The BMG participated in the plenary meeting of the Inclusive Framework on BEPS, held in The Netherlands on Thursday 22 June.
The BMG has submitted comments on a further discussion draft from the OECD relating to transfer pricing of hard-to-value intangibles.
The transfer of intangible property rights to related entities is one of the main techniques used by multinational enterprises (MNEs) to avoid taxes through base erosion and profit shifting (BEPS). Such assets are especially hard to value if they are transferred at an early stage, since their income-generating potential will be speculative, although best known to the firm itself. The three examples in the discussion draft all involve a transfer of such rights that have been only partially developed. Specifically, the examples involve a patented pharmaceutical compound that is partially through its clinical trials.
Although the draft still claims to apply the fiction of the arm’s length principle, it allows for transfer pricing adjustments based on actual outcomes, due to “information asymmetry” and its negative effects. Our comments support this approach, and propose some specific ways to strengthen it further.
The CCCTB adopts a sound approach to taxation of multinationals (MNEs), by treating them in accordance with their business reality as unitary firms. It aims to identify the tax base of the whole corporate group, disregarding internal transactions between the affiliates, and to apportion the taxable profit according to factors reflecting the firm’s real activity (sales, assets, employees) in each country. In our view, this is the most effective way to end both competition between states to offer tax incentives, and tax avoidance by MNEs shifting income between affiliates to minimise tax.
In our view, however, the aim should be to create a level playing field in relation to tax on corporate profits not only within the EU but worldwide. Unless this is done, EU member states will continue to compete with each other to offer tax preferences to MNEs from outside the EU. They will also continue to be vulnerable to tax competition from jurisdictions not covered by the CCCTB (including the UK, after Brexit). The CCCTB can and should be recast so that it attributes to the EU as a whole a portion of the worldwide profits of MNEs reflecting their actual activities within the EU, as well as allocating that profit among EU states, using the same criteria.
We also propose a ‘compensation mechanism’, in case another country (e.g. the US) adopts the alternative which has been proposed for a destination-based cash-flow tax with a ‘border adjustment’.
We also warn against the 2-stage approach proposed by the Commission, and criticise the proposed ‘super-deduction’ for R&D expenditures, and the so-called Allowance for Growth and Investment. As some business groups have also argued, it is better to define the tax base broadly, allowing scope for cuts in the rate (which are already taking place), than to build in selective and distorting special allowances.
16 May 2017
We applaud the continued interest of the OECD and Working Party 6 in its work to make the profit-split approach a more viable and important tool in intercompany pricing.
In this submission we propose the development and use of defined allocation keys and weights to apply the profit-split method to actual profits of common business models (see Appendix). In our comments to the specific questions we point out that the examples in the discussion draft assume, without explicitly saying it, that the various business units of a multinational enterprise (MNE) are normally independently managed, albeit with common ownership and some top-level management over policy and direction. In contrast to this assumption, we believe that most MNEs operate as centrally-managed unitary businesses performing core functions and using intangible property in multiple countries. We therefore suggest that it is appropriate to apply the profit-split method to actual profits in these cases. Nevertheless, if Working Party 6 takes a different view, due to their belief that some level of integrated risk sharing is required for application to actual profits, the profit-split method with defined allocation keys and weights could be applied to anticipated gross profits or other measure appropriate for the specific business model. Whether our recommended approach or this alternative is chosen and inserted into the Guidelines, it would greatly simplify things for taxpayers and tax authorities alike.
A presentation was made on behalf of the BEPS Monitoring Group by Professor Kerrie Sadiq, to the first meeting of the Enlarged Framework of the OECD Committee on Fiscal Affairs, in Kyoto (Japan) on 29 June 2016. The outline of this presentation is here.
This report consists of a draft revised chapter of the OECD Transfer Pricing Guidelines, with no indication of the changes made, or explanation of the reasons or intended effects, which makes the issues effectively inaccessible to all except the insider community of practitioners. This along with several other reports will result in extensive revisions and additions to the Guidelines, but it will be a piece-meal patch-up, incoherent and in some respects contradictory. The revised text could be adopted and have effect around the world, even in countries outside the OECD and G20, without the need for adoption by states. We therefore recommend that it should be regarded as only provisional, and a more fundamental reconsideration should be begun, in conjunction with the UN Tax Committee.
There can be good reasons for MNEs to share within the group the costs of activities which benefit various parts. However, such collaborative arrangements within MNEs are generally coordinated administratively, and are very different from contractual arrangements negotiated between genuinely independent enterprises each with its own separate business. Based on the mistaken starting point that CCAs between related parties should be treated as if they had been negotiated by independent ones, the proposals in this draft are contradictory and imprecise, difficult to administer, and in their present form would be ineffective in preventing MNEs from using CCAs for BEPS purposes. The suggestion that contributions should be priced according to the value of the benefits and not normally on their costs will again lead tax authorities into the quagmire of searching for non-existent comparables or estimating hypothetical values. On the other hand, it accepts that costs should usually be shared by applying an appropriate allocation key, and aims to prevent inappropriate outcomes by allowing subsequent adjustments to valuations and introducing the requirement that participants in a CCA must have the ‘capability and authority to control’ risks.
We support these proposals, as necessary measures to check CCAs from being used for profit-shifting, and indeed suggest that they should be strengthened. We nevertheless deplore the increased complexity which is needed to make the Guidelines effective, due to the adoption of a mistaken approach. In view of the many tax planning mechanisms available to MNEs for fragmenting activities and attributing functions to different entities, separating supposedly routine activities, such as contract manufacturing or distribution, from supposedly high-value functions such as design, financial services, or IP management, to allow MNEs also to plan allocation of joint costs without considering apportionment of profits is a continued encouragement to BEPS behaviour.
This Summary is based on BMG submissions prepared by various of our members up to March 2015.
Overall, we consider that some of the OECD proposals could provide a more effective basis for MNE taxation, especially those which have moved towards treating them on a more realistic basis as unitary firms. Others will increase complexity and rely on detailed and intrusive audits and subjective judgments, and hence be difficult to administer especially by developing countries, exacerbating the likelihood of conflicts.