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THINKING ALOUD (BusinessLaw)BUSINESS TAXES:Global Transfer Pricing Tax

Updated on December 8, 2016
GLOBAL TRANSFER PRICING
GLOBAL TRANSFER PRICING | Source
Transfer Pricing
Transfer Pricing | Source

DISCLAIMER:

The writer makes no warranty of any kind with respect to the subject matter included herein or the completeness or accuracy of this article which is merely an expression of his own opinion. The writer is not responsible for any actions (or lack thereof) taken as a result of relying on or in any way using information contained in this article and in no event shall be liable for any damages resulting from reliance on or use of this information. Without limiting the above the writer shall have no responsibility for any act or omission on his part. Readers should take specific advice from qualified professionals when dealing with specific situations.

Chén Róng’s

Little English-Chinese Dictionary

  • in one fell swoop = tóng shí jì tuō wán chéng de

  • all and sundry = quán bù

  • Do not throw stones if you are living in a glass house = bié zé guài tā rén rú guǒ nǐ yě yǒu cuò wù

  • ….. ‘red flag’ = tí gāo jǐng tì

  • .... behind a veil = chuí lián tīng zhèng

  • an uphill task = jiān jù gōng zuò


Contractual Terms of Transaction

Factors affecting Transfer Pricing

Writer: Chén Róng


The manner a company carries out an activity is related closely to the terms and conditions of the contract it has with another company. Therefore, the tax authority will examine this contractual relationship between the buyer and seller of goods and services in its analysis of transfer pricing between associate firms. There were times the written contract, signed and delivered, does not provide sufficient enough evidence to determine if a particular transaction has been done at arm's length. In such a case, the tax authority will examine other correspondence and communications between the contracting parties. There were occasions where the terms of arrangement are not explicitly defined; the authority may have to make deduction on the basis of economic relationship and conduct of the contractual parties. Risks exposure is an important determinant if transfer mispricing takes place.

The table below will illustrate (simplified version) what the writer means to say.


Exposure to Risks
Firm 'A'
Firm 'B'
Product Liabillity Risks
Firm A is primarily engaged in research, product and technology development. There is risk of product failure and the consequential risk to its reputation.
Firm B is exposed to product liability risks if the produced goods do not conform to the order specifications as provided by the buyers of goods. There are further risks arising from non-conformity with national/international product standards. Are such risks mitigated by due process of Firm B’s own research and development centre in ensuring excellent quality and safety standards? Which party – Firm A or Firm B assumes such risks under contract?
Technology Risks
Firm A is exposed to technology risk, being the technology owner. Owing to market competition and an ever-changing technology, the company needs to continuously upgrade its existing technology and develop new technology. Firm A continues to focus on providing products with updated technology
Firm B’s manufacturing operations are non-complex since product technology and know-how have been provided by firm A. Hence, firm B does not face any major technology risk. What does the contract with Firm A say?
Foreign Exchange Risks
Firm A exports technology and components to Firm B; hence it is exposed to appreciation/depreciation of local currency against the foreign currency. Therefore Firm A is exposed to this risk. Does Firm A bear this risk under contract?
Firm B imports technology and components from Firm A and sales are restricted to domestic markets; the imports are exposed to appreciation/depreciation of local currency against the foreign currency. Therefore Firm B is exposed to this risk. Does Firm B bear this risk under contract?
The Table shows the risk-exposure of Firm A and Firm B in context of their contractual relationship as buyer and seller of products. When the parties establish a price for the transaction, this is transfer pricing. Transfer pricing is not illegal in

Shell India violated transfer pricing rules

It was reported by Television channel ET Now on Feb 26, 2013, that Shell India was said to have violated transfer pricing rules by the country’s Income Tax Department. “The income-tax order relates to the issue of 87 crore shares by Shell India to an overseas group entity, Shell Gas BV in March 2009. The shares were issued at Rs.10/share, which has been contested by the income-tax authorities in Mumbai. The income-tax department has challenged the valuation methodology of Shell India and has pegged the value of the shares at Rs.180/share instead”.

Indian quasi-judicial tax authorities have also ruled in recent orders that the country's transfer-pricing (TP) rules apply to share transfers between foreign parents and affiliates of Indian companies, as well as to buybacks, hence the case against Shell for violation of TP rules. Shell had denied any tax liability arising out of its transaction with the parent, and alleged that this would be a tax on foreign direct investment. Shell India had said that the transaction related to capital raising and no income (that could be taxed) was generated.

Lessons for small companies:

  • Big companies like Shell have financial resources which small companies lack. To save you time, trouble and financial ruin, it pays to be upfront with your investment strategies. If your intention is one of direct foreign investment, why use another route that may be interpreted as tax evasion?
  • If you were to argue that the transfer pricing order by the tax authorities was based on an incorrect interpretation of tax rules, be prepared for a long drawn expensive legal wrangling to settle the difference of opinion. Why sail in uncharted waters?
  • If what you do involves a loophole in law, the country concerned may pass laws to recoup tax retrospectively. Think before you leap.
  • To avoid disputes on particular set of transactions, it is recommended that an agreement between you as a taxpayer and the tax department on advance pricing procedure be entered into before the deal.

This account is just the writer’s personal opinion on the matter and, therefore, should not be interpreted as professional advice.


Transfer pricing

& putative corporate tax havens

Writer: Chén Róng



"Transfer Pricing" is shorthand for companies shifting profits to corporate tax havens to avoid tax in developed countries. The writer argues that governments should keep their focus on putative corporate tax havens and not place 'Knowledge Economies" under the same category. Singapore, Hong Kong and Dublin, to name a few, are knowledge economies and their systems are designed and constantly evolving to attract global companies to take up residency and create jobs and revolutionise industries through research and development. Even if a company's profits are higher as a result of locating itself in a knowledge economy, that money will flow out and eventually taxed as in the form of dividends in the hands of shareholders.

Declining and low tax rates by themselves are not proof that these offshore jurisdictions are venues for unfair shifting of corporate profits and other aggressive tax avoidance activities. These offshore financial centres compete through efficiency. They have high regulatory standards comparable to other developed nations. Besides, by lowering taxes, companies are substantially more viable and more likely to grow and develop over the initial difficult years and become prosperous enterprises in time.

With putative corporate tax havens, all industrial activities take place outside their territories; but, a large chunk of the tax-avoiding revenue stay with them. For instance, in today’s business world, intellectual property migration to putative corporate tax havens is the biggest problem in transfer pricing. It enables pharmaceutical firms, software companies and other corporations to reduce tax liability in their markets. IP is an important component-value of many companies. By sending their IP to such havens, the associated royalty incomes can be booked there. Where IP is developed is not relevant, as is the location of the legal owner. It has no nationality to talk about. The income of a multinational company cannot be said to arise from a single market where it has a presence.

Putative corporate tax havens share certain common features. The table below shows a partial list of such places in the world and whose wealth creation benefits few people.

Putative Corporate Tax Havens
Commonalities
Location
Bermuda
One-man booking office; poaching business from more pressurizee offshore corporate jurisdictions; no local sales or real economical activities taking place; hiding corporate debts of offshore companies or funds (e.g.hedge funds) which are obscure exotic derivatives; registering shell subsidiaries strictly for tax avoidance.
An island in the North Atlantic Ocean, located off the east coast of the United States.
. Luxembourg
one-man booking office; poaching business from more pressurizee offshore corporate jurisdictions; no local sales or real economical activities taking place; hiding corporate debts of offshore companies or funds (e.g.hedge funds) which are obscure exotic derivatives; registering shell subsidiaries strictly for tax avoidance.
A landlocked country in Western Europe.
Mauritius
one-man booking office; poaching business from more pressurizee offshore corporate jurisdictions; no local sales or real economical activities taking place; hiding corporate debts of offshore companies or funds (e.g.hedge funds) which are obscure exotic derivatives; registering shell subsidiaries strictly for tax avoidance.
An Indian Ocean Island, off East Africa
Belize
ne-man booking office; poaching business from more pressurizee offshore corporate jurisdictions; no local sales or real economical activities taking place; hiding corporate debts of offshore companies or funds (e.g.hedge funds) which are obscure exotic derivatives; registering shell subsidiaries strictly for tax avoidance.
Belize is situated on the East coast of Central America and has borders with Mexico
Cayman Islands, Anguilla & the British Virgin Islands
one-man booking office; poaching business from more pressurizee offshore corporate jurisdictions; no local sales or real economical activities taking place; hiding corporate debts of offshore companies or funds (e.g.hedge funds) which are obscure exotic derivatives; registering shell subsidiaries strictly for tax avoidance.
Carribean

A tribute to National Library, Singapore.


Last year, when the writer read a book review on TREASURE ISLANDS by Nicholas Shaxson, he recommended this offshore banking and tax havens publication be bought by the National Library, Singapore, for its central library. The recommendation was immediately accepted.

Certainly, the writer was the first person to read it when the book was purchased within less than three months. Singapore is a place with a large population of international banks and multinational companies; TREASURY ISLAND – uncovering the damage of offshore banking and tax havens - comes handy.

Chén Róng

Transfer Pricing in Africa.

In Africa, with its vast quantities of natural resources, this is a major concern among authorities who are concerned that multinational enterprises can adjust transfer prices on cross-border transactions to reduce taxable profits. For example, a subsidiary company in one country may decide to sell its goods to its subsidiary in another country for US$1m when it is actually worth $10m. By doing this, $9m is concealed from tax authorities.

Karen Miller, Ernst & Young, African Region

Business Taxes:

Global Transfer Pricing Tax

WRITER: Chén Róng



Business people should not be caught out! Global transfer pricing tax is a concern of multinational companies and their tax experts as much as it is something all business owners need to ponder on.

A good working knowledge of transfer pricing rules is essential for running a business in present day. Regardless of the size of a business, if it is in international trade and services, it needs to have someone within the organisation who understands some ground rules. Business owners should not let the term mislead them into thinking that transfer pricing involves only cross-border sale and purchase of goods. The rules apply to royalties, management charges, interest-free loans, and any other intangible property that move between related or connected businesses. The Objective: Governments the world over are trying to prevent clever business people from getting away with declaring their profits in countries where there is a lower tax rate and, hence, reducing the tax they have to pay.

The reason small business enterprises in countries like Singapore and Hong Kong do not hear any ringing of warning bells is because these places are comparatively low-tax territories. Transfer pricing is a major concern with high tax jurisdictions such as countries in Europe, Australia and United States of America -- in part owing to the need to challenge companies which are restructuring into lower tax jurisdiction. Moreover, governments in the West are running national deficits and there is an urgent need to correct fiscal imbalances; there is a need to avoid the so-called 'fiscal cliff’ come January 2013. In the US where the government is implementing an avalanche of taxes all at one fell swoop; measures that may lead to tightening of all tax loopholes, particularly those leaking through tax havens.

Why is there a need for low tax jurisdictions to implement transfer pricing laws?

  • Cities like Hong Kong and Singapore are awakening to the need for implementing transfer pricing guidelines as more foreign companies use them as backdoor to China and other emerging markets - Myanmar, Vietnam and Cambodia; more recently, Iskandar (Johor, Malaysia). The result: Diminishing taxes. Both local and foreign companies are re-locating labour-intensive manufacturing works to nearby countries; but Singapore remains their regional headquarters for strategic purposes. In past years, expanding into overseas markets was associated only with large multinational companies; these MNCs have the capital and resources to accomplish growth strategies through relocation. However, the ease of communications has enabled smaller companies to grow their business internationally by taking baby steps with the help of sales agents or contract manufacturers. In recent times, owing to high rentals and inability to get workers, small and medium enterprises (SMEs) have set up sales offices and manufacturing location overseas to penetrate new markets. It was done to such an extent that such wholly owned or controlled corporate entities become a part of market-share strategies, such as lowering of prices relative to comparable products in the same markets. Transfer pricing implications are strong with such strategic changes. Moreover, both territories are open economies that attract foreign companies from the world over. These foreign companies may also get caught up with laws in their own homeland.

An Illustration: A UK-Company with a wholly-owned subsidiary in Singapore had to move part of its production to Malaysia's Iskandar special economic region. It was due to tighter foreign worker policies in 2012 and higher wage costs plus higher rental costs associated with rising industrial property prices in Singapore. Now all transaction prices between the UK-Company and its non-UK resident entities will come within the radar of the UK transfer pricing laws, as these are considered related or connected parties.

  • Both Hong Kong and Singapore are anxious to differentiate themselves from tax-haven countries. These are black-listed jurisdictions where nil or ultra-low tax rates are dished out to all and sundry. These fiscal paradises, developed by creative business lawyers, provide a haven for secrecy about ownership of companies and their ultimate beneficiaries, hence, invariably thwarting all transfer pricing regulations. You can easily “Google”' an entire list of tax havens with click of the computer-mouse, as I am allotted only limited hub real estate for this article.

One other reason: Both Asian territories are keen to align themselves with international practices and the principled applications of Organization for Economic Cooperation and Development's (OECD) Transfer Pricing Guidelines. This move is to prevent the erosion of their own tax bases, as more tax authorities are introducing transfer pricing legislation in some form or other in recent years. I do not have the necessary know-how to explain how those tax treaties (e.g. Singapore/USA Tax Treaty) between various jurisdictions can help you negotiate both voluntary and involuntary transfer pricing adjustments. It can be done; however, you need to consult tax experts for an updated road map in navigating the tax conundrum.

Companies should think twice if they plan to pull some shenanigans with emerging markets such as Vietnam. They need to be aware that Ho Chi Minh City's Department of Taxation is now pursuing foreign-invested enterprises suspected of transferring large parts of their revenue on trademark and technology to their parent companies. It is considered an attempt to short-change the Vietnamese tax authority.

What exactly is transfer pricing?

Where a price paid by a related party differs from the arm's length price; and if it also confers a potential tax advantage on one of the parties, the transaction is one of transfer pricing. This party's profit must be computed for tax purposes as if the arm's length price had been payable in place of the actual price.

The above UK-Company illustration is a case in point: If the price the Iskandar subsidiary/associate charges the UK-Company is the same as it charges all other customers, that transaction will clearly be an arm's length price. Otherwise, the reason for a transaction running afoul of the rules should not be ignored. For instance, if the UK-company buys in bulk it might justifiably pay a lower price per unit than a small retailer customer pays; or if it is given a much shorter credit period, paying a lower price is reasonable. Whether a transaction is permissible under the rules has to depend on surrounding circumstances. But what is meant by 'arm's length'?

Investopedia (business dictionary) defines it as 'a transaction in which the buyers and seller of a product act independently and have no relationship to each other'; and that both parties in the deal are 'acting in their own self-interest and are not subject to any pressure or duress from the other party'.

This is only a guideline.

What the Revenue considers as arm-length price (i.e. independent commercial price) is a matter of judgment although, in the writer's opinion, it should be determined in accordance with OECD guidelines as they create a level of certainty for businesses. Governments need to implement programs that provide taxpayers with transfer pricing certainty and ensure that it does not audit reasonable transfer-pricing policies that may otherwise seem aggressive. Transparency of rules and regulations across borders will be a boon to business; opaqueness creates uncertainties, inconveniences and higher costs which run counter to government initiatives in promoting free trade. Having said that, bigger companies now have in place management strategies, including advance pricing agreements (APAs) with at least one tax authority. APAs are programmes designed to help companies voluntarily resolve actual and potential transfer pricing disputes in a proactive manner as opposed to the traditional examination process.

What transactions fall within the framework of transfer pricing laws?

  • If a business has dealings with a foreign subsidiary company (e.g. 51% or more voting shares in a joint venture) the case for observing transfer pricing regulations is obvious. It is safe to regard the situation as one falling within the framework of transfer pricing regulations, as the authority concerned may not take into consideration whether it has a controlling interest in the corporate entity.
  • If a business has dealings with a 'related party’ (or a connected party) such as an associate, it has to watch its steps because it may come within the ambit of transfer pricing laws. Which corporate entities come within the legal definition? If a company is party to a joint venture in a foreign country, and it holds voting shares of not more than 50%, the joint venture company is an associate company. Certainly, the question of whether or not it has significant influence over the associates may be a moot point.
  • Businesses need to stay vigilant on related or connected party transactions under specific laws. A related party may be differently defined for different legal purposes spreading over diverse jurisdictions. Companies formed to facilitate sale and marketing or manufacturing functions in foreign countries may have common directors and shareholders. It is probably impossible to deny the existence of related party transactions. Mining firms were discovered to have low-balled the value of coal when selling to traders, marketers and intermediaries (firms they own) which then sell the coal at higher rates abroad.
  • There are circumstances when a company may just be one of many parties in a joint venture. One party may insist that its registered 2% stake in the venture is insignificant to justify a 100% transfer-pricing tax. But investigation by the authority may review the existence of controlling votes in the venture held in the name of nominees. It remains the beneficial owners of those shares and fails to disclose such facts to the authority. Do not throw stones if people are living in a glass house, so the saying goes.
  • An accountable situation arises when a company exercises management control over a foreign corporate entity (the Iskandar corporate entity) which is supposedly an independent party or contractor. A quick check at the Registry of Companies may show that there is no crossover of directors and shareholders between the companies engaged in various business transactions - raising no 'Red-flag' whatsoever. All business transactions appear innocuous and straightforward, hence there is no question of transfer pricing tax arising. But insiders may tell of a dubious relationship between the business owners. The boss of the UK-Company actually had his confidante incorporate and hold all shares in the Iskandar corporate entity. Although all business transactions done between the two entities appear straightforward principal to principle dealings, the truth of the matter was: the UK-company has full control of the Iskandar operation. In common law jurisdiction, company laws have clear distinctions between de jure and de facto directors as a kind of litmus test for management control over companies. The Malaysian confidante may be registered as a director (de jure director) but the UK-company's boss is the de facto director in law. Why is it so?

A de jure director is a person legally appointed by the Company under its Articles of Incorporation. De jure (Latin) carries the meaning of in law and de facto, in fact Therefore, although in law the Malaysian confidante may be the director of the company, she has little say in management decisions as a matter of fact. The person who has the real power to direct business affairs is actually the UK-Company boss. Those who have read Daniele Vare’s "The Last Empress" will have a clear picture of what is meant here. Cixi, the concubine who became China's last empress, became Empress Dowager and a regent ruler over the throne in 1861. The Emperor was a figurehead who commanded no political power. Empress Dowager was ruling and welding power behind a veil, holding court behind a screen - that much for Chinese history!

The UK-company boss was exercising management power without being legally or officially installed as in the case of a de jure director. Nevertheless, the law says he is in fact (de facto) the person with the power of a director and, hence, he has complete management control over the Malaysian company. With lifting of the veil, transfer pricing tax liability arises.

What defensive measures should a small business have?

Answer: Documentation. The paper trail becomes important once the revenue man comes knocking on your door. Contract documentations may be in the form of faxes, emails or just exchange of letters instead of the usual single contractual agreements; including Memorandum of Agreement or Memorandum of Understanding, if any. All such documents should be collated meticulously, and kept for future reference should the need arise. The worst case scenario is where transactions are done orally over the phone or in unrecorded meetings; it is not that oral agreements are not legally binding contracts. They are, but proving one can be an uphill task, especially if events took place in times of business urgency and time lapse will be an issue when choppy recalling of facts becomes unconvincing.

What is more: the contracts should be carefully drafted and their terms clearly explained. For instance, a company should know whether the contract manufacturer it appoints is acting as an independent principal; or, is it a firm of subcontractors? When a company farms out a process instead of employing workers to do it at their premises, it can be considered an extension of the manufacturing operations, in which case, working with an associate company has clear price transfer implications. Most business owners may care more for the technical or engineering aspects of the contract and ignore tax and other legal obligations that can spell troublesome liabilities for the business.

This write-up is not a piece of legal advice. It cannot be. Every business has its own peculiarities and special circumstances. This article serves only as a wake-up call for those who put little thoughts on transfer pricing rules. One other caveat: The allocation of income between two or more businesses owned or controlled by common interests is a related subject, well; the writer not competent to write about and do not count on him writing a related hub. Some small business taxpayers may even find certain tax processes costly, burdensome and untimely. So it pays that business owners seek help from tax consultants at early stages of each transaction.

If a business owner thinks his business is too small to be noticed by price transfer jurisdictions in Europe and United States because he is locating his business on these far-off Asian islands, he may be in for a shock. Empirical evidence provides that most tip-offs to transfer pricing authorities came from employees and business rivals. With the 'Idles of March' coming round the corner - it seems timely for quoting a passage from Shakespeare's Julius Caesar as reminder for giving some deep thoughts on transfer pricing and its rules:

There is a tide in the affairs of men.

Which, taken at the flood, leads to fortune.

Omitted, all the voyage of their life is bound in shallows and in miseries.

Incidentally, why was Julius Caesar so engrossed in other affairs that he brushed aside the 'Idles of March' warnings of the soothsayer?

Do not let history repeat itself!

READ OTHER STORIES AT:

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Transfer pricing is causing huge problems in Africa.

— Dr Mohamed "Mo" Ibrahim Sudanese-British mobile communications entrepreneur and billionaire
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