OECD Draft Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations.

On December 2, 1994, Tax Executives Institute submitted the following comments to the Organisation for Economic Co-Operation and Development in Paris, France, concerning the organizations draft transfer pricing guidelines. The comments were developed under the aegis of TEI's International Tax Committee, whose chair is Philip J. Bergquist of Apple Computer, Inc. Contributing materially to the preparation of the comments were Lisa Peschcke-Koedt of Hewlett-Packard Company and Roger D. Wheeler of General Motors Corporation.

This letter responds to the request for comment on the discussion draft entitled, OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, Part I: Principles and Methods (hereinafter referred to as the "Draft Guidelines"), which was released earlier this year, by the Committee on Fiscal Affairs of the Organisation for Economic Co-operation and Development.

As the principal organization of corporate tax professionals in North America, Tax Executives Institute (TEI) commends the Committee on Fiscal Affairs for its work on the Draft Guidelines. We agree that there is a need to update the OECD's extant transfer pricing reports. We also agree that -

[C]ountries need to reconcile their legitimate right to tax the profits of a taxpayer based upon income and expenses that can reasonably be considered to arise within their territory with the need to avoid taxation of the same item of income by more than one tax jurisdiction.

Given the growth in global trading by multinational enterprises and the increased globalization of national economies, the need for greater uniformity in transfer pricing rules and interpretations is manifest. Differing requirements exacerbate the compliance burden on both taxpayers and tax administrations, create barriers to cross-border transactions, and lead to double taxation. Inconsistencies among taxing jurisdictions will invariably lead to increased transfer pricing disputes between taxpayers and tax administrations, as well as tax authorities in different countries, and consequently should be minimized. The OECD's effort to establish reasonable guidelines is a major step in the right direction toward minimizing tax disputes and the resultant double taxation.

Background

Tax Executives Institute is the principal association of corporate tax executives in North America. Our approximately 5,000 members represent nearly 3,000 of the leading corporations in the United States and Canada. TEI is a non-profit organization that represents a cross-section of the business community; it is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and governments alike. As a professional association, TEI is firmly committed to maintaining tax systems that work - systems that are administrable and with which taxpayers can comply.

A substantial number of TEI members work for multinational companies that engage in international trade, including many non-U.S. owned enterprises. Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the various tax laws relating to the operation of business enterprises. Consequently, TEI members have a special interest in the Draft Guidelines.

General Approach

The Draft Guidelines reaffirm the OECD's support for the arm's-length principle as set forth in Article 9 of the OECD Model Tax Convention and in its 1979 report, Transfer Pricing and Multinational Enterprises. TEI agrees with the OECD's views "that the arm's length principle should govern the evaluation of transfer prices among associated enterprises" and that global formulary apportionment does not represent a realistic alternative to that principle.(1) We also endorse the OECD's position that the tax authorities generally must respect transactions as actually structured, because, in our view, each taxpayer is undoubtedly in the best position to determine which method produces the most reliable results when applied to its unique facts. The government's use of data from other (unrelated) enterprises could be unfair where the data cannot be analyzed by the taxpayer.(2) The OECD's approach will foster international competitiveness and cooperation to the benefit of governments and taxpayers alike. We suggest, however, that the rules in the Draft Guidelines are too restrictive, especially concerning non-transaction-based methods such as profit-split methods.

Use of Profit-Split Methods

The Draft Guidelines include profit-split methods (such as residual analysis and contribution analysis) as acceptable arm's-length pricing approaches.(3) The guidelines discourage the use of such methods, however, and provide that they should be used only as a last resort.(4)

The Draft Guidelines provide that "[t]o date, practical experience has shown that in the majority of cases, it is possible to apply transaction-based methods."(5) The majority of cases, however, is not all, and it is clear that there will be cases where it is not feasible to use a transaction-based method. In such cases, profit-split methods can be effectively applied in setting or verifying transfer pricing, settling tax audits, or resolving competent authority proceedings. Such methods might also be employed where the burden of gathering the required data is extreme in relation to the taxpayer's volume of transactions. Hence, while we agree that transaction-based methods will generally produce more reliable results than profit-based methods - where the data are available, in the right circumstances a profit-split method using internal data and readily available market-based data may well be less burdensome than a transaction-based method and produce equally acceptable results.

Profit-split methods may be especially relevant in the context of transactions that are integrated, or where the taxpayer or multinational enterprise has valuable, unique intangibles, and in various industries where profit margins vary widely among competitors. Particularly where intangibles are involved, transaction-based methods may prove vexing: there may be no useful market data or comparable transaction because such transactions are not entered into with unrelated parties. The use of a profit-split method in these cases will generally produce results in accord with the arm's-length principle.

The Draft Guidelines explain the restrictions on the use of profit-split methods by noting the lack of appropriate comparability and consistent information (including accounting methods) across members of the multinational group. Many multinational enterprises, however, have already adopted consistent accounting and currency policies in order to manage their global business more efficiently and effectively. If reasonable documentation requirements are adopted, many taxpayers can provide data sufficient for applying a profit-split method.

The Draft Guidelines question whether the profit-split methods' focusing on internal data is consistent with how unrelated parties structure their relationships. We believe it is. In fact, companies often discuss various elements of their business plans - including expected costs and marketing strategies - with unrelated enterprises in negotiating pricing or establishing other aspects of their relationships. (This is particularly true in the context of joint ventures, or where there is a long-term ongoing business relationship.) The sharing of similar information among affiliates is clearly analogous.

In conclusion, TEI recommends that taxpayers not be discouraged from using profit-split methods - based on internal data and reliable market-based data (where available) - where the taxpayer can demonstrate that such a method is the best method. Taxpayers should not have to disprove the applicability of any other method, subject to reasonable documentation establishing that the method employed is based on reliable data and the results are accurate. We urge the OECD to provide more guidance and support for applying profit-split methods in these circumstances.

Adjustments to Transfer

Prices/Results

TEI generally agrees with the OECD's approach to adjustments to transfer prices or results between affiliates.(6) Third parties generally set prices based on expected costs, volume, profitability, etc. In some cases, third parties may also agree to compensate an entity based on actual costs or results (as in the case of subcontracted services) or to renegotiate or reset prices, even retroactively, if significant changes occur.

Third parties do not, however, generally agree to adjust prices or results outside these circumstances or after the relevant period (i.e., fiscal year) has closed, for example, based on results actually achieved. Worldwide uniformity in the approach to adjusting prices or results between affiliates is vitally important to taxpayers and sound tax administration. Absent consistent treatment, taxpayers face double taxation, unfair customs duties, and an exposure to penalties. TEI urges the OECD to maintain its position on this point and to encourage its member countries (including the United States) to follow such guidelines. It is also critical that tax administrators permit offsetting or correlative adjustments for transfer pricing adjustments between affiliates to avoid double taxation.

Documentation, Penalties,

and Advance Pricing

Agreements

Part II of the OECD report will address documentation requirements and administrative procedures, including advance pricing agreements (APAs).(7) TEI encourages the OECD to establish uniform and practical documentation guidelines that do not place an unfair or costly burden on taxpayers, or expose taxpayers to penalties where they acted reasonably in establishing transfer prices. It is essential that tax administrators cooperate in providing clear, workable, consistent, and easily administrable rules. The required documentation should be limited to the data reasonably necessary to establish that the results are accurate and the method employed was the most reliable.

TEI encourages the OECD to issue guidelines to facilitate compliance across country boundaries and to affirm the importance of APA alternatives. TEI pledges its support of these efforts.

Conclusion

Tax Executives Institute appreciates this opportunity to present our views on the Draft Guidelines. If you have any questions, please do not hesitate to call Philip J. Bergquist, chair of TEI's International Tax Committee, at [phone] or Mary L. Fahey of the Institute's professional staff at [phone].

Letter to New York Governor-Elect George Pataki 

on Appointment of Commissioner of Taxation and Finance

November 29, 1994

On November 29, 1994, Tax Executives Institute sent the following letter to George Pataki, Governor-Elect of the State of New York, concerning the appointment of the next Commissioner of New York Department Taxation and Finance. Preparation of the letter was coordinated by Alan Getz, Vice President-Region II, whose responsibilities encompass the four TEI chapters located in New York. Steven M. Friedlander of the Rochester Chapter contributed materially in the drafting of the letter.

Congratulations on being elected Governor of New York State. As the premier association of corporate tax executives in North America, Tax Executives Institute wishes you success in your administration and pledges its best efforts to assist you in serving all the individual and business taxpayers in the State.

For your information, Tax Executives Institute is a group of in-house tax professionals that was organized in New York 50 years ago. Today, we have nearly 5,000 members who are employed by more than 2,700 of the largest companies throughout the United States and Canada. Our members are responsible for coping with the tax laws - from both a planning and a compliance perspective - on a day-to-day basis. Our 47 local chapters - including four in New York State - have a sustained history of cooperating with state and local tax administrators (including the Commissioner of Taxation and Finance) to improve tax rules and procedures, to prevent misunderstandings, and to building and maintaining a tax system that works - one that is consistent with established policy goals and with which taxpayers can comply.

We understand that, upon taking office, you will appoint a new Commissioner of Taxation and Finance. We urge you to take advantage of this opportunity by naming to the post an individual with substantial business tax experience.

TEI is not a neutral observer in this matter. Our members deal frequently with the New York Department of Taxation and Finance, often on a day-to-day basis. They know from experience (in New York and throughout the country) that leadership makes a difference. The Institute is convinced that firsthand knowledge of how the tax rules affect business operations will prove invaluable in making the Commissioner of Taxation and Finance sensitive to the myriad challenges confronting taxpayers in the 1990s. That sensitivity, in turn, will undeniably help make the Commissioner more effective. Clearly, many individuals outside the business sector possess the technical and managerial qualifications to serve as Commissioner of the Department. We earnestly believe, however, that "front-line" business experience would enable the Commissioner to faithfully pursue your administration's commitment to improve New York's tax system. Stated differently, someone who has had to struggle with the demands of the tax laws on a day-to-day, transaction-to-transaction, tax return-to-tax return basis will not only share that commitment, but be well qualified and positioned to implement it.

Tax Executives Institute appreciates this opportunity to share our views with you. If you should have any questions about this matter, please do not hesitate to have your staff call [Linda B. Burke! at [phone]. Alternatively, your staff may call Alan Getz who works in New York and who currently serves as one of the Institute's Regional Vice Presidents and as a member of our Executive Committee; Mr. Getz's telephone number is [phone].

(1) Draft Guidelines [paragraphs] 30-31, 184. (2) See Draft Guidelines [paragraphs] 17, 30, 31, 152, 158 & 179-95. (3) See Draft Guidelines [paragraphs] 25, 27, 128, 133, 134, 135, 136, 138 & 159. (4) Draft Guidelines [paragraph] 173. (5) Draft Guidelines [paragraph] 172. (6) See Draft Guidelines [paragraphs] 46, 80, 138, 139 & 141. (7) See also Draft Guidelines [paragraphs] 28, 84.