draining development.pdf - Khazar University

The Role of Transfer Pricing in Illicit Financial Flows 241on research and development, and it both develops and guides marketingcampaigns around the world. Its transfer pricing policy specifies aroyalty of 4 percent of sales. The U.S. tax authority looked at the value ofthe brand and indicated that, based on analysis of comparable transactions,a more appropriate charge would be in the range of 7–11 percent(thus increasing the U.S. reported income). In looking at the same transaction,the Canadian tax authority analyzed company functions in Canadaand indicated that it would disallow any crossborder royalty; it indicatedthat the marketing campaign in Canada, together with otheractivities and investments of the Canadian entity, created local brandawareness and equity.In this dispute, the MNE is essentially neutral: the Canadian subsidiaryis 100 percent owned, and internal transfers are a zero-sum game,plus the tax rates in the two jurisdictions are broadly similar, and thebusiness environment is sufficiently comparable. Still, it now faces aconundrum on how to set its transfer prices as it is pulled by one taxauthority and pushed by the other; failure to comply immediately withboth demands could mean large penalties and late-interest payments. 6Ultimately, the company could simply let the dispute go to competentauthority, let the tax authorities decide how to benchmark the royaltycharge, and focus on avoiding double taxation. However, there is no certaintyof a settlement that fully eliminates double taxation, and the processof appeals and arbitration is a costly and time-consuming exercise. 7In other words, despite the focus in the public discourse on the potentialfor transfer pricing abuses, there is a flip side that places MNEs at risk ofbeing caught between competing tax authorities and ending up withdouble taxation (a significant cost if corporate tax rates are in the rangeof 30–35 percent in Canada and the United States) and large interestpayments, as well as heavy penalties (which could amount to 10 percentof any adjustments proposed by a tax authority).This case highlights the fact that the theoretical simplicity of the ALPis matched by judgment and complexity in implementation, but it alsoillustrates some of the tough choices faced by MNEs in navigating thesometimes choppy waters of a multijurisdictional taxation system. In thiscase, the underlying transaction involves a unique intangible asset andwide-open questions on the existence, ownership, and localization of theasset. In practice, the absence of exactly comparable market transactions