August and September 2019 were busy months for international transfer pricing cases; this article summarizes the following judgments and the application of the precedents to the Middle East and North Africa region (MENA) transfer pricing regimes:
- Amazon.Com Inc. & Subsidiaries v. Commissioner of Internal Revenue
- Glencore Investment Pty Ltd v. Commissioner of Taxation of the Commonwealth of Australia
- Luxembourg & Fiat Chrysler Finance Europe State Aid Ruling v. European Commission
In 2005 and 2006, Amazon entered into a business restructuring and cost sharing agreement with buy-in payment of $255 million (to be paid over a seven-year period (present value $217 million) from a newly created Luxembourg subsidiary that would act as co-owner for pre-existing intangible assets. The Internal Revenue Service (IRS) contended that the payment was not at arm’s length attempting to include “residual business assets” in the calculation of a buy-in of $3.6 billion:
- Amazon’s culture;
- the value of the workforce in place;
- going concern value;
- goodwill; and
- growth options.
The Court of Appeal agreed with the Tax Court (March 2017 ruling) that residual business assets should not be included in the definition of intangible assets for the purposes of calculating the buy-in payment under the IRS transfer pricing regulations that existed at the time. The Tax Court adopted the comparable uncontrolled transaction method and calculated the value of the buy-in payment to be $780 million.
The case acknowledged that the restructuring of the European business of Amazon was performed in a way that shifted a substantial amount of income from U.S.-based entities to European subsidiaries. However, the Tax Court and the Court of Appeal both found in favor of Amazon demonstrating the importance of robust economic analysis to support transfer pricing.
The case (and the vastly differing starting valuations for Amazon and the IRS) further highlights the importance of the recent work of the Organisation for Economic Co-operation and Development (OECD) in relation to intangibles and business restructurings.
The IRS have since amended the definition of intangibles for tax purposes to include items such as the value of the workforce in place. The Court of Appeal confirmed that if the case were governed by recent transfer pricing regulations, the IRS would have been victorious.
Glencore International AG purchased 100% of the copper concentrate produced by Cobar Management Pty Ltd in Australia (part of the same group) under a price sharing agreement of the average copper price less a 23% deduction for treatment and copper refining charges. The Australian Tax Office raised an additional tax assessment (totaling circa AU$70 million ($46 million) excluding interest for 2007, 2008 and 2009) contending that the consideration paid for the copper concentrate was not arm’s length.
The court found that the price paid by Glencore International AG was within an acceptable arm’s length range. The case is likely to go to appeal.
The ruling sets out a discussion of the ability of a tax administration to disregard a structure under two particular circumstances as set out in the OECD Transfer Pricing Guidelines (OECD Guidelines):
- economic substance of the transactions differs from its form;
- the arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner and the actual structure practically impeded the tax administration from determining an appropriate transfer price.
The Glencore ruling made reference to Cameco Corporation v. The Queen (2018 TCC 195):
“…the task under the traditional transfer pricing rules is to ascertain the price that would have been paid in the same circumstances if the parties had been dealing at arm’s length. The traditional transfer pricing rules must not be used to recast the arrangements actually made among the participants in the transaction or series, except to the limited extent necessary to properly price the transaction or series by reference to objective benchmarks.”
It is clear that intra-group transactions with underlying economic substance and commercial rationale may be supportable even if they convey a tax advantage to the taxpayer.
Fiat applied a transactional net margin method (TNMM) in a Luxembourg tax ruling (tax years 2012 to 2016) agreeing that the arm’s length principle had been applied to:
- a “risk remuneration” calculated on hypothetical regulatory capital at a pre-tax expected return of 6.05%; and
- a “functions remuneration” calculated on capital used at an interest rate of 0.87%.
The European Commission set out a number of granular items to include that:
- the chosen profit level indicator of hypothetical regulatory capital was not considered appropriate;
- the hypothetical regulatory capital figure was underestimated; and
- choice of beta value when using the capital asset pricing model did not provide an arm’s length result.
In light of the above it was found that a state aid advantage had been conveyed to the taxpayer.
The Starbucks state aid ruling released on the same day as the Fiat ruling found that the taxpayer had not been in receipt of state aid as the pricing was consistent with the arm’s length principle (in this case the application of the TNMM over the comparable uncontrolled price (CUP) method did not convey an advantage to the taxpayer)).
Application to MENA Transfer Pricing Regimes
MENA Jurisdictions that Refer to the OECD Guidelines
Cases that discuss economic and OECD precedents will always be of relevance to tax authorities as they look to interpret local transfer pricing provisions.
This is particularly the case for MENA jurisdictions that reference the OECD Guidelines (including but not limited to Egypt and the Kingdom of Saudi Arabia).
The Amazon case summarized above provides an example of the issues that can arise if there is no consistent definition of transfer pricing concepts such as intangibles assets and therefore it is a positive development that so many MENA territories are not only adopting Action 13 Transfer Pricing Documentation standards but also other elements of the OECD Guidelines.
MENA Jurisdictions that Follow the IRS Approach
The IRS took the position of moving away from the OECD Guidelines for the definition of intangible assets following a number of high-profile transfer pricing cases. Many MENA jurisdictions are adopting the OECD Guidelines as mentioned above and have not stepped too far away from the core definitions as of yet.
MENA Jurisdictions that have not Adopted the OECD Guidelines
At present there are a few MENA jurisdictions (e.g. Kuwait) that have not adopted the OECD Guidelines. We are seeing deemed profit challenges in these locations that can appear arbitrary without a consistent international framework.
International transfer pricing cases often consider economic and OECD principles that may be relevant to the 134 inclusion framework countries with transfer pricing requirements.
Therefore, it is important to consider these cases and their relevance to intra-group transactions in MENA. The above cases have one clear thing in common—they all highlight the importance of robust economic support, commercial rationale and reasoning underlying transfer pricing methods and prices.
Shiv Mahalingham is Deloitte Regional Head of Transfer Pricing (MENA)
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.