draining development.pdf - Khazar University

The Role of Transfer Pricing in Illicit Financial Flows 239tion on their profits. Procedurally, effective application of the ALP in away that minimizes crossborder disputes requires a system of bilateraltax treaties, together with mutual agreement and competent authorityprocedures that encourage principled negotiations and timely resolutionsbetween the tax authorities on different sides of each transaction.The ALP was formally defined in article 9 of the OECD Model TaxConvention on Income and on Capital and, later, in the OECD’s transferpricing guidelines, as follows:[When] conditions are made or imposed between . . . two [associated]enterprises in their commercial or financial relations which differ fromthose which would be made between independent enterprises, then anyprofits which would, but for those conditions, have accrued to one of theenterprises, but, by reason of those conditions, have not so accrued, maybe included in the profits of that enterprise and taxed accordingly. (OECD1995, I-3)From this definition, the tax authority retains the right to adjust thetransfer prices in a way that restores market prices. In adopting the ALP,a number of countries have gone further in laying out a framework oftransfer pricing rules, including the following:• Specific provisions for recharacterization and adjustments of transactions(that is, repricing carried out by the tax authority)• Documentation requirements (typically, on a contemporaneous andtransactional basis)• Penalty provisions for noncompliance (typically focused on penalizingegregious failures of compliance rather than good faith errors)• Advance pricing arrangements (which allow an ex ante agreementbetween taxpayers and tax authorities on the treatment of specifictransactions)Less than an exact science at the implementation levelNotwithstanding the broadbased agreement on the underlying theoreticalprinciple and an extensive framework for settling disputes, the applicationof the ALP tends to be fact intensive and judgment-based, whichposes challenges and opportunities for tax authorities and taxpayersalike (box 8.2). In other words, while the more popular discourse centerson potential transfer pricing abuses by MNEs, there is also no guarantee