Dispute Resolution Tools Offer Aid, Certainty to Multinationals

As the global economy tackles inflationary headwinds, multinationals are gearing up to confront the uncertainty brought by seismic shifts in transfer pricing landscape.

With OECD Pillar Two impact anticipated in the near-term, and continuing ambiguity on the timing and effect of Pillar One on traditional transfer pricing systems, multinationals would be well-advised to attain certainty through alternative (and advance) dispute resolution of transfer pricing disputes.

The tools available include advance pricing agreements, mutual agreement procedure under bilateral treaties, arbitration, and mediation. Each of these is often overlooked and underrepresented. In this article, we highlight the benefits of these mechanisms.

Available Choices

Some practitioners contend that the world is moving toward global formulary apportionment and abandoning the arm’s-length principle, which has been the bedrock of profit allocation for decades. As the tug-of-war between the two extreme approaches continues, the taxing authority in each country is aggressively auditing large multinationals with a meaningful economic presence there (such as through having material end-user customers geographically located there) and trying to maximize its slice of multinationals’ global profit through increased transfer pricing audits, leading to an increased number of disputes that are difficult to resolve.

These disputes can involve multiple jurisdictions, multiple years, and take a long time to resolve, leaving the multinational, its financial management, its external attest firm, and its shareholders with considerable uncertainty. This requires a lot of crystal ball gazing to effectively determine the outcome of these disputes and appropriately reserve for them in published accounts relied on by stakeholders.

What choices are available to a multinational to mitigate this uncertainty? One option is to continue with business as usual, continue to accept the strain on its resources committed to defending its positions, with the potential of ending up in time-consuming and costly litigation. Even if a taxpayer has the courage of its convictions to pursue validation of its transfer pricing approach by litigating the matter, there is no certainty that the outcome in one jurisdiction will be respected in the other, and there is still the possibility of double taxation.

For example, the settlement of a foreign transfer pricing dispute resulting in payment of additional tax by a controlled foreign corporate affiliate of a US multinational can give rise to double taxation. If the IRS does not agree with the adjustment, which resulted in an increase of foreign equivalent of taxable income and income tax, it may dispute whether the tax paid is creditable against a US tax applicable to the same income for US foreign tax credit purposes. Among other requirements that must be met for a foreign tax to be creditable, the increase in foreign tax at issue here cannot be a non-compulsory payment.

Alternative Remedies

As a general matter, Treasury Reg. Section 1.901-2(e) requires a taxpayer to exhaust its remedies in legally minimizing its foreign tax liability. The IRS appears to be increasing its scrutiny of credits of previously contested tax liabilities, contending that this requirement has not been met where the taxpayer did not pursue competent authority relief and/or MAP. This creates a strong impetus to pursue alternative remedies. These tools allow the multinational to attain greater certainty, reduce the risk of double taxation, and proactively manage the narrative with tax authorities to ensure no reputational damage and ensure an improved reputational position with them.

An APA provides increased certainty, as it eliminates both current and future transfer pricing audit risk. It is a cooperative way of resolving disputes or potential disputes and builds trust and transparency with governments. Removal of a transfer pricing audit threat allows the multinational to plan resources appropriately and reduce compliance costs over the term of the APA. Finally, it enhances the taxpayer’s reputation and can create a “halo effect” with an increasingly interconnected tax administration community, potentially reducing future contentious tax audits.

In contrast to an APA, a MAP can be initiated separately from domestic dispute resolution mechanisms by applying what is typically Article 25 of bilateral tax treaties between countries. The MAP is a mechanism for competent authorities of a jurisdiction to discuss cross-border taxation of specific transaction to try to alleviate double taxation for the benefit of the taxpayer.

MAP cases are an increasing trend, but MAPs are still underused, mainly due to lack of understanding of the process and perceived obstacles. Based on the 2021 MAP Statistics from the Organization for Economic Cooperation and Development, 53% of MAP cases were fully resolved, resulting in no double taxation, and 22% cases were resolved unilaterally or via domestic remedy. These statistics suggest that three-fourths of the cases end up providing relief to the taxpayer.

In addition to transfer pricing disputes, MAPs also can be considered for beneficial ownership, capital gains tax, taxpayer residency, attribution of profit to permanent establishment, and more. In case the tax treaty partners cannot come to an agreement, an increasing number of treaties provide the possibility of arbitration.

As the transfer pricing landscape evolves, heightened audit activity can be expected. It is for the taxpayers to evaluate, based on a cost-benefit analysis, whether using alternative or advance dispute resolution tools is an option. In our experience, and as the statistics suggest, these tools are for the benefit of the taxpayer and have positive consequences beyond providing certainty and eliminating double taxation.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Kevin Glenn is a partner in DLA Piper’s New York office. He has more than 35 years of experience in advising multinationals in respect of cross-border tax matters, including a particular focus on post-integration and tax efficient intellectual property related tax planning.

Rachit Agarwal is transfer pricing director for DLA Piper in London. He advises multinationals on intragroup financing arrangements, achieving optimum operating model design, developing risk mitigation processes with a view on audit defense and valuing IP and other assets.

Randall Fox is head of international transfer pricing for DLA Piper in London. He and his team of more than 30 professionals across Europe work with a broad range of clients on operating model design, bilateral APAs, valuation of intangible assets, defense documentation, and related transfer pricing controversy preparation.

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