In many countries the institute of the control over the correctness of pricing is combined with the institute of the consolidated tax-payer concerning the profit tax and the institute RUSSIAN ECONOMY: TRENDS AND PERSPECTIVES of the controlled foreign companies. The Ministry of Finance of the Russian Federation has also developed and promulgated the bill on consolidated accounts for profit tax. It is planned to introduce new statements on control over the correctness of the pricing and consolidated taxation account for profit tax simultaneously. Such a “duet” will mean that if the tax-payer meets the criteria for consolidation it can evade from the control over its pricing concerning profit tax. The Ministry of finance of the Russian Federation has also declared the intention to develop the institute of the controlled foreign companies as well in three forthcoming years in the document on the directions of the fiscal policy. All these measures are in concordance with the progressive international experience in the field of control over transfer pricing.
The fact that the bill enhances the list of methods for estimation, supplementing it with two methods basing on profit – method of comparable profitability and method for profit distribution- can only be regarded as positive. Moreover the bill considerably elaborated the known methods from article 40 of the Tax Code of the Russian Federation. Besides defining the essence of these methods the bill suggests the basic methodology for each. In contrast to the current situation when there is no document establishing or recommending methodical basis for the application of any method, such a solution of the problem is quite a progress.
It should be acknowledged that in the majority for countries there are no special national methodical recommendations on application of one or another method. The countries also do not attempt to set a rigid hierarchy of the application of methods. However the majority for countries, being IECD members, legalized the OECD Guidelines on transfer pricing in their territory and that is why do not need to adopt special national guidelines.
Some countries, such as the USA, for instance, adopted special Recommendations of the US Treasury on application of the methods.1 Some countries, Kazakhstan, for instance, included the OECD Guidelines on methodology nearly fully in the law, providing the taxpayers and taxation bodies with the unified instrument.
Obviously, before the method is chosen the right task is to be set, the chosen method should be practically applicable and form the result corresponding to the conditions at the market, which represents the reasonable estimation of what the result would be if such deals had been made under market conditions. Besides, it is necessary for some legal criteria for the estimation of the correctness of the result obtained to exist. The attention should be called to the fact that despite the progressive nature of the methodology suggested by the bill, it lacks the distinctness as to the answer to the question on which of the received figures to be taken as the most correct and final result in order to calculate taxes on its basis.
It is also to be noted that the bill does not envisage the hierarchy for the application of the methods for the estimation, declining the archaic approach of article 40 of the Tax Code of the Russian Federation, which is currently in effect. 2 On the other hand, the taxation bodies usually chose the simplest methods to recalculate the price. That is why some reference points for application of the estimation methods should be established by recommendation. It is especially important under current conditions in Russia, where it is quite difficult to obtain the data on market prices. In this connection it would be purposeful to pay attention to the approach which was developed for this issue by the OECD. The OECD Guidelines and many countries are of opinion that each of the methods of estimation of transfer pricing is specific for the types of deals. OECD has revealed the influence of the 1 www.irs.gov 2 The version of article 40 of the Tax Code of the Russian Federation currently in effect envisages hierarchic use of the expenses method, the method for the comparable uncontrolled price and the method of the price of the followed sale without any specification as to the type of the deal SOME ASPECTS OF IMPROVEMENT OF MEASURES...
methods on the reliability and correctness of the results obtained. The recommendations of the OECD concerning all transactional methods advice to apply the separate analysis to each deal depending on its type. Thus, for instance, the expenses method is advisable when considering prices for supply of goods or rendering services. Method of the price of the followed sale is preferable for agreements connected with the sale, distributorship.
Transactional methods based on the analysis of the profit are nearly always used in order to check the results obtained with the help of other methods.
The method of the comparable uncontrolled price which is recognized as the preferable in nearly all the situations if there are comparable data for uncontrolled market is worth dwelling on. Incase there are no comparable uncontrolled prices the analysis of the distribution of the functions and the risks between the parties can serve as a basis for determination of the profit margin. Thus, in most cases when there are no comparable data it is desirable to use the methods based on the analysis of the profit. The choice of the particular method depends on a number of factors. According to OECD Guidelines the taxation bodies should take into account five factors of comparability – characteristics of assets and services, analysis of functions, conditions of the deal, strategy of economic activity. Then the taxation body and the tax-payer should analyze 1) the degree of comparability of controlled and uncontrolled deals and 2) the quality of the available information.
The search for comparable parameters is very important. Since the principle of “arm’s length” is based on the comparison of the conditions of the deal between the companied in question with the conditions of the deal with third parties. This should result in solution of the problem of search for comparable deals and the search for the independent third parties making similar deals in similar branches. The comparability suggests that there is a reasonable degree of similarity between the economically significant characteristics.
If there are no comparable deals according to the international practice it is recommended to define and calculate the corresponding deviations. It should be noted that the bill does not provide for such a case. The following can be regarded as sources for the data used to define, enhance and/or check the list of the comparable figures:
Prices and quotations at the world exchanges, information from the reliable sources (trends in the branch, market research);
Customs statistics, sources of information for the authorized public authorities and local authorities;
Industrial and trading associations (review of branches, list of members) Branch analysts (market analysis, financial analysts, crucial factors and forecasts for development), mass media and publications of the branch (general information on the market, franchising references), the Internet (reference sites and sites of some companies) Databases All the sources are united by the single feature of the possibility to be accepted as relevant in the court of law. Such a situation is included in the conditions of the existing article of the Tax Code of the Russian Federation but it has not been clarified by the bill for future purposes. In foreign countries there special databases working on the commercial basis and including a broad spectrum of information on market prices, financial indices etc.
however a similar company in the Russian Federation has been operating since recently, combining the data on Russia and Ukraine, Bureau van Dijk’s Ruslana. Its possibility now cannot be compared with those of the similar companies in Europe and at other world markets, thus, for instance the European taxpayers and taxation bodies have access for the data from:
o Bureau van Dijk’s Amadeus (20 million of companies) and OneSource Europe (more than 1 million of companies);
RUSSIAN ECONOMY: TRENDS AND PERSPECTIVES o French companies: Bureau van Dijk’s Diane (more than 600 thousand of companies);
o Netherland companies: Bureau van Dijk’s Reach (more than 150 thousand of companies);
o German companies: Bureau van Dijk’s Daphne (more than 15 thousand of companies);
o UK copmanies: Bureau van Dijk’s Fame (more than 625 thousand of companies) o USA companies: Bureau van Dijk’s Amadeus, Disclosure SEC and Corp/worldscope, Moody’s, Stantard and Poors Compustant etc.
The forming database Ruslana mentioned includes no more than 1500 million of pieces of data on companies and they have not been updated at present, which excludes the possibility of their use in the court of law. Such sources of information mentioned in the bill cannot be recognized as relevant due to corresponding limitations of each individually. In this connection there arises the problem of using the confidential information, for instance, its protection by the tax secret (for instance data received during the examination of other taxpayers, information comprising commercial secret of the examined taxpayer and other information received during tax examinations) and the possibility to access it not only by the taxation bodies but also by taxpayers themselves.
There is no unanimous position in this respect in the world. For instance, in the USA the practice of the use of the confidential information to support the positions of the taxation bodies is rarely applied since it is not recognized by courts of law, while in other countries such as France, Germany, Canada, Australia and Korea it is possible to use confidential.The taxation bodies however should be ready to support it with the data from official and available sources.
According to the international practice the taxpayers and taxation bodies use the indices of market prices in definite range – that is the market price should belong to the definite range. In many countries taxpayers and taxation bodies use so-called interquartile ranges and the ranges for price variations.2 If prices belong to such range, there is no recalculation made according to the regulations of transfer pricing. Thus, in accordance with the existing regulations if the prices for the services mentioned do belong to the acceptable range,the real price of the deal is recognized as market one.4 Similarly, as to agreements on distribution of expenditures, the regulation, according to which the recalculation is not made in case the profit increased or decreased by up to 20% is in effect in the USA.Such approach is also suggested by the bill. Nevertheless this method is the most complicated to apply in practice with the sufficient degree of reliability, since the requirements for the data comparability for this method are much higher than for any other method.
Besides, it is very difficult to find comparable uncontrolled prices due to the lack of the information because of the mentioned reasons. It should be noted that the method of the comparable uncontrolled price is usually used as a secondary method in the international practice to check the results obtained with other methods. In the bill presented however it is envisaged as an independent and “all-sufficient” method.
1 In France if there is more than one set of comparable data the taxation bodies represent such data in the form of the list of companies and the range of parameters not mentionning which indices belong to which company. However if the data is available only for few companies their names are not mentioned.
2 Interquartile range in the range of values from 25% to 75% of the set of comparable values 3 The amendments abolition the range of prices concerning services were adopted in the USA as long ago as October 2003. Instead such a regulation concerning services with smal margine there was a new method introduced – method of the simplified expenditure base 4 Regulations of the USA Ministry of Finance, Section 1.482-2(b).
5 Regulations of the USA Ministry of Finance, Section 1.482-7.
SOME ASPECTS OF IMPROVEMENT OF MEASURES...
Thus, when applying any of the methods mentioned above the search for the comparable parameters should be made at the level of the deal. The draft of the law, however, does not define the possible actions of a taxpayer and taxation bodies, does not suggest the specification of the methods by types of deals, which will inevitably lead to disputes and will probably result in the leading methodology being inapplicable.
Due to the difficulty in search for the comparable deals many countries oftener apply the methods based on the analysis of the profit, with whose help one can define the profit gained from different deals.
The bill suggests introduction of the institute of the preliminary agreements on pricing (hereinafter, PAP) in the Russian Federation, which quite a progressive innovation. Preliminary agreements on pricing are concluded between a taxpayer and one taxation body (unilateral agreement) or several taxation bodies (bilateral/multilateral agreements). The bill envisages the introduction of only unilateral; agreement and only in the Russian jurisdiction. The problem accompanying the conclusion of unilateral PAP is that there are no guarantees of adoption of a definite method for transfer pricing by the taxation bodies of another country. In the USA about 2/3 of the agreements are bilateral. In some countries (France, for instance) it is the bilateral agreements that are mainly concluded. In many countries the preliminary agreements on pricing have been applied for a long time. The first PAPs were applied in the 1980-ies. By that time it was made clear that in order to make decision concerning some cases of transfer pricing, when considering and estimation multistep and multilateral agreements one could need several years. The procedure of PAP on the other hand enables taxpayers and taxation bodies to come to the agreement on the procedure for taxation of different deals, including the deals on the expenditure distribution, beforehand. PAP does not necessarily apply to all the deals and can be restricted to the deals with some counteragents. The bill discussed does not envisage such a limitation;
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