Einde inhoudsopgave
Treaty Application for Companies in a Group (FM nr. 178) 2022/2.2.3
2.2.3 Theory of the firm & taxation
L.C. van Hulten, datum 06-07-2022
- Datum
06-07-2022
- Auteur
L.C. van Hulten
- JCDI
JCDI:ADS657668:1
- Vakgebied(en)
Europees belastingrecht / Richtlijnen EU
Vennootschapsbelasting / Fiscale eenheid
Internationaal belastingrecht / Belastingverdragen
Vennootschapsbelasting / Belastingplichtige
Voetnoten
Voetnoten
Both on a national and international level.
Art. 9 OECD MTC and the corresponding OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD, OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, Paris: OECD Publishing 2022).
OECD, OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, Paris: OECD Publishing 2022, par. 1.6. To be able to determine which conditions would have been made between independent enterprises various transfer pricing methods are available. See par. 5.3.2.2.
This approach is reconfirmed in various paragraphs of the guidelines (e.g., par. 9.12 states that ‘the arm’s length principle requires an evaluation of the conditions made or imposed between associated enterprises, at the level of each of them’).
E.g., R.J. Vann, ‘Taxing International Business Income: Hard-Boiled Wonderland and the End of the World’, World Tax Journal 2010, vol. 2, no. 3. Interestingly, the functionally separate entity approach (part of the arm’s length principle) is significantly influenced, or even derived from the idea that ownership and property rights, as well as contractual law, are primary value drivers. Consequently, the transactional cost theory of the firm is both used to defend the arm’s length principle and to defend the unitary taxation of multinational enterprises (R.J.S. Tavares, ‘Multinational Firm Theory and International Tax Law: Seeking Coherence’, World Tax Journal 2016, vol. 8, no. 2, par. 1).
E. Reimer et al., Klaus Vogel on Double Taxation Conventions, Alphen aan den Rijn: Kluwer Law International 2022, p. 705.
M.F. de Wilde, ‘Sharing the Pie’; Taxing Multinationals in a global market, Amsterdam: IBFD 2017, par. 1.1.2.2, footnote 16.
P. Oosterhuis & A. Parsons, ‘Destination-Based Income Taxation: Neither Principled nor Practical?’, Tax Law Review 2018, vol. 71, no. 3, p. 529.
R.S. Avi-Yonah, K.A. Clausing, & M.C. Durst, ‘Allocating business profits for tax purposes: a proposal to adopt a formulary profit split’, Florida Tax Review 2009, vol. 9, no. 5, par. 2.
W. Hellerstein & C.E. McLure, Jr., ‘The European Commission’s Report on Company Income Taxation: What the EU Can Learn from the Experience of the US States’, International Tax and Public Finance 2004, vol. 11, no. 2, par. 3.1.
J. van der Meer-Kooistra, ‘A Model for Making Qualitative Transfer Pricing Adjustments’, International Transfer Pricing Journal 2004, vol. 11, no. 5, par. 2.
J. van der Meer-Kooistra, ‘A Model for Making Qualitative Transfer Pricing Adjustments’, International Transfer Pricing Journal 2004, vol. 11, no. 5, par. 1.
OECD, OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, Paris: OECD Publishing 2022, par. 1.10. See also par. 5.3.2.2.
An integrated group of companies can benefit from economies of scale in transactions costs, logistics, brand development etc. Associated enterprises can thus carry out transactions in an economically more effective manner than independent entities. See, e.g., H.N. Higinbotham & M.M. Levey, ‘When Arm’s Length Isn’t Really Arm’s Length: Issues in Application of the Arm’s Length Standard’, Intertax 1998, vol. 26, no. 8/9, par. 2 and J. Wittendorff, ‘The Arm's-Length Principle and Fair Value: Identical Twins or Just Close Relatives?’, Tax Notes International 2011, p. 239.
For separate entities functions and risks are allocated in view of, e.g., efficiency and risk management, while for groups of companies other factors play a role (H.N. Higinbotham & M.M. Levey, ‘When Arm’s Length Isn’t Really Arm’s Length: Issues in Application of the Arm’s Length Standard’, Intertax 1998, vol. 26, no. 8/9, par. 3).
H.N. Higinbotham & M.M. Levey, ‘When Arm’s Length Isn’t Really Arm’s Length: Issues in Application of the Arm’s Length Standard’, Intertax 1998, vol. 26, no. 8/9, par. 4.
The pricing margins that are the outcome of a true arm’s length situation are not necessarily indicative for the margins that would have been obtained in a comparable hypothetical bargain between related parties (H.N. Higinbotham & M.M. Levey, ‘When Arm’s Length Isn’t Really Arm’s Length: Issues in Application of the Arm’s Length Standard’, Intertax 1998, vol. 26, no. 8/9, par. 5).
H.N. Higinbotham & M.M. Levey, ‘When Arm’s Length Isn’t Really Arm’s Length: Issues in Application of the Arm’s Length Standard’, Intertax 1998, vol. 26, no. 8/9, par. 6.
Due to information symmetry, de facto control and reduced transaction costs, the risk and costs associated with controlled financial transactions might be lower (J. Wittendorff, ‘The Arm's-Length Principle and Fair Value: Identical Twins or Just Close Relatives?’, Tax Notes International 2011, p. 239).
Implicit support means that the credit rating of a group company might be higher than if it were a stand-alone company (J. Wittendorff, ‘The Arm's-Length Principle and Fair Value: Identical Twins or Just Close Relatives?’, Tax Notes International 2011, p. 239).
Additionally, there are intra-group transactions that cannot exist between third parties. Moreover, the correct information is not always available to apply the arm's length principle.
E.g., M. Kobetsky, ‘The Case for Unitary Taxation of International Enterprises’, Bulletin for International Taxation 2008, vol. 62, no. 5 and S. Picciotto, ‘Taxing Multinational Enterprises as Unitary Firms’, ICTD Working Paper 2016, no. 53.
The starting point for taxation purposes1 is the independent legal entity. The fact that entities are taxed independently ensures that all transactions within a group are, in principle, important for determining the taxable amount. One can think of intra-group dividends, gains on disposal and intra-group services and supplies. This leads to all kinds of issues from a tax perspective. It can lead to double taxation and can provide opportunities for tax avoidance. A multitude of ad hoc rules have been implemented in trying to solve this tax issue. One of these rules is the arm’s length principle.
The arm's length principle is the standard for determining transfer prices for transactions within multinational groups.2 Under the arm's length principle, related entities must act as if they were independent parties. The members of the group should be treated as operating as separate entities, rather than as inseparable parts of a single unified business. Under this method (the separate entity approach), the geographic source of income of a group of companies that conducts activities in various states can be determined by reference to the income that would have been earned in the various states had the activities been conducted by independent enterprises. The arm’s length principle aims to adjust profits by refence to the conditions that would have been obtained by independent enterprises in comparable transactions and comparable circumstances, the comparable uncontrolled transactions.3 Via this method the members of a multinational group are treated as separate entities, rather than as group members.4
The theory of the firm is often cited in tax literature to critically discuss the current transfer pricing rules.5 The basic fundamental criticism of the arm’s length standard is that is does not reflect economic reality.6 It is a fiction: the assumption is that the intra-group transfer price is set as if affiliates are unrelated, however, in reality the activities take place within the multinational. The decision to let these activities take place within the multinational is motivated by economic considerations.7 The arm’s length standard therefore does not account for efficiencies (as described by Coase) that are achieved by intercompany rather than third party transactions.8 The separate accounting system ignores the fact that multinational groups of companies exist to avoid the inefficiencies that result from unrelated companies that must transact with each other on an arm’s length basis.9 Due to the economic interrelationships among cross-border activities it is impossible to determine what the source of income of the activities is.10 However, the arm’s length principle also does not take into account that specific investments in the relationship may be required.11
Groups of companies may choose to carry out transactions in a different manner than independent parties. Therefore, the relationships between associated enterprises may be different from the relationships between independent entities that enter into potentially comparable transactions. As a result, market transactions and intra-company transactions cannot truly be comparable.12 Group entities can benefit from economies of scale or synergies, which cannot always be properly reflected in the arm’s length principle.13 There can, for example, be differences with respect to economies of integration,14 the allocation of functions and risks,15 the ownership of intangibles,16 bargaining situations,17 the impact of agreements that adjust pricing for tax purposes,18 financial transactions,19 as well as implicit support.20
All in all, the arm’s length principle does not take into account that multinational groups of companies in essence arise to avoid the inefficient outcome that would be the result should unrelated companies have had to transact on an arm’s length basis.21 Key for a multinational company are the organizational and internalization advantages. The question is thus how to deal with the 'additional’ returns (the economic rents) that a group of companies makes compared with a stand-alone entity operating in the marketplace. In tax literature it is suggested to stop determining profits per entity, and to introduce a far-reaching group approach into national and international tax law.22 This system is called unitary taxation and applies a full group approach. In the following section the rationale behind such a system will be explained.