In order for a multinational enterprise to conduct effective cross-border trades, it requires efficient supply chain management. The competitiveness of an organization draws significant influence from the proficiency of its respective supply chain. Multinational organizations consider the advantages that arise from supply chain management. One of the aspects that these organizations consider in terms of management of their supply chains is transfer pricing. Issues concerning transfer pricing usually arise when multinational enterprises consider restructuring their supply chains in terms of tax efficiency. Typically, tax planning is one of the vital steps included in planning the enterprises’ supply chains. This is because of the benefits that a multinational enterprise stands to accrue from a tax-effective supply chain. However, conflicts of interest may arise in the application of tax liabilities for the enterprises and the tax administrators. Regardless, the inclusion of Organization for Economic Cooperation and Development transfer pricing guidelines and other domestic regulations mitigate this issue by ensuring both parties gain from transfer pricing.
A transfer price constitutes the amount issued by a section of an enterprise for an asset, and a commodity or a service it provides to a different section of the similar venture. Indeed, the transfer price outlines the tax base of the nations involved in the international transactions (Bullen, 2011). Accordingly, the parties participating in the operation are the relevant bodies of the group of the multinational enterprise. Additionally, the tax bodies of the respective nations are part of the enterprise’s entities. This explains the reason why taxes implemented in one country possess an effect in other countries. Naturally, when the tax entity of a respective nation alters the gains of a particular Multinational Enterprises (MNE) group’s member, the action poses an implication on the tax base of a different country. Based on these suppositions, it is clear to surmise that cross-border taxation circumstances comprise issues concerning jurisdiction, income apportionment and valuation.
Usually, transfer prices establish the proceeds of the related parties implicated in the cross-border business. In order for transfer prices to undergo effective implementation, it is also significant to apply the Arm’s Length Principle. Article 9 of the OECD Model Tax Convention provides that, “(where) conditions are made or imposed between the two (associated) enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly” (OECD, 2010, 33). The arm’s length principle asserts that the prices and conditions under which managed transactions transpire should exercise similarity in the same manner they would perform cross-border operations with unrelated bodies (Bullen, 2011). Under this principle, the transactions within an MNE group undergo comparison with transactions occurring among unrelated entities in order to determine satisfactory transfer prices. The justification for the arm’s length principle concentrates on the equal treatment of transactions occurring among intra-groups.
Accordingly, various issues concerning transfer pricing arise in the supply chain management of multinational enterprises according to the OECD Base Erosion and Profit Shifting (BEPS) Report. Foremost, the transfer of intangibles and risks are a major transfer pricing issue. The shifting of intangibles and risks comprises one of the restructuring activities that MNEs may engage in the management of their supply chains. Additionally, the validation of management may comprise the transfer of intangible property and risks via the alteration of contracts between the organization’s subsidiaries or the multinational enterprise and its suppliers. The valuation of intangibles, for instance, copyrights and trademarks, for tax obligations is a convoluted tax. Usually, it is complex to measure the expenditure of development and the ensuing profits as well as assessing the relationship between these two aspects (Kobetsky, 2011). However, the nature of intangibles facilitates their mobility and provides an opportunity for effective tax planning and the maximization of profit. Nonetheless, the transfer pricing of intangibles poses risks since it can create valuation disputes among tax authorities.
The increasing significance of intangibles arises from third-party suppliers who serve an increasingly considerable share of the supply chain. While conventional organizations depended largely on the effectual utilization of their assets, recent innovation in information technology and the globalization of the international economy has provided novel ways of enhancing competitiveness through intangibles. Regardless of the benefits of intangibles, complexities may arise while attempting to carry out valuation for tax obligations. For instance, insufficient external comparables, together with future uncertainties, hinder the creation of accurate valuations (OECD, 2013a). Furthermore, it is hard to utilize extensive transactional and economic information for assessment of the intangibles’ value due to the absence of direct comparables. Accordingly, it may also be difficult to disaggregate an intangible’s value. Assessing the relationship between the outlay of building up an intangible and the payoff is nearly impractical. Furthermore, tax authorities may imply a disparate perspective from that of the enterprise concerning the returns originating from an intangible asset.
In terms of restructuring, transfer-pricing issues may also rise from the transfer of risks. This is one of the issues under consideration by the OECD with reference to transfer pricing and cross-border transactions. Usually, the restructuring of a multinational enterprise or its subsidiaries poses a threat on the tax bases of the nations, which comprise the enterprises’ locations. Restructuring of an enterprise’s supply chain may involve a risk transfer. Such transfers may imply negative implications on the respective country’s tax base. Usually, the transfer of risks leads to an effectual alteration in the functional profile of a subsidiary. Common variants of risks comprise operational, credit, foreign exchange, marketing, stock and risks associated with the ownership and management of intangibles (OECD, 2013a). For instance, a subsidiary may be a wholly fledged distributor, but after restructuring, the subsidiary may carry out limited operations, possess few or null assets and attain minimal risks.
Another transfer-pricing issue in supply chain management comprises the use of excess debt for financing. Usually, the capital that an enterprise may own may possess a considerable portion of leverage than equity. Even though this instance seems perplexing and disadvantageous to a firm’s payoff, it is exploitative based on a taxation perspective. This is because a multinational enterprise may incur more benefits in terms of financing via debts than equity. Furthermore, financing through debts is more beneficial since the reimbursement of interest on debts may undergo deduction for purposes of tax. However, the distributions on inventory comprise dividends that are not liable for deduction. Based on this assertion, it is evident that multinational enterprises may perform tax avoidance schemes due to the manner of financing. Excessive leveraging enables these organizations or subsidiaries to avoid certain taxes in their respective jurisdictions.
The use of excessive leveraging by MNEs for tax avoidance purposes provides an understanding of the Thin Capitalization regulations instituted by the OECD BEPS Report. Thin capitalization involves a situation in which an organization’s capital constitutes a much smaller contribution of equity in relation to debt (OECD, 2013b). This means that debt largely finance the operations of the respective enterprise. As mentioned, enterprises may resort to debt financing based on the financial advantages that accrue from it. One of these advantages constitutes tax avoidance. Tax avoidance hinders tax authorities from valuation and levy of certain taxes on multinational enterprises. This is detrimental to the countries engaged in cross-border transactions based on the implications arising from tax avoidance of the enterprises. Accordingly, restricting tax authorities from charging tax may cause a significant impact on the tax-base of both countries. Furthermore, tax avoidance by the multinational enterprises may cause relation disputes between both countries involved in the cross-border dealings.
Tax avoidance does not only occur through excessive leveraging. Another way in which multinational enterprises avoid tax is through the allocation of profits from high tax regimes to low tax regimes. This comprises another transfer-pricing issue. Normally, most of the multinational enterprises engaging in this strategy comprise organizations based in the United States. According to Hoffelder (2013), U.S multinational enterprises occasionally distribute their profits to other nations in order to benefit from jurisdictions with low taxes. However, this scheme is not only common among U.S multinational enterprises. Usually, these organizations are able to defer or avoid tax based on the shareholding power of the taxpayers in their current inferior tax jurisdictions. The taxpayers utilize foreign enterprises to avoid tax since they possess a controlling share within the lesser tax jurisdictions. Furthermore, these taxpayers also possess parking income in those jurisdictions.
However, the OECD BEPS Report provides certain regulations that concentrate on this specific issue. One of these regulations is the Controlled Foreign Company (CFC) Regulations. The CFC regulations focus on the prevention of tax facing deference or avoidance by multinational enterprises via taxpayers. The regulations also focus on controlling the parking income. They view these types of returns as repatriated. Based on this perspective, the parking income are liable for taxation due to repatriation. However, it is impractical to have both transfer pricing regulations and CFC rules (OECD, 2013b). In a jurisdiction where there are CFC rules as well as transfer pricing standards, it is significant to consider whether the CFC regulations possess priority in relation to the modification of the returns received by the taxpayer. The rules of transfer pricing suppose that all transactions originally take place with respect to the principle of arm’s length. Based on this statement, it is apparent that transfer-pricing regulations have priority over CFC rules in application.
The OECD BEPS report also provides for other transfer-pricing issues. These issues constitute problems that arise from the restructuring of multinational enterprises. Apart from the transfer of intangibles and risks, significant transfer-pricing problems comprise the artificial division of asset ownership among legal entities and dealings between associated parties that would hardly occur between autonomous entities (Asakawa, 2012). These problems mainly involve the implications that arise from transfer pricing especially in the restructuring of multinational enterprises. Furthermore, these issues affect supply chain management of the enterprises. This is because restructuring involves the alteration of the management of the organization’s supply chain. For instance, restructuring may comprise the conversion of wholly fledged distributors to reduced-risk distributors or the specialization of operations such as research and development.
In conclusion, transfer pricing is a significant issue in supply chain management. The main issue concerning transfer pricing involves the implications it poses on taxation of multinational enterprises. The issues that arise from this concept mainly arise from the restructuring of multinational enterprises. These issues are compliant with the OECD Transfer Pricing Guidelines and the BEPS Report. They comprise the transfer of intangibles and risks, excessive leveraging and tax avoidance. However, based on these issues, the BEPS Report provides mitigating strategies, which include CFC Rules and Thin Capitalization guidelines.
Asakawa, M. (2012). Base erosion and profit shifting. World Commerce Review, 6(2), 52-53.
Bullen, A. (2011). Arm’s length transaction structures: Recognizing and restructuring controlled transactions in transfer pricing. Amsterdam: IBFD Academic Council.
Hoffelder, K. (2013, Apr 22). Profit shifters face global crackdown. Retrieved from http://www3.cfo.com/article/2013/4/tax_apple-google-general-electric-transfer-pricing-beps-oecd
Kobetsky, M. (2011). International taxation of permanent establishments: Principles and policy. Cambridge: Cambridge University Press.
Organization for Economic Cooperation and Development. (2010). OECD transfer pricing guidelines for multinational enterprises and tax administrations. Paris: OECD Publishing.
Organization for Economic Co-operation and Development. (2013). Addressing base erosion and profit shifting. Paris: OECD Publishing.
Organization for Economic Cooperation and Development. (2013). OECD action plan on Base Erosion and Profit Shifting. Paris: OECD Publishing.
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