TRANSFER PRICING ENVIRONMENT
The prices applied to transactions between various entities of an international group must be justified to the national tax authorities.
The price of these transactions between related companies must comply with the arm’s length principle and correspond to the prices that would have been applied to independent third parties.
In France, compliance of transfer prices with the arm’s length principle is enshrined in article 57 of the General Tax Code, which provides that the prices applied by a French company to other companies of an international group must comply with this principle.
Furthermore, these companies are required to justify the price levels applied either as part of a tax audit and at the request of the tax authorities (art L13 B of the Tax Procedure Handbook), or, for larger companies, when preparing pre-established documentation as part of a tax audit (article L13AA of the Tax Procedure Handbook).
The content of the documentation for these companies has been specified in detail by decree no 2018-554 of 28 June 2018.
Beyond the national context, transfer prices are also regulated by bilateral tax treaties, where the arm’s length principle is taken from article 9 the OECD and UN Model Tax Conventions.
The OECD has, in its various reports on transfer prices, specified the scope of transfer prices, the arm’s length criteria and the economic analyses that must be carried out before setting transfer prices.
For developing countries outside the scope of the OECD, and in particular African countries, the UN published a transfer pricing guide in 2013 that also specified the various transfer pricing regulations, including scope of application, methods, etc.
The European Commission has also made recommendations through the European Commission Transfer Pricing Forum, which is composed of experts who advise the Commission and issue opinions on transfer pricing matters.
All transactions are subject to transfer pricing and must comply with the arm’s length principle, including the following:
- Tangible and intangible assets: products, trademark royalties, patents, know-how, etc.
- Services: research and development, management, administrative and financial services, marketing, human resources, etc.
- Financial flows, in particular intra-group loans
- Exceptional events, including company restructurings, mergers and acquisitions, asset transfers, etc.
Transfer prices are justified on the basis of the following two elements:
- A functional analysis carried out to identify the role of each party to the transaction and assess the functions it carries out, the risks it incurs and the assets it holds.
- An economic analysis carried out to determine the arm’s length price through comparative benchmark exercises such as those included in our offers.
Transfer pricing implications
International tax competition
Transfer prices fit into the context of increasing international tax competition.
Despite the efforts of various organisations, in particular the OECD, the UN and European Union bodies, to reach an international consensus, individual administrations are upholding different positions on how to apply these principles, and are implementing approaches other than the arm’s length principle, which results in a high number of adjustments and double taxation of the same tax base in different jurisdictions.
At the European level, for example, the CCCTB Project on the implementation of a Common Consolidated Corporate Tax Base has still not materialised despite numerous ongoing discussions at the European Commission and many proposed drafts.
This lack of harmonisation on tax bases and taxation rates is a reflection of a complex international context where international tax competition remains firmly present.
Click below for an interview with Cyril Maucour, the DS Avocats partner in charge of our transfer pricing practice with the Friedland Institute on the topic of tax competition in Europe, and in particular CCCTB issues: https://www.youtube.com/watch?v=98iDrO6VSok
Increase in the number of tools available to tax authorities
Tax authorities today have access to increasingly powerful and varied tools for controlling the transfer prices applied by international groups.
First, they have access to the accounts of the audited company, as well as the group’s consolidated accounts. They can therefore check whether the transfer pricing policy has been applied to the group’s accounts by looking at intra-group contracts and invoices.
These checks are now facilitated by the obligation to keep computerised accounts that comply with the model prescribed by the tax authorities. In France, for example, the obligation to submit the FEC file in the event of an audit came into effect in 2014.
In the context of transfer pricing, authorities have access to full transfer pricing documentation for the companies that fall within the scope of these regulations. In France, these are any groups that generate a consolidated turnover of more than 400 million euros.
The BEPS project, which has been implemented by means of various tools, in particular the multi-lateral instrument (MLI), has succeeded in significantly reinforcing the transfer pricing obligations of international companies and has contributed to an increasingly complex environment:
- The implementation in 2016 of the Country by Country Reporting (CbCr) requirements, codified into law in France by article 223 C of the General Tax Code, enabling the automatic exchange of information between tax authorities;
- The entry into force of The Multilateral Instrument (MLI), which modifies existing bilateral treaties on the basis of various levels of transparency in more than 40 OECD member countries.
(Link to the list of signatories and table of current bilateral ratifications: http://www.oecd.org/tax/treaties/beps-mli-signatories-and-parties.pdf)
- The introduction of bilateral conflict resolution mechanisms (in particular amicable settlement and arbitration).
Similarly, at European level, a number of both draft directives and already-adopted directives have also raised the general level of transfer pricing obligations, such as, in particular, European Directive 2018-822 of 25 May 2018, known as DAC 6, which notably requires tax schemes considered aggressive to be declared.
Implications for international groups
Transfer pricing is a key issue for international groups, as compliance with the arm’s length principle enables them to:
- Limit the risks of being deemed to have a permanent establishment in various countries as well as the risk of double taxation;
- Avoid audits, adjustments, and the application of significant penalties, both administrative and criminal
As an example, the majority of corporate tax adjustments relate to permanent establishment issues and transfer pricing (mainly prices for inter-company services). According to the data published by the finance ministry for 2018, 85% of tax adjustments were related to the matters indicated above.
The situation is similar in many other countries.
This has multiple implications for companies as they must now manage several distinct issues:
- the basic issue of tax adjustments, or the fair application of the arm’s length principle and proof of compliance with the principle;
- the issue of documentation penalties, which can be significant (for example, in France, the penalty applied is the highest of the following amounts: €10,000, 0.5% of the amount of the wrongly-documented or non-documented transactions, or 5% of the adjustment amount);
- and the issue of penalties (40% or 80% in France, for example), as well as criminal prosecution for tax evasion. It is worth noting that in France the risk of criminal prosecution has been increased by the entry into force of the law of 23 October 2018 on the fight against tax evasion, which put an end to the budget ministry’s monopoly on prosecuting tax evasion (the “verrou de Bercy”), by introducing the obligation to submit to the public prosecutor’s office the most significant tax adjustments that exceed the €100,000 threshold for adjusted taxes.
Transfer pricing audits and litigation
Tax audits in France
In France, transfer prices can by audited through traditional tax audit methods by carrying out an accounts check procedure, for example.
However, the Tax Procedure Handbook provides transfer pricing-specific procedures which allow the tax authorities to check the prices of intra-group transactions directly (article L13B) and to access certain information relating to the transfer pricing policy in effect, in particular the transfer pricing documentation required by article L 13 AA of the Tax Procedure Handbook.
Simultaneous tax audits
Local tax authorities may also carry out joint audits with other tax authorities.
The OECD’s Committee on Fiscal Affairs has put together a model convention for simultaneous tax audits for countries wishing to enter into this kind of cooperation.
The OECD has specified that these procedures will enable tax authorities to communicate more easily and minimise the difficulties encountered by taxpayers and tax authorities when setting transfer prices. The OECD also recommends that countries use these procedures more often and that they facilitate the exchange of information.
Transfer pricing litigation in France
Before the matter is brought before the courts, companies are able to go through preliminary procedures including escalation processes or referring the matter to bodies such as the appeals officer (Interlocuteur Départemental) or the departmental commission for direct tax (Commission Départementale des Impôts Directs) in an attempt to reach an agreement.
The number of contentious cases related to transfer pricing in France remains high, however, and the Administrative Appeal Courts and State Council are frequently asked to rule on these matters.
International dispute resolution
In order to limit the instances of double taxation (for example, the payment of corporate tax in one country and withholding tax in another), tax authorities and taxpayers have access to amicable dispute settlement procedures.
These arbitration and/or amicable settlement procedures are found in bilateral tax conventions, in article 25 of the OECD and UN models, and in article 16 of the multilateral instrument.
At the European level, the European Arbitration Convention of 23 July 1990 was supplemented by an amicable settlement procedure provided by European Directive 2017/1852, which was transposed into French law by the finance law of 2019, in articles L 251 B et. seq. of the Tax Procedure Handbook.
International groups also have access to other transfer pricing-specific procedures that allow them to avoid conflicts with the tax administration on these matters.
Groups can thus request transfer pricing rulings referred to as Advance Pricing Agreements (Accords Préalables de Prix – APAs), which may be unilateral or bilateral, and which allow both tax authorities involved to provide input.
Our transfer pricing team will assist you with tax audits and litigation in France as well as abroad by providing support to your company through each stage of the proceedings.
The team will also assist with APA negotiations and with reaching amicable settlements to disputes with the tax authorities.