International transfer pricing restrictions: impact on corporate financial policy

ADMINISTRAÇÃO CONTÁBIL E FINANCEIRA

International transfer pricing restrictions: impact on corporate financial policy

Stephen T. Limberg^I; John R. Robinson^II; Raimundo L.M. Christians^III

^IVisiting Professor, EAESP/FGV Professor, The University of Texas, Austin. E-mail: [e-mail]

^IIProfessor, The University of Texas, Austin

^IIIInternational Tax Partner, Price Waterhouse São Paulo, S.P., Brazil

ABSTRACT

Transfer pricing is a pervasive issue that presents significant tax savings potential concerning international enterprises. The authors discuss company incentives to manage transfer prices in an article appearing in the preceding issue of this journal. In response to these incentives, governments have increasingly enacted and enforced domestic restrictions on transfer prices. In this article, contemporary norms restricting transfer pricing are analyzed. The OEGO and US pricing standards are assessed and Brazil's recent application of these standards is considered. Transfer pricing methods are described and evidence of their use is presented. We conclude by describing an intercompany transfer pricing policy intended to facilitate internaI financiaI management and minimize externaI tax threats.

Key words: financial policy, international tax, transfer pricing, restrictions.

RESUMO

Precificação de transferência é um tema muito difundido e que apresenta significativos potenciais de economias de impostos, sobretudo no que se refere a empresas internacionais. Em artigo anterior, os autores abordaram os incentivos das empresas para melhor administrar os preços de transferência. Em resposta a esses incentivos, os governos têm, cada vez mais, aprovado e imposto restrições internas aos preços de transferência. Neste artigo, as atuais normas que restringem a precificação de transferência são analisadas. Os modelos de precificação dos EUA e OECD são avaliados e as recentes aplicações desses métodos no Brasil são considera­das. Os métodos de precificação são descritos e a sua eficácia é apresentada. Concluímos por meio da descrição das políticas de precificação de transferência entre empresas que têm por finalidade facilitar o gerenciamento interno e minimizar a ameaça das taxações externas.

Palavras-chave: políticas financeiras, impostos internaticionais, preços de transferência, restrições. Key words: financiaI policy, international tax, transfer pricing, restrictions.

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1. LIMBERG, S.T., ROBINSON, J.R. ANO CHRISTIANS, R.L.M. International transfer pricing strategies for minimizing global income taxes. In: Revista de Administração de Empresas, v. 37, n. 2, 1997.

2. ORGANIZATlON FOR ECONOMIC CO­OPERATION AND DEVELOPMENT. Transfer Pricing Guidelines for Mu/tinationa/ Enterprises and Tax Administrations. OECD publlcation service, July 1995.

3. Law 9430 (December 27, 1996). Articles 18-24.

4. Exposição de Motivos (E.M.) N° / MF Brasília, de outubro de 1996. Paragraph 12.

5. THE UNITED STATES TREASURY DEPARTMENT. US Regulation Section 1.482.

6. See US Regulation Section 1.482­1 (c)(III) that elaborates on the relevant factors in determining the economic substance of a transaction which include the assumption of risk by the controlled taxpayer as reflected in its: (a) Paliem of conduct, (b) financial capacity, and (c) managerial and operacional control, See US Regulation Section 1.482-1(c)(III)(C) examples (1) and (2) for illustralions.

7. See US Regulation Section 1.482-1 (c).

8. A reduced price is allowed under US Regulalion Section 1.482-1(c) only if there is documentanon that substantlates: (a) The controlled party bears the cost of the strategy and is likely to benefit, (b) the reasonableness of the strategy's time period, and (c) the strategy and ilts terms are established before the strategy was implemented.

9. Details for determining a price range are limited under the DECD guideiines. in contrasto US Regulation Section 1.482­1 (e) is more detailed and indicates, in part, that in determining an arm's length range only one (l.e., the best) pricing method is be used. As will be discussed in the next section, numerous methods for determining an arm's iength price are possible. Therefore, an arm's length range ís not determined by applying two or more pricing methods to one controlled transaction.

10. See US Regulation Section 1.482-1 (g).

11. The sale of inventory is the predominant transaction to which these methods are applied because inventory is the most prevalent type of intercompany transfer. See, for axample, US INTERNAL REVENUE SERVICE, Controlled foreign corporations, 1984: An industry focus. Statistics of Income Bulletin, p. 31-52 , Fall 1989.

12. Law 9430 (December 27, 1996). Article 19, Section 3.1.

13. The distributor's gross protit maybe, In some cases, based on an arm's length brokerage fee, such as a percentage of sales. Product differences are less significant than with CUP because the focus is on comparable gross protits, not products. For exemple, many home electronic devices, such as masters and blenders, may have similar rnark-ups, thus the nature of the product is not as critical as under CUP.

14.In this context, the term "unconditional discounts allowed" means discounts that are consistent for all customers.

15. Law 9430 (December 27, 1996). Article 18.11.

16. Law 9430 (December 27,1996). Article 19, Sections 3.11 and 111.

17. Law 9430 (December 27,1996). Article 19.

18. Law 9430 (December 27, 1996). Article 21. Section 2.

19. The OECD Guidellnes indicate that the cost plus mark-up of the supplier ideally should be established by reference to the cost plus mark­up that the same suppliereams in comparable uncontrolled transactions. The cost plus rnark­up that would have been eamed in comparable transactions byan independent enterprise may also serve as a guide. The US Regulations indicate that the appropríate gross profil is cornputec by multiplying the supplier's cost of producing the transferred property by the gross margin earned in comparable uncontrolled transactions.

20. Law 9430 (December 27,1996). Article 18.111.

21. Law 9430 (December 27,1996). Article 19, Section 3.IV.

22. Comparability under PSM is especially dependent on the factors under TNPM as described in footnote 25. In addilion, comparability depends particularty on the degree of similarity in the contractual terms of the controlled and independent companies.

23. So-called contribution analysis uses the relative value of the functions pertormed by each associated enterpríse to split operating profits or gross profit (with deductions specifically identified by entity). So-called residual analysis allocates a normal profil to each party based on independent rnarket retums from data used in traditional methods, then any residual gain or loss is allocated based on the facts and circumstances. Other approaches suggested by the OECD include setting príces so multinational enterpríses eam equivalent rales of return on capital, which assumes equal risk, and splilling multinational profits based on comparable independent transactions. However, it is unlikely to find comparable independent transactions in cases where traditional transaction methods would not be used.

24. Under the US Regulations, specilied ratios called proíit levei mocaiors include, but are not limited to, rate of return on capital, operating profil to sales, and gross prolrt to operating expenses (the so-called Berry Ralio). the US Regulations elaborate by indicating thal the facts and circumstances include consideratlion of the relevant fines of business, the product or service markets involved, the assel composítíon employed (including the nature and quanlity of tangible assets, intangible assets and working capital), the size and scope of operations, and the stage in a business or product cycle. White the Regulations reíterate that all of the general comparability factors must be considered, the comparability of a controlled and independent company under lhis approach is particularly dependenl on a comparison of the: (1) Resources employed, (2) risks assumed, and (3) functions performec (where it is noted that the degree oflunctional comparability required to obtain a reliable result is generally iess than that required under RPM and CPM). Other comparability consíderations are also noted.

25. Other factors influencing TNPM net margins include, for exarnple. the theat of new entrants, competitive position, management efliciency, individual strategies, threat of substitute prooucts, varying cost structures and business experience. Moreover, it is necessary to consider the accuracy of assel valuanon in the calcutation, and whether specific costs should be passed through, rnarked­up, ar excluded entirely to arrive at net margin.

26. Law 9430 (December 27, 1996). For imports see Article 18, Section4. For exports see Article 19, Section5.

27. Law 9430 {December 27, 1996). For Imports see Article 18, Section5. For exports see Artlcle 19, Section 6.

28. Law 9430 (December 27, 1996), Article 18, Paragraph 9.

29.The US Regulations define Intangible property as any commercially transferable interest included in the following six classes of íterns, provided that it has substantial value independent of the services of an individual: 11) Patents, inventions, formulas, processes desígns. patterns, or know-how, (2) copyrights and literary, musical, ar artistic compositions, (3) trademarks, trade names, or brand narnes. (4) trancetses, licenses, or contracts, (5) methods, programs, systems, procedures, campatuns, surveys, studies, forecasts, estimates, customer lists, or technical data, and (6) other similar items.

30. Very narrow exceptions to this rule are available. However, due to the numerous requírements, the utility of these exceptions is limited.

31.STAFF OF THE US JOINT COMMITTEE ON TAXATION, General Explanation of the Tax Reform Act of 1986. 99th Congress, 2nd Session, p. 1016, 1986.

32. US DEPARTMENT OF TREASURY. A study of intercompany pricing. Us printing office, p. 479, October 1988. In adopling the commensurate wíth income standard, the US devialed from the premise that the arm's length stanoard depends solely on íne tacts exisling at the lime a transaction is entered into (see, forexample, the US courtcase R. T. french, 60 TC 836, 1973), Nevertheless, the US does notconsider the periodic adjustment requirement to be a deVlation from the arm's length standard beeause unrelated persons rarely make long-lerm licenses with no provisions for future adjustments, particularty for intangibles with high profít potential. Consislent wlth thls view, periodtc adjustments need not be made if a company can establísh that an uncontroiled license agreement would not nave included an adjustment clause and any post-agreement increases in the profitability of the intangible are attributable to unanticipated events occurring after the license was made (US DEPARTMENT DF TREASURY. A study of intercompany pricing. US prinling office, p. 477-478, October 1988).

33. In addition to applying these comparabllity standards and the general principies discussed under the arm's lenglh standard, in determining comparability the US Regulations set forth the following eight specific factors that may be particularly relevant in comparing controlled and uncontrolled transactions under the CUT pricing method: (1) The terms of the transfer, (2) the stage of development of the intangible, (3) rights to receive updales, revisions. or modifications of the intangibie, 14) the uniqueness of the properly and the perlod tor which it remains uníque, (5) the duration of the license, contract, or omer agreernent. and any termination or renegotiation rights, (6) economic and product liability risks assumed by the transteree. (7) the exístence and extent of any collateral transactions or ongoing business relationships between the transferor and the transferee. and (8) the functions to be pertormed by the transferor and the transferee.

34. Law 9430 (December 27, 1996). Article 22 pertains to interest and Article 18, Paraqraph 9 pertalns to technical, scientific, administrative. and similar assístance.

35. Under this exception, trace receivables are defined as debt incurred in the ordinary course of business trem saías, leases, and services, so long as the debt is not evidenced by a written agreement requiring the payment of ínterest. This exception reflects the common busíness practice of not charging interest on these so-cateo trade receivables, and serves as an important rule of administrative ease given the large number of these transactions. The interest-free period for intercompany trade receivables is generally limited to between tnree and six months.

36. Under thiss safe harbor, the interest rate on an intercornpany loan is deemed equal to the arm's length rate if it is between 100 and 130 percent of the so-called applicable federat rate. The aplicable federal rate is the average interest rate (redetermined monthly) on obligafions Df the US federal govemment that have rnaturitiy dates similar to those of the intercompany loan. For a discussion of the tnree sítuatíons in which a company cannot rely upon me safe harbor rule see US Regulation Section 1.482-2(a).37. Law 9430 (December 27, 1996). Article 22.

37. Law 9430 (December 27, 1996). Article 22.

38. Services for which no charge is necessary include the following. (1) Services that are ancillary to an intercompany sale or lease. Examples of such services include installing equipment acquired by an afllliate, and training the acquiring afllliate's personnel to operate the equipment. This exemption serves as a rule of administrative ease and reflects the common business practice of impounding the costs of ancillary services in the associated sale or rental price. (2) Services if the probable economic benefits to the recipient are so indirect or remote that an unrelated party would not charge for the service. This may occur with services for the joint benefit of the provider and afliliated recipient. (3) Some types of supervisory services. For example, parent executives commonly visit foreign subsidiaries In order to provide advice. Whether and how much to charge tor such visíts ís otten diflicult to determine, partícularly when the visíts are occasional and bríet, the executives do not participate in the subsidiary's normal day-to-day business activities, and the subsidiary has its own managerial stafl. To relieve this problem, no charge is required tor sucn services if they merely duplicate services that the subsidiary independently performs tor itselt.

39. The relevant costs normally include direct costs such as the salaries of the employees performing the services, travel expenses, and materiais and supplles, as well as indirect costs such as an allocable portion of the service provider's overhead.

40. This safe harnor rule does not prevent a company from establishing, based upon the facts ofthe case, that a diflerent charge is more appropriate under the general arm's length standard.

41. Law 9430 (December 27,1996). Article 18, Section 9.

42. A company is given the opportunity to show that the arm's length rentai for the sublease diflers from the rentals paíd under the head lease. Otherwise, the related lessor is treated as a mere conduít for the lease it entered into with the unrelated lessor.

43. Evidence of forrnulary apportionment use is shown in Exhibit 5 which is discussed in the next section. Moreover, proflts of specific companies maybe compared on a case-by-case basís under previously discussed profits methods and specilic companies may agree to formulas with governments, such as the US, under mutual agreement procedures, advance pricing agreements, or other bilateral or multilateral determinations. While federal governments have not adopted formulary apportionment, It is the primary method of allocating prolits among the states within the USo

44. $8 million = ($40 million of gross sales in A)/{$100 million of worldwide gross sales) . $20 mlllion of worldwide taxable income.

45. $12 million = ($60 million of gross sales in 8)/($100 miilion of worldwide gross saíes) . $20 million of worldwide taxable income.

46. The OECD Model Tax Conventíon, Article 25(3), indireclly provides for APAs through cornpetent authorilies who are directed to endeavor to resolve difficulties by mulual agreement. Lacking a domestíc law authorizing APAs, a clause such as Article 25(3) in a counlry's trealies may provide authority for APAs.

47. OECD COMMITTEE ON FISCAL AFFAIRS. Model tax convention on income and capital. Article 9(1). OECD publication service, March 1994, Article 25.

48. Corresponding adjustments are authorized under Article 9(2) of the OECO Model Tax Convention. Professor Límberg gratefully acknowledges the support of Philips do Brasil Ltda. and of the Genter for the Study of Western Hemispheric Trade at The University of Texas, in Austin.

• 1. LIMBERG, S.T., ROBINSON, J.R. ANO CHRISTIANS, R.L.M. International transfer pricing strategies for minimizing global income taxes. In: Revista de Administraçăo de Empresas, v. 37, n. 2, 1997.
• ²
  ORGANIZATlON FOR ECONOMIC CO­OPERATION AND DEVELOPMENT. Transfer Pricing Guidelines for Mu/tinationa/ Enterprises and Tax Administrations. OECD publlcation service, July 1995.
• 31.STAFF OF THE US JOINT COMMITTEE ON TAXATION, General Explanation of the Tax Reform Act of 1986 99th Congress, 2nd Session, p. 1016, 1986.
• 32. US DEPARTMENT OF TREASURY. A study of intercompany pricing. Us printing office, p. 479, October 1988.
• In adopling the commensurate wíth income standard, the US devialed from the premise that the arm's length stanoard depends solely on íne tacts exisling at the lime a transaction is entered into (see, forexample, the US courtcase R. T. french, 60 TC 836, 1973), Nevertheless, the US does notconsider the periodic adjustment requirement to be a deVlation from the arm's length standard beeause unrelated persons rarely make long-lerm licenses with no provisions for future adjustments, particularty for intangibles with high profít potential. Consislent wlth thls view, periodtc adjustments need not be made if a company can establísh that an uncontroiled license agreement would not nave included an adjustment clause and any post-agreement increases in the profitability of the intangible are attributable to unanticipated events occurring after the license was made (US DEPARTMENT DF TREASURY. A study of intercompany pricing. US prinling office, p. 477-478, October 1988).
• 47. OECD COMMITTEE ON FISCAL AFFAIRS. Model tax convention on income and capital. Article 9(1). OECD publication service, March 1994, Article 25.

Publication Dates

• Publication in this collection
  06 Oct 2011
• Date of issue
  Sept 1997