By Konstantin Sakuth, Linklaters LLP, Munich
The EU Joint Transfer Pricing Forum (JTPF) recently published a report on joint transfer pricing audits, setting out ten recommendations for EU governments that wish to undertake such an approach.
The report, titled A coordinated approach to transfer pricing controls with the EU, issued late October, discusses how joint transfer pricing audits or “controls” should be conducted and what it takes to make such controls the most promising and efficient, including organizational and procedural matters.
This note focuses on the first part of the report, dealing with the legal framework for a cooperative approach to transfer pricing controls in the EU.
Transfer pricing joint audit framework
The concept of “joint audit” originates from the OECD but the JTPF points out that EU tax administrations are in a position to conduct such an audit if the necessary legal framework is set in place.
The initiative between Italy and Germany is one example for a joint audit within the EU which was also advertised in a recent interview by a representative of the Bavarian tax administration (Dr. Thomas Eisgruber) and his Italian counterpart (Vito Furnari).
It was stated that taxpayers even specifically ask to be subject to a joint audit and that such audits can be preferred when two countries aim to avoid the opening of a mutual agreement procedure (MAP) (see below).
Participation of foreign officials in other countries’ tax matters
National law sets certain limits when it comes to the involvement of foreign officials in tax procedures.
The JTPF collected data from the Member States by asking them (i) whether their national law allows the presence of visiting foreign officials in administrative offices and enquiries (passive participation) and (ii) whether national law allows visiting foreign officials to interview individuals and examine records (active participation).
Besides Hungary, all Member States replied to the questionnaire which led to the following results: Almost all Member States have legal provisions in place which allow passive participation, with Luxembourg and Romania being the only two exceptions.
With respect to the possibility of active participation, the answers were almost evenly divided amongst the Member States, i.e., 50/50 yes and no.
In light of these results, one of the recommendations of the JTPF is for Member States to implement national legislation which would enable visiting foreign officials to actively participate in audit proceedings.
Downward transfer pricing adjustments
As it is the case for every relationship, the relationship between the taxpayer and the tax administration is likely to work best when it is based on dialogue and trust, according to the JTPF’s report.
It seems reasonable to assume that a tax administration can expect to receive more trust from the taxpayer if the taxpayer can count on a corresponding downward adjustment whenever it would be required to mitigate potential double taxation (see Article 9(2) of the OECD Model Tax Convention).
However, the problem is that this requires an agreement on the “right” arm’s length price which inevitably would result in one country being forced to give up on collected tax revenues.
The questionnaire sent to the Member States also asked whether national law allows a downward adjustment as a result of a coordinated transfer pricing control.
The answers reveal that 14 out of the 27 responding Member States do have such a legal provision.
Germany and Spain didn’t indicate a clear “Yes” but stressed that certain circumstances would be required for such downward adjustments, e.g., in Germany such adjustment would depend on the procedural status of the tax assessment or would have to be the result of a MAP.
The remaining 11 Member States do not permit downward adjustments.
Considering this rather taxpayer-unfriendly situation in certain EU countries, another recommendation of the JTPF is for the Member States to implement national provisions allowing downward adjustments if a common understanding of the fact and circumstances and of the application of the arm’s length principle is given.
Tax administration relationships
One can be doubtful about whether jurisdictions can and are willing to agree on arm’s length transfer prices.
Some fear that in future tax administrations from different jurisdictions will fight even more severely for their slice of the tax revenue pie. The JTPF intends with its recommendations to achieve more effective audits which would make MAPs redundant. Whether this noble aim can be accomplished remains to be seen.
The yearly released MAP statistics could be used as a benchmark.
So far, the number of newly initiated MAP cases continues to be substantial. The most recent statistics of the EU on pending MAPs under the Arbitration Convention show that 547 cases were initiated in 2017 compared to 481 in 2016.
But – on a more positive note – the number of resolved cases increased from 314 in 2016 to 534 in 2017. As a caveat, it should be kept in mind that these are numbers for the EU only.
Considering that multinational enterprises do not operate only within the EU, but globally, one should take a wider view. Obviously, the more countries involved the more potential there is for disputes and MAPs (in this regard see MAP Statistics for the OECD Inclusive Framework countries).
Joint audit – the way forward
It is up to each Member State now to consider the recommendations of the JTPF and possibly offer the taxpayer a mutually beneficial transfer pricing control.
As a next step, one must get the non-EU countries on board, which could be achieved by including provisions on joint audits in double tax treaties, as proposed by Mr. Eisgruber in the recent interview on joint audits.
—Konstantin Sakuth is an Associate with the tax team of Linklaters LLP in Munich and holds an LL.M. in International Tax Law from WU Vienna.