Double taxation is the spectre that stalks the battlefield of transfer pricing disputes which cannot be satisfactorily resolved.
Many countries view the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations as the ghostbuster most likely to succeed in banishing the spectre for two reasons:
- They present a way of determining a fair allocation of multinational profit between countries and should avoid manipulation for unfair tax advantage.
- They provide procedures whereby disputes that arise can be resolved cost-effectively with a reasonable degree of predictability.
It is hoped that a combination of the use of the OECD guidelines together with mutual agreement procedures (“MAPs”) in treaties, advance pricing agreements (“APAs”) and more recently, arbitration will provide the solution. Only time will tell whether this combination will prove to be the best route to follow.
Unpredictability in tax litigation
A tax authority will adjust prices between related persons that appear to be unfair. Much power is placed in the hands of the tax authority in the exercise of this discretion. While the courts can in principle control the tax authority's exercise of discretion, there must be a legal test against which to evaluate the conduct of the tax authorities. To date, the arm's-length standard (“ALS”) has been adopted as the best test. It is based on the idea of finding comparable transactions between unconnected persons that would provide objective evidence of a fair transfer price.
Methods based on comparing the profitability of comparable transactions in companies undertaking similar activities or, in comparing the profitability of such companies, has assisted in finding a fair transfer price because these methods do not require a direct comparable to be found as under the strict ALS.
Unfortunately, these methods only produce a range of acceptable prices and may result in in an element of subjectivity in reaching a conclusion. The submission of expert evidence by competing experts requires careful and objective analysis by judges who are highly experienced in tax law.
It is this unpredictability in the outcome of litigation that often leads taxpayers to seek alternative procedures for resolving disputes in transfer pricing.
Alternative procedural approaches for resolving disputes
Litigation can be avoided where taxpayers believe they may have a good opportunity to present their arguments at an administrative level before the tax authority becomes committed to a final position in a tax dispute destined for resolution in court.
Although the taxpayer may disagree with the tax authorities' findings, they may feel that they will have a better and more cost-effective opportunity to present arguments on complex transfer pricing issues to the tax authorities than to the courts. This is provided that the tax authority will adopt a reasonable position that does not undermine the commercial basis of the taxpayer's affairs.
Aside from local administrative alternative dispute resolution procedures, there are also the options of APAs and MAPs. The main advantage that MAPs and bilateral or multilateral APAs offer, is that the agreement of the tax authorities on both sides of the transaction is secured which eliminates double taxation. However, APAs are not currently available in South Africa.
The main advantage for taxpayers of the MAP process is that it is relatively simple to use but it tends to be rather slow and there is no guarantee that it will produce a result which eliminates double taxation. Once a matter has been submitted, the taxpayer has no further role in the process which is then concluded by the relevant tax authorities.
The last option is arbitration which has the potential to offer an improvement on the MAP process. Many tax authorities do not look favourably upon arbitration and the deadlines relating to the arbitration procedures may act as an inducement to the tax authorities to ensure that the MAP process provides an outcome before arbitration is resorted to. Arbitration procedures are have not yet developed into a widely used procedure.
With acknowledgement to: Resolving Transfer Pricing Disputes, 2012 Cambridge University Press.
Originally published by ENSafrica, October 2020
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