Caroline Silberztein Head of the Transfer Pricing Policy Unit at the OECD in the second part of her Q&A with the New European Economy

New European Economy (NEE): Where does the OECD stand on transfer pricing for business restructuring issues?

 

Caroline Silberztein (CS): In January 2005, the OECD Centre for Tax Policy and Administration organised a Roundtable on Business Restructurings (“the January 2005 CTPA Roundtable”) which was attended by senior officials from OECD member countries as well as from China, South Africa and Singapore and by a wide panel of private sector representatives. Government and private sector participants addressed a wide range of issues, including administrative approaches taken in examinations, treaty, transfer pricing and VAT issues. The discussions at the January 2005 CTPA Roundtable demonstrated that business restructurings raise difficult transfer pricing and treaty issues for which there is currently insufficient OECD guidance. These issues, which involve primarily the application of transfer pricing rules upon and / or after the conversion, the determination of the existence of, and attribution of profits to, permanent establishments, and the recognition or recharacterisation of transactions, may lead to significant uncertainty for business as well as for governments and possible double taxation or double non‑taxation, in the absence of a common understanding. Recognising the need for work to be done in this area, the Committee on Fiscal Affairs decided to start a project to develop guidance on these transfer pricing and treaty issues.

The discussions at the January 2005 CTPA Roundtable demonstrated that business restructurings raise difficult transfer pricing and treaty issues for which there is currently insufficient OECD guidance

There is no legal or universally accepted definition of business restructuring. Business restructurings which are in the scope of the OECD project consist in the cross-border redeployment by a multinational enterprise of functions, assets and / or risks. A business restructuring may involve cross-border transfers of valuable intangibles. Since the mid-90’s, example of commonly observed business restructurings have consisted of conversion of full-fledged distributors into limited-risk distributors or commissionaires for a related party that operates as a principal, conversion of full-fledged manufacturers into contract-manufacturers or toll-manufacturers for a related party that operates as a principal.  Business representatives who participated in the January 2005 CTPA Roundtable explained that among the business reasons for restructuring are the wish to maximise synergies and economies of scale, to streamline the management of business lines and to improve the efficiency of the supply chain, taking advantage of the development of Internet‑based technologies that has facilitated the emergence of global organisations.

 
The OECD project on Business Restructurings is concerned with the treaty and transfer pricing aspects of business restructurings i.e. essentially with the application of Articles 5, 7 and 9 of the OECD Model Tax Convention. Business restructurings are typically accompanied by a reallocation of profits among the members of the MNE group, either immediately after the restructuring or over a few years. One major objective of the OECD project is to discuss the extent to which such a reallocation of profits is consistent with the arm’s length principle and more generally how the arm’s length principle applies to business restructurings. One important question is to determine the circumstances in which the restructured entity would at arm’s length be compensated or indemnified for the restructuring.

This project is carried out with input from the business community at different points in time and under different formats. To start with, the January 2005 CTPA Roundtable was attended by a wide panel of private sector representatives. Shortly after it started its work on the treaty and transfer pricing aspects of business restructurings, the OECD decided to set up an informal group of academics, business representatives and consultants (the "Business Advisory Group") in order to obtain technical and factual input from the business community on the issues discussed by the JWG in the early stages of its work. In effect it was felt that the project could greatly benefit from discussions with a small group of tax and transfer pricing specialists with significant experience with business restructurings in a variety of industry sectors, which they have acquired either as tax managers of large companies or as advisors. In drawing up the list of members of the Business Advisory Group, the OECD tried to achieve as good a geographical balance as possible while keeping the Group reasonably small for the purpose of ensuring effective discussions. It should be stressed that the Business Advisory Group was by no means intended to be a substitute for a wider consultation process, and an invitation was posted on the OECD Internet site (www.oecd.org/ctp/br) for any interested parties who wished to provide input in the interim on the issues that are within the Working Group's mandate to submit comments to the OECD Secretariat.
As for the next step, it is expected that a Discussion Draft on the transfer pricing aspects of business restructurings will be released for public comment by the end of 2008.

 

NEE: What are the latest developments from the recent WCO/OECD Transfer Pricing and Customs Valuation talks?

Business participants explained that dealing with two sets of valuation rules often created unnecessary compliance costs. Moreover, they were concerned that different responses could be given to basically the same question (“what is the fair transfer price?”) due to often conflicting interests between customs and transfer pricing

The OECD and the WCO jointly organised two major Conferences on Valuation of Related Party Transactions for Transfer Pricing and Customs Purposes, in May 2006 and May 2007. Business participants explained that dealing with two sets of valuation rules often created unnecessary compliance costs. Moreover, they were concerned that different responses could be given to basically the same question (“what is the fair transfer price?”) due to often conflicting interests between customs and transfer pricing. In effect, in the country of import, the higher the transfer price, the higher the customs duties basis – but the lower the taxable profit. Many business representatives advocated the setting up of mechanisms that would draw the consequences for customs purposes of adjustments made for transfer pricing purposes and of mechanisms that would provide more certainty and consistency in valuation.

At the two conferences, the WCO and the OECD expressed their wish to encourage dialogue between customs, tax authorities and business, possibly by establishing a mechanism for liaison. In particular, it seems desirable to continue sharing best practices between countries’ revenue and customs administrations. A “whole of government” approach is desirable between customs and tax authorities. In this connection, both customs and tax authorities could benefit from better understanding each other’s rules, objectives and constraints.

Many interesting proposals were presented by the participants at the second conference, including the possible setting up of a central arbitration body and the greater use of technology-based audit mechanisms. The WCO Technical Committee on Customs Valuation could play a role in examining specific proposals from its membership. At the global level, the WCO and the OECD should continue their existing cooperation, such as sharing of knowledge and developing training material, including an e-learning module. There was a suggestion to create small focus groups of customs and tax experts involving also the WTO and business representatives, in order to study further the issues identified, with an initial focus on practical and concrete case studies, based on commercial reality. Specifically, further work could be done in the following areas:

• Valuation: These issues would benefit from an examination of the interaction between the valuation methods used by customs and revenue authorities, the hierarchy of methods used, what role if any functional analysis could play for customs, and whether a common definition of intangibles could be arrived at.
• Provision of greater certainty for business: The prospect of making more use of joint rulings or APAs attracted a lot of interest among the participants. Another related topic that could be explored is whether more effective dispute resolution mechanisms can be developed, possibly covering both direct taxes and customs duties.
  

How can we improve compliance? One practical area for possible study is whether greater consistency could be achieved in the transfer pricing and customs documentation requirements, e.g. the extent to which transfer pricing documentation packages prepared by taxpayers could be a useful basis for customs authorities’ reviews. A related question is whether better flows of information can be achieved between tax authorities and customs authorities, including an examination of the pros and cons of joint audits that could go with joint dispute resolution mechanisms.

Improving administrative capacity of tax and customs departments: Governments should continue building their administrative capacity in better addressing transfer pricing and customs valuation. The WCO and OECD discussed whether joint training programmes could be developed. It would be worth reviewing the experience of countries that have merged or de-merged their customs, VAT and direct tax departments.

In April 2008, the WCO Technical Committee on Valuation is expected to discuss whether to take forward this project and if so what should be the scope. The OECD Secretariat already signalled that in case the WCO wishes to pursue this work, we will support the initiative.

 

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