post Friday May 25, 2012
Rewinding to 20 years back, how has it evolved since its inception? What can we expect for the future?
In 1993, the Clinton administration decided to implement more stringent regulations on corporate income tax flows between cross-border subsidiaries in avoidance of those payments. Now, 20 year later, the issue of income tax avoidance (albeit legally) is still a hot topic. Specifically, how transfer pricing aids in reducing corporations tax burden. Many argue that the laws have been ineffective, as multinationals are said to be “gaming" the system.
However, corporations have a due diligence towards their shareholders to maximize post-tax profits. And as such, they employ legal practices that allow them to reduce their taxes by as much as possible also, to a certain extend companies cannot be blamed for wanting to pay as little tax as possible, as the U.S has one of the highest tax rates.
These tactics have grown since the revision of the 482 regulations and have developed into tax and transfer pricing practices. Due to the increased globalization, tax and transfer pricing practices have become even more significant. Political issues have also emerged as NGO’s accuse large corporations of diverting taxable profit through illicit mispricing schemes. According to a study conducted by Kimberly Clausing, in 2008, approximately $90 billion in federal income taxes was lost as a result of those practices. However there is great debate on how informative and reliable that figure really is.
Nowadays, the IRS is better capable of collecting information from tax payers, which used to be a struggle back in the 90’s. So what changes had the Clinton administration made to the section 482 regulations? One of the changes included the use of a different method for valuation, leading to the creation of profit split, the residual profit split and the comparable profit method. Another change was the requirements in documentation. Tax payers would be penalized 20%-40% of tax underpayment if they fail to support their transfer prices with documents prepared before the filing of the return.
The problem faced now, however, is that of cost sharing. In the income method, when amortizing intangibles an infinite lifetime is assumed, thus increasing the value of existing assets and makes the cost sharing less attractive for companies. To the point that they have started using licensing agreements instead. Hence many companies decided to actually transfer the R&D activities to foreign jurisdiction in order to avoid the U.S transfer pricing regulations.
It can be said that transfer pricing is still a debate, that especially arises during presidential campaigns. Obama is said to “treat excess returns of a controlled foreign corporation from certain intangibles as sub part F income, if that income is subjected to low foreign effective tax rates. The IRS is showing great commitment by having appointed their first ever transfer pricing director, Samuel M.Maruca. Also, the reorganized the advanced pricing and mutual agreement function into one department. Coupled with the increased level of education in transfer pricing obtained during the years, the new changes are likely to translate into significantly more effective enforcements.
[Source: Transfer pricing report: news archive, http://www.bnai.com/ViabilityComparableProfitsMethod/default.aspx]
Image courtesy of: http://aat.lv/services/transfertcenas/
