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Thursday, 18th April 2024 |
| Rumours have been circulating that Ireland may introduce transfer pricing rules into its taxation code. It is not clear what need they would meet. It is clear they would be expensive to administer. |
Transfer pricing rules require that taxable profits be computed as if transactions were entered into by the taxpayer on a pre specified basis, usually open market value. Many jurisdictions, including the United States and the United Kingdom incorporate such rules in their tax legislation. At present such rules exist in Ireland only to a limited extent. Recently there has been public speculation that such rules might be included in the Irish tax code, although it is understood that the Revenue Commissioners have indicated that it is not on the agenda for the next 12 months.
A monster
Should we have such rules? It is well however before we do down that road to take heed of the monster which they have become in other jurisdictions.
Any large group is likely to do business across borders. The classic example of a US multinational. Inevitably a large part of the transactions of such a group are between group companies. US transfer pricing rules make it necessary for such multinational transactions out of the USA to be priced on an arm’s length basis.
The establishment of that basis is now a specialised discipline in itself. It requires the employment of teams of economists and tax advisers. Their employment adds nothing to the operations of the multinational but without it, the multinational stands exposed to long term uncertainty as to its tax liabilities, and to potentially large penalties if it is discovered not to have used arm’s length transfer pricing.
This is not a situation where cost arises only to the taxpayer. Where the taxpayer has employed teams of highly qualified valuations experts, economists, and tax advisers, it is necessary for the Revenue authorities to field a similar multi-disciplinary highly expert team. Such teams do not come cheap. A tax collecting authority which wants to apply transfer pricing rules must face very large costs if it wishes to police this area.
Advance agreements
Many jurisdictions that have transfer pricing regimes have tried to offer certainty to trading companies that their pricing structures will not be challenged by the Revenue retrospectively. This reassurance is given by an advance pricing agreement (an APA).
An APA is an agreement between a company and Revenue authorities that a particular pricing structure will for a period be recognised as being open market value.
It may be thought to simplify the system. It does give certainty, but the negotiation of an APA involves the usual multi disciplinary team of accountants, lawyers, economists, and valuations experts, with the Revenue authorities requiring equal expertise on their side to make the system work.
APAs do not reduce the expense of operating the system, they merely remove some of its inconveniences. Indeed, in so far as companies whose transfer pricing policies might never be subject to challenge by the Revenue authorities feel the need for such an agreement to provide it with certainty, the overall cost of operating a transfer pricing regime can be increased by an APA system.
Transfer pricing rules therefore impose very significant costs on cross border businesses and on the Revenue authorities who seek to apply them.
Why do it?
Why have transfer pricing rules? In any situation where profits can be moved from a high tax jurisdiction or category of income, to a lower taxed jurisdiction or category of income, while remaining in the same ultimate beneficial ownership, transfer pricing rules may be necessary to prevent the high tax jurisdiction or income source from having its profits shifted to the low tax source transactions at under market value.
Is this a threat for Ireland? Ireland’s standard corporate tax rates is 20p.c., and falling to 12.5p.c. on trading income within two years. Indeed the effective tax rate for many companies is already at or under 10p.c. What lower tax regimes does Ireland fear? What evidence is there of the diversion of profits out of Ireland into lower tax regimes? Such diversion may occur at the margins of the economy. But viewing Ireland in the context of the world economy and world tax rates, it would be astonishing if there is any serious fear that profits are likely to be artificially diverted out of Ireland. In so far as there is any artificial distortion of profits, the suspicion may be that profits are being diverted into Ireland from elsewhere!
Irish rules
Ireland does have some transfer pricing rules. There are rules designed to ensure that manufacturing relief is not abused. The need for such rules disappears once there is only a single tax rate on all trading income. There is also the basic requirement that any expense incurred by a company for which it wishes to claim a deduction in computing taxable profits should be incurred wholly and exclusively for the purpose of its trade. This requirement, together with other rules that impact on transactions between closely held companies and their shareholders where they are at over value in favour of the shareholder, provide the Revenue with a defence against abusive transactions.
The Irish economy has been largely driven by offering tax incentives to non residents to set up business here. We should be hesitant to be convinced by a relatively short period of prosperity into abandoning old tax principles, and instead copying the tax practices of continental scale economies such as the USA. |
Eric Wallace is a Tax Partner in KPMG.
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| Article appeared in the August 2000 issue.
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