Everald Dewar | In new transfer pricing regime, ‘breaking up is hard to do’
As the reality of Brexit sinks in, Britain and the rest of the world anticipates what its post-divorce relationship with the European Union will look like.
There will be conflicts of interest between Britain and European Community countries when it comes to customs valuation, and the same is true in relation to transfer pricing (TP).
Here in Jamaica, since the advent of 2016, the transfer-pricing landscape has changed dramatically. Prior to then, the law wholly lacked the legislative clout in relation to customs valuation. It simply provided that in transaction between connected parties and computing taxable profits, if the commissioner of Tax Administration Jamaica (TAJ) suspects that the consideration is at an overvalue or undervalue that affects tax liability, he may substitute this consideration for one carried out at arm's-length price.
Arm's length means on the same basis as would be agreed by independent parties.
With this cryptic directive, in the search for an arm's-length price, the taxpayer and the TAJ were left to sort out their salvation together.
The new TP provision, unlike its predecessor, is not fortuitous and has a less opportunistic tone.
Like most territories of the former British Empire and members of the Commonwealth realm, Jamaica specifically incorporated into its laws the guidelines on TP set by the Organisation for Economic Co-operation and Development (OECD). Enshrined in the guidelines is the principle that international transactions between connected entities should be at arm's length.
This means that when signing a tax return, taxpayers will be confirming that their related-party transactions are carried out at arm's length. If they do not consider this the case, appropriate adjustments should be made in the tax return. This means the burden of proof to demonstrate arm's-length pricing has been effectively shifted from the commissioner to the taxpayer.
Documentation and penalties
A new record-keeping requirement has been introduced, effective 2016, for corporations whose turnover exceeds $500 million - that is, large taxpayers. This includes documenting the methods used to determine TP and to produce a study of comparables and functional analysis that were undertaken.
Penalties will be imposed if returns filed are not in accordance with arm's-length principles, or if it can be shown that the return was submitted fraudulently or negligently by the taxpayer and there were tax lost as a result.
Let us say a holding company provides services to other companies within the group at a price of 'cost plus five per cent'. If, following a review, the TAJ establishes that the arm's-length range is 10 to 15 per cent, they will seek to impose a penalty, whether or not the policy is documented, if the company cannot demonstrate why five per cent qualifies as arm's length.
However, if the company had undertaken a study, analysing comparable companies that it reasonably believes supports a five per cent margin, penalties would not be imposed.
If the partiers to a transaction are related, a special valuation can be undertaken to determine arm's length.
The special valuation method must be used only where the actual price is not a fair indication of the arm's-length price.
The starting point is the actual price paid for the goods or services and then the introduction of exceptional valuation methods if it can be shown that the price paid was not characteristic of an arm's-length transaction.
The TAJ will target specific industries for TP audits. There will be red flags combined with high visibility that will trigger enquiries. Those susceptible and more likely to receive attention are businesses with high-value intangibles such as software companies.
Exclusive TP enquiries will arise for loss-making distributors, below-market outbound intra-group loans, high payment for brought-in management services, and transactions with low tax jurisdictions and tax havens.
There are significant resources available to the TAJ, including press reports, trade publications, and publicly available company accounts.
Although this is a new area, transfer-pricing issues will be handled in the same manner as all other TAJ enquiries. For large taxpayers, less emphasis will be placed on time-consuming initial information gathering and lengthy record requests.
Instead, the TAJ will be requesting a copy of the TP study for the period under enquiry. It will then be able to ascertain quickly whether or not a company has complied with the new provisions.
- Everald Dewar is senior taxation manager at BDO Chartered Accountants in Kingston.