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momentum on transfer pricing is building; value creation is the key

Momentum on Transfer Pricing is building; value creation is the key

12 december 2017 - Theo -

We are now two years down the road of the OECD BEPS report (Base Erosion and Profit Shifting) and it seems momentum is still building to tackle aggressive tax payers.

The fundaments in the BEPS discussion lie in the difference between countries legal systems and the information gap of tax authorities to assess value creation taking place on their turf. With the interest of the tax authorities of course in taxing the profits connected to the value creation.

With respect to value creation, the BEPS report in its Actions 8-10 pushed for an economic approach towards tackling the issue. Next to this the OECD pushed for a considerable compliance effort for multinationals in Action 13. The OECD has not been consistent in its approach though. In the same BEPS reports, local tax authorities are granted additional ammunition to step away from the economic approach and get awarded additional taxation rights by means of more lenient permanent establishment rules. Next to this, the issue of the ‘digital economy’ is revitalized in the current discussion, possibly creating ‘virtual’ taxation rights rather than taking an economic approach.

It is in my view fair to balance reporting obligations with assessment duties…

To assess value creation taking place in the countries where a multinational operates, the BEPS Action plan has put considerable reporting requirements on tax payers. Rather than to await how local tax authorities can assess value creation, legislators find political momentum to push for new initiatives to be deployed. It is in my view fair to balance reporting obligations with assessment duties; local tax authorities should be provided with the opportunity to demonstrate their x-border knowledge and the power of Information Technology on the more detailed transfer pricing information they are being supplied with by taxpayers on a global level; let’s take it one step at a time.

The essence in challenging aggressive structures is not how profits are directed to low tax jurisdictions though, but where these profits originate from.

In the current climate, changes in tax legislation are driven by the combat of tax driven structures. The essence in challenging aggressive structures is not how profits are directed to low tax jurisdictions though, but where these profits originate from. The European Commission put it as follows in its press release to make Apple pay back EUR 13B to the Irish government in State Aid: “…Apple’s commercial risks, sales and other activities should have been recorded in their jurisdictions.” In other words: are the countries were Apple is selling its products, raising taxes accordingly? In the Google UK case, the facts are essentially similar. The Google UK sales team should have been remunerated based on its merits, rather than pushing for a UK permanent establishment of the Irish sales reporting entity. The fact that Facebook is contemplating of moving towards a local sales structure is relevant in that Facebook acknowledges its responsibility, what essential changes are made to its sales structure that can account for a change in value creation – the feet on the ground – remains to be seen.

Only people create value

The Sales function is mission critical to every company. To properly assess value creation, I propose the following principles to guide in the assessment of value creation of the Sales function.

  •       Only people create value
  •       For an employee, salary is a representation of value creation

As a consequence, without ‘feet on the ground’ it is difficult to connect profits to a jurisdiction.

On the other hand, a local country can make a proper initial assessment of the value creation by the local Sales force for based on their compensation.

The fact that Apple sales were recorded centrally could provide an explanation why local tax authorities could miss out on local value creation reflecting these sales. Apple’s VAT filings must have given the local tax authorities a proper indication on the whereabouts of Apple’s customer base, though. The same argument would apply for Google. For B2C sales regarding electronic services local VAT needs to be charged from 2015, enabling the local tax authorities to connect local sales to a customer base.

It is the task of local tax authorities to use the additional information provided by tax payers to ensure profits are reported where value creation takes place.

The current discussion on international tax is circulating around the aggressive behaviour of corporate tax payers in Europe. New reporting requirements as part of BEPS will create the transparency the countries have asked for. It is the task of local tax authorities to use the additional information provided by tax payers to ensure profits are reported where value creation takes place. Rather than continuing to change the rules of engagement, it is time to ride the wave and that applies to taxpayers, policy makers and tax authorities alike.

Theo Koelman

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