Transfer Pricing

THE PACIFIC ASSOCIATION of Tax Administrators (the members of which are the tax authorities of Canada, Australia, Japan and the United States) recently became the first international body to attempt to simplify the complex web of multi-jurisdiction transfer pricing documentation.

This summer, the Association released a draft transfer pricing documentation package for multinational enterprises with the following ambitious goals:

• 'to avoid the imposition of Pacific Association of Tax Administrators member transfer pricing documentation-related penalties;

• 'to assist taxpayers to efficiently prepare and maintain useful transfer pricing documentation;' and

• to respond 'to the potential difficulties that multinational enterprises face in complying with the laws and administrative requirements of multiple tax jurisdictions.'

The Association developed this package to enable multinational enterprises to submit one set of documents that would satisfy the requirements of every member country. Given that the compliance burden of multinationals involved in transfer pricing-related transactions continues to escalate, the Association's move was anticipated by the international tax and business community as an important step. It was one that would pave the way for other international bodies to consider similar harmonisation and simplification strategies.

While the Association's initiative has been applauded by business and tax practitioners, they are equally disappointed by the absence of several vital components, and this signals that the package is unlikely to achieve its goals. Following are the perceived gaps, along with some possible solutions, for the Assocation's proposals.

• 'First, multinational enterprises need to make reasonable efforts, as determined by each Pacific Association of Tax Administrators member tax administration, to establish transfer prices in compliance with the arm's length principle.

• 'Second, multinational enterprises need to maintain contemporaneous documentation of their efforts to comply with the arm's length principle.

• 'Third, multinational enterprises need to produce, in a timely manner, that documentation upon request by a Pacific Association of Tax Administrators member tax administrator.'

Moreover, every member has the discretion to determine whether a taxpayer has complied with the arm's length principle. Among these countries, there are no consistent definitions, applications or enforcement of such central issues to the arm's length principle as the following, which are reflected in the Organisation for Economic Co-operation and Development Guidelines:

• acceptable transfer pricing methodologies;

• prioritising, selecting and applying transfer pricing methodologies;

• selection of comparables;

• standards of comparability and acceptable comparability adjustments;

• determination of arm's length range;

• methodologies for year-end adjustments;

• acceptance of post year-end adjustments; and

• use of the commensurate with income standard.

The Association clearly states in the draft package: 'This Pacific Association of Tax Administrators documentation package is not intended to impose legal requirements greater than those imposed under the local laws of an Association member'. Given that there are no common standards for reasonable effort or compliance with the arm's length principle, the Association cannot offer any certainty regarding the imposition of penalties.

To ensure the first principle can be met, the Association needs to provide a definition, standard or guidelines for determining whether a taxpayer has indeed made a 'reasonable effort' to achieve an arm's length transfer price, and should also address all of the issues central to the arm's length principle.

The Association believes 'this documentation package is consistent with the general principles outlined in chapter 5 of the Organisation for Economic Co-operation and Development Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations'. But, in fact, the second principle of the Pacific Association of Tax Administrators proposal contravenes the spirit of the Guidelines, which state in paragraph 5.16, 'The information relevant to an individual transfer pricing enquiry depends on the facts and circumstances of the case. For that reason, it is not possible to define in any generalised way the precise extent and nature of information that would be reasonable for the tax administration to require and for the taxpayer to produce at the time of examination'.

It is neither practical nor useful to mandate a complete list of documents that are required for every transaction. The Association should encourage multinationals to produce documentation based on the facts and circumstances of the specific transaction. In this context, the 53 documentation requirements might better serve as examples of the types of documents that might be considered.

Again, no single benchmark or standard is offered to interpret 'timely manner', rather, the Association leaves this to a member's respective rules. Given that many transactions involve two or more Association member countries, this means there are no clear guidelines to follow. In Canada, for example, documentation must be available when tax returns are due. For corporations, this is six months after the end of the taxation year. If the Canada Customs and Revenue Agency issues a written request for documentation, an organisation has 90 days to comply.

The Association should therefore provide some form of guidance regarding potentially conflicting time scales for documentation submission.

The Association's efforts would be better directed at giving some consideration to the relevance, materiality and cost of preparing documentation in respect of the value of the transactions.