A US Treasury report on earnings stripping, transfer pricing and tax treaties accuses foreign multinationals of manipulating international tax rules and sets transfer pricing improvements as a key priority for the American tax administration.
The American Jobs Creation Act, passed by Congress in 2004, instructed the Treasury Department to compile the report and make recommendations on earnings stripping, transfer pricing and tax treaties. A letter from Eric Solomon, the assistant Treasury secretary for tax policy, to senior politicians, including Max Baucus, the chairman of the Senate Finance Committee, explained that a further report on the effectiveness of corporate expatriation provisions in the legislation would take longer to put together because further guidance was required and more time was needed to assess their impact.
The transfer pricing section of the report focuses on issues relating to the shifting of income from the US through transactions between related parties. It reviews Treasury regulatory guidance under Internal Revenue Code section 482 and the effectiveness of current transfer pricing rules and compliance efforts to ensure that related-party transactions cannot be used to shift income out of the US improperly.
It recommends that three key areas of transfer pricing policy must be modernised urgently.
• Cost sharing: Revision of the existing guidance on contributions for which arm’s-length consideration (buy-in payments) must be provided as a condition to entering into a cost sharing arrangement;
• Services: Completion of the related-party services regulations to reflect legal, business and economic developments since the regulations were issued in 1968; and
• Global dealing: Completion of new rules to allow taxpayers to determine the amount of income from a global dealing operation that is subject to tax in the US, as well as the source of such income and the circumstances under which such income is effectively connected with a US trade or business.
“Despite a marked improvement in the current transfer pricing rules and compliance efforts since 1986,” the report said, “there are certain aspects of the final regulations that may not be sufficiently clear, complete, or effective. These include the rules for cost sharing arrangements, inter-company services, marketing intangibles and global financial dealings.
“The transfer pricing regulations applicable to services were originally promulgated in 1968 and have remained in force, essentially unchanged, for almost 40 years. These regulations have proven to be inadequate to handle the increased volume and complexity of multinational operations and transactions that have occurred since that time.
“Prior to 2007, the absence of updated services regulations led to discontinuities between transfer pricing for services and transfer pricing for tangible and intangible property. Transfer pricing for tangible and intangible property is addressed in the otherwise comprehensive regulations under section 482 that were promulgated in 1994.”
The report noted that regulatory projects have been undertaken: proposed cost sharing regulations (2005); regulations addressing cross-border services (proposed 2003, temporary and proposed 2006); and re-proposed global dealing regulations expected to be issued shortly.
“Top priority in this area should be given to the prompt finalisation and implementation of the three transfer pricing regulatory proposals,” the report continued. “When fully effective, these regulations will address known gaps in transfer pricing administration, and will eliminate some of the known avenues for non-arm’s length income shifting available to multinational groups.”
