The price of agreement

There are few subjects in corporate tax more difficult to understand than transfer pricing. Mention it to those concerned about tax avoidance, and it is an area open to abuse. But for the finance directors of large multi-nationals, the complexity of transfer pricing is a huge headache.

The issue has become so complex that multi-nationals are now looking to make up-front arrangements with the Inland Revenue to avoid the huge costs and risks of non-compliance. Though the idea of advanced pricing agreements (APAs) is not new, observers say it is on the increase.

Transfer pricing relates to the exchange of goods and services between subsidiaries in different tax regimes of one company. It is important because the prices used to transfer those goods and services have an effect on the company’s tax liabilities in all the jurisdictions concerned.

Arriving at a price, however, is easier said than done. The issue in transfer pricing today is how to arrive at the kind of ‘arms-length’ price tax authorities demand. When the goods and services transferred are hardly ever traded on the open market, how can you determine a price?

‘What you normally end up with in valuation is a range of reasonableness, rather than being able to set a price. It is extremely hard to be certain that the price you opt for is immune from challenge from the tax administrations,’ says Andrew Hickman, head of transfer pricing at KPMG.

The costs of a challenge can be very significant, he says. If the Revenue starts to pick holes in prices down the line, new audits can take years and involve large sums of money.

Issues of transfer pricing affect every multi-national group, and are a growing issue. ‘Increasingly, multi-nationals are organising themselves across a product line or across a divisional structure, not across legal entities. As such there is a mismatch between how our clients are managing their business and the requirements of the tax legislation,’ he says.

And tax is also the only reason why companies would work out the transfer price of goods. ‘Whether prices are market prices is not an accounting requirement, it is purely a requirement of the tax authorities.’

More tax authorities around the world have started a programme for APAs. ‘Tax authorities are realising it is difficult for them to have a transfer pricing audit. It’s more efficient for them to deal in a collaborative way with a group,’ says Hickman.

Steve Hasson, head of transfer pricing at PricewaterhouseCoopers, says APAs are still a minority sport: ‘There are maybe 20 to 30 APAs concluded every year,’ he says.

Among the companies thought to be most affected are the large pharmaceuticals, and AstraZeneca and GlaxoSmithkline.

A GSK spokesman said that, while it had no plans to negotiate any APAs in the UK, the company had done so in the US. Whatever the situation, campaigners for tax justice will be keeping a watchful eye.

Prem Sikka, professor of accounting at Essex University, says one important issue is whether the Revenue has the authority to conclude tax arrangements in advance. When it made informal arrangements with Mohammed Al Fayed several years ago, it found the deal was challenged in court. Does it have the authority to arrange tax liabilities in advance?

Hickman thinks so, arguing that APAs are a question of outlining frameworks and rules of thumb rather than up-front payments.

Sikka also believes that, if the Revenue is defining and interpreting the law, it should be doing so in public. Any arrangements it makes with companies might also apply to others, and it must be scrupulously consistent.

The extent to which such agreements are genuinely bespoke, might go some way to answering that criticism. In the absence of any such agreements in the public domain, however, campaigners for tax justice and businesses looking for guidance, will just have to remain in the dark.

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