Transfer Pricing 2024

Transfer Pricing 2024 – Global Overview

Transfer pricing remains a primary focus of the international tax community. International efforts led primarily by the OECD, together with increasing unilateral efforts by individual governments worldwide, have created an ever-more complex and contentious environment for multinational enterprises (MNEs) seeking to meet their global obligations. The financial strains placed on governments by the recent COVID-19 pandemic have only exacerbated these pressures. 

OECD Leads a Global Transfer Pricing Agenda Now Focused on a Two-Pillar Framework

The OECD continues to lead international efforts to harmonise transfer pricing principles and obligations. In 2022, the OECD published a new version of its Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the “OECD Guidelines”) reflecting principles raised in the final reports on the OECD’s initiative to combat base erosion and profit shifting (BEPS). With the participation of the G20 and Inclusive Framework members, many countries have embraced the OECD’s guidance in whole or substantial part. Most recently, and ongoing, the OECD has focused on addressing tax issues related to the growing digitalisation of the global economy. Members of the OECD/G20 Inclusive Framework have now unanimously adopted a two-pillar approach. The group continues to issue guidance to countries that have enacted or are considering enacting legislation consistent with the two-pillar approach – Pillar One and Pillar Two. 

The Pillar One proposal includes two parts – Amount A and Amount B. Under Amount A, MNEs with income above a certain threshold would be required to pay a “tax on residual profits” in countries where they generate significant revenue, without regard to physical presence. The tax would be calculated based on a formula that considers the MNE’s sales, employees, and assets in each jurisdiction, as well as a fixed return for routine activities. The proposal also includes mechanisms for resolving disputes between countries and ensuring that the tax does not result in double taxation. Pillar One Amount A is intended to cover both highly digitalised businesses and consumer-facing companies with cross-border activities. Pillar One Amount B provides a simplified and streamlined approach to the application of the arm’s length principle to baseline marketing and distribution activities. The OECD’s February 2024 report on Amount B was incorporated into the OECD Guidelines as an annex, and jurisdictions can choose to apply the Amount B approach for fiscal years commencing on or after 1 January 2025. Individual countries have the option to apply the Amount B approach and, if applicable, whether it will be optional or mandatory for companies operating in that country.

Pillar One Amount A’s move away from physical nexus requirements appears contrary to the emphasis on physical presence in the OECD’s earlier BEPS work and the OECD Guidelines. Those pronouncements placed a heavy weight on the physical presence of personnel – including, notably, with respect to development, enhancement, maintenance, protection and exploitation (DEMPE) functions – in determining economic ownership of intangibles and assumptions of risk, and consequent profit and loss allocations, for transfer pricing purposes. 

It remains to be seen whether Pillar One Amount A portends a broader movement away from the arm’s length standard – which has long been the bedrock of international transfer pricing – or whether it is more reflective of the current political environment in which transfer pricing is seen as a tool to advance certain policy objectives. But regardless of which view ultimately prevails, Pillar One Amount A provides a clear example of the challenges facing MNEs as they try to navigate the shifting sands of the international transfer pricing environment. The OCED’s current plan is to continue to work on an agreed Multilateral Convention to implement Pillar One Amount A, after an initial draft was released in October 2023. 

Pillar Two of the OECD’s plan focuses on achieving a minimum global tax rate of 15% for all MNEs above a certain income threshold. Pillar Two has progressed far more than Pillar One, with many jurisdictions already implementing legislation to incorporate Pillar Two effective in 2024. Pillar Two relies on the arm’s length standard for pricing controlled transactions, and transfer pricing will remain important under the new regime.

Unilateral Measures by Individual Jurisdictions Create Transfer Pricing Challenges for MNEs

Compounding these global challenges are unilateral measures undertaken by individual jurisdictions to buttress their own transfer pricing regimes. While many countries have agreed to repeal their digital services taxes (DSTs) pending implementation of Pillar One Amount A, some continue to apply them or intend to implement them if Pillar One Amount A is not implemented. This uncertainty only adds to the complexity that MNEs face in the international market.

Beyond the DST realm, individual jurisdictions have taken unilateral measures in other areas as well, relying on domestic measures even as they await and apparently support broader OECD initiatives.

Canada

In Canada, for example, the Canada Revenue Agency (CRA) has looked to the “recharacterisation” rule in the Canadian Income Tax Act to try to recharacterise intercompany transactions that the CRA believes would not have occurred at arm’s length. The CRA has advanced arguments under the recharacterisation rule in two recent cases, both times unsuccessfully, but shows no sign of abandoning the argument going forward. The CRA has even declared that, because it views the recharacterisation rule as a domestic anti-abuse measure, it will not negotiate application of the rule in the mutual agreement procedure (MAP) process. Instead, it will only participate in a MAP to enable the counterparty to provide correlative relief. Canada continues to focus on, and is looking to modernise, its general anti-avoidance rule. 

The UK

The UK diverted profits tax (DPT) is another example of a domestic measure to strengthen an individual jurisdiction’s transfer pricing enforcement tool kit. The DPT targets MNEs that use what HM Revenue & Customs (HMRC) considers to be artificial arrangements to divert profits from the UK corporation tax net. Introduced on 1 April 2015, the DPT currently carries a punitive 31% rate (compared to the current UK corporation tax rate of 25%) on profits falling within its scope. There are two ways in which a taxpayer’s multinational structure could be caught by the DPT: 

• a company in the structure (UK or non-UK resident) is party to an arrangement that lacks economic substance; or 
• avoidance by a non-UK company of a UK taxable presence. 

A DPT charging notice from HMRC brings heightened transfer pricing scrutiny in addition to the risk of liability for a 31% charge on a portion of the taxpayer’s profits. And to increase disclosure of potential DPT subjects, HMRC requires taxpayers requesting an advance pricing agreement (APA) to state their opinion as to whether the DPT is likely to apply to their arrangements. 

Australia

Australia enacted its own DPT in 2017, aimed at ensuring that “significant global entities” pay tax consistent with the economic substance of their activities in Australia, and preventing the diversion of profits offshore through related-party arrangements. Where arrangements are found to divert profits from Australia to a country with an effective tax rate below 24% and there is insufficient economic substance to justify those profits, a DPT liability is assessed at 40% of the diverted profits. In enacting the DPT, the Australian government stated that approximately 1,470 taxpayers were in the DPT’s scope, 130 of which were estimated to be in the “high risk” category. There is ongoing DPT litigation in the Federal Court of Australia. 

France

France has taken the concerning step of introducing the risk of criminal exposure in transfer pricing disputes. The OECD’s November 2017 document titled “Fighting Tax Crimes: the Ten Global Principles” stated that “it is important that jurisdictions have the possibility of applying criminal sanctions in respect of violations of the tax law”. Since 2018, the French tax administration has been obliged to forward to the public prosecutor any tax audit file that gives rise to a reassessment above EUR100,000 and the application of certain specified penalties. The law is broad and could significantly increase the number of criminal referrals and prosecutions, including, potentially, on issues of transfer pricing.

Belgium

In addition to these and other statutory or regulatory enhancements to individual jurisdictions’ transfer pricing frameworks, countries are also bringing to bear additional resources in aid of their transfer pricing enforcement efforts. In Belgium, for example, the specialised transfer pricing department (“TP cell”) within the Belgian tax authority has, in recent years, expanded and significantly increased its activities, including in conjunction with local audit teams. The Belgian special tax investigation team (the team that typically conducts dawn raids) has also increased its focus on transfer pricing, with some senior members from the TP cell having joined this team. Information gathered through dawn raids is often used by the team to perform and test functional analyses of the relevant Belgian taxpayers. The Belgian tax authority is also increasing its use of data mining and data analytics techniques to risk-assess taxpayers for potential transfer pricing exposures. The use of these techniques is growing in a host of other jurisdictions as well.

Increasing Use of APAs and MAPs to Address a Rise in Controversy/Litigation and the Risk of Double Taxation

The cumulative effect of all the above is, not surprisingly, heightened controversy. Virtually every jurisdiction reports that transfer pricing audits are increasing in number, complexity and amounts assessed, and are increasingly accompanied by assertions of penalties. The increased audit activity is often unilateral, but there is also reported growth in bilateral and multilateral audits. And the issues in scope span the gamut – for countries adhering to OECD guidance, there is a heavy focus on DEMPE functions and, where relevant, hard-to-value intangibles. 

A number of jurisdictions are focusing on intercompany financing transactions, challenging the interest rates charged on intercompany loans, the pricing of guarantee fees, and the nature and pricing of cash pool arrangements. Marketing intangibles are another source of controversy, as are business restructurings generally. And virtually all jurisdictions are witnessing or predicting growth in transfer pricing litigation, as increasingly aggressive enforcement activities prove unresolvable at administrative levels. In this contentious environment, the risk of double taxation presents major concerns.

Fortunately, APAs and MAPs exist to help mitigate double tax concerns. But those systems are already resource-constrained and demand appears only to be growing. Several jurisdictions are establishing or growing their APA programmes, and many jurisdictions report increasing taxpayer demand for the certainty an APA can afford. The process remains slow, with APAs often taking three years or longer to complete. 

MAP availability is critical to resolving the competing claims, and double tax risks, arising from the landscape described above, and, as with APAs, a number of countries are establishing or growing their MAP resources. But the MAP network is at severe risk of overload even before the full impact of the OECD’s BEPS initiatives is absorbed. In November 2023, the OECD released MAP statistics for 2022 which reflected that more than 2,300 MAP cases were closed in 2022. This was a decrease relative to 2021, resulting in a slight increase in ending inventory over the previous year.

The Lingering Impact of COVID-19 Exacerbates Tensions in the Transfer Pricing Landscape

While the COVID-19 crisis appears to be over, this remains an extremely challenging time for taxpayers seeking to manage their global transfer pricing concerns amid a more dynamic and uncertain economic environment. Important aspects of the landscape appear to be changing and evolving in real time, creating heightened uncertainty, increasing controversy and litigation, and risking overload of the APA and MAP processes designed to offset these pressures and avoid double taxation. 

This confluence of circumstances already existed before the pandemic, and the financial strains on government coffers brought about by the pandemic and other macroeconomic events only exacerbated the tensions. Yet, there is also hope that the past is a prologue and that interested stakeholders will find a way to work through their differences to find common ground. Until then, it is sure to be an extremely interesting time for all involved.