Transfer Pricing News – 2010 Year in Review
Author: Will James
Canada – Update on General Electric Capital Canada Inc. v. The Queen
The General Electric Capital Canada Inc. v. The Queen tax court case deals with a guarantee fee paid by General Electric Capital Canada Inc. (GE Canada) to its U.S. affiliate, General Electric Capital, Inc. (GE U.S.). Beginning in 1995, GE Canada paid a 1 percent guarantee fee to GE U.S. that the Canadian Revenue Agency (CRA) argued was not warranted, as it was implicit that GE U.S. would bail out GE Canada in the event of a default.
Using a yield (or benefit to the borrower) approach based on standalone credit ratings, the analysis presented to the tax courts demonstrated GE Canada received interest cost savings of 1.83 percent. Therefore, the 1 percent guarantee fee paid by GE Canada was below the calculated arm’s-length price. The tax court upheld GE Canada’s deduction, as it agreed with the taxpayer that the guarantee fee boosted GE Canada’s credit rating. While this case has been appealed to the Canadian Federal Court of Appeal, it illustrates the contentious nature of guarantee fees and shows tax authorities are aggressively pursuing the need for a guarantee fee in the guarantor’s jurisdiction and the deniability of the deduction for one in the borrower’s jurisdiction.
China – Government Remains on the Offensive by Aggressively Pursuing Transfer Pricing Adjustments
China’s State Administration of Taxation (SAT) has significantly increased its scrutiny of taxpayers’ transfer pricing documentation. Certain tax bureaus are requesting contemporaneous documentation from 100 percent of enterprises even if they met the criterion of the documentation safe harbor. The bureaus appear to be taking a more proactive approach overall to enforcing documentation requirements, tracking intercompany activities of taxpayers in their respective districts and potentially selecting taxpayers for future transfer pricing audits.
These aggressive collection tactics will most certainly continue as a result of the SAT’s issue of circular Guoshuihan  No. 323 in July 2010, which outlined the mandate to audit at least 10 percent of the taxpayers subject to the contemporaneous documentation requirements. Taxpayers are supposed to be exempt from the need to prepare transfer pricing documentation if they meet the following criteria:
- Total related-party tangible goods transactions (both inbound and outbound) exceeding renminbi (RMB) 200 million (approximately $30 million)
- Total related-party intangible goods, service and finance transactions (in the aggregate) exceeding RMB 40 million (approximately $6 million)
Chinese tax authorities have widened the scope of their transfer pricing investigations by not only focusing on the intercompany purchase and sale of tangible goods, but also looking at other significant transfer pricing issues, including cost sharing, transfers of intangible property, thin capitalization, equity transfers, etc. Given the aggressive nature of the Chinese tax authorities, it would be prudent to prepare transfer pricing documentation even if you meet the documentation safe harbor provisions. Failure to comply with these rules could result in potential double taxation, penalties, late payment fees and/or an adjustment, which would place a company on a list of important audit targets, allowing the SAT to monitor your transfer pricing activities for a five-year period.
Egypt – New Transfer Pricing Guidance Issued
On November 29, 2010, the Egyptian Tax Authority (ETA) held a conference in Cairo to issue the first part of the country’s transfer pricing guidelines. Several other parts covering more complex issues will be issued in the future. The guidelines serve as a guide to the application of article 30 of the Income Tax Law No. 91 of 2005, the inauguration of transfer pricing law in Egypt. While the guidelines include requirements for documents demonstrating the arm’s-length nature of a taxpayer’s controlled transactions, they are not prescriptive in nature, and the ETA stated that taxpayers are in the best position to determine the appropriate level of transfer pricing documentation.
Currently, taxpayers are expected to prepare documentation to support the arm’s-length nature of their controlled transactions in adherence to the 2005 law. Taxpayers are not required to submit the documentation studies along with the tax return, but they must be available upon request in a tax audit. Egyptian tax law places burden of proof on the tax authority if the taxpayer can produce sufficient supporting documents for the transactions declared on the tax return. However, the burden of proof shifts to the taxpayer if the tax return is not filed or if the taxpayer fails to produce documents supporting its tax positions.
Presently, comparables data for the Egyptian market are not available in the public domain. ETA would like to see Egyptian comparables, but given the lack thereof, it would accept data from other geographic regions after adjustments have been made to reflect the differences between the markets. At this time, the ETA would accept global and internal company studies conducted by member companies that transact with the Egyptian company, especially when those studies have been authorized and accepted by other tax authorities.
Greece – Due to Its Dire Economic Situation, Greece Lowers the Documentation Threshold
On April 20, 2010, the Greek Parliament passed Law 3842/2010, increasing the number of companies subject to local transfer pricing documentation requirements and penalties for not meeting these requirements. Originally, as an exemption under Law 3728/2008, companies with intercompany transactions less than €200,000 were not subject to the country’s documentation requirements. The new law lowers the transaction threshold to €100,000 and is effective for 2010 and subsequent years.
The new legislation also institutes a 20 percent penalty on the volume of transactions for which there is insufficient documentation; the previous penalty for failing to meet documentation requirements was a lump sum of €8,800. Taxpayers must now submit documentation within 30 days of request (instead of 60 days with the previous legislation), and the new penalty also applies if the taxpayer fails to submit the documentation within this period.
Hong Kong – Clarification on Double-Taxation Agreement Rules
The Inland Revenue Department (IRD) issued Departmental Interpretation and Practice Notes No. 46, Transfer Pricing Guidelines – Methodologies and Related Issues (DIPN 46) on December 4, 2009. DIPN 46 clearly states the IRD will follow the principles of the Organization for Economic Co-operation and Development (OECD) Guidelines when evaluating transfer pricing documentation requested from taxpayers. The IRD is expected to deviate some from the OECD Guidelines looking at interquartile ranges and applying the “best method” when analyzing intercompany transactions. Similar to the U.S. transfer pricing regulations, the IRD does not specifically define any ownership threshold for a country to be considered a related party. DIPN 46 also indicates that transfer pricing documentation is expected for cross-border transactions as well as intercompany transactions between two Hong Kong taxpayers. Regarding intercompany services transactions, DIPN 46 says the service-providing taxpayer is required to earn a profit margin and shareholder costs, i.e., stewardship costs, are not to be recharged.
As of the issuance of DIPN 46, the IRD has completed double taxation agreements (DTAs) with five countries: Belgium, Luxembourg, People’s Republic of China, Thailand and Vietnam. All five DTAs acknowledge the arm’s-length standard and follow the OECD Guidelines. Even with the DTAs in place, the IRD may not acknowledge a downward adjustment if it construes it is not arm’s-length in nature.
With the release of DIPN 46, the IRD is expected to place an increased effort on investigating related-party transactions; there also are expected to be more challenges from the IRD on intercompany transactions, as evidenced by a few recent high-profile tax court cases involving transfer pricing.
Hungary – Tax Authority Appears Starved for Revenues
According to a tax audit directive of the Hungarian Tax and Financial Control Administration (APEH) for 2010, the number of tax audits involving transfer pricing-related issues is expected to continue growing. The Hungarian tax authority intends to focus on controlled transactions, especially with respect to international transactions, requests for advance pricing agreements, noncash contributions and divestments of shareholders. This additional APEH scrutiny comes as no surprise, as general reviews directly targeting transfer pricing almost tripled from 2008 to 2009. Parallel to the increase in the number of transfer pricing reviews, the amount of net tax difference resulting from these audits also has drastically increased, from Hungarian forint (HUF) 1 billion and HUF 5.3 billion in 2007 and 2008, respectively, to HUF 9.8 billion in 2009.
In the last few years, Hungary has made notable changes to its transfer pricing rules and methods of investigation. The most notable include:
- Beginning with tax year 2010, every taxpayer can opt to prepare transfer pricing documentation in line with the EU Masterfile concept.
- The definition of associated parties has been revised so that, from 2010, transfer pricing rules also apply to transactions between a taxpayer’s headquarters and its branch offices.
- When an entity establishes another entity in which it has a controlling interest, transfer pricing rules will have to be applied to contributions in kind flowing between the entities at the time of establishment.
- While the mere existence of documentation in appropriate form was previously sufficient for the tax authorities, the number of transfer pricing reviews in which the APEH scrutinizes the calculation of the arm’s-length price, the selected method and whether comparables are correct has increased.
- Simplified transfer pricing documentation is allowed for the 2009 tax year (where the filing deadline is after January 1, 2010) if the transaction does not exceed HUF 50 million.
Indonesia – Getting in on the Act by Releasing Transfer Pricing Regulations
The Indonesian Tax Office (ITO) issued regulation PER-43/PJ/2010 (PER-43) on September 6, 2010. PER-43 is intended to clarify to taxpayers the ITO’s documentation and filing requirements with respect to transactions between taxpayers and their related parties. PER-43 also defines transfer pricing terminology.
PER-43 says taxpayers are responsible for preparing transfer pricing documentation and requires taxpayers to disclose the existence of transfer pricing documentation in a tax return disclosure. These include a background of the taxpayer and a summary of its business, transfer pricing policy, comparability analysis, selected comparables and explanation of the determined arm’s-length price or profit, including the methodology used. In addition, PER-43 states only related-party transactions with value greater than 10 million Indonesian Rupiah require a transfer pricing analysis.
While most of the guidelines in PER-43 are in line with OECD Guidelines, the regulation does differ with respect to the selection of transfer pricing methodology to be used when analyzing a transaction between related parties. The OECD uses a “most appropriate method” approach that takes into account different facts and circumstances of each transaction. On the other hand, the ITO provides a hierarchy of transfer pricing methods in PER-43.
Ireland – After Much Anticipation, Ireland Released Transfer Pricing Rules
On February 4, 2010, Ireland published Finance Bill 2010, which contained the country’s first set of transfer pricing rules. The rules take effect January 1, 2011, and cover all arrangements agreed on or after July 1, 2010.
They will only apply to large companies and trading operations involving the supply and acquisition of goods, services, money or intangible assets. Income from passive activities such as rents, royalties and interest are excluded where such income is taxed at the 25 percent corporate tax rate. For most cases of interest-free intercompany loans, the new rules should not apply. The measures provide an upward adjustment where sales are understated or expenses overstated in transactions between associated entities. The arm’s-length test should be applied according to OECD transfer pricing principles.
The rules do not apply to companies with fewer than 250 employees and either turnover of less than €50 million or assets of less than €43 million. Documentation will be required and must be prepared on a timely basis. There should be no need for incremental documentation where it already exists for the counterparty. Only specially authorized officials are empowered to make transfer pricing enquires, and the Finance Bill has no special measures dealing with penalties.
Companies with Irish operations need to review and assess their level of compliance with the new rules in advance of filing their 2011 tax return in 2012.
Italy – A New Venture into Transfer Pricing
On September 29, 2010, Italy issued its first set of transfer pricing rules. Italian taxpayers can face penalties ranging between 100 percent and 200 percent of taxes assessed. However, the penalty can be significantly reduced if the taxpayer has prepared adequate documentation. The documentation, which must be in Italian, is closely aligned with the OECD Guidelines and the European Union (EU) Code of Conduct and needs to be prepared annually. Taxpayers also must file an annual communication to the tax authority, with their tax return indicating that it has the proper documentation. Companies with annual revenues of less than €50 million, provided their facts have not changed, do not need to update their documentation until the third year after the initial preparation of their transfer pricing study. For tax periods preceding those in progress as of May 31, 2010, (the effective date of the rules), the documentation needed to be electronically submitted by December 28, 2010.
Japan – A Step in the Right Direction: Tax Authority Revises Transfer Pricing Rules
On June 30, 2010, Japan’s National Tax Administration (NTA) issued a proclamation to its auditors to more carefully review comparables prepared by taxpayers in any transfer pricing examination before using confidential third parties (so-called “secret comparables”) in its audits. The revisions to Administrative Guidelines 2.2 focused on the need for tax auditors to consider transaction price negotiation processes between the taxpayer and third parties. Guideline 2.5 also was modified to include procedures designed to force the tax authority to review taxpayer-prepared comparables, offer explanations when such comparables are not acceptable and to only use secret comparables when the taxpayer’s comparables are truly inadequate.
On June 29, the NTA also released a report that covered various reforms to its application of the transfer pricing rules and stated the tax authority’s willingness to increase cooperation with foreign tax authorities. The new reforms help the NTA rectify the perceived inconsistency in applying Japan’s transfer pricing rules and the use of secret data against taxpayers. Issuance of the rules comes in the wake of several high-profile public losses by the tax authorities in mutual agreement procedures, e.g., TDK Corporation, Capcom and Shin-Etsu.
Kazakhstan – Transfer Pricing Rules Continue to Evolve
On June 14, 2010, Kazakhstan President Nursultan Nazarbayev signed into law amendments to modify the country’s existing transfer pricing rules under Law No 67-IV, which became effective January 1, 2009. The changes are effective retroactively from January 1, 2010.
The amendments are intended to provide additional clarity and increase consistency with international transfer pricing standards. The amendments revise prior definitions and introduce new concepts to improve the transfer pricing framework related to the exchange of commodities, which represent a large portion of the Kazakh economy.
The amendments provide a list of conditions under which taxpayers are subject to reporting obligations. Taxpayers not on the list are required to keep records supporting their pricing decisions and to submit these records to tax authorities upon request.
Panama – Comprehensive Transfer Pricing Framework Introduced
On June 29, 2010, Panama’s legislature approved comprehensive transfer pricing rules to regulate related-party transactions. The regulations are pending executive branch approval.
The proposed transfer pricing rules are largely based on the OECD Guidelines, which are incorporated by reference. The regulations will adhere to the arm’s-length principle and identify as acceptable methods the comparable uncontrolled price method, resale price method, cost plus method, profit split method and transactional net margin method.
Panama’s transfer pricing rules only will apply to transactions between Panama and tax treaty partner countries, which will appear to significantly limit the geographic scope of the new rules. The transfer pricing rules will be effective for fiscal years beginning after ratification of double-taxation treaties with partner countries.
The new regulations will encourage taxpayers to maintain contemporaneous documentation. Taxpayers will have 45 days to provide such documentation upon request from the tax authority; penalties for failing to maintain documentation have yet to be specified.
Russia – Draft Rules Pass the Lower House
On February 19, 2010, the State Duma of the Russian Federation adopted a draft law that proposes a number of significant changes to Russia’s transfer pricing rules. The rules were expected to take effect starting January 1, 2011, but have not been approved by the upper house and president. Significantly, the suggested amendments would bring the rules much more into line with OECD Guidelines than the current 1999 rules.
The strict hierarchy for applying transfer pricing methods would be abolished, although the comparable uncontrolled price method remains the preferred method. Russia also will allow the use of three new methods: processed product sale, comparable profitability and profit split.
The most important proposed change would be the requirement that taxpayers maintain transfer pricing documentation if their intercompany transactions exceed 100 million rubles (approximately $3.3 million). Taxpayers would be assessed a 40 percent penalty if they do not maintain proper documentation.
Slovakia – Increased Focus on Transfer Pricing
While transfer pricing has been part of Slovakian tax rules since 1992, only recently has the government focused on the topic. The Slovakian government just established a specialized transfer pricing audit department, issued formal transfer pricing documentation guidelines and instituted advance pricing agreement procedures. Slovakia’s transfer pricing documentation rules were effective as of January 1, 2009.
The type of transfer pricing documentation requested by the transfer pricing audit department depends upon whether or not the taxpayer uses international financial reporting standards (IFRS) or local generally accepted accounting principles (GAAP) for financial reporting. IFRS reporters are required to provide general documentation (regarding the whole group of related parties) and specific documentation (regarding a related party). Such items required by the general and specific documentation are, but not limited to:
- Description of the group’s business activity and strategy, industry identification, business relations and activities within the industry
- General description of the functions performed by individual group members, as well as anticipated risks borne by members
- A list of controlled transactions and a description of individual controlled transactions of the taxpayer
- An overview of the intangibles owned or used by the taxpayer and the method and extent of their use
- A list of cost contribution agreements
- A description of the taxpayer’s transfer pricing system and information regarding selection and application of transfer pricing method(s) and price determination for controlled transactions
Taxpayers using local (Slovakian) GAAP are expected to maintain simplified documentation, including a simplified functional and risk analysis, selected method and comparable transactions/companies that support the arm’s-length price.
Penalties can be assessed if transfer pricing documentation is not presented within 60 days and result in fines of up to €33,000 per request (penalties are not tax-deductible).
Transfer pricing audits have been increasing, and taxpayers demonstrating one of the following characteristics will have a greater chance of being audited:
- A sudden drop in the Slovakian affiliate’s profitability
- Provision of management and consulting services
- Long-term loss-making Slovakian affiliates
- Other intercompany transactions wherein tax inspectors suspect transfer prices are not at arm’s-length
United States – IRS Lowers Uncertain Tax Position Disclosure Requirements, Refocuses on International Issues
On September 24, 2010, the IRS released the final instructions for Schedule UTP, which would require U.S. taxpayers to report uncertain U.S. tax positions on their federal tax returns. Taxpayers will be required to rank these uncertain tax position (UTP) issues based on the U.S. income tax reserve recorded for the position taken in the return, including interest and penalties. Taxpayers also must designate tax positions for which the reserve exceeds 10 percent of the aggregate amount of the reserves for all UTPs reported on the schedule.
The UTP filing requirement will be phased in over five years. Corporations with total assets equal to or exceeding $100 million, $50 million and $10 million must file Schedule UTP beginning in tax years 2010, 2012 and 2014, respectively. Only corporations that recorded a reserve with respect to a tax position in audited financial statements or did not record a reserve because the corporation expects to litigate the position must report such positions. For UTPs related to transfer pricing, the taxpayer will need to indicate “T” followed by a number to indicate a ranking of that position among all other uncertain tax positions.
Effective October 1, 2010, the Large and Mid-Size Business division was renamed the Large Business and International Division (LB&I). The emphasis of the LB&I will be on international tax matters. Its international functions will include Competent Authority and International Coordination, International Business Compliance and International Individual Compliance units. The division also will include a transfer pricing director and chief economist to oversee transfer pricing efforts.
Uruguay – Additional Guidance from Tax Authorities
Uruguay’s Tax Office has provided guidance multiple times with respect to Law 18,083, the country’s initial set of transfer pricing laws, since it was issued in December 2006 and implemented in January 2009.
Resolutions 2,084/009 and 2,269/009, issued in late December 2009, provide guidance on when two parties involved in transactions are deemed to be related, as well as guidelines about which parties are subject to Law 18,083. Accordingly, a party is required to submit annual transfer pricing documentation if it is on the Tax Office’s list of major taxpayers, performs related-party transactions exceeding 10 million indexed units (approximately $1 million) or has been otherwise notified by the Tax Office.
On May 6, 2010, the Tax Office issued resolution 819/010, further defining a related-party transaction as occurring when the principal activity of an entity arises from an agreement to act as an agent, distributor, dealer or supplier of goods, services or rights for another entity. Furthermore, an activity is considered a “principal activity” when the level of revenue generated by the activity represents at least 50 percent of the amount of the entity’s total income for the year.
Vietnam – Circular 66 Refines Transfer Pricing Rules
New Vietnamese transfer pricing guidelines outlined in Circular 66 became effective on June 6, 2010, replacing those in Circular 117. While Circular 66 mostly reiterates Circular 117, there are some key changes and expanded definitions worth noting.
Circular 66 only applies to organizations engaged in the production and trading of goods or services (“enterprises”) involved in business transactions between related parties. This is a change from Circular 117, which also applied to individuals.
Circular 66 clarifies some sections of Circular 117 by expanding the definition of related parties, quantifying the material difference that would require an adjustment to a comparable price or transaction and defining the use of an interquartile range. In addition, the new guidelines distinguish between sale and purchase transactions when determining arm’s-length transfer prices.
Also required under Circular 66, enterprises must declare related-party transaction information on form GCN-01/QLT and submit it with their annual Corporate Income Tax Return.
To learn more about transfer pricing solutions or to discuss your company’s current transfer pricing positions, please contact your BKD advisor.