Complaints at tax confusion

By BRIAN FALLOW

The Inland Revenue has another 40 or so multinational companies in its sights for scrutiny under the transfer pricing rules.

But so far the IRD's "crackdown" on transfer pricing has been a slow-motion affair, according to tax practitioners.

Transfer pricing rules aim to prevent multinationals from ducking their fair share of tax by manipulating the prices paid in transactions between related companies in different countries. Broadly, the rules require companies to estimate an arm's-length price for such transactions, the price unrelated companies in a free market would pay.

A second batch of transfer pricing questionnaires was sent out yesterday, even though the department is still processing the information from the first batch in February.

Companies were selected on the basis of criteria which included poor profitability compared with businesses in the same sector and transactions with low-tax jurisdictions.

IRD spokesman John Nash said that of the 80 companies targeted in the first round, one in four required no further action, and another one in four would require further specific inquiry or audit action.

The remainder fell into a grey zone, Mr Nash said. Further action might be necessary, depending on material the taxpayers concerned had yet to supply.

Tax practitioners, however, complain that nine months after the first batch of questionnaires was sent out, the recipients cannot be sure which of those categories they are in. Formal responses from the IRD are expected this month.

"They would like to know where they stand," said Jenny Croker, director of transfer pricing services at PricewaterhouseCoopers.

A major difficulty companies faced in establishing an arm's-length price was a dearth of publicly available information about comparable businesses' practices. A company, for example, is not supposed to benchmark itself against another multinational's subsidiary, in case it has a transfer pricing problem too.

Robyn Russell of Deloittes said companies had to weigh up often-substantial compliance costs against the risk of a tax adjustment. "At this stage, they don't have much to go on, to judge how the IRD is going to react."

If the search for comparable data took you to the United States or Britain, compliance costs could be huge.

"So now companies are asking, 'Is the IRD really going to do something about this? Does it make business sense to cover that risk?"'

In guidelines on transfer pricing, promulgated in their final form last week, the IRD refuses to renounce the use of so-called "secret comparables," that is, the use of confidential information about one firm in the context of considering the transfer pricing practices of another.

On the face of it, this presents two problems: preserving the confidentiality of the first taxpayer's information, and the unfairness of measuring the second taxpayer against a benchmark it cannot see or challenge.

Stean Hainsworth, of PricewaterhouseCoopers, said Australia had recently agreed not to use secret comparables as part of its assessment process, while the United States had taken that position since the early 1990s.

Mr Nash said: "In a small economy, we have to make use of whatever information we come across. That does not mean we will use that information in the assessment process, but it does help us in case selection."

A Court of Appeal decision in the ER Squibb case made it clear that the information could be provided to the taxpayer, but in sanitised form with names and any distinguishing characteristics in the material removed.