Tageblatt, 11 October 2017
With globalisation on the rise, a growing number of multinational enterprises and their subsidiaries are trading with one another across national borders. For countries that wish to collect tax, this is a complicated matter. The important question is how much tax is owed to which country.
Example: Group Z manufactures cars. In one country, a subsidiary of Group Z manufactures car windows. In another country, a different subsidiary of Group Z manufactures the car seats. In a third country, the parts are put together. The car is sold in a fourth country. These activities are coordinated from Group Z’s headquarters, which are located in a fifth country. The research centre that developed the car is in a sixth country. Group Z then makes a profit on the sale of the car. But which country has a right to collect tax (on the profit), and how much?
The OECD Guidelines were compiled in order to clarify these types of complex situations. The aim of these Guidelines is to distribute overall profit across the various countries in line with the market (arm’s length principle), taking into account roles, assets and risks.
The Guidelines state that Group Z must produce a "transfer pricing study", explains Loek de Preter, an expert from PwC. As part of the study, the enterprise must calculate and demonstrate what prices it would have paid if it had not purchased the products or services - in this example, the car seats or assembly - from its own subsidiary.
A subsidiary is deemed to be part of the group if the parent entity holds the majority of its shares and can exercise control.
For the group itself, the issue is not an important one (if taxes are not involved): what prices should Subsidiary X charge Subsidiary Y (both of which belong to the same group)? According to de Preter, the end result is all that matters to the group. In other words, the profit.
Yet the study is crucial to the tax authorities of all the countries involved. They wish to know the true market value of the relevant service to enable each of these countries to collect the tax they are owed.
However, the question of market prices only applies if all the transactions in this example are conducted within a single group (and between multiple countries): If Group Z draws from a non-internal supplier, to purchase safety belts or tyres, for example, then the situation is clear. Group Z will pay the market price for the safety belts or tyres. The manufacturers of the safety belts and tyres will then pay tax in their country on the profit they earn.
However, all companies that act within the group and across borders must submit this type of transfer pricing study to the tax authorities of the countries involved.
The transfer prices must then be adjusted to market prices. Theoretically, this makes it possible to calculate what portion of the profit on, say, a car sale would have been apportioned to the car seat manufacturer if they were not a subsidiary. The country where the manufacturer’s headquarters are domiciled will then be entitled to that portion of the tax.
"Each country will then receive tax on the relevant portion of the profit - or loss - in line with the market," says Loek de Preter.
For the group, producing this study is of course a huge administrative task. "The OECD has published a good 2,000 pages of transfer prices in the last two years alone," according to de Preter.
In this sense, it is an interesting business line for specialised consultancy. Loek de Preter, who is responsible for this area at PwC in Luxembourg, leads a team of 50.
But let’s get back to the study. In the "master file" document, which is produced centrally, the enterprise’s added value must be presented along with other data, and must then be provided to the other tax authorities involved. If they are satisfied with the enterprise’s internal prices - in other words, if these prices are presented as being in line with the market in a country-specific study and the resulting profit corresponds to the local company’s relative share in the enterprise’s profit - then everything is in order and the taxes can be paid.
However, there is always the possibility of differing opinions because "this is not an exact science". If a tax authority challenges calculated prices as compared to those found on the market and makes corrections that increase the revenue and tax burden, a corresponding correction should also be made in the other country, because the enterprise’s profit will not have changed and double taxation therefore needs to be prevented. If the tax authority in the other country is not prepared to accept this, then there will be discussions between the tax authorities involved. This formal procedure is called the "mutual agreement procedure" (MAP). In the event of a real dispute where countries cannot agree, dispute resolution will be conducted. A decision will be made by a recognised arbitrator, and this decision shall be binding.
"But that only happens very rarely," states de Preter. "The countries want to reach an agreement." Globally, only 2,500 new MAPs were recorded in 2015. Luxembourg was involved in 212 of these.
"But the Luxembourg financial administration resolves these cases efficiently," according to de Preter, who has almost 30 years’ experience at PwC and other enterprises involved in this area. In late 2015, there were only 137 open, unresolved cases involving Luxembourg. In the same year, Belgium still had 632 open cases, and the Netherlands had 259.
This is a new area for the Luxembourg authorities. It is only since 2015 that enterprises active in Luxembourg (and other countries) have needed to compile a transfer pricing study. "Prior to that, without a local study, Luxembourg generally held a less favourable starting position in discussions," de Preter says. Meanwhile, Germany has had these studies since 2004. "Today, the studies mean that Luxembourg can also give its response with support from a local study, for example if it deviates from an analysis carried out in Germany."
Globally, a total of 76 countries adhere to the OECD Guidelines, including Luxembourg. There are additional rules in 20 countries, such as the USA. Brazil is among the countries that do not participate.
In the case of trade within an enterprise between German Federal States or between US States, this task is not necessary. However, for trade within an enterprise on the EU’s internal market, companies must produce these studies. As de Preter explains, this is because every EU country has its own tax laws and because there are different tax rates and tax regulations.
Communications & Media Relations , PwC Luxembourg
Tel: +352 49 48 48 5821