Friday, June 22, 2012

Another expert criticises OECD transfer pricing rules, says they create 'secret body of law'

We have assembled quite a roster of high-level experts who are prepared to go on the record exposing the gaping intellectual and practical holes in the OECD's dominant guidelines for taxing multinational corporations. At a TJN seminar in Helsinki last week, quite a few of these experts came together to look at this and to discuss alternatives. And for all those who are prepared to go on the record, there must be many who share our views but for professional and other reasons won't speak out.

Now we have a new high-level expert, who wasn't at our seminar and whom we haven't quoted before, lending his voice: François Vincent, formerly Revenue Canada’s principal legal adviser on transfer pricing matters and now with KPMG as Leader, Global Transfer Pricing Dispute Resolution Services. The OECD Guidelines, he writes, appear not to be science at all:
"Taxpayers, by definition, need to be able to determine the tax payable in order to be able to account for that tax. Conversely, tax authorities need to be able to determined tax payable in order to properly administer their tax system. The needs of both parties are thus convergent. The need for certainty within the context of a tax treaty was organized by the [Canadian] Federal Court of Appeal….. Unfortunately, it is the standard set by the arm’s length principle that creates a systematic impreciseness in its application [our emphasis added, as below].

The main cause may be that, at its root, the arm’s length principle is supposed to match the transactions or dealings entered into either between non-arm’s length entities or between a branch and the rest of an enterprise with similar transactions that would have been entered into between arm’s length entities.

In reality, in all but a few cases, this is simply not possible because the MNE’s transactions / dealings cannot be matched with those of arm’s length parties. Therefore, taxpayers, their advisors and tax authorities are left trying to reconstruct, from largely dissimilar transactions or entities, what arm’s length parties would have done under similar circumstances. This exercise or reconstruction is, in the words of the OECD, “not an exact science”. Given the wide range of results and positions observes, one might remark that it does not appear to be a science at all."

(Extracted from: Francois Vincent, “Transfer Pricing in Canada;” 2011 Edition, Carswell, Toronto (2011)).
This reminds us of comments made at our Helsinki event by Vikam Vijayraghaven, a Chennai-based tax practitioner, who said transfer pricing was as complex as modelling the weather, adding that

"Transfer pricing is not art, it's not science . . . it's magic."
Vincent also says that the OECD’s transfer pricing rules have resulted in a secret body of law:

"One of the greatest current concerns is that transfer pricing has moved many tax jurisdictions worldwide to a state of taxation by negotiation rather than taxation by legislation. This, in turn, gives rise to lack of certainty for taxpayers and the raises the specter of a secret body of law (the compendium of the aggregate of competent authority and arbitration decisions)"
Vincent further emphasises the uncertainty of the OECD’s transfer pricing rules too:
These days it seems that, even though we are virtually inundated with guidance from world tax authorities in respect of how to apply the arm’s length principle, we are no closer to certainty. At the time of getting ready to prepare their tax returns, taxpayers are still scratching their heads as to whether the chosen transfer pricing methodology or method of attribution of profits to PEs will be acceptable to tax authorities……While it is laudable for tax authorities wish to protect their base from unreasonable stripping of profit in favour of low or zero tax jurisdictions, the current state of the application of the arm’s length principle in the vast majority of situations is remarkably imprecise and inherently gives rise to suggestions that either the taxpayers or the tax authorities are abusing the fuzziness of the rules.
Although Vincent says the views expressed above represent the “author’s personal point of view,” his message is highly important, given his professional experiences and associations.

He suggests the systematic application of a global profit-split method, by application of a profit allocation formula. TJN will have more to report about that alternative, quite soon: we discussed it extensively at our Helsinki seminar last week.

Footnote: The OECD admitted that its methods are not an "exact science" in this text:|

However, because transfer pricing is not an exact science, there will also be many occasions when the application of the most appropriate method or methods produces a range of figures all of which are relatively equally reliable. In these cases, differences in the figures that comprise the range may be caused by the fact that in general the application of the arm’s length principle only produces an approximation of conditions that would have been established between independent enterprises. It is also possible that the different points in a range represent the fact that independent enterprises engaged in comparable transactions under comparable circumstances may not establish exactly the same price for the transaction.
With thanks to David Spencer.


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