New transfer pricing regime ‘neutral’ for Ireland as a location for investment

Considering the effectiveness of the larger nations in driving the global tax agenda and with a greater focus on tax transparency, Ireland’s new transfer pricing law will help the Irish Revenue in negotiating on cross border tax related issues and demonstrate a robustness in transfer pricing matters.

The Finance Bill 2010, as initiated, introduced transfer pricing law into Irish tax law. The law will apply to companies for accounting periods beginning on or after 1 January 2011.

Transfer pricing is concerned with the pricing of transactions between connected companies and is a key issue facing multinational companies. The internationally agreed standard for setting transfer prices is the ‘arm’s length principle’ which is based on intra-group transfer prices being similar to those which would be charged between independent persons dealing at arm’s length in otherwise similar circumstances.

Although no codified transfer pricing regime is currently in place in existing Irish tax law, there are a number of sections and case law principles that are of relevance to transfer pricing and require the application of the arm’s length principle including sections dealing with the deductibility of expenses that are ‘wholly and exclusively’ incurred for the purpose of a trade, provisions relating to the 10 per cent manufacturing regime and case such as the Belville Holdings v Cronin, so arguably this new law does not represent a huge change for corporates.

Transfer pricing - why now?
The global recession has meant that tax authorities worldwide are devoting more resources to audits in order to stabilise falling tax receipts. There is an increasing frequency of transfer pricing adjustments arising from other jurisdictions such as the US and UK that Irish Revenue has to deal with. A number of high profile groups have moved their head office locations from jurisdictions such as the UK and Bermuda to Ireland recently and media comment about such moves, in certain quarters, have unjustifiably questioned Ireland’s low corporation tax regime. Other issues include the proposed Obama US tax changes and their impact for US multinational companies operating outside the US which may impact on Ireland as a location for investment.

With the above factors, the spotlight on Ireland’s tax regime has increased significantly and the presence of a codified transfer pricing regime should assist Irish Revenue in negotiating on cross border tax related issues going forward and demonstrate a robustness in transfer pricing matters.

The new transfer pricing regime

The basic rules

The new law will apply to arrangements (arrangement is widely defined as any agreement or arrangement of any kind whether or not it is, or is intended to be, legally enforceable) involving the supply and acquisition of goods, services, money or intangible assets between associated companies where the profits, gains or losses arising from these relevant activities are chargeable to tax in either company as trading profits.

It applies to both domestic and cross-border trading transactions between companies and also applies to Irish branches of foreign companies that are within the charge to Irish tax on their trading activities.

No definitions of goods, services, money or intangible assets are provided in the law. However, the law would appear to be drafted to ensure a broad range of activities fall within its remit.

As would be expected, both the person making the supply and the person making the acquisition must be ‘associated’. In practice, the associated test is met if there is more than a 50 per cent shareholding connection between two companies either directly or indirectly.

The profits, gains or losses of a company must be within the charge to tax as trading items. Therefore, the scope of the law will not include passive or investment type activities such as rental or other investment activities.

The law allows only for income to be adjusted upward and the expenses to be adjusted downward to an arm’s length figure where not otherwise reflected at arm’s length.

Given that most companies would optimise their income in their Irish operations to benefit from the 12.5 per cent corporate tax rate, it is unlikely that Irish Revenue is expecting large adjustments to income that will yield substantial cash flow for the Irish exchequer.

Documentation

On the documentation side, the main issue for tax payers is what documentation is required, when it is required and how costly will it be to meet the requirements of the law.

As the law is to be interpreted in accordance with OECD principles which includes guidance on documentation, transfer pricing documentation prepared in accordance with OECD guidelines are acceptable.

Companies should have available records that would reasonably be required for the purpose of determining whether the trading income of a company is computed by virtue of the arm’s length principle.

In some cases, it is likely that transfer pricing documentation will be prepared in the jurisdiction where the counterparty company to the Irish company is located. It may be possible to rely on this counterparty documentation to meet the Irish documentation requirement. Most countries base their transfer pricing laws and regulations on the OECD Guidelines, but in certain circumstances, there are deviations from these principles (e.g. in the US, the pricing of transactions between related parties is governed by Section 482 of the Internal Revenue Code which in certain areas differs to the OECD Guidelines).

To the extent that documentation is not available in the counterparty jurisdiction, for example if no transfer pricing regime exists or documentation is not yet prepared in the other jurisdiction, then the Irish company will be required to prepare documentation.

The transfer pricing law states that records should be prepared on a ‘timely basis’, which is undefined in the law. However, as a company has to file its tax return for a calendar year end by the following 21st September, there is an onus to have documentary support to file transactions on an arm’s length basis.

Records are to be made available for inspection to Irish Revenue within a period of not less than 21 days of request. Such a request will typically arise on an audit of a particular year.

Criteria for exemption from the transfer pricing law

The above criteria apply to the consolidated group on a worldwiode basis and must be applied on a year by year basis.

Exemption for small and medium sized entities

Somewhat similar to UK transfer pricing law, there is an exemption from applying the new law for certain small and medium sized entities as outlined in the table. The exemption broadly follows the guidelines laid down in the EU’s recommendation 2003/361/EC. It will apply to many Irish small and medium enterprises and takes them outside the scope of transfer pricing.

Special provisions for domestic companies

The law includes special provisions that eliminate double counting where the transactions are between two companies within the charge to Irish tax. Where the taxable profits of one company are increased due to a transfer pricing adjustment imposed, a downward adjustment to the taxable profits of the other company will be available. Relief for the second company will only be available where the additional tax due by the first company on the upward adjustment is paid.

There are also other provisions included for domestic companies that ensure that cash flow within a group is not adversely affected.

Timing of introduction and grandfathering of existing arrangements

The law relating to transfer pricing will apply to companies for accounting periods beginning on or after 1 January 2011. This provides an opportunity for companies to review the position of all their intercompany transactions to ascertain how the law will impact them.

Also included in the Finance Bill are certain grandfathering provisions of existing arrangements, the terms of which, whether legally binding or not, are agreed 1st July 2010. To the extent that arrangements are in place before 1st July 2010, then these arrangements will not be within the remit of this law.

Advance pricing agreements

Typically Advance Pricing Agreements (APAs) are entered into by multinationals in advance of making a decision to invest to provide certainty on the pricing of transactions. Irish Revenue has facilitated a small number of bilateral and multilateral APAs with companies in the past.

As APAs form a vital part of investment decisions, there will be strong interest in how Irish Revenue deals with this issue on a practical basis, particularly as competitor countries to Ireland have a well established APA facility for proposed investments.

Aside from the APA issue, we welcome Irish Revenue’s guidance and clarification of certain aspects of the law as transfer pricing is one of the most significant tax issues facing multinational companies today. The interpretation of the law will be of particular interest to companies operating in the financial sector due to the various types of intercompany transactions that are entered into, many of which can be multijurisdictional and complex.

What is the impact for Ireland?
One of the fallouts from the economic crisis is the more complex and prescriptive regulatory environment. The effectiveness of the larger nations in driving the tax agenda was demonstrated through the efforts of the G20 in increasing the level of exchange of tax information and the focus on tax transparency. The introduction of a formal new transfer regime is appropriate in the context of a renewed focus on regulation and in this environment should be neutral as regards Ireland’s attractiveness as a location for investment.

Irish plcs, multinational companies and their advisors already deal with transfer pricing issues on a day to day basis with foreign taxation authorities and therefore Ireland’s new law should not be a significant additional burden to them. The financial services sector in Ireland has contributed significantly to Ireland’s development in terms of employment and growth since the early 1990s. Companies have been attracted to invest here by a combination of factors including our favourable taxation environment, highly qualified English speaking workforce and our strategic location. As the new world order in financial markets develops, it is vital that Ireland remains high on the agenda when companies decide where to locate and one of the benefits of the new law is companies may perceive that Irish Revenue is more readily available to assist them in defending their pricing policies when in discussion with overseas tax authorities.

This article was first published in February 2010 in FINANCE DUBLIN. ©2010 Fintel Publications Ltd