Policy Proposals Business Law Comments on the Public Discussion Draft on BEPS Action 8: (Hard-to-Value Intangibles)
Head of Transfer Pricing Unit, Centre for Tax Policy and Administration
Organisation for Economic Co-operation and Development
Keidanren hereby submits its comments on the Public Discussion Draft "BEPS Action 8: Hard-to-Value Intangibles" published by the OECD on June 4, 2015.
Some companies arbitrarily transfer intangibles under development (including rights therein) at an undervalued price to a low-tax jurisdiction and then shift substantial amount of the income derived from the intangibles to a subsidiary domiciled in that jurisdiction. Such a wrongful practice has been pointed out as one of the root causes of base erosion and profit shifting (BEPS). We do understand the need of nations to devise measures against abusive arrangements of this kind.
However, the proposed approach is, albeit some ingenuities shown, essentially an attempt to levy taxes using hindsight, in that it is designed to adjust the ex-ante pricing of transactions based on the ex-post outcomes. As such, a question arises as to its appropriateness as a measure against BEPS. Aware of the difficulty in valuing intangibles and the need to eliminate arbitrariness, companies that conduct controlled transactions involving intangibles endeavor to value the intangibles using methods that are as diverse as possible. Thus, tax administrations should respect the relevant agreements and management decisions, as well as the taxpayer's valuations underlying them, to the fullest extent. If these could nevertheless be overturned depending on the ex-post outcomes, tax consequences would become unpredictable while the administrative load relating to documentation and the burden of proof would increase.
It is debatable in the first place whether independent enterprises always have a price adjustment clause built into their agreements or renegotiate the agreement terms. There also are cases in which profit generated by intangibles is less than anticipated. Furthermore, as the criteria for application of the proposed approach are neither sufficiently clear nor objective, they may be broadly interpreted by tax administrations. A question would also arise regarding the appropriateness and timeliness of additionally introducing such an extremely powerful taxation tool in the circumstances where a variety of measures to enforce taxation have already been recommended pursuant to the actions of the BEPS Action Plan.
In view of these, we cannot help feeling that the proposed approach goes beyond what is necessary to achieve the objective. In the ensuing process of finalizing the revisions to Chapter VI of the Transfer Pricing Guidelines, we suggest that the scope of application of the proposed approach be at least narrowed, and that the following matters at a minimum be considered:
(1) Scope and Features of Hard-to-Value Intangibles (HTVI)
Paragraphs 9 and 10 describe the scope and features of HTVI. As these paragraphs merely provide qualitative explanations, we suggest that several examples of anticipated situations be added. For instance, paragraph 9 refers to an absence of "reliable comparables," a "lack of reliable projections," and "highly uncertain" assumptions, while paragraph 10 mentions "intangibles that separately are not HTVI but which are connected with the development or enhancement of other . . . HTVI" and "intangibles that are anticipated to be exploited in a manner that is novel at the time of the transfer." All of these, though, are concepts that can be broadly interpreted. We are strongly concerned that numerous intangibles may in substance fall within the category of HTVI.
(2) Significant Difference
We suggest that a clear definition be provided of the "significant difference" between ex-ante projections and ex-post outcomes referred to in paragraph 13. Each country faces different BEPS concerns and deals with different types of businesses and transactions, which we presume may make it difficult to set uniform criteria. Still, it would be necessary to adopt numerical criteria such as the percentage of deviations and monetary amounts, at least, in order to prevent tax administrations from enforcing taxation subjectively and arbitrarily.
Paragraph 14 sets two exemption criteria: one is to provide "full details" of ex-ante projections, and the other is to provide "satisfactory evidence that any significant difference . . . is due to unforeseeable or extraordinary developments or events." With regard to the first criterion, we suggest that the word "full" be deleted. The term "full details" may allow tax administrations to demand disclosure of source code and other trade secrets that are essentially unrelated to taxation, or to otherwise act in a way that deviates from the norm, in exchange for not taxing the transaction in question.
As for the second criteria, given an undue burden it would impose on taxpayers, either the criterion should be deleted or the burden of proof (or disproof) should rest with tax administrations. When a company has valued transactions using a multifaceted method and submitted the results to the tax administration, the company is considered to have fulfilled its obligation. It would be excessive to impose upon the company any more burden of proof. Furthermore, the word "satisfactory" needs to be clarified because what constitutes "satisfactory" evidence is unclear. (Similarly, although paragraph 12 refers to "where the tax administration is able to confirm the reliability of the information," it is not clear in what situations tax administrations are viewed as able to make such confirmation.)
In addition, consideration should be given to incorporating the following three elements into the exemption criteria:
(i) Restricting the scope of application to transfers to low-tax jurisdictions
As the proposed approach is presented as part of the BEPS Project, its application should be restricted to the transfer of HTVI to a low-tax jurisdiction. In fact, the majority of cases to which the proposed approach will apply are expected to involve such transfers. However, it may be difficult to revise the Transfer Pricing Guidelines in a manner that restricts their application to particular jurisdictions. If that is the case, the scope of application of the proposed approach may be properly narrowed by formulating the criteria in such a way that the approach will in substance apply to transfers to low-tax jurisdictions only.
Specifically, one possible option to achieve this is to restrict the scope of application to transactions in which the linkage between the existence of HTVI and the ex-post profit levels is clear. When HTVI has been transferred to a low-tax jurisdiction, especially to a tax haven, it is safe to assume that the degree of the contribution of factors other than HTVI to the profit levels is relatively low, and therefore that identifying the correlation between HTVI and the profit levels is comparatively straightforward. By contrast, in the case of transfers to non-low-tax jurisdictions that include advanced industrialized countries, we assume that the profit levels cannot be explained by HTVI alone because there are other conceivable reasons, such as a new owner of HTVI having added value.
(ii) Excluding a transaction once a certain period has passed after its implementation
With the business environment changing daily, it is rather normal that developments not factored into initial projections arise. To prevent taxpayers from suffering unpredictable tax consequences for a long period of time, a transaction should be excluded from the scope of application of the proposed approach once a certain period of time has elapsed since the transaction was entered into.
(iii) Considering companies' ex-post adjustments and adopting a method that focuses on shareholding
We assume that the proposed approach will obviously not apply to cases in which a company has voluntarily adjusted profit levels among the associated enterprises using a residual profit analysis and other methodologies. The Public Discussion Draft, though, appears to provide no clear explanation on this point. As it would be excessive for a tax administration to make an adjustment according to the ex-post outcomes on top of the voluntary adjustment already made by the company, this point should be added to the exemption criteria or otherwise clearly stated.
Consideration should also be given to adopting a method whereby the application of the proposed approach will be more focused on transactions that have a greater risk of involving arbitrariness. For example, it is conceivable to restrict its application to transactions conducted between the parent and its subsidiary that is wholly owned and directly controlled by the former.
(4) Dispute Resolution and Accumulation of Cases
If the proposed approach were to be adopted, it would become part of Chapter VI of the Transfer Pricing Guidelines. In that event, every effort should be made to ensure that any double taxation resulting therefrom is resolved, in accordance with the provisions of Articles 9 (Associated Enterprises) and 25 (Mutual Agreement Procedure) of the OECD Model Tax Convention, as a matter involving the application of the arm's length principle—although it is debatable whether the approach constitutes a measure consistent with that principle.
Additionally, from the perspective of preventing arbitrary enforcement, it is crucial to accumulate cases of taxation, share them internationally, and thereby refine the application criteria.
Subcommittee on Taxation