All around the globe, finance directors of multinational groups point to transfer pricing (“TP”) as the most pressing tax item on their agenda. This is because of the potential for TP adjustments to wreak havoc through the most lovingly-tended profit margins. By way of example, GlaxoSmithKline settled a TP dispute with the United States IRS for $3.4 billion in 2006.
The Irish Finance Bill 2010 was published today (4 February 2010) and includes details of new TP legislation. This follows a decade of rumours about the subject. Historically, Ireland has had no TP legislation. We argued, in an article published in December 2009 that introducing TP legislation would be a retrograde step for Ireland. To view that article, please click here. However, the Irish Government has decided to proceed and we now direct our attention to the draft legislation. So, do groups with an Irish tax presence need to worry?
Why has TP been introduced now?
Although Ireland has had, to date, no TP legislation, there have been a number of TP cases brought by foreign tax authorities involving multinational groups with Irish operations. As a result, Ireland has seen a number of TP adjustments over the past few years. It is likely that the background to the Irish TP legislation is both the list of US TP challenges involving Irish subsidiaries of US multinationals, and, additionally, the increased protectionism of tax authorities throughout the world. The recent Xilinx case (in which we were also involved) received worldwide coverage.
It is understood that the introduction of TP in Ireland is not designed as a revenue raising measure. Rather, it is a defensive measure intended to provide the Irish Revenue Commissioners with shiny new armour to defend the Irish tax base while reassuring foreign tax authorities that Ireland will not countenance improper TP. At the same time, there seems to be an effort to ensure that the TP compliance burden in Ireland is not terribly onerous. Such an interpretation is bolstered by the curiously generous grandfathering provisions contained in the draft legislation.
The three key dates to note are as follows. The Finance Bill is expected to be enacted by early April 2010. There will be little time, and perhaps little appetite, for parliamentary scrutiny of what is marketed as a move to “align Ireland’s tax code in this area with the international norm”. Grandfathering will apply to all TP arrangements existing prior to 1 July 2010. The Irish TP legislation is due to come into force on 1 January 2011.
The form of Irish TP legislation
The draft Irish TP legislation is quite simple. Here are the headline points:
- The legislation will apply to associated persons, where one of the persons is (directly or indirectly) participating in the “management, control or capital” of the other, or the same person is (directly or indirectly) participating in the management, control or capital of each of these two persons. There is no elaboration of “participating”. There is no concept of a potential participator i.e. a person who is entitled to participate on the exercise of certain rights.
- The legislation will apply only to trading or professional operations (i.e. taxable at the rate of 12.5% under Schedule D Case I or Case II). The legislation will apply to the supply and acquisition of goods, services, money or intangible assets. Non-trading operations (the profits of which attract Irish corporation tax of 25%) are not within the ambit of the legislation. This means that activities which are outside a company’s normal trading operations (e.g. investment income, income from real estate, etc), will not be subject to TP legislation. Notably, companies taxed under section 110 of the Taxes Consolidation Act 1997, such as securitisation companies, are similarly not subject to TP legislation.
- Small and medium sized enterprises are exempt from application of the TP rules. This is based on a European Commission Recommendation and essentially excludes enterprises with fewer than 250 employees, and assets of less than €50 million or turnover of less than €43 million. This will have the advantage of excluding a large number of domestic Irish companies from the TP regime, while not falling foul of the embargo on excluding domestic enterprises from TP legislation enunciated by the European Court of Justice.
- Where the arrangement between associates is otherwise than at arm’s length, an adjustment is to be made to recalibrate the arrangement on arm’s length terms. The adjustment may be made where the Irish company has understated income or overstated expenses. The adjustment is made to reflect arrangements that would be entered into by “independent parties”. This arm’s length standard is bolstered by Article 9(1) of the OECD Model Tax Convention and the OECD guidelines on TP. Where the provisions of an actual double tax agreement are inconsistent with Article 9(1) and the OECD guidelines, the double tax agreement shall take priority.
- Double counting in domestic TP adjustments is avoided by ensuring that a corresponding adjustment is available for an Irish company that is on the other side of a TP adjustment suffered by another Irish member of the group. In cross-border situations, double taxation relief may be affected.
- The onus is placed upon the taxpayer to maintain and retain such records as “may reasonably be required” to justify the relevant pricing methodology - not a very prescriptive standard. Of course, this means that there will be an inevitable danger of mission-creep, where the tax authorities gold-plate the statutory requirement in the absence of certainty regarding the documentation required.
- The grandfathering provisions of the legislation are curiously and remarkably generous - see further details in the paragraph below.
Everyone loves a generous grandfather
Arrangements which are agreed prior to 1 July 2010 will not fall within the TP legislation. The term “arrangements” is defined as arrangements or agreements, whether or not legally enforceable or intended to be legally enforceable.
This would appear to permit groups to justify any existing non-arm’s length arrangements forever into the future. It is unclear whether amending an existing arrangement in the future, where certain terms remain unchanged, would cause grandfathering to be lost. An unfortunate consequence of this type of grandfathering is that tax considerations could lead to stagnation in commercial arrangements as the tax consequences of updating arrangements could carry a high TP price.
New entrants to the Irish market after 1 July 2010 will, obviously, not benefit from grandfathering.
What do you need to do?
The first, crucial, step is to avail of the grandfathering arrangements before 1 July 2010. This will involve reviewing existing arrangements (whether contractual or otherwise) and ensuring that they are up to date. If no arrangements are in place, or existing arrangements are inadequately documented, new arrangements should be put in place. Arrangements should be carefully documented and dated. The arrangements should identify functions, reflect the location of assets and regulate the contractual allocation of risk to achieve an optimal TP result. There will be much legal analysis of what amounts to an “arrangement” and much thought will need to be given as to how best to approach this technical legal issue.
The second step to take is to review what legal documentation will be required in the future. Procedures for retention of reasonable documentation, to support the TP methodology, will need to be put in place.
For multinational groups already operating in compliance with other TP regimes, the process will mean integrating Ireland into the system of country by country reporting. TP experts within multinational groups should also educate their colleagues about the implications of Irish TP legislation, particularly as regards grandfathering. Termination, and renegotiation, of arrangements could result in the loss of grandfathering. This is likely to be a commercially sensitive issue in the years ahead.
Finally, for domestic Irish groups, the compliance process will be somewhat more difficult. If the exemption for small and medium enterprises does not apply, robust systems will need to be designed and implemented to plan and document a TP methodology. It may make sense to approach the Irish Revenue Commissioners to seek a ruling on existing or proposed arrangements.