As the US Presidential election campaigns trundle on, team Obama have brought the taxation of international groups into the limelight. The campaign initially branded Ireland a tax haven but it has since retracted its original statement. Numerous steps have been taken by the Irish legislature over the years to distance itself from the taboo that is a tax haven. In Finance Act 2010 the late Minister for Finance, Mr Brian Lenihan introduced transfer pricing in order to “align Ireland's tax code...with international norms, namely, the OECD transfer pricing guidelines.”

This article provides an overview of the Irish transfer pricing provisions, documentation requirements, and the practical difficulties which taxpayers may experience.

A New Reality?

Finance Act 2010 introduced transfer pricing legislation which is enacted in Part 35A TCA 1997. The provisions apply to companies and Irish branches with accounting periods commencing on or after 1 January 2011. Transfer pricing endeavours to apply the arm's length principle to transactions between connected companies. This principle ensures that the price paid by connected companies reflects the amount of consideration which independent parties would pay.

Historically, it has been the tax authorities in high tax jurisdictions which have endeavoured to ensure that transfer pricing rules were being adhered to. While transfer pricing rules are used by many jurisdictions as a revenue gathering and protection mechanism, the provisions were enacted in Ireland for a number of reasons, including to:

• increase regulation and transparency in order to assist Ireland not being perceived internationally as a tax haven, and
• assist multinationals with Irish operations in challenging other jurisdictions from seeking to apportion higher levels of profit to that jurisdiction.

While Finance Act 2010 officially enacts transfer pricing legislation, Ireland has a number of existing transfer pricing provisions in effect. These include:

• A deduction is not permissible if an expense is not “wholly and exclusively” incurred for the purposes of the trade (section 81 TCA 1997).
• If a Revenue inspector is of the opinion that due to the close connection between companies, a resident company generates less taxable income than expected, the non-resident company may be liable to tax in the name of the resident company as if it were an agent of the Irish resident company (section 1036 TCA 1997).

Effect of New Legislation

Section 835D(2) TCA 1997 provides that transfer pricing provisions are to be interpreted in accordance with the OECD Transfer Pricing Guidelines. The Guidelines indicate that arrangements between related parties should be at arm's length. The legislation applies to an arrangement:

“ involving the supply and acquisition of goods, services, money or intangible assets, where, at the time of the supply and acquisition, the person making the supply and the person making the acquisition are associated, and the profits or gains or losses arising from the relevant activities are within the charge to tax under Case I or II of Schedule D in the case of either the supplier or the acquirer or both.”

The new provisions will only apply to arrangements between related companies undertaken as part of a trading activity which are taxable at the 12.5% rate. Consequently, the provisions do not apply to interest free loans granted by companies who do not advance loans as part of a trading activity.

One Size Fits All?

Small and medium sized organisations (as defined in the Commission Recommendation 2003/361/EC of 6 May 2003) are exempt from the transfer pricing provisions. A small or medium sized organisation is one which has less than 250 employees and it has;

• turnover of €50 million or less; or
• total assets of €43 million or less.

If the company is a member of a group, or it has associates, the limits apply to the group as a whole and not just the specific entity. A significant number of Irish trading groups should be outside the scope of the Irish provisions by virtue of the small and medium sized exemption.

Irrespective of organisational size, the new provisions only apply to arrangements agreed on or after 1 July 2010.

Documentation Requirements

Section 835F TCA 1997 addresses documentation requirements. This is supplemented by the June 2010 Tax Briefing “Transfer Pricing Documentation Obligations” from the Revenue Commissioners. The legislation requires the taxpayer to have transfer pricing documentation available, it does not however stipulate the form in which it should be kept. While the Tax Briefing does not provide an exhaustive list of documentation required, it is recommended that the documentation available clearly identifies the:

• associated persons,
• nature and terms of transactions,
• method by which the pricing of transactions was undertaken. This should include a study of comparables and any functional analysis undertaken,
• budgets, forecasts or other documentation relied upon in in arriving at arm's length terms, and
• terms of relevant transactions with third parties and associates.

It is recommended that transfer prices and related documentation be reviewed at regular intervals in order to determine whether pricing remains arm's length.

While the legislation does not indicate when the documentation should be prepared, it is best practice that it should be prepared at the time the terms of the transaction are agreed. In order for a company to be able to make a complete and correct corporation tax return, the documentation should exist at the time the tax return is required to be filed.

If during the course of a Revenue audit a transfer pricing adjustment is required to be made, Revenue have indicated that the quality of supporting documentation will be a factor in determining whether the adjustment should be regarded as an innocent error or a technical adjustment. No transfer pricing specific penalties have been introduced. The standard interest and penalty provisions will apply.

Practical Problems

Tax practitioners may currently be in the process of reviewing client's corporation tax computations and returns in respect of the 2011 accounting period. For many practitioners, it is possible that this is the first time they will have had to consider transfer pricing requirements. Looking at Revenue authorities in foreign jurisdictions, the transfer pricing aspects of intragroup financial transactions are becoming increasingly contentious. This is in part due to the inherent subjectivity associated with the issue. Areas which foreign tax authorities are tending to focus on include:

• transactions lacking in substance or which Revenue believe to be lacking in economic rationale,
• related party loans with interest rates higher than benchmark rates,
• taxpayers with high debt equity ratios relative to third party organisations operating in a similar sector, and
• the allocation of benefit derived by participants from internal cash pooling arrangements and other centralised group arrangements.

As a consequence of various tax incentives, Ireland is an attractive location in which to hold group intangibles. As there is no internationally adopted definition of “intangible property”, difficulties can arise from a transfer pricing perspective. The issue was dramatically illustrated in the settlement reached between the IRS and Glaxo Smith Kline. The USD$3.4 billion settlement was attributed to marketing activity undertaken by US entities which increased the value of the intangibles. The UK parent however did not adequately compensate the US entities for the work undertaken.

A transfer of an intangible is feasible without an agreement, formal contract or indeed payment. This may occur if technical staff of a group company visit another group entity. Know how may be exchanged on an informal basis. If the company subsequently benefits from improved products or processes, it is arguable that there is a transfer of an intangible and a transfer pricing adjustment is required.

Conclusion

Given the evolution of the global tax environment it is not surprising that Ireland should adopt transfer pricing legislation. The enactment of the provisions should not cause an additional compliance burden on multinationals as they should be in a position to rely on the transfer pricing documentation prepared for other jurisdictions. Consideration however needs to be given to the extent of intra-group transactions and the pricing policy adopted. This review should not be limited to documented transactions. In these challenging economic times, international Revenue authorities will be endeavouring to reinforce their tax base. It is important that where an Irish dimension is involved, a robust basis for allocating income to Irish entities should be in place.

Cormac Kelleher is a corporate tax manager with Mazars and a tutor with the Chartered Tax Consultant qualification.

Email: ckelleher@mazars.ie