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Manipulation of Transfer Pricing of Intangibles: the Role of the Arm’S Length Principle, the EU State Aid and the BEPS Action Plan

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Manipulation of Transfer Pricing of Intangibles: the Role of the Arm’S Length Principle, the EU State Aid and the BEPS Action Plan Manipulation of transfer pricing of intangibles: the role of the arm’s length principle, the EU State Aid and the BEPS Action Plan. Name: Evgenia-Charikleia (Erika) Dimopoulou Anr: 547817 Snr: 2007089 Supervisor: Dr. E.D.M. (Eveline) Gerrits Academic Year: 2016-2017 Master thesis International Business Taxation / track: International Business Tax Law, Tilburg School of Law, Tilburg University Title: “Manipulation of transfer pricing of intangibles: the role of the arm’s length principle, the EU State Aid and the BEPS Action Plan.” Name: Evgenia-Charikleia (Erika) Dimopoulou Anr: 547817 Snr: 2007089 Supervisor: Dr. E.D.M. (Eveline) Gerrits Date: 08/08/2017 Table of Content CHAPTER 1: Introduction 1.1 Motivation of study 1.2 Research question (including sub-questions) 1.3 Importance of the study 1.4 Research Methodology 1.5 Overview of the chapters CHAPTER 2: The arm’s length principle & its (un)certainty 2.1 Transfer pricing as major international taxation issue 2.2 The arm’s length principle in the OECD & UN Models and the OECD guidelines 2.3 Advantages and disadvantages of the arm’s length principle 2.4 Formulary Apportionment as the predominant alternative CHAPTER 3: Tax Treatment of Intangibles in the context of Transfer Pricing 3.1 Definitional and valuation issues regarding intangible property 3.2 Transfer Pricing methods for transactions involving intangibles 3.3 Comparative analysis of the preferred methods 3.4 Aggressive tax planning and tax avoidance by MNEs CHAPTER 4: Advance pricing agreements and EU State Aid 4.1 State aid as is prescribed in TFEU: advantage and selectivity 4.2 Advance pricing agreements 4.3 Significant cases that triggered a public debate 4.4 The role of the European Commission CHAPTER 5: The project of BEPS and its effectiveness 5.1 BEPS Action Plan 5.2 Actions 8-10 and transfer pricing of intangibles 5.3 BEPS and the EU 5.4 Observations on the BEPS project CHAPTER 6: Conclusion List of Abbreviations ALKI: Alki Limited Partnership AOE: Apple Operations Europe AOI: Apple Operations International APA: Advance Pricing Agreement ASI: Apple Sales International ATP: Aggressive Tax Planning BEPS: Base Erosion and Profit Shifting CJEU: Court of Justice of the European Union CPM: Cost Plus Method CUP: Comparable Uncontrolled Price DG Comp: Directorate-General for Competition EU: European Union FFT: Fiat Finance and Trade IP: Intellectual Property MNE: Multinational Enterprise OECD: The Organization for Economic Co-operation and Development PSM: Profit Split Method R&D: Research and Development RPM: Resale Price Method SCBV: Starbucks Coffee EMEA BV SCTC: Starbucks Coffee Trading Company SARL SMBV: Starbucks Manufacturing EMEA BV TFEU: Treaty on the Functioning of the European Union TNMM: Transactional Net Margin Method U.S.: United States UK: United Kingdom UN: United Nations Abstract In the era of economic globalization, MNEs tend to take advantage of their internal cross border transactions of intangibles. The application of the arm’s length principle in transfer pricing, the difficult identification and valuation of intangibles, as well as the selection of the right transfer pricing method are issues that make these transactions vulnerable. MNEs intend to reduce their tax burden through aggressive tax planning practices, which are encouraged by governments’ incentives and advance pricing agreements in order to attract investments in the EU. State Aid rules may apply in such cases. In order to fight against BEPS, caused by the foregoing practices of States and MNEs, the OECD launched an Action Plan and more than a 100 countries have willingness to cooperate. CHAPTER 1: Introduction 1. Motivation of study Nowadays, the globalizing economy is dominated by Multinational Enterprises1 (hereinafter MNEs). Due to the power of the MNEs2 and the intricate mechanisms that they adopt in order to escape taxation, transfer pricing techniques have become an additional tool for tax avoidance. Transfer pricing is defined as the setting of a price of goods and services in case of an internal transaction between related entities under the control of a single enterprise and it is based on the arm’s length principle which is an international standard. Albeit quite simple this mechanism seems, many corporations tend to adopt aggressive tax planning schemes, by adjusting their transfer prices in a way that income can flow from high-tax to jurisdictions of low-tax rates. In addition, tax arrangements with governments constitute a useful tool for the reduction of their tax burden. In the past, transfer pricing concerned only transactions of physical goods, while now it involves rights in intangible goods, as well as, services. Intangible assets may include intellectual property such as patents, trademarks, designs, know-how, copyrights, licenses and literary or artistic compositions. In many cases, MNEs fail to estimate the price of these non- physical and non-financial assets in accordance with the market price of similar assets – as they would be sold to an arm’s length customer- especially when the entities concerned are located in different countries, with various tax rates, aiming at avoiding taxation. In recent years, case law, as for instance, “Starbucks case” or “Apple case”, proves that the way of moving profits through transfer pricing is common practice in this kind of corporations. Particularly, this is relevant for technology companies that deal with intellectual property (e.g. know-how), the value of which is deemed subjective and present difficulties in its calculation. On the other hand, regarding the above mentioned “Starbucks case”, the role of the States in the application of the arm’s length principle appears to be crucial. Since the tax competition between the States is an element of the developed globalized economy, there are many cases of State Aid related to transfer pricing which reveal the States’ intention to improve their financial position using tax benefits. Thus, the tax authorities might be unexpectedly lenient and conciliatory. In some cases, they “misapply” the law in order to create incentives for foreign investments or to favor domestic companies instead of multinationals. 1 Maarten F. de Wilde,(2010), 'Some Thoughts on a Fair Allocation of Corporate Tax in a Globalizing Economy' , Intertax: international tax review , Volume 38 - Issue 5 p. 281- 305 2 The term MNE is not limited to very large organizations, but also includes smaller organizations with one or more subsidiaries or permanent establishments in countries other than where the parent is located, as it is clarified in the “Review into Australian Taxation Office’s management of transfer pricing matters”, (Australian Government, Inspector-General of Taxation). [1] Taking into account the current situation, this study aims at investigating the application of the arm’s length principle in establishing transfer prices, especially in transactions between related enterprises involving intangible property. From an EU perspective, another significant aspect to be addressed is States’ intervention in the form of State aid through tax agreements with MNEs. Furthermore, the importance of the OECD BEPS Action Plan in order to tackle international aggressive tax practices must be examined. 2. Research question (including sub-questions) The central research question of the thesis is: What is the importance of the arm’s length principle and the role of BEPS Action Plan in tackling the use of transfer pricing, especially regarding intangible assets, by MNEs aiming at tax avoidance and which is the role of State Aid in this practice? 2.1 The application of the arm’s length principle & its (un)certainty. How to comply with the arm’s length principle when establishing transfer pricing? - Examination of transactions between related enterprises which involve intangible property 2.2 Since the non-physical nature of intangibles imposes difficulties in estimating their value, taxpayers tend to take advantage of transfer pricing. Which issues may arise while using the existing transfer pricing methodologies? How do MNEs use these issues for tax planning purposes? 2.3 Which is the role of the State aid rules regarding APAs? Which cases of tax avoidance confirm the crucial role of State aid? Which is the role of the Commission? 2.4 What is the importance of the “OECD BEPS Action Plan” as an international framework aiming at combating aggressive tax planning and tax avoidance? 3. Importance of the study Since the field of transactions (and their taxation) between entities under control of the same enterprise, especially concerning intangible property, is one of the darkest and at the same time most challenging issues of International Taxation, an investigation seems really interesting. In a world of new technologies and intellectual property, the difficulties in estimating the value of intangible assets involved in such transactions, create the ambition of MNEs to exploit this situation in order to obtain legal tax avoidance. Thus, an analysis of the different perspectives of transfer pricing, the application of the arm’s length principle as well as measures to restrict tax avoidance tend to be an intensive necessity. An analysis of State [2] aid rules in the EU and the international BEPS project, which are deemed promising tools for reforming of the international tax system must follow. 4. Research Methodology This research is going to be based on findings of current literature (books, journals, academic researches and opinions), European Union legislation,
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