Arcotia Hatsidimitris - International Tax Dialogue

14 – 1. INTRODUCTION
Transfer pricing in context
Large Multi National Enterprises (MNEs) generally operate on a global basis and are able to
decide where to locate activities and how best to structure and finance them to take advantage of
different market opportunities. As a commercial matter they need to determine how global profits
should be allocated between group members so that they can measure performance and that involves
deciding the transfer price at which goods and services should pass internally. However, MNEs also
have large discretion in the way in which they structure their business models and set internal trading
terms. As a result they are able to allocate some of their global profits to group members in low-tax
territories without moving corresponding economic activity, assets, risks or functions. Issues also
commonly arise because group members can be unsure how to price intra-group transactions, even
when they have no tax planning motive. The complexity of MNEs and the fact that some of their intragroup
transactions are not directly comparable to transactions undertaken between unrelated parties
can make it difficult for MNEs to comply with transfer pricing rules.
Transfer pricing rules exist to address the potential mismatch between profit allocation and the
distribution of risks, assets and functions across the group. They require MNEs to price, for tax
purposes, their internal or intra-group transactions and calculate profits as if the transactions had taken
place between independent businesses – the arm’s length principle. This is the international standard
set out in Article 9 of the OECD and United Nations model tax conventions and used by most tax
administrations around the world 1 .
The use of the arm’s length principle attempts to ensure a consistent basis for profit allocation
and also helps to prevent MNEs from suffering economic double taxation – taxation of the same profit
by more than one tax administration. In addition, the arm’s length principle provides broad parity of
tax treatment for MNEs and domestic corporates, preventing distortion of their relative competitive tax
positions.
In recent years the complexity and importance of transfer pricing risks have increased as a result
of growing globalisation, cross-border mergers and the increasing sophistication of the financial
sector. This added complexity reflects fundamental changes in the way MNEs operate and how they
have developed their business models. For example, advances in technology mean that the global
operations of MNEs are increasingly integrated and tend to be focused on regional rather than national
markets. As a result internal supply chains, which often extend across borders, have evolved or been
restructured to reflect these trends. In addition, intangible assets, such as patents and trademarks play
an increasingly important part in the process of adding value. At the same time the contribution MNEs
make to cross border trade has continued to increase. Direct assessment of the share of international
trade that is attributable to intra-group transactions is difficult because little data is collected on trade
transactions between related parties. However, a recent OECD study that looked at data that is
available in nine OECD countries concluded that intra-firm exports of foreign affiliates already
represent 16% of total exports. The study suggests that adding the exports of parent companies to their
affiliates abroad, one could come close to concluding that export sales to related parties represent onethird
of total exports, the proportion suggested by US trade statistics, which do track intra-firm trade 2 .
As a result of these trends, the pricing difficulties that can arise because intra-group transactions
are not directly comparable to transactions that commonly take place between unrelated parties, or
because they involve the provision of highly specialised services and the use of unique intangible
assets, are becoming more commonplace. It follows that where these factors are present transfer
pricing enquiries and disputes require high levels of resource and specialist industry and economic
expertise that is scarce within tax administrations and which may need to be obtained externally.
DEALING EFFECTIVELY WITH THE CHALLENGES OF TRANSFER PRICING © OECD 2012