30/06/23

INTERNATIONAL TAX: Change Is In The Air For Countries’ Transfer Pricing Tax Laws

As published on: forbes.com, Thursday 29 June, 2023.

Some countries are considering making changes to their international tax laws on transfer pricing, and it may be wise for the United States to consider doing so as well.

There is a pattern of countries enacting relatively vague transfer pricing legislation and then leaving it in place untouched for decades. The United States, for example, passed what is now section 482 of the Internal Revenue Code in its original form in 1928 and made only one substantive amendment until the 2017 Tax Cuts and Jobs Act enacted the second. Section 482 and its international counterparts are often lacking in specifics, leaving responsibility for substantive rulemaking to tax administrations’ official guidance, positions taken by examiners, and interpretations of reviewing courts.

But every once in a while perceived problems with the legislative text itself prompt governments to make amendments. For two of the United States’ peer countries, “once in a while” is evidently now. In June both Canada and the United Kingdom opened public consultations proposing significant changes to their transfer pricing rules.

Public consultations on planned legislation are generally not part of the lawmaking process in the United States, but they are common in countries with parliamentary systems that have nothing equivalent to the U.S. separation of powers. Analogous to the notice and comment process for agency regulatory action in the United States, consultations provide interested parties an opportunity to weigh in before the legislation can be enacted.

For proposed corporate tax legislation, the interested parties are generally trade groups, tax advisory firms, and companies likely to be affected by the proposal. In the case of Canada’s planned amendments to subsection 247(2) of the Income Tax Act, the sentiments of these groups are unlikely to be favorable.

In a June 7 consultation document, Canada’s Department of Finance proposed major statutory changes principally designed to prevent another government loss like the one in Cameco Corp. v. The Queen, 2018 TCC 195, aff’d, 2020 FCA 112. The Canada Revenue Agency lost the bitterly fought case, which allowed one of the world’s biggest uranium producers to shift considerable profits to low-taxed offshore subsidiaries while leaving the parent company with tax losses in Canada. Although the offshore subsidiary had only one employee and the Canadian parent performed substantially all the functions necessary to manage the group’s global operations, Cameco’s tax planning arrangement was accepted as legitimate by the Tax Court of Canada and an appeals court.

Understandably frustrated with this outcome, which turned on a questionable parsing of the text of subsection 247(2), the Canadian government has proposed that key portions of the OECD transfer pricing guidelines be incorporated into domestic law. Although the OECD guidelines are the basis for settling double tax disputes between countries and often serve as important interpretive guidance, they have no binding legal effect unless domestic law refers to them.

The proposed statutory amendments would grant the CRA greater powers to disregard risk allocations in accordance with principles contained in the OECD guidelines, which could have changed the outcome in Cameco had they been available. However, whether the amendments would really give the CRA the upper hand in future Cameco-like cases remains to be seen.

The United Kingdom’s legislative proposals may get a somewhat warmer reception from taxpayers and their representatives. Many of the proposals contained in HM Revenue and Customs’ June 19 consultation document attempt to align U.K. domestic law with the OECD’s transfer pricing guidelines and model tax convention. But the most significant proposals concern the controversial U.K. diverted profits tax (DPT), which gives HMRC powers it would not otherwise have in cases concerning transfer pricing and the avoidance of a local taxable presence. The DPT regime imposes a punitive rate on amounts deemed to have artificially escaped domestic corporate tax, and it creates considerably harsher assessment, collection, and appeal procedures.

The U.K. proposal is to merge the DPT with general corporate tax law, which could mitigate the DPT’s conflicts with the United Kingdom’s bilateral treaty commitments and soften administrative procedures. Whether a merger will actually achieve this depends critically on the details, which are generally absent from the consultation document.

Each set of proposals reflects country-specific circumstances, but both seek greater alignment with the multilateral international tax standards endorsed by the OECD. Both proposals also attempt to patch potential gaps in the transfer pricing rules to preempt faulty interpretations from taking hold, especially Canada’s.

The United States should take careful note of these initiatives and consider whether either might be useful in the U.S. context. Although amendments to section 482 would be welcome, the prospects of a divided and distracted Congress agreeing to rewrite section 482 are remote so soon after the statute’s amendment in 2017. Fortunately, there are alternative ways to make similar substantive changes to U.S. law.

Nearly all the United States’ substantive transfer pricing rules appear in the section 482 regulations issued by Treasury and the IRS, not the statute itself, and regulatory amendments do not require legislative approval. Fully aligning the regulatory scheme with OECD standards may not be the best option in the United States, which has a somewhat unique approach to transfer pricing and a history of resistance to multilateral standards. But the IRS’s mixed litigation track record suggests that it, like the CRA, may need stronger legal provisions to combat aggressive profit-shifting arrangements by large multinationals.

Unfortunately, a series of post-TCJA section 482 regulatory projects that consistently appears in the Treasury and IRS annual priority guidance plans seems to be stalled for the foreseeable future. This could reflect the hazards imposed by the recent wave of regulatory validity challenges under the Administrative Procedure Act, scarce resources, internal disagreements, some combination thereof, or something else entirely. But the Canadian and U.K. consultations should at least serve as a reminder that amendments to the U.S. transfer pricing regime are long overdue.

Tags

International Tax Transfer Pricing Tax