The factual nature of transfer pricing (TP) determinations can be an extremely complex subject that frequently vexes both taxpayers and tax administrations alike. In the understandable desire to find bright line rules that do not require the exercise of judgment and analysis, it is often proposed that “safe harbors” be provided.
What is a Safe Harbor?
The theory of a safe harbor is that the burdens imposed in applying the arm’s-length principle may be ameliorated by providing circumstances in which taxpayers could follow a simple set of rules under which a national tax administration would automatically accept transfer prices. In effect, a safe harbor is a defined parameter. If the TP result falls within that parameter, tax administrations would not be allowed to make an adjustment.
Factors Supporting Use of Safe Harbors
The basic objectives of safe harbors are as follows:
- Simplifying compliance for eligible taxpayers in determining arm’s-length conditions for controlled transactions;
- Providing assurance to a category of taxpayers that the tax administration will accept prices charged or received on controlled transactions without further review; and
- Relieving the tax administration from the task of conducting further examination and audits of such taxpayers regarding their TP.
Problems Presented by Use of Safe Harbors
- Implementation in a given country would not only affect tax calculations within that jurisdiction, but would also impinge on the tax calculations of associated enterprises in other jurisdictions;
- It is difficult to establish satisfactory criteria for defining safe harbors, and accordingly they can potentially produce prices or results that may not be consistent with the arm’s-length principle;
- Application of safe harbors to specific situations can be arbitrary in nature;
- In situations where there are bilateral issues, or Competent Authority possibilities, the use of safe harbors can complicate the negotiations and raise a specter of double taxation; and
- Safe harbors can be viewed by some tax authorities as opening avenues for multinational enterprise (MNE) tax planning.
Current work of the OECD Secretariat
In the Fall of 2012, the Organisation for Economic Co-operation and Development (OECD) Secretariat advised that it will release a discussion draft concerning safe harbors to rewrite the pertinent provisions of the Guidelines. The draft will include draft memoranda of understanding agreements that could be used by Competent Authorities, or others, to develop bilateral, negotiated safe harbors that would apply to straightforward transfer pricing cases, such as low-risk distribution, manufacturing and research and development activities.
As this process evolves, it will also be appropriate for the OECD and specific country tax authorities to address MNE concerns that a taxpayer adopting a safe harbor in one country may not be able to obtain relief through Competent Authority procedures when it faces double taxation due to challenges in other jurisdictions.