The CD recently issued a report targeting corporate tax planning and transfer pricing strategies, which it asserts constitute a serious risk to tax revenues, tax sovereignty among nations and tax fairness. (CD (2013), Addressing Base Erosion and Profit Shifting, CD Publishing)
The issue has become political with government leaders, including David Cameron in a speech at the World Economic Forum in Davos, calling for greater tax transparency and "fairness" by multinational enterprises (MNEs). The Economist's cover story this week features tax "dodging" and offshore finance. These developments and the recent Starbucks case in the UK highlight reputational issues to MNEs from tax and transfer pricing strategies that the CD concedes are legal and which often stem from deliberate features of countries' own tax systems.
Interestingly, the CD's report cites only a slight decrease in the unweighted average of taxes in corporate income as a percentage of total taxation in CD countries from 8.8% in 1965 to 8.6% in 2010 and a net increase in the overall corporate tax burden (measured by the corporate tax-to-GDP ratio) of 2.2% to 2.9% over the same period (pp 15-16). These data don't mute the report's calls for swift, coordinated action by governments on the following "key pressure" areas:
- transfer pricing, especially involving intellectual property and other intangibles;
- mismatch in entity and instrument characterization (e.g., an entity being fiscally transparent in one jurisdiction but treated as a corporate taxpayer in another or a security treated as equity with returns characterized as non-deductible dividends in one jurisdiction but as debt with deductible interest in another);
- electronic commerce and treaty rules;
- intra-group financing transactions;
- inadequate anti-avoidance rules;
- "harmful" tax competition among nations.
In our view, the current impression in the public domain of unfettered, aggressive tax and transfer pricing planning by MNEs is not consistent with the robust enforcement environment in Canada and other CD nations. This is especially true in transfer pricing, where MNEs are subject to lengthy audits often resulting in large reassessments leading to double tax as taxpayers are caught between two tax authorities seeking to tax the same income on both sides of the border, for example, by denying legitimate deductions or asserting inflated returns on routine marketing expenditures. The Supreme Court of Canada's recent decision in the Glaxo case (2012 SCC 52) provides some counterbalance, acknowledging that transfer pricing is not an exact science, that the selection by a taxpayer of a transfer price within a reasonable range should be respected and that transfer pricing reassessments should afford a realistic picture of a company's profits having regard to its functions, assets and risks. While this guidance from the Supreme Court is welcome, it's clear that in the current environment, there will be sustained pressure on MNEs to adequately analyze and document their international tax and transfer pricing planning strategies to mitigate reassessment and corporate reputational risks.