Part 1 - AL-Tax

International Taxation Handbookas to whether a transfer price is arm’s length often comes several years after thetransaction between related parties took place. Also, cross-country differences inaccounting and tax provisions often trigger transfer pricing as a game of dice forthe taxpayer and the tax authorities, instead of a predictable governance: Whethera transfer of economic value needs to be priced or not depends upon the interpretationof country-specific provisions and case law. MNCs and tax authorities havecontroversial positions about – or are often not fully aware of – which kinds of valuetransfer need to be priced and which do not. Consequently, many such interpretationsare done by courts rather than, in the first place, by the taxpayer. 4 Sincemuch related-party business is outside any pricing mechanism at all (Ernst &Young, 2003), today’s tax bases of multinationals are generally underestimated,let alone the controversial search for appropriate prices.6.2.2 Identifying the tax baseTransfer pricing and income allocation in the course of taxing multinationals are primarilydriven by the problem of defining and identifying the tax base. 5 To do so,transfer pricing experts, such as internal experts of MNCs as well as consultants andtax authorities, make use of analyses on the basis of so-called functions, risks, andassets to assess transfer prices under the ALP. However, despite these analyticalexercises and the use of top-level expertise, 6 transfer pricing can be characterized byvagueness, fuzziness, premature concepts, and lack of transparency. Transfer pricingis still at an early stage of institutionalization and standardization – if comparedwith classical national tax issues. For example, whether, in principle, a trademark isvaluable or not is subject to the business partners’ assessment (as long as the relevantaccounting principles do not prescribe the valuation and its accounting). The valuationoptions offer a huge range of possible results. The size of the trademark’s valuemay be even more subject to the business partners’ discretion and assessment. Theanswers to such questions significantly affect whether the cost incurred in developingsuch a trademark is deductible for tax purposes. So, the amount of the state’s corporateincome tax revenue depends to a large extent on the view that both the MNC(and its related-party taxpayer) and tax authorities can agree on various items definingthe tax base.An even more challenging problem in setting appropriate transfer prices in accordancewith the ALP is related to business restructuring activities and investmentissues. Restructuring as an ongoing process of shifting business functions, risks, andassets from one tax jurisdiction to another one – mostly from a high-wage or hightaxjurisdiction into a more preferential one – leads to huge vagueness regarding116