Benchmarking—the process of screening, selecting, and analyzing comparable companies—is time consuming. Analysts can spend innumerable hours every year preparing transfer pricing documentation, with a substantial portion of that time dedicated to benchmarking. Even with improvements in the quality of databases (which offer a vast array of quantitative and qualitative data), the sets of potential comparables that analysts must sift through are often enormous.

With the applications of artificial intelligence (or “AI”) expanding by the day, it is time to start thinking about whether AI could automate parts of the benchmarking process.

Continue Reading Artificial Intelligence for Benchmarking: The Wave of the Future

On March 23, 2021, the United States’ Advance Pricing and Mutual Agreement Program (“APMA Program”) released its 2020 annual report (“2020 Annual Report”) to the public concerning advance pricing agreements (“APAs”). COVID-19 has caused unprecedented disruptions  to taxpayers and tax administrations alike, but the 2020 Annual Report shows that the APMA Program remained highly productive in 2020. Last year taxpayers filed 121 APA requests—the same amount as in 2019. And in 2020, APMA executed 127 APAs—seven more than the prior year.

Continue Reading APMA to COVID-19: Don’t Stop Me Now

Overview.  As discussed in prior blog posts, Amount A is a proposed new taxing right over a share of residual profit of MNE groups that fall within its defined scope.  The calculation and allocation of Amount A will be determined through a formula that is not based on the Arm’s Length Principle (ALP).  The formula will apply to the tax base of a group (or segment where relevant) and will involve three components:  Step 1:  a profitability threshold to isolate the residual profit potentially subject to reallocation;  Step 2: a reallocation percentage to identify an appropriate share of residual profit that can be allocated to market jurisdictions under Amount A (the “allocable tax base”); and Step 3: an allocation key to distribute the allocable tax base amongst the eligible market jurisdictions (i.e. where nexus is established for Amount A).  This three-step formula to determining the Amount A quantum could be delivered through two approaches:  a profit-based approach or a profit margin-based approach.  A profit-based approach would start the calculation with the Amount A tax base determined as a profit amount (e.g. an absolute profit of EUR 10 million) whereas a profit-margin approach would start the calculation with the Amount A tax base determined as a profit margin (e.g. a PBT to revenue of 15%).  Both approaches would apply the three steps of the allocation formula similarly, and hence would deliver the same quantum of Amount A taxable in each market jurisdiction.

Continue Reading OECD’s Pillar One Blueprint: Profit Allocation

Consider the following hypothetical: Researchers at a US-parented drug company develop an artificial intelligence (or “AI”) system that can identify new therapeutic targets with minimal human intervention. The drug company sells the system to its foreign affiliate in a lower-tax jurisdiction. What is the appropriate valuation of the system on this outbound transfer (e.g., based on the cost to create it or based on the value of the IP it is likely to generate)? And, when the AI system later successfully creates a new therapeutic, which entity will be entitled to the non-routine returns from sales of the therapeutic: the US parent that developed the system, the foreign subsidiary that owns the system that developed the therapeutic, or some combination of both?

Continue Reading Transfer Pricing for AI-Generated Intellectual Property

As discussed in prior blog posts, Amount A is a proposed new taxing right over a share of the residual profit of MNE groups that fall within its defined scope. The tax base is therefore determined on the basis of the profits of a group (rather than on a separate entity basis), and it is necessary to start with consolidated group financial accounts.

Continue Reading OECD’S Pillar One Blueprint: Tax Base Determinations

The Mutual Agreement Procedure (“MAP”) is a useful dispute resolution mechanism for multinational companies facing a transfer pricing or other assessment resulting in double tax, whether in the U.S. or abroad. In order to fully avail themselves of the advantages of the MAP process, taxpayers should pay careful attention to the applicable procedures to optimize their chances of a successful resolution.

Continue Reading The Mutual Agreement Procedure (“MAP”): Advantages and Potential Pitfalls for Resolution of Double Tax Issues

The Pillar One revenue sourcing rules determine the revenue that would be treated as deriving from a particular market jurisdiction. The rules would be relevant in applying the scope rules, the nexus rules and the Amount A formula. The sourcing rules are reflective of particularities of Automated Digital Services (ADS) and Consumer Facing Businesses (CFB) and more broadly were designed to balance the need for accuracy with the ability of in-scope MNEs to comply, without incurring disproportionate compliance costs. This is proposed to be achieved through the articulation of sourcing principles, supported by a range of specific indicators, subject to a defined hierarchy (likely to be of particular importance in connection with third party distribution). This approach of providing a range of possible indicators within the hierarchy recognizes the different ways MNEs currently collect information in the context of their business model, while still providing certainty to MNEs and tax administrations that the defined set of acceptable specified indicators can be relied upon to provide acceptable outcomes.

To source the relevant in-scope revenue to a market jurisdiction, a sourcing principle would be identified for each type of in-scope revenue, accompanied by a list of acceptable specific indicators an MNE will use to apply the principle and identify the jurisdiction of source. For example, for the direct sale of consumer goods, the principle would be to source the revenue based on the jurisdiction of final delivery of the goods to the consumer, and the acceptable indicator would be the jurisdiction of the retail store front where the consumer good is sold or shipping address.

The acceptable indicators would be organized in a hierarchy. The MNE should generally use the indicator that is first in the hierarchy, as this will be the most accurate. However, an MNE may use an alternative indicator that appears second in the hierarchy, if the first indicator was not reasonably available or if the MNE can justify that the first indicator was unreliable, and so on with the remaining indicators. This approach is intended to ensure that there is sufficient flexibility to accommodate the different ways that MNEs collect information. Information would be considered unreliable if it is not within the MNE’s possession, and reasonable steps have been taken to obtain it but have been unsuccessful. Information would be considered unreliable if the MNE can justify that the indicator is not a true representation of the principle in the source rule.

The MNE would need to justify and document its approach and include it in the standardized documentation package to be developed as part of the broader work on tax certainty. It is expected that an in-scope MNE would need to retain documentation describing the functioning of its internal control framework related to revenue sourcing, containing aggregate and periodic information on results of applying the indicators for each type of revenue and in each jurisdiction, and explaining the indicator used and, if relevant, why a secondary indicator was applied instead (such as the steps taken to obtain information or why a primary indicator was considered unreliable).

Continue Reading OECD’s Pillar One Blueprint: Revenue Sourcing Rules

In a decision dated December 11, 2020 (Value Click Case), the French Administrative Supreme Court overturned a Paris Court of Appeal decision dated March 1, 2018, and concluded that the French affiliate of the group (“French Co”) should be considered as the dependent agent of the Irish affiliate company (“Irish Co”) in France for permanent establishment (“PE”) purposes. The decision is a significant reversal of prior court cases, such as the Google decision dated April 25, 2019, and it may lead to the unilateral application by France of an expansive interpretation of the definition of PEs under Article 12 of the MLI adopted with no reservation by France. Continue Reading Landmark Decision in France Regarding PE of Digital Company

According to the OECD, the new international taxation framework set forth in its Pillar One blueprint recognizes that in an increasingly digital age, taxing rights can no longer be exclusively determined by reference to physical presence. The blueprint therefore contains new nexus rules for in-scope revenue under Amount A. (For an overview of Pillar One and a discussion of the scope of Amount A, please see our prior blog posts.) The scope tests seek to capture those large MNEs that are able to participate in an active and sustained manner in the economic life of market jurisdictions through engagement extending beyond the mere conclusion of sales, in order to generate profits, without necessarily having a commensurate level of taxable presence in that market (based on existing nexus rules).

The nexus rules are designed to protect the interests of smaller jurisdictions, and in particular developing economies, and their desire to benefit from the new taxing right. The new nexus rules determine entitlement of a market jurisdiction to an allocation of Amount A only. They do not alter the nexus rules for other tax purposes. The new nexus rules could apply differently for ADS (Automated Digital Services) and CFB (Consumer Facing Businesses). For ADS, exceeding a market revenue threshold could be the only test to establish nexus. According to the OECD, the very nature of the ADS allows them to be provided remotely and such businesses generally have a significant and sustained engagement with the market even if there is not a physical presence. For CFB, the OECD believes that the ability to participate remotely in a market jurisdiction is less pronounced. This, together with the additional complexity and compliance costs associated with sourcing revenue derived by CFB and the broad acknowledgment that profit margins are typically lower for CFB compared to ADS, could justify a higher nexus standard for CFB. One approach for satisfying this higher nexus standard is through a higher threshold and the presence of additional indicators (“plus” factors) which would evidence an active and sustained engagement in that jurisdiction beyond mere sales.

Continue Reading OECD’s Pillar One Blueprint: Nexus for Purposes of Amount A

The new taxing right established through Amount A of Pillar One[1] only applies to those multinational entity (MNE) groups that fall within the defined scope of Amount A.  The scope of Amount A is based on two elements:  an activity test and a threshold test.

According to the OECD, the definition of the scope responds to the need to revisit taxing rules in response to a changed economy.  The existing international tax rules generally attach a taxing right to profits derived from a physical presence in a jurisdiction.  However, given globalization and the digitalization of the economy, the OECD believes that businesses can, with or without the benefit of local operations, participate in an active and sustained manner in the economic life of a market jurisdiction through engagement extending beyond the mere conclusion of sales, in order to increase the value of their products, their sales and their profits.

Continue Reading Tax Challenges Arising From Digitalisation, Report on the OECD’S Pillar One Blueprint: Scope of Amount A