In brief
Across the globe, transfer pricing disputes have increased following a waterfall of changes, e.g., BEPS, increased transparency, global compliance obligations, intangibility of value creation and digitized taxation. The pandemic added its synchronized impact by provoking countless economic and social ripples on the already turbulent waters. Against this backdrop, the Middle Eastern economies are battling lower oil prices and budget deficits, which in turn increase the pressure for fiscal receipts.
In the last couple of years, we have observed an increase in transfer pricing (TP) audits and disputes in many countries in the MENA region, which have caught many MNEs by surprise, especially in countries where formal TP regulations are not in place yet. In the next few paragraphs, we outline a few field observations and provide some practical advice for effective dispute management.
What we see on the ground in MENA
- Greater attention to transfer pricing — The tax authorities in the region have increasingly been focusing on transfer pricing. The income tax legislations of most countries here require that transactions between related parties be at arm’s length. In addition, Saudi Arabia, Qatar and Egypt have transfer pricing regulations already in place, requiring extensive documentation and compliance obligations. Jordan also recently introduced TP regulations, and we expect that many others will follow suit in the short to medium term.
- Origination in another country — Many disputes often start in another country/region and lead to a company in the region being asked to explain why it is in receipt of the ‘residual profit,’ especially if it has a zero corporate tax rate regime. Being able to articulate how each location contributes to value creation (and subsequent profit allocation) is critical in these cases, and this is typically achieved through a value chain analysis exercise. However, as digitization accelerates and technology evolves, attributing profit neatly to particular activities and jurisdictions becomes more difficult as organizations routinely work with digitized networks and dispersed workforces and customer bases.
- Tax authorities’ evolving expertise — TP audits and disputes in Oil & Gas and Infrastructure as well as in transactions involving goods and royalties are the most frequent ones we see originating from the MENA tax authorities (TAs). However, the local authorities are fast familiarizing themselves with other business models, thanks to the availability of TP documentation packages, and as such now launch enquiries confidently across other sectors. In some cases, a TP enquiry may lead to other enquiries e.g. WHT, Customs or VAT, or multi-faceted enquiries can start simultaneously. Although local TAs currently do not offer APAs as a solution, rulings can in some cases offer a degree of certainty to MNEs.
- A focus beyond ‘transactional’ transfer prices — The MENA TAs have quickly learnt that transfer prices within arm’s length ranges do not always lead to an arm’s length result for the entity. For this reason, we are seeing an insistence from some TAs on understanding how the overall profit allocation to the local entity is commensurate with the functions, risks and assets of the entity and how it compares to the profit of other entities abroad in the same value chain.
- Improvements needed in TP processes and governance — Preparation of local TP documentation has not been a major issue for MNEs as the vast majority of them already had documented policies for the Group. Where we have seen nervousness from some taxpayers are in articulating their tax calculations and confirming that the policies were implemented as intended and documented. Processes and governance dealing with the annual TP cycle, as well as extraordinary events, e.g., restructurings, need to be part of good TP housekeeping for MNEs, and this certainly pays dividends when an audit or dispute arises.
Baker McKenzie’s model for effective dispute management [1]
- Thoroughly understand the legislative basis for transfer pricing rules, particularly for planning and dispute resolution purposes. It is important to have a thorough understanding of the applicable legislation that underpins the TP-related issues applicable to the company’s operations, including the relevant aspects of the tax laws, the detailed TP obligations and the international rules that the country is committed to (such as the OECD and the UN). This would be to ensure a strong legal grounding for the company’s actions, in order that its pricing structures and its reporting are compliant, and for the company to be adequately prepared for any dispute resolution with the relevant authorities or potential litigation through the courts and tax tribunals. This is becoming increasingly critical in many countries in MENA.
- Be prepared for a desire for information. Tax authorities have an increasingly demanding appetite for facts and documentary evidence. Time spent building a clear understanding of the facts and the availability of evidentiary support is often invaluable in putting the company on the front foot in later settlement negotiations. Tax authorities’ powers to obtain information and documents vary from jurisdiction to jurisdiction and are often extensive. In responding to any tax authority request for information, it is important to be clear on both the taxpayer’s rights and obligations.
- Cooperation and redlines. Reaching a negotiated settlement requires both parties to the negotiation to have trust in the other party. Creating an atmosphere of cooperation and transparency is often critical to building this trust. At the same time, it is important to stand firm on the technical merits of the case and to be clear on your redlines, i.e., those points that will not be conceded for the purposes of reaching a negotiated outcome. Knowing your alternative routes to resolution, including the formal litigation process, and what would be involved in following through on a threat to litigate increases the strength of your bargaining position.
- Global complexity and the importance of consistency. For cross-border matters involving international taxation, in particularly transfer pricing, consideration should be given to how a settlement being agreed in one jurisdiction might affect the ability to reach settlements in other jurisdictions. Documenting differences in facts and any aspects of a settlement specific to a particular interpretation of the respective local regulations and the OECD guidance can be used in future audits to differentiate settlements reached in another jurisdiction. Equally, it is important to be alive to the increasingly complex interaction of different taxes and the volume of new international rules and regulations.
- Negotiate or play to win. Tactics for reaching a negotiated settlement or litigating for a successful outcome tend to diverge. While it is possible to run these tactics in parallel, it is of key importance to ensure that the impact of all decisions made in the negotiations on the litigation track are considered and vice versa. Know your appetite for litigation.
Baker McKenzie’s team of qualified tax lawyers, litigation and dispute specialists, accountants and economists has diverse experience in managing TP and tax disputes in MENA and globally. Clients remark that compared to other advisors, we take a forensic view of assessment, based on our expertise of the legal bases and legislative complexities, coupled with extensive experience dealing with TP policies disputed by Tax Authorities around the world. Put simply, our skillsets put us in a position to recognize risk much quicker than others and enable us to advise how to manage it, plan around it and support our clients in disputes.
[1] Adapted from “The Shape of Water – Tax Disputes in the Age of Intangible Value” by Baker McKenzie.
