Queen Elizabeth sent her first email long before you did. I got that from one of those sites giving details of this day in history, according to which she sent it on March 26th 1976 from the Royal Signals and Radar Establishment. (The Ministry of War used real names in those days, whereas now RSRE is part of something that calls itself QinetiQ.) Anyway, I was looking to find some great OECD-related anniversary that I could write about (the first lip reading tournament held in America?) to justify not reporting on the Annual International Meeting on Transfer Pricing under the auspices of the Tax Treaty and Transfer Pricing Global Forum being held here today and tomorrow.
Transfer pricing is important and interesting, it’s just that, as Brian Atwood, chair of the OECD Development Assistance Committee noted in this post the other day, it’s one of those subjects that’s “founded on concepts that are both technically demanding and arduous to understand and implement”. In fact, delegates to the meeting will be working on how to simplify and streamline the process, since even the experts admit that the rules are complex.
So what is transfer pricing and why does it matter?
Around 60% of world trade actually takes place within multinational enterprises, for example the headquarters in the US paying a subsidiary in India to carry out research or manufacture components. This payment is a transfer price. Transfer prices are used to calculate how profits should be allocated among the different parts of the company in different countries, and are used to decide how much tax the MNE pays and to which tax administration.
They’re also useful to the company itself first, because they can avoid being taxed twice if the various countries they are active in have signed agreements with each other on how to tax MNEs. In most cases, these are based on the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations.
In many cases, they’re calculated using a technique with the deceptively simple name of “the arm’s-length principle”, although some countries, notably Brazil, use other methods. The ALP states that operations should be priced by comparing them with similar operations carried out on a commercial basis at market prices, as if both parties were independent entities – at arm’s length from one another.
In practice, this can be extremely difficult, particularly in developing countries. For instance, the developing country subsidiary may be the only firm in its particular line of business, so there’s nobody to compare with. Likewise, transactions involving high value-added services or intangible assets like intellectual property may be unique. And in many countries, publicly available information that the tax authorities can use is limited.
Given that there is no simple method for calculating a transfer price, the final value is the result of a negotiation between the company and the tax authority. In an ideal world, this would be based on equal access to information, a shared objective and a “zero sum game” where being taxed in one jurisdiction is offset by an exemption in another.
Of course it doesn’t work like that. Companies want to pay as little tax as possible and governments need tax revenue. There’s a whole international business whose goal is to help companies “manage the level of taxes paid on a global basis at a competitive level” as PwC put it in their prospectus. These international consultancies have more people working on transfer pricing than any national tax authority. Writing in The Guardian, 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.”
The meeting at the OECD coincides with an initiative from The International Tax Review to ask tax practitioners to vote for who they think are the leading forces in global transfer pricing development. Apart from PwC, there are NGOs like ActionAid, MNEs like GlaxoSmithKline, and multilateral agencies and international organisations, including the OECD. You can vote here.
The OECD Observer has good articles explaining transfer pricing in more detail: