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You don’t have to be an OECD member to be influenced by its tax policy. Sophie Ashley discusses how the organisation’s transfer pricing reports will impact Asian practitioners

This article was first published in the October 2012 Malaysia edition of Accounting and Business magazine.

When the Organisation for Economic Co-operation and Development (OECD) released a draft on the transfer pricing (TP) aspects of intangibles a year earlier than expected, tax practitioners were generally pleased to have an insight into how this crucial project was progressing. Alongside this report, drafts on the timing issues related to TP and safe harbours in chapter IV of the OECD’s TP Guidelines for Multinational Enterprises and Tax Administrations were also released.

These strands of policy aim to simplify the complicated aspects of tax and TP, considering the number of countries implementing TP legislation is increasing all the time.

Most Asian countries do not have in-depth TP regulations and, because the OECD is the only organisation that provides these, the reports are widely referred to by Asian tax authorities and taxpayers.

Intangibles project

Intangible assets are easily the biggest contributor to international tax disputes so, despite the majority of Asian countries not being OECD members (save for South Korea and Japan) the outcome of this intensive report will still have a huge impact on the way many Asian tax authorities choose to treat intangible assets for TP purposes.

While all 34 members of the OECD are involved in the intangibles draft, this involvement is extended to observers: Argentina, Brazil, China, Colombia, India, Malaysia, Russia, Singapore and South Africa.

Section A of the draft defines an intangible asset as ‘something which is not a physical or a financial asset, and which is capable of being owned or controlled for use in commercial activities’ and is divided into the following headings: patents; know-how and trade secrets; trademarks, trade names and brands; licences and similar limited rights in intangibles; goodwill and ongoing concern value; group synergies; market-specific characteristics; and assembled workforce.

Synergies, market-specific characteristics and assembled workforce are of particular relevance to the Asian tax market.

‘Location savings are a particularly relevant issue,’ says Marlies de Ruiter, head of the tax treaties, transfer pricing and financial transactions division at the OECD. ‘And [with]corporate synergies, while important everywhere, the Asian region may have fewer head offices so may get a lesser share of corporate synergies at this stage. It’s also about whether profits go to countries where activities take place or low tax jurisdictions without economic substance.

‘Workforce in place is relevant because if you have a workforce in place that is more efficient, for example in China, how should you deal with that efficiency? How should it be rewarded? What profit should be allocated to that efficiency?’ de Ruiter adds.

The draft suggests these factors are not considered intangibles but should be taken into account in a TP comparability analysis. This may add to the dispute environment in Asia considering the way India and China, in particular, apply these concepts to their advantage already.

Because the draft questions whether services rendered in connection with the development of an intangible asset should be compensated at an arm’s-length rate, Indian advisers say, while such service providers do not claim entitlement to intangible-related returns, they should be provided with arm’s-length compensation for the functions they perform.

‘According to the OECD, in evaluating whether associated enterprises retained to perform functions related to the development of intangibles have been compensated on an arm’s-length basis, it is necessary to consider the amount of compensation paid and the level of activity undertaken,’ says Rajendra Nayek, of Ernst & Young in India.

‘In the context of Indian multinationals’ R&D centres, as the operations move up the value chain, it becomes important to periodically review the level of activity undertaken to assess whether the compensation paid adequately considers the higher level of activity undertaken,’ adds Shweta Pai, also from the Indian Ernst & Young office.

Safe harbours

The draft on safe harbours is part of the OECD’s project to improve the administrative aspects of TP in its drive for simplification. ‘The tone of the guidance is presently quite hard so we are attempting to soften the tone, showing a need for simplification but also saying you can do safe harbours in bilateral and multilateral manners,’ says de Ruiter.

While it is expected an increased use of safe harbours around the world will reduce double taxation or double non-taxation, it is down to the individual tax authorities to negotiate ranges and protocol for taxpayers to follow.
From an Indonesian perspective, the concept of a safe harbour is to reduce the compliance burden for small and medium-sized enterprises with immaterial related-party transactions.

‘To address the issue of taxpayer’s capability and cost of preparing TP documentation, the Indonesian Tax Office relieves taxpayers from the obligation to conduct comparability analysis on transactions falling within the purview of the safe harbour rule,’ says Permana Adi Saputra, of PB Taxand, Indonesia. ‘However, the authorities still do a TP audit on such transactions.

‘Therefore, it will be useful if the OECD can also provide clear guidelines on the safe harbour concept and how taxpayers can defend themselves from TP audit and dispute about safe harbour application.’

Timing issues

There are two systems that are at the heart of the timing issue; the price-setting and outcome-testing approaches. These refer to two different ways to establish the price: at the time of the transaction (ex ante) and; after the transaction takes place (ex post).

The ex ante approach is more in line with the way independent parties deal with each other as they negotiate based on the best information available at the time the transaction was undertaken, having regard to the functions performed and risks assumed relative to each other.  Independent parties would unlikely renegotiate the relationships based on the actual outcome of the transactions.  If this approach is taken by the tax authorities, it would mean that taxpayers would always have to explain and justify their TP relationships based on actual outcome of the transactions, probably on top of the expectations and business rationale at the time the transactions were undertaken, which would pose a very heavy burden on taxpayers.

‘The issue of two systems is relevant to businesses so we want their input about what it means and how we can draft guidance, so it’s important to hear from a range of companies. Governments are aware that having two different systems is leading to double taxation,’ says de Ruiter, who encourages Asian countries and companies to submit comments to the OECD.

On a practical level, Adi Saputra says timing depends on the condition of the transaction: ‘A company doing a big, but one-off, project may use the ex ante approach by obtaining a comparable price through a tender process. However, if there is no direct comparable at the price level at a given time, the ex post approach may be applied. The taxpayer, after considering all five comparability factors, may compare the margin of the company based on the outcome of the transaction with that of comparables.’

Asia is watching

Putting all of these reports into a global context, both OECD and non-OECD countries could have the benefits of building their TP enforcement, with the latest crossborder issues, on a more common platform with trading partners in the same region. This may also avoid significantly diverse enforcement practices emerging in different countries, which may discourage multinationals from expanding their outbound investments and crossborder activities within the Asia region.

While most Asian countries reference the OECD in their tax legislation, they are likely to apply local modifications.

‘The key point here is that not all Asian non-member countries are at the same level of development, either economically or in the transparency of their legal systems. Based on this, a one-size-fits-all approach is neither possible nor desirable,’ says Ron Parks, of KPMG in Vietnam.

Peer reviews

In addition to the reports, the OECD is also working to improve tax transparency on a global scale, through its Global Forum on Transparency and Exchange of Information for Tax Purposes and the forum has already begun its phase two reviews, though a full report has not yet been released.

The forum incorporates 109 countries, which are currently undertaking peer reviews that evaluate how open each country is in sharing information, the process of which aims to improve the systems for exchange of information.

The forum is coming towards the end of its phase one peer reviews. These are mostly complete or underway. It is now launching its phase two peer reviews which evaluate each jurisdiction’s compliance with the standard in practice. Phase two reviews will also eventually include ratings.
‘Some of the key changes that have come about as a result of our peer reviews are that many member jurisdictions have already introduced or proposed changes to their laws to address the recommendations made,’ says Monica Bhatia, head of the secretariat of the forum.
Some of the important changes to tax laws include:

  • The end of strict bank secrecy for tax purposes.
  • Elimination of practices such as domestic tax interest requirements which prevented effective exchange of information.

The forum has already adopted 79 peer review reports containing 495 recommendations for jurisdictions to improve their ability to cooperate in tax matters. Countries are swiftly moving to address the recommendations and asking for supplementary reports to reflect changes they have made. There has been continuous support by the G20 for the work of the forum, including in the latest Communiqué after the G20 Leaders’ Summit in Los Cabos, Mexico in June 2012.

Sophie Ashley is editor of


Last updated: 8 Apr 2014