Thursday, June 09, 2011

TJN's Spencer speaks out strongly at United Nations

TJN Senior Adviser David Spencer has just delivered a hard-hitting speech at a major United Nations meeting on transfer pricing, an arcane-sounding but extraordinarily important issue in the field of international tax.

Spencer's speech is here. It is an outspoken document, couched in diplomatic language, which contains too much important stuff for us to summarise in detail on this blog - so here is a short summary. Read the whole document for the full effect.

Companies can manipulate their internal trade ("transfer") prices to shift profits and cut their tax bills. Governments try to stop them - but this is a highly complex area, and the dominant standard model for checking these internal prices is the the OECD's furiously defended model known as the 'arm's length rule' - whereby internal prices are supposed to be set according to supposedly independent, 'arm's length' prices reflecting their real value. The trouble is, the arm's length rule is hopeless in the modern global economy, enabling corporations to run rings around governments - and especially those of developing countries.

In essence, international rule-setting is dominated by the Organisation for Economic Co-operation and Development, a club of rich countries. It is so dominated, in fact, that the OECD substantially influences - or perhaps 'interferes with' would be more appropriate term - the UN Tax Committee, which is supposedly independent of the OECD and is the appropriate forum for reflecting the interests of developing countries in particular: as the UN has said, the UN Tax Committee is tasked to "give special attention to developing countries and countries with economies in transition."

Spencer makes seven key points, summarised below:
  • The arm's length rule generates such complexity that even sophisticated developed countries struggle to implement it. What chance do developing countries have?
  • The OECD rules on 'arm's length' pricing rely on finding comparable transactions in the market. But typically, no comparables even exist. Developing countries are powerless here.
  • Information on what corporations are up to is hard to find. The OECD should therefore support country-by-country reporting, a core TJN project.
  • Alternative approaches such as safe harbours and the profit-split method should be actively considered. These would typically be more appropriate and easier to administer for developing countries than the OECD's method.
  • The UN Tax Committee's Transfer Pricing Manual does not adequately address the issue of tax havens, which assume critical importance in this area.
  • The UN Tax Committee doesn't seem to be living up to its mandate to look after the interests of developing countries. As Spencer memorably puts it: "by focusing solely on the OECD’s arm’s-length principle, the Subcommittee could be considered to be prolonging the life of an ill patient, rather than trying to analyze and resolve the underlying problem: the disease of transfer mispricing."
  • On the seventh point, it is worth simply quoting Spencer in full:
A significant source of support, for the OECD Transfer Pricing Guidelines and its Arm’s Length Principle comes from people who have a significant vested interest in the continued use of those Guidelines and the Arm’s Length Principle: auditing firms and law firms and economic consulting firms which derive substantial income from advising and consulting about those Guidelines. The more complex those rules are and the more difficult to administer those rules, the more money those firms make.

And employees of governments and international organizations who have developed expertise in the OECD Guidelines and whose careers depend to some significant degree on the OECD Guidelines also have a vested interested in the continued use of the OECD Guidelines and the Arm’s-Length Principle. To quote Martin Sullivan, a distinguished economist: “There is the small but influential army of private-sector pricing consultants– many of them former [U.S.] Treasury officials and U.S. Internal Revenue Service officials–who have built careers around the arm’s-length method.” Therefore, there should be more involvement by disinterested academics and NGOs in the development of the Manual and transfer pricing rules, especially for developing countries.
Strong, and important, words. He also mentioned the OECD's strange behaviour with respect to international financial transparency and information exchange - something that TJN wrote about in the Financial Times recently, and which we have commented on many times.

A month ago we wrote an article "Developing countries are finding their voice" which noted encouraging signs that developing countries are becoming more active in this arena. As recent UN discussions were summarised, there were strong opinions voiced from developing countries:
"that the OECD should not try to dominate the development of international tax issues: no more Rule Makers forcing Rule Takers to accept what the Rule Makers decide. I was quite surprised by the vigor of their argument."
We hope and believe that we are seeing the beginning of the emergence of something new and profoundly important. Fragile green shoots.


Blogger Physiocrat said...

Sorry to have to keep reminding on this point, but land value taxation is immune from leakage of revenue through transfer pricing. The liability arises indisputably in the country in which the site is located and it falls indisputably on the owner of the site. If the charge is not paid, the land can as a last resort be sold to pay the debt.

3:19 pm  
Blogger Derek said...

Physiocrat is right. Why does TJN spend time lobbying for measures which would make tax avoidance a little more difficult when it could promote a tax which would make tax evasion near impossible and tax avoidance absolutely impossible.

9:37 pm  
Blogger TJN said...

Because a) it's pie in the sky, politically, for a wholesale shift to LVT only; b) because it savages the whole 'no taxation without representation' problem; because despite what you say, it is easily avoided by shifting assets out of residential properties to other forms of income, offshore. We support LVT, but only as part of a comprehensive tax system. Your LVT-only position is, in our view, an extremist one.

2:15 am  
Anonymous Anonymous said...

“It is ridiculous for any man to criticize the works of another if he has not distinguished himself by his own performances” - Joseph Addison (1672-1917)

>The ALP may have its flaws, but a realistic and comprehensive alternative is yet to be presented...

>The burden generally falls on the MNEs to find comparables - appropriately drafted legislation can empower a TA to make adjustments in the absence of necessary information (see Australia)

>Country-by-country reporting will assist in identifying issues (most of which can already be identified by willing tax administrations with the necessary capacity) however, the transactions still need to be priced/profit split on a (legislated) basis

>profit split still requires a basis for the split – what basis, if not the ALP?

>safe harbours will assist with the compliance burden and should be more common place - but recognise that they are double edged sword for taxpayers and tax administrations and are limited in their application (note: the OECD is currently looking at this - see OECD report on simplification measures)

>formulary apportionment would also be open to abuse, and given the recent EU example, it is clearly very politically ambitious, even where there is common interest)

In the absence of a realistic alternative, the focus should not be on criticising the current system, but on finding ways that it can be adapted to make it work for in different situations and on assisting and building capacity in developing country tax administrations.

11:49 am  

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