INTERNATIONAL TAXATION AND TRANSFER PRICING STRATEGIES

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INTERNATIONAL TAXATION AND TRANSFER PRICING

STRATEGIES

1. Introduction

Multinational companies need to take into account certain global issues while

they are managing their operations in different countries and these are the

international taxation and transfer pricing. Transfer pricing refers to the method

and Profit Split pricing. Thirdly, international tax planning entails regulating

business operations, and other economic activities, or legal entities in a manner

that optimizes the tax cost all across the globe, while dealing with various systems

of taxation. These include tax treaties, management of intellectual property,

location selection of operations among others that go a long way in minimizing tax

cost and thereby maximizing the net705 profit of multinationals in cross-border

spaces.

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2. Transfer Pricing Fundamentals

2.1 Arm's Length Principle

The principal of Arm‟s Length is the outstanding foundation for international transfer pricing

Bakker and Levey (2022) posit that, using the ALP can be a bit challenging because… Since

related party transactions differ from each other, it becomes difficult for one to find an exact

market comparable. This increases the difficulty in defending transfer pricing policies during a

tax audit, meaning that good transfer pricing documentation and careful comparability analysis

are needed. the ALP is an important aspect that ensures the independence and impartiality of the

international taxation system. It aids in eradicating one kind of risk or the other where cross-

border transactions within MNEs are involved, that is, double taxation or non-taxation. This

principle also aligns with the idea of halting base erosion and profit shifting (BEPS), regarding

taxation as a right that should be claimed where value is created. Nonetheless, critics justify that

the ALP can fail to present the current reality in terms of integrated business environments

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international tax system. But because transfer pricing remains a rather political and hot topic to

this day, and because the very nature of international business and global trade is a dynamic one,

there is always a need to make changes and adjustments to the existing framework of rules and

regulations and make them fit the existing problem solving challenges (Hoor, 2021).

2.2 Transfer Pricing Methods

Transfer pricing methods are an important part of the Arm‟s Length Principle as they can be used

to Price Intertaxical Transactions as if they are between entities that do not belong to the same

group. The OECD list some methods for determining arm‟s length price which includes

Comparable Uncontrolled Price (CUP), Resale Price Method (RPM), Cost Plus Method (CPM),

Transactional Net Margin Method (TNMM), and Profit Split Method (PSM) (OECD, 2022).

determine the arm‟s length price involves deducing the right gross margin from the resale price

to an unrelated party to satisfy the needs of distributors (Feinschreiber & Kent, 2022). CPM, on

the other hand, allows a supplier to add a mark-up or percentage to the supplier‟s cost which is

more preferable if the grossers are manufacturers or service providers. PSM and TNMM are

more sophisticated and can be applied only when the precise methods are impossible to

implement. TNMM measures the net income in relation to an appropriate benchmark, while

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share of the joint profits (Choudhary, 2022). As these methods prove helpful in natural language

processing. they are not without their drawbacks. This is because the approach that is used in

acquisition of comparables is prone to the following challenges which include the following A

major pro of the cost approach is that it takes into consideration the current and present value of

an acquiring firm and the industry it operates in, unlike the income approach Apart from the

above mentioned implications, there are some other implications of using this approach which

are as follows: The use of comparables data can be misleading especially when acquiring

Principle as well as for keeping the prices of intra-parties‟ transactions reasonable and fair.

While the previous models such as CUP, RPM and CPM models are very simple to understand

and implement, TNMM and PSM models allow for variations that can be useful in some rather

complicated circumstances.

2.3 Documentation Requirements

The documentation of transfer pricing policies and strategies are a key part of compliance with

the international taxation standards to provide evidence that those transactions were conducted at

arm‟s length. Within the Transfer Pricing Documentation, MNEs have the option to use the

OECD‟s three-level documentation regime, including Master File, Local File, or Country-by-

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the structure of the MNE and its worldwide business activities, business restructuring, transfer

pricing, and distribution of income and economic activities internationally. Conversely, the Local

File offers more refined data on distinct operations within each area; such information

encompasses functional descriptions of transactions, similar transactions, and financial data

pertaining to those transactions (Collier & Andrus, 2022). Essentials of Notably, it is now

absolutely crucial to have a clearly documented Methodology on transfer pricing. While the

Arm‟s Length Principle seeks to ensure that MNEs do not engage in pricing that grant them

improvement of transparency as the tax administration obtains a broad view of the MNE‟s

distribution of income, taxes, and dedicated activities that can potentially be associated with

BEPS threats (Haslehner et al. , 2022). However, creating transfer pricing documentation might

be time-consuming and intricate in most cases, it would demand much time and efforts from an

expert. Some of the challenges include: There is a need to harmonize information as it is written

in different levels in the documentation and to upgrade information due to changes that may

occur in the business operation or transfer pricing policies (Feinschreiber & Kent, 2022). Also,

the enhancing control by tax authorities in the different countries means that MNEs need to have

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it can help to manage risks in case of transfer pricing tax audit. The three-step structure of the

OECD framework gives the firm a guideline through which to document MNEs‟ transfer pricing

policies effectively. Nevertheless, the preparation and maintenance of documentation that would

be required in transfer pricing cannot be overlooked for lack of facial value because of the key

role it plays in tracking and accounting for such dealings and especially when it comes to

These include provisions for Determination of Residence, Allocation of taxing Rights between

Contracting States with regard to Business Profits, Dividends, Interest, Royalties, Capital Gains

etc. These treaties often contain provisions that attempt to describe concepts such as the notion of

fixed place of business (PE), residency and apportionment of taxing rights (OECD, 2022). To the

same effect, Collier and Andrus (2022) point that tax treaties‟ key advantage is minimizing or

eradicating withholding taxes on cross border payments so as to enable ease in international

transactions. Tax treaty analysis, MNEs can gain insights of the different tax treaties that exist in

different countries that can be more importantfor planning the business tasks better. With such

knowledge of DTAs it becomes easy for any company to search for ways of reducing its

international taxation law liability while at the same times remaining within the legal

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(Duff & Rousseau, 2021). Moreover, tax treaties contain provisions of MAP aimed at further

resolution of tax disputes and avoiding double taxation through the negotiations carried out by

the competent authorities of the treaty countries. However, the efficiency of tax treaties can be

challenged by BEPS through which profits are shifted to low taxation countries that have little or

no economic connection with the transactions through which such profits are earned. For the

same reasons, BEPS Action Plan 6 contains measures to combat treaty abuse, such as the PPT

and the LOB clause (OECD, 2022). They are aimed at ensuring that the treaty related benefits

consolidating the ownership of subsidiaries and other investments. These structures provide

several benefits when it comes to taxation, including the ability to optimise withholding taxes on

dividends, interests, and royalties through having properly negotiated tax treaties (Hoor, 2021).

Other forms of treaties that can be beneficial to holding companies include participation

exemption regimes where dividends and capital gains received from subsidiaries are exempted

from taxation in order to guard against having the same income subjected to tax twice (Casley &

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company would be created lies in the fact that countries have different tax regimes as well as

different networks of treaties. Treaty shopping countries such as the Netherlands, Luxembourg

and Switzerland attract investors as they provide comprehensive treaty network viable tax

policies as well as legal regime of certainty and stability (Choudhary, 2022). These jurisdictions

may also offer other favourable provisions pertaining to holding companies particularly in the

matter of exclusion of capital gains and dividend income further to boosting the desirability.

Current trust regimes of holding companies are being subjected to financial authorities to

ITA and provide the necessary tax incentives, as well as, being able to take advantage of the

identified double taxation, tax treaties, and other beneficial local taxation systems. Nevertheless,

new forms of globalization, the new wave of international tax action, including changes in the

focus on the concept of substance and an increasing number of anti-abuse measures, require

certain planning and compliance to preserve these advantages. Due to the tax regimes, the

holding companies must prove that they are not only shells but engaging in substantive activities

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Another advantageous characteristic of IP is that it should be an important feature of

international tax planning because IP could create considerable profits through royalties or

licensing fees. This is because a majority of MNEs deliberately position IP ownership in low-tax

jurisdictions to limit their international tax responsibilities. Some among them are Ireland,

Luxembourg, and Singapore given their attractive taxation policies of IP income such as tax

exemption or low tax rates in respect of qualifying IP profits (Herzfeld, 2022). It is widely

practiced due to centralization of IP through IP holding companies to control the acquisition and

management of intellectual properties. CCAs are another way of dealing with IP within MNEs;

hence, the pointers reviewed above can be effectively applied in this context. These

arrangements entail multiple participants exercising cost and risk- assumption in proportion to

advantage when developing or exploiting IP. The OECD‟s BEPS Action Plan 8-10, which

provides a response to the difficulties encountered in the field of IP and transfer pricing, states

that value should reflect the returns on IP to express the value-creating activities involved in

developing and managing the IP. This in turn indicates that mere legal ownership of IP is

insufficient to generate large returns, rather, both technical and substantial activities for

development, improvement, maintenance, protection, and utilization (DEMPE) of the IP have to

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principles of the MAP framework, the dispute-solving process is rational and well-ordered,

although sufficient time-consuming and requiring many resources. In the same vein, Bakker

Levey stated that one of the weaknesses of MAP is the protracted negotiation, thus, increasing

uncertainty for MNEs as pointed out by Bakker and Levey (2022). Another dispute mechanism

is arbitration since it provides for a more definitive and time bound solution as compared to

MAP. According to OECD‟s BEPS Action Plan 14, arbitration has been encouraged as a

mechanism that could also improve effectiveness of dispute resolution mechanisms. MAP, as

taxpayers and the tax authorities to set out future transfer pricing methodology. This strategy is

proactive and is more beneficial than having to go through auditations and legal litigations

(Choudhary, 2022). Unilateral and bilateral APAs share their benefits in practice and while the

bilateral APAs are more comprehensive since they entail mutual agreement between two

jurisdictions‟ tax authorities and as such remove double taxation issue. it may be argued that

there is a need to have effective methods in place for asking controversy in transfer pricing.

5.3 Advance Pricing Agreements

APAs are thus long-term strategic instruments that reduce risks involved in transfer pricing for

MNEs needed by benefiting corporations. An APA is thus a legally binding contract entered into

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one or more tax authorities that outlines the transfer pricing method suited for particular

transactions over a given period of time. APA can save the time and efforts of the MNE in the

future from the possible future disputes and audits regarding the transfer pricing and can set up a

stable taxation environment for the definite period the APA covers (Bakker & Levey, 2022). To

obtain an APA, there are complex negotiations with comprehensive documentation that are

required to prove that the planned method of determining transfer prices complies with the arm‟s

length standard. This consists of compiling of accounting data, functional requirements and

transfer pricing disagreements associated with APAs. When both the taxpayer and the tax

authorities reach an understanding of the transfer pricing methodology at an early stage, the

expected taxation implications are known, then the parties are more likely to adhere to the set

laws and regulations and thus, there will not be many cases in which contentious audits can arise

(Herzfeld, 2022). Nonetheless, it is also important to note that the APA process may be rather

costly and can take quite some time to be developed and implemented, which may necessitate the

efforts of the both the taxpayer and the tax authorities. In his perspective, Choudhary (2022)

noted that there is a strong necessity to undertake vast preparations and produce coherent

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as it faces the following challenges;The BEPS Action Plan 14 presents by OECD on APAs has

justified the mechanism to enhance resolve on the cross border tax dispute and transfer pricing

standard.

6. Base Erosion and Profit Shifting

6.1 BEPS Action Plans

Specifically, the OECD and G20 designed a series of BEPS Action Plans to contain the problems

relating to aggressive international tax planning schemes that exploit legitimate differences in the

domestic tax laws to shift profits to locations that are either low or no tax. The BEPS project

(OECD, 2022). The first one Linked to Action 1 that is focused on the Main report on BEPS

Action Plans: Tax challenges arising from digitalisation of the economy. It recognises that these

challenges have been compounded by the digitalisation of the economy that makes it harder to

tax profits where they are earned. They provide recommendations on how countries can be able

to implement efficient taxation measures in digital transactions (OECD, 2022, pp. 135).

According to Herzfeld (2022), it is important to Respond to and confront challenges related to

digital economy because countries suffer huge loses through the shift of many contemporary

organizations to the digital format. This entails the obligatory automatic sharing of unidentified

tax arrangements, particularly preferential regimes. The aim is to make, accordingly, that the tax

incentives areavailed only where there is real economic activity, which means that countries

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high risk area. They explain that the transactions between related parties should be Done on an

arm‟s length basis to ensure that the profits accruing from the transactions are in line with the

prevailing economic conditions, and therefore control the use of transfer pricing as a tool of

distorting profits (Bakker & Levey, 2022). As part of Action 13, the Country-by-Country

Reporting (CbCR) has been embarked on whereby MNEs are expected to file a report to the tax

authorities portraying the overall picture of the economic activity including income and taxes

paid at country level. This kind of transparency provides tax authorities with better opportunities

2022).

of CbCR is to help the tax authorities gather the data required in order to perform risk analyses

and to determine the areas of concern which require additional scrutiny. According to Bakker

and Levey (2022), CbCR is an important step towards making the operations of MNE‟s more

transparent and minimising chances of profit shifting. This is due to the fact that through detailed

data, tax authorities can understand the flow of incomes and economic activities of an MNE and,

thus, identify potential discrepancies and abnormality thus pointing to aggressive tax planning.

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countries through the signing of agreements enables other tax authorities to have a complete

picture of an MNE‟s operations. Herzfeld (2022) noted that the above increase in exchange of

information enhances co-ordination in addressing BEPS issues, cutting down chances of double

taxation and enhancing efficiency in tax regimes. However, there are some issues that

accompany implementation of CbCR. This means that MNEs must provide accurate and

reconciled reports to all jurisdictions; this is possible by putting in place good information

collection and reporting mechanisms. Choudhary (2022) has highlighted that the compliance cost

through artificial trades and structures that lack valid economic rationale and business purpose

(OECD 2022). The fight against base erosion and profit shifting being one of the key topics of

the BEPS project, one of the major anti-abuse steps included in the project is the PPT that is a

part of Action 6. The PPT is one of the general anti-abuse rules contained in tax treaties and

prevents entitled tax benefits if one of the aims and objectives of a transaction or arrangement

was to obtain the benefits in question but for this, it is required to prove that the granting of these

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(OECD, 2022). Referring to the PPT, Bakker and Levey (2022) consider it to be a highly

effective instrument in the hands of tax authorities to address with the phenomenon of treaty

important anti-abuse measure that could be concluded from this comparison is that the LOB rule

is more prescriptive and specific than the PPT. The LOB rule specifies how the treaty benefits

are to be provided through significant conditions that a resident of any of the contracting state

should meet while applying for the benefits. It is therefore meant to eliminate possibilities of

subsidiary to the parent company provided certain conditions prevail, thus closing off the tax

deferral on foreign income (Choudhary, 2022). Another aspect is anti-hybrid rules which seek to

match tax losses from the differences in the taxation status or treatment of entities or a particular

instrument in more than one taxing jurisdiction and eliminate tax benefits out of them.

The emergence of digital economy has over time put a lot of pressure on the convectional

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business largely in a jurisdiction without establishing a physical structure that would qualify as a

PE, and therefore cast doubts about the effectiveness of the existing rules on PE (OECD, 2022).

The OECD‟s BEPS Action 1 is devoted to the major problems arising from the digital economy

and suggests that the changes in the definition of PE should take into consideration important

digital presence. Such prejudices cover terms like a „substantial economic presence‟ or a „virtual

permanent establishment‟ which means that purely digital business could be considered as

having a taxable presence in a given country without having a physical presence there at all

establishments yet reap on the most ruling tax policies. In response to these positions, the OECD

offered a consolidated approach under Pillar One of the BEPS 2. 0 project. It aims at assigning

taxing right to the country where the consumers or user are located to give recognition to the

value generated by a digital company in a market jurisdiction. This is a shift from a pure notion

of location-based interactions to a broader evaluation of economic involvement with a market

market (OECD, 2022). Consequently, due to new opportunities opened by the digital economy, it

is crucial to reconsider and further develop the nexus and PE rules for successful and equitable

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A methodology that identifies the business units where profits would be assigned for tax

purposes within an MNE and more specifically to its PEs is profit attribution rules. It has only

become even more daunting to apply these rules as the digital economy does not conform to the

ways in which incremental value creation is recorded using the traditional approaches. These

have been some of the factors that have led to the emergence of various issues as highlighted by

the OECD‟s BEPS project that tries to address these concerns through more refined guidelines

and principles. In accordance with the general principles of profit allocation, profits are to be

allocated to a PE in proportion to value added, depending on the PE‟s functions, assets, and risks.

However, in the present era of digital economy where traditional economic activities might not

necessarily represent a business value in terms of physical location and footprint, opportunities

businesses. This docket entails the concept of Amount A whereby part of the residual profits of

some of the largest and most profitable Multinational Enterprises (MNEs) will be required to be

attributed to market jurisdictions where users and consumers are based notwithstanding physical

nexus. It is meant to enhance the capture of the value delivered by digital engagements and

particularly the part played by the users in improving the profitability of digital organizations

(OECD, 2022). Choudhary claims that these rules for division of profits are rather new going

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transfer pricing strategy as well as documentation. This concentration on user-based allocation is

a problem in the systems by identifying and measuring the value of users in user-based

organisation and implementing it in every country including in multiple jurisdictions that have

different interpretations and implementation of the new rules.

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representatives of both buyers‟ and sellers‟ market jurisdictions as well as holder countries for

digital businesses (OECD, 2022). This article by Feinschreiber and Kent (2022) posits that while

DSTs may help the implementing countries to earn revenue in the short term, the dangers of

fragmentation of the international tax system and increased tensions in trade relations cannot be