Despite the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines (TPG) and the arm’s length principle being accepted by the majority of the countries, tax authorities may still apply the OECD TPG differently. This often leaves MNEs trying to avoid double taxation as a result of the differences in interpretation adopted by different jurisdictions.
The concept of double taxation lends itself to two types, namely juridical double taxation and economic double taxation.
In the former, a taxpayer is doubly taxed due to the operation of the law which imposes an obligation to pay tax on a specific source of income, irrespective of the fact that another jurisdiction has already taxed such income. Whilst the latter comes to the fore when different tax authorities consider the same income within the tax base of distinct taxpayers. This may be caused through the application of:
- Transfer pricing (TP) audits by national competent tax authorities which involve the review of a company’s transfer pricing affairs to ascertain the taxpayer adherence to the applicable local TP legislation.
- TP adjustments made in one jurisdiction which are not complemented by a corresponding adjustment in the other jurisdiction giving rise to double taxation.
Tax authorities in different jurisdictions often have diverging views on the specific tax treatment of specific sources of income and, such disputes may possibly be resolved through the application of certain mechanisms, including:
A Mutual Agreement Procedure (MAP) which is a method designed to relieve double taxation, typically arising from TP cases, to resolve treaty-related tax disputes and issues in interpreting or applying a double tax treaty. The MAP provides a bilateral mechanism for the competent authorities engaged to negotiate with each other with the aim of resolving the underlying tax issues by mutual agreement.
An Advanced Pricing Arrangement (APA) which is an arrangement entered into between the Competent Authority and the relevant foreign competent authority. Such arrangement pre-establishes a relevant body of conditions for the determination of the arm’s length amount with the intention of avoiding TP disputes. An advance pricing agreement may be of a unilateral, bilateral or multilateral nature.
Taxpayers will need to consider the most appropriate risk management strategy in order to mitigate the risk of TP disputes. An APA may be a suitable measure to address such risks especially for smaller taxpayers due to the fact that it tends to be easier to deal with just one tax authority rather than having to deal with multiple tax authorities. However, agreeing upfront with one tax authority does not necessarily mean that the tax authorities in other jurisdictions would do the same.
There could be other ways of resolving or avoiding a dispute and one of them could well be to take no action in resolving the dispute. The benefits of resolving double taxation might not be sufficiently material to justify the costs. A cost-benefit analysis should always be performed before resorting to dispute resolution and even if resolution is pursued, the route to take will also depend on such analysis.
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