Following the work of the OECD/G20 Inclusive Framework on BEPS on Actions 8–10, multinational businesses have worked to ensure alignment of their intercompany arrangements with the OECD’s revised guidance. Similarly, tax authorities have dedicated much of their recent attention to the OECD/G20’s key areas of focus, especially cross-border intangibles transactions, intra-group financing, and contractual allocations of risk.
This has led to many tax authorities across the world having a greater focus on transfer pricing, with a resulting increase in transfer pricing yields.
Given the increased attention by tax authorities to transfer pricing, the following trends have been observed:
Disputes are increasing at a global level, with many more progressing to litigation;
The average time taken to resolve disputes continues to increase;
There is greater sharing of information between tax authorities; and
There is an increasing body of case law related to transfer pricing.
The resolution of disputes is typically taking longer given the complexity of the transactions and the increased information required to support the transfer pricing position. This is influenced by the enhanced sharing of information between tax authorities, which accelerated in the early stages of the COVID-19 pandemic, resulting in increased scrutiny of taxpayers’ positions.
Additionally, an increasing body of case law has emerged globally in recent years concerning transfer pricing across goods, manufacturing, and distribution, to extractives, financial services, intellectual property licensing, and professional services. Earlier cases primarily concerned the transfer pricing of financial transactions and goods; however, more recently, transactions have increasingly concerned intangibles and issues relating to permanent establishments.
Domestic case law in some jurisdictions has featured the development of a ‘commercial rationality’ principle and an increasing preference for pragmatic transfer pricing evidence. Such developments have in all cases been dependent upon the interpretation of the text of domestic transfer pricing legislation by domestic courts, and the alignment between domestic transfer pricing legislation and the associated enterprises article of the OECD Model Tax Convention (Article 9), with availability of the OECD Transfer Pricing Guidelines and commentary as interpretive aids.
Inherent challenges remain in pricing complex transactions. This article provides some observations from recent case law and conveys what Deloitte has observed in enquiries and audits concerning the nature of evidence required to support transfer pricing policies. Furthermore, it offers recommendations for managing these challenges through audit preparedness.
Observations on TP enquiries
The information and data being requested by tax authorities has evolved in recent years to often be a longer list of items, which still includes the typical financial statements, transfer pricing documentation, intercompany agreements, and board and meeting minutes. Now, however, there is also a common request for further business evidence on the decision-making process through organisation charts, role titles, job descriptions, salary data, meeting materials, and, increasingly, requests for emails.
These requests for emails may be specific to particular individuals, a specified period, or certain key words. This increasing list of information assists tax authorities with determining their conclusions, which is enhanced using ever-improving data analytics tools to interrogate emails and other data. This can lead to yet further requests for information – for example, emails or documents that are referenced in the original set of emails analysed – or clarifications on anomalies detected.
It is being increasingly observed that following requests for business-related information and data that allows for conclusions on the appropriateness of the transfer pricing policies, tax authorities are then requesting further data to understand whether such policies have been implemented accurately in the books and records of the company. These requests can include detailed data across a range of areas; for example:
The source data for cost bases used for central service charges;
The source data underlying allocation keys or profit splitting factors; and
Segmented profit and loss accounts for entities performing multiple functions.
Tax authorities are using this data to demonstrate where there is inaccurate implementation of transfer pricing policies, which may lead to adjustments. Where such inaccuracies are detected, this has the potential for further requests to demonstrate the accurate implementation of other policies.
Case law
Recent case law has highlighted specific requirements that if not met, may lead businesses to be less likely to be successful in upholding their transfer pricing position, as in the following instances.
Contemporaneous documentation was not available to support transfer pricing policies, whether due to a lack of contemporaneous and inadequate benchmarking (Ice Machine Manufacturer A/S, Danish Western High Court (Case No. SKM2020.224.VLR)) or where there are unexplained deviations from transfer pricing agreements and policies (see further: Pharma Distributor A/S, Eastern High Court of Denmark (Case No. SKM2020.105.OLR)).
There is a mismatch between the transfer pricing policies and the implementation of these transfer pricing policies, and inconsistency in transfer pricing documentation (see further: Mopani Copper Mines Plc, Supreme Court of Zambia (Case No. 2017/24)).
There is a failure to provide adequate evidence to confirm and support the appropriateness of the comparable uncontrolled prices (CUPs) or the transactional net margin method (TNMM) comparables (see further: Prime Plastichem Nigeria Limited, Nigerian Tax Appeal Tribunal (Case No. TAT/LZ/CIT/015/2017)).
The terms of an intercompany transaction, viewed objectively, do not make commercial sense, often referred to as ‘commercial rationality’ (see further for the development of the principle: Chevron Australia Holdings Pty Ltd v. Federal Commissioner of Taxation, [2015] FCA 1092 (23 October 2015); Chevron Australia Holdings Pty Ltd. v. Federal Commissioner of Taxation, [2017] FCAFC 62 (21 April 2017); and Singapore Telecom Australia Investments Pty Ltd v. Federal Commissioner of Taxation (often referred to as the Singtel case), [2021] FCA 1597 (17 December 2021)), which supports the proposition that taxpayers must have evidence of the commercial rationality of their intercompany arrangements; ideally, in the form of observable market evidence of comparable arrangements. In the absence of such evidence, businesses need to critically assess whether the commercial rationale for a unique arrangement is both realistic and verifiable.
There is an inability to evidence arm’s-length parties amending agreements in a similar way as seen between related parties (see further: Federal Commissioner of Taxation v. Glencore Investment Pty Ltd [2020] FCAFC 187, where the taxpayer was able to locate market evidence of similar pricing models, and Altera Corporation & Subsidiaries v. Commissioner (Case Nos. 16-70496, 16-70497, June 7 2019), the U.S. Court of Appeals for the Ninth Circuit, where it was found that stock-based compensation could not be included in cost-sharing arrangements because the evidence showed that parties acting at arm’s length do not do so).
Reference should also be made to the recent Upper Tier Tribunal decision in Blackrock Holdco 5 LLC v. The Commissioners for Her Majesty’s Revenue and Customs [2022] UKUT 00199 (TCC) (United Kingdom), where the tribunal found that regard must be had to the actual transaction when comparing the actual transaction with an arm’s-length transaction and this cannot take into account conditions that do not exist in the actual transaction (see also the earlier decision in DSG Retail Limited, Mastercare Coverplan Service Agreements Limited, Mastercare Service and Distribution Limited v. The Commissioners for Her Majesty’s Revenue and Customs [2009] UKFTT 31 (TC) (United Kingdom)).
What can be observed from the recent case law is that, in many cases, multinational enterprises struggled to support their transfer pricing arrangements due to a lack of contemporaneous evidence or incomplete transfer pricing documentation, and, in some instances, were unable to demonstrate implementation in alignment with their transfer pricing documentation or why the transfer pricing method selected was reliable.
In particular, where it is possible for tax authorities to challenge transfer pricing positions on commercial rationality, it is important for businesses to assess intercompany contracts as a whole, and each term thereof, for commercial rationality. This is particularly in circumstances where tax authorities form a view that the contract as a whole or one or more terms therein are driven by tax avoidance purposes.
Contemporaneous documentation of commercial rationality for the contract and the contracting terms is also prudent.
Audit preparedness – managing TP evidence across multinationals
Emerging case law and the observations from enquiries and audits supports that reliance on the preparation of transfer pricing documentation to local and international standards is only the starting point in supporting transfer pricing policies that are subject to dispute.
Having regard to the nature of the transactions concerned and their complexity, preparing for an audit or potential audit requires the collation and analysis of transfer pricing contemporaneous data, information and data sources; transfer pricing process and control documentation; business documents; and, in many cases, emails. The nature and extent of detail of the documentation depends on the actual transaction type, the complexity of the arrangement, and the industry in which the transaction arises.
In light of the existing transfer pricing analysis and documentation requirements, together with what has been observed in enquiries and audits and in the emerging case law, businesses may want to consider the following:
Identifying and collating contemporaneous comparable data, information sources, documents, and emails that detail commercial or financial relations in respect of the tested transactions (including taking evidence from key persons across the business, where appropriate), as well as evidence pointing to commercially rational decision making;
Evaluating the consistency in the various information and data sources in support of the transaction;
Ensuring tailored intercompany agreements are prepared and implemented for transactions to assist in its delineation;
Reviewing existing intercompany agreements having regard to established transfer pricing policies to determine whether policies have been implemented correctly and whether economic substance continues to match form;
Identifying market evidence of key terms affecting price (whether in external contracts or otherwise);
Identifying and collating evidence from the market where the arrangement is one that can be identified between independent parties and the usual conditions/provisions of such arrangements (i.e., covenants) and commercial rationality;
Understanding the information and data provided to tax authorities to date on the specific type of transaction and/or transfer pricing policy;
Identifying contemporaneous group control policies (i.e., group risk policies) and determining their relevance to transactions between group members to ensure the appropriate review and sign-offs are in place and the appropriate processes followed;
Confirming the appropriateness of, or implementing, end-to-end processes to ensure the transfer pricing policies are executed accurately in the books and records, with clearly defined roles and responsibilities that are known to the relevant individuals; and
Capturing and retaining on a contemporaneous basis the underlying data, across multiple data sources where relevant, to support the transaction, along with control documentation to support decisions made where changes or adjustments may be made to the transfer pricing policy; for example, changes in the functional profiles of the parties to the transaction.
Ultimately, the information, data, and documents compiled should be determined based on an evaluation of the nature and extent of the transaction complexity.
How to support TP arrangements
Despite observing a global trend of increasing transfer pricing enquiries and often a longer period to reach resolution, the approaches to information gathering seen in enquiries and audits and the growing body of case law does provide guidance as to how to be best placed to support transfer pricing arrangements where a tax authority audit is undertaken.
The collation of the appropriate documentation on a contemporaneous basis is fundamental, but, most importantly, what is collated should be reviewed and analysed to evaluate the extent of support for the transaction and the associated transfer pricing policy.
Furthermore, the extent of consistency across the information should be considered and any inconsistency evaluated for reasonableness and to pre-empt any questions that may arise from the information.
Ultimately, the objective is to be comfortable on a contemporaneous basis that, having regard to the evidentiary picture, the information and data supports the pricing of the transaction and any inconsistencies are understood at the time rather than identifying these during an audit.
