Transfer price is still not right

Lack of consistent application of transfer pricing rules makes this an area ripe for international litigation


The cost of inter-company supply of goods, provision of services or transfer of intangibles among associated enterprises resident in different countries can dramatically influence the tax burden of a company and the amount of taxes collected by the countries involved.

This is where transfer pricing rules come in to play, which aim to ensure that related enterprises apply the same conditions (including pricing) that independent parties under comparable circumstances would be subject to – the so-called ‘arm’s length price’.

Transfer pricing for multinational enterprises (MNEs) has become one of the most interesting areas of international tax law. As a result of economic globalisation, inter-company cross-border transactions are becoming increasingly important. Transfer pricing is now a key issue when profits need to be allocated among the countries involved.

The attention to transfer pricing is becoming more pronounced as national tax authorities become more conscious of the role it plays in determining the taxable profit of MNEs, redirecting their resources to this area. Companies are putting more focus on managing their pricing policies, while transfer pricing rules are increasingly applied in ­areas that previously received little attention. Marketing intangibles is one example: in recent cases a major reduction of the effective tax rate was achieved by centralising the intellectual property in a company resident in low tax jurisdiction and charging the other group companies – mostly resident in high tax jurisdictions – with royalties.

The greater involvement of other disciplines – such as corporate governance and international accounting standards (IAS) development – in developing transfer pricing rules for tax purposes has also played its part, as has the Organisation for Economic Co-operation and Development’s (OECD’s) move to step up its efforts to bring the transfer pricing guidelines in line with the knowledge and insights gained in the recent past.

Despite the efforts of the OECD and international organisations, the way to a clear and uniform application of the arm’s length principle globally is still far from reach. The transfer pricing discipline is particularly complex because it cuts across disciplines such as tax law, intellectual property law, international accounting rules and corporate governance. As a result, it could happen that the tax authorities of the countries involved in a transaction may take different positions on what is the correct application of the arm’s length principle for that transaction.

Transfer pricing is the Achilles heel of most tax schemes. This will certainly be the hot topic for the next decade and the area of the most relevant tax litigations.

In this context, advance pricing arrangements (APAs) represent a suitable tool to efficiently manage the uncertainty that characterises transfer pricing. This is because APAs allow taxpayers to agree on a certain transfer pricing policy with one (unilateral APA), or more (bilateral or multilateral) tax authorities.