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Recent developments in transfer pricing Back  
Financial services firms in Ireland will generally be trading intercompany in some capacity with their parent headquartered overseas. Usually this takes the form of ‘purchasing’ services from the parent eg. management services provided to the subsidiary from the parent. Notwithstanding the fact that Ireland does not have a separate statutory transfer pricing regime, in general tax authorities on the other side of the transaction with financial services companies in Ireland do have transfer pricing regimes, and will therefore be interested in the prices at which intercompany services are traded.
Recent studies conducted in 2005 within the financial services industry in the U.S. still find transfer pricing to be a significant issue, with many companies facing challenge on a number of transfer pricing issues and expecting the level of challenge to increase. Indeed over 50p.c. of U.S. financial services firms state that they set aside a provision for transfer pricing risk in financial statements.

Much scrutiny is being given to the return to various types of services such as marketing services and services in relation to derivative products carried on intra-group in financial services companies provided by overseas offices on behalf of parent companies. In addition, head office expenses from parent companies into overseas subsidiaries are often the focus of scrutiny by local tax authorities. Most tax authorities will expect to see detailed back-up documentation to support the charges. Often, where documentation does not exist or is deemed to be inadequate the amounts claimed as deductions will be disallowed.

As with any transfer pricing analysis it is important in the financial services industry to document where the key risks and value added functions in the supply chain are located. Of particular importance in this industry is to clearly document and reward at arm’s length any cross border use of proprietary financial databases and models. Recent OECD pronouncements have highlighted the need to adequately document the key value drivers in the organisation and introduced the concept of KERT- Key Entrepreneurial Risk Taking functions.

Code of conduct
The EU council on 27th June 2006 adopted a Code of Conduct on transfer pricing documentation for associated enterprises in the European Union. This code aims to standardise the documentation that multinationals must provide to tax authorities on their intra-group pricing. The key points arising from the Code of Conduct are the following:-
* Member states will accept standardised and partially centralised transfer pricing documentation for associated enterprises in the EU.
* Member states will allow smaller businesses to produce less complex transfer pricing documentation.
* Member states should not impose a documentation-related penalty where taxpayers comply in good faith, and within a reasonable timeframe.
* In order to ensure the application of this code, member states are invited to report annually on the practical functioning of this code.

Some of the important points and practical implications of the Code are that where pan-European comparable prices (which are determinded by comparable searches) are used instead of local specific comparable prices, the Code recommends that this fact in and of itself should not subject the taxpayer to transfer pricing related penalties for non-compliance. In addition, the Code does not require member states to introduce transfer pricing documentation requirements at all, only that where member states introduce or amend their documentation requirements care is taken to incorporate the approach of the code. Of course the Code is not a legally binding initiative, but rather has regard to the sovereignty of member states.

Attribution of profits to a permanent establishment - insurance
One of the key points of this OECD produced draft document (as with pronouncements on attribution of profit to banks and global trading), is that the basic premise is that profit should follow the key entrepreneurial risk taking functions in the supply chain. The examples given in the document state that where it is established that these functions are performed solely by the permanent establishment (‘PE’) then the PE will be attributed the newly created insured risks, together with the associated underwriting income and investment income from the assets required as surplus and reserves to support the insured risks. Where the facts show that key activities take place in more than one locale then ‘the relative value of those functions performed in the different parts of the enterprise are used to attribute the insured risk and the associated underwriting and investment income from financial assets’.

In a recent meeting by OECD, business and practitioner representatives to discuss the Draft in May of this year, commentators highlighted the important role played by strategic and risk management activity versus underwriting within an insurance business. The point was made that where activities relate to strategic risk management outside the PE then a cost plus approach to these activities might not be appropriate. In addition, practitioners argued that the implication of the OECD’s identification of key risk taking activities appears to force taxpayers towards a Profit Split type approach to their transfer pricing system. Practitioners noted that where there is clearly an identified transactional arms’ length price for a particular activity that this should be used.

The last main point addressed was regarding whether the OECD is willing to recognise internal reinsurance between a PE and its head office. To date the thinking appears to be that if risks are underwritten locally and that the management of those risks is then managed centrally then this type of set up should be recognised. The OECD stated that they will attempt to produce a second draft of the Part IV document prior to finalising for further discussion. They have a target date of early 2007 to finalise.

IRS regulations
On July 31st The IRS issued final and temporary regulations on intercompany services and intangibles. This replaced the controversial proposed service regulations issued in 2003. The key points are the following:-
* A new ‘service cost method’ allows taxpayers to charge cost for any of 48 services that are deemed not to contribute significantly to key competitive advantages, core capabilities or the fundamental success or failure of the business.
* Allows taxpayers to charge cost for any service with a median comparable arm’s length range mark-up of seven percent or less.

The new rules also narrow the definition of what qualifies as stewardship expenses, which will require more of those types of expenses to be charged out. In addition, shared services arrangements are explicitly allowed for analogous to cost contribution arrangements under the OECD Transfer Pricing guidelines.

As evidenced here, transfer pricing regulations continue to evolve and transfer pricing issues continue to be a main area of focus for most multinationals. Under these circumstances it is important to continue to seek the appropriate advice in order to avoid the many pitfalls in this area.

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