handbook-tb

Eric M. Zolt2.2.2.6 Transfer pricingTransfer pricing has been described as “the Achilles heel of taxholidays,” 33 although it can be a problem with other forms of investmentincentives as well. The tendency is to think of transfer pricingas a phenomenon that occurs internationally in transactions betweenrelated enterprises in different countries. Transfer pricing can also takeplace in a single country where an investor has two or more operationswithin a country or where the investor derives income from more thanone activity. If one of those operations, or one type of income, enjoys atax preference, profits will tend to be allocated to the preferred activity.Transfer pricing is likely to take place where: (a) an investorundertakes two or more activities, one of which qualifies for an incentive(for example, manufacturing, exporting) and another does not; (b)an investor has operations in two or more locations, one of which is ina tax-privileged region and another is not; or (c) an investor owns twoor more subsidiaries, one of which enjoys a tax holiday and anotherdoes not. In each of these cases the investor will wish to allocate asmuch profit as possible to the tax-exempt (or tax-privileged) entity oractivity. In cases (a) and (b) there may be only a single entity, in whichcase there is no transfer pricing as such, but an equivalent result isachieved through the allocation of revenues and expenditures.Substantial challenges exist for monitoring transfer pricing,especially for small or less-developed countries. One approach may beto use those tax incentives that are less prone to transfer pricing abuses.For example, in contrast to tax holidays, investment allowances orcredits provide an exemption from tax of a given amount, rather thanfor a given period. Consequently, artificial transfers of profits to a firmthat has been granted an investment allowance or credit may result intax liability being postponed but not eliminated.33Charles E. McLure, Jr., “Tax Holidays and Investment Incentives: AComparative Analysis,” (1999) Vol. 53, Bulletin for International Fiscal Documentation,326-327.478