Bureau van Dijk: Time to put policy to the test - Luis Carrillo
Tax avoidance has hit the headlines with growing regularity since the collapse of the global economy in 2008, and transfer pricing is often portrayed as a tool used by big businesses to avoid paying their dues. Luis Carrillo of company database firm Bureau van Dijk (BvD) debunks this myth and outlines how businesses can ensure their transfer pricing policy is defensible - despite the current lack of clarity in the global regulatory framework.
The overriding motivation for multinational businesses is profit maximisation, so it is not surprising that many have been accused of boosting their bottom line by minimising their tax liabilities. In recent years, some of the biggest and best known companies in the world - including Apple, Starbucks and Google - have been accused of paying far less tax than they should by channelling revenue to low-tax jurisdictions.
The tool often blamed for enabling this technique is transfer pricing - the setting of prices for goods and services sold between companies within the same group - but it is far from new. Its emergence into the public consciousness seems to have been triggered in part by the failing health of the global economy and the need for governments to maximise tax revenues, though there
are many factors at play.
Piece of cake
"Transfer pricing has been around for a long time as a topic. The IRS came out with transfer pricing rules in 1994, which had specific guidelines on the methods that could be used. The following year came the first mention of it in OECD guidelines, which gave indications of how to set transfer pricing policy. Some multinationals may have been using transfer pricing as a way to avoid tax - some aggressively, even to the point of tax evasion - so the rules were designed to prevent that," says Luis Carrillo, transfer
pricing director at Bureau van Dijk (BvD).
"It has become a hot topic because, with globalisation, all governments want a piece of the tax pie. The focus is on transfer pricing because it is an easy way to increase revenue without raising taxes. It is an easy win for cash-strapped governments affected by the downturn, so there is a strong impetus for them to focus on transfer pricing," he adds.
BvD publishes software and company databases covering listed and unlisted companies across the world. BvD's databases (which include over 18 million companies with detailed financials worldwide) and software are used to establish arm's length transfer pricing policies for all types of intra-group transactions.
Based on his experience in analysing this type of information, Carrillo believes that media opinion - not to mention international regulation - regarding transfer pricing does not reflect the nature of today's world of international business.
"In today's economy, globalisation defines how things are, so multinationals have to operate on a global basis in order to grow. When you cross borders, you have transfer pricing issues, but there is a big misunderstanding that companies set up international operations to take advantage of transfer pricing. Most of them set up structures on the basis of their business needs," he remarks.
Apple and Google - the former accused of ducking tax on $30 billion in foreign profits between 2009 and 2012, the latter reported as having cut its tax bill by half in 2011 by funnelling revenue to Bermuda - have at times been criticised for setting up operations in Ireland, where tax rates are relatively low. Carrillo believes, however, that this move can be seen simply as sound business rather than strategy for tax evasion.
"They set up there because they could access a highly qualified, English-speaking workforce for a fraction of the price it would cost in San Francisco. It is a reality of business that companies set up international operations on the basis of their business structure, often ignoring the tax implications. The tax department is often not involved in setting strategy," he adds.
One of the reasons that transfer pricing strategies can be hard to define is that there is no global standard that clearly defines how to approach the issue. In theconfusing regulatory landscape, there are many initiatives to provide the necessary clarity, and the OECD has worked hard to establish a framework based on the arm's length principle.
An equal playing field
OECD member countries have agreed that the way to achieve a fair division of taxation - and avoid the real risk of being taxed twice on the same profit - is to treat intra-group transactions on the same basis as transactions between unconnected parties.
"The problem is that it is a zero-sum game. You either keep all governments happy and give the arm's length principle the death of a thousand cuts, or you go the free-market route in which case some governments will earn less tax revenue on the basis that fewer profits are attributed to the local operations of multinational enterprises. The UN is now entering the debate with its own guidelines, but the bottom line is the choice between imposing what companies pay, or letting the market decide," Carrillo notes.
"There is a lack of clarity among most governments about what companies should do. There is a debate over how to treat intangibles, for example, and there is a big question about how to reduce the risk of double taxation. If goods or services flow between two countries, then both governments have the intention to maximise the tax they receive. All that multinationals can do is to have as much documentation as possible to substantiate their activities and clarify the terms on which they trade between internal companies," he adds.
Whatever reasoning defines a company's transfer pricing strategy, the crucial factor is to have a defensible case for diverting revenue to intra-group entities. This depends on having the right documentation in place and having comparable examples that support the validity of transfer pricing decisions it makes.
A case in point is the dispute between the IRS and GlaxoSmithKline (GSK), which was settled in 2006 but concerned GSK's transfer pricing payments between 1989 and 2000. In 2006, GSK agreed a settlement under which it would pay $3.4 billion.
Carrillo explains: "GSK's transfer pricing policy did not properly compensate the US operations for the marketing activities it performed. As a result, the IRS was able to argue that the US operations of GSK were developing valuable intangibles, and since GSK US paid for the development of those marketing intangibles, they were due the profits attributable to those intangibles. GSK's transfer pricing policy and documentation did not properly reflect the economic reality of its operations. More important, though, is that GSK's transfer pricing adjustment by the IRS would have resulted in double taxation for GSK. Had GSK not settled, it would have had to pay UK taxes as well as US taxes on the same $300 billion in profits."
The problem, Carrillo emphasises, is that companies too often do not give due consideration to their transfer pricing policies, which are consequently inadequate. There is also an issue concerning confusion over what transfer pricing actually constitutes.
"Companies need to be able to defend their policy," he says. "Transfer pricing covers tangible property transfers, intangible property transfers, provision of intra-group services and provision of intra-group loans; so capital gains (such as Vodafone's sale of its US operations to Verizon) and dividend payments (such as Google sending money to Bermuda) are not in the scope of transfer pricing. So, there are a lot of misunderstandings out there about moving profits through transfer pricing. Companies must ensure they have clear policies."
This is where a company like BvD can help, as it can leverage its vast database of corporate financial information to provide its clients with examples of how comparable companies address the issue of transfer pricing.
"As long as the arm's length principle remains the main framework for defining transfer pricing policies, then you need to find a way to quantify that standard. We run a business information company and we publish a lot of information on private companies, so we can come up with independent comparables for things like tangible or intangible property transfers. That is helpful where countries follow the arm's length principle, but it is more of a struggle in places like Brazil that have imposed formulas for what companies should pay," Carrillo explains.
"Most countries, however, follow the OECD guidelines, so our data is useful to substantiate transfer pricing policies. You have to qualify those policies no matter what your group structure, and our analytics are complementary to what other guidance companies seek on tax structures. Ideally, I would like to see more clarity on how intra-group flows will be treated for tax purposes, because the lack of it creates risk and can hold companies back from investing in some economies. It will take a long time to achieve that clarity, but in the meantime we can help companies get their policies right," he adds.