draining development.pdf - Khazar University

The Role of Transfer Pricing in Illicit Financial Flows 259risks of collection of accounts receivable; risks associated with product liability;and financial risks such as those caused by currency exchange rate and interestrate variability.9. Adjustments routinely undertaken in transfer pricing analyses account for differencesin accounting practices for inventories, intangible assets, or depreciation;level of working capital; cost of capital; level of market; treatment offoreign exchange gains; and impact of extraordinary items. The total of theseadjustments can sometimes produce a substantial cumulative adjustment tothe underlying market price, in which case the OECD guidelines questionwhether the degree of comparability between the selected companies and thetested party is sufficiently high, but, in practice, there are no specific criteria bywhich to make this determination. Of course, in the absence of a more adequatemethod or more comparable data, the analysis in question may remainthe most feasible, and, in any case, it may still produce a relatively tight rangeof arm’s-length prices.10. The OECD views profit-based methods (such as the transaction net marginmethod or, in the United States, the comparable profit method) as generally lessreliable than the traditional transaction methods such as the comparable uncontrolledprice, which is a product comparable method. The latter, however,requires the identification of transactions involving the same product and thirdparties (to be used as the comparable uncontrolled transaction by which to pricethe related-party transaction), and, in practice, companies tend not to transactwith a third party on the same terms as a related party. Differences in transactionswith related and unrelated parties include (a) volume or other size or scalefactors, (b) level of the market, (c) temporary versus permanent relationship,(d) primary sourcing versus secondary sourcing, and (e) after-sales service, warrantyservices, and payment terms. Thus, either comparability adjustments arenecessary (if a potential comparable uncontrolled transaction can even be identified)or profit-based methods must be used.11. In this context, form means that the legal setup or structure of the transactionstakes precedence in terms of its characterization (and treatment) for tax purposes,whereas economic substance implies that the underlying business or economicrationale is paramount (regardless of the legal form). Where the economicsubstance concept applies, for example, tax authorities may look throughintermediate transactions and merely consider the aggregate effect for purposesof tax treatment. In the specific case of Canada and the United States, this haspromoted the use of hybrid transactions that are characterized differently ineach country (so that the same transaction, for example, may be viewed as adividend receipt by one jurisdiction and an interest payment by the otherjurisdiction).12. As defined in Wikipedia (http://en.wikipedia.org/wiki/Tax_avoidance_and_tax_evasion [accessed August 31, 2009]), “tax avoidance is the legal utilization of thetax regime to one’s own advantage, in order to reduce the amount of tax that is