Author:Tian, George Yijun
Position:Organisation for Economic Co-operation and Development
  1. Introduction 36 II. Transfer Pricing & Cloud Computing Technology 38 A. Transfer Pricing and Transfer Pricing Rules 39 1. What is 'Transfer Pricing'? 39 2. What are Transfer Pricing rules and Arm's Length Principles? 39 B. Cloud Computing: Key Features 40 1. What is Cloud Computing technology? 40 2. Different types of Cloud computing services 42 3. Key feature of cloud technology & Role of Technology Companies 44 III. Multinationals' Major Strategies for Transfer Pricing Arrangements in the Cloud 45 A. Intangible assets & Cloud Computing 45 B. Major Transfer Pricing Strategies for IP and Cloud- related Transactions by MNEs & Implementation of Arm's Length Principle 47 1. Strategy 1: IP Ownership Transfer Strategy vs. CSP Relocation Strategy 47 2. Strategy 2: IP Licensing Strategy vs SaaS Subscription Strategy 49 3. Strategy 3: IP Service Agreement vs. Cloud Service Agreement 51 4. Strategy 4: Cost-sharing Arrangement 53 5. Summary and Remarks 55 IV. Major Challenges for Implementing Arm's Length Principle to Cloud-related transactions 55 A. Challenge 1: Lack of Comparables 56 B. Challenge 2: Complexity of IP Package and Business Structure of MNEs 57 C. Challenge 3: Lack of Information on Intangible Transaction in Financial Statements 59 D. Summary and Remarks 61 V. Possible Solutions--Insights from the OECD BEPS Recommendations and Australian New Transfer Pricing Laws 61 A. Insights from the OECD BEPS Action Plans & OECD Transfer Pricing Guidelines 61 1. OECD BEPS Action Plan & General Principles for International Tax Jurisdiction Justification 61 2. Use of Profit Split Method and Arm's Length Price 63 3. Separation of Ownership of Intangibles and Remuneration 66 4. New Approach for Assessing Intragroup Transferring of Risks or Capital--"Conduct Focus" plus "Commercial Rationality Test". 70 5. New Requirements on Transfer Price Documentation 72 6. Summary and Remarks 73 B. Insights from the Recent Development of Australian Transfer Pricing Laws--Diverted Profit Tax 74 1. Multinational Anti-Avoidance Laws-- Implementing BEPS Action Plan 75 2. Diverted Profits Tax Law 2017 -- Reverse of Burden of Proof. 79 3. Summary and Remarks--Insights for Other Countries 86 VI. Conclusion 90 I. INTRODUCTION

    Cloud computing ("CC") has significantly changed the way in which information is collected, stored, handled and distributed by individuals, businesses and government agencies. Gartner identifies the top ten strategic technology trends for 2017, and three of them are directly related to or built upon CC technology. (2) Like many other technology developments, CC brings us both opportunities and risks. One recent study predicted that overall demand for CC will grow 18 percent in 2017 "to $246.8 billion in total worldwide revenue from $209.2 billion" in 2016. (3) On the other hand, CC poses significant and difficult questions in tax laws, particularly in the cross-border tax area. (4) As an increasing number of businesses move to cloud computing solutions, "items we view as tangible" products are transformed into intangible or digital products. (5) This arguably brings significant challenges to the traditional tax system, which was established on the basis of physical transactions and trade.

    In international tax, Transfer Pricing ("TP") is certainly "one of the most important issues." (6) An increasing number of multinational enterprises ("MNEs") artificially shift profits from high-tax to low-tax countries (such as tax havens) by using a variety of techniques. A study conducted by the U.S. Congressional Research Service in 2015 indicates a significant increase in corporate profit shifting over the past several years, and estimated losses from income shifting by multinational corporations are estimated at nearly $100 billion USD per year. In relation to developing countries, the UN Conference on Trade and Development ("UNCTAD")'s World Investment Report 2015 indicates that the amount of corporate profits shifted from developing countries is about $450 billion USD, (8) and finds that tax avoidance practices result in a significant leakage of development financing resources, and an estimated $100 billion USD tax revenue loss per year for developing countries. (9)

    In order to address cross-border tax avoidance issues, the OECD issued the OECD BEPS Action Plan in 2014 and amended the OECD Transfer Pricing Guideline in 2015. Many countries have started to reform their domestic laws to implement the recommendations of the OECD and take action to combat illegal Transfer Pricing activities by MNEs. For example, Australia passed the Tax Laws Amendment (Combating Multinational Tax Avoidance) Act in 2015, (10) and its Treasury Laws Amendment (Combating Multinational Tax Avoidance) Act and Diverted Profits Tax Act received Royal Assent in April 2017. (11) Most recently, after the Australian Tax Office ("ATO") court victory, the U.S. oil giant Chevron is now facing a $300 million tax bill in Australia. (12)

    This article examines whether and how traditional tax rules on TP, which have their foundations in physical transactions and trade, can apply in the current virtual, digital world of cloud computing. It aims to identify the difficulties current approaches face as they are applied to this developing technology, and attempts to explore some practical solutions for future Transfer Pricing law reforms at both the international and national level by drawing on insights from the Transfer Pricing rules of the OECD and Australia.

    Part II of the article sets up the conceptual background for the whole article. It first introduces basic concepts of Transfer Pricing and key principles of Transfer Pricing rules. It then introduces the basic concept of CC, various types of CC services and key features of CC technology. Part III examines major forms of cloud-related Transfer Pricing activities. Part IV examines the existing challenges for implementing Transfer Pricing rules to intangibles, and whether the wide applications of cloud computing technology may intensify these challenges. Part V attempts to explore possible solutions for addressing these challenges by drawing on insights from the recent development of the Transfer Pricing rules of the OECD and Australia, including the potential impacts of these rules on cloud-related MNEs. It contends that, although the OECD BEPS Action Plan has made a remarkable contribution to address BEPS problems, including the Transfer Pricing problem, it still has its limits. When adopting the OECD recommendations, it is imperative for individual countries to adopt a more systematic and innovative approach by taking into account their own economic and social circumstances, and make international approaches (e.g. OECD's Transfer Pricing recommendations and international cooperation) and domestic approaches (e.g. Australian Diverted Profits Tax law) work collaboratively to address the Transfer Pricing challenges in the cloud.


    Transfer Pricing is not a new problem. It already existed to a great extent even before cloud computing technology had been developed. But wide applications of cloud computing technology have arguably increased the likelihood of this widespread problem. (13) Before conducting a systematic analysis on cloud-related Transfer Pricing practices, this part first describes the basic concepts of Transfer Pricing and cloud computing, the main categories of cloud computing services, as well as some of the key characteristics of cloud computing technology.

    (13) See Orly Mazur, Transfer Pricing Challenges in the Cloud, 57 B.C. L. Rev. 643, 665 (2016) (explaining that the cloud computing has "the potential to significantly contribute to this widespread problem by increasing the likelihood that this type of base erosion will accelerate.").

    1. Transfer Pricing and Transfer Pricing Rules

      1. What is Transfer Pricing?

        Put simply, "Transfer [P]ricing is a term used to define the price charged between associated enterprises for the transfer of goods, services and intangible property." (14) More specifically, when an MNE group undertakes business across the world, its affiliates are often located across different taxing jurisdictions. The mismatch of income tax rates in different national taxing jurisdictions is the key reason and driving force for many MNEs (15) to pursue a planning strategy in order to allocate its resources and assets in the most tax efficient matter. Although such a "tax efficient method" may not be per se illegal, it is often "looked [upon] with suspicion by tax authorities." (16)

      2. What are Transfer Pricing rules and Arm's Length Principles?

        The tax laws in many countries (such as the U.S. (17) and Australia (18)) require that the Transfer Pricing between the affiliated companies meet the "Arm's Length" principle ("ALP"), that is, the price of the associated parties should be the same as the price for the hypothetical neutral third party. (19) The rationale behind this is, if two unrelated companies trade with each other, a "market price" (or "arm's length" price) for their transaction will generally apply. (20) "This is known as 'arms-length' trading, because it is the [result] of genuine negotiation in a market." (21)

        MNEs, which have moved their operations to the cloud, arguably "must apply the [T]ransfer [P]ricing rules to determine an arm's-length price" for any intra-group cloud transactions also. (22) Due to the application of the ALP, MNEs cannot artificially manipulate the price for cloud-related business transactions to shift profits from a high tax country to a low tax country, such as tax havens.

        However, the traditional taxation systems, including Transfer Pricing rules, were established on the basis of physical transactions and trade even before the Internet was invented. (23) This has arguably created challenges for MNEs trying to determine, plan for, and comply with their obligations under the existing tax laws...

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