OECD Transfer Pricing Guidelines

Excerpt from Practical European Tax Strategies by Peter Hann (KPMG in the UK)



The OECD has been moving rapidly with its projects to revise the transfer pricing guidelines and to issue a new version of the Model Tax Convention. Revised transfer pricing guidelines will be issued within the next few years, while the new version of the Model Tax Convention is expected to be finalized as soon as June 2008. The main issues relating to transfer pricing are summarized below.


Transfer Pricing Guidelines

Profit-based Methods

Following consideration of the responses to a consultation held in 2006 on transactional profit methods, in January 2008 the OECD published “issues notes” on various aspects of profi t based methods as part of a further consultation exercise.

The OECD working party has been examining the status of the transactional profit methods (transactional net margin method and profit split), which are at present regarded as methods of last resort in the OECD guidelines. The working party has tentatively concluded that the correct guidance on the approach to the selection of a transfer pricing method is to emphasize that the method used should take into account the appropriateness of that method in view of the functional analysis and comparability analysis, and also taking into account the strengths and weaknesses of the OECD recognized methods. This should also involve consideration of the availability of reliable information, especially of uncontrolled comparables, and the degree of comparability including the reliability of comparability adjustments that would need to be made.

The OECD Working Party takes the view that the traditional transactional methods (comparable uncontrolled price (CUP), resale price method and cost plus) have intrinsic strengths. Their latest proposal in these issues notes would, however, remove the exceptional status of the profit methods and put more emphasis on the functional analysis to determine the appropriate transfer pricing method and on the consideration of the relative strengths of the different methods in a particular case.

Owing to the intrinsic strengths of the traditional transactional methods, the OECD still considers that when a traditional transactional method and a transactional profit method can be applied in an equally reliable manner, the traditional transactional method is to be preferred.


Read More on the issues addressed in the “issues notes” published as part of the consultation:

FAS 123R and Cross-Border Tax Issues

Excerpt from Practical US/International Tax Strategies by Albert W. Liguori, Michael Murphy and J.D. Ivy (Alvarez & Marsal Taxand, LLC)

Most public companies provide some form of stock compensation to their executives and employees and as a result must grapple with the tax and financial statement treatment of such equity compensation awards. Crossborder employment situations further complicate the tax and financial statement treatment of these awards.

The impact of recent developments in the transfer pricing arena as they relate to how equity compensation is treated under Statement of Financial Accounting Standards No. 123R (FAS 123R) and FAS 109 have now become natural opportunities for companies to determine not only whether they are in compliance with the financial statement and transfer pricing rules but also to undertake some tax-efficient planning.

Under FAS 123R, stock based compensation, which includes stock options and restricted stock units, must be valued at grant date and recognized as an expense for book purposes over the equity compensations’ vesting period. The vesting period is also known as the “service period” for which an employee earns the right to benefit from such equity compensation. Naturally, the amount expensed must be tax-effected. However, most foreign jurisdictions as well as the U.S. do not allow a tax deduction for equity compensation until the vesting is complete or the equity compensation is exercised. This difference in time (i.e., expense now, deduct later) results in deferred tax accounts. When accounting for these deferred taxes, it is important to know if and where a deduction will ultimately become available for the stock compensation, a task easier said than done.

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China Issues Guidance on 15% Tax Rate for High/New Tech Enterprises

Excerpt from Practical Asian Tax Strategies by Todd Landau and Edward Shum (PricewaterhouseCoopers, China)

A new joint circular recently issued by the Chinese authorities provides important guidance on the availability of Chinese tax incentives under the new Corporate Income Tax (“CIT”) law, including the preferential 15% tax rate, for investments in High/New Tech Enterprises (“HNTE”). These rules have retrospective effect from January 1, 2008.

According to the new Chinese CIT law, effective from January 1, 2008, HNTEs can enjoy tax incentives, including a preferential CIT rate of 15%. In order to further clarify the criteria for qualifying as HNTEs, the Ministry of Science and Technology (“MST”), Ministry of Finance (“MoF”) and StateAdministration of Taxation (“SAT”) have issued the “Administrative Measures for Assessment of High-New Tech Enterprises” (“Measures”) andthe “Catalogue of High/New Tech Domains Specifically Supported by the State” (“Catalogue”) by way of a joint circular GuoKeFaHuo (2008) No.127,with retrospective effect to January 1, 2008.

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EU to Modernize VAT Rules on Financial and Insurance Services

Excerpt from Practical European Tax Strategies by Tracey Paveley (Baker & McKenzie)

The European Union (EU) has recognized that the EU VAT legislation in relation to financial and insurance services is becoming increasingly out of date as providers introduce more sophisticated and diverse financial products into the marketplace. Businesses are finding it difficult to define these products for VAT purposes within the confines of the current legislation.

This uncertainty surrounding the VAT treatment of financial and insurance products has led to an increased amount of tax litigation, particularly as businesses are often required to negotiate the application of the VAT exemption in multiple Member States. This process can be very costly for businesses.

In addition, there is growing concern that EU financial institutions are less efficient than their U.S. counterparts. The embedded irrecoverable VAT cost suffered by EU providers of financial or insurance services is considered one of the factors contributing to this perceived inefficiency.

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Brazilian Exporters Surprised by Change of Position on Inflation Correction

Excerpt from Practical Latin American Tax Strategies
published by WorldTrade Executive

Brazilian exporting firms have been surprised by the sudden reversal of a longstanding policy correcting tax credits for inflation.

For years, exporters have been able to use credits from their “presumed” excise tax (IPI) to compensate for payments of Brazil’s PIS-Cofins corporate social security taxes. This compensation was created as a fiscal incentive for exporters. Rather than exempt exporters from PIS/Cofins, which would have required legislation, the government adopted an administrative approach, granting a credit for what companies would have paid in excise taxes, the reason why it is referred to as the “presumed IPI.”

In practice, exporters have commonly allowed these credits to accumulate over several years before claiming them. Since these credits often date back six or seven years, the tax department has permitted companies to adjust their credits for inflation, using the country’s base interest rate.

But starting last December, the tax department has rejected this practice. In a series of decisions in February and March of this year, the department’s Superior Chamber of Fiscal Appeals, the last administrative recourse for companies, has supported this new policy, turning down the appeals of exporting firms.

More: How does this affect compensation for exporters?>

Mexico's Dictamen Fiscal Is Similar to New Fin 48 in the US

Excerpt from Practical Mexican Tax Strategies by Steve Axler & Dinorah Gonzalez (Halliburton)

One of the concerns resulting from the introduction of FIN 48 for many in-house tax practitioners, especially for US based multinational companies, is that the US Internal Revenue Service would now essentially have a road map to various tax positions taken by the taxpayer. However, the disclosure of tax positions to the tax authorities is not a new or unusual event in Mexico. In fact, for large taxpayers in Mexico this is an annual occurrence known in Spanish as the Dictamen Fiscal.

Often simply referred to just as “the Dictamen”, this is a tax audit of a Mexican legal entity or person that carries out business activities or any foreign residents with a permanent establishment in Mexico. The Dictamen Fiscal can only be performed by a registered and certified Mexican public accountant. Upon completion of the Dictamen, the accountant will issue a report which will be filed with the Mexican tax authorities (Servicio Administración Tributaria or “SAT”) stating whether, according to the applicable tax regulations and audit standards, the taxpayer has complied with its obligations. The public accountant is required to sign the Dictamen under penalty of perjury.

It cannot be emphasized enough the influence that a Mexican statutory auditor has regarding the tax positions taken by a taxpayer in Mexico.

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The Pot Calling the Pot Black: Congress Points a Finger at the Internal Revenue Code (and Itself)

Excerpt from Practical US/Domestic Tax Strategies by Joseph B. Darby III (Greenberg Traurig LLP)

On April 10, 2008, the Small Business Committee of the U.S. House of Representatives released a Report stating that small businesses, which could otherwise help the U.S. economy get “back on track,” are burdened by a variety of barriers under the “remarkably outdated tax code.”

In the legendarily famous words of Homer Simpson himself, “Duh!”

What makes this Report newsworthy is not the content but rather the author. We are familiar in politics with the “pot calling the kettle black,” since, after all, finger-pointing and blame-shifting is pretty much what Congress does. However, since the primary party to blame for the tax code being “remarkably outdated” is Congress itself, Congress has, in effect, decided to point a finger at itself: This is the pot calling the pot black. Now that is news, indeed.

The funny thing is that the Report is absolutely dead-on accurate in its criticisms of the Code—so much so that it gives the reader a small hope that some of the changes might actually be enacted. Experience shows that when members of Congress are bickering and blaming each other, very little gets done. However, when Congress decides to look in a mirror and blame itself—well, almost anything seems possible.

Although the Report is concerned primarily with “small business” issues, the recommendations (if adopted) would benefit all tax-paying businesses, by simplifying the law and eliminating burdensome recordkeeping. Best of all, the Report might actually initiate a movement in Congress to consider the extraordinary burdens it places on U.S. taxpayers as part of the “voluntary” U.S. income tax system. In short, the Report is a surprisingly candid document that should be read by taxpayers of all sizes and stripes.

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Accounting—In Practice—for Back Office and Headquarters Services After Changes to Intercompany Service Transactions

Excerpt from Practical US/International Tax Strategies' interview with Transfer Pricing Specialist Eric Ryan, DLA Piper

In 2006 the Treasury Department and the IRS issued temporary regulations under Code Section 482 that phased out the simplified cost based method for reporting intercompany service transactions, and replaced it with the Services Cost Method (SCM). In order to find out how companies are adapting to the changes, Tax Strategies talked with Eric Ryan, a Partner with DLA Piper, resident in the Palo Alto office. Mr. Ryan has been working closely with many companies, primarily in high tech sectors, to implement the new rules.

Strategies: What kinds of companies are most affected by the changes to the new transfer pricing methods provided under the temporary service regulations?

Ryan: The key companies that are affected by this are U.S. multinationals that, on a regular basis, are charging out to their foreign affiliates some portion of what they consider U.S. headquarters costs. These companies in particular have basically had to do a complete relook at what they were doing previously.

Strategies: What has been the general taxpayer reaction to the SCM or Services Cost Method and the temporary regulations that allow expenses to be charged to affiliates without a markup?

Ryan: With the exception of one or two items, I think it has actually been favorable. Of course the SCM—the no-markup approach—is an exception to the arm’s length standard because the tax authorities would otherwise assume that there’s a profit motivation in arm’s length dealings. So what the IRS tried to do here was to keep the categories of expenses that could be allocated out without a markup to non high value-added activities. There was an earlier version of these proposed regulations issued in 2003 that had a formula which was just not workable, and it took a lot of effort to figure out if you could qualify for the new markup. Now the IRS has issued this list of 101 things that companies can allocate without a markup and that list, which is in Rev. Proc. 2007-13, we are coming to find out, is fairly extensive for General and Administrative activities.

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2008 Tax Reform in Japan

Excerpt from Practical Asian Tax Strategies by Yumiko Arai and Al Zencak
(PricewaterhouseCoopers, Tokyo)

The 83 trillion yen Japanese state budget and tax reform bill for fiscal 2008 passed the House of Representatives with a majority vote by the ruling parties. The budget and the tax reform bill cleared the lower house with an approval of the ruling Liberal Democratic Party and its coalition partner New Komeito party, making sure that the budget will pass through the parliament in time for the beginning of the new business year (April 1). The following excerpt reviews some of the major corporate taxation changes currently contained in the 2008 tax reform legislation.

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Thank God I'm a Country Boy

Why Country Songwriters Now Get Capital Gain Treatment for Their Music

Published in Practical US/Domestic Tax Strategies by Joseph B. Darby, III (Greenberg Traurig LLP)

As a tax lawyer, my professional life has the elements that my grandfather believed were essential to a really good job: indoor work, no heavy lifting.

In fact, there are only three things that I do as a tax lawyer. I help taxpayers (1) avoid income, (2) defer income, and (3) convert ordinary income into long-term capital gains. That’s really all there is to it, other than reading and understanding the Internal Revenue Code. All in all, as I said, a pretty cushy existence.

However, late at night, after everyone else has gone to bed, I sometimes wish I had time for one other important thing: I wish I had time to write country-western songs. You know the type of songs I’m referring to: mournful ballads sung with a twangy drawl, about how my old dog done died, and my new dog won’t hunt, and the finance company repossessed my truck, and my dern wife done run off with the guy from the finance company in my old truck, and my 12-gauge shotgun was in the back of the truck they took so I kain’t shoot no one, and my latest batch of homemade whisky just kilt four of my few remaining friends and blinded the rest, so there ain’t no one left who can see that I’m all tore up inside.

That’s what I call music.

Unfortunately, country songwriting is a tough racket, and so I have stuck until now with the practice of law, with the occasional tax or sports article on the side. The problem was that, until recently, all income from writing activities was taxed at ordinary federal income tax rates. There was no percentage in that kind of work, I figured.

You can imagine my amazement, therefore, when country songwriters managed to convince Congress in 2005 and 2006 that their creative endeavors deserved a special tax dispensation and that the sale of a copyright in a song is no longer ordinary income, but rather can be taxed at favorable capital gains tax rates.

This is a story worth telling. In fact, I may even write a song about it.

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