No discussion about tax avoidance is complete without the topic of the legal manipulation of transfer prices in order to optimise the overall tax burden of a multinational group of enterprises. Transfer prices are those prices that related parties, meaning companies or persons which are legally independent, but ultimately under common economic control and therefore pursuing common goals, pay each other for assets, goods, and services that they exchange amongst each other. Although extensive transfer pricing regulations prescribe that those prices must conform to the so-called arm’s length principle, meaning that the prices need to be the same as paid under comparable circumstances by an independent third party, the complex, abstract und often subjective nature of transfer pricing and the arm’s length principle allow for considerable leeway which can result in base erosion and profit shifting.
Developing countries suffer proportionally more from base erosion and profit shifting than developed countries as they depend to a larger extent on tax revenue from big multinational companies. Through structuring and adequate planning of the functional and risk profile of the different group companies, developing countries in most cases host only those subsidiaries considered to be undertaking merely routine functions, meaning they are compensated with steady, but relatively low returns. Under-pricing transactions then reduce the profits and thus tax revenue even more. Consequently, effective, and efficient transfer pricing control is one major goal of tax administrations in developing countries.
Due to the complexity and often subjective nature of transfer pricing, experience has shown that applying the arm’s length principle is particularly difficult for partner countries. A lack of access to comparable data that is necessary to establish and verify the correct transfer price and other capacity constraints are well-known challenges for these countries, proving that merely introducing a transfer pricing system does not ensure success.
Therefore, it is of the utmost importance to partner countries to find manageable solutions that ensure effective transfer pricing controls. Those solutions need to be pragmatic and flexible and take into account the limited capacities and information available in developing countries, while complying with the arm’s length principle.
The Centro Interamericano de Administraciones Tributarias (CIAT), with funding from German development cooperation, has therefore developed a practical transfer pricing handbook tailored to the needs of such countries. The handbook "Cocktail of Measures for the Control of Harmful Transfer Pricing" and describes common transfer pricing challenges found in developing countries while at the same time offering practical solutions and approaches to them. Tax administrations can take inspiration from the "cocktail" and analyse and select those solutions that seem most appropriate for their particular context. Thus, the handbook can be a useful tool for tax administrations in lower capacity countries in order to make sure that big multinationals pay their rightful share.