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Europe as one market - update on transfer pricing Back  
In November 2005, the European Commission adopted a proposal for a pan-European common approach to EU Transfer Pricing Documentation (EUTPD) requirements, which offers a significant boost for multi-national companies seeking to minimise the complexity and costs associated with transfer pricing in Europe while mitigating associated risks. The development will also assist Irish indigenous companies, writes Joan O’Connor in the pricing of cross-border intra-group transactions.
Multi-national companies (MNCs) increasingly regard Europe as one market. More and more frequently they find themselves negotiating contracts on a regional basis for Europe as a whole, rather than on a country-by-country basis. European markets are integrating
Joan O'Connor

or in some circumstances, have already integrated with price or profit divergence between countries not meaningfully different to those found in integrated markets such as the United States. However, tax authorities rules on the pricing of cross-border intra-group transactions (transfer pricing) have failed to keep pace with this business reality. Companies operating in Europe have until now, had to comply with different countries complex and sometimes incompatible transfer pricing rules when preparing their transfer pricing documentation. This imposed unduly high compliance costs on companies operating in Europe and lead to a situation where taxpayers felt that the ‘correct’ pricing policy in one country could trigger an audit in another country.

The European Commission study, Company taxation in the internal market’ SEC (01) 1681 identified high compliance costs and potential double taxation for intra-group transactions as major tax obstacles to cross-border economic activities within Europe. The study showed that compliance costs relating to transfer pricing result primarily from the obligation to prepare appropriate documentation and find comparables. An essential aspect of transfer pricing documentation is the need for high quality comparables for benchmarking purposes - the arm’s length concept as such is based on the existence of such comparables. Until recently, companies have performed costly comparability analysis on a country-by-country basis. Companies have been reticent to take a pan-European approach to documentation due to concerns that it would not be accepted by some European national tax authorities, which typically insisted that only companies from their country be included in a comparable company set. Companies also feared a pan-European approach would make their operations more transparent without achieving any benefit for this increased transparency in the form of penalty protection.

With the effective removal of economic boundaries and market barriers within Europe and the fact that the number of closely comparable companies in any given country for a given functional and risk profile can be limited, a pan-European comparables set may provide closer functional comparability than a local country set. Deloitte member firms made an official submission to the EU Joint Transfer Pricing Forum (JTPF) showing that pan-European transfer pricing documentation based on pan-European comparable companies was more reliable than a country-by-country approach for many fact patterns when employing the most common transfer pricing method, the transactional net margin method (TNMM). It was shown that a country-specific comparability analysis and a pan-European comparability analysis would result in interquartile arm’s length ranges that were not statistically different at a 95 percent level of confidence, even for non euro currency counties and in spite of the fact that GAAP is not harmonised across the EU.

In November 2005, the European Commission adopted a proposal for a pan-European common approach to EU Transfer Pricing Documentation (EUTPD) requirements based on the work of the JTPF. The European Commission recommended that Member States accept standardised and partially centralised transfer pricing documentation for associated enterprises in the EU and that Member States undertake not to require smaller and less complex enterprises (including Small and Medium Sized Enterprises) to produce the same amount of documentation that might be expected from larger and more complex enterprises. The JTPF recommend that tax administrations should evaluate domestic or non-domestic comparables with respect to the specific facts and circumstances of the case and that the use of non-domestic comparables by itself should not subject the taxpayer to penalties for non-compliance.

A company now has documentation related penalty protection in all European countries once it complies in good faith, in a reasonable manner, and within a reasonable time with the EUTPD. These developments offer a significant boost for MNCs seeking to minimise the complexity and costs associated with transfer pricing in Europe while mitigating associated risks. EUTPD allows companies to take a uniform approach to their European transfer pricing rather than dealing with Europe as 25 countries with 25 different sets of rules. Setting and defending transfer prices on a pan-European basis can; reduce companies’ compliance burden by avoiding duplicative country specific TNMM searches; help synchronise internal transfer pricing systems; reduce tax audit exposure and potential conflict in arbitration and competent authority proceedings; and potentially help avoid double taxation.

The simplification of companies’ European transfer pricing requirements and the increased certainty that EUTPD brings must be weighed against the increased transparency it requires on the part of companies with respect to their European operations. The use of the EUTPD approach is optional for businesses and the JTPF recommends that businesses should not be subjected to sanctions merely because they decide not to use it.

The introduction of EUTPD is to be achieved through ‘soft law’. That is to say, it will not be implemented through a European Directive and it will be up to Member States to decide how to implement it at a national level. The success of the EUTPD approach is demonstrated by the fact that various Member States have already amended or included into their national documentation rules provisions that companies can avoid penalties by complying with domestic rules or by applying the EUTPD approach. Member States still retain the option not to require transfer pricing documentation at all or to require a more limited version of the EUTPD.

The EUTPD will bring advantages to companies operating in Ireland whether they are subsidiaries of MNCs or Irish indigenous companies. Despite the lack of formal transfer pricing legislation in Ireland, the existence of transfer pricing rules in foreign tax jurisdictions means that the Irish companies are already aware of the need to price transactions with foreign affiliates on an arm’s length basis. Prior to EUTPD the existence of different sets of documentation requirements represented a burden particularly for Irish indigenous companies wanting to set-up and/or conduct business with affiliated companies in Europe. The EUTPD will bring certainty and allow companies to be proactive in the planning of their transfer pricing approach allowing them to optimise their transfer pricing strategies rather than merely complying after the fact.

Companies need to take a strategic approach to pan-European comparable sets, a balanced representation of all major geographic markets that affiliates operate in is desirable. The results of particular geographic subsets should be examined to ensure they support the overall conclusions presented. Companies should not however always assume that the pan-European approach will work for them, some industries have not integrated fully due to the specific regulations, facts, and circumstances pertaining to them. In these situations a pan-European approach may not be appropriate. Finally problems with different documentation requirements will persist in doing business both inside and outside the EU and thus companies may have to prepare separate documentation packages for EU and non-EU purposes.

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