Multinational enterprises that transfer pricing transactions need to be more proactive in complying with the principles of transfer pricing. A company’s ability to comply with the principles of transfer pricing is its ability to avoid tax penalties and an audit.
Companies should proactively commit themselves to meet these standards before transferring their cash activities worldwide. In addition, multinational enterprises need to formulate proper policies that will comply with the international system for the intergovernmental exchange of information and establish adequate procedures for mitigating risk which is an important part of every fiscal year process within a multinational enterprise.
July 1, 1998. At a business meeting, the general manager of Multinational Enterprise X, an entity engaged in the manufacture and distribution of products around the world to retail outlets including Multinational Enterprise Z, expressed her desire to audit individuals within her global management team as well as in MNE X’s local subsidiaries.
The audit team would review financial information and sales data on a quarterly basis and prepare written reports by August 15th. After the annual worldwide restructure, MNE Z planned to recompense employees for any shortfalls in 1994 with cash bonuses based on each employee’s total compensation for that year. Employees who had been under the assumption that bonuses would be made in shares of MNE Z stock based on their 1994 performance were disappointed when they realized they would not receive any form of bonus payment.
After a meeting with the MNE X senior accounting team, it was decided to pay bonuses in cash as opposed to stock options. By this time, it was already August 10th and most financial statements had been sent to the appropriate accounting department within MNE X. Additionally, the audit team had already compiled preliminary statements and prepared a list of employees likely to make less than target compensation for 1994 when cash bonuses were factored in.
Are there any exemptions to the transfer pricing rules?
Withholding taxes are not imposed on certain items of income.
These items include:
· Foreign-source dividends paid by a company that is taxable in another country, or
· Dividends paid to US taxpayer by another US company that are not actually paid to the shareholders; and
· Dividends from companies whose shares are listed on an exchange in another country.
If a foreign dividend is exempt from US withholding tax, then the transfer pricing rules will not apply to that dividend. Although this type of arrangement is common practice, it can cause substantial problems if not conducted properly.
The Comparable Uncontrolled Price (CUP) method:
This method is the most likely to be adopted by any company. When a company uses the CUP method, it identifies and selects comparable uncontrolled transactions (SUPs) from independent third parties and compares the transfer price to these SUPs. Once again, the procedure for selecting comparable information is similar to that for selecting comparable uncontrolled prices. The items that are needed are:
1. The property or service involved in the SUP;
2. The buyers and sellers involved in the SUP;
3. The respective locations of the buyers and sellers with relation to the pricing company;
4. The time period over which services were provided or goods supplied;
5. The nature of the property or service;
6. The volume of business between the buyer and seller; and
7. The prices charged or paid in comparable transactions between unrelated parties for the property or service, as well as any adjustments for differences in risks assumed by the buyer and seller that may be known to either party.
In September 2004, Brazil’s TCU (a federal agency) reviewed the country’s transfer pricing policies and recommended reforms to make them more consistent with OECD rules. In its report, it stressed that Brazil should establish an information statement containing “sufficient information on each transaction” that will allow tax administrators to determine whether transfer prices conform to OECD guidelines. The report also recommended the establishment of a database that would include information on all transfer pricing reports.
In addition, the TCU report called for audits on a sample of transfer pricing reports and urged Brazil to provide taxpayers with advance notification of possible transfer price adjustments in excess of $50,000. At the same time, it supported the use of presumptive prices based on market transactions since these prices generally reflect arm’s-length conditions and are more likely to approximate actual comparables than other adjustment methods.
How significant is tax compliance in your country?
“Transfer Pricing is an issue that attracts frequent media attention in Russia because it often ends up in high-profile court cases against large companies. The increased interest in transfer pricing is indicative of the tax policy of the Russian government at present.”
In a 2005 article “Russia’s Transfer Pricing Nightmare”, an expert on Russia and Russia-related issues, John P. Sullivan, writes:
“Transfer pricing is a hot topic in Russia as it is around the world, as a result of pressure from trade partners for Russia to close gaps in its tax systems and transfer pricing practices.
“In May 2004, the US State Department issued Country Report on Human Rights Practices for 2004 which included a section titled ‘Tax Administration’ that said “Possible unreported income from corruption may have resulted in significant revenue losses to the federal budget.