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New EU code will greatly ease settlement of transfer pricing Back  
The EU has just adopted a Code of Conduct which aims to eliminate double taxation in the area of transfer pricing. Gavan Ryle looks at the background to the Code and how it can benefit Irish companies engaged in international operations.
OOn 7 December last, the EU Council of Economic and Finance Ministers adopted a Code of Conduct to eliminate double taxation in the area of transfer pricing. The Code of Conduct aims to ensure more effective and uniform application by EU Member States of the 1990 Arbitration Convention (90/436/EEC) which was designed to deal with double taxation issues faced by taxpayers arising from transfer pricing adjustments.
The purpose of this article is to provide some background on how this new Code of Conduct has come into being, to highlight the key elements of the Code of Conduct and lastly, to consider some of the implications for multinational companies operating in Ireland arising from the adoption of the Code of Conduct.

How has the new Code of Conduct come into being?
The Code of Conduct was a key element of the first report of the EU Joint Transfer Pricing Forum (JTPF), a body established by the European Commission in July 2002 to consider a number of tax obstacles that are preventing multinational companies that operate in the EU from benefiting fully from the Internal Market. The JTPF consists of a chairman, a tax expert from the tax administration of each (pre 2004 accession) Member State and 10 experts from the business community. The tax administrations of EU candidate countries (as at June 2002) were invited to send observers to the meetings of the JTPF, and, with the exception of Romania all appointed an observer. From an Irish perspective, it should be noted that the Revenue Commissioners have sent representatives to each of the meetings of the JTPF to date.

Since its first meeting on 3 October 2002, the primary focus of the JTPF has been to improve the processes associated with the 1990 Arbitration Convention. At the time the JTPF was established, this convention had not been in force since 2000, due to some Member States failing to ratify a protocol to prolong its application beyond 31 December 1999.

The reason that this issue was given priority by the JTPF was that, in the absence of a workable Arbitration Convention, multinational companies that were experiencing double taxation within the EU were relying solely on the dispute settlement procedures in applicable double taxation treaties. The problem for such companies is that these treaties, unlike the Arbitration Convention, do not impose a binding obligation to eliminate double taxation. As such, at a time when tax administrations across the EU were devoting increasing resources to transfer pricing reviews and audits, multinational companies had no assurance that disputes between two tax administrations of EU Member States over their transfer pricing policies would be resolved so as to eliminate double taxation.

What does the new Code of Conduct achieve?
To backtrack a little, double taxation in a transfer pricing dispute arises where, for example, (i) the German tax authorities increase the taxable profits of a German company on the basis that it has paid in excess of an arm’s length price for an international related party transaction with an affiliated company in Ireland (perhaps the supply of goods, the licence of intangible rights or the provision of services), and (ii) the Irish tax authorities do not make a downward adjustment to the taxable profits of the Irish company.

Prior to the Code of Conduct, the affected multinational would be seeking resolution of the double taxation of its profits in Germany and Ireland through the tax treaty between the two countries, with no certainty on how long this process would take or even that the double taxation issue would be resolved.

By reference to the example above, the new Code of Conduct now establishes common procedures that should lead to resolution of this dispute and elimination of the double taxation within a maximum of three years. Specific procedures that are aimed at meeting this timeframe include:

• Clarification of the starting point of this three year period, specifying the necessary actions of the multinational company to request the application of the Arbitration Convention
• Clarification of the starting point of the initial phase, being the two year period during which the competent authorities of the relevant Member States must attempt to resolve the dispute through the ‘mutual agreement’ procedure of the relevant double taxation treaty
• Operation of the mutual agreement procedure, ensuring that this process is transparent towards the affected multinational company
• Operation of and arrangements for the arbitration procedure (the second phase of the Arbitration Convention), should the competent authorities not reach mutual agreement within two years

A further aspect of the Code of Conduct that should be noted is a supplementary recommendation made in the Code. While this is not an agreed procedure like those highlighted above, it is recommended that the relevant tax authorities suspend collection of the relevant tax payments during the cross border dispute resolution procedures. Should this recommendation be acted upon, this is likely to require legislative amendment in many Member States to ensure that the same procedures apply to collection of disputed tax payments in cross border cases as apply to domestic appeals or litigation procedures.

Finally, the first report of the JTPF also includes discussions on the tasks ahead and the timeframe for extending the scope of the Arbitration Convention to ultimately apply the Code of Conduct across the 25-country EU.

What are the implications for multinational companies in Ireland?
Multinational companies operating in Ireland, be they subsidiaries of foreign owned companies or Irish companies with overseas subsidiaries, are all too aware of transfer pricing as a key taxation issue, despite the lack of broad based transfer pricing legislation in Ireland.

With (at least) two sides to every international related party transaction, the prevalence of sophisticated transfer rules in many of the tax jurisdictions where affiliated or subsidiary companies are resident effectively means that the Irish entity in a multinational company must be aware of the need to price transactions with overseas affiliates on an arm’s length basis.

As of now, in the absence of broad based Irish transfer pricing legislation and active transfer pricing auditing resources within the Revenue Commissioners, transfer pricing disputes involving Irish entities in a multinational company can only be expected to arise in the tax jurisdiction of an affiliated company, and not in Ireland. Further, the tax rate differential between Ireland’s trading rate of 12.5 per cent and the higher rates in other EU Member States can often single out transactions with Irish affiliates for particular attention in the course of transfer pricing reviews conducted by tax administrations of other EU Member States.

With this in mind, the success of the JTPF in drafting the Code of Conduct and having it adopted by the Council can only be good news for multinational companies in Ireland. Going forward, Irish companies engaging in international related party dealings can have the confidence that they are now shielded from double taxation from transfer pricing disputes arising within another EU Member State, and also that the dispute resolution process is now likely to run far more efficiently at a reduced resource and financial cost to the taxpayer.

Taking this point a step further, the existence of the Code of Conduct may also lead to a change in the mindset of Irish companies as they review their transfer pricing policies with affiliated companies in other EU Member States. In the absence of such certainty on the elimination of double taxation, multinational companies typically hold back on fully optimising their transfer pricing policies, fearful of protracted, costly disputes and potential double taxation in the event that a tax administration took issue with their policies.
Now, with the security extended by the Code of Conduct, the potentially serious consequences for an Irish company of a transfer pricing adjustment in another Member State from transactions with an affiliate in that tax jurisdiction are significantly reduced. Perhaps it now becomes a case of ‘nothing ventured, nothing gained’ as Irish entities in a multinational company consider whether transfer pricing policies with EU affiliates lead to an optimal effective tax rate outcome for the multinational company?

A word on what is next
Finally, it is also worth noting that the JTPF has not gone away now that the Code of Conduct has been adopted. Taxation Commissioner L?szl? Kov?cs announced in December 2004 that the EU Commission have decided to extend the term of the JTPF beyond its initial 2004 end date, and that the JTPF should now continue until the end of 2006.

Other key agenda items for the JTPF are the practicalities of standardising transfer pricing documentation requirements across the EU and the use of binding rulings, commonly known as ‘advance pricing agreements’, between tax administrations and multinational companies on transfer pricing. Given the success with the Code of Conduct, we can expect further procedures in these other areas when the JTPF issues its next report in 2005.

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