictions, with a view to increasing transparency and shining a bright light on any residual transfer pricing abuses that are still occurring.
As a transfer pricing expert who has worked in the sector for more than two decades, these new compliance obligations trouble Richard Slimmen, managing director of Quantera Global, a leading transfer pricing advisory firm.
"If you look at transfer pricing over the past 20 years, it has always been a practice that was difficult to regulate because it's very dependent on interpretation of facts," he says. "There has been a huge reliance on the legal framework around transactions to interpret those facts. That made it possible for a lot of companies to build structures based primarily on contractual arrangements that allowed them to use or, as they are now considered to have done, abuse the tax regulations and artificially shift the allocation of profits."
"I think the major shift that you see coming from BEPS is that the artificial use of contractual arrangements to allocate profits in a way that does not match with the economic realities of the business is no longer accepted," adds Slimmen. "It's rather uncertain what the BEPS-inspired regulations will look like in the coming years."
Balancing the books
Slimmen began his career in the public sector as a tax inspector for the Dutch Government in 1988. He stayed in government, advising on transfer pricing issues, for 19 years before joining KPMG in 2007 as a transfer pricing specialist. Slimmen assumed his current position as managing director at Quantera Global in 2013.
"My experience is that, especially when I went to private practice, it was sometimes surprising to see how theoretical the conversations were," he says. "The discussion on the public side would often have a totally different perspective. Being a former tax official allows me to better anticipate what will and what will not work, and enables me to be as pragmatic as possible. A lot of the time, there is full focus on the technical content of a discussion, but proper process management is relatively unattended.
Experience shows, however, that good process management is often key to obtaining the best results."
He recalls a recent case where one interpretation of current transfer pricing regulations could have led to disaster for one particular company under investigation.
"Quantera Global was asked to help out in a controversy case that was truly escalating, which was managed by another adviser who was not really experienced in transfer pricing," says Slimmen. "Nevertheless, he had given it a try, with the result being that the taxpayer was actually about to go bankrupt if the assessments were to be paid. Quantera Global then got involved in that case and found out there had been too sharp an assessment from the previous adviser, together with bad process management that had escalated the discussions. We were able to put aside the emotion and get people thinking about the actual issue again, and at the end of the day, almost all assessments were withdrawn."
The anecdote is representative of the company's deft approach to assisting its multinational clients with their transfer pricing needs. "Often enough, multinationals feel compelled to issue a lot of detailed transfer pricing documentation," Slimmen explains. "That can be a huge burden. In fact, you can be pragmatic in your approach without shedding the key compliance issues that are required by the authorities. It is all about not losing the perspective that what you're dealing with is also a practical and not just a theoretical challenge."
Stakeholders beyond CFOs
In that sense, the waters are already muddied. With the introduction of new BEPS-inspired regulations, Slimmen believes tax departments of large corporations may as well be staring into pitch. Since the beginning of the global financial crisis, the general corporate attitude has largely transformed from considering transfer pricing as simply an arcane accounting issue to another way in which transfer pricing is closely linked with reputational issues.
"If you look at the news that the public is being fed by the media on the subject, you can now see that some companies are almost being accused of 'doing transfer pricing'," he says. "Tax, and especially transfer pricing, has now become a strategic issue that requires close attention from board level. Part of our job is ensuring that the tax departments of our clients are aware that they also have to manage stakeholders other than the CFO.
"The way we seek to help our clients is to really scrutinise and challenge them on whether their transfer pricing policies will remain sustainable in the long term," adds Slimmen. "That is no longer only a technical discussion but a strategic one too.
"Quantera Global provides a sounding board to bounce off ideas and thoughts on transfer pricing risk management on a case-by-case basis. That's because there's no one-size-fits-all approach to this issue, since any approach to transfer pricing modelling now requires balancing of technical interpretations with strategic considerations. The many new BEPS-related regulations, together with the many different stakeholders and countries involved, have created a great number of uncertainties that nobody has 'the' right answer to."
Working in harmony
The enthusiasm for the BEPS recommendations among public authorities is not to be underestimated. In October 2015, G20 finance ministers meeting in Lima endorsed the findings of the final reports of the BEPS Action Plan, while the UK and Australian Governments have already passed laws tightening the transfer pricing compliance obligations of multinationals within their own tax jurisdictions. Proper dispute resolution will be key to the success of BEPS. However this will require substantial additional capacity at tax authority level to deal with the generally anticipated steep rise in disputes. For now the signs are however not that tax authorities actually are making substantial efforts to increase dispute resolution capacity.
Ultimately though, Slimmen is confident that the public and private sectors will act in concert to prudently implement the BEPS recommendations. When the alternative is total chaos it is likely that parties will have a strong incentive to mutually resolve their issues.