What are the tax policy considerations for multinational enterprises in the digital economy?
The global transformation to digitised models has led to debate and tensions in the international tax system about where profits should be taxed. The permanent establishment (PE) requirements in many countries’ tax laws require a physical presence and do not recognise digital participation in many countries. Also, the legal entity concept does not match the “borderless value creation” that mobile intangible assets create.
Many jurisdictions, including the European Union (EU), have implemented or proposed digital taxes on top-line revenue and introduced the concept of virtual permanent establishment.
Profit allocation is based on the arm’s-length principle (ALP) in international tax rules. Is the ALP still fit for purpose in the digital economy?
Some believe the ALP will disappear, but it hasn’t because of the lack of consensus on an alternative.
We believe the ALP will prevail, but the industry must move to a standard based on market evidence. Many companies are not prepared for this, given the way they currently handle transfer pricing.
The ALP states that the amount one related party charges to another must be the same as if the parties were not related. Therefore, the arm’s-length price is what one would observe on the open market.
As companies become digital, using the ALP to allocate profits for tax purposes between parts of a multinational has become more controversial because the market price is more difficult to establish for intangibles such as data. Pricing intercompany transactions has also become harder as data becomes more valuable, and companies grapple with its rapidly moving size, speed, and complexity.
Pricing intangibles is different because it focuses on industry economics and market evidence. It can’t be easily characterised into a broadly defined range, so it requires a customised analysis.
The challenge is that few market transactions are publicly available to help price data. Often, there hasn’t been enough evidence in controversial transfer pricing cases. But in that case, the company usually wins against the tax authority in negotiations or if it goes to court.
What are the practical considerations in performing value chain analyses?
Value chain analysis (VCA) is tied to transfer pricing because it identifies where profits are created. Some consultants will try to “boil the ocean” with extensive fact finding and functional analysis. For example, VCAs do not generally need a hyperdetailed analysis of development, enhancement, maintenance, protection, and exploitation (DEMPE) nor a microanalysis of risks and controls.
Our approach cuts to the chase, while still running key issues to the ground. It looks at the most important things in the value chain, such as where capital has been employed, and uses transactional evidence to support ALP pricing. Utilizing market evidence is absolutely a best practice.
What is Ryan’s competitive edge?
Clients throughout Europe and the rest of the world call on Ryan for our unique approach, expertise, and success in handling transfer pricing and valuation. They appreciate our “inverse pyramid” model, in which seasoned veterans in economic theory work every client engagement directly, versus the common practice of staffing engagements with junior associates who fit most fact patterns into a broadly defined range. A bespoke analysis based on market data is the best approach.
Ryan pioneered the use of market evidence over the widely employed, but often-challenged, profits-based methods. Ryan’s approach offers the most robust defence of intercompany transactions, providing successful outcomes in tax controversy litigation around the world.
We have market-leading expertise on intangible property valuation and integration of transfer pricing and tax valuation, and our record is unmatched in negotiating audit settlements, advance pricing agreements, and defending sensitive intercompany transactions.
Clients appreciate our bespoke, restructuring-related valuation and economic analyses in transfer pricing design and controversy; and in bankruptcy settings. Our market evidence-based approach fosters the most robust defence of intercompany transactions, providing successful outcomes in tax controversy litigation.