draining development.pdf - Khazar University

The Role of Transfer Pricing in Illicit Financial Flows 243or service becomes less of a traded commodity and more of the intermediategood that is often the subject of intrafirm transactions or even amore unique service or intangible, transfer pricing comes to rely evenmore on (1) comparability adjustments and ranges of prices obtainedfrom a group of similarly comparable transactions and (2) profit-basedmethods, rather than product-based prices. 10In practice, derived ranges for arm’s-length pricing can be quite broad.In a cost-markup situation, for example, it is not uncommon for a rangewith a central point (or average) at 10 percent to have a minimum of lessthan 5 percent and a maximum of around 15 percent. The range arisesfrom differences in results across comparable companies and may also beaffected by adjustments for differences in comparability between thetested party (the company for which the range is being calculated) andthe comparable companies (which provide the market evidence).In addition, to account for possible differences in the business andeconomic cycles, a three- or five-year average of results is typically usedas the market benchmark (OECD 1995). The OECD guidelines recognizethat, particularly in applying profit-based transfer pricing methods,it is necessary to take account of business cycles and special circumstances,such as the startup of a business, that cannot be fully addressedthrough comparability adjustments. Absent this option, a profit-basedmethod might indicate that a transfer pricing adjustment is called for(simply) because the tested party is at the bottom of its business cyclewhen the uncontrolled comparables are at the peak of theirs.Finally, differences in approach across tax authorities (for example,Canada with its general reliance on form and the United States with itsgeneral reliance on economic substance) create interstate frictions.Moreover, inconsistencies in domestic tax codes also create domesticfrictions and additional opportunities for tax planning; for example,Canada actually blends an application of legal form for general antiavoidancepurposes with a reliance on economic substance for transferpricing regulations. 11 These frictions can become either a source of concernfor multinationals aiming to comply with differing provisions or anopportunity for tax arbitrage in the presence of creative tax planningand a favorable fact pattern. At the least, these frictions make MNEs basetheir decisions on transfer pricing issues not only on the underlying factsand the legal requirements, but also on the degree of aggressiveness (and