Comments on OECD draft relating to transfer pricing aspects of business restructuring.

• Author: Muller, Johann
• Position: Organisation for Economic Co-operation and Development

February 18, 2009

On February 18, 2009, Tax Executives Institute submitted the following comments on a discussion draft released by the Organisation for Economic Co-operation and Development relating to the Transfer Pricing Aspects of Business Restructuring. The comments were prepared under the joint aegis of TEI's European Direct Tax Committee, U.S. International Tax Committee, and Canadian Income Tax Committee, whose chairs, respectively, are Johann H. Muller of AP Moeller-Maersk, Brian C. Ugai of The Starbucks Coffee Company, and Rodney C. Bergen of The Jim Pattison Group, Inc. Also contributing to the development of TEI's comments were: Alain Berlier of Givaudan Flavors Corporation; Nick Hasenoehrl of Haemonetics Corporation; Alexander KoIbl of General Dynamics Corporation; Janice L. Lucchesi of Akzo Nobel, Inc.; Jon D. Masunaga of FMC Technologies, Inc.; Nancy A. Perks of Microsoft Corporation; Monika M. Siegmund of Shell Canada Limited; Alice A. Smith of Eaton Corporation; Peter H. Taylor of Dupont du Nemours International; Sander van der Fluit of Shell International Exploration & Production BV; and Daniel J. Wenzel of S.C. Johnson & Sons, Inc. TEI Tax Counsel Jeffery P. Rasmussen served as staff liaison for this project.

On 19 September 2008, the Committee on Fiscal Affairs (CFA) of the Organisation for Economic Co-operation and Development (OECD) released a discussion draft on the Transfer Pricing Aspects of Business Restructurings (hereafter the "discussion draft" or "report"). The discussion draft addresses transfer-pricing issues posed by business restructuring transactions as well as post-restructuring controlled transactions among related parties in the context of Article 9 of the Model Tax Convention. It sets forth guidance to taxpayers and taxing authorities on the treatment of those transactions. On behalf of Tax Executives Institute, I write to express concern that the discussion draft is likely to increase uncertainty, thereby exacerbating the number, scope, and degree of controversy between taxpayers and taxing authorities as well as among taxing authorities themselves.

TEI Background

Tax Executives Institute was founded in 1944 to serve the professional needs of business tax professionals. Today, the organization has 54 chapters in Europe, North America, and Asia. As the preeminent international association of business tax professionals, TEI has a significant interest in promoting sound tax policy, as well as in the fair and efficient administration of the tax laws, at all levels of government. Our 7,000 members represent 3,200 of the largest companies in the world.

Executive Summary

TEI commends the OECD for undertaking the study on business restructuring and issuing its report for public consultation. The report represents an important step in developing a methodology for applying the OECD's Transfer Pricing (TP) Guidelines to business restructuring transactions and post-restructuring controlled transactions. Indeed, there are many helpful statements on the role of taxpayers and tax authorities as well as guidance on the application of the TP Guidelines.

There are, however, aspects of the report with which we disagree. On balance, we believe the report:

* encourages tax authorities to substitute their judgment for taxpayers in determining whether a restructuring transaction is commercially rational;

* fails to provide guidance to ensure that cases of double taxation will be re solved in accordance with Article 9(2);

* fails to provide an analytical framework through which taxpayers may determine (and their financial statement auditors may confirm) whether the restructuring (or post-restructuring controlled transactions) will be safe from recharacterisation or adjustments; and

* increases taxpayer documentation burdens, especially to document "alternative" transactions--ones that either independent parties might engage in or that might have been "realistically available" to the transferor(s) and transferee(s).

Consequently, we encourage the OECD to weigh the comments by TEI below and consider reissuing another discussion draft before revising the TP Guidelines or the Model Tax Convention.

Prefatory Comments

According to paragraph 7 of the discussion draft, business restructurings are typically accompanied by a reallocation of profits among the members of the multinational enterprise (MNE) group. One objective of the OECD's report is to discuss the extent to which a reallocation of profits is consistent with the arm's length principle (under Article 9 of the Model Tax Convention) and more generally how the arm's length principle applies to business restructurings. Other objectives are (1) to ensure that business restructurings do not lead to unintended "double non-taxation" and (2) to limit the risk of double taxation of MNE profits.

TEI commends the OECD for initiating the study and attempting to provide guidance on the application of the transfer-pricing principles to business restructurings. Recent legislative and administrative efforts by some countries attacking business restructurings strongly suggest a need for guidance. In keeping with the OECD's goal of promoting sustainable economic growth, the discussion draft attempts to balance the competing interests of the OECD Member States in protecting their tax bases and permitting businesses to optimise their structures and operations in order to compete in a global environment.

Regrettably, the report seemingly favours the views of Member States that believe their tax bases are being eroded by restructurings and fails to reflect the extent to which commercial business needs drive restructuring transactions. The report helpfully acknowledges that taxpayers are entitled to structure their business operations as they see fit:

Tax administrations do not have the right to dictate to an MNE how to design its structure or where to locate its business operations. MNE groups cannot be forced to have or maintain any particular level of business presence in a country. They are free to act in their own best commercial and economic interests.... In making this decision, tax considerations may be a factor. (1) The overall tenor and tone of the draft, however, is not as dispassionate as the TP Guidelines require. Indeed, references to "so-called toll manufacturers," "mere facts," and other pejorative phrasing could encourage tax authorities to attack a restructuring where less profit flows to a jurisdiction after one of the four identified transactions. (2) What's more, because non-OECD countries may convert the report into tax legislation or regulations, the ultimate effect may be detrimental to OECD-based businesses.

The report also omits discussion of the need for countries to ensure that their tax systems remain competitive. This is not to suggest that countries should engage in a "race to the bottom;" rather, it is a reminder that taxes can be an impediment to business efficiency. For example, in the absence of effective cross-border tax loss utilisation rules, companies must be mindful of where they incur costs as well as whether they are incurring the proper amount of expenses to achieve the expected returns. Where losses mount, business functions and costs must be shifted to achieve better after-tax results. Indeed, in a competitive global marketplace, businesses must ensure that all operating costs in their supply chains are minimised. Since tax rules and market conditions are continually changing, businesses must restructure periodically to align costs, especially following the acquisition of a new business in a merger or acquisition.

Scope Limitations of the Report

Paragraph 5 of the report states that corporate reorganizations that occur as a result of a merger or acquisition are not within the scope of the project. Only internal restructurings are within the scope of the project. An MNE's merger or acquisition of a third party, however, will nearly always be preceded or followed by one or more internal restructurings. Hence, nearly every business restructuring transaction by an MNE will be implicated by this project.

In another scope limitation, Member State domestic anti-abuse and controlled foreign corporation rules are not addressed. This is regrettable since many of the attacks on business restructuring transactions have been, and may continue to be, based on domestic anti-abuse rules. TEI encourages the OECD to reconsider this limitation because nearly any tax measure might be an anti-abuse rule. More important, without guidance on the proper coordination of the Member State anti-abuse rules and Article 9 (as well as other treaty articles) taxpayers will be exposed to substantial risks of double taxation.

Finally, the domestic tax treatment of an arm's length payment, including rules governing the deductibility of payments that are the focus of the report, is outside the scope. Again, TEI regrets this limitation. The goal of the Model Tax Convention is to minimise double taxation. If one country taxes a payment received under its domestic law while the other does not permit a deduction under its domestic law, double tax arises. By suggesting that countries may require an arm's length payment for a restructuring without addressing the treatment of the payer, the report is increasing the risk of double taxation as well as uncertainty for taxpayers.

Business Restructurings

MNEs devote substantial resources to ensuring that their businesses are profitable, grow, and comply with myriad commercial and tax law provisions, including transfer-pricing rules. They also continually review the efficiency of their operations and the legal structures that support them. In this light, business restructurings are a response to global competitive pressure, changing market demands, regulatory requirements, and technological developments.

Paragraph 4 of the discussion draft states that business representatives at the January 2005...