By Peter Kelly AGBEEHIA
Transfer Pricing is the pricing of goods, services or intangible assets transferred between related entities usually within a Multinational Enterprise (MNE) Group. The related entities can be subsidiaries, divisions or affiliates of a multinational group operating in different jurisdictions.
The basis for transfer pricing is the increase in the volume of global and international trade and the incentive it creates for multinational enterprises to set up operations in other jurisdictions. More so, global trade is becoming increasingly complex with focus on trying to unravel complex multinational structures and ensuring that multinationals pay a fair share of taxes in the jurisdictions in which they operate. (Heard all the drum-beating about BEPS Pillar 2? Watch out for more!)
The Arm’s length Principle is the cornerstone of transfer pricing essentially advocating that when entities which are related trade with each other, the prices and terms of their arrangement should be coterminous with or similar to the prices and terms unrelated entities which are completely independent of each other would have agreed assuming they were also engaged in a similar transaction.
Sounds simple? Not really!
The application of the arm’s length principle is not a cast in stone! In other words, it is not really simple and straightforward. It requires various types of analysis depending on the related party transaction(s) in question and other factors at play. At the heart of the analysis is what we call ‘Comparability Analysis’ which involves an assessment of several relevant factors such as the legal agreements and contractual terms; the functions performed, the assets deployed and the risks assumed in the related party arrangement; the characteristics of the property being transferred in the related party arrangement; the economic circumstances under which the related party arrangement occurred and how specific market and industry factors impact the terms of the arrangement; and the business strategies pursued by the related parties; all being considered in coming to the single conclusion as to whether or not the related party transaction in question was conducted at arm’s length.
Even more keenly, global TP players such as tax authorities are becoming concerned about whether the body language of related parties and their commercial practices reflect what they have agreed in principle — what is usually referred to as the doctrine of ‘Substance Over Form’. In effect, the fact that the terms of an arrangement between related entities are merely agreed, documented and considered to be arm’s length may not in fact necessarily mean they are conducted at arm’s length.
Also, in recent times, what is considered arm’s length is causing a stir globally and generating debates especially as the OECD Transfer Pricing Guidelines does not mandate a uniform approach to determining the Arm’s Length Range. This has caused transfer pricing to be shrouded in much complexity and to be subject to changing jurisprudence.
For example, traditionally, there’s been consensus amongst the generality of global TP Players and key actors that there is no basis in law or fact for a tax authority to adjust a taxpayer’s margin to the median when it fell within the arm’s length range of the agreed comparable companies considered for purposes of the analysis especially where the range comprises results of relatively equal and high reliability.
In Spain, the courts have ruled that all points within the arm’s length range are equally reliable and valid for the performance of a transfer pricing adjustment, with the tax authorities having the burden of proving the comparability defects in order to select a specific point of the range.
It’s also been held that where a taxpayer’s value is within the arm’s range of benchmarked results, no pricing adjustment will be performed. However, where the value chosen by the taxpayer falls outside the full range of benchmarked results, a transfer pricing adjustment will be made relying on the measures of central tendency (Usually, the median obtained). The tax authority must also refer to the existence of defects of comparability in performing an adjustment.
In a more recent ruling in France v SAS Roger Vivier Paris (RvP), an Administrative Court of Appeal upheld the application, by the French Tax Authorities, of the mean or average operating margin (rather than use of the median) as the best measure of central tendency in performing a transfer pricing adjustment and in determining the arm’s length value that should have been applied by the taxpayer. The court noted that the taxpayer could not advance any useful argument or present any rebuttable evidence as to why it considered the method applied by the French Tax Authorities inappropriate.
World Trade
World trade refers to the global exchange of goods and services across international borders. It is a major driver of economic growth, with both goods and services being traded among countries. International trade is regulated by multilateral organizations like the World Trade Organization (WTO), as well as regional trade agreements like the North American Free Trade Agreement (NAFTA) or the European Union’s internal market and, in Africa, we can now talk about the African Free Continental Trade Agreement (AfCTA)
The United Nations projected Global Trade to hit US$33 trillion in 2024, demonstrating remarkable resilience in the face of global economic shocks and geopolitical tensions.
In 2023, the value of global trade was estimated at around US$32 trillion, with trade in goods estimated at US$25 trillion (encompassing everything from raw materials to finished products) and trade in services estimated around US$7 trillion (covering industries like finance, information technology, transportation, and tourism).
The key actors in world trade include the largest trading nations such as China, the United States, the European Union, and Japan and their main trade involves importing and exporting goods and services at very significant levels. Generally, sectors such as Technology and electronics; Automotive; Oil and energy; Pharmaceuticals; Agriculture and food products are the main drivers of global or world trade.
Intercompany Trade
Intercompany trade, also known as intra-company trade, is the trade of goods and services between subsidiaries or affiliates of the same multinational company operating in different countries. Intercompany trade involves the movement of components, intermediate goods, and services between subsidiaries of the same multinational corporation located in different countries. For example, a company might produce parts in one country and assemble the final product in another.
Global supply chains are a key feature of international trade, where different stages of production are dispersed across multiple countries, often to minimize costs and maximize efficiency.
Intercompany trade represents a significant portion of world trade, estimated at 30-50percent of global trade. Large multinational corporations, especially in industries like technology, pharmaceuticals, and automotive, dominate this form of trade. Intercompany trade is subject to transfer pricing and tax implications as companies may shift profits through pricing strategies to take advantage of lower tax jurisdictions. Governments closely monitor these practices to ensure tax compliance.
Conclusion
World trade is vast and complex, with intercompany trade playing a crucial role within it. While world trade encompasses the entire exchange of goods and services between countries, intercompany trade focuses specifically on the transactions between different branches of multinational corporations, making up a significant portion of global trade activity.
Multinational Groups considering operating in other jurisdictions must therefore assess the potential tax and transfer pricing implications of their structure and transaction flows including factors such as Permanent Establishment (PE) and Place of Effective Management and Control (POEM(C)) Risks; withholding tax implications; the impact of double taxation agreements; VAT and customs implications; the concentration and location of intellectual property and financing activities; as well as how other local legislation such as exchange control and business laws can affect their operations.
>>>the writer is an Independent Consultant in Ghana with extensive experience in Transfer Pricing, Taxation and Business Regulation. He has Certification in Rethinking International Tax Law; a course jointly sponsored by Coursera and the University of Leiden, Netherlands. He has also has consulted for multinationals in various jurisdictions and for an International Transfer Pricing and Tax Structuring firm with offices in South Africa, Mauritius, Ireland and United Kingdom (UK) where he was engaged to prepare transfer pricing documentation, transfer pricing planning reports, transfer pricing health check reports and design efficient transfer pricing models for clients operating internationally and across Africa. He has cross-sector experience working for clients in the areas of Mining, Petroleum Sub-contracting Services, Telecommunications, Financial Technology (FinTech), Education Technology (EdTech), Engineering Consultancy, Labor Sourcing, FMCG, Maritime, Manufacturing, Renewable Energy, Utilities and Not-for-profit Causes. If you found this article useful and would like to discuss further, kindly reach out to the author via [email protected]
