Front Matter Page

Fiscal Affairs Department

Contents

• I. Introduction

• II. Multinational Enterprises and Transfer Pricing

  1. Why transfer pricing matters

  2. Tax avoidance and evasion through the use of tax havens

  3. Elimination of economic double taxation

• III. Arm’s Length Price Principle

  1. Arm’s length price principle and international guidelines for its application

  2. National rules

     1. Forms of rules

     2. Scope of application

     3. Definition of control

     4. Methodology for establishing transfer prices

  3. Remaining issues

• IV. Surveillance of Transfer Pricing

  1. Centralized administrative system

  2. Use of economists

  3. Industrywide pricing program

  4. Time limitations

  5. Information requirements

     1. Annual reporting

     2. Foreign-based information

     3. Exchange of information based on tax treaties

     4. Extraterritorial power to gather foreign information—recent developments in the United States

     5. Information on comparable transactions

  6. Burden of proof

  7. Penalty

• V. Systems to Improve Predictability or Flexibility of Taxation

  1. Safe harbor

  2. Preconfirmation or advance pricing agreements

  3. De minimis rule

  4. Set-offs

• VI. Recent Discussions on Pricing Methodologies and Some Alternative Approaches to International Income Allocation

  1. The “commensurate-with-income” standard and methodologies proposed thereunder

  2. Some taxation techniques adopted to deal with the difficulty of applying the arm’s length price principle

  3. Unitary apportionment for international income allocation

  4. Cost-sharing arrangements

• VII. Conclusion

• Appendix

  • Elimination of Double Taxation

• Text Tables

  1. Comparison of Transfer Pricing Rules

  2. Comparison of Tax Administration Practices for Monitoring Transfer Pricing

• References

Summary

Tax authorities in several countries have intensified their surveillance of transfer pricing in recent years. Concurrently, international discussions on methods for determining arm’s length prices are being renewed, especially in the area of application of so-called “fourth methods” and valuation of intangible property where the existing international rules do not provide sufficient guidelines.

Developments have also taken place in the area of tax administration practices for monitoring transfer prices. More centralized administrative systems and more powerful administrative tools—for example, longer time limitations and some extraterritorial measures for collecting foreign-based information—have been introduced in some countries.

One argument against the transfer pricing approach is that it is difficult to apply the pricing rules to actual cases and to determine precisely the arm’s length prices. In light of this, some systems for improving the predictability of taxation together with a prudent attitude on the part of tax authorities in their transfer pricing examination practices are essential. The system of advance pricing agreements involving prediscussions between competent authorities could particularly be important.

In spite of all these efforts, the argument remains that the application of the arm’s length price rule is difficult and unpredictable. Unitary apportionment, which is a frequently proposed alternative to international tax circles, though it is unlikely that there will soon be an international consensus for a move to this approach.

A transfer pricing policy is an important issue not only for developed countries but also for developing countries, where taxation of foreign-related businesses often represents a substantial part of total tax revenue. Some taxation techniques are often used in developing countries to deal with the problem of less-equipped tax administrations. In discussing international transfer pricing rules and practices, appropriate attention should be paid to these taxing practices in developing countries.