draining development.pdf - Khazar University

240 Draining Development?of a fair application of the ALP by tax authorities. During competentauthority negotiations, for example, officers and representatives of separatetax authorities may be more concerned about protecting theirrespective tax bases than about a straightforward application of the ALP. 5Additionally, the formal dispute resolution mechanisms do not mandatean outcome that necessarily avoids double taxation or even a timely conclusion,despite the emphasis on principled negotiations.Consider, for example, the recent case of a company with well-knownbrands that were initially developed in the United States and that arelegally owned by the U.S. parent, but that are marketed globally. Howmuch of a royalty for the use of the brand should the U.S. parent chargeits Canadian subsidiary, or, equivalently, how much of the operatingprofit of the Canadian subsidiary should be attributed to the value ofthese brands? The U.S. parent continues to expend substantial amountsBox 8.2. A Trading Intermediary: ReduxAccounting treatment: The trading intermediary records all the revenue from its contracts, thecost of purchasing the goods from the parent company, and the cost of subcontracting theparent company for administrative and other business functions (at the equivalent cost, plus amarket-related markup). The remaining profit is booked by the intermediary.Possible taxpayer’s position: The trading intermediary should be compensated for the business andmarket risks it has assumed. It trades on its own account, signs purchasing and sales contracts, takeslegal possession of inventory, and has sufficient working capital to finance its own operations.Management had the foresight to set up the business structure at an opportune time (and, if marketdevelopments had gone in the other direction, the intermediary would have incurred losses).Possible tax authority’s position: The trading company is recording larger than market-relatedprofits because it is overpricing the risks assumed, or, equivalently, it is underpricing the uniquecontribution of the strategic guidance provided by the parent company, particularly on the negotiationof contracts.Current debate: The ability of taxpayers to modify their business structures in conformity withthe ALP is currently a topic of much debate. In this case, the question could be framed around thesufficiency of the economic substance in the trading company effectively to take on all the risksthat the parent company ascribes to its subsidiary, where, in the opinion of some tax authorities,the risks necessarily follow the assets and functions. In this case, the taxpayer could argue that thenegotiating functions are more routine (based quite simply on the widely available spot price andmarket trends), and some observers would argue that the tax authority is simply adapting its ownconceptual framework to ensure short-term revenue maximization (which is generally not goodpublic policy).