The steps taken recently by the OECD confirm the tax authorities' growing interest in intangibles, and the prices at which they are exchanged within international groups.
Transfer pricing can be defined as the prices at which all goods and services are exchanged within groups of companies, i.e. companies having common interests.
Although the question of assessing such pricing with regard to the "arm's length" principle arose in the 1930's, it was in the United States, in facing up to the country's excessive levels of debt, that transfer pricing became a real tool of economic policyand really took off.
Currently, given the ongoing economic difficulties, the trend of moving fiscal resources from one country to another constitutes an even greater issue and an instrument of economic policy for all countries, including those which are not members of the OECD.
In the absence of tax requirements, groups of companies would in reality sometimes be less concerned by this issue than the tax authorities of the countries in which they are based. Indeed, although the question of transfer pricing may arise between two countries and may constitute a significant issue in itself, in contrast, the related issue of allocation of taxable profits would be relatively low for groups of companies having fiscal bases in both countries when those countries have materially equivalent tax rates.
For example: if a service, of which the cost price is equal to €900,000, is billed at €1,100,000 by a French parent company to its American subsidiary and re-billed at $1,200,000 by the American subsidiary to third party clients, the resulting profit will be taxed in France at a rate of 33 1/3% on €200,000 (i.e. a fiscal return for the French administration of €200,000 x 33 1/3% = €66,666), and in the United States at 35% on $100,000 (i.e. a fiscal return for the US administration of €100,000 x 35% = $35,000). The issue for governments with regard to transfer pricing is to call into question the allocation of the €/$300,000 margin between France and the United States. A reduction of €100,000 in the transfer price for example, would indeed lead to a reduction in French fiscal revenues of €33,333 and an increase in American fiscal revenues of $35,000. On the other hand, the impact of such a correction for our group of companies in the example would be limited to the difference in the tax rate, which is relatively weak. In theory, the additional fraction in tax payable in the United States ($35,000 in this example) would indeed be compensated by a reduction in the tax burden in France (of €33,333). However, in practice, additional tax paid by a group of companies to one of the countries for previous financial years in the context of tax inspections, is not easily accompanied by a correlative rebate awarded by the other country. Groups of companies are thus frequently economically penalised.
Tax authorities in different countries, faced with the pressure of economic policies, are focusing further on questions of transfer pricing, and more particularly, recently, on the transfer pricing of intangibles.
Three main reasons lie behind the recent attention paid to intangibles by tax authorities.
Firstly, the business of provision of services has grown significantly all over the world over the last few years. Secondly, due to globalisation, it has become difficult to determine the place where service provider groups carry out their provision of services, these being themselves the result of an aggregation of different services carried out in different countries. Thirdly, transfers of activity are multiplying in the context of globalisation and groups of companies have no hesitation in moving whole departments from one country to another.
These three elements have attracted the attention of the tax authorities and examples of tax adjustments linked to transfer pricing of intangibles are now numerous when the authorities note the availability, free of charge, or for a very low cost, of intangibles between companies related to each other. They therefore consider that this service ought to have been remunerated at a higher price, in accordance with the "arm's length" principle. Note, in 2006 the American pharmaceutical group, GlaxoSmithKline, finally settled a dispute with the US Internal Revenue Service regarding the transfer pricing of its marketing intangibles, after fourteen years of proceedings. The group concluded an agreement with the Internal Revenue Service by which GlaxoSmithKline would pay USD $3.1 billion.
The guiding "arm's length" principle with regard to transfer prices is that transactions between related companies correspond to those applied by independent companies, failing which the profits indirectly transferred abroad are incorporated into the tax results of the company in question. In France, this principle is included in Article 57 of the French Tax Code.
Internationally, the reference framework for transfer pricing is constituted by the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, (the "Guidelines") published in 1995 by the OECD. These Guidelines establish a general framework of proposals and recommendations in which the Committee on Fiscal Affairs of the OECD comment on the "arm's length" principle and suggest it be applied according to a methodology based on an analysis of comparability (systems analysis) and determination of methods of assessment of intra-group transactions (comparable uncontrolled price, resale price, cost plus, profit split, net margin).
Two Chapters of the Guidelines concern transfer prices of intangibles more specifically: Chapter VI added in 1996 entitled "Special Considerations for Intangible Property" and Chapter VIII added in 1997 entitled "Cost Contribution Arrangements".
Although these Chapters relating to intangibles shed a certain amount of light on the matter, many questions still remain.
Amongst these is the question of identification of intangibles. Is it a matter of intangibles in the legal sense (trade marks, patents, software etc), in the accounting sense (intangibles appearing on the company accounts) or in the 'fiscal' sense (when a notion of taxable 'wealth' is identified)? In this regard, a question was posed, for example, at the OECD conference in September 2009, as to what extent the Sun may constitute a taxable intangible asset for companies in the tourism sector with regard to transfer pricing policies.
The question of (i) identifying the entity which owns the intangible (in the legal, economic or functional sense) and (ii) valuation methods to be applied by groups of companies to determine the full transfer price, also arise. Should the methods indicated by the OECD in its general recommendations be applied or should account be taken of the specificity of the intangibles and suggest a new method of calculation?
It is in this context that the Committee on Fiscal Affairs of the OECD has undertaken a public consultation on the transfer pricing aspects of intangible assets with a view to revising Chapters VI and VIII of the Guidelines. On 23 September 2010, it published comments received on its website, including from Bird & Bird LLP, to the questions broadcast in its invitation for comments on 2 July 2010 and, in 2011, it should begin drafting a new version of these Chapters, which will clearly be very welcomed.