Transfer Pricing News

Complexity & Subjectivity: A Dangerous Cocktail

The first time someone mentioned BEPS to me (several years ago now), I thought it was a reference to a new party drug. The comment "everyone is doing BEPS now" dropped into an otherwise social lunch with a young guy at the very start of his tax career, who was, to coin a phrase, a bit of a "party boy". To explain my own ignorance, I'd been on a long sabbatical from work, and tried very hard to avoid reading newspapers, much less tax journals for several months, whilst getting delightfully lost driving around the warmer parts of Europe with two small children.

Fast forward to the end of 2015, and most of the world now knows about BEPS. Party drug it ain't! However, having ploughed through most of the 15 reports by now, it is, metaphorically at least, a potentially dangerous cocktail.

First off, the good stuff. The OECD has produced a heroic amount of high quality work in a very limited time scale and should be congratulated for this. The final reports are detailed and insightful, and show a deep expertise and understanding of a range of complex international tax issues to which there are no easy solutions. Much as it would be easy criticise the OECD authors, I don't and wouldn't.

The problem is the underlying nature of reports themselves, i.e. "principle" rather than "rule" based, and their remit, i.e. "guidance" rather than "legislation", which combine to create a very wordy narrative that is almost always open to interpretation.

As a native English speaker, it isn't cool to admit to having struggled with the language in some sections, or needing to force myself to re-read paragraphs a few times before the meaning or context coalesced in my brain. Equally, as an advisor, it isn't good business to admit that much of the guidance is still open to interpretation by tax authorities and the impact in certain key areas remains unclear.

In my own area of specialisation, transfer pricing, we all welcome that "substance" is (re)accentuated, and some lazy TP analysis of corporates, tax authorities and advisors will now be facing a hard time (e.g. default remuneration levels based on “high level functional analyses”, clumsy auto-pilot applications of the TNMM, and benchmarking ranges so wide you could drive a bus through them). However, the "analysis bar" has been raised pretty high and shifted into a realm of peak subjectivity (e.g. an 11 dimensional DEMPE analysis of intangibles is introduced, shifting discussions of legal versus economic ownership to a matter of "value creation", where legal ownership may yield no or very limited remuneration, and funding by “cash boxes” may only yield a risk free return).

Whilst we all see the theoretical merits in such a thorough analysis, the practical application is more complex. Moreover, a thorough analysis will be more expensive for both corporates and tax administrations, and a greater level of detail introduces a greater level of subjectivity and interpretation (i.e. scope of controversy). In addition, the new guidance fails to fully acknowledge the reason some "TP short-cuts" developed in the past, i.e. attempts to proxy or otherwise simplify in a practical way sophisticated market dealing within a controlled group of companies with limited external comparables.

Whilst BEPS helps to refocus the TP spotlight on 3rd party arm's length dealing and market pricing, it comes at a cost. Firstly, we should accept the direct price that must be paid now in doing “better analysis” and the indirect price to be paid shortly in terms of more “audit activity” and “controversy” to come.

In conclusion, and to return to my original metaphor, BEPS is a potentially dangerous cocktail of complexity and subjectivity that will fundamentally change the nature of TP analysis required and the scope for future audit challenge.