Quantera Global: There can be only one - Richard Slimmen
The arm's length principle (ALP) was developed by the OECD as part of the Transfer Pricing (TP) Guidelines for Multinational Enterprises and Tax Administrations to provide a basis for the allocation of profits over different countries. Richard Slimmen, managing director at Quantera Global, questions whether these guidelines and the ALP are still the international standard for dealing with TP.
The Transfer Pricing (TP) Guidelines from the OECD were intended to provide a common set of principles that would allow countries to solve international disputes about the allocation of profits within multinational enterprises (MNEs). The ultimate goal was and still is to avoid double taxation. And although countries do have different opinions about specific fact patterns and disputes do frequently arise, the existence of a single common set of principles and internationally accepted guidelines on the interpretation of these principles has proved to be fairly effective in minimising double taxation. The vast majority (more than 90%) of MAP cases related to TP adjustments was solved due to the existence of this widely accepted set of principles.
Shift in focus
Over the past few years, the political focus on avoiding double taxation has slackened and is seemingly overtaken by a focus on combatting (partial) tax avoidance. In 2012, top management of several MNEs were interviewed by a UK parliamentary committee chaired by Margaret Hodge about their company's alleged tax avoidance. Due to the enormous media attention that ensued, public opinion called for immediate and strong political action, resulting in the OECD starting its Base Erosion and Profit Shifting (BEPS) project followed by the European Commission, which presented its Anti-Tax Avoidance Package (ATAP).
Through the BEPS project, the OECD introduced many internationally agreed measures to counter tax avoidance, which became final in 2015. The implementation of these measures is now in full swing across the globe and many countries have already taken explicit legislative measures or are on the verge of doing so. It would seem logical to - for now - trust that all these measures resulting from the BEPS project will sufficiently help to fight tax avoidance. However, the European Commission seems to lack that trust.
In addition to the measures introduced by the OECD in the BEPS project and the European Commission in its ATAP, the latter has pulled another rabbit out of its hat in order to fight loathed fiscal constructions: the instrument of state aid. By now, there are multiple examples (such as Apple and Starbucks) in which the European Commission, after in-depth investigation, came to the conclusion that the structures under investigation were unacceptable, which would result in state aid.
We can all agree that fighting tax avoidance is a noble cause. However, the way in which the European Commission is pursuing this goal seems to completely upset the relatively stable international practice of TP. As a result, no one is sure anymore of how to set up TP structures that will avoid any unwanted discussions with the European Commission and, at the same time, avoid discussions with individual countries about the appropriate profit allocations.
European Commission versus the OECD
First of all, the European Commission seems to disregard the carefully built consensus surrounding the internationally accepted arm's length principle (ALP), as introduced by the OECD. Or could it merely be a basic but important misunderstanding? The European Commission bases its ALP not on Article 9 of the OECD model convention but on the Treaties of the European Union (EU) instead, which results in quite different conclusions. The confusion is increased by the fact that the European Commission uses the same terminology but applies a different foundation; ALP-European Commission style does not equal ALP-OECD style. But isn't the European Commission part of the OECD?
Fiscal autonomy is a great good and still very much in the hands of the individual countries, not the European Commission. State aid as an instrument to criticise fiscal structures might not be the right way to go. But even if state aid should be used to fight tax avoidance, then it should be done consistently and without creating uncertainty on a global scale.
The current approach the European Commission takes by either using or not using TP arguments as building blocks to determine state aid seems rather inconsistent. In the Starbucks case, TP itself seems to be under scrutiny, since all intercompany transactions were expressly examined on correct allocation and whether prices paid for transactions were in line with market prices. The European Commission came to the conclusion that, according to its own ALP standard, this was not the case. Naturally, this conclusion caused a wave of criticism worldwide. Governments, fiscal authorities, corporations and TP specialists were in a mire, demanding to know what this ALP-European Commission style entailed for future TP transactions and if they would ever be able again to predict whether the European Commission would find perfectly sound TP structures to be state aid.
In the case of Apple, the European Commission seems to have changed its tune a bit. Has it taken the criticism to heart? Has it learned from the Starbucks case? For Apple, no verdict was passed on the acceptability of its intercompany transactions, deeming them to be 'out of scope' for a state aid evaluation. Only the possibility that these transactions might not have been allocated correctly is mentioned, but the European Commission expressly does not take a stand on the TP structures in place. Instead, it focuses on the internal Irish rules and regulations in place, and deems those to constitute state aid.
There should be only one
By seemingly 'applying TP standards' in the Starbucks case, the European Commission has created a great deal of confusion in the way in which countries and companies should deal with TP. The European Commission should end the confusion of tongues and embrace the ALP as developed by the OECD for the assessment of TP structures. It would help if the European Commission would avoid the use of the same label (ALP) to address a different issue. By taking a clear stand in this respect, a more logical and practical difference would arise between TP in general and the assessment of state aid, for which specific criteria are set. Assessing TP transactions should remain at the discretion of the individual countries, applying the OECD ALP. A proper application of the OECD ALP alone should never lead to a conclusion of state aid. Only if and when TP structures are clearly implemented incorrectly with the consent of tax authorities, should the European Commission look into it and assess whether this constitutes state aid, or not. Would the European Commission come to the same conclusions in the Starbucks case at this moment and, if so, would it use the same arguments?
Looking at the Apple case and the way the European Commission assessed that, one could conclude (or at least hope) that the European Commission has learned from its earlier mistake to create global confusion and has 'clarified' its position towards the OECD ALP as the one and only international TP standard. However, until this moment, it cannot be anything more than an assumption, and recent history has proven that it is dangerous to rely on assumptions alone. Therefore, it would be great if the European Commission would make an effort to take away the confusion and confirm that there indeed can be only one ALP.