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Global developments in transfer pricing issues

Important developments have taken place in the field of Transfer Pricing World over. The significant developments have taken place in the United States and OECD: In the United State the Altera Case1 has extended a major victory for taxpayers. As regards base erosion and profit shifting items (BEPS), developments are taking place in OECD. In this regard competing views are being debated in order to sort out the issue concerning treatment of BEPS action items.

There are many other issues relating to Transfer Pricing which are of importance and among them significant importance has been gained by pricing documentation.2 However, new taxes (like diverted profit tax introduced by UK) are also creating problems and issues.

Impact of Altera Case: Taxpayers have gained ground by winning proposition in Altera corporation case3 decided by the US tax court and the matter concerns tax and administrative law. The case related to the validity of cost sharing regulations introduced in 2003 in USA; in fact these regulations amended the existing law which was introduced in 1995.4.

The fact is that under 1995 law, cost sharing was not required; the view was upheld by the Tax Court in the Xilink case.5 However, another exception to the above rule stood related to the parties who may operate at arm’s length.

In the Altera case, the court came to the conclusion that the regulations requiring controlled parties to share stock based compensation in a QCSA was invalid because it did not comply with the requirement of “reasoned decision making”, an accepted standard.6

The standard set in this case stands carved out of the Administrative Procedure Act, which required that before acting the Administrative agencies are required to examine relevant evidence and a satisfactory explanation is to be given including a rational connection between the facts found and choices made.7 In this regard, it was held by the court that:

(I). While implementing the 2003 cost sharing rules, the tax authorities did fail to consider properly the available evidence so as to determine whether the third parties shared cost of stock based compensation at arm’s length.

(II). The arm’s length standard in transfer pricing cases is important one to decide objectivity.

(III). The tax authorities are required to follow the reasoned decision making standard.

Another important issue relates to taxpayer’s attorney client privilege where a tax payer has taken a reasonable cause defence. For example, in a case a gross under-statement was alleged against the taxpayer who refused to share certain documents at the discovery stage by contending that the information contained in the documents fall under the attorney client privilege. It may be noted that the taxpayer in the case was being penalised for an offence relating to information accuracy. The tax authorities accordingly contended that information being withheld was not protected since the tax payer had claimed that he acted in good faith. The court accepted the plea of the tax authorities.8 The court held that:

(a) Taxpayer had waived privilege by taking the reasonable cause defence.

(b) It would be unfair to deprive the government of knowledge of legal advice obtained to avoid taxation.

This ruling will:

i. Limit the practical usefulness of the reasonable cause and good faith defence by taxpayers;

ii. Taxpayer may be much more reluctant to assert defence.9

The OECD has issued 2015 discussion draft on risk, re-characterisation and special measures with respect to transfer pricing.

As per the documents, in transactions between independent parties, the divergence of interests between the parties ensures (1) that contractual terms are concluded that reflect the interests of both parties; (2) that the parties will ordinarily seek to hold each other to the terms of the contract; and (3) that contractual terms will be ignored or modified after the fact generally only if it is in the interest of both parties.

The primary method for sharing reports between tax administrations is through the automatic exchange of information, pursuant to government-to-government mechanisms such as bilateral tax treaties, etc. The OECD proposed a new section D.3 to the OECD transfer pricing guidelines relating to hard-to-value intangibles. It deals with arm’s- length pricing when valuation is “highly uncertain” at the time of the transaction. The discussion draft accepts the use of ex post results in evaluating transfer pricing arrangements as a means of evaluating the ex ante pricing of a transaction involving hard-to-value intangibles.

The UK diverted profits tax and similar proposals. Countries are evaluating whether the UK proposed diverted profits tax would be creditable in other countries and whether the tax would be a candidate for additional guidance in countries like the US, where foreign tax credit splitter rules apply.

(Author is an Advocate and is currently working as an Associate with M/s Azim ud Din Law Associates Karachi. To see author’s other areas of interest visit Zafars Blog on International Studies http://blogoninternationalstudy.blogspot.com/)

1 The case related to the requirements prescribed by law in respect of cost sharing. The law requires that stock based compensation must be shared as part of the cost pool. The said requirement now stands invalidated.

2 The main proposition revolves around the OECD requirements (proposed) relating to country by country reporting.

3 Altera Corporation vs. Commissioner, 145 T.C No 3 decided on July 27, 2015

4 This law required checks on controlled parties who entered into qualified cost sharing Agreement known as QCSA. The regulations in fact required sharing of costs related to stock based compensation.

5 Xilinx vs. Commissioner, 125TC 37 (2005)

6 Moto Vehicle Mfrs, Association V. State Farm Mut Auto IAC Co 463 US 29(1983)

7 State Farm, 463 US 43

8 Eaton Corporation vs. Commissioner, Docket No 5576 – 12.

9 In the case of Illinois tool works Inc vs. Commissioner, Docket No 10418-14 the tax payer did withdraw its reasonable cause defence plea after the decision of Eaton’s Case.

Copyright Business Recorder, 2015

Zafar Azeem, "Global developments in transfer pricing issues," Business Recorder. 2015-10-29.
Keywords: Economics , Taxpayer Compliance , Income Tax , US Tax courts , Public administration , Corporations , United States , US , UK , QCSA , OECD , USA , BEPS