Rules allocating tax jurisdiction

Question 1

What is the rule for tax jurisdiction of immovable property?

Answer 1

• Article 6: allocation rule: State where immovable property is situated: art. 6(1)
• Definition of “immovable property”: art. 6(2)
  
  • See domestic law of that State
  • Always:
    
    • Livestock, equipment sued in agriculture or forestry

Question 2

What kind of income from immovable property falls under art. 6?

Answer 2

• 2 people who can earn income: owner & usufruct of immovable property.
• Payments as consideration for the right to work natural resources:
  
  • Not: ships and aircraft
  • Income from the direct use, letting or use in any other form of immovable property
  • Also income from immovable property of an enterprise

Question 3

What is art. 9?

Answer 3

• Article about associated enterprises: transfer pricing: art. 9(1)
• Upward adjustment of profits if the transaction between related parties was not “at arm’s length”
• Goal:
  
  • Prevent tax evasion/avoidance
  • Prevent shifting of income from high tax to low tax jurisdictions by understating sales (gross profit) or overstating costs

Question 4

What is arm’s length pricing?

Answer 4

• In commercial or financial relations
• A price applied by independent business enterprises under conditions of free competition in the same or comparable transactions

Question 5

What are the associated enterprises?

Answer 5

• Type 1: Where an enterprise of a CS participates (in)directly in the management, control or capital of an enterprise of the other CS
• Type 2: the same persons participate (in)directly in the management, control or capital of an enterprise of another CS and an enterprise of the other CS

Question 6

What are the transactions between the associated enterprises?

Answer 6

• And in either case conditions are made or imposed between the 2 enterprises in their commercial of financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly

Question 7

What are the 4 methods for transfer pricing?

Answer 7

1. Comparable Uncontrolled Price Method
2. Resale Price Method
3. Cost Plus Method
4. “Fourth” Methods

Question 8

Who has the burden of proof?

Answer 8

• Burden of proof that the price is not at arm’s length = tax authorities.
• Very little hard law = soft law = OECD TP Guidelines
  
  • OECD still expects tax authorities and multinationals to apply the guidelines = international consensus

Question 9

What is the arm’s length principle (ALP)?

Answer 9

• Related taxpayers must set transfer prices for any intercompany transaction as if they were unrelated entities but all other aspects of the transaction remain unchanged.
• Look to comparable transactions: factors determining comparability
  
  • ​Problem: nothings is comparable
• Tax authorities should compare controlled transaction to a control transaction = companies are not controlled = uncontrolled transaction.

Question 10

What is the comparability?

Answer 10

• Problem: nothing is comparable
• Factors determining comparability:
  
  • Characteristics of goods and services:
    
    • Nature, quality, volume, type of transactions
  • Functional analysis:
    
    • Consider differences in assets, cost of production and differences in risks, understand group and organization
  • Contractuel terms
  • Economic/market circumstances: geographical, market, governement regulation
  • Business strategies: innovation, risk aversion, market penetration

Question 11

Which method does the OECD prefer?

Answer 11

• OECD favors “transactional”-methods not “formulary apportionment”-methods
  
  • Formula apportionment-method: method to allocate global profits of a multinational on a consolidated basis among the group companies according to a predetermined formula
• No automatic assumption that associated enterprises do not deal at arm’s length (from managerial point of view local subs have incentive to operate at arm’s length to judge real performance of various profit centers)
• Burden of proof of non arm’s length character on tax authorities

Question 12

What is the CUP method?

Answer 12

• Comparable Uncontrolled Price Method = best method
• The transfer price is set by reference to comparable transactions between a buyer and a seller which are not related enterprises (comparison between controlled and uncontrolled transaction)
  • Problem: how to find the comparable

Question 13

What types of comparables exist within the CUP method?

Answer 13

1. Internal comparables
   
   • Sales made by company under audit (or group member) to an unrelated party; sales made by an unrelated party to company under audit (or group member);
   • Eg. Audi manufacturer selling to:
     
     • Dependent Poland = subsidiary
     • Independent Greek distributor
2. External comparables: sales between unrelated parties
   
   • For Starbucks: different company selling coffee

Question 14

When should the CUPs be adjusted and not rejected?

Answer 14

• CUPs may be adjusted and should not be rejected in case of differences between the CUP and the related party transaction if these differences:
  
  1. Can be valued
  2. Have a reasonably small effect on the price
• Problem: very subjective terms.
• Examples:
  
  • Differences of sales: quantity discounts
  • Terms of transactions: delivered price (price includes transportation costs) vs. fob factory (free on board: buyer in charge of transportation costs
  • Time of transaction

Question 15

What makes a CUP not comparable?

Answer 15

• Certain differences do not allow an adjustment ot the CUP = price is not comparable even after adjustment and no reliable CUP-price
• Examples: differences in:
  
  • Quality of products: Citroën vs. Mercedes
  • Geographic markets
  • Market level: wholesale distributor vs. retailers

Question 16

What are examples of CUP method?

Answer 16

• Example 1 of CUP Method
  
  • Japanese company manufactures steel products and ships them to related and unrelated businesses in the UK
  • The products shipped to related and unrelated companies are the same
  • Terms and conditions of the sales and the markets are identical (except for payment terms
  • Sales price to related UK company is lower than to unrelated UK buyers (suspect)
• But: difference:
  
  • Related parties: payment terms of 90 days
  • Unrelated parties: payment terms of 45 days
    
    • The unrelated party sale is a CUP
    • However, the difference in payment terms must be taken into account to adjust the actual arm’s length inter-company price
      
      • It is not logic that the party having the longest payment term, enjoys the lowest price

Question 17

What is the second example of CUP Method?

Answer 17

• A French company sells cheese to related companies located in the USA and Germany
• It also sells the cheese to an unrelated company in the UK
  
  • transfer price needed for the sale to subs
• The UK company sells the cheese to the individual customers (UK company = retailer)
• The related US and German company distribute cheese to unrelated grocery stores (UK company = wholesaler)
  
  • The price charged to the unrelated company is not a CUP, due to difference in market level

Question 18

What is the resale price method?

Answer 18

• Resale price: price at which a product that has been purchased from an associated enterprise is resold to an independent enterprise
• This price is to be reduced by an appropriate gross margin (“the resale margin”)
• Gross margin = amount out of which reseller seeks to cover cost of goods sold and other operating expenses and in light of functions performed (taking into account assets used and risks assumed) make an appropriate profit
• Method typically applied where associated company is distributor: usually fully fledged distributors

Question 19

How do we apply the arm’s length price with the resale price method?

Answer 19

• The arm’s length price for the original transfer of goods between associated enterprises is then given by the difference between the resale price and the gross margin under the uncontrolled transaction
• 2 methods to determine gross margin:
  
  1. Internal comparable
     
     • Gross margin to be derived from third party sales and third party purchases by the tested party (i.e. unrelated party sells to reseller/tested party, reseller sells in open market)
  2. External comparable
     
     • When no internal comparables exist, gross margin to be derived from sales by other resellers in the same or a similar market buying goods from unrelated party (i.e. unrelated party sells to unrelated reseller, reseller sells in open market)

Question 20

When is an uncontrolled transaction comparable to controlled transaction?

Answer 20

1. None of the differences between transactions compared or between participating enterprises materially affect the resale price margin
2. Reasonably accurate adjustments can be made to eliminate material effect of such differences

Question 21

What is the comparibility for the resale price method ?

Answer 21

• As gross profit margin represents compensation for functions performed , product differences under RPM are less important than under CUP, but closer comparability produces better results (e.g. unique intangible).
• Easiest to apply where reseller adds little/no value to good as compared to reseller processing good, incorporating it in other one, use intangibles to add value to good etc.
• Level of activity determines gross margin = compensation of functions performed taking into account assets used, functions performed & risks assumed
  
  • Stock risk (incl. financial), advertising, marketing, develops own intangibles used in creation/adding value to good sold
• Best results where goods are resold within short time (otherwise: storage cost, obsolecence etc.)

Question 22

What is the Cost Plus Method?

Answer 22

• Method most used: certainly with services: certainly for financial services.
  
  • Not for the internal bank multinational = intra-group bank –> better the CUP method
• Typically applied when the manufacturer is a contract manufacturer or for determining the arm’s length charge for services (other than financial services)
• The arm’s length price is set by adding an appropriate mark-up to the cost of production
• The appropriate mark-up = the % earned by the manufacturer on unrelated party transactions which are the same or very similar to the intercompany transaction

Question 23

What are the costs to be included in the basis for the cost plus method?

Answer 23

• Which costs are to be included in the basis? Necessity of careful comparative review of the accounting policies of the companies in order to consistently define the costs to be marked up:
  
  • The more customers the less costs need to be included in base (cfr. Belgian case law)
  • Eg. if you have 1 client: all costs through markup

Question 24

What is toll manufacturing?

Answer 24

• Contract (or toll) manufacturing: the goods transferred under the comparable transaction need not be physically similar to the goods transferred under the intercompany transaction Þ the contract manufacturer is compensated for the manufacturing service provided rather than for the particular product manufactured

Question 25

What is the fully-fledged manufacturers?

Answer 25

• Fully-fledged manufacturers: the product manufactured is critically important to determine the mark-up Þ mark-ups vary considerably from one product to another largely because of manufacturing intangibles that have been developed by the fully-fledged manufacturer:
  
  • Difficult to find a comparable case for a fully-fledged manufacturer

Question 26

What is the example of Cost Plus Method?

Answer 26

• Dutch Co is a specialist glass manufacturer Þ conducts all R&D activities and manufacturing activities in the Netherlands
• After production of the glass, it is transferred to a Belgian sub where it is shaped, through a special technique developed by the Dutch Co.
• The shaping process is not complex, and does not require highly skilled labour (“routine functions”)
• The Belgian sub never acquires ownership of the glass and so he is a contract manufacturer:
  
  • Limited manufacturing services
  • No market risk
  • No ownership of raw materials
  • After processing, goods transferred back to Dutch parent for sale in the Dutch market
• No CUP exist (the Dutch co does not use another unrelated contract manufacturer)
• But the Belgian sub also performs manufacturing services for unrelated cies, thus comparable info will be available from these transactions
• The mark-up earned on services provided to unrelated cies can be used to apply cost plus method

Question 27

What are the Fourth methods?

Answer 27

• Transactional net profit methods:
  
  • Since 2010 TP Guidelines: no longer a method of last resort, but an equivalent method (“the selected transfer pricing method should be the most appropriate method to the circumstances of the case”
• Eg. Profit Split Method (“PSM”): BEPS AP 10

Question 28

What are the conditions for PSM?

Answer 28

Profit split method:

• Each party makes unique and valuable contributions (intangibles);
• Business operations are highly integrated such that contributions of each party cannot be reliably valuated in isolation from each other
• Parties share assumption of economically significant risks or separately assume closely related risks
• Lack of comparables is insufficient to warrant use of profit spilt;
• If reliable comparables available unlikely that profit split is most appropriate method: if it is impossible to find comparable because so integrated and then you are unable to define contribution each component.
• Which profits and which key to split them?

Question 29

What is an example of the PSM?

Answer 29

• Aco (resident of A) parent of Retail-group engaged in retail fashion industry. Developed know-how and enhanced value of trademark & goodwill through intensive marketing (marketing intangible)
• Group wishes to expand to B. Aco grants group member Bco right to use know-how etc. for purpose of retail sales in B. B has strong track record in building brand recognition and loyalty in B through experienced inhouse marketing team
• Aco & Bco will jointly perform marketing and distribution activities in B
• Aco & Bco assume risks associated with (no) success of the commercialisation of products in B
• PSM is acceptable as contributions of Aco and Bco are unique and valuable to the sales business in B
• Actual sales profits will be split
• Key: % of each company’s expenditure in relation to the intangible & marketing strategies

Question 30

What is the conclusion to be drawn from transfer pricing?

Answer 30

• Important to justify arm’s length character of transfer pricing method applied
• Need for accurate information + documentation to be provided by taxpayer
• In several jurisdictions: if information + documentation duty is not fulfilled Þ reversal of burden of proof
• Avoid litigation, seek legal certainty before engaging in intra group transactions
  
  • Conclusion of Advanced Pricing Arrangements (APAs): assumptions, methods for determining TP, comparables, adjustments, time frame
• Importance of Country by Country-reporting by MNE’s and of mandatory exchange of rulings between tax authorities (within EU and outside EU)

Question 31

What is article 9(2)?

Answer 31

• Corresponding downwards adjustment in other Contracting State: avoidance of economic double taxation arising due to upwards adjustment of transfer prices in one State
• Possible solutions:
  
  • Re-opening of assessment (open ended or effect of statute of limitations?)
  • BEPS Action 14: CS cannot rely on domestic statute of limitations so as not to proceed to downward adjustment
• Purpose:
  
  • Purpose: each company is taxed on the profits it should have earned if it had operated at market conditions
  • International economic double taxation is avoided

Question 32

Does the downward adjustment happen automatically?

Answer 32

• No: Adjustment not automatic in other Contracting State (“agree in principle and on amount”)
• Possibility of mutual consultation between competent authorities = so called “mutual agreement procedure” (MAP) (Art. 25)
  • Irrespective of domestic law remedies (Court actions)
  • Upon taxpayer’s initiative (within 3 years of notification of double taxation)
  • If competent authority believes it cannot resolve the issue itself it must consult with competent authority of other State
  • Procedure between States: taxpayers are not parties (“black box”)

Question 33

Are States obliged to reach an agreement?

Answer 33

• No obligation for States to reach agreement (Art. 25 (2) “shall endeavour to arrive at a satisfactory solution”)
• Even if agreement is reached: re-opening of assessment (open ended or effect of statute of limitations?)
  
  • BEPS Action 14: CS cannot rely on domestic statute of limitations so as not to proceed to downward adjustment

Question 34

What is the arbitration convention?

Answer 34

• Substantive provision (Art. 4): adjustment of profits of associated enterprises and PEs in accordance with arm’s length standard
  
  • = Article 9 OECD MC
• Procedural rules (Art. 6 et seq.): enterprise believing that tax authorities do not respect arm’s length standard, must initiate procedure with competent authority of its State of residence within 3 years, if competent authority believes it cannot resolve the issue itself it must consult with competent authority of other State
  
  • Much more advantageous than OECD MAP

Question 35

What is the binding arbitration in the Arbitration Convention?

Answer 35

• If competent authorities do not reach agreement within 2 years, must set up Arbitration Committee (reps of comp. auth. + even number of independent specialists)
• Each enterprise may/must appear before Arbitration Committee & provide evidence (Art. 10)
• Committee delivers opinion within 6 months applying the arm’s length principle and eliminating economic double taxation
• Binding on competent authorities, unless both States agree to deviate from it

Question 36

Does the OECD implement binding arbitration?

Answer 36

• Yes: moving towards binding arbitration.
• 2008 change to Art. 25 à art. 25 (6) binding arbitration if mutual agreement procedure remains unresolved for 2 years. Upon taxpayer’s initiative case à arbitration committee (Comm. Art. 25 § 63 et seq.)
• Arbitration Committee: each CS appoints one arbitrator, both appoint a third arbitrator
• Taxpayer may/must present position in writing or orally to arbitration committee
• Binding decision (unless otherwise agreed by parties)
• Scope broader than EC Arbitration Convention (any unresolved mutual agreement procedure, e.g. dual residence under Art. 4)
• 2006 Belgium/US tax treaty one of the first treaties with binding arbitration and many others have followed since
  
  • •OECD BEPS Action 14: 25 States opt for mandatory binding arbitration, including Belgium

•“The Best Arbitration is no Arbitration” Arbitration should have deterrent effect on tax authorities so that they do reach agreement under MAP

Question 37

What is the EU Directive 2017?

Answer 37

• Purpose: create within EU an efficient MAP with binding arbitration in order to close loopholes/inefficiencies of MAP under tax treaties and the EU Arbitration Convention (scope to of arbitration too small, arbitration panels not formed, timing not respected etc.)
• To be transposed in domestic law on 1/7/19
  
  • In Belgium: Law of May 2, 2019
  • Applicable to disputes re income and capital taxes derived after 1 january 2018

Question 38

What is the procedure in the EU-directive 2017?

Answer 38

• Scope: disputes between MS re interpretation and application of tax treaties = very broad
• In motion: within 3 years after first notification of action of tax authorities leading to dispute
• Complaint with tax authorities of each MS concerned (English allowed)
• MAP: max. 2 years with max. one year extension
• Arbitration: max. 6 months with max. 3 months extension
  
  • But only if dispute concerns double taxation
• MS must execute Arbitration decision even if statute of limitations is reached under domestic law
• All current road blocks to be solved by action of taxpayers before national court (e.g. formation of arbitration panel, non-execution of decision)
• Meant to replace the Arbitration Convention for income earned after 1/1/18

Question 39

What is article 8?

Answer 39

• “International traffic” = definition art. 3.1 (e): new definition OECD MC 2017:
• “any transport by ship/aircraft except when the ship/aircraft is operated solely between places in a Contracting State and the enterprise that operates ship/aircraft is NOT an enterprise of that State”. Examples:
  • A ferry operated between Germany & Denmark by a German shipoperator = international traffic under DTC D/Dk
  • A ferry operated between 2 ports in Denmark by a German shipoperator is NOT international traffic under DTC D/Dk
  • A ferry operated between 2 ports in Germany by a German shipoperator is international traffic under DTC D/Dk

Question 40

What is the rule for international transportation?

Answer 40

• Rule: “Profits of an enterprise of a CS from operation of ship/aircraft in international traffic shall be taxable only in that State”
  
  • Enterprise of CS is enterprise carried on by resident of CS (Germany in examples)
  • PE is not relevant (Art. 8 <> fragmentation of tax base over many CS)
  • Except if ship/aircraft is not operated in international traffic, there PE is relevant
• Profit from operation of ship and aircraft in international traffic: directly obtained from transportation of passengers and cargo by ship or aircraft (owned, leased, chartered) and from (i) activities directly connected or (ii) ancillary (ex. leasing ship/aircraft on charter fully equipped, supplied and crewed (not bareboat charter), bus service to and from airport, inland pick up service, leasing and storage of containers).