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July 28, 2014

Transfer Pricing: Good News and Bad News

First the bad news:  With major governmental hearings in the U.S. Congress and British Parliament, with public claims and press reports of alleged profit shifting, and even a documentary movie (see “We’re Not Broke”) the spotlight on transfer pricing has never been brighter or hotter.  But wait, then there is the tripling of transfer pricing disputes in Japanese Competent Authority, and the ₤1 billion under transfer pricing audit by HM Revenue and Customs (HMRC) in 2011, a 47 percent increase and the DKK 15.6 billion (€2.1 billion) in actual transfer pricing adjustment announced by the Danish tax authorities, SKAT in 2010.  Oh, and did I mention the Organisation for Economic Co-operation and Development (OECD) just agreed to launch a new project on base erosion and profit shifting (BEPS)?

For the last several years, governments around the world have been increasing the resources and efforts dedicated to transfer pricing in attempts to defend their tax base and increase their tax revenues.  Not only have they been increasing the number of bodies, but also the quality and specialization of employees, including economists, financial analysts and international tax specialists.  In addition, they have revamped and refocused their organizational structures, policies and practices with regard to transfer pricing.

In the United States, the Internal Revenue Service (IRS) is in the midst of a major reorganization and expansion of its transfer pricing efforts, integrating its Advance Pricing Agreement (APA) and Mutual Agreement (Competent Authority) Programs, creating a separate Transfer Pricing Practice and establishing a transfer pricing director.  This follows on similar efforts by governments in Australia, the United Kingdom and China, among others.

So what’s the good news for taxpayers?

The IRS announced that it had closed 140 APA cases in the 2012, the highest single year total ever—and, more than a 3 times the number closed in 2011.  China reported the closing of 12 APA (four bilateral and eight unilateral) cases, a 50 percent increase over 2010, with a backlog of nearly 100 cases, most of them bilateral.

Despite all the efforts and resources devoted to “catch” taxpayers, governments are really more interested in joining in with taxpayers to craft APAs.  Almost every government that has mandatory documentation requirements also has a voluntary APA program.

Transfer pricing is not black and white, there is a lot of grey.  And, business operations, whether related party or third party, are complex.  These specialized groups have some of the most capable and experience transfer pricing specialists within their respective governments.  While some might view this as a potential a disincentive to enter the APA program, just consider how difficult (and potentially costly) it would be to try and negotiate with someone who doesn’t understand the issues, but is convinced that a transfer pricing assessment is justified.  Transfer pricing is founded on the basis of principled negotiation—it doesn’t always meet this standard but it is the touchstone.  Moreover, once an agreement is reached, not only is the issue settled, but it also remains the basis for future (renewed) determinations as well—removing the threat, cost and acrimony of transfer pricing as an audit issue forever.

In an era of increasing scrutiny and contentiousness—this may be as good as it gets.

© 2014 McDermott Will & Emery

About the Author

Chief Economist, Transfer Pricing

A. Tracy Gomes is Chief Economist for the Transfer Pricing practice in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Houston office.

Tracy advises firm clients on a range of tax matters relating to international transfer pricing and competent authority proceedings, as well as the valuation of intellectual property, business enterprises and financial products.  He has particular experience in the valuation of technology and brand intangibles.

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