TRANSFER PRICING is the phenomenon by which related corporate entities in different jurisdictions determine the price at which a transfer of goods or services between them should be deemed to have occurred. It is a necessary and common phenomenon, yet it has become one of the most contentious areas of the tax environment. Companies including Google, Starbucks and Amazon have attracted criticism from government, with Public Accounts Committee chairwoman and Labour MP Margaret Hodge branding their practices “evil”.
Is it a necessary “evil”, then? It is necessary because, when goods or services pass between such related entities, the respective taxation and accounting obligations of each entity require that a price be allocated to the transfer, even though the same ultimate entity is both the seller and purchaser. It is also common because any transfer of a good or service from one corporate entity to another in the same group of companies will typically necessitate the allocation of a transfer price to that transaction.
Because of its importance to international trade, individual governments have sought to regulate transfer pricing at the domestic level. Compliance with these regulations – typically demonstrating that the transfer price of a good or service is an “arm’s length” or “transaction” value – has thus become an important part of corporate governance.
Non-compliance can have serious consequences. For instance, the UK’s transfer-pricing rules permit tax authorities to adjust (for tax purposes) the price deemed to be paid under an international transaction between related entities when that transaction did not occur at arm’s length or created a tax advantage. As recent headlines about management of corporate tax liability suggest, a company that manipulates its transfer prices may suffer reputational damage. Neither uncertain tax liability nor public dissatisfaction are attractive outcomes.
However, in contrast to widespread and increasing domestic regulation of transfer pricing, there is little international regulation. The Organisation for Economic Co-operation and Development, for its part, has provided guidance, most prominently in its 2010 Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations. But that document, as its name indicates, contains only guidelines. It is not a binding treaty between states requiring them to harmonise all, or even adopt any, domestic regulations on the issue. Given this lack of international regulation, the question is whether any international instruments indirectly regulate transfer pricing. Two types of treaties come to mind.
The first type concerns treaties on customs valuations. The Customs Valuation Agreement – which is one of the treaties administered by the World Trade Organisation (WTO) – is a key example.
At its heart, it requires states to apply (for customs duty purposes) an objective “transaction value” to a good when it enters its customs territory. If a state fails to do so, then it can be sued by another state before the WTO, and be made to correct its customs regime. The WTO has in recent years considered how the phenomenon of transfer pricing might affect a state’s ability to comply with the Customs Valuation Agreement.
One result of that consideration is that a state may, in certain circumstances, be sued for allowing imports into its territory at a customs value which is distorted due to transfer mispricing. Thus, if a company in state A believes it is suffering a competitive disadvantage in state B because another company in state C is exporting to state B at transfer-mispriced values, the company in state A may have grounds to request that its government use the WTO to stop state B allowing such a situation to continue.
The second type of treaty that indirectly regulates transfer pricing internationally concerns treaties on international investment. Such treaties are typically concluded by two states, and contain protections for international investments passing between them. Thus, when a company from state A invests in state B, an investment treaty between those two states usually stipulates that the company’s investment must receive “fair and equitable treatment”, “non-discrimination” and “full protection and security” from state B. If state B breaches those protections, the company can commence an arbitration directly against it.
Such protection may be relevant to the way in which a state introduces, amends or implements transfer-pricing laws. For example, if a state amends its laws in a way that drastically changes the domestic business environment in which the company invested, or if the state implements a law inconsistently or discriminatorily, the company would have grounds to argue that the state has breached the investment treaty and must pay compensation.
Companies dissatisfied with the practicalities of international transfer-pricing regulations therefore have options under international law. They are not necessarily limited to domestic remedies. Through detailed knowledge of the law of international trade and investment, companies can ensure that they benefit from a level playing field and investment protections provided by the international regulation of trade pricing. ?
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Lucas Bastin is a barrister at Quadrant Chambers. He specialises in international law and cross-border litigation