11 May TRANSFER PRICING: A MUTUALLY BENEFICIAL FRAMEWORK
By Miguel Vasquez
Transfer pricing has been the focus of Governments in Trinidad and Tobago (‘T&T’) for some time, and was once again came to the fore in March, 2023 when a team from the Inter-American Center of Tax Administrations visited the Ministry of Finance and the Inland Revenue Division. The visit was recognised as an opportunity to create a transfer pricing regime tailored to T&T. Statements surrounding the need for transfer pricing legislation in T&T have, for the most part, been made from the perspective of the loss of tax revenue for T&T from companies that were allegedly manipulating their income by conducting transactions that were not at arm’s length. What this perspective ignores is that taxpayers can also derive significant benefits from the implementation of transfer pricing legislation in T&T, for a number of reasons.
This article aims to provide an overview of transfer pricing legislation, and to consider how both sides, i.e., tax authorities on one side, and taxpayers on the other, can benefit from transfer pricing legislation.
For the removal of doubt, it is important to note that T&T does not currently have specific transfer pricing legislation. To the extent the tax authority (the ‘Inland Revenue’) can intervene or examine related-party transactions, it has done so through the following legislative provisions:
- Section 10(1)(b) of the Income Tax Act, which imposes a blanket two percent (2%) restriction on outgoings and expenses in respect of management charges paid to or for the benefit of a non-resident, and which seeks to limit a potential avenue for shifting value from a related party taxpayer.
- Section 67 of the Income Tax, which allows the Inland Revenue to disregard an “artificial” or “fictitious” transaction which reduces or would reduce the amount of tax payable. “Fictitious” is interpreted to mean a sham, while “artificial” is given a broader meaning to encompass the following circumstances: (i) A transaction that is not at arm’s length; (ii) A transaction that does not make commercial sense, is unnatural and not one which one would expect in circumstances of persons acting freely with each other; (iii) A transaction where there is substantial disparity between the price at which the transaction is carried out and the fair market value of it; and (iv) where the circumstances are such that one can fairly infer that there was a device to reduce or avoid tax by the taxpayer.
- The Associated Enterprises Article of a Double Taxation Treaty, which, where present, allows Member States of the respective treaties to “disregard” transactions between associated enterprises and tax the enterprise as if the transaction was made between independent enterprises.
In the absence of specific transfer pricing legislation, authorities have considered that this creates opportunities for base erosion and profit shifting to occur, whether through transfers of intangibles for less than full value, the over-capitalisation of lowly taxed group companies, or from contractual allocations of risk to low-tax environments; in transactions that would be unlikely to occur between unrelated parties.
Transfer pricing legislation will aim to create a framework that requires taxpayers to prepare, maintain and provide documentation to support the arm’s length nature of their transactions with related parties. This documentation requirement is intended to enhance transparency for tax administrations such as the Inland Revenue, in order to provide it with information needed to properly make an assessment. Very few countries have created their own comprehensive framework of transfer pricing rules, but rather, place reliance on the OECD Transfer Pricing Guidelines (the ‘TP Guidelines’), which represents internationally agreed principles.
The TP Guidelines set out in detail, a standardised approach to the documentation required to be maintained, which includes:
- A “master file,” which should contain standardised information to provide a high-level overview relevant to all group members, in the nature of its global operations, its transfer pricing policies, and its global allocation of income and economic activity;
- A “local file,” which should refer to the local taxpayer, providing detailed information of specific intercompany transactions to demonstrate that the taxpayer has complied with the arm’s length principle; and
- ACountry-by-Country Report, which will contain certain information relating to the global allocation of group income and taxes paid together with certain indicators of the location of economic activity within the group. Only companies that are part of groups with annual consolidated group revenue equal to or exceeding a certain amount is usually required to comply with this requirement.
The reporting requirements will be tailored to suit the circumstances of a taxpayer, particularly where certain requirements may not be relevant to that taxpayer.
While taxpayer companies will be required to comply with disclosure and documentation requirements, transfer pricing legislation is primed to provide significant benefits to taxpayers. In its absence, the determination of arm’s length prices in related-party transactions has been met with arbitrary and inconsistent treatment at times, particularly in circumstances where (i) associated enterprises may engage in transactions that independent enterprises would not undertake; (ii) there may be difficulties in obtaining adequate information to apply the arm’s length principle; and (iii) the application of the principle in a vacuum may present an administrative burden to evaluate certain numbers and transactions.
Transfer pricing legislation would create the possibility of having:
- Advance pricing arrangements (‘APAs’) which is an arrangement that determines, in advance of controlled transactions, an appropriate set of criteria such as the method, comparables and appropriate adjustments and critical assumptions as to future events, for the determination of the transfer price for subject transactions over a fixed period of time. An APA will not fix the actual price for a transaction but rather the basis on which future pricing is to be determined. APAs may be useful for (i) global securities and commodity trading operations; (ii) multilateral cost contribution arrangements; and (iii) attribution of profits to permanent establishments.
- Safe harbours, which create regimes that apply to a defined category of taxpayers or transactions and that relieves eligible taxpayers from certain obligations otherwise imposed by a country’s general transfer pricing rules. By following a simplified set of prescribed transfer pricing rules in connection with a specific transaction, taxpayers may benefit from the certainty that actual prices in controlled transactions will be accepted by the Inland Revenue with a limited audit, or without an audit beyond ensuring that the taxpayer has met the qualifying conditions and complied with the safe harbour provisions which will enable it to benefit. Safe harbours also simplify compliance and reduce compliance costs both in determining and documenting pricing and conditions for controlled transactions.
Beyond what transfer pricing legislation will provide, taxpayers may also derive the following benefits:
- Enhanced transparency and certainty: Transfer pricing legislation provides greater transparency and clarity regarding intercompany transactions and transfer pricing policies. This transparency can foster trust and confidence among taxpayers as clear guidelines create certainty regarding tax treatment and ensuring fair business practices, to assist in proactively managing risk. The Inland Revenue will be better placed and responsible to make well-informed decisions regarding a taxpayer.
- Attract foreign investment: Foreign investors often seek countries with transparent and well-defined tax frameworks. The provision of a clear set of rules and guidelines for transfer pricing reduces uncertainty and enables investors to feel more secure in their understanding of the transfer pricing requirements and potential tax implications.
- Improved tax compliance: Legislation and documentation requirements will encourage taxpayers to maintain detailed records and conduct thorough transfer pricing analyses. This promotes tax compliance to require businesses to strive to align their transfer pricing practices with the arm’s length principle and disclosure requirements.
- Reduced risk of disputes: Transfer pricing documentation serves as evidence of arm’s length pricing and can help prevent transfer pricing disputes between taxpayers and tax authorities. It helps to mitigate tax risks by establishing clear rules and procedures for determining arm’s length prices. This reduces the likelihood of tax assessments, penalties, and double taxation resulting from transfer pricing disputes. Taxpayers can have greater certainty about their tax obligations, enabling them to plan and allocate resources more effectively.
- Alignment with international standards: Implementing legislation that aligns with international transfer pricing standards can signal T&T’s commitment to international best practices. This alignment can enhance the country’s reputation as a reliable and compliant jurisdiction.
Contrary to the perception that transfer pricing primarily benefits tax authorities, transfer pricing legislation can also be advantageous to taxpayers. Legislating transparent and robust transfer pricing policies can be crucial for ensuring fairness, fostering sustainable growth, competitiveness, certainty, and confidence for taxpayers.