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Transfer Pricing Meets State Aid: Conflicting Arm’S-Length Standards and Other Lessons from the Apple Saga by Steven D

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Transfer Pricing Meets State Aid: Conflicting Arm’S-Length Standards and Other Lessons from the Apple Saga by Steven D © 2017 Tax Analysts. All rights reserved. Analysts does not claim copyright in any public domain or third party content. SPECIAL REPORTS tax notes international® Transfer Pricing Meets State Aid: Conflicting Arm’s-Length Standards and Other Lessons From the Apple Saga by Steven D. Felgran and Mat Hughes regulations, have dramatically increased the risks MNEs face for their tax positions and the associated reputational risks. This article reviews and analyzes the interaction and dissonance between the OECD BEPS project and EU state aid law, as best demonstrated by the European Commission’s final decision in the Apple case. I. Transfer Pricing and the OECD BEPS Project A. Transfer Prices and Declared Profits MNEs typically operate multiple companies Steven D. Felgran and Mat Hughes are across many tax jurisdictions, with a range of economists with AlixPartners LLP in New York intercompany agreements and operational links and London, respectively. among them. Those agreements and links can include: In this article, the authors discuss transfer pricing, state aid, the Apple case, and how • purchases and sales of tangible goods multinational enterprises should manage risk. between companies; • payments for intangibles, such as for the use A quote widely attributed to Benjamin of intellectual property rights, including via Franklin is that “in this world nothing can be said royalty rates; to be certain, except death and taxes.” However, in • group charges for various head office recent years risk and uncertainty regarding the services and shared services across appropriate levels of tax for multinational companies (such as management, finance enterprises have increased because of substantial and reporting, and IT services); and changes in the tax and state aid environments. • intercompany debt and financing There are two key drivers of the increase in agreements. MNEs’ tax risks. The first arises as a result of a Those arrangements affect the profits series of reports published by the OECD as part of declared, and thus the taxes paid, by specific its ongoing base erosion and profit-shifting companies. Accordingly, while transfer pricing project. The second arises from the European arrangements are unavoidable (services, goods, Commission’s decisions finding illegal state aid in and financing supplied on an intergroup basis are connection with MNEs’ individual tax rulings. not costless), tax authorities understandably want The different, expanding roles of those two to avoid MNEs artificially transferring profits supranational organizations, combined with a through their transfer pricing arrangements to new global emphasis on tax transparency and low- (or no-) tax jurisdictions to avoid paying tax more active enforcement of transfer pricing in high-tax jurisdictions. TAX NOTES INTERNATIONAL, DECEMBER 4, 2017 959 For more Tax Notes International content, please visit www.taxnotes.com. SPECIAL REPORTS © 2017 Tax Analysts. All rights reserved. Analysts does not claim copyright in any public domain or third party content. B. The OECD’s Role and Transfer Pricing Methods requirements in the existing international standards, to ensure alignment of taxation International consensus is important for with the location of economic activity and transfer pricing regulations, not least because value creation; and improving inconsistent rules could lead to companies facing transparency, as well as certainty for double taxation and legal uncertainty. 4 businesses and governments. For more than 20 years, the OECD has been producing transfer pricing guidelines that are Several BEPS reports are of particular interest: used by both OECD members and nonmembers.1 Action 5 is intended to counter harmful tax The OECD’s transfer pricing guidelines center practices more effectively, actions 8-10 attempt to around the requirement that transfer prices be align transfer pricing outcomes with value arm’s length. The OECD guidelines apply the creation, and action 13 covers transfer pricing arm’s-length principle to many related-party documentation and country-by-country transactions. There are various methods that reporting. In short, the BEPS action plan taxpayers can use to test their transfer prices for emphasizes that transfer pricing should reflect arm’s-length equivalence. These methods fall into value creation or economic substance (so that tax two categories: traditional transaction methods, liabilities reflect underlying economic profits which include the comparable uncontrolled price, based on the economic activities being carried out resale price, and cost-plus methods; and by various group companies) and increases transactional profit methods, which include the MNEs’ obligations to document transfer pricing transactional net margin method (TNMM) and arrangements and be transparent regarding the profit-split method. where they are reporting their profits. Following the BEPS project, the OECD C. The BEPS Project guidelines now address concerns that MNEs Even though regulations based on the OECD might shift intangible rights, such as the right to guidelines have long existed to test the arm’s- use IP, to low- or no-tax jurisdictions. The concern length nature of MNEs’ transfer pricing, concerns is that by shifting those rights, MNEs might try to have remained. Indeed, according to the OECD, justify booking excessively large profits in aggressive tax planning has caused $240 billion, jurisdictions with low tax rates, even when they or up to 10 percent of global corporate income tax are not performing economic activities that would revenue, in annual tax avoidance.2 As a result, in justify booking those profits there. A lack of 2013 the OECD began a multiyear initiative to economic substance in the location where IP fight BEPS by identifying 15 actions3 to reduce tax rights were purchased and excess profits were avoidance and forming various working parties to booked was not widely identified as a problem study the problem and produce new guidance. until the BEPS reports and the 2017 OECD The OECD has described the BEPS action plan as: guidelines. The BEPS reports and 2017 guidelines also structured around three fundamental addressed the creation of a principal company or pillars: introducing coherence in the head office with no economic activities, also domestic rules that affect cross-border known as a “cash box,” in a low-tax jurisdiction, activities; reinforcing substance as well as corporate inversions. Moving headquarters is acceptable from a tax liability perspective, but not if the new headquarters lack 1 The OECD’s transfer pricing guidelines were first published in 1979 economic substance. In some instances, MNEs and adopted by the OECD Council in 1995. The guidelines have been have used stateless entities that do not pay any revised several times — most recently in July 2017 to reflect changes resulting from the BEPS project. The 2017 edition incorporates tax. substantial revisions made in 2016 to reflect the clarifications and The BEPS project was substantially completed revisions agreed to in the base erosion and profit-shifting reports on actions 8-10 and 13. in 2015 and has already gone into effect or will go 2 OECD release regarding discussion topics for the G-20 finance ministers meeting (Oct. 5, 2015). 3 OECD, “Action Plan on Base Erosion and Profit Shifting” (July 19, 4 2013). Supra note 2. 960 TAX NOTES INTERNATIONAL, DECEMBER 4, 2017 For more Tax Notes International content, please visit www.taxnotes.com. SPECIAL REPORTS © 2017 Tax Analysts. All rights reserved. Analysts does not claim copyright in any public domain or third party content. into effect in many major jurisdictions.5 For jurisdiction, a local tax examiner can explore example, the United States has agreed to annual whether the taxpayer’s affiliate in the examiner’s CbC reporting for tax years beginning on or after jurisdiction is making transfer payments to an June 30, 2016, for U.S. entities that are the ultimate affiliate in the low-tax jurisdiction. Merely paying parents of a multinational group, making 2017 the royalties, service fees, or other payments to the first reportable period for calendar-year MNEs.6 low-tax jurisdiction does not necessarily indicate tax avoidance, but the examiner can use those D. Documentation and Reporting data to ask the taxpayer more targeted questions. The action 13 BEPS report and the 2017 OECD The reverse is also true: For example, if a local tax guidelines call for a three-tiered approach to examiner realizes that a taxpayer with substantial operations in his jurisdiction is booking relatively transfer pricing documentation: 8 • a master file covering the totality of a MNE’s little income, he can investigate. operations and its transfer pricing policies; While CbC reporting information may be • a local file providing information about the used only by tax authorities and is disseminated relevant related-party transactions and through a government-to-government exchange amounts involved at the local affiliate; and mechanism, there is speculation that it will • a new CbC template for reporting revenues, ultimately become public in some form. In particular, the European Commission has said it profits (or losses), taxes paid and accrued, 9 assets, and employees in every country wants the reports to become public. If the where the MNE operates.7 appearance or fact of tax avoidance becomes public through media reporting, that will further The CbC report is the OECD’s attempt at full raise reputational concerns associated with transparency
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