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Transer pricingperspectives*

The emerging perect storm o transerpricing audits and disputes

*connectedthinking

Thought Leadership Journal



PricewaterhouseCoopers


Transer pricing perspectives

Table o contents The emerging “perect storm” 3

Permanent establishments: The denitional battleground 9

Global best practices in avoiding transer pricing audits and disputes 19

Mandatory binding arbitration 29

The challenge o “triangular” transer pricing cases 41

APA and MAP programs: Steps or improvements 49






The emerging “perect storm”

Global tax audits, controversies, anddispute resolutionToday’s multinational corporations (MNCs) are acing the most challenging

tax environment in history because o a combination o our global orcesconverging to create a “perect storm.” The unstable environment createdby these orces is resulting in a substantial increase in the number and sizeo transer pricing audits, adjustments and disputes. This new environmentplaces a premium on audit and dispute avoidance techniques. This paperdiscusses these our global orces and looks at proactive steps, includingresolution techniques, MNCs can take to weather the storm.

The rst o these global orces is creating a surge o transer pricing auditsand disputes around the world. Fiscal demands on developed and emergingcountries (including inrastructure and entitlement demands) are placingsignicant pressure on governments to raise revenue and prevent baseerosion. At the same time, the Organisation or Economic Cooperation andDevelopment (OECD) has reported that tax revenue in 20 o the largestcountries is near all-time highs as a percentage o gross domestic product.These actors are orcing nations to continually pursue revenue enhancementinitiatives and enorcement activities to meet increasing scal demands.

As nations step up their eorts, the number o transer pricing audits anddisputes climbs.

Evidence o this trend can be seen in data obtained during a clientengagement by a team o transer pricing specialists across our globalnetwork o rms. The graphs below show the trend lines or (i) transer pricingdispute engagements, which totals in the hundreds, and (ii) a subcategory odisputes—total transer pricing audit deense engagements—or the period

rom 2005-07 (with the index base years set as o 2005). We have broadlydened “disputes” or this analysis to include audits, administrative appeals,competent authority matters, advance pricing agreements (APAs), litigationassistance, and other dispute resolution alternatives.






As these graphs indicate, the number o disputes remained relatively stablerom 2005-06. However, in 2007 there was a substantial increase in the numbero transer pricing disputes in which PwC was engaged to assist clients, withthe most dramatic increase occurring in the area o transer pricing auditdeense. Because tax audits are typically the rst phase in a transer pricingdispute, we can conclude that the other categories o dispute resolutionprojects also will start to show more rapid growth rates in t he near uture. We

see this upward trend in transer pricing disputes continuing, based on year-to-date 2008 inormation submitted to our internal database Project Tracker.

The second global orce relates to the constant competitive pressures onMNCs to structure their worldwide business operations eectively andeciently. These pressures include achieving eciency expectations incorporate structures and unctions; the constant search or low-cost rawmaterials, labor and suppliers; continuing pressure to meet earnings per sharetargets; competitor benchmarking; and heightened scrutiny o comparativeglobal eective tax rates. As a result, MNCs are driven to ocus on the mostecient global entity structures, operations and transactions while striving toachieve a deensible and competitive eective global tax rate.

Third, governments around the world are cooperating as never beore to sharetaxpayer and industry inormation, to assist other countries with documentand inormation requests, and to participate in multinational audits (including“simultaneous” examinations). For example, MNCs in the United Statesare experiencing an increased number o requests rom non-US revenueauthorities (e.g., Japan’s National Tax Agency) or documents and inormationheld by US-based companies. This is a disturbing trend or many MNCs.

Fourth, MNCs are acing a new era o regulations, penalties, transparencyand disclosure around the world. More than 50 nations have enactedtranser pricing documentation regimes, with more on the way (e.g., China).Those countries are increasingly examining transer pricing t ransactionsand documentation, and they are asserting sizeable adjustments and

reassessments in many cases. In addition, with the advent o FIN 48 inthe United States, MNCs are required to place greater emphasis on theidentication, evaluation, and disclosure o uncertain tax positions. This hasled to a transparent environment where uncertain tax positions o MNCs aredisclosed to governmental authorities and the public.

Total dispute resolution projects growth

(Indexed to 2005)

Audit deense projects growth(Indexed to 2005)

2005 2006 200790%

110%

130%

150%

170%

190%

I n d e x e d g r o w t h

Audit defense projects: Transfer pricing audit defense engagements. Source: PricewaterhouseCoopers project tracker

100%

107%

181%

2005 2006 200785%

95%

105%

115%

125%

135%

145%

155%

165%

I n d e x e d g r

o w t h

Total dispute resolution projects: Transfer pricing audit defense, administrative appeals, competent authority matters,

APAs, other dispute resolution alternatives, and litigation assistance. Source: PricewaterhouseCoopers project tracker

100%

99%

152%






MNCs need to develop centralized points o contact within the globalenterprise, and they need t o apply coordinated actions in monitoring andresponding to transer pricing examinations and disputes. Because theresolution o a transer pricing dispute in one country may have prooundramications or the same taxpayer in other jurisdictions, MNCs need torevisit their use o one-o approaches to handling audits and disputes in theirorganizations. The key to achieving successul results will be coordinated

global strategic planning, with local tactical implementation. I properlyplanned and implemented, these steps should assist MNCs in avoiding certaintranser pricing audits and disputes and ultimately achieving the most ecientand avorable results or the company.

In responding to the emerging “perect storm,” this issue o Transer PricingPerspectives ocuses on several important global dispute resolution topics,including recent developments involving the taxation o PEs, recommendedimprovements to APAs and Mutual Agreement Procedures (MAPs) around theworld, and “best practices” in the global dispute resolution arena. This editionalso will identiy the challenges presented by “triangular” transer pricing casesand consider the possible eect o t he new mandatory binding arbitrationprovisions in several recent international tax treaties. This new era o globaltax audits and disputes raises numerous challenges or MNCs and theiradvisors—are you prepared or the storm?

C. David Swenson

Washington, D.C.PwC’s Global Tax Dispute Resolution Leader

Garry B. Stone

Chicago, ILPwC’s Global Transer Pricing Leader

These our global orces have coalesced to create an unstable climate orMNCs, resulting in a substantial increase in the number and size o transerpricing audits, adjustments, and disputes. As part o this process, weare experiencing an unusual “commonality o issues and controversies”around the world, ranging rom permanent establishment (PE) audits andcontroversies in India, Korea and France; to “guarantee ee” cases in Canada,

Australia and Japan; to “marketing intangibles” issues in the United States,

the United Kingdom and many other countries. Likewise, disputes areincreasingly commonplace throughout the world concerning the allocation omanagement ees and the proper treatment o “equity-based” compensationin cost pools or transer pricing purposes.

This surge in audits and disputes is placing signicant strain on the traditionalmethods o resolving transer pricing controversies: audit-level settlements,administrative appeals, mediation, APAs (with rollback eatures), competentauthority negotiations, arbitration, and litigation. In addition, many expertsexpect that growing pressure rom the FIN 48 disclosure requirementsmay lead a large number o companies to seek the certainty o traditionalbilateral advance pricing agreements, thereby increasing the demands on

APA and competent authority oces around the globe. Furthermore, thelatest statistics show that more than 75 percent o the inventory o the UScompetent authority oce relates to “oreign initiated” adjustments, and thishas led to an increased Internal Revenue Service ocus on the “exhaustiono remedies” by US taxpayers in non-US jurisdictions, as well as the relatedoreign tax credit ramications.

This new environment places a premium on audit and dispute avoidancetechniques. Transer pricing audit and dispute avoidance includes not only thepreparation o “quality” transer pricing documentation, but also the properstructuring o entities, unctions and risks; the preparation o appropriateintercompany agreements; and periodic “course o conduct” audits. In thenew global tax environment, MNCs must be proactive (not reactive), and theyneed to adopt holistic approaches (not ragmented responses) to tax audits

and controversies. These steps include implementing policies to avoid transerpricing audits and disputes rom the beginning o a project or transaction,including proactive use o APAs.

David Swenson

Garry Stone






Permanent establishments:

The denitional backgroundBy: Joseph Andrus (US) and Richard Stuart Collier (UK)

Rules dening tax jurisdiction are a oundational element o any system ointernational taxation. Although domestic tax statutes oten assert broad

jurisdictional rules, which are constrained primarily by the practical limits othe country’s enorcement powers, modern treaty practice has been morerestrained. Under treaties, at least those based on the Organisation orEconomic Cooperation and Development (OECD) model, the outer limit oa country’s jurisdiction to tax the business-related income o nonresidententerprises is dened by reerence to the permanent establishment (PE)concept. The undamental contours o the PE denition are old (at least bythe standards o modern taxation), and have been broadly adopted andremarkably stable or many years.

Despite the longstanding nature o these denitions, a t horough rethinking othe treaty rules relating to taxing jurisdiction is underway. This new school othought is motivated, in part, by technological and other changes in the conducto international business, such as the growing importance o services andglobally integrated service businesses in the international economy; governmentperception in many quarters that multinational corporations have sometimesengaged in unduly aggressive tax planning and transer pricing practices;and by a desire o some countries, usually thought o as capital importersor “source” countries, to claim a larger piece o the tax pie. Developmentsrefecting these pressures include, but are not limited to, the ollowing:

Various publications o the OECD, including recently released amendments•

to the model treaty commentary, in connection with OECD’s long-runningproject on the attribution o income to PEs under Article 7 o the model treaty

The OECD’s ongoing business restructurings project, which recently has•

given rise to a separate project specically ocused on PE denitional issues

Recent and proposed changes to the OECD model treaty commentary on•

Article 5 relating to the PE denition in a service business context






The PE defnition

Under the OECD model treaty, a PE exists, and jurisdiction to tax businessincome is created when either o two conditions is satised. First, i anonresident enterprise maintains an oce or other xed place o business ina country, it generally will be deemed to have a PE and be subject to tax inthat country. Second, i a nonresident enterprise has, in the host country, a“dependent agent” that habitually exercises the power to contractually bind its

principal, the enterprise will be deemed to have a PE. Under the OECD modeltreaty, these are the exclusive jurisdictional tests. Without either a xed placeo doing business in the source country or a dependent agent that possessesthe power to contract on behal o its principal in the source country, thebusiness prots o an enterprise cannot be subjected to the taxing jurisdictiono the source country.

Implicit in the jurisdictional lines drawn in these provisions o the model treatyis the virtually sel-evident principle that a variety o business activities, withclear economic consequences inside the borders o the source country, maybe undertaken without bringing the enterprise inside the jurisdictional taxnet o the source country. For example, the sale o products or services romoutside the source country to customers inside the source country does notgive rise to tax liability o the seller in the customer’s country o residenceunder the OECD model treaty ormulation. This is true regardless o whetherthe purchaser o the product is related to the seller. Thus, under the traditionalreading o the model treaty rules, the activities o a buy-sell distributionsubsidiary almost certainly will not create tax jurisdiction over the relatedsupplier. Similarly, the provision o incidental services by employees o anenterprise resident in the source or host country to an aliate nonresidentin the source country ordinarily should not create tax liability or thenonresident entity, provided it has no oce or xed place o business in thesource country.

The growing importance in the economy o businesses perorming•

nancial intermediary unctions that operate on an integrated and virtuallyborderless basis

Court decisions including those involving Philip Morris in Italy, National•

Westminster Bank in the United States, Zimmer in France, and severalcases in India that address certain PE issues

Aggressive and widespread audit activity in many countries involving broad•

assertions o taxing jurisdiction, particularly assertions o taxing jurisdictionover nonresident aliates o a sales or manuacturing subsidiary, or anonresident aliate o an entity engaging in nancial services transactions

Expansion o the US APA program t o cover allocations o income to PEs•

A signicant increase in the percentage o pending competent authority•

matters involving assertions o the existence o a PE, many o which haveproved dicult or impossible to resolve.

Because o the variety o these recent developments and because the OECDand government tax authorities have not pursued expansion o the rulesrelating to taxing jurisdiction in an integrated or holistic ashion, the currentPE debate has something o a stealth quality to it. It is legitimate to questionwhether the revolutionary developments in communications technologyo the past two decades and the resulting global integration o businessmodels have given rise to a need to rethink undamental concepts relatingto jurisdiction to tax. However, the OECD and global tax administratorshave come to the point o posing these questions in a rather roundaboutmanner. Thereore, one wonders whether the current exercises at the OECDand elsewhere represent mere ne-tuning o the existing rules to refectcurrent business conditions, or whether a more undamental change in theadministration o international tax law is underway.

s legitimate toestion whether

e revolutionaryevelopments in

mmunicationschnology o theast two decadesd the resulting

obal integration osiness models have

ven rise to a need tothink undamentalncepts relating toisdiction to tax.






Pressures on the traditional rules and historical practice

Three distinct sets o pressures have emerged in recent years testing thecontinuing delity o the international tax community to the traditional treatyrules on jurisdiction to tax business income. One o these pressures derivesrom developing communications technology and the consequences othat technology or the manner in which businesses organize themselvesand their cross-border business aairs. Another relates to the prevalent

application o tax planning strategies intended to limit taxable income in hightax jurisdictions and enhance taxable income in low tax jurisdictions, to theextent permitted by applicable transer pricing rules. The third involves thegrowing economic importance o countries, such as India and South Korea,which have traditionally viewed themselves as capital importers with a stronginterest in aggressive assertion o their jurisdiction to tax.

In addition, it has become increasingly obvious at a technical level that theremay be stark dierences between the income allocation outcome under anintra-entity approach under Article 7 and the result under a pure inter-entitytranser-pricing approach. This is because the PE allocation exercise under

Article 7 oten will become an all-or-nothing aair. In other words, i a PE isdeemed to exist, and i one ollows a “people unction” approach under Article7, 100 percent o the prots at issue will oten be allocable to that PE andtaxed in the location o a provider o services. However, i a transer pricingsolution alone had been applied, a lower level o prot arguably would beattributable to the location o the service provider because risk assumptionand business capital would be deemed to reside outside the service provider’s

jurisdiction. This “all-or-nothing” eature o PE disputes makes the route oalleging a PE a more potent weapon or the tax authorities when comparedwith a challenge to the transer pricing arrangements.

Moreover, the model treaty takes substantial pains to suggest that taxing jurisdictions should not be created in some situations in which the nonresidententerprise actually maintains an oce or xed place o business or a dependentagent in the source country. So-called preparatory and auxiliary activitiesmay be perormed through a xed place o business in the country withoutbringing the enterprise within that country’s tax net. For example, a nonresidententerprise that maintains a supply o goods at a xed place o business inside

the source country rom which it lls orders does not thereby become subjectto the source country’s taxing jurisdiction. Similarly, an enterprise establishinga purchasing oce in the source country does not thereby subject itsel to thecountry’s taxing jurisdiction. These rules traditionally have served to enhancethe ree fow o trade in goods and services without creating an undue tax drag.

When controversy has arisen regarding the existence o a PE, oten it hasbeen possible to resolve the controversy on transer pricing grounds. Ian allegation is made that a sales subsidiary in a local country acts as thedependent agent o, and t hereore constitutes a PE o its supplier, it has beenpossible to resolve the controversy on transer pricing grounds by agreeing onthe amount o income to be reported by the local sales aliate. Similarly, in anancial services context, i a broker dealer resident in Country A establishesan aliate in Country B to originate business and develop client relationshipsin Country B, it generally has been possible to nesse the question o whetherthe Country B aliate constitutes a PE o the Country A broker dealer merelyby agreeing to allocate an appropriate share o the enterprise’s global incometo the Country B aliate under transer pricing principles.

None o this is to say that the PE rules are always clear in their application.Essentially, the actual nature o jurisdiction to tax questions has given riseto learned debate and practical controversy. Until recently, however, mostsuch controversy could be resolved on the basis o transer pricing/incomeallocation principles.

This “all-or-noeature o PEdisputes makeroute o allegin

PE a more potweapon or theauthorities whcompared withchallenge to thtranser pricingarrangements






that would not be possible i the same business operations were conductedin a single legal entity operating under the new OECD Article 7 principles. Itbecame evident to tax jurisdictions that, rather than creating a transer pricingsystem o income allocation or real branch operations that ignored “articial”and “questionable” allocations o risk between separate related entities,a more potent challenge could be made based on a broad reading o PEtaxing powers.

Tax administrators in developed markets with higher tax rates have viewedthe emergence o principal company structures, involving overt allocations obusiness risk to lower tax jurisdictions, with increasing alarm. They also haveexpressed concern over some nancial intermediaries that have sought toisolate business risk rom operational unctions by treating high tax countrytraders and other key personnel as service providers and allocating riskand associated returns to lower tax jurisdictions. The perception, thereore,grew that assertions o expanded taxing jurisdiction under the PE denitioncould be used as one tool to attack t he tax structures giving rise to theseconcerns. Further, although the new Article 7 approach, based exclusivelyon people unctions, may be clear in conceptual terms, its application (e.g.,at the “eld agent” level o discussion) can be vague and uncertain, addingurther potential or the PE approach to be pressed into service. That hasrefected itsel in audits and tax controversies around the world. Inevitably,however, the coalescing pressures leading governments to assert expandedtax jurisdiction have reached the point o bumping up against the limits o thetraditional PE denition, giving rise to pressure to reconsider the denitionalrules themselves.

The eect o these practical and technical pressures became evident duringthe course o OECD work on the attribution o income to PEs under Article 7.In ocusing on how income should be allocated among the various branchesor PEs o a nancial institution, the OECD sought to adopt rules ostensiblyconsistent with existing transer pricing principles. In doing so, the OECDthought it important to adopt a system that disregarded potentially articial ormodiable activities, such as the location where nancial assets are booked

or nancing transactions executed. Instead, it ocused on the location othe people undertaking key business activities and making critical businessdecisions. In particular, the OECD eectively concluded that no weight shouldbe given to arbitrary taxpayer determinations as to where, within the samelegal entity, particular nancial risks associated with the business were borne.

It was a short step rom the adoption o a “unctional substance-based”system or allocating income among branches o a single legal entity to therealization that, where separate related legal entities are involved, a similar“substance-based” result could be more dicult or governments to achieve.One o the core building blocks o modern transer pricing rules under theOECD transer pricing guidelines and the US transer pricing regulations isthat agreements between related entities regarding the allocation o businessrisks generally are to be respected by the tax authorities, provided thosearrangements have economic substance. Tax administrators increasinglyobserved that taxpayers sometimes seek to take advantage o this principleto allocate business risks o all kinds (and the income arguably associatedwith those risk bearing unctions) to a “principal” company operating in alower tax jurisdiction. In some o these situations, taxpayers may seek toseparate risk bearing and risk management to achieve transer pricing results






expressly permitted by the tax authorities in relation to the transer pricingarrangements), one can question whether it is appropriate or sensible todebate questions o the existence o inadvertent PEs.

Because these issues arise in a context where the group has conceded thatit is subject to the state’s tax jurisdiction, it should be clear to all involved inthe debate that jurisdictional principles are being used as a stalking horse

to address more undamental income allocation concerns. We seem tohave come ull circle rom a situation where more fexible income allocationprinciples routinely were used to nesse and resolve dicult questionsunder the PE denition, to a world where expansive jurisdictional argumentsare being used to address perceived income allocation abuses. The risk,o course, is that by proceeding in this roundabout way, the jurisdictionalrestraint refected in the existing PE denition may be lost.

Expansive claims o jurisdiction to tax can have serious consequences orthe system o international tax and trade. Broad, competing jurisdictionalclaims increase the tax and tax compliance burden on internationalbusiness. Moreover, the controversies engendered by such broad claims areextraordinarily dicult to resolve. The all-or-nothing nature o a dispute overwhether a PE exists makes the compromise o such a dispute in the mutualagreement process hard to achieve. Recent comments by Internal RevenueService (IRS) ocials, suggesting the IRS may become increasingly unwillingto allow oreign tax credits or taxes imposed under jurisdictional claims andother theories o non-US tax administrators with which they disagree, wouldseem to only heighten this concern.

As the OECD turns overt attention to PE denitional issues, these concernsshould be kept rmly in mind. Notwithstanding the path that has broughtthe debate to the place it currently occupies, it may be a better idea to try toaddress the income allocation concerns o tax administrators directly, ratherthan expanding the PE denition to “x” an income allocation “problem.”

The coming defnitional debate

The OECD recently has indicated that it will undertake a separate projectrelated to the Article 5 PE denition in the context o its work on businessrestructurings. It also recently published alternative treaty language andcommentary allowing countries to assert taxing jurisdiction over serviceentities, even in situations where the entity has no xed place o business in a

jurisdiction. These developments are taking place only a ew short years ater

a thorough OECD review o the challenges to the international tax systempresented by electronic commerce concluded that the traditional PE ruleswere suciently robust to resolve the jurisdictional issues raised by changingbusiness models.

It is a curious act that, even though the PE rules are designed primarily topermit determinations as to when a global business enterprise will becomesubject to tax in a source jurisdiction, some o the most dicult questionsraised under those rules arise in situations where a multinational group ocompanies has conceded it is subject to tax in the country by establishinga local resident aliate. For example, particularly dicult issues haveincluded: the determination o whether a local resident sales aliate or“commissionaire” will be treated as a dependent or an independent agent o arelated enterprise; the conditions under which a local sales or manuacturingaliate will be deemed to contractually bind aliated suppliers or customers;the conditions under which acilities o a local aliate or customer are“made available” to the nonresident enterprise; and whether with sucientregularity and permanence they will become a xed place o business o thatnonresident enterprise.

Also troubling is that a similar theme is emerging in situations that seeminglyhave nothing to do with the tax authority concerns reerred to earlier. Forexample, where prot-splitting arrangements between related partiesconducting an integrated business are in place (perhaps having been

It should be cleainvolved in the dthat jurisdictioprinciples are

being used asa stalking horsto address moundamental inallocation con






Global best practices in avoidingtranser pricing audits and disputes By: David Swenson (US), Helen Fazzino (Australia) and Mauricio Hurtado (Mexico)

“Prevention,” goes the saying, “is better than the cure.” This holds true orglobal tax disputes. Although it is impossible to avoid every tax dispute orcontroversy, it is possible—and desirable—to ensure that steps are takento minimize the chances o an adverse audit and the related possibilities oadjustments and assessments leading to a dispute.

Disputes are protracted and expensive. In addition to the direct costs,signicant management time is required by the relevant revenue authorities.Some companies nd themselves the subject o recurring audits, with theirtranser pricing policies being questioned in numerous jurisdictions. Inaddition to the signicant costs and penalties that may be imposed, recurringaudits may be indicative o a deeper malaise within the organization.

In contrast to recurring audits, our experience suggests that some companiescan consistently get their approach endorsed by the relevant revenueauthorities. Some o these companies simply have not been subject toas much audit activity as others, but in many cases the companies tookproactive steps to achieve this avorable position.

It is not possible—or perhaps even desirable—to avoid all risks and disputes.Rather, the approach should be to manage risks so that global commercialobjectives can be achieved within the risk tolerances o the local scalauthorities. This article looks at steps companies should take to ensurethey can receive a clean bill o health rom—and avoid the costs o disputeswith—tax authorities involving their transer pricing arrangements.






Engaging the right stakeholders

Depending on the magnitude and complexity o the specic business activityenvisaged, the process o creating a plan will draw in a range o stakeholders.The corporate tax department is likely to drive the process o identiyingtranser pricing issues, but it is also likely that a tax/transer pricing /legal teamwill need to be involved as well as intellectual property specialists, particularlywhere there are considerable intangible assets at issue. It is essential to

assemble a dedicated team o people who represent the dierent disciplinesrequired and are amiliar with the disparate issues involved. This will ensurethat no issues are overlooked. O course, operational unctions should be parto the team because it is their business requirements that largely will drive therelevant changes.

A common approach

Although the scale and complexity o projects or which transer pricingplans are required may vary considerably, the same approach should holdtrue in all contexts. A meticulous approach to upront strategy development/ transaction planning should apply as much in comparatively challengingsituations—such as where a high value intangible is being transerred to a tax-avored jurisdiction—as it applies to a standard structure—whereby a productis produced in one country and then shipped to another or distribution.The steps discussed here are valid and appropriate or either one. Theocus should be on proper planning to comply with local regulations and toavoid disputes.

Starting at the beginning

From the outset o any planned development involving the cross-bordercreation or relocation o related corporate entities, there is a need to perormwhat oten is called a transer pricing study, or plan. This plan is developedor a variety o business circumstances that may include a specic unction,product development or production. In the course o developing a study orplan, it is important to ensure that relevant transer pricing issues are identied

as early as possible. This should include not only a review o various “hot”issues in the specic countries concerned, but also other developmentsaround the world. We live in an increasingly connected global tax environment,and governments are increasingly identiying certain issues and examiningthose issues in their tax environment. A current example o an issue identiedwould be matters relating to the taxation o permanent establishments (PEs).

Developing a plan should cover the suggested corporate structure andtransaction fows required or the particular business activity and theidentication o the appropriate transer pricing methodologies associatedwith those corporate structures and transaction fows. This process shouldaddress the overall transer pricing ramework and strategy (i.e., how basictransactions are dealt with, how unctions are remunerated, and how risksare moved and structured), as well as the transer pricing modus operandiwhen executing business strategies and transactions. All material transactionsneed to be managed by the same process, using the simplest approachpossible to deal with standard issues. The process also should recognize thatsome transactions will have signicant eects. For example, issues relatingto moving intellectual property rom one jurisdiction to another will need tobe addressed with greater particularity. Having established the undamentalapproach, the strategy process can then engage the right stakeholders atheadquarters and in the local jurisdictions.

It is essentialto assemble adedicated teamo people who

represent the ddisciplines reqand are amiliawith the dispaissues involved






relationships that unrelated parties would enter into. For example, a mismatchin the allocation o risks between entities creates issues or tax authoritiesto investigate. Worse, it could provide an entrée or them to question thecommerciality o the overall arrangement. A ocus on the quality o the transerpricing documentation should not detract rom attention to the quality anddetail o the intercompany agreements created at the outset. Investing in thatdocumentation is a key step, but one that can be overlooked in the concern

to ensure that transer pricing documents meet the highest standards. By thisstage, completing documentation should be a simple process demonstratingthat the dealings and agreements are at arm’s length.

Aligning orm and substance

Matching orm with substance in this way is essential. Oten intercompanyagreements dier considerably rom the transactions that take place, andthis can create signicant problems down the line. To prevent this, manualsdetailing standard operating procedures should be adopted, especially in thecontext o large projects. In one example, a multinational company (MNC)decided to migrate a global brand to a specic, tax-avored jurisdiction.Standard operating procedures were prescribed in detail that laid out whatemployees needed to do to ensure that substance and orm were kept instrict alignment.

Once a structure is established and unctionally operational, it is important toimplement a periodic review to test the “course o conduct.” This review looksat a suitable time lapse to validate structures, operations and transactionfows ater they have been established to ensure the match betweensubstance and orm continues to hold. Such a review also can ensure thatas business develops, operational activities are not inadvertently creatinga mismatch between orm and substance. The testing should include ananalysis o nancial results and the application o the selected transer pricingmethodologies to assess whether the related structures and operations arewithin the appropriate range.

Building solid oundations

When a company plans to evaluate the options or restructuring the provisiono intercompany services, transer pricing is an important element o thatreview. A company may conclude that certain unctions should be located inparticular countries and identiy the transaction fows between certain entitieswithin the corporate group. The corporate tax unction must then interacteectively with the appropriate corporate operational ocers, the general

counsel, the human resources department and others, depending on the sizeand parameters o the project.

Having completed the planning phase o identiying the appropriatestructures, transaction fows and pricing, implementation is the next phase.Here, it is essential that the rigor and details that have applied to the planningare translated into eective implementation “on the ground.”

Establishing the corporate entities and accurately documenting theintercompany agreements are vital. Commercial documentation precedesthe establishment o the transer pricing documents that support thevarious methodologies chosen or pricing, services rendered, and unctionsperormed. The corporate documents in question should describe in detailthe commercial agreements that establish the unctions and risks o therespective corporate entities, ensuring the proper debt-equity ratios andintercompany agreements are in place.

Once the corporate phase is complete, the required transer pricing policiesare drated to support the nancial results and the fows o income andcosts related to the unctions and methodologies that are used. Althoughthis is the phase that generally receives the greatest attention, it is criticalthat the transer pricing documentation is refective o the economic realityas identied in the prepared corporate documentation. We encountertranser pricing documentation and agreements that do not accuratelyrefect the underlying corporate structures and relationships or the t ype o

s critical thate transer pricingocumentation isfective o the

onomic realityidentied in the

epared corporateocumentation.






The importance o a global transer pricing dispute strategy

The issue o cost-sharing identied above is just one example o a number oissues that MNCs are acing rom tax authorities around the world. MNCs haveoperations in more countries than ever beore, so there is a greater emphasison transer pricing. This leads to a greater probability o exposure to audits andassessments. One company with which we are amiliar has 16 audits relatedto PEs in progress in dierent countries around the world; another has 30

dierent kinds o audits in progress worldwide. There is a new global disputeenvironment, and it is orcing companies to adopt a similarly global response.

In the not-so-distant past, companies tended to handle audits and disputeson a local basis. A local aliate would handle the audit and report back on theresult o a specic case. Today, a number o actors are orcing a change in thatapproach. Audits are emerging around the world with a commonality o issues,and the implications o settling an audit in one country can have a potentiallydramatic eect in other countries. In addition, tax authorities are sharinginormation through mutual agreement procedures and dispute resolutionprocesses, bilateral and multilateral advance pricing agreements (APAs), taxinormation exchange agreements, and wider use o tax treaty networks.

Thereore, it is increasingly advisable or a large MNC to take a two-sided andeven global perspective o its transer pricing arrangements and acknowledgethat the disputes to which its activities give rise need to be seen rom multipleviewpoints. In this environment, companies are realizing a signicant premiumattributable to global strategic planning. This type o planning typicallyinvolves a team dedicated to monitoring audits and the issues that arebeing raised. Team members identiy “hot” issues around the world, such asmarketing intangibles and PEs. They also have a centralized point o contactwithin the company who works with them as well as outside advisors tomonitor developments on a global basis.

I a company cannot avoid an audit, taking the steps briefy outlined herewill ensure that the company has high-quality, robust and consistentdocumentation. Today, more and more companies are taking these steps.But many are not necessarily doing so in a complete or structured way,leaving them vulnerable to audits and disputes. Focusing on transer pricingdocumentation, regardless o its quality, is not enough. The commercialcontracts and agreements underpinning corporate structures must be o an

equally high quality to prevent or mitigate any potential dispute.

O course, sometimes the best planning and implementation will not avoid adispute because there is a conceptual chasm between the revenue authoritiesand the taxpayer. For example, this presently is the case in the UnitedStates on issues relating to cost sharing. There is a signicant philosophicaldierence between what the revenue authorities believe taxpayers should doand what taxpayers and their advisors believe is necessary and appropriate.In such cases, no amount o careul planning or implementation can bridgethe divide between the two parties. But even in these instances, makingsure that the steps taken are consistent with best practices should make itpossible to deend a position eectively. The steps required to do this maybe: rst, to identiy when this situation exists; then to assess the likely risks;and nally, to ensure that the arrangement, analysis and documentation eithermaximize the chance o acceptance by the tax authorities or minimize thelikelihood o penalties.






Global management o tax obligations

In addition, teams members need to address tax obligations on asimilarly global basis. They need to have an overall view o the company’sopportunities to use oreign tax credits, separate country loss utilization,and oreign currency exposures and opportunities. In eect, such a globalstrategic plan looks at a wide variety o issues to determine where prot andloss can be located and how to resolve disputes in a avorable way. Looking

at the tax attributes o a company rom a global perspective creates the abilityto identiy the advantages and disadvantages o resolving particular disputeson the most avorable possible basis. Similarly, where operations in some

jurisdictions are experiencing periods o commercial weakness, the globaltranser pricing system can be altered to ensure that inadvertent outcomes donot expose the business to transer pricing risks.

A global team also can help develop a consistent approach to economicacts and theories on a worldwide basis. Inconsistent positions previouslycould be used and arbitraged rom one country to another. Today, however, anumber o drivers are making a globally consistent approach vitally important.Governments are communicating more eectively, audits are merging witha commonality o issues and the OECD is taking a more prominent role inguiding tax policies. Consequently, developing a consistent approach aroundthe world is rapidly becoming a necessary capability to avoid disputes withincreasingly connected and well-inormed tax authorities.

Some o the largest companies operate with just such an in-house transerpricing group that uses specic tools and databases to centralize inormationabout transer pricing documentation or dierent geographies in additionto other supporting documentation such as contracts and intercompanyagreements. Having the right tools and ensuring their availability is a bestpractice in and o itsel.

In addition to collecting inormation and gathering relevant intelligence, globalteams are taking a proactive approach to addressing their global transerpricing strategy. For example, one company has a cascading APA approachthat obtains APAs in certain countries and then appropriately leverages theresults o those agreements with other countries. O course, this approachwould not be appropriate or all companies, but it exemplies the importanceo having the ability to develop and implement a strategically proactiveglobal approach.

As global transer pricing teams understand the specic exposures acrosstheir transer pricing system, they can adjust their arrangements to avoidbeing penalized or poor arrangements in more than one country. Furthermore,they can adjust their global approaches to intellectual property managementand cost-sharing.

Today, howevenumber o drivare making aglobally consis

approach vitalimportant.






Mandatory binding arbitration

A new avenue or dispute resolution or a meansto increase the pressure on swit settlemento Mutual Agreement Procedure cases?By: Isabel Verlinden (Belgium), David Swenson (US) and Steve Nauheim (US)

Because o a signicant increase in audit, assessment and adjustment activityby tax authorities, the number o tax disputes continues to rise. As a result,the demand likely will escalate or alternative means to achieving resolutiono disputes. A number o recent developments have brought the issue oarbitration as a means o resolving international tax disputes—and particularlythose involving transer pricing—into the spotlight. In Europe, the EuropeanUnion (EU) Arbitration Convention has been heavily discussed. In the UnitedStates, two tax treaties (Germany and Belgium) with provisions or mandatorybinding arbitration recently passed through the political approval process(a third treaty, with Canada, is pending ratication). But does mandatoryarbitration represent a new avenue or resolving international disputes orwill its introduction serve as a catalyst or more ecient avenues to achieveresolutions o controversies? This article discusses the background to theissues and considers the extent to which those issues may encourage ordeter taxpayers and tax authorities rom considering arbitration as a useuladdition to the dispute resolution mechanisms used today.

The Apple legacy

As a means o tax dispute resolution per se, arbitration does not enjoy aparticularly avorable reputation in the United States. This may be largely dueto the outcome o a 1993 arbitration procedure between Apple Inc. and theInternal Revenue Service (IRS), in which Apple lost the dispute. Deploying the

“baseball” approach—whereby the independent arbiter chooses one viewthat prevails over the other—the arbitration panel’s decision in avor o the IRSin the Apple case sent a chilling eect through the US business community.

Although in that instance the arbitration was directed toward the resolution o atax dispute between the taxpayer and the IRS, the unavorable outcome or thetaxpayer meant that arbitration, in the domestic context, was widely perceivedas an unattractive alternative to the other means o resolving tax disputes.






Will the provisions o the new treaties generate dierent results? Will theavailability o mandatory binding arbitration open a new avenue or disputeresolution, or will it put needed pressure on revenue authorities to improvetheir processes?

Frustration with competent authority proceedings

Beore addressing those questions, it is worth looking at the context inwhich these new treaties have been agreed. When disputes prove insolvable,disputing parties have recourse under existing treaties to competent authorityproceedings as part o the MAPs that seek to resolve issues o double taxationbetween countries, among other measures. But these procedures long havebeen a source o rustration to taxpayers and their advisors, principally dueto the average length o time that it takes to reach a resolution—generallybetween two and six years. Indeed, the provision in double-taxation treatiesor MAPs provides only that competent authorities should “endeavor” to nda solution to double taxation. In certain complex cases, competent authoritiesmay conclude that a solution to the double taxation in question has not beenound or that more time is required to nd one.

The intention behind the mandatory binding arbitration provisions in the newUS agreements with Belgium and Germany may be to pressure competentauthorities to reach agreement within a certain period o time. Such agreementwould help prevent the need or arbitration, which occurs i competentauthorities ail to reach an agreement within a set timerame. The arbitrationprocess will ollow the “baseball” approach, under which one o the positionswill prevail, with no compromise available between the competing positions othe competent authorities.

A push or switer resolution

Fiteen years later, the revenue authorities and the US business communityare becoming more critical o what they perceive to be a protracted timetableor the resolution o disputes between countries. They are also more critical osituations in which competent authorities seem unable to reach an agreement.Revenue authorities and businesses, thereore, see the threat o mandatoryarbitration as a useul means to apply pressure on tax authorities to resolve

disputed cases more quickly. This view was summed up in a letter romthe Securities Industry and Financial Markets A ssociation in response tothe US Treasury Department’s Model Income Tax Convention, which said:“The incorporation o arbitration procedures in U.S. tax treaties will increasethe likelihood that a dispute will be resolved in MAP (mutual agreementprocedures) because both parties will have the incentive to reach agreement,as neither will be able to delay indenitely the resolution o a case.”

Unblocking the dispute logjam

The mandatory nature o the arbitration clauses in two new US treaties withBelgium and Germany (and the pending treaty with Canada) represents adeparture rom previous experience in the United States. The rst treaty towhich the United States was a party that contained an arbitration clause wasthe US-Germany Double Taxation Treaty in 1989. In that instance, arbitrationwas voluntary. Perhaps unsurprisingly, no relevant cases were settled througharbitration under the auspices o that treaty. John Harrington, international taxcounsel or the US Treasury, outlined in testimony beore the Senate ForeignRelations Committee the reasons why he believed the voluntary nature othe arbitration provision in the treaty with Germany had not been eectivein seeing disputes move into arbitration. He told the committee: “Althoughwe believe that the presence o these voluntary arbitration provisions mayhave provided some limited assistance in reaching mutual agreements, ithas become clear that the ability to enter into voluntary arbitration does notprovide sucient incentive to resolve problem cases in a timely ashion.”

In certain comcases, compeauthorities maconclude that

solution to the taxation in quehas not been or that more tirequired to n






To date, the progress o the three agreements through the US Senate approvalprocess has been relatively smooth. Although the German and Belgianagreements were held up briefy during the Senate approval process in late2007, each agreement has been approved, and the Canadian agreementis expected to be approved in late 2008. Previous treaties were rejected orheld up in the United States as a direct result o arbitration clauses and someSenators’ concerns, including a perceived threat to tax sovereignty that

mandatory arbitration provisions may represent.

As the treaties go through the approval process, a number o keyquestions remain to be addressed. Until they are answered, it will not bepossible to assess whether the use o mandatory arbitration is a likelynew route to achieve resolution o international tax disputes or whetherthe threat o mandatory arbitration will be sucient to expedite competentauthority proceedings.

Questions that need to be addressed include:

Is mandatory arbitration truly mandatory? Is it truly “binding”?•

Under the 1989 US-Germany treaty, voluntary arbitration was provided. Butno cases were brought under it, suggesting perhaps that, or arbitration tobe an eective mechanism, a mandatory element is required. The questioninvolves the extent to which the arbitration procedure is truly “mandatory”and “binding,” as taxpayers may decide not to participate in the process, orto reject the results o arbitration.

When should arbitration start?•

I arbitration is to start at a dened point (such as a date based on wheninormation necessary to undertake substantive consideration or a mutualagreement is received by both competent authorities), a key issue is howthat date should be determined. Much debate has taken place in Europein connection with the same issue as it applies to the EU ArbitrationConvention. Challenge and debate over when the arbitration processshould start has arisen as countries seek to prolong their ability to manage

their tax decisions and policies.

Taxpayers seek certainty

Another pressure point or competent authority proceedings is that taxpayersare seeking more certainty in managing their tax risks and potential exposureto risks. One means t o achieve this is through advance pricing agreements(APAs). The United States has oered an APA program since 1991, and sincethen many other countries have ollowed with their own programs. The APAprocess also may trigger a competent authority proceeding, which urther

adds to the inventory caseload or the competent authorities concerned.So the pressure on competent authorities will continue to increase, not onlybecause o the increase in disputes arising rom audits and assessments, butalso because more companies are seeking to use the APA process to achievea measure o certainty to manage their international tax risks more eectively.Because o these pressures, the inventory o competent authority cases likelywill increase, which will do little to mitigate taxpayers’ concerns regarding thetimetable or resolving disputes. What can governments do t o expedite thecompetent authority process?

This is where the concept o mandatory binding arbitration may play a role,and the United States arguably has taken the lead in seeking to includemandatory binding arbitration within bilateral treaties.

Many questions remain

A number o signicant question marks hang over the detail o the envisagedarbitration process and whether taxpayers will seek to make use o the newmechanism to solve their disputes. A number o indicators suggest thatthe threat o arbitration, rather than its use, is seen as the main lever orexpediting competent authority proceedings. This perception was conrmedin the testimony o Harrington beore the Senate Foreign Relations Committeeon pending income tax agreements when he said: “It is our expectation thatthese arbitration provisions will be rarely utilized, but that their presence willencourage the competent authorities to take approaches to their negotiations

that result in mutually agreeable conclusions.”

number odicators suggestat the threat obitration, rather

an its use, isen as the mainver or expeditingmpetent authorityoceedings.






What is the applicable authority?•

In reaching nal arbitral decisions, what should be the appropriatehierarchy o authority running rom the treaty provisions to OECD principlesto each country’s domestic law? What priorities should be accorded tothose authorities?

Should decisions create precedent?•

Under the 1989 US-Germany treaty, decisions reached by the arbiters

theoretically would be accompanied with a rationale or a decision thatcould be taken orward as precedent or, at a minimum, be considered inlater cases with similar circumstances. This, in eect, would create anadditional body o law above the provisions contained in the treaties. I therationale o the arbiters were not made public, however, arbitration wouldnot create a body o eective guidance. Further, the strict condentialityapplying to arbitration means that it would be challenging to see how abody o eective guidance and precedent could be created without makingdetails o the arbitration public.

Should decisions be binding on taxpayers?•

The decision o the arbitration panel is binding on the governmentsinvolved. Should the decisions also be binding on the taxpayers?Taxpayers may still have t he ability to reuse to accept the decisionso an arbitration panel and pursue litigation i they are dissatised withthe outcome.

How will eective dates be established?•

When are the provisions under the t reaties eective? How and in whatorder will they address pending cases? What priorities will be given tocases that have been pending or a number o years? Should those caseshave the highest priority or will a “trigger” date or arbitration mean that twomore years are required.

What issues are eligible?•

What are considered eligible issues or arbitration? There is somedierence as to which issues are eligible or arbitration under the threetreaty provisions in the US agreements with Belgium, Germany andCanada. Should all subjects covered by a treaty be eligible or arbitration?I eligibility should have limits, how should these be determined?

Should taxpayers participate?•

What level—i any—o taxpayer participation will be permitted? Taxpayerparticipation in other orms o dispute resolution, including competentauthority proceedings, is seen as a vital element in reaching satisactoryoutcomes. Limitations on taxpayer input to arbitration may mean thattaxpayers will be unwilling to make use o this potential avenue orresolving transer pricing disputes. Taxpayers should be allowed toparticipate in the process in an appropriate and limited ashion.

How should arbiters be selected?•

What standards will be set or selecting the arbiters, and what timetable willbe established within which they need to reach a decision? Selecting theappropriate arbitration panel with members who have sucient knowledgeand standing as well as the requisite neutrality to reach a decision may bea challenging prospect. Will the relative scarcity o such individuals imposea limit on the caseload that can be realistically addressed?

Baseball arbitration or a negotiated settlement?•

Deciding the arbitration approach is clearly critical. Whether to use the naloer approach (baseball arbitration), or an independent opinion approachis a signicant issue. Would better outcomes be secured i arbiters wereencouraged to reach a reasoned decision and opinion in much the sameway as a judicial body does, or should the stress on timely resolution meanthat arbiters should aim to reach a decision quickly and select one o thetwo nal positions as they do under baseball arbitration?






The role o the EU Joint Transer Pricing Forum

The orum’s aims

Making arbitration work in reality is a subject that continually gives riseto raised eyebrows within Europe, both or tax authorities and taxpayers.Consequently, arbitration has become one o the key topics to be addressedby the EU Joint Transer Pricing Forum. The European Commission

established this orum in late 2002. Its aim is to come up with nonlegislativerecommendations to help companies operating across the EU manage theirtranser pricing challenges in harmony. Besides representatives rom the taxadministrations o the EU member states, the orum also includes 15 businesssector experts, an independent chairman, and observers (such as the OECD).

Ater an initial two-year term, the orum was extended or another two yearsand was smoothly reinstituted again in 2007.

Achievements to date

The proceedings o the orum have resulted in three communications. Therst was a code o conduct on the EU Arbitration Convention, which aimedto enhance the convention’s role as an eective tool or resolving economicdouble taxation within the EU. The second communication presented a codeo conduct on transer pricing documentation compliance in the region.In February 2007, the EU Commission published a third communicationon the proceedings o the orum. It invited the EU Council to endorseproposed guidelines on APAs and asked the member states to implementthe recommendations included in the guidelines in their national legislationor administrative rules. The purpose was also to put emphasis on disputeavoidance through upront agreements (APAs) rather than purely ocusing ondispute resolution (through arbitration) to mitigate the risk o wasting valuablemanagement time in addressing past transactions.

The EU experience: The Arbitration Convention

The European experience with arbitration in complex international transerpricing disputes has a long, detailed history. The EU Arbitration Conventionwas implemented as a means to orce resolution o transer pricing disputesbetween EU member states. Conceived as a directive, which is adoptedinto member states’ domestic legislation, the member states perceived itas a threat to their tax sovereignty and objected. As a result, the arbitration

directive was withdrawn and replaced by t he EU Arbitration Convention. Approval o the EU Arbitration Convention was a tortuous process but wasratied in its present orm in 2004. It is extended every ve years, providedthat no contracting member state objects.

The EU Arbitration Convention requires competent authorities to reach ullagreement on double-taxation issues arising rom transer pricing disputes.Disputes must be resolved within two years, or the matter is transerred to anadvisory commission that will reach a decision within six months. Competentauthorities have one nal chance to reach an agreement within that timeperiod. I they ail to do so, the commission’s decision is binding on bothparties. Though it is unclear how many cases have been settled by suchan arbitration process, the implied threat o removing jurisdiction rom thecompetent authorities in each country has motivated many to resolve caseswithin the two-year time period. Here again, it is the potential or arbitrationrather than the process itsel that is seen to be eective in expediting cross-border transer pricing disputes within the European Union.

e implied threat omoving jurisdictionom the competentthorities in

ch country hasotivated manyresolve casesthin the two-year

me period.






i the distributor’s margin is perceived as too slim. In such a situation, wereject the idea o allowing countries the ree choice to “reeze” the arbitrationcase until an investigation under competent authority provisions with theUnited States has taken place. Moreover, at the end o the day, tax authoritiesmight also have less appetite to see the case end up in a binding arbitrationas it cannot lead to a “splitting the baby” type o settlement under the rules obaseball arbitration.

The OECD’s plea or binding arbitration

As set out above, under the current state o play, the MAP according to thetreaty can drag on indenitely as countries are required only to “endeavor toagree.” The OECD has stepped into the breach by urging a clear timerameand greater certainty in dispute resolution. In 2004, only a week prior to the EUmember states completing the ratication procedures to extend indenitelythe EU Arbitration Convention, the OECD released its drat progress report,“Improving the Process or Resolving International Tax Disputes.” That reportsuggested arbitration as a supplementary mechanism or the settlement o taxtreaty disputes.

In February 2007, the OECD released the nal report containing a number oproposals to improve the resolution o international tax disputes. The mostimportant in the context o this article is a proposal to add to the OECD ModelTax Treaty a provision that calls or mandatory arbitration. Consequently, theOECD’s Committee on Fiscal Aairs has agreed to modiy the basis or mostnegotiations between countries on tax matters by including the possibility oarbitration in cross-border disputes i they remain unresolved or two years.The business community will welcome this idea, and we sincerely hope thatthis will become a widespread tool or achieving eective dispute resolutionwithin an acceptable timerame.

Mandatory binding arbitration o international tax disputes is a new andemerging alternative. It is controversial, and its long-term eect is uncertain.

The business community hopes arbitration proves a viable alternative orresolving disputes on a more timely and cost-eective basis.

Where did these initiatives lead to in Europe?

The role o the orum is to acilitate actions on both the avoidance (through APAs and robust documentation) and resolution o double-taxation issues(through making the EU Arbitration Convention work smoothly). As mentionedabove, however, to date there is no convincing evidence on whetherarbitration is being called upon switly. Even though there are no ormalstatistics, our experience and research suggest that an increasing number o

taxpayers appear to be making requests with their local tax authorities to taketheir cases to arbitration. But it looks as i those requests are simply used as ameans to increase the pressure or a settlement that at least partly addressesthe double taxation.

Very ew cases have resulted in an actual arbitration, although there havebeen a number o instances where a panel o arbiters has been set up and hasreached a decision to resolve the double taxation, as well as cases in progressor which a panel has been set up. A landmark case involves a dispute in 2003between France and Italy over the pricing within the Electrolux group betweena manuacturing and distribution entity, respectively.

Agenda

It is clear that the business community has high expectations o the potentialor arbitration to become a more easily accessible route among the array ostrategic options to avoid double taxation. In this context, it will be interestingto observe the developments relating to the interaction o the EU ArbitrationConvention with other procedures. For instance, the resolution o so-called“triangular cases” involving a non-EU taxpayer will be a particularly hardnut to crack. Consequently, a burning issue will be how to marry treatydevelopments on binding arbitration (such as in the above-mentioned UStreaties) with the EU Arbitration Convention. An example o this situationmight be a case in which a US manuacturing entity sells products into aBelgian logistics center, which then sells the goods to a German distributor

or commercialization in the market. In such a case, even though the Belgiantax authorities might be happy with the intercompany price (perhaps undera cost-plus method or the role o the logistics center as a mere serviceprovider), the German tax authorities might challenge the intercompany price






The challenge o “triangular”transer pricing cases By: David Swenson(US), Hugo Vollebregt (The Netherlands), Isabel Verlinden(Belgium) and Spencer Chong (China)

As the economy globalizes, the numerous processes in the research anddevelopment, manuacture, sale, and distribution o goods and servicesincreasingly are perormed by separate entities within a multinational group.The fow o products and services through intercompany transactionsrequently involves three or more countries.

Initially, transer pricing cases generally arose rom the transer o tangible orintangible property between two related companies in two tax jurisdictions. Inthose cases, the assessments made by the tax authorities in each jurisdictionat times created bilateral disputes. The diculties and complexities involvedwith resolving those cases are well documented. Now, however, we areseeing a new development in transer pricing cases that is adding a layero complexity and raising challenging—and as yet unanswered—questions.We are observing an increasing number o situations whereby multinationalentities are involved in transaction fows that give rise to transer pricingdisputes in more than two countries, otherwise known as a “triangularcase.” These new multilateral cases generate many dicult procedural andsubstantive issues and increase the diculties o reaching a global agreementamong all countries involved.






Figure 2: Example 2 shows an entity in Country A that is engaged in R&Dactivities with a related entity in Country B. Their relationship is structuredthrough a cost-sharing arrangement. Another related entity in Country Bmanuactures and assembles the nal product. The nished goods arethen passed to an entity in Country C, which is responsible or sales anddistribution. This example shows how two entities in t he same country (in thiscase Country B) can also contribute to the creation o a triangular transer

pricing case.

Fig 2: Example 2

Transer pricing examples o “triangular cases”

(all entities are “related parties”)

Examples o triangular cases

The ollowing examples show some o the circumstances under whichtriangular cases may arise:

The rst (Figure 1: Example 1) shows an instance where research anddevelopment (R&D) activities are carried out by an entity in Country A and alicense o the technologies is provided to a related entity in Country B, where

the manuacturing takes place. The nished products are then transerred toCountry C or sales and distribution. Historically, transer pricing adjustmentswould involve only one leg o these transactions (i.e., rom A to B or rom B toC). Increasingly, however, we are seeing situations in which a transer pricingadjustment is made in one country but has an eect in two other countries.

Fig 1: Example 1



Country “A”

R&D unctions

Country “C”

Distribution/salesunctions

Country “B”

Manuacturing/ assembly unctions

Country “A”

R&D unctions

Country “C”


Country “B”

Cost sharingarrangement

Country “B”







The amount o prot in the economic amily o the three or more partiesis a constant. The question is how the pool should be divided to refect aair allocation among all o the aected parties. The allocation o prot is,in eect, a “zero-sum” game. As more countries show interest in transerpricing issues and audit transactions and raise assessments to maximizetheir share o global tax revenue, these economic considerations will becomemore pressing.

Although these situations are rare at present, we believe these types o caseswill increase steadily. The emerging world o complex R&D pushes productsthrough multiple countries. As a result, multinational corporations—as well astax authorities—will be aced with a number o challenges as they addressthese triangular cases.

What are the issues?

The issues raised by trying to address and resolve triangular cases areprocedural and substantive.

Is it possible, or example, to create a tripartite mutual agreement procedure(MAP)? Tax treaties generally operate between two countries. Although eachcountry involved may have tax treaties with the other countries, these treatieswill not address the relationship among three or more countries. Thereore,the procedural issues include how the resolution o such a case will proceed.Is there a sequential order to be ollowed? I so, how is it established? In theexample described above in Figure 3, would a MAP be instituted betweenthe rst two countries (B and C), and then, depending on the result o thatprocess, would a new competent authority matter between the other twocountries (B and A) be required? Or, should there be a more creative approachthat rolls together the issues rom the beginning?

Many other structures and operating systems may give rise to triangularcases. What triggers a triangular case? A simple instance is shown in Example3 below. Here, tax authorities in Country C (where the entity responsible ordistribution and sales unctions is located) conduct an audit and concludethat the price paid by t he entity in Country C or the manuactured goodspurchased rom the entity in Country B is too high. Accordingly, an adjustmentis made to that price. That adjustment means that the entity in Country B

should reduce the price or the product in Country B, thus reducing its incomein Country B. The diculty arises when Country B decides that, as a result othe adjustment by Country C, Country B also needs to make a transer pricingadjustment. This eectively suggests that the amount paid to Country A orthe parts, or the amount o the cost-sharing or royalty payment to Country A,has been overstated and, thereore, an adjustment is made to the Country Bentity to refect that assessment, potentially triggering a correlative adjustmentto the entity in Country A.

Fig 3: Example three



Country “A”

Parts manuacturingunctions

Country “C”


Country “B”


The emerging o complex R&pushes producthrough multip

countries. As aresult, multinacorporations—as well as taxauthorities—waced with a no challenges they address ttriangular case






The EU Joint Transer Pricing Forum

The EU Joint Transer Pricing Forum is one o the ew international bodies todate that has specically addressed the issue o triangular cases. The orumlooked at triangular cases in the context o the EU Arbitration Convention.The orum’s paper examines the possible eects triangular cases will haveon the way the Arbitration Convention works. Specically, the paper arguesthat triangular cases should not be allowed to infuence the operation o

the Arbitration Convention, particularly in light o the perceived benetsthe Arbitration Convention has conerred by expediting the resolution ocompetent authority proceedings.

The paper also argues that a number o pragmatic solutions could preventthe need to alter the Arbitration Convention to accommodate the possibilityo triangular cases. These suggested solutions include an additional MAPbetween the additionally aected countries, extending the workings o existingbilateral treaties to third parties, or even an extension o the ArbitrationConvention to a third state.

Practical cooperation required

It is clear that the challenging issues at the heart o triangular cases are likelyto increase as global trade expands and economic pressures mount. Practicaland swit resolution o the issues will be needed i multinational taxpayersare to avoid bearing a heavier burden o uncertainty on the development andexecution o their tax and business policies. International cooperation andwillingness to compromise will be required rom tax authorities i those aimsare to be realized.

These questions create considerable uncertainty or taxpayers. Given the timeit already takes or competent authorities to reach agreement in some cases,the possibility o consecutive treatment suggests the prospect o a long timelapse between the adjustment and its resolution.

Many o the same challenges apply in the context o binding arbitration.Would arbitration(s) among the parties in the dispute run concurrently

or consecutively? Or, should involvement occur simultaneously? Whatprocedures should be adopted i two o the countries are in the EuropeanUnion (EU), where the Arbitration Convention applies, and the third countryis outside the EU? What type o methods should be used in these triangularcases to resolve the substantive transer pricing issues? Should eachcountry apply its own domestic rules to resolve the dispute, or should a new“integrated method approach” be developed? To date, there have been ewcases to address these problems. But relevant indicators suggest that thenumber will rise, requiring more solutions.

The Organisation or Economic Cooperation and Development (OECD)Convention does not deal directly with triangular cases. However, it may bepossible to apply its language and intent to a triangular case. This approachmay oer hope, but it does not satisactorily resolve the essential problemsat the heart o multilateral disputes. It is, undoubtedly, a subject to which theOECD will need to turn its attention.

is approachay oer hope,t it does nottisactorily resolve

e essentialoblems at theart o multilateralsputes. It is,doubtedly, abject to which the

ECD will need torn its attention.






Advance Pricing Agreements andMutual Agreement Procedures

Steps businesses and governments can take

to improve the systemsBy: Regina Deanehan (US), Claudia Kühnlein (Germany), Martin Skretkowicz(Canada), David Swenson (US), Veli-Matti Tala (Finland), Hugo Vollebregt (TheNetherlands) and Nadia Mashlab Gutierrez (The Netherlands)

With scal decits at record levels in major countries, governments acetremendous pressure to enorce tax laws and maximize their tax revenue.Governments are cooperating internationally to exchange inormationabout taxpayers, and multinational corporations (MNCs) are subject tosimultaneous tax audits. Tax conficts relating to the development and useo technology and marketing intangibles also exist between developed andemerging countries. As a result, MNCs are acing a daunting array o rulesconcerning documentation o transactions, disclosure o nancial inormation,transparency o tax issues, analyses o tax reserves, and reasonedconclusions regarding tax exposures. These global orces are leading to adramatic increase in tax audits, disputes and tax adjustments around theworld. At the same time, there are signicant competitive pressures on MNCsto operate eciently and to produce a competitive global eective tax rate.

The world needs ecient mechanisms to enhance and secure internationaleconomic relationships, thereby leading to more certainty in an uncertainenvironment. The importance o abolishing double taxation is obvious in thiscontext. Advance pricing agreements (APAs), mutual agreement procedures(MAPs) between competent authorities, and arbitration procedures serve this goal.

This article analyzes how taxpayers and governments can improve the useo these international or supra-national procedures to resolve disputes. Itdescribes what confict theory has to add to the problem o international taxconficts, and it looks into developments in international institutions and incountries infuencing global opinion. Finally, it addresses how taxpayers andgovernments can enhance the current dispute resolution mechanisms.






clear. As the Organisation or Economic Cooperation and Development(OECD) reminds us, transer pricing is not an exact science and requires theexercise o judgment by tax administrations and taxpayers.

A third weakness is the time taken to conclude court disputes. Unlike mosttax disputes, a t ranser pricing controversy is not a one-o issue but coversmany years. As long as the court has not rendered its decision or the nancial

year in dispute, the controversy will continue into the ollowing nancial years.Thereore, the ability o courts to reach a timely decision is a major concern.

A nal weakness is that either party to a case, and notably the taxpayer, maybe unhappy with the court’s decision. Although it relates to prior nancialyears, the court’s decision sets the standard or uture years, and thetaxpayer’s accounting system may be a barrier to meeting this standard.

In addition to power and rights, reconciling interests is the third way t o resolvedisputes. In this approach, the disputants try to reach an understanding oeach other’s aims rather than simply adopting intransigent positions. Thisapproach requires disputing parties to share inormation, views and concerns.The tax director may seek certainty on whether the tax administration willaccept the taxpayer’s transer pricing model so he or she can sign o on thecompany’s new accounting system. The tax administration may be instructedby the government to reduce compliance costs or taxpayers and the taxadministration alike.

Reconciling interests as a way to resolve tax disputes is gaining momentumat a rapid pace, but it is not without its challenges. Taxpayers may hesitateto share inormation and possible settlement directions with the taxadministration due to concerns that their openness may be used againstthem. To overcome this barrier when discussing mutual interests to resolve

Improving confict results

Confict theory suggests that basic elements in any dispute are power,rights and interests. When it comes to power as a method or resolving taxdisputes, the relationship between a taxpayer and the tax administration isasymmetrical. The ormer holds most o the inormation while the latter canavail itsel o the wide ormal powers it enjoys under tax laws. This imbalanceresults in dierent perceptions o respective powers. Determining who is more

powerul is an inecient tool in resolving tax disputes because each side’sperception o the power balance may result in investments in unwarrantedadditional resources.

This leaves rights and interests as elements or solving a dispute betweentaxpayers and tax administrations. Traditionally, determining who is “right”through a legal dispute has been seen as the preeminent means to resolve taxconficts. I the tax administration makes a claim that the taxpayer rejects, thedispute may end in court. The advantage o this is that the responsibility orresolving the dispute rests in the hands o a neutral arbiter. But this approachalso has a number o weaknesses.

The rst weakness involves allocation o resources. Parties to a dispute maydisagree on acts and circumstances or on the merits o those acts andcircumstances. The court (not having any means to conduct independentinvestigations) has to decide which acts are correct and determine themerits o the circumstances. Only ater considering the merits can the courtapply an independent standard, such as tax laws. Moreover, analysis o actsand circumstances requires disputants to dig into the past, which divertsresources away rom working to improve the situation or the uture.

A second weakness o determining who is “right” is that the tax laws—notablyin transer pricing cases that rely on the arm’s-length standard—are rarely

Reconcilinginterests as a wto resolve taxdisputes is ga

momentum atrapid pace, buis not without challenges.






International developments: OECD

Traditionally, resolving international tax disputes has been based on the MAPo the OECD Model Tax Convention. The MAP is used to solve existing orexpected double-taxation cases. The OECD also has published its guidanceon APAs in its transer pricing guidelines.

On its website in 2007, the OECD published guidance on the correct conduct

o MAPs. The document, “Manual on Eective Mutual Agreement Procedures(MEMAP),” is intended to be part o broader eorts to improve existinginternational tax dispute procedures. The basic philosophy o MEMAP isto investigate and identiy best practices or MAPs and publish them asguidance. The goal o the MEMAP is to increase awareness o MAPs and howthey should unction between taxpayers and tax administrations, particularlyaddressing the key issues o a practical approach and greater consistencyo MAPs. Although the status o the MEMAP is airly low, the power o bestpractices should not be underestimated. The OECD’s goal or the MEMAP is anongoing development process, and other measures are taken when necessary.

Also in 2007, the OECD adopted a report dealing with tax treaty disputesand their resolution. In this report, the OECD announced that it will amend itsModel Tax Convention (in the update due later in 2008) to oer taxpayers t heoption o bringing unresolved issues to arbitration two years ater presentingthe case to the competent authorities o the two countries involved. TheOECD proposes that both countries appoint one arbiter, and t he twocollaborate to appoint a chair. The OECD also states that, i appointments arenot made, the OECD will appoint the arbiters at the request o the taxpayer.

The proposed arbitration procedure is not an alternative or additional mechanismto a MAP. It has been designed as an extension o a MAP and addresses onlyissues that have not been solved during regular MAP negotiations.

their disputes, taxpayers and tax administrations may use condentialityagreements that state that options discussed and solutions oered remainstrictly between the parties. Condentiality agreements can help ensurethat negotiations will not be shared, even with the court, in the event thatparties do not nd a mutually acceptable solution and resort to litigation.Condentiality agreements allow taxpayers and tax administrations to openup and share their interests, so that or the rst time in the controversy, they

understand the other party’s position. Experiences in the Netherlands showthat discussing interests in this way is possible. Indeed, tax administrationscan exercise restraint when the company oers inormation or settlementdirections in an eort to reconcile interests. These experiences show that thismethod is benecial or both parties. It solves transer pricing disputes romprevious years and oers the possibility o reaching an APA.

In conclusion, reconciling interests may be a cost-eective, quickalternative to resolving transer pricing disputes between taxpayers and t axadministrations. APAs and MAPs oer an existing legal ramework or thisalternative. During the past 15 years, the value o these programs has beenaccepted, and, increasingly, litigation has been viewed as the option o lastresort. Empirical evidence indicates that, despite a substantial increasein transer pricing audits and controversies, transer pricing litigation hasdeclined in many countries. The cost o litigation, the lengthy process andthe inevitable uncertainty make litigation an undesirable alternative or bothtaxpayers and governments. In the new environment o nancial disclosuresrelated to uncertain tax positions, companies are anxious to avoid many yearso uncertainty with respect to material tax risks and exposures. Thereore,

APAs and MAPs have become two o the primary alternatives to resolvetranser pricing disputes.

uring the past 15ars, the value oese programss been accepted,

d, increasingly,gation has beenewed as theption o last resort.






Codes and guidelines are sources o sot law. Codes are political commitmentso the member states that will not aect their rights and obligations or leadto division o legislative powers between the member states and the EU.Guidelines have a similar kind o binding eect.

Other international institutions: United Nations and International Chamber o Commerce

The UN Committee o Experts on International Cooperation in Tax Mattersrecently has started to discuss dispute resolution. The goal o this committeeis to ollow and evaluate development o the OECD in the dispute resolutionarea and possibly include similar provisions into the UN Model TaxConvention. The International Chamber o Commerce is conducting a taxdialogue with other operators in the eld o international tax law and in severalpolicy papers has supported taxpayers’ rights to arbitration procedures,especially in the area o transer pricing.

Developments in infuential countries

As tax administrations have increased their ocus on transer pricing, dierentinterpretations o the term “arm’s-length principle” have driven disputes.Resolving those disputes has proved to be time-consuming and a strainon taxpayer and tax administration resources. Both taxpayers and taxadministrations have recognized a need or change.

The rst signicant area o change was the introduction o APA programswhere taxpayers and tax administrations could agree on transer pricingmethodologies on a prospective basis. Not only do APA programs providecertainty or taxpayers and reduce audit time, but also they slow down thegrowing number o double-taxation cases that competent authorities have tonegotiate under the MAP contained in most tax conventions.

When designing the proposed arbitration procedure, the OECD acknowledgeddierences in countries’ tax policies and how they organize their taxadministrations. Thereore, the proposed amendment will create only aramework or dierent types o arbitration procedures that countries mayinclude in their tax treaties. In addition, countries that are members o both theEuropean Union (EU) and the OECD have to modiy the arbitration proceduresto ulll their obligations under the EU Arbitration Convention. This means

that broader adoption o the proposed arbitration procedure depends on thegoodwill o the OECD member states. Although it might take several yearsbeore arbitration becomes a core part o tax-dispute resolution mechanisms, itis clear that the MEMAP and the proposed arbitration procedure are importantmilestones in developing the unctionality o the OECD’s Model Tax Convention.

International developments: EU

Completed in 2001, the EU’s major research project on member states’corporate tax regimes concluded that transer pricing and double taxationare signicant obstacles to the development o a European internal market.Thereore, the EU established the Joint Transer Pricing Forum to create sot-law tools to be implemented in member states’ national legislation.

To date, the orum has launched three reports. The rst report is a code oconduct and solves interpretation issues with respect to the EU ArbitrationConvention. Its goal is to ensure that the convention operates more eciently,but delays in implementation by member states have meant that this remainsan aspiration rather than a reality. The second report also takes the orm oa code o conduct and harmonizes member states’ requirements or transerpricing documentation. This code has been implemented into several nationallegislations. In its third report, the orum presented its results in the eld odispute avoidance and resolution procedures, as well as guidelines or APAs.

Although only recently published, several member states have indicated theirwillingness to launch national APA programs.






China, which concluded its rst unilateral APA in 1998, recently enhanced thelegal status o an APA under the Unied Corporate Income Tax Law (UCIT),eective January 1, 2008. Even though China has completed more than 150unilateral APAs, there have been only three BAPAs, with two being completedin 2007. It is anticipated that the ormalized transer pricing laws under theUCIT will result in more BAPAs as taxpayers seek certainty rom potentialdouble taxation.

The administrations in Sweden, Finland and Denmark are investigating thepossibility o adopting ormal APA programs. (Denmark is willing to enterinto inormal APA negotiations with taxpayers.) In the meantime, competentauthorities in Sweden and Denmark may accept oreign unilateral APAsthat become bilateral based on the MAP included in the relevant taxconvention. Although the situation has not arisen, Finland potentially mayalso accept oreign unilateral APAs. Finland also has a domestic advancetax ruling program available to taxpayers looking or certainty with respect totranser pricing.

Countries with mature APA programs have implemented changes as enoughtime has elapsed or both the tax administrators and taxpayers to identiyweaknesses and areas or improvement. Tax administrations are acingchallenges to balance the desire to make their APA programs more attractiveto taxpayers while implementing changes to protect against potential abuse.

Since APA programs began, taxpayers have been concerned about theamount o time required to complete an APA and oten perceive the coststo outweigh the benets. To address these concerns, the United States andCanada have increased sta in an attempt to decrease the time to completean APA. Furthermore, in 2004, Canada introduced the APA First Step program,which involves the revenue authority visiting large taxpayers not takingadvantage o the APA program to promote it.

In the late 1980s, several countries, including the United States, Canada and Australia, began discussing the mechanics o adapting APA programs. During1990 and 1992, Canada entered into a pilot program with the United States ontwo APAs, but the rst APA concluded was between Australia and the UnitedStates in 1991.

In 1994, the members o the Pacic Association o Tax Administrators,

representing the tax administrations o Australia, Canada, Japan and theUnited States, developed bilateral advance pricing agreement (BAPA)guidelines, which became an annex—“Guidelines or Mutual AgreementProcedure (MAP) APAs” to the OECD’s Transer Pricing Guidelines orMultinational Enterprises and Tax Administrations. The mechanism or taxadministrations to communicate with one another was the MAP in the OECDModel Tax Convention.

Other countries began to see the benets o an APA program, and graduallythe number oering an APA program increased, but t hey took dierentapproaches in their implementation processes. For example, some countriesinsist on annual reporting requirements as part o the APA that they will reviewin lieu o an audit. Others omit such stipulations. There are plenty o exampleso divergent approaches. For instance, Canada recently announced that it willnot consider a “rollback” o the methodology agreed upon in a unilateral APA;whereas countries such as the United States will allow the use o a rollbackprocedure in certain situations.

Additions to the growing list o tax administrations adopting an APA programinclude Germany, which released on October 5, 2006, a comprehensivecircular on APAs, combined with the creation o a central team o tax ocialsully dedicated to dealing with APAs and MAPs; Turkey, which instituted an

APA program or taxpayers registered with the Major Taxpayers Tax Oce,which became eective January 1, 2008; and Portugal, which plans tointroduce an APA regime in 2008.






In addition, the United States introduced a simplied structure that resultedin higher ees. Also, owing to ears that taxpayers may inappropriately usethe APA program, there are discussions that a congressional committee mayreview and approve APAs with large transactions.

Canada now requires a submission within three months o a preling meetingbecause some taxpayers were attending preling meetings, delaying

submission, and then deciding not to proceed, causing the CRA to losethe ability to audit some prior years. Furthermore, Canada will not accepta taxpayer into the program until ater the submission has been reviewed.Other changes implemented by Canada exclude the rollback o agreedmethodologies with unilateral APAs and the tightening o the number o yearsa rollback can be applied in BAPAs.

MAPs and APAs: tax directors’ concerns

MAPs and APAs oer extensive opportunities to optimize the overall taxburden as well as t o achieve urther benets such as reducing compliancecosts and gaining “certainty” in a risk-adverse climate. Nevertheless,companies oten hesitate to initiate these procedures. Why do companiessometimes seem to view the advantages o MAPs and APAs asovershadowed by potential downsides?

Tax directors have expressed their concerns about triggering the attention othe tax administration o the second country when initiating MAPs. This aspecthas to be considered particularly when the business model and the transerpricing documentation do not ully comply with local standards. Companiesin this situation oten preer to start unilateral settlement negotiations andsometimes are willing to accept double taxation rather than risk a tax auditin the other country. I companies adopt this position, they are still vulnerableto retrospective transer pricing audits that will cover the same nancialyear. There is a good chance that the deadlines or ling an MAP will haveexpired by then with the result that the company may be hit by transer pricing

adjustments on both sides o the border without any recourse to a MAP.

The introduction o simplied, less onerous programs targeting smalltaxpayers is a urther development. Such programs are aimed at taxpayerswhose relatively low levels o transaction complexity and volume mean thatthey would not otherwise request an APA because o the cost involved.The United States was the rst country to release such a program. In 2005,Canada ollowed suit with a small-taxpayer APA program that oered aunilateral APA with a simplied process that includes the opportunity to have

the Canada Revenue Agency (CRA) perorm the economic analysis. To date,only about seven taxpayers in Canada have taken advantage o this program.France also recently introduced a simplied program or small and medium-sized enterprises.

Countries also are conducting public orums to discuss improvements to their APA programs. In 2006, Canada held one, where recommendations weremade or revisions to the guidelines and or program changes. In November2007, Australia also sought public input, hosting a orum or taxpayers andtax proessionals to discuss, among other transer pricing issues, the APAprogram. At this orum, PricewaterhouseCoopers’ appointment to conduct anexternal review o Australia’s APA program was announced.

On the other hand, tax administrations have made changes that taxpayersmay perceive in a less positive light. On June 25, 2007, Japan’s National Tax

Agency (NTA) issued expanded guidelines relating to transer pricing thatincluded the ollowing provisions relating to APAs:

The NTA may reuse to process an APA application i certain requested1.nancial inormation or the Japanese company’s oreign related parties, orany other inormation, is not provided.

The NTA may also reuse to process an APA application i it lacks an2.economic rationale (i.e., a transaction where the agreement betweenthe parties is not supported by the economic substance revealed by aunctional analysis).

Tax directors hexpressed theconcerns aboutriggering the

attention o thtax administrao the secondcountry wheninitiating MAPs






Other companies may consider waiting until the subject o an APA is raised ina tax audit. This approach may be driven by a shortage o internal resourcesto deal with the APA process. However, in view o the increased ocus otax administrations on transer pricing issues, such an attitude is rarelyappropriate. By not taking action on a requent basis, the company mayexpose itsel to dicult debates with respect to nancial accounting, issues oormal tax laws (notably, burden o proo), and deadlines or MAPs. Thereore,

a shortage o internal resources may backre in the long run.

A dicult relationship with the tax administration infuences the company’swillingness to start MAPs and APAs, especially when prior contacts havedamaged trust. Nonetheless, companies are aware that, in the absence oclear standards in transer pricing, personal opinion plays a decisive role, bothwithin companies and tax administrations. Some parties hide behind ormaland legal positions rather than dealing with the economic aspects o theirdisputes. The best way to respond may be to deal with it contemporaneouslyrather than taking past experiences into account.

In conclusion, it is air to say that companies that do not look into using MAPsand APAs are not using all possible means to manage their eective tax rates,to reduce exposures, and to gain certainty.

Improvements to APAs and MAPs

In the present environment, two o the most requently used alternatives orresolving transer pricing disputes are APAs and competent authority MAPs.This section will rst discuss basic improvements to the APA programsaround the world, ollowed by a discussion o suggested improvements orcompetent authority MAPs.

Tax directors have expressed the same concerns about APAs. Will an APAtrigger a tax audit in either country? This possibility cannot be ruled out, andits likelihood may vary by country. When considering calculating the risks, twoaspects need to be considered. First, conducting tax audits at the start o an

APA application will be detrimental to the country’s APA program. Secondly,almost all tax audits pay detailed attention to transer pricing issues so thatthe issues also will be examined outside the MAP/APA arena. Companies may

preer to discuss issues on a contemporaneous basis rather than discuss actsand circumstances o years past. In this context, tax administrations enjoywide ormal powers that they may be tempted to invoke with respect to issuesarising rom previous nancial years with ar less respect to current issues.

Tax directors also have expressed concerns about data requests by taxadministrations in relation to MAPs or A PAs, especially i those data requestsexceed what they would normally expect during tax audits. (It should benoted that the OECD calls upon countries not to ask or more inormationduring APAs than during regular tax audits.) It has been suggested thatsuch thorough data requests are driven by the limited experience o localtax auditors in the area o transer pricing. Our experience suggests thattaxpayers can benet rom requesting the support o the more experienced

APA team and competent authority o a country in analyzing the company’stranser pricing model rather than trying to solve the issue with the local taxadministration o the same country. The application o an MAP or an APArequires a country to bring more experienced people to the table, which helpsin nding an ecient solution to the dispute.

Companies arethat, in the abso clear standain transer pric

personal opinilays a decisiverole, both withcompanies anadministration






nature o transer pricing and the quasi-adversarial positions o the partiesin the negotiations. Furthermore, the cost o an APA must be comparedwith the substantial cost o properly managing an audit o the issue by therevenue authority, responding to any proposed adjustment emerging romthe audit, and the pursuit o one or more alternative dispute resolutionmethods to settle the controversy. One recommendation to addresstaxpayer complaints concerning the length o time involved is or taxpayers

to le a comprehensive and complete APA request rom the outset o theprocess, with all the acts, issues, methods, critical assumptions, economicanalyses and other critical data completed and led rom the rst day. Inaddition, in bilateral cases, governments should encourage taxpayers tole the APA applications simultaneously in both countries. This will acilitateeach country starting about the same time and rom the same point oreerence, which should assist in moving the case though the bilateralprocess as quickly as possible.

Early agreement to case plans and adherence to deadlines.3. It isimportant to taxpayers and revenue authorities that a number o projectmanagement techniques are employed to expedite APAs. In this regard,tax authorities should require the parties to agree to a case plan within therst 30 days o ling the APA application. From a timing perspective, it isextremely important or the government’s APA team leader to propose thedrat case plan early in the process and obtain the taxpayer’s agreement.

Among other items, the case plan should contain a series o deadlines ormilestones in the process. Strict adherence to these deadlines is essential.This process is a two-way street. Any deviations rom the case plan shouldbe approved by the APA program leader. In addition, a representativerom the competent authority’s oce should be part o the government’s

APA team rom the beginning o the process and should attend all o thesubstantive meetings.

APA Programs

Despite the existence o APA programs in more than 20 countries and thewide acceptance o APAs, many improvements are necessary. O course, APAprograms vary rom country to country, and many countries have continuedto strengthen their APA programs over the years. Nevertheless, virtually allcountries can improve their existing programs, and the recommendationsbelow include primary areas that deserve attention. Many other

recommendations could be oered, but in our experience t he areas discussedbelow are among the most important.

Proactive use o prefling conerences.1. Preling conerences areextremely important tools or taxpayers and governments. We recommendthat all countries use (i not require) these meetings in all but the simplest

APA cases. Preling conerences should not be limited in number or scope,and taxpayers should be encouraged to use these meetings proactively toacilitate an early understanding o the case. Preling conerences usuallyassist in bringing the parties together to enable an understanding o thekey issues and to acilitate the ling o a more complete APA submission.Furthermore, all potentially contentious issues should be identied at thepreling conerence, including those outside the realm o transer pricing.Taxpayers should be encouraged to provide a complete set o materialsand should identiy all critical acts. In addition, in BAPAs, tax authoritiesshould encourage taxpayers to engage in similar preling conerenceswith the revenue authorities o the other relevant country. These prelingconerences should acilitate in ling a more “agreeable” APA submission.

Comprehensive APA requests and simultaneous flings in BAPA cases.2.

The two most requently voiced complaints about the APA process in manycountries are that the APA negotiations take too long and the process is tooexpensive. Much o this is unavoidable and relates to the inherently actual






Taxpayer participation.6. Taxpayers should ully participate in the APAprocess. No party to the negotiations is as well inormed as the taxpayerand its advisors. As necessary, taxpayers should make actual, legal,industry and economic presentations during the course o the negotiations.In BAPA cases, taxpayers should make such presentations on the criticalaspects o the case to the tax authorities o both countries. This does notmean that taxpayers should be “at the table” during the actual competent

authority negotiations. Taxpayers, however, can acilitate an understandingo the acts, issues, law and economics that will serve to inorm both taxauthorities and help draw the countries closer together or settlement.

Striking a balance between “perect” transer pricing and “objective7.practicality.” The arm’s-length principle is easy to state conceptuallybut extremely dicult to apply in practice. Governments should beencouraged to balance their desire to achieve “perect” transer pricingwith the need or fexibility and objectivity in reaching practical transerpricing results. By entering the APA process, the taxpayer has signaledits desire to resolve the t ranser pricing issues through negotiations ratherthan through conrontation and litigation. In turn, the revenue authoritiesshould approach the process with the same desire and should strive to beas fexible as possible in reaching agreement on the transer pricing issues.This means that in certain dicult cases, creative and fexible approachesmay be necessary to reach agreement between the parties.

Industry specialization.4. Many industries operate with unique terminology,governmental approvals, and special regulations. Thereore, possession orelevant industry experience by members o the government’s APA teamwill reduce the time or processing the APA request and should reducethe expense o the process. Ideally, APA team leaders should have strongpersonal “industry experience” so that they have a better understandingo the case and can be more prepared to expedite the negotiation o the

APA. In some countries, it may not be possible to nd an experiencedteam leader. In these cases, other members o the government APA teamshould have such expertise, and, i an economist is assigned to the case,it is particularly important or the economist to be experienced in therelevant industry.

Proactive use o subgroups in large APA cases.5. Eective APAproject management o large cases requires not only the use o prelingconerences, strict adherence to case plans and industry specialization,but also the use o specialized subgroups. Using subgroups and smallerworking committees should be standard practice in large APAs. Thesesubgroups can be devoted to such areas as comparable companyidentication and selection, critical assumptions, asset intensityadjustments, economics, accounting methods, and analysis o writtenagreements. In these large cases, it is not necessary or practical or allmembers o the APA team to be involved in every issue. In many cases,these subgroups will increase the overall understanding o the acts, reduceconficts and move the case orward to completion in a timely manner.






Periodic reports on the state o the APA program.10. APAs are condentialdocuments and, thereore, generally not publicly available. As a result,there is a danger o creating a secret body o APA law known only to therevenue authority and certain taxpayers and their advisors. To preventthis situation, governments should periodically issue reports on the stateo their country’s APA program. Taxpayers and their advisors need to beaware o the positions accepted and the current trends in the countries

where an APA will be led. These reports should contain statisticsabout the number o APA applications, completed APAs, renewalsand withdrawn APA requests. More importantly, they should set orthdetailed inormation concerning the types o transactions covered, thecountries involved, the transer pricing methods accepted, the prot levelindicators used and a substantial amount o additional inormation. Thereports also should contain practical guidance on material issues opento dierent interpretations (e.g., the borderline between “know-how” and“services” or “routine services” and “nonroutine services”). O course,sensitive taxpayer inormation such as trade secrets and identiyingnancial inormation must be kept condential. Nevertheless, a great dealo inormation on critical aspects o the APA program can be published(especially in an aggregate orm) without breaching taxpayer condences.

Annual reports will reduce the secret body o APA law and serve todisseminate critical inormation to taxpayers and the public.

Use o mediation.8. The purpose o an APA is to reach agreement betweenthe taxpayer and the revenue authorities, but that goal is not reachedin every case. In situations where the negotiations are protracted or astalemate is reached, the government and taxpayer should agree toconsider nonbinding mediation. Presenting the case to a neutral mediatormay serve to draw the parties closer to agreement. Litigation should bethe option o last resort, and mediation should be used to avoid urther

controversy and resolve dierences between the parties.Limitations on the use o certain taxpayer inormation in subsequent9.litigation. Taxpayers should be encouraged to enter the APA processwithout ear o negative consequences in certain areas. One potentialarea involves the use o taxpayer inormation in subsequent litigation iagreement cannot be reached in the APA process. Governments shouldadopt a clear policy that i agreement cannot be reached, then the t axauthority cannot use certain taxpayer inormation gained in the APAprocess unless the government obtains the inormation through normalinormation-gathering means in the course o the litigation. This policyshould encourage taxpayers to enter the APA process without concernthat i the negotiations ail, the taxpayer will be placed at a proceduraldisadvantage i litigation ensues.






Given the developments as a result o globalization, revenue shortages andthe need or more timely resolution o cross-border disputes, it is importantthat governments and taxpayers work to improve MAPs by making them moreecient and responsive to the issues presented.

Below are some proposed actions that governments can take to improvethe procedures:

Commit the necessary resources to MAPs to handle cases eciently. At1.present, it can take more than a year to simply receive the position paperrom the government proposing the adjustment.

Streamline internal processes. One example o a process that can be2.adopted is insisting that position papers be developed and exchangedwithin our months o the date o ling the competent authority request.

Develop timelines or case resolution similar to those developed or APAs.3.

Increase the use o technology to resolve cases. Video conerencing is4.an eective means to increase the number o meetings the governmentauthorities can have to resolve cases. This technology has improvedsignicantly within the past several years so it can be used eciently. Aswell as reducing costs, such ace-to-ace meetings generally are moresuccessul in resolving cases than correspondence.

Improve the timeliness and quality o training that competent authority5.analysts receive to cover not only technical issues but also training innegotiating skills and cultural awareness.

Be willing to have taxpayers participate in act-nding discussions with the6.governments involved in the particular dispute. It is more ecient, and itensures that both tax authorities have the same acts.

The underlying assumption o entering the APA process is that the partieswill negotiate in good aith and reach agreement on the transer pricingmatters covered by the APA. The hope is that disputes and litigation willbe avoided. But, the APA process must be practical and ecient. Therecommendations set orth above are designed to assist governments inmaking the process less costly and to enable the parties to reach agreementin a shorter period o time.

MAPs

MAPs are a product o the tax treaties that have been negotiated by countrieson a bilateral basis. They provide the mechanism or taxpayers to avoiddouble taxation. The competent authorities o each country are designatedon behal o their respective countries to negotiate and eliminate doubletaxation. The use o MAPs has been evolving as a means o resolving cross-border disputes. Although relie rom double taxation long has been availableassuming a bilateral tax treaty is in place, taxpayers previously have not reliedon or used the process as much as they have in the past several years. Theprocess was viewed as taking too long with little or no input rom taxpayersin resolving their disputes. There was also an inconsistent commitment oresources by various tax authorities to provide the necessary resources toresolve cases in a timely ashion. We conducted a survey involving more than30 countries (EU and non-EU) to identiy local governments’ trends with regardto MAPs and how they interact with the available domestic legal remedies.The results o the questionnaire are presented on t he ollowing page.






Yes No No (continued) L.P.E. no ino N/A Depends

EU Non-EU EU Non-EU EU Non-EU EU Non-EU

estion 1 here any guidance published on domestic rules

procedures or MAP, both on operational andhnical issues?

Germany, Netherlands,United Kingdom, Austria,Spain, France

Australia, China, India,Japan, Singapore, UnitedStates, Canada, Korea

Belgium, Czech Republic,Denmark, Poland,Sweden, Italy, Romania

Mexico, Brazil, Switzerland,Turkey, Argentina,Norway, Taiwan, Russia

Luxembourg, Slovenia

estion 2 here any inormation published on the outcome oPs (e.g. technical aspects), number o MAPs, typessues, etc?

Austria Australia, Japan, UnitedStates, Canada

Belgium, Czech Republic,Denmark, Germany,Netherlands, Poland, Spain,Sweden, United Kingdom,

Italy, France, Romania

China, India, Singapore,Mexico, Switzerland,Turkey, Argentina, Norway,Taiwan, Russia, Korea

Luxembourg, Slovenia Brazi l

estion 3a s there been any legislation introduced to enact thede o Conduct or the eective implementation oEU Arbitration Convention’?

Germany, Austria, France Belgium, Czech Republic,Netherlands, Poland,Spain, Sweden, UnitedKingdom, Italy, Denmark,Romania

Luxembourg, Slovenia China, Japan, Switzerland, Argentina, Mexico, Australia, India, Singapore,United States, Brazil,Turkey, Canada, Norway,Taiwan, Russia, korea

estion 3b ot, does the country adhere to the Code?

Czech Republic,Netherlands, Spain,Sweden, United Kingdom,Italy, Denmark

Belgium, Romania Luxembourg, Slovenia,Poland

China, Japan, Switzerland, Australia, India,Singapore, United States, Argentina, Mexico, Turkey,Brazil, Canada, Norway,Taiwan, Russia, Korea

estion 4 the country initiate a MAP i the case has notn presented to a domestic court?

Belgium, Germany,Netherlands, Poland,Spain, Sweden, UnitedKingdom, Austria,Denmark, France, Romania

Australia, China, India,Japan, Singapore,Mexico, United States,Switzerland, Canada,Norway, Russia, Korea

Italy Luxembourg, Slovenia,Czech Republic

Turkey, Argentina, Brazil,Taiwan

estion 5 the country initiate a MAP i the case is pending a

mestic court?

Belgium, Denmark,Germany, Poland, Spain, Austria, Italy, France,Romania

Australia, China, India,Mexico, Russia

Netherlands, Sweden,United Kingdom

Singapore, Switzerland,Canada, Korea

Luxembourg, Slovenia,Czech Republic

Brazil, Turkey, Argentina,Japan, Taiwan

Norway, United

estion 6 possible to suspend a domestic court procedureding a MAP?

Denmark, Germany,Netherlands, Sweden, Austria, France, Italy

Australia, India, Japan,United States, Norway,Canada, Russia, Korea

Belgium, Poland, Spain,United Kingdom, Romania

Mexico, Switzerland Luxembourg, Slovenia,Czech Republic

Brazil, China, Singapore,Turkey, Argentina, Taiwan

estion 7 the country initiate MAP/Arbitration procedurer a court decision has been made?

Denmark, Germany,Netherlands, Poland,Sweden, United Kingdom, Austria, France, Romania

Australia, China, India,Singapore, Mexico, UnitedStates, Switzerland,Canada, Russia

Belgium Brazil, korea Luxembourg, Slovenia,Czech Republic, Spain

Japan, Turkey, Argentina,Singapore, Taiwan

Italy Norway

estion 8 ot, may the Competent Authorities in the countryiate rom a domestic court decision?

Czech Republic, Germany,Netherlands, Poland,United Kingdom, Italy,Denmark, France, Romania

India, Switzerland,Norway, korea

Belgium Australia, United States,Brazil, Canada, Russia

Luxembourg, Slovenia,Sweden, Austria, Spain

China, Japan, Mexico,Singapore, Turkey, Argentina, Taiwan

tual agreement procedures

uestionnaire






Yes No No (continued) L.P.E. no ino N/A Depends

EU Non-EU EU Non-EU EU Non-EU EU Non-EU

estion 9court procedures take less than 2 years inr country?

Austria, Russia Singapore Belgium, Denmark, Italy,Netherlands, Spain,Sweden, Germany, France

Australia, India, Japan,Brazil, United States, Argentina, Canada,Norway, Taiwan, Korea

Luxembourg, Slovenia,Czech Republic

China Poland, United Kingdom,Romania

Mexico, SwitzeTurkey

estion 10ractice, are there thresholds (such as minimumustments) imposed by the authorities in the countryulting in denying a MAP?

Belgium, Czech Republic,Denmark, Germany,Netherlands, Poland, Spain,Sweden, United Kingdom, Austria, Italy, France, Romania

Australia, China, India,Japan, Singapore, Mexico,United States, Switzerland,Turkey, Argentina, Canada,Norway, Russia, Korea

Luxembourg, Slovenia Brazil, Taiwan

estion 11es the country imposes legal ees or administrativerges or entering into a MAP?

Belgium, Czech Republic,Denmark, Germany,Netherlands, Poland, Spain,Sweden, United Kingdom, Austria, Italy, France, Romania

Australia, China, India,Japan, Singapore, Mexico,United States, Switzerland,Turkey, Canada, Norway,Russia, Korea

Luxembourg, Slovenia Brazil, Argentina, Taiwan

estion 12aractice, are the tax authorities in the country willinglose a deal/settlement whereby the taxpayer willve his right to present his case or a MAP?

Belgium, Denmark,Germany, Netherlands,United Kingdom, Austria,Italy, France

Australia, China, Japan ,Korea

Czech Republic, Poland,Sweden, Romania

India, Singapore, Mexico,United States, Switzerland,Canada, Norway, Russia

Luxembourg, Slovenia Turkey, Argentina, Brazil,Taiwan

Spain

estion 12bhere a high risk or a tax audit wheneverorresponding adjustment is requested inr country?

Austria, Belgium, CzechRepublic, Denmark, Italy,Netherlands, Poland,Sweden, Romania,Germany, United Kingdom

Argentina, China, Mexico,Turkey, Switzerland,Taiwan

Spain, France Australia, India,Singapore, United States,Canada, Norway, Korea

Luxembourg, Slovenia Japan, Brazil, Russia

estion 13joint tax audits easible rom your countryspective?

Austria, Belgium, CzechRepublic, Germany, Italy,Netherlands, Poland,France, Romania

Australia, China, India,Singapore, Canada,United States, Korea

United Kingdom Japan, Switzerland,Turkey

Luxembourg, Slovenia,Spain

Taiwan, Russia Denmark, Sweden Argentina, BrazNorway

estion 14the local tax authorities grant suspension oing taxes which are disputed under a MAP?

Belgium, Denmark,Netherlands, Sweden, Austria, Italy, France, Romania

Japan, United States,Switzerland, Canada,Norway, Taiwan, Korea

Poland Mexico, Russia Luxembourg, Slovenia Brazil, Turkey, Argentina Czech Republic,Germany, United Kingdom

Australia, ChinaSingapore

estion 15the local tax authorities grant suspension oing interest and/or penalties which are disputeder a MAP?

Belgium, Denmark,Netherlands, Sweden,Italy, France, Romania

Japan, United States,Switzerland, Canada,Norway, Taiwan, Korea

Poland, Spain, Austria Mexico, Russia Luxembourg, Slovenia Turkey, Argentina, Brazil Czech Republic,Germany, United Kingdom

Australia, ChinaSingapore

estion 16here fexibility to use alternative languages othern local languages? (i.e. English only or non-Englishaking countries)

Austria, Denmark,Netherlands, Sweden,France

India, Switzerland,Canada, Norway, Korea

Czech Republic, Poland,Germany, Italy, Spain

Argentina, China, Japan,Mexico, Taiwan, Russia,Singapore

Luxembourg, Slovenia,United Kingdom

Brazil, Turkey, UnitedStates, Australia

Belgium, Romania

ual agreement procedures






Tearing down barriers

Reconciling the interests o taxpayers and governments is an eective andtimely approach to resolving transer pricing disputes. In many cases, it maybe preerred over litigation because double taxation is an almost unavoidableresult o court cases on t ranser pricing. APAs and MAPs oer excellentopportunities or taxpayers and governments to cooperate in nding amutually acceptable solution. Thereore, the immense eort by international

institutions to improve APAs and MAPs should be welcomed and supported.

Companies increasingly are interested in APAs and MAPs. Their key concernsinclude the progress o the contacts between competent authorities, thelength o time to resolution and the eeling o being let out during the process.

Ater all, they have created the object o the negotiations (i.e., the valueand the tax), and the outcome o the negotiations between the competentauthorities also will infuence the design and organization o their nancialsystems. Governments addressing these issues can take steps to tear downbarriers to prosperity.

Similarly, below are suggestions o actions that taxpayers can take to improvethe process.

Taxpayers and their representatives must be prepared to be actively1.involved in the process. This means carrying out additional act-gatheringor the governments that are negotiating their case. It also can meanparticipating in meetings with the tax authorities to be sure that the natureo the business and the transactions in question are understood.

Taxpayers and their representatives have to be prepared or a negotiated2.settlement. This means developing, i necessary, a strategy or resolvingthe dispute, including considering the “go orward” implications o acompetent authority settlement.

Taxpayers must improve the quality o documentation available to the tax3.authorities to support their transer pricing transactions.

Are there consequences to taxpayers and governments i steps are not takento strengthen the MAP? Unequivocally, the answer is yes. Taxpayers will nothave the timely certainty that they need in their dealings with various tax

jurisdictions, and governments will not have the appropriate revenue due themon a timely basis. Arbitration will have to be invoked, which could be costlyand urther delay outcomes o tax disputes. MAPs need to be strengthened sothe outcomes or which they are designed can be achieved more eectively,eciently, and in a timely manner.




Global Dispute Resolution network

David Swenson, Global LeaderWashington DC, USA

(1) 202 414 4650

GDR regional coordinators

Region Coordinator

A7* Spencer ChongShanghai, China

(86) 21 6123 2580

Asia Pacic Lyndon JamesSydney, Australia

(61) 2 8266 3278

CEE/CIS/Europe East Svetlana StroykovaMoscow, Russia

(7) 495 967 6024

Europe West Hugo Vollebregt Amsterdam, Netherlands

(31) 20 568 6632

India Shyamal MukherjeeNew Delhi, India

(91) 11 41150269

Japan Toyoharu NakamuraTokyo, Japan

(81) 3 5251 2355

Latin/South America Mauricio HurtadoMexico, Mexico

(52) 55 5263 6045

North America Richard BarrettWashington DC, USA

(1) 202 414 1480

United Kingdom Steve HassonLondon, UK

(44) 207 804 5393

United Kingdom Susan SymonsLondon, UK

(44) 207 804 6744

Global Transer Pricing network

Garry Stone, Global LeaderChicago, USA

(1) 312 298 2464

TP regional coordinators

Region Coordinator

Asia Pacic Helen FazzinoMelbourne, Australia

(61) 3 8603 3673

CEE/CIS Janos KelemenBudapest, Hungary

(36) 1 461 9310

Europe Isabel VerlindenBrussels, Belgium

(32) 2 710 44 22

North/South America Horacio PenaNew York, USA

(1) 646 471 1957

This document is not intended to provide, and does not provide, tax advice that may be relied upon by the reader. This document is

provided by PricewaterhouseCoopers LLP or general guidance only, and does not constitute the provision o legal advice, accounting

services, investment advice, written tax advice under Circular 230 or proessional advice o any kind. The inormation provided herein

should not be used as a substitute or consultation with proessional tax, accounting, legal, or other competent advisers.

© 2008 PricewaterhouseCoopers LLP. All rights reserved. “PricewaterhouseCoopers” reers to PricewaterhouseCoopers LLP or, as the

context requires, the PricewaterhouseCoopers global network or other member rms o the network, each o which is a separate and

independent legal entity. *connectedthinking is a trademark o PricewaterhouseCoopers LLP (US).

BS-BS-09-0002-A.0808.DvL

* A7 includes Hong Kong/China, Malaysia, Thailand, Philippines, Singapore an d Taiwan



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