Transfer pricing is one area of tax where transparency has increased dramatically as a result of BEPS. BEPS Actions 8-10 set out to ensure transfer pricing is better aligned to value creation within multi-national organizations. This includes guidance on the application of the arm’s-length principle and the approach for appropriate pricing of hard-to-value intangibles.
The world’s tax authorities now have information on how a given company divides profits country-by-country, and can compare that to data on dozens of that company’s industry peers. And those authorities will be sharing data with other tax administrations where the company does business.
For this reason, Tracee Fultz, EY Global Transfer Pricing Leader, describes BEPS 2.0 as a “game-changer.”
Given such openness, companies can expect growth in the number and scale of transfer pricing audits, as well as instances of double taxation. They also face increased scrutiny and risk in areas such as permanent establishment and intangibles like intellectual property, as a fast-changing economy sparks new definitions of what constitutes substance.
“The margins on a country-by-country basis will be more visible, and that's bound to give rise to questions as to why margins differ between countries,” says Chris Sanger, EY Global Government and Risk Tax Leader. “Although the differences could be perfectly justified, they may still prompt questions and ultimately controversy. In a trusting co-operative compliance environment, where the tax authority understands your model, they're both less likely to be surprised when those results come out and more able to appreciate why such disparities could arise. This again points to the benefits of getting to that level of trust.”
All of which demands more of transfer pricing teams in terms of skills, processes and, crucially, technology.
Fultz asserts that one of the ways BEPS will change the tax department lies in encouraging the transfer pricing function to automate. Companies should pivot from the common practice of adjusting transfer pricing in hindsight in favor of being proactive, carving a clear understanding of where and how value is created across the business, and why their profit allocation systems are appropriate.
“BEPS doesn't mean the end result of the transfer pricing is any different,” says Fultz. “But how you document that transfer pricing, and the information and data you need to do so, certainly is. Very much so. The tax department needs broad automation and process controls for setting, monitoring and invoicing its transfer pricing. That’s the big challenge. Right now, I’d estimate only 10-20% of companies have automated the whole thing. BEPS will force everyone up that curve.”
One proactive means of gaining clarity around transfer pricing is the Advanced Pricing Agreement (APA), in which two countries come to an arrangement as to a company’s transfer pricing. An APA can give a company certainty in its transfer pricing for as long as five years, while also leaving it clear of risk of transfer pricing adjustments and double taxation.
Yet APAs can be a resource-intensive process, as they require someone in the internal tax department to oversee them. Yet according to the EY 2021 Transfer Pricing and International Tax Survey, 82% of companies anticipate 82% of bilateral APAs will be useful to prevent disputes in the coming three years and 70% said multilateral APAs will be very or somewhat useful during that time.
Another proactive approach is the OECD’s new International Compliance Assurance Programme (ICAP), a voluntary program that uses country-by-country reports to reduce transfer pricing disputes. ICAP doesn’t offer the legal certainty of an APA, serving instead as more of a non-binding, advisory health-check, where governments study a company’s transfer pricing documentation and advise on whether it’s appropriate.
Other tools are reactive. A mutual agreement procedure (MAP), for example, enables two tax authorities to communicate directly if there are concerns a taxpayer may be subjected to double taxation. The MAP process can be complex and burdensome and, like an APA, can easily tie up resources. Yet governments have made a commitment under BEPS Action 14 that MAPs should only take 24 months before moving to arbitration.5 This may make MAP more effective.
Litigation, meanwhile, offers another potential avenue, albeit one that’s often costly and which applies only to that one particular country. If a company wins its case, or makes a settlement along the way, there’s no guarantee it won’t be exposed to taxation elsewhere.