Tax authorities squeeze multinationals over transfer pricing

The ‘B word’ is now regularly used by multinationals as they struggle to deal
with the increasingly complex world of transfer pricing.

The B word we are talking about is billions; as in the amount of pounds and
dollars being collected by the authorities around the globe in back taxes,
interest and penalties.

Those billions are the price that multinationals and their subsidiaries are
having to pay for being less than forthright in charging market rates for goods,
services and – increasingly, nowadays – intellectual property.

For British-based multinationals, the recent fine of $3.1bn (£1.7bn) imposed
by the Internal Revenue Service (IRS) in the US on GlaxoSmithKline must have
touched a nerve. True, the amount covered 16 years of tax returns on the
relationship between the British company and its US subsidiary, but even so it
is a staggering amount, and the highest ever settlement won by the IRS.

Computer software company Symantec is also fighting a $1bn IRS assessment
over its dealings with its operations in Ireland.

Putting a subsidiary in a low-tax country like Ireland is a clear red rag to
the IRS. But Bob Ackerman, who heads up transfer pricing services for Ernst
& Young’s Americas region, argues there is nothing wrong with moving to a
low-tax regime if such a decision is best for the business.

Sometimes, though, companies make two common mistakes when they locate a
subsidiary, both of which raise the suspicions of the tax authorities. First,
they put a subsidiary in a country purely to avoid tax. The tax tail should
never wag the business dog, Ackerman says.

Second, multinationals get overly aggressive in trying to put more profit in
low-tax countries. When that happens, it is going to be challenged by the

Multinationals are hiring more people in their tax departments to deal with
transfer pricing. Not to be out-muscled, tax authorities around the world are
hiring compliance inspectors as fast as they can.

The extent of dubious pricing is difficult to judge, but some US trade
figures illustrate some clear abuses.

Research by Professor Simon Pak of Pen State University and Professor John
Zdanowicz, of Chapman Graduate School of Business, found businesses drastically
under or over charge subsidiaires for goods.

Analysing US trade data, they found loo rolls being sold to China for more
than £2,000 a kilogram, whilst thermometers were being imported from Germany for
six cents each.

If that is a guide to general business practice, you can understand why the
authorities are concerned.

The IRS is notoriously aggressive in cracking down on companies it suspects
are dodging taxes through transfer pricing, but it is not alone.

Experts say the tax authorities in Canada, Japan and Australia can also be
classified as aggressive. In Europe the Germans, British and French, while not
aggressive, are ‘focused’. And China is set to become a major player eventually.

As proof of Australian zeal for transfer pricing revenues, the country has
stepped up its operations to track down what tax commissioner Michael D’Ascenzo
described as ‘very large royalty flows’ to related offshore companies by big

The Australia Tax Office has just announced it has raised more than A$2.5bn
(£1bn) in assessments from transfer pricing audits in the past five years.

To be fair it is not easy for multinationals to perfect a transfer pricing
strategy. Some 48 countries have transfer pricing rules and each country says it
follows guidelines on the matter that were issued by the Organisation for
Economic Cooperation and Development. Those guidelines are supposed to spell out
what ‘arm’s length’ or market rate pricing should be.

The problem, according to Ackerman, is that each country has a different
approach to defining what arm’s length actually means. More specifically each
country follows different processes to try and determine whether a company’s
transactions are arm’s length or not.

There is no doubt that some transactions in particular will set alarm bells
ringing in the various tax authorities. Specific triggers include the charging
out of high-value services, the migration of intellectual property, and changes
in the supply chain that could be abused.

To keep an audit at bay, Ackerman advises companies to keep up to date. It is
all well and good knowing the various laws of the land, but it is even more
important to stay current, and to follow judgments in court cases to understand
better what is allowable and what is not.

The bottom line is that transfer pricing tax laws are becoming more
complicated, both for taxpayers to comply with and for the authorities to
administer. The US, for instance, is introducing new rules for services and
intangibles starting next January.

Such a scenario leads only to controversial decisions and in the future such
controversies can only multiply.

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