UN releases draft of the Transfer Pricing Practical Manual for Developing Countries

February 15, 2013

On 4 October 2012, the United Nations (UN) released the draft text of the Transfer Pricing Practical Manual for Developing Countries (the Manual) and on 15 October 2012, the Committee of Experts approved it. The Manual reflects the thinking of developing countries — and also identifies the challenges faced by companies doing business within them — related to transfer pricing.

This article was first published in the Ernst & Young Global Tax Policy and Controversy Briefing, Issue 11, December 2012 (pdf, 4.25 MB)

In 2009 the UN Committee of Experts on International Cooperation in Tax Matters instituted a Subcommittee on Transfer Pricing — Practical Issues, with the mandate to develop a practical manual on transfer pricing considering the arm’s length principle embodied in Article 9 of the UN Model Convention.

The then envisaged Manual, in particular, had as its objective to consider and reflect the realities for developing countries at different stages of their capacity development, the specific experiences of developing countries and work done in other fora such as the OECD and African Tax Administration Forum (ATAF).

The initial term of the mandate was extended to allow for presentation of a draft Manual for adoption during the eight annual session in October 2012. The Subcommittee on Transfer Pricing — Practical Issues has met its goal and, on 4 October 2012, the UN released on its website a series of draft chapters of the Manual, which has now been approved.

Purpose of the UN Manual on Transfer Pricing

The purpose of the UN Manual is to provide practical guidance to developing country governments, tax administrators and taxpayers. As such, the Manual has some notable differences compared to the OECD Guidelines. Like the OECD Guidelines, the Manual serves strictly as practical guidance, not as a legislative proposal or mandatory policy, and therefore much effort has been spent in trying to reflect complicated issues in a simple and clear fashion, in turn illustrated by many examples.

Considering its intended audience, the Manual serves mainly to educate its readers on a range of issues including:

  • The business framework. How do MNEs operate and manage their transfer pricing?
  • The general legal environment that needs to be considered when introducing transfer pricing legislation
  • The importance of issues such as the burden of proof
  • What considerations go into establishing transfer pricing capability in the administration of a country
  • What transfer pricing methods are available and how they work in practice
  • What system of transfer pricing documentation requirements can be used
  • How transfer pricing audits and risk assessment can be conducted
  • The importance of dispute avoidance and resolution options

The Manual’s chapter on comparability provides for extensive detail on how to conduct a functional analysis and how comparability screening should be conducted, including details as to how to apply adjustments. Obtaining comparables is seen in practice as one of the major challenges encountered in developing countries and therefore this issue is elaborated upon within the draft.

An additional notable aspect is the attention to location savings and location-specific advantages. From a developing country perspective, the Manual emphasizes that additional consideration should be given to the particular attractiveness that (developing country) markets offer companies doing business there and subsequent turnover generated from activities there.

These items include the availability of relatively low labor costs and skilled people to render services but also the fact that there may be access to a large consumer force with spending power. This aspect is emphasized more specifically and as a particular developing country issue than currently included in the OECD Guidelines.

A significant difference from the OECD Guidelines is that the Manual includes a country-specific chapter, in which Brazil, China, India and South Africa all list either the transfer pricing system in place in their country (e.g., Brazil’s fixed margins system) or issues of particular concern for their respective jurisdiction (e.g., China’s location-specific advantages, India’s control over R&D activities and South Africa’s challenges with comparability and the high cost of foreign management services).

According to the preamble to chapter 10, this chapter neither reflects input from the entire UN subcommittee nor overall consensus, but the country-specific subchapters are submitted by representatives of the respective country governments, as illustration of how they handle developing country-specific challenges under domestic law or under domestic audit approaches.

Notable absences

Notable by their absence are chapters on services, intangibles and business restructuring. Cost sharing and advance pricing agreements (APAs) are mentioned in passing, but are not yet detailed in any separate chapter(s). The Manual is seen as a work in progress, even now, after it has been adopted. It is expected that the Manual will be updated in a future phase and that services and intangibles will be high on the agenda to receive further guidance.

Impact and considerations

The whole issue of transfer pricing and the role of MNCs is high on the political agenda of many governments, as can be seen from the communiqué of the latest G20 summit (please see article on page 21) and the way that governments around the world are now focusing on how to help developing countries to build the capacity of their tax administration to deal with this and other tax issues.

The publication of the draft Manual undoubtedly heralds a fresh focus on transfer pricing by developing country revenue authorities themselves. Recent statements by a number of African commissioners also show that transfer pricing is high on their agenda.

With their attention ranging from issuing new local legislation, building and refining auditing practices and capability and increasing enforcement resources generally, its existence — although a work in progress — provides taxpayers a new level of insight into the continuing evolution of transfer pricing practices in developing countries and offers a framework around which companies can continue to build their transfer pricing policies and administration in developing countries.

The Manual represents a most useful contribution to the transfer pricing debate and should help in encouraging governments to work together to find common solutions to practical problems that arise in the application of the arm’s length principle.

The Manual may also assist in helping business to get more engaged in the transfer pricing debate, working with tax administrations in developing countries to help them overcome two important constraints that they face in auditing MNCs: finding sufficient information on comparables and auditing the transfer pricing of MNCs.

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