Not that long ago, a company operating on a global scale would have a tax policy that looked something like this: it might have its headquarters and back-office functions spread across the US and the UK, but the true jewel of the company – at least according to tax authorities – was its intellectual property. That would be housed in a Bermuda entity and taxed according to Bermuda’s very liberal tax regime. The structure and countries might vary, but the point was always the same: minimise corporate income in a high-tax country and maximise it in a low-tax one.

Not surprisingly, there was tension between global tax authorities and multinationals over such structures and the resulting transfer pricing – that is, how the goods, services and intellectual property belonging to the company are valued as they move across borders within the company’s foreign units.


But now these tensions have risen to even greater heights following the implementation of the OECD Base Erosion and Profit Shifting (BEPS) framework, which calls for companies to use arm’s-length pricing in their inter-company valuations and which encourages tax authorities to share information among themselves.

Spirit of BEPS

“The spirit of the BEPS initiative was to look at the functions that were performed within the country and then make a determination as to how that contributes to the overall value chain of the company on a global basis,” says Henric Adey, director and national leader of the transfer pricing practice at accounting firm EisnerAmper. “What the OECD wanted to prevent was that old-school model in which a company would report all or most of its income from a country in which it didn’t have a significant footprint.”

These tensions will heighten further as the various provisions from the BEPS project continue to go into effect.

In July 2017, the OECD updated its transfer pricing guidelines to reflect the principals of the BEPS project. These guidelines require a company to produce three documents for tax authorities – a master file, local file and a country-by-country report – which, taken together, provide a complete roadmap to tax authorities about its local and global tax practices. The first country-by-country reports are due to be exchanged by countries in June.

Looking for revenues  

But even without all of the documentation in place, tax authorities have been stepping up their scrutiny of multinationals’ transfer pricing structures. There has also been a noticeable reluctance among them to forge advance pricing agreements with these companies. “In general, tax authorities have become much more savvy and they’re hiring a lot more economists to come up with novel ways to try and tax more of the income,” says Darren Lo, partner at public accounting firm Moss Adams.

The result for the world’s multinationals is a lot less certainty than there used to be, according to Ken Harvey, a partner and certified public accountant at Moss Adams. For example, consider the situation of a US-based software company selling into the UK with just a sales office in the country to distribute that software to customers, he says, adding: “Often the salesperson in the UK would be remunerated based on a bonus, according to the level of sales that they generated in the region.”

Before 2016, the UK tax authority would have accepted that the reimbursement would have been at cost plus a certain percentage of mark-up, about 5% to 10%, according to Mr Harvey. “The UK authority is now being a little bit more aggressive as it is taking the view that if someone is remunerated on a bonus, it cannot necessarily be on a cost plus basis anymore,” he adds.

Essentially, Mr Lo says, the UK authority is now looking for a greater share of the income, by taxing some of the sales, as opposed to just basing it on the level of cost.

Unknown terrain  

It is no accident this example centres around software, as tax authorities have been heavily focusing on the tech industry. Tax authorities are now parsing how much profit should be derived from an intangible and how much profit should be attributed to such factors as where the customers are or where the person who issues the invoice is located, according to Mr Harvey.

It is a very unfamiliar terrain now and the best protection companies have is to review their overall exposure to transfer pricing risk, says Mr Adey, who adds: “Determine what is the materiality of your intercompany transactions and whether the company’s value chain aligns with its tax and transfer pricing model. You need to map out who does what, where do we create value, what is our intellectual property, what are our more routine functions, and how it all falls together.”