Transfer pricing makes big splash on global taxes

Multinationals have generated big-time revenues with its subsidiaries spread all over the world, which means huge profits and that’s taxable income. In recent years, a number of conglomerates – Amazon, Apple, Google and Starbucks – have engaged in so-called profit-shifting (profit allocation) via transfer pricing methods to pay minuscule taxes.

Such schemes do boost shareholders’ value, but they burden governments with less taxes, sparking more deficit spending to fund social services.

“You cannot blame companies from using current rules and methods to boost profits for shareholders,” David Chamberlain, executive director of Transfer Pricing for Ernst & Young (EY) Shanghai, told CNTV in an exclusive interview. “But governments have a very legitimate concern on excessive profit-shifting and they have the right to crack down on it.”

Understanding transfer pricing

Transfer pricing serves a useful purpose for corporate accountants and tax officials.

“When a multinational has significant business in a particular country, it typically sets up a local subsidiary to carry on that business,” Chamberlain said. “If the parent company and the subsidiary sell goods or services to each other, it is necessary to set a price for these transactions.”

He added, “Transfer pricing simply refers to the process of determining what those prices are … The effect of transfer pricing is to determine how much of the profit each country earns.”

Yet, here’s where disputes erupt with tax collectors. Countries have set different tax rates; so a subsidiary in the United States with a corporate tax rate – 35 percent – might shift its profits to Bulgaria with a 10 percent tax rate.

More than a few multinationals have long earned notoriety for opening empty offices in tax havens to place their corporate profits there.

OECD bridging tax fairness

Nonetheless, Chamberlain remains optimistic the Organization for Economic Cooperation and Development (OECD), G20 leaders and governments can work together to implement more tax fairness policies on multinationals.

“The OECD has made very serious headway,” he said and noted that earlier this month, they had completed a 2-year project to combat Base Erosion and Profit Sharing (BEPS).

The BEPS project represents the most drastic change in international tax rules in nearly 100 years. It tackles excessive interest deductions to hybrid instruments (tax shelters) to tax treaty shopping, while utilizing transfer pricing as its centerpiece.

BEPS has declared that, “a tax haven subsidiary … Will not be allowed to earn significant profits. Instead, the profits will be allocated to the other group companies, where strategic decisions are made and substantial activities are undertaken.”

New reporting method rules the roost

New OECD laws may not be sufficient to enforce tax fairness on multinationals, but Chamberlain insists BEPS offers a good solution.

“The new (tax) reporting requirements (mandates that) all multinationals with more than 750 million euros in revenues will be required to file country-by-country reports,” Chamberlain said. “(It) will reveal where the multinational profits have ended up and compare it to where the group has sales, assets and employees.”

Such reports will be filed at the multinational’s home country and tax authorities from that nation would share the report with all countries where the conglomerate does business. Consequently, tax authorities from other countries can review those documents to determine accurate figures on taxable income.

Sustainable tax collections for sustainable development

Governments have criticized multinationals for exploiting transfer pricing methods to avoid taxes, but they should ask themselves a couple of questions. Are their tax rates too high? Do they really need more government spending? If lower tax rates get introduced, perhaps more corporations would report taxable income more accurately.

Of course, parking profits in tax havens should be deemed unethical, and hence the OECD is playing a pivotal role to adjust transfer pricing policies to normalize tax collections for all nations and that’s good news for more enhanced social services worldwide.