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Transfer pricing Back  
The Government is considering the introduction of new transfer pricing rules. This is something which should not be done hastily. It could damage economic development.
In the September 2000 issue I commented on rumours then circulating that new transfer pricing rules might be introduced. This prospect has received confirmation in Tax Strategy Document No. 40 (dated 17 October) where it was stated ‘It was noted that a paper on transfer pricing would not be on the agenda for TSG before the budget but would be considered in the context of the Finance Bill.’

A Tax Strategy Document is a Civil Service pre Budget discussion paper.

It would be reasonable to infer from this that the introduction of new transfer pricing rules in the Finance Bill 2001 was actively considered. So far new rules have not been included in the Bill.

Depending on what the new transfer pricing rules involve, their introduction may be a minor matter, or it could be a matter with serious implications for our future economic development.

We have transfer pricing
Ireland has transfer pricing legislation at present. S1036 of the Taxes Consolidation Act 1997 effectively prohibits an Irish taxpayer from arranging their transactions with a non resident person so as to understate the true profits arising in Ireland. This is a normal feature of a tax code which you would expect to find in any country.

Any payment by a trader must be wholly and exclusively for trade purposes if it is to be tax deductible. Thus uncommercial payments are generally not tax deductible on first principles. There are also specific statutory rules in this area.

S453 of the Taxes Consolidation Act 1997 deals specifically with companies claiming manufacturing relief (the 10 per cent rate of corporation tax). It imposes open market value on transactions with connected parties where the company claiming the relief either buys from the connected party at under market value, or sells to a connected party at over market value.

In other words, it ensures that the profits on which manufacturing relief are claimed cannot be overstated, while the income of a connected party is correspondingly understated. The section provides for the adjustment to open market value of the income not only of the company claiming manufacturing relief, but also of the person with whom they are dealing.

There are also provisions in capital gains tax and in the rules relating to the taxation of petroleum exploration which can impose open market value on transactions between connected parties.

These rules have been in existence for very many years and have given rise to no difficulty in their operation.

The reasoning behind s1036 and s453 is easily understood. S1036 guards against Irish profits being artificially placed in low tax jurisdictions overseas. S453 guards against profits properly taxable at the standard rate of corporation tax being artificially placed within the 10 per cent corporation tax regime. For as long as we have two rates of corporation tax applying to trading profits, s453 is a necessary protection.

However from 1 January 2003, when we will have two effective corporation tax rates of 10 per cent and 12.5 per cent it is doubtful if it will have any future usefulness as the two rates will be very close together.

IFSC rules
In addition to these sensible measures above, there has been one additional transfer pricing measure. This is specific to the IFSC. It does not appear in our legislation. It is imposed administratively as a condition of the licences granted to IFSC companies. This is a requirement that the auditor of an IFSC company should annually confirm that the company’s transactions have been carried out on an arm’s length pricing basis.

Notwithstanding the existence of this condition in licences, the requirement was held in abeyance until 1998, when the Revenue activated it.

At that time the Revenue, in a widely disseminated letter explained that the requirement for this auditor certificate was ‘viewed as a compelling argument in support of the contention that the IFSC is a well regulated centre. These procedures are consistently referred to as a defence to claims put forward by some jurisdictions that excessive profits are attributed to the IFSC. They are particularly important in the context of the current debate on harmful tax competition.’

In so far as the profits of an IFSC company were based on transactions that did not meet with the arm’s length requirement described, it was likely that the Revenue would have taken the view that they were taxable at the standard rate of corporation tax, currently 20 per cent but dropping to 12.5 per cent over the next two years.

Why make changes?
The special procedures in the IFSC were justified by the Revenue in the context of the ongoing debate on harmful tax competition. But the IFSC regime is being phased out in a fashion agreed with the EU. There cannot therefore be any continuing sensitivity in that area.

Our 12.5 per cent corporation tax rate has not been included in the EU list of harmful tax competition measures nor is it a State aid. However little other EU member states may like it, it is not really open to attack by the EU.

Neither is there any real possibility of persuading EU member states to lessen their hostility to it. By coincidence, many of the major EU states are now governed by left of centre high spend high tax political parties. It is a delusion to suppose that such governments will be mollified by further transfer pricing measures in Ireland.

If those governments have concerns about excessive profits being attributed to trading operations in Ireland, they have for the most part already on their own statute books transfer pricing rules similar to those in Ireland. These aim to ensure that profits properly attributable to their economies are not artificially transferred into low tax jurisdictions.

That being so, it would seem neither necessary nor useful for Ireland to adopt further measures. Any further measures run the risk of being administratively impractical, if based on auditor certificates, and a serious threat to inward investment, if it opens up the threat of a 25 per cent corporation tax rate which could be imposed at the Revenue’s discretion.

Going further on transfer pricing in order to placate our fellow EU members would also be ironic, since several of those fellow members attempt to attract inward investment by using their transfer pricing rules to grant taxable deductions for expenses not actually incurred!

Life is tough. We cannot always expect to be loved. Let us look after our own interests as no one else will.

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