4. Transfer pricing Flashcards
What should taxable income represent for tax systems to work as intended?
It should broadly represent the value creation within the states’ tax liability. Transactions and transfers between associated enterprises must thus be carried out based on market prices.
What is the general risk with incorrect pricing?
Eroding the tax base in one state while increasing it in another state. Erosion = not taxed for income created in the state.
What are two things incorrect pricing can be used for?
- Imitate group consolidation. Giving products to a subsidiary instead of selling them (where one would have had a loss and one a profit).
- Tax arbitrage - moving profits to a state with a lower tax rate by giving products instead of selling. Only makes sense if there is a difference in tax rates between the states.
What is the solution to incorrect pricing?
All pricing should be based on the Arm’s length principle, which means that market prices should apply. Market prices are prices that would apply when dealing with non-associated companies (buyer & seller does not influence each other). In practice it can be difficult to prove what market prices are (can be an argument between taxpayers and tax authorities).
Are there opportunities for tax planning even if you use correct prices?
Yes. you can benefit from putting some functions of the value chain in a low-tax state, such as retailing.
What are states’ different interests regarding market price (subsidiaries)?
A Home state of a seller will not allow the price to be below market value, and will thus claim for higher prices to increase income and thereby tax base.
A Home state of a buyer will not allow the price to be above market value, and will thus claim for lower prices, so that costs decrease and the taxpayer is eligible for less tax deductions.
What is a dealing?
A fictitious agreement internally, for example between a company and its PE, which are really the same entity.
What are principles for incorrect pricing for PE’s, with the exemption method and the credit method?
Under the exemption method, both states are interested in correct arm’s length pricing:
- The state where assets, products and/or services originate from does not want the price to be too low (less taxable income).
- The “buyer” state does not want the price to be too high (less taxable income).
In the credit method, correct market pricing is less of a problem for the Home state (X). The Home state taxes the worldwide income, so incorrect pricing can increase credit for foreign taxes, which can lower actual paid taxes in the Home State. In the PE-state (sourced income), pricing is still decisive for calculating the taxable income. For market value, State Y hence does not want the PEs purchases to be too expensive, or their sales to be too cheap.
What is exit taxation?
Exit taxation is similar to transfer pricing. We need to establish the market value of transferred assets or functions, but there is no actual sale of them. Upon transferring assets/functions outside of a State’s tax liability, the state will tax unrealised profits or gains. They will tax the transfer at market value as if it was a sale, in the state where they were moved from. With the credit method, they are however unlikely to tax the transfer, because the worldwide income is still taxed in the state.
The receiving state will need to calculate new bases for the incoming businesses, which can be fictitious acquisition values needed for tax purposes and for calculating deductions (depreciation, amortization, etc). Normally, it is taxed as a purchase in this state based on the market acquisition cost.
