Shining the spotlight on more rigorous Transfer Pricing behaviour
Fri 12 Feb 2021
While 2020 is a year we may all wish to forget, changes made during the year on Transfer Pricing (TP) give us some clues as to the primary drivers of TP behaviour in 2021. These clues include US guidance from the Internal Revenue Service (IRS) on TP documentation, highlighting the penalty risks; OECD work and guidance on the digital economy’s taxation and during the global pandemic; plus a range of Court cases considering TP issues. Such issues include innovative business agreements, evidence to support intra-group pricing, and TP method and benchmarks choice.
The overarching theme is the importance of appropriate TP documentation. A taxpayer’s TP documentation should adequately explain the rationale for any TP positions taken and provide the necessary information to support them. In April 2020, the IRS issued informal guidance meant to encourage taxpayers to prepare appropriate TP documentation. It’s a signal that TP documentation will face increased scrutiny from the IRS and assess penalties with more regularity.
A renewed focus on the digital economy
In October 2020, the OECD issued the Pillar 1 and Pillar 2 Blueprint reports to create a global framework for taxing digital service businesses. Because the digital economy has been rapidly expanding, many countries have seen this as an opportunity to raise additional tax revenue by targeting this industry. If there is unilateral adoption of tax measures targeting digital service companies, it will likely result in double taxation and added tax uncertainty for these companies and retaliatory tax actions between countries.
Companies which operate in this space should consider the potential effects of a digital service tax given the jurisdictions in which they do business or have customers – and plan their TP strategies accordingly. Once a digital service tax framework is adopted, taxpayers may need to revisit their TP documentation and add additional descriptions/analysis as necessary.
In December 2020, the OECD issued guidance regarding TP issues related to the Covid-19 pandemic and the unusual economic conditions that it has created. Having documentation that thoroughly describes any changes in TP strategy caused by the pandemic and supports the taxpayer’s TP analysis/results will be critical.
Court rulings make an impact
Several court cases in 2020 help detect general principles being discussed or disputed in court that impact the TP environment in the future. For example, in the case of Ice Machine Manufacturer A/S the Danish Western High Court found that the taxpayer had not provided sufficient evidence to support its long-term losses by not presenting facts or extraordinary circumstances that justified its losses; had not provided enough information to support its entity characterisations, and had not performed a reliable benchmarking analysis.
In the case of Società Italiana Per L’Oleodotto Transalpino SPA, the Italian Court of Cassation determined that the taxpayer had not chosen appropriate profit allocation keys. The court ruled that the taxpayer had not fully examined or documented the contribution made by each party during the course of doing business. Therefore, its analysis did not produce an appropriate arm’s length return for the related parties.
In the US, the Tax Court rejected The Coca-Cola Company’s use of a formula-based profit split to calculate the royalties owed by its subsidiaries for the use of its intangibles. The court also rejected the taxpayer’s use of the comparable uncontrolled price method to benchmark the royalty because the taxpayer had not presented sufficiently comparable license agreements.
Concerning Prime Plastichem Nigeria Limited, although there was some confusion regarding some points, the Nigerian Tax Appeal Tribunal noted its concern that the taxpayer had changed its TP analysis method even though no changes to its business or circumstances had occurred. Such changes would have been appropriate only if the availability of reliable benchmark data had also changed.
Although many tax authorities temporarily suspended their audit programs during the pandemic, most suspensions have ended, and the expectation is that TP audits will increase. The TP environment is quite different now, and taxpayers should not rely on strategies or documentation simply because they have worked in the past, significantly where the new business environment has caused a change in business processes. The best strategy is to be proactive and reduce TP risk by putting reliable documentation in place and undertaking regular review programmes.
 In June 2020, the U.S. Trade Representative published a notice of its intention to investigate the Digital Services Taxes (DSTs) adopted or under consideration by Austria, Brazil, the Czech Republic, the European Union, India, Indonesia, Italy, Spain, Turkey, and the United Kingdom.
 Please note that these cases are often complex, and only certain aspects of each are highlighted.
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