Transfer pricing issues account for the majority of all the tax cases, disputes and investigations. Transfer pricing is the single most important topic in international taxation. Some of the issues and areas of dispute include the following:
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The question of arms length pricing and deductibility of charges for intra-group services such as administrative, accounting, legal, computer, currency management, training, recruitment, R&D, financial, royalties, communications and other such activities between parts of related entities. Adjustments made by the tax authorities could lead to double taxation.
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Pricing of raw materials, finished or partly completed products between related entities.
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Remuneration of distributors, agents and commissionaires.
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Profit and cost sharing agreements.
Case Study
We were retained by a multinational company in the computer software services industry whose accounts had come under enquiry by the UK tax authorities in relation to the deduction of intra-group costs and expenses incurred in another jurisdiction where their software development centre was located.
We made presentations to the UK Inland Revenue first explaining how the software services model worked generally in terms of the revenues arising in the major western economies where the sales and marketing operations were located. We explained the “offshore” software development model required that costs occurred in the jurisdictions where programming skills were available cost-effectively. Due to the Internet, software development could effectively take place round the clock on a global basis and rotated geographically according to staff availability and skills.
A transfer pricing study had already been carried out in accordance with OECD Transfer Pricing Guidelines, with a full analysis organisation-wide of functions and transactions on a departmental basis. Documentation was provided of quotations of what the recruitment, training, communications, administration and other technical support costs would have been if these functions had been contracted out to independent third parties. Details of marks-ups and margins for intra-group services were provided. The tax inspector was impressed by the quality and level of documentation and planning that had gone into the study well before the filing of the tax return. The accounts and UK tax return were agreed without any adjustments whatsoever.
Other areas where we can assist:
* Multicurrency management: the business purpose is to pool exchange risks in one place, execute F/X transactions at the lowest costs, manage F/X risks by matching income and expenses in the same currency and hedging activities, managing inter-company loans and reducing overall borrowing costs. The multicurrency management centre could charge a fee with a small mark-up on an arms length basis.
* Debt Factoring: debts could be assigned to a company in a low tax jurisdiction, which could then employ an “agent” to collect the debts and be remunerated on an arms length commission basis.
* Advertising and Travel Agencies: offshore commission split arrangements with sub-agencies can be operated.
* Transport and Distribution: group companies pay commissions to the offshore logistics management centre thus claiming local deductions. All transactions must be at arms length.
* Captive insurance / re-insurance: the offshore captive insurance company accepts a lower premium on certain risks and re-insures the rest. Full deductions can be obtained for the premiums paid by the on-shore companies, but by careful timing the re-insurance costs can be paid at the end of the term, thus showing a surplus which accrues tax-free offshore. All transactions must be bonafide and at arms length.