Transfer pricing is a technical accounting practice used when two arms of the same company, often in different jurisdictions, trade goods or services with one another. It establishes the cost of such transactions based on a similar trade between two unrelated entities in the market.
It is possible to manipulate transfer pricing to book artificially low profits and therefore pay less tax – a common avoidance or evasion method used by many multinational corporations.
It is estimated around 60% of all international trade happens within, rather than between, multinational corporations, and mispricing of these transactions costs governments around the world billions in lost revenues.
In 2009, Christian Aid estimated that there was $1.1tn in bilateral trade mispricing into the European Union and US alone from non-EU countries between 2005 and 2007.
But it is developing countries, which rely most heavily on corporate tax revenues, that are the hardest hit by multinational tax avoidance, and who struggle to build the highly sophisticated systems needed to prevent it.
In a blog published this week by Jan Leoprick, a senior economist covering tax policy and administration issues for the World Bank, he noted that doing so “will not be easy”.
“To capture revenues from multinational corporations, tax authorities must master rule-making, enforcement and auditing” around transfer pricing and “balance revenue goals with the desire to maintain a fair and predictable investment climate”, he wrote.
“If governments are too aggressive or careless, they can subject corporations to double taxation, which risks undermining investor confidence.”
The bank’s handbook on transfer pricing aims to help developing countries develop appropriate and effective legislation, promote taxpayer compliance, deal with specific technical issues, avoid and resolve disputes and establish a dedicated audit programme.
It also provides guidance on applying the ‘arms-length principle’, which is used to set a transfer price for two related entities as if they were independent, separate parties.
The arms-length principle can be tricky to apply in practice, especially for authorities lacking in capacity. While there are other options available, the guidance states that for the majority of governments the benefits of using the principle will outweigh the difficulties in implementation.
One of the key messages, according to Leoprick’s blog, is that “tailoring is critical”. Transfer pricing manipulation, or transfer mispricing, risks are “specific to individual countries”: sometimes one sector is more vulnerable, with varying consequences for public revenue; there is a wide degree of variation in the number of multinationals in each countries’ tax base; and a country’s capacity should also be taken into account.
“To be clear, the handbook is a technical read,” wrote Leoprick. “It gets into the details, and provides nuance for policymakers.
“We are trying to reach those who can make the day-to-day changes in the governments that need it the most.”
Also this week, the World Bank launched a free, open data platform, TCdata360, which collects publicly available information from over 20 sources including the World Bank, International Monetary Fund and World Trade Organisation.
It then analyses and visualises this data to help policy makers, development practitioners, academics and citizens better understand issues and create more informed policies in the areas of trade, investment, innovation and the general economy.
Anabel Gonzalez, senior director of the World Bank’s trade and competitiveness global practice, said “accessible, easy-to-use open data can have significant economic and societal benefits”.
“TCdata360 provides a platform for transforming data into millions of stories on critical trade and competitiveness issues that provide the public and governments with better information to debate and determine policies.”
