Check Point Software Technologies was assessed administrative penalties by the tax authorities (FIRS) for failure to file a country-by-country report, and a complaint was filed with the Tax Appeal Tribunal by the company. Decision of the Tribunal The Tax Appeal Tribunal held that the administrative penalties issued by the FIRS in enforcement of the CbCR Regulations were unconstitutional and void because the Board of the Federal Inland Revenue Service, which was legally empowered to make the regulations, did not exist between 2012 and 2020. Since the FIRS Board did not exist during the said period, the exercise of the delegated powers under the provisions of the Nigerian CbCR regulations was not possible – any step, process or action taken in the name of the Board would be null and void. Excerpts “A careful consideration of the provisions of Section 61 as exposed above shows that the National Assembly has delegated its powers specifically to the Board of the Federal Inland Revenue Service to make these rules, guideline and regulations and to no any other person or authority. By necessary implications therefore, it is only the Board of FIRS and legally constituted and properly composed that can exercise the said powers donated by the National Assembly in Section 61. In the course of prosecuting this Appeal, the Appellant had presented concrete evidence before this Honourable Tribunal that during the period under consideration the Boards of all federal parastatals and agencies (including that of the Federal Inland Revenue Service) were dissolved and had not been reconstituted. This fact was not disproved or contradicted by the Respondent before this Honourable Tribunal. The non-existence of a Board during the said period under consideration would mean that a legal and legitimate exercise of the delegated powers under the provisions of Section 61 was not possible meaning that any step, process or action done in the name of the Board will be null and void. … It is therefore the decision of this Honorable Tribunal that the purported Regulation on CBC of 2018 was not made by the Board of the Federal Inland Revenue Service that was legally constituted and properly composed, since it was dissolved and had not been reconstituted by the government at the time when the said regulation was made.” “In line with the above position, it is the decision of this Honourable Tribunal that the Notices of the Administrative Penalties served on the Appellants by the Respondent in the enforcement of the CBC Regulation 2018 are unconstitutional and void. It is therefore, hereby quashed by this Honourable Tribunal and the Respondent is hereby directed to raise fresh Notices of the Penalties based on the relevant provisions of the Federal Inland Revenue Service (Establishment) Act, 2007 and relevant laws.” Click here for translation Nigeria vs Check Point Software Technologies BV NIG LTD TAT August 2023 ...

A Regional Tax Court in Germany had requested a preliminary ruling from the European Court of Justice on two questions related to German transfer pricing documentation requirements. whether the freedom of establishment (Article 49 TFEU) or the freedom to provide services (Article 56 TFEU) is to be interpreted in such a way that it precludes the obligation to provide transfer pricing documentation for transactions with a foreign related parties (Section 90 (3) AO) and whether the sanctions regulated in section 162(4) AO could be contrary to EU law The Regional Tax Court considered that these provisions establish special documentation requirements for taxpayers with transactions with foreign related parties. In the event of non-compliance with these documentation requirements, section 162(4) AO leads to a sanction in the form of a fine/surcharge. Neither was provided for taxpayers with transactions with domestic related parties. However, such discrimination can be justified by compelling reasons in the public interest. In this context, the Regional Tax Court considered the legitimate objective of preventing tax avoidance and the preservation of the balanced distribution of taxation powers between the Member States as possible grounds for justification. However, the Tax Court was not confident in regards to the level of sanctions – i.e. whether the fine/surcharges went beyond what was necessary to achieve the intended purpose. Judgement of the European Court of Justice The Court ruled that German transfer pricing documentation requirement and related sanctions was not in conflict with EU law. “Article 49 TFEU must be interpreted as meaning that it does not preclude national legislation under which, in the first place, the taxpayer is subject to an obligation to provide documentation on the nature and content of, as well as on the economic and legal bases for, prices and other terms and conditions of his, her or its cross-border business transactions, with parties with which he, she or it has a relationship of interdependence, in capital or other aspects, enabling that taxpayer or those parties to exercise a definite influence over the other, and which provides, in the second place, in the event of infringement of that obligation, not only that his, her or its taxable income in the Member State concerned is rebuttably presumed to be higher than that which has been declared, and the tax authorities may carry out an estimate to the detriment of the taxpayer, but also that a surcharge of an amount equivalent to at least 5% and at most 10% of the excess income determined is imposed, with a minimum amount of EUR 5 000, unless non-compliance with that obligation is excusable or if the fault involved is minor.” ECJ C-431-21 ...

Frucor Suntory (FHNZ) had deducted purported interest expenses that had arisen in the context of a tax scheme involving, among other steps, its issue of a Convertible Note to Deutsche Bank, New Zealand Branch (DBNZ), and a forward purchase of the shares DBNZ could call for under the Note by FHNZ’s Singapore based parent Danone Asia Pte Ltd (DAP). The Convertible Note had a face value of $204,421,565 and carried interest at a rate of 6.5 per cent per annum. Over its five-year life, FHNZ paid DBNZ approximately $66 million which FHNZ characterised as interest and deducted for income tax purposes. The tax authorities issued an assessment where deductions of interest expenses in the amount of $10,827,606 and $11,665,323 were disallowed in FY 2006 and 2007 under New Zealand´s general anti-avoidance rule in s BG 1 of the Income Tax Act 2004. In addition, penalties of $1,786,555 and $1,924,779 for those years were imposed. The tax authorities found that, although such deductions complied with the “black letter” of the Act, $55 million of the $66 million paid was in fact a non- deductible repayment of principal. Hence only interest deduction of $11 million over the life of the Arrangement was allowed. These figures represent the deduction disallowed by the Commissioner, as compared to the deductions claimed by the taxpayer: $13,250,998 in 2006 and $13,323,806 in 2007. Based on an allegedly abusive tax position but mitigated by the taxpayer’s prior compliance history. In so doing, avoiding any exposure to shortfall penalties for the 2008 and 2009 years in the event it is unsuccessful in the present proceedings. The income years 2004 and 2005, in which interest deductions were also claimed under the relevant transaction are time barred. Which I will refer to hereafter as $204 million without derogating from the Commissioner’s argument that the precise amount of the Note is itself evidence of artifice in the transaction. As the parties did in both the evidence and the argument, I use the $55 million figure for illustrative purposes. In fact, as recorded in fn 3 above, the Commissioner is time barred from reassessing two of FHNZ’s relevant income tax returns. The issues The primary issue is whether s BG 1 of the Act applies to the Arrangement. Two further issues arise if s BG 1 is held to apply: (a) whether the Commissioner’s reconstruction of the Arrangement pursuant to s GB 1 of the Act is correct or whether it is, as FHNZ submits, “incorrect and excessive”; and (b) whether the shortfall penalties in ss 141B (unacceptable tax position) or 141D (abusive tax position) of the Tax Administration Act 1994 (TAA) have application. In 2018 the High Court decided in favor of Frucor Suntory This decision was appealed to the Court of Appeal, where in 2020 a decision was issued in favor of the tax authorities. The Court of Appeal set aside the decision of the High Court in regards of the tax adjustment, but dismissed the appeal in regards of shortfall penalties. “We have already concluded that the principal driver of the funding arrangement was the availability of tax relief to Frucor in New Zealand through deductions it would claim on the coupon payments. The benefit it obtained under the arrangement was the ability to claim payments totaling $66 million as a fully deductible expense when, as a matter of commercial and economic reality, only $11 million of this sum comprised interest and the balance of $55 million represented the repayment of principal. The tax advantage gained under the arrangement was therefore not the whole of the interest deductions, only those that were effectively principal repayments. We consider the Commissioner was entitled to reconstruct by allowing the base level deductions totaling $11 million but disallowing the balance. The tax benefit Frucor obtained “from or under” the arrangement comprised the deductions claimed for interest on the balance of $149 million which, as a matter of commercial reality, represented the repayment of principal of $55 million.” This decision was then appealed to the Supreme Court. Judgement of the Supreme Court The Supreme Court dismissed the appeal of Frucor and ruled in favor of the tax authorities both in regards of the tax adjustment and in regards of shortfall penalties. Excerpt “[80] The picture which emerges from the planning documents which we have reviewed is clear. The whole purpose of the arrangement was to secure tax benefits in New Zealand. References to tax efficiency in those planning documents are entirely focused on the advantage to DHNZ of being able to offset repayments of principal against its revenue. The anticipated financial benefits of this are calculated solely by reference to New Zealand tax rates. The only relevance of the absence of a capital gains liability in Singapore was that this tax efficiency would not be cancelled out by capital gains on the contrived “gain” of DAP under the forward purchase agreement. [81] There were many elements of artificiality about the funding arrangement. Of these, the most significant is in relation to the note itself. [82] Orthodox convertible notes offer the investor the opportunity to receive both interest and the benefit of any increases in the value of the shares over the term of the note. For this reason, the issuer of a convertible note can expect to receive finance at a rate lower than would be the case for an orthodox loan. [83] The purpose of the convertible note issued by DHNZ was not to enable it to receive finance from an outside investor willing to lend at a lower rate because of the opportunity to take advantage of an increase in the value of the shares. The shares were to wind up with DAP which already had complete ownership of DHNZ. As well, Deutsche Bank had no interest in acquiring shares in DHNZ. Instead, it had structured a transaction that generated tax benefits for DHNZ in return for a fee. Leaving aside the purpose of obtaining tax advantages in New Zealand, the convertible note ...

Eaton is an Ohio corporation with a global presence. It manufactures a wide range of electrical and industrial products. During the relevant period—2005 and 2006—Eaton had its foreign subsidiaries in Puerto Rico and the Dominican Republic manufacture certain products which Eaton then sold to its other affiliates and third-party customers. In 2002, Eaton applied for an APA related to these transactions. In 2004 the IRS and Eaton entered into the first APA which covered tax years 2001 through 2005. And in 2006 a second APA was entered which covered tax years 2006 through 2010. A few years after entering in to the APAs, Eaton reviewed its records and caught some inadvertent calculation errors. After letting the IRS know, Eaton corrected the mistakes. But the IRS thought that Eaton’s mistakes were serious enough to warrant its unilateral cancellation of the APAs for tax years 2005 and 2006. And after cancelling the APAs, the IRS handed Eaton a notice claiming a deficiency of tens of millions of dollars. Eaton filed a petition in the Tax Court, challenging the deficiency notice and the IRS’s cancellation of the APAs. The Tax Court sided with Eaton on the major issues, concluding that the IRS had wrongfully cancelled the APAs. However, the Tax Court also concluded that Eaton’s self-corrections didn’t constitute § 482 adjustments, and denied relief from double taxation. It reasoned that relief under Revenue Procedure 99-32 applies to § 482 adjustments only. An appeal was filed by the tax authorities – and a cross appeal by Eaton – with the Sixth Circuit (US Court of Appeal). Judgement of the Court The Court sided with Eaton on all issues presented, including Eaton’s claim for relief form double taxation. The Court held that (1) the IRS had the burden of proving that there were grounds to cancel the APAs under generally applicable contract-law principles and failed to meet that burden, and (2) the IRS could not impose IRC Section 6662 penalties on Eaton Corporation’s self-reported adjustments, and (3) that Eaton was eligible to claim relief from double taxation. US vs Eaton Aug 2022 Sixth Circuit ...

The tax returns of Nam Tai Trading Company Limited (“NT Trading”) for the years 1996/97, 1997/98 and 1999/2000 were found by the tax authorities to be incorrect due to non arm’s length pricing of controlled transactions. Mr Koo and Mr Murakami, were directors of NT Trading at the time. Mr Koo signed the first and third of those returns, and Mr Murakami signed the second. NT Trading’s attempts to challenge the Inland Revenue Department’s assessments were unsuccessful. In 2013, the directors were assessed to additional tax under section 82A(1)(a) of the Inland Revenue Ordinance (Cap. 112) (the “Ordinance”) on the basis that the Returns were incorrect. At the relevant time, section 82A(1)(a) provided: “(1) Any person who without reasonable excuse— (a) makes an incorrect return by omitting or understating anything in respect of which he is required by this Ordinance to make a return, either on his behalf or on behalf of another person or a partnership… shall… be liable to be assessed under this section to additional tax…” The directors successfully appealed to the Court of First Instance against the assessments of additional tax. The Judge found that the Returns were required to be made, and were made, by NT Trading, not the directors of the company. Thus, the directors could not be liable for additional tax under section 82A(1)(a). The Judge’s finding was upheld by the Court of Appeal. An appeal was then filed by the tax authorities with the Final Court of Appeal. Judgement of the Final Court of Appeal The Court unanimously dismissed the appeal. The Court observed that the requirement to make a return results from a written notice being given under section 51(1) of the Ordinance. Notices are given to the person who is required to “furnish” a return. In the present case, the notices were addressed to NT Trading, and no reference was made to either Mr Koo or Mr Murakami. The tax authorities argued that, although NT Trading was primarily required to make the Returns, the directors were also required to do so because they, as its principal officers, were “answerable” under section 57(1) of the Ordinance for doing the acts which were required to be done by NT Trading. The Court rejected the tax authorities’ argument. The Court observed that the obligation under section 57(1) falls on all the members of the class to which it refers. There is nothing which singles out Mr Koo or Mr Murakami as subject to the requirement to make NT Trading’s returns. Additionally, the language of answerability does not, in terms, impose a legal obligation to do anything. Section 57(1)’s purpose is to facilitate the exercise of the tax authorities’ functions in relation to companies. Furthermore, there are provisions in the Ordinance that expressly impose a requirement on certain persons to do acts (including the making of returns) on behalf of others. Thus, there is a distinction between a responsibility to ensure that a company makes a return, and an obligation to make a return on a company’s behalf. Section 57(1) falls within the former category and does not have the effect of requiring the Returns to be made by the directors on behalf of NT Trading. FACV No 1 of 2022 ...

In 2009-2011 Fortis Petroleum Norway AS (FPN) bought seismic data related to oil exploration in the North Sea from a related party, Petroleum GeoServices AS (PGS), for NKR 95.000.000. FBN paid the amount by way of a convertible intra-group loan from PGS in the same amount. FPN also purchased administrative services from another related party, Consema, and later paid a substantial termination fee when the service contract was terminated. The acquisition costs, interest on the loan, costs for services and termination fees had all been deducted in the taxable income of the company for the years in question. Central to this case is the exploration refund scheme on the Norwegian shelf. This essentially means that exploration companies can demand cash payment of the tax value of exploration costs, cf. the Petroleum Tax Act § 3 letter c) fifth paragraph. If the taxpayer does not have income to cover an exploration cost, the company receives payment / refund of the tax value from the state. On 21 November 2018, the Petroleum Tax Office issued two decisions against FPN. One decision (the “Seismic decision”) which applied to the income years 2010 to 2011, where FPN was denied a deduction for the purchase of seismic services from PGS and interest on the associated seller credit, as well as ordinary and increased additional tax (hereinafter the «seismic decision»), and another decision (the “Consema decision”) which applied to the income years 2011 and 2012 where, FPN’s claim for deduction for the purchase of administrative services from Consema for the income years 2011 and 2012 was reduced at its discretion, and where FPN was also denied a deduction for the costs of the services and a deduction for termination fees. Finally in regards of the “Seismic decision” an increased additional tax of a total of 60 per cent, was added to the additional taxation on the basis of the incorrectly deducted seismic purchases as FPN had provided incorrect and incomplete information to the Oil Tax Office. In the “Seismic decision” the tax office argued that FPN used a exploration reimbursement scheme to run a “tax carousel” In the “Consema decision” the tax office found that the price paid for the intra-group services and the termination fee had not been determined at arm’s length. An appeal was filed by Fortis Petroleum Norway AS with the district court where, in December 2020, the case was decided in favour of the tax authorities. An appeal was then filed with the Court of Appel Judgement of the Court of Appeal The court upheld the decisions of the district court and decided in favour of the tax authorities. The Court concluded that the condition for deduction in the Tax Act § 6-1 on incurred costs on the part of Fortis Petroleum Norway AS was not met, and that there was a basis for imposing ordinary and increased additional tax. The Court of Appeal further found that the administrative services and the termination fee were controlled transactions and had not been priced at arm’s length. Excerpts – Regarding the acquisition of seismic exploration Based on the case’s extensive evidence, and especially the contemporary evidence, the Court of Appeal has found that there was a common subjective understanding between FPN and PGS, both at the planning stage, during the conclusion of the agreement, in carrying out the seismic purchases and in the subsequent process. should take place by conversion to a subscription price that was not market-based. Consequently, seismic would not be settled with real values. This was made possible through the common interest of the parties. The parties also never significantly distanced themselves from this agreement. The Court of Appeal has heard testimonies from the management of PGS and FPN, but can not see that these entail any other view on the question of what was agreed. The loan was never repaid, and in the end it was converted to the pre-agreed exchange rate of NOK 167. In the Court of Appeal’s view, there is no other rational explanation for this course than that it was carefully adapted to the financing through 78 per cent of the exploration refund. The share value at the time of conversion was down to zero. The Court of Appeal agrees with the state that all conversion prices between 167 and 0 kroner would have given a share price that reflected the value in FPN better and which consequently had given PGS a better settlement. On this basis, the Court of Appeal believes that the conversion rate did not cover the 22 percent, and that there was a common perception that this was in line with the purpose of the establishment of FPN, namely not to pay “a penny” of fresh capital. The Court of Appeal has also emphasized that the same thing that happened in 2009 was repeated in 2010 and 2011. For 2009, the Oil Tax Office came to the conclusion that it was a pro forma event and a shift in financial risk. In 2010 and 2011, the same actors used the same structure and procedure to finance all costs from the state. It is thus the Court of Appeal’s view that there was a common understanding between the parties to the agreement that the real relationship within was different from that which was signaled to the tax authorities regarding sacrifice and which provided the basis for the deduction. Furthermore, in the Court of Appeal’s view, the loan transactions were not fiscally neutral. The seismic purchases constituted the only source of liquidity and were covered in their entirety by the state. In light of ESA’s decision from 2018 as an element of interpretation, such a loss of fiscal neutrality would indicate that when the company has thus not borne any risk itself, sacrifice has not taken place either. Even if the debt had been real, assuming a sale without a common interest of the parties, in the Court of Appeal’s view in a tax context it could not be decisive, as long as 22 ...

In 2012, Flir Commercial Systems AB sold intangible assets from a branch in Belgium and subsequently claimed a tax relief of more than SEK 2 billion in fictitious Belgian tax due to the sale. The Swedish Tax Agency decided not to allow relief for the Belgian “tax”, and issued a tax assessment where the relief of approximately SEK 2 billion was denied and a surcharge of approximately SEK 800 million was added. An appeal was filed with the Administrative Court, In March 2020 the Administrative Court concluded that the Swedish Tax Agency was correct in not allowing relief for the fictitious Belgian tax. In the opinion of the Administrative Court, the Double tax agreement prevents Belgium from taxing increases in the value of the assets from the time where the assets were owned in Sweden. Consequently, any fictitious tax cannot be credited in the Swedish taxation of the transfer. The Court also considers that the Swedish Tax Agency was correct in imposing a tax surcharge and that there is no reason to reduce the surcharge. The company’s appeal is therefore rejected. An appeal was then filed with the Administrative Court of Appeal Decision of the Administrative Court of Appeal The Court upheld the decision of the Administrative Court and the assessment issued and the penalty added by the tax authorities. The Administrative Court of Appeal found that when assessing the amount of credit to be given for notional tax on a transfer of business, the tax treaty with the other country must also be taken into account. In the case at hand, assets were transferred to the company’s Belgian branch shortly before the assets were disposed of through the transfer of business. The tax treaty limited Belgium’s taxing rights to the increase in value accrued in Belgium after the allocation and a credit could be given up to an amount equal to that tax. In the case at hand, the company had claimed a notional credit for tax on the increase in value that had taken place in Sweden before the assets were transferred to Belgium, while the transferee company in Belgium was not taxed on the corresponding increase in value when the assets were subsequently disposed of, as the Belgian tax authority considered that the tax treaty prevented such taxation. The Court of Appeal held that there were grounds for back-taxation and the imposition of a tax surcharge on the basis of incorrect information. The information provided by the company was not considered sufficient to trigger the Tax Agency’s special investigation obligation and the tax fine was not considered unreasonable even though it amounted to a very large sum. Click here for English Translation Click here for translation Sv Flir 2434-2436-20 ...

Another way for countries to encourage taxpayers to fulfil transfer pricing documentation requirements is by designing compliance incentives such as penalty protection or a shift in the burden of proof. Where the documentation meets the requirements and is timely submitted, the taxpayer could be exempted from tax penalties or subject to a lower penalty rate if a transfer pricing adjustment is made and sustained, notwithstanding the provision of documentation. In some jurisdictions where the taxpayer bears the burden of proof regarding transfer pricing matters, a shift of the burden of proof to the tax administration’s side where adequate documentation is provided on a timely basis offers another measure that could be used to create an incentive for transfer pricing documentation compliance ...

Care should be taken not to impose a documentation-related penalty on a taxpayer for failing to submit data to which the MNE group did not have access. However, a decision not to impose documentation-related penalties does not mean that adjustments cannot be made to income where prices are not consistent with the arm’s length principle. The fact that positions are fully documented does not necessarily mean that the taxpayer’s positions are correct. Moreover, an assertion by a local entity that other group members are responsible for transfer pricing compliance is not a sufficient reason for that entity to fail to provide required documentation, nor should such an assertion prevent the imposition of documentation-related penalties for failure to comply with documentation rules where the necessary information is not forthcoming ...

Documentation-related penalties imposed for failure to comply with transfer pricing documentation requirements or failure to timely submit required information are usually civil (or administrative) monetary penalties. These documentation-related penalties are based on a fixed amount that may be assessed for each document missing or for each fiscal year under review, or calculated as a percentage of the related tax understatement ultimately determined, a percentage of the related adjustment to the income, or as a percentage of the amount of the cross-border transactions not documented ...

Many countries have adopted documentation-related penalties to ensure efficient operation of transfer pricing documentation requirements. They are designed to make non-compliance more costly than compliance. Penalty regimes are governed by the laws of each individual country. Country practices with regard to transfer pricing documentation-related penalties vary widely. The existence of different local country penalty regimes may influence the quality of taxpayers’ compliance so that taxpayers could be driven to favour one country over another in their compliance practices ...

This compliance objective may be supported in two important ways. First, tax administrations can require that transfer pricing documentation requirements be satisfied on a contemporaneous basis. This would mean that the documentation would be prepared at the time of the transaction, or in any event, no later than the time of completing and filing the tax return for the fiscal year in which the transaction takes place. The second way to encourage compliance is to establish transfer pricing penalty regimes in a manner intended to reward timely and accurate preparation of transfer pricing documentation and to create incentives for timely, careful consideration of the taxpayer’s transfer pricing positions. Filing requirements and penalty provisions related to documentation are discussed in greater detail in Section D below ...

Since penalties are only one of many administrative and procedural aspects of a tax system, it is difficult to conclude whether a particular penalty is fair or not without considering the other aspects of the tax system. Nonetheless, OECD member countries agree that the following conclusions can be drawn regardless of the other aspects of the tax system in place in a particular country. First, imposition of a sizable “no-fault” penalty based on the mere existence of an understatement of a certain amount would be unduly harsh when it is attributable to good faith error rather than negligence or an actual intent to avoid tax. Second, it would be unfair to impose sizable penalties on taxpayers that made a reasonable effort in good faith to set the terms of their transactions with associated enterprises in a manner consistent with the arm’s length principle. In particular, it would be inappropriate to impose a transfer pricing penalty on a taxpayer for failing to consider data to which it did not have access, or for failure to apply a transfer pricing method that would have required data that was not available to the taxpayer. Tax administrations are encouraged to take these observations into account in the implementation of their penalty provisions ...

It is generally regarded by OECD member countries that the fairness of the penalty system should be considered by reference to whether the penalties are proportionate to the offence. This would mean, for example, that the severity of a penalty would be balanced against the conditions under which it would be imposed, and that the harsher the penalty the more limited the conditions in which it would apply ...

Because cross-border transfer pricing issues implicate the tax base of two jurisdictions, an overly harsh penalty system in one jurisdiction may give taxpayers an incentive to overstate taxable income in that jurisdiction contrary to Article 9. If this happens, the penalty system fails in its primary objective to promote compliance and instead leads to non-compliance of a different sort – non-compliance with the arm’s length principle and under-reporting in the other jurisdiction. Each OECD member country should ensure that its transfer pricing compliance practices are not enforced in a manner inconsistent with the objectives of the OECD Model Tax Convention, avoiding the distortions noted above ...

Improved compliance in the transfer pricing area is of some concern to OECD member countries and the appropriate use of penalties may play a role in addressing this concern. However, owing to the nature of transfer pricing problems, care should be taken to ensure that the administration of a penalty system as applied in such cases is fair and not unduly onerous for taxpayers ...

It is difficult to evaluate in the abstract whether the amount of a civil monetary penalty is excessive. Among OECD member countries, civil monetary penalties for tax understatement are frequently calculated as a percentage of the tax understatement, where the percentage most often ranges from 10% to 200%. In most OECD member countries, the rate of the penalty increases as the conditions for imposing the penalty increase. For instance, the higher rate penalties often can be imposed only by showing a high degree of taxpayer culpability, such as a wilful intent to evade. “No-fault” penalties, where used, tend to be at lower rates than those triggered by taxpayer culpability (see paragraph 4.28) ...

Civil monetary penalties for tax understatement are frequently triggered by one or more of the following: an understatement of tax liability exceeding a threshold amount, negligence of the taxpayer, or wilful intent to evade tax (and also fraud, although fraud can trigger much more serious criminal penalties). Many OECD member countries impose civil monetary penalties for negligence or willful intent, while only a few countries penalise “no-fault” understatements of tax liability ...

Although some countries may refer to a “penalty”, the same or similar imposition by another country may be classified as “interest”. Some countries’ “penalty” regimes may therefore include an “additional tax”, or “interest”, for understatements which result in late payments of tax beyond the due date. This is often designed to ensure the revenue recovers at least the real time value of money (taxes) lost ...

Some civil penalties are directed towards procedural compliance, such as timely filing of returns and information reporting. The amount of such penalties is often small and based on a fixed amount that may be assessed for each day in which, e.g. the failure to file continues. The more significant civil penalties are those directed at the understatement of tax liability ...

There are a number of different types of penalties that tax jurisdictions have adopted. Penalties can involve either civil or criminal sanctions – criminal penalties are virtually always reserved for cases of very significant fraud, and they usually carry a very high burden of proof for the party asserting the penalty (i.e. the tax administration). Criminal penalties are not the principal means to promote compliance in any of the OECD member countries. Civil (or administrative) penalties are more common, and they typically involve a monetary sanction (although as discussed above there may be a non-monetary sanction such as a shifting of the burden of proof when, e.g. procedural requirements are not met or the taxpayer is uncooperative and an effective penalty results from a discretionary adjustment) ...

Care should be taken in comparing different national penalty practices and policies with one another. First, any comparison needs to take into account that there may be different names used in the various countries for penalties that accomplish the same purposes. Second, the overall compliance measures of an OECD member country should be taken into account. National tax compliance practices depend, as indicated above, on the overall tax system in the country, and they are designed on the basis of domestic need and balance, such as the choice between the use of taxation measures that remove or limit opportunities for noncompliance (e.g. imposing a duty on taxpayers to cooperate with the tax administration or reversing the burden of proof in situations where a taxpayer is found not to have acted in good faith) and the use of monetary deterrents (e.g. additional tax imposed as a consequence of underpayments of tax in addition to the amount of the underpayment). The nature of tax penalties may also be affected by the judicial system of a country. Most countries do not apply no-fault penalties; in some countries, for example, the imposition of a no-fault penalty would be against the underlying principles of their legal system ...

Penalties are most often directed toward providing disincentives for non-compliance, where the compliance at issue may relate to procedural requirements such as providing necessary information or filing returns, or to the substantive determination of tax liability. Penalties are generally designed to make tax underpayments and other types of non-compliance more costly than compliance. The Committee on Fiscal Affairs has recognised that promoting compliance should be the primary objective of civil tax penalties. OECD Report Taxpayers’ Rights and Obligations (1990). If a mutual agreement results in a withdrawal or reduction of an adjustment, it is important that there exist possibilities to cancel or mitigate a penalty imposed by the tax administrations ...

This section describes three aspects of transfer pricing compliance that should receive special consideration to help tax jurisdictions administer their transfer pricing rules in a manner that is fair to taxpayers and other jurisdictions. While other tax law compliance practices are in common use in OECD member countries – for example, the use of litigation and evidentiary sanctions where information may be sought by a tax administration but is not provided – these three aspects will often impact on how tax administrations in other jurisdictions approach the mutual agreement procedure process and determine their administrative response to ensuring compliance with their own transfer pricing rules. The three aspects are: examination practices, the burden of proof, and penalty systems. The evaluation of these three aspects will necessarily differ depending on the characteristics of the tax system involved, and so it is not possible to describe a uniform set of principles or issues that will be relevant in all cases. Instead, this section seeks to provide general guidance on the types of problems that may arise and reasonable approaches for achieving a balance of the interests of the taxpayers and tax administrations involved in a transfer pricing inquiry ...

DIGITEX INFORMATICA S.L. had entered into a substantial service contract with an unrelated party in Latin America, Telefonica, according to which the DIGITEX group would provide certain services for Telefonica. The contract originally entered by DIGITEX INFORMATICA S.L. was later transferred to DIGITEX’s Latin American subsidiaries. But after the transfer, cost and amortizations related to the contract were still paid – and deducted for tax purposes – by DIGITEX in Spain. The tax authorities found that costs (amortizations, interest payments etc.) related to the Telefonica contract – after the contract had been transferred to the subsidiaries – should have been reinvoiced to the subsidiaries, and an assessment was issued to DIGITEX for FY 2010 and 2011 where these deductions had been disallowed. DIGITEX on its side argued that by not re-invoicing the costs to the subsidiaries the income received from the subsidiaries increased. According to the intercompany contract, DIGITEX would invoice related entities 1% of the turnover of its own customers for branding and 2% of the turnover of its own or referred customers for know-how. However, no invoicing could be made if the operating income of the subsidiaries did not exceed 2.5% of turnover, excluding the result obtained from operations carried out with local clients. Judgement of the Court The Audiencia Nacional dismissed the appeal of DIGITEX and decided in favour of the tax authorities. Excerpt “1.- The income derived from the local contracts for customer analysis and migration services corresponds to the appellant Group entities and designated as PSACs, i.e. to the same affiliates. Therefore, the taxpayer should have re-invoiced the costs of the project to these subsidiaries, according to the revenue generated in each of them. And this by application of the principle of correlation between income and expenditure set out in RD 1514/2007. The plaintiff should not be surprised by this consideration insofar as this was done, at least partially, in the financial year 2010, in which it already re-invoiced EUR 339 978.55. Consequently, it cannot be said that the defendant administration went against its own actions when it took the view that the plaintiff in 2009 should have recorded in its accounts an intangible asset of EUR 50 million, in view of what happened later, in 2010, when the contracts with the subsidiaries were concluded and the PSACs became PSACs. Therefore, it was the plaintiff itself that went against its own actions, acting differently between 2010 and 2011 when it came to allocating the costs derived from the intangible amortisation and the financial expenses of the loan contracted. 2.- Even if we were to admit that the services provided by the plaintiff have added value by incorporating both a trademark licence and know-how, this does not mean that such re-invoicing does not have to be carried out, when, as has been said, in 2009 DIGITEX INFORMATICA S.L was acting as PSAC under the mediation contract, but as a result of the new contracts entered into with the Latin American subsidiaries in 2010, this position as PSAC was assumed by the said subsidiaries present in the seven Latin American countries. As regards the method of determining the profit, it is appropriate to refer to the operating margin expressly contained in the contracts concluded by the plaintiff with the subsidiaries and not to the general margin determined by the plaintiff in accordance with folio 32 et seq. of the application (according to the final result of the profit and loss account), despite the reports provided by the appellant. And so it is that the latter cannot contradict itself by going against its own acts to the point of altering the literal nature of the contracts, even if it indicates that the will of the parties in the other to the contrary, in accordance with the provisions of Article 1281 of the CC.” Click here for English Translation Click here for other translation Spain vs DIGITEX INFORMATICA SL SAN_629_2021 ...

The tax authority conducted an inspection, where it found that PJSC Galnaftochim, when conducting business transactions with a non-resident related party, had to submit a report on controlled transactions. PJSC Galnaftochim, disagreeing with the results of the audit, appealed to the court to cancel the tax assessment notice, as there were no grounds for submitting the relevant report. When paying interest to a non-resident for using a loan, PJSC Galnaftochim paid a tax of 2% of the total interest amount and believed that the transaction was not a controlled transaction within the meaning of the Tax Code of Ukraine. The District Administrative Court upheld the claim of PJSC Galnaftochim in a ruling upheld by the Lviv Administrative Court of Appeal. The courts proceeded from the fact that the legislator, when defining the criteria for classifying a business transaction as a controlled transaction, emphasises that such a transaction must affect the object of income taxation. At the same time, the business transaction under study on payment of interest for the use of credit funds does not meet this criterion, and therefore cannot be reflected in the accounts provided for accounting for profits, losses and financial results. This transaction reduces assets, as it inherently involves writing off funds in favour of the recipient, and also reduces interest payment obligations without affecting the financial result. An appal was then filed by the tax authorities with the Supreme Court. Judgement of the Supreme Court The Supreme Court partially upheld the appeal, cancelled the decisions of the lower courts and remanded the case for a new trial to the court of first instance. The determination of whether transactions are business transactions for transfer pricing purposes is based on their impact on the taxable profit reflected in the income tax return in accordance with the law. For the purposes of transfer pricing, only those business transactions that affect or may affect the taxpayer’s profit, as well as certain types of income that are taxed separately from the profit for non-residents and taxpayers, are taken into account. The courts should provide regulatory justification in their decisions for the conclusion that a transaction involving the repayment of interest on a loan cannot be recorded in the accounts used to record profits, losses and financial results, and that the transaction reduces receivebles and liabilities for interest payments without changing the financial result. The actual impact of the transaction on payment of interest on the use of the loan on the taxable profit reflected in the declaration cannot be left out of the study. Click here for English translation Click here for other translation Ukrain SC 813-3748-16 ...

The tax authority conducted an inspection of Groklin-Carpathians LLC, which revealed that the company had failed to file a controlled transactions report for 2015. On this basis, the tax authority issued a documentation penalty notice to the company. Groklin-Carpathians LLC appealed the decision, which was upheld by both the District Court and the Court of Appeal. The tax authorities then appealed to the Supreme Court. Judgement of the Supreme Court The Supreme Court dismissed the appeal. “Taking into account the circumstances of this case, as well as the officially expressed position of the fiscal authority on the procedure for determining the transaction as a controlled one, the panel of judges agrees with the conclusions of the courts of previous instances that the plaintiff has no statutory obligation to reflect the return of intangible assets in the TP Report, since such transactions do not in any way affect the increase or decrease of the plaintiff’s taxable object, which in turn indicates that the challenged tax notice is unfounded.” Click here for English translation Click here for other translation Ukrain SC 0740-860-18 ...

In the case at hand a related-party transactions had been carried out between a person (shareholder) and a related company. The transaction took place in 2007 and 2008 and was exempt from Spanish transfer pricing documentation requirements. The tax authorities issued an assessment where the transfer pricing had been adjusted and a penalty/fine was added to the claim. The taxpayer was of the opinion that the exemption from penalties extended to cases where the controlled transactions were exempt from transfer pricing documentation requirements. On that basis an appeal was filed. The appeal was dismissed by the lower court Judgement of the Supreme Court The Supreme court upheld the decision of the lower courts and dismissed the taxpayers appeal. According to the court, the exemption from penalties provided for in the rule on related-party transactions requires the taxpayer to be obliged to prepare transfer pricing documentation, and is therefore not applicable to those taxpayers who are exempt from the documentation requirement. In order to use the exemption from penalties, the following requirements must be met: The transfer pricing documentation requirements have been complied with; The declared value coincides with the value derived from such documentation; That, notwithstanding the above, the Tax Administration has made a transfer pricing adjustment. If the taxpayer is exempt from the formal transfer pricing documentation obligations, the tax authorities may adjust the transfer price of the related-party transactions and apply the general penalty regime provided for in the General Tax Law. Click here for English translation Click here for other translation Spain Penalty TP doc STS_951_2020 ...

Following an audit the tax authorities issued a tax assessment and a substantial fine to S.p.A. ST. MEDICAL related to costs deducted in FY 2010, which the tax authorities claimed were partially fictitious. “the Economic Police carried out, on 22.10.2012, a tax audit of the appellant, which, during the contested management period (1.1.-31.12.2010), had as its business the wholesale trade in medical and surgical equipment, tools and similar items, keeping, for the purpose of monitoring its business, books and records of category C of the Commercial Code. During the audit carried out, in addition to the books kept by the appellant, various items of information found at its registered office (sales invoices, service receipts, delivery notes, delivery notes, exclusive distribution contracts between the appellant and foreign companies, with attached price lists of the products to be distributed, etc.) were seized for further processing, including items issued by the limited liability company ‘Praxis Company of Medical Equipment Ltd’ (‘Praxis’), established in Cyprus, the object of whose activity is either Following the completion of the processing of that information, the audit report of 12.3.2014 of the Financial Police was drawn up, which included the following findings: (a) the appellant company had Praxis as its main supplier, of which it was, in essence, the sole customer; (b) from 2008 onwards, the Cyprus company had as its sole shareholder the company ‘Poren Ventures Limited’, a company incorporated under the laws of the British Virgin Islands, with capital consisting of 50. 000 shares, of which 49 999 shares were held by the sole partner and manager of the appellant; c) the Cypriot company operated, in the context of triangular transactions, as an intermediary between suppliers – foreign companies (Alphatec Spine, Misonix INV, PFM, Sorin Group and Sorin Biomedica Cardio S.R.L. ) and the appellant, despite the fact that the latter was able to obtain the same products directly from foreign companies, with some of which it had concluded exclusive distribution agreements (Alphatec Spine, Misonix INV and PFM), (d) in the context of the transactions between them, the Cypriot company issued invoices to the appellant, in which it indicated purchase prices for the products supplied which were, on average, 241% higher than the prices at which the same products were priced by the foreign companies …and (e) the goods supplied were sent by the foreign firms directly to the appellant, which then sold them to public hospitals in the country at the high prices at which they had been supplied by the Cypriot company, thereby technically inflating the cost of their purchase (by recording the invoices issued in that regard in its books) and reducing its profit accordingly, to the detriment of the interests of the Greek State. ” “according to the auditors’ estimate, to the value of these products in case their purchase had been made directly by the foreign companies, without the mediation of the Cypriot company, amounted to 1.531.457€, i.e. an amount, by 3.384.906€, lower than the value indicated on the invoices issued for the respective transactions (4.916.364€). During the audit, it was also found that, for the supply of those goods, the appellant, although it had entered in its books all the purchase invoices issued by Praxis in 2010, ultimately paid to Praxis, by means of bank transfers, only part of the value indicated on those invoices, namely €4,809,073, against a total debt of €10,119,105. The report of the Economic Police was sent to the appellant’s Income Tax Department IZ of Athens, which carried out a new tax audit…” “Following this, the auditor of the Athens IZ Tax Office…..drew up the report of 29. 4.4.2015, in which it fully adopted the findings of the Financial Police, from which, in its assessment, it appeared that the foreign firms treated the appellant and Praxis as a single enterprise, in the interests of the same person. In the same report, it proposed to impose a fine on the appellant for the receipt by it of invoices issued by the Cypriot company which were partially fictitious in terms of price. There followed the 173/29.4.2015 act of the Head of the Athens IZ Tax Office, by which, invoking Articles 2(2)(a) and (b) of the Greek Tax Code, the Head of the Athens Tax Office issued a decision of the Head of the Athens Tax Office. 1 and 18 par. 2 of the Commercial Code and 5 par. 10 and 19 par. 4 of Law No. 2523/1997, imposed a fine on the appellant for receiving partially fictitious tax information, amounting to twice the value of the transactions classified as fictitious (€3,384,906 x 2 = €6,769,813). “ The assessment and fine was later upheld by the Administrative Court and the Administrative Court of Appeal. Not satisfied with this result, S.p.A. ST. MEDICAL filed an appeal with the Supreme Administrative Court. Judgement of the Supreme Administrative Court The Court partially allowed the appeal of S.p.A. ST. MEDICAL and remanded the case back to the tax authorities in order to examine whether instead the conditions for imposition of a penalty provided for in Article 39(7) of the Income Tax Code were fulfilled. Excerpts ” transactions in which the value shown on the tax documents is higher than the value which could have been agreed under the prevailing market conditions do not, in principle, constitute a case of partial deception, provided that that value corresponds, as stated above, to the price actually agreed between the parties. ” “In the view of the Court of First Instance, such is the nature of the overpricing of the products sold by the Cypriot company, resulting, in its view, from the large discrepancy between the purchase price and the selling price, from the close economic dependence of the two companies and from the general circumstances in which those transactions took place. However, in the light of what has already been said, that finding is incorrect, in the light of the ground of appeal in the main proceedings, as set out in the appeal of 24.10.2008 C ...

Monsanto Chile, Since 2018 a subsidiary in the Bayer group, had been issued a tax assessment related to FY 2009 and 2010 resulting in additional taxes of approximately $800.000.000. and penal interest of 1,5% per month in an amount of $2.216.759.197. Monsanto filed an appeal in regards to the penal interest of $2.216.759.197. In the appeal the company argued, that the interest should be inapplicable since the case has been delayed by Courts due to both lack of activities and COVID 19. Decision of the Court In a split decision the Constitutional Court ruled in favor of Monsanto and declared the penal interest inapplicable. “For all the reasons stated in this ruling, this Court concludes that the application of the penal interest provided for in the third paragraph of Article 53 of the Tax Code, in this specific case, contravenes the constitutional guarantees contained in numbers 2 and 3, paragraph 6, of Article 19 of the Constitution. For this reason, it shall be declared inapplicable due to unconstitutionality.“ Click here for English translation TP Chile Bayer ...

“Glass Corp” Panama, was issued a fine for not filing (in time) Transfer Pricing Report – Form 930 – for the fiscal year 2012. Article 762-I of the Tax Code in Panama establishes that failure to comply with filing obligation of transfer pricing documentation results in a fine of 1% of the total amount of the transactions with related parties. The decision of the Court “since it has been demonstrated that the formal duty to submit the Transfer Pricing Report contained in Article 762-I of the Tax Code has not been fulfilled by the company, this Administrative Tribunal considers that it is appropriate to confirm Resolution No. 201-579 of 15 October 2014 and the administrative act by which the General Revenue Directorate resolves to maintain it in all its parts.“ Click here for English translation Panama Exp. 176-18 ...

Eaton Corporation is a global manufacturer of electrical and industrial products headquartered in the US.  This case concerning the computation of penalties is related to a previous 2017 dispute concerning the cancellation of two advance pricing agreements (APAs) establishing a transfer pricing methodology (TPM) for covered transactions between Eaton Corp and its subsidiaries. In 2011 IRS determined that Eaton had not complied with the applicable terms of the governing APA revenue procedures and canceled APA I and APA II, effective January 1, 2005 and 2006, respectively. The US Tax Court found that the cancellation of the APAs was an abuse of discretion (US vs Eaton TC opinion from July 2017), and the APAs remained in effect. Irespective of the ruling related to the cancellation of the APAs, the IRS determined that a section 482 adjustment were still necessary to reflect an arm’s-length result for Eaton’s intercompany transactions, and that the computations should include 40% penalties pursuant to I.R.C. sec. 6662(h). Section 6662(a) imposes a 20% penalty on an underpayment of tax attributable to any of the reasons listed in section 6662(b). These include “[a]ny substantial valuation misstatement under chapter 1”. Sec. 6662(b)(3). As relevant to this case, a “substantial valuation misstatement” occurs when the net section 482 transfer price adjustment for the taxable year exceeds the lesser of $5 million or 10% of the taxpayer’s gross receipts. When the net section 482 transfer price adjustment for the taxable year exceeds the lesser of $20 million or 20% of the taxpayer’s gross receipts, section 6662(h) increases the penalty to 40 percent of the underpayment. Eaton held that there were no adjustments pursuant to I.R.C. sec. 482 as the APAs were still in effect and therefore the computation of additional taxes from the transfer pricing adjustment should not include penalties. The Tax Court held in favor of Eaton. Since the APAs remained in effect, there are no allocation of income and deductions pursuant to section 482 and no “net increase in taxable income for the taxable year * * * resulting from adjustments under section 482 in the price for any property or services”. Accordingly, Eaton is not liable for section 6662(h) penalties for the years in issue. US-vs-Eaton-USTC-Oct-2019 ...

The Transfer Pricing Department of the General Directorate of Revenue of the Ministry of Economy and Finance, through Resolution 201-1429 of 24 October 2014, decided to sanction the taxpayer Chevron Products Antilles, LTD, now Chevron Panama Fuels Limited, with a fine of one million balboas (B/. 1,000,000.00), for failure to file the Transfer Pricing Report-Form 930 for the 2012 tax period. As a result of the issuance of the resolution mentioned in the previous paragraph, Chevron’s legal representative filed an appeal for reconsideration with the tax authority, which was resolved by Resolution 201-1321 of 1 March 2016, through which the accused act was maintained in all its parts. This resolution was notified to the taxpayer on 8 April 2016. Chevron then filed an appeal before the Administrative Tax Court, which by Resolution TAT-RF-057 of 22 May 2019, confirmed the provisions of the main administrative act and its confirmatory act, being notified of this appeal ruling on 18 June 2019, thus exhausting the governmental channels. Chevron then appealed to the Third Chamber, on 30 July 2019, in order to declare null and void, as illegal, the administrative resolution through which the General Directorate of Revenue of the Ministry of Economy and Finance, decided to sanction Chevron Products Antilles, LTD, now Chevron Panama Fuels Limited, with a fine of one million balboas (B/. 1,000,000.00), and that as a consequence of such declaration, it be resolved that Chevron has not failed to comply with the obligation to file the transfer pricing report-form 930 for the fiscal period 2012; that it should not pay any fine or sanction; and that, in the event that its principal had paid the fine, the amount of money should be returned to it. In support of its claim, Chevron points out that the contested administrative act does not recognise the right of its principal to be exempt from paying income tax, due to its location in an oil-free zone and for carrying out foreign operations, whose costs and expenses come from foreign sources; in other words, it is excluded from taxable income. In addition to the above, Chevron alleges that by not reporting transactions with related parties abroad, which have the effect of income, costs or deductions in the determination of the taxable base for the calculation of income tax, is under no obligation to file the transfer pricing report (form 930); for which reason, the sanction imposed violates the principles of due process and strict legality. The Judgement of the Court The court dismissed the appeal of Chevron and upheld the fine issued for not filing tranfer pricing documentation. Excerpt: “From the foregoing, it follows that the plaintiff, Chevron Panama Fuels Limited, was obliged to include in the income tax return filed, the data relating to operations with related countries tax residents of other jurisdictions together with the submission of the transfer price report-form 930, within six (6) months after the date of the close of the tax period, a requirement stipulated in article 762-I of the Tax Code, which states the following: “Article 762-1. Transfer pricing report. Taxpayers must submit, on an annual basis, a report of the operations carried out with related parties, within six (6) months following the closing date of the corresponding tax period, under the terms established in the regulations to be drawn up for this purpose. Failure to submit the report shall be punishable by a fine equivalent to 1% of the total amount of the related party transactions. For the purpose of calculating the fine, the gross amount of t he transactions shall be considered, regardless of whether they represent income, costs or deductions. The fine referred to in this paragraph shall not exceed one million balboas (B/.1,000,000.00). The sworn income tax return shall include the data related to related operations, as well as their nature or other relevant information, under the terms provided therein. The Directorate General of Revenue shall adapt the internal administrative procedures in order to comply with this regulation”. (Emphasis added). It is for the above reasons that the Directorate General of Revenue imposed the corresponding fine on the plaintiff taxpayer, Chevron Panama Fuels Limited, since it failed to file the transfer pricing report form 930, within six (6) months after the closing date of the tax period, as required by article 762-I of the aforementioned Tax Code.” Click here for English translation Click here for other translation V-1060-19-559-19 Chevron Panama Fuels Limited (Anteriormente denominada Chevron Products Antilles Limited) vs MEF ...

“Oil Export S.A” Panama, was issued a fine of $ 1 mill. for not filing Transfer Pricing Report – Form 930 – for the fiscal year 2012. Article 762-I of the Tax Code in Panama establishes that “Failure to submit the report shall be sanctioned with a fine equivalent to 1% of the total amount of the operations with related parties. For the calculation of the fine, the gross amount of the operations shall be considered, regardless of whether they are representative of income, costs, or deductions.” The fine referred to in the paragraph shall not exceed one million balboas (B/.1,000,000.00). The decision of the Court “Consequently, since it has been demonstrated that —[“Oil Export S.A”]— did not comply with the formal obligation to submit the Transfer Pricing Report contained in Article 762-I of the Tax Code, the Tax Administration considers that it is appropriate to confirm Resolution No. 201-1429 of 24 October 2014 and its confirmation act.“ Click here for English translation TAT-RF-057 de 22 de mayo de 2019 ...

HMRC Profit Diversion Compliance Facility Chapter 1 – introduction 1.1 Background Companies should recognise and pay tax on profits where the economic activities to generate those profits are carried out. HMRC has found that some Multinational Enterprises (MNEs) have adopted cross border pricing arrangements which are based on an incorrect fact pattern and/or are not consistent with the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines (TPG), as clarified through Actions Points 8-10 of the OECD Base Erosion and Profit Shifting Project. This is for 2 main reasons: Firstly, some have made incorrect assumptions, or not implemented arrangements as originally intended or declared to HMRC, so that there is a divergence between the fact pattern on which the Transfer Pricing (TP) analysis is based, and what is actually happening on the ground. This could be for a variety of reasons, including: insufficient understanding or incorrect/misleading statements on the nature or relative value of functions, assets and risks at the outset businesses change over time so that the functional profile may become different from that originally assumed or intended some businesses undervalue the contributions made by staff in the UK and overvalue the contributions of staff in other tax jurisdictions Secondly, the TP policies are not in accordance with the OECD TPG, for example because of: over reliance on TP policies predicated on contractual assumption of risk and legal ownership of assets, giving insufficient weight to the location of the control functions and/or the contributions to those control functions in relation to the risk and/or the important functions in relation to the assets too heavy a reliance on inappropriate comparables These arrangements often result in a reduction of UK profits, and may involve the diversion of UK profits to an overseas entity where the profits are taxed at lower rates or not at all. In a high proportion of investigations into such arrangements HMRC is finding that the arrangements don’t stand up to scrutiny and significant additional tax is due. The Diverted Profits Tax (DPT) was introduced to encourage MNEs using such arrangements to change their behaviour and pay Corporation Tax on profits in line with economic activity. Many MNEs with arrangements targeted by DPT have changed their TP policy and/or business structure leading to the right amount of UK Corporation Tax being paid, eliminating any potential DPT. 1.2 Co-operative Compliance HMRC prefers MNEs to fully disclose significant tax uncertainties or inaccuracies and to ensure compliance with tax law, and will work co-operatively, proactively and transparently with MNEs to resolve any tax uncertainties and risks. 1.3 Profit Diversion Compliance Facility HMRC is introducing a new Profit Diversion Compliance Facility for MNEs using arrangements targeted by DPT to give them the opportunity to bring their UK tax affairs up to date. HMRC recognises that many MNEs operate TP policies to achieve compliance with the OECD TPG, regularly review and update their policies, and discuss them with HMRC during business risk reviews and at other times. If a MNE is confident that their transfer pricing is up to date and they are paying the right amount of Corporation Tax, then they should not use the new compliance facility. The new facility is designed to encourage MNEs with arrangements that might fall within its scope to review both the design and implementation of their TP policies, change them if appropriate, and use the facility to put forward a report with proposals to pay any additional tax, interest and where applicable, penalties due. This will: enable MNEs to bring their tax affairs up to date openly, efficiently and without investigation by HMRC if a full and accurate disclosure is made give them certainty for the past and a low risk outcome for profit diversion in the future provide an accelerated process, HMRC will aim to respond to the proposal within 3 months of submission allow the MNE to manage its own internal processes around what evidence to gather, who is interviewed, what comparables are used (if any), and how the analysis is presented give unprompted penalty treatment if HMRC has not already started an investigation into profit diversion, 31 December 2019 is an important deadline for registration for some MNEs (see section 3 of chapter 4 of this guidance) This guidance sets out what HMRC would expect to see in such a report. The review of the arrangements should be proportionate to the scale and complexity of the business, the extent of tax at risk, the cause of any inaccuracies and failures to notify, and the proposals. The report should be free standing and self-explanatory. While it will be the responsibility of the MNE to review its arrangements and make a disclosure, HMRC is prepared to meet with MNEs who register to use the facility at the outset of the process to discuss plans for the review and later again before the final report and proposal is submitted, so that the MNE can present its findings and conclusions and hear any comments from HMRC. This work will be a priority for HMRC and a specifically designated, experienced team of specialists will risk assess all reports when received and consider whether the facts described and conclusions reached are soundly based on appropriate evidence, and if the TP policy and methodology adopted is reasonable and consistent with the OECD TPG. HMRC expects to be able to accept most proposals if they take account of this guidance and reflect the principles in it. Even if HMRC cannot accept the proposals as first presented, the report should provide a good basis for quick and efficient resolution, through dialogue, of particular differences of view between HMRC and the MNE. While the facility is aimed at arrangements targeted by DPT, businesses do not need to provide a technical analysis of whether DPT applies if they consider that their proposals eliminate any profit potentially chargeable to DPT. All technical analysis and any payment made can be on a without prejudice basis. HMRC will not regard the making of a proposal as indicating that the MNE thinks DPT could, or should, apply. 1.4 HMRC investigations Tackling profit diversion is a priority for HMRC. HMRC is conducting extensive research and data analysis and has invested in new teams of investigators. Investigations into profit diversion are usually resolved by agreeing transfer pricing adjustments. HMRC has identified a number of MNEs in a variety of business sectors which could be diverting profits, ...

Monsanto Chile – since 2018 a subsidiary of Bayer – is engaged in production of vegetable seeds and Row Crop seeds. The company uses its own local farmers and contractors, employs some 250 people and hires a maximum of 2,000 temporary workers in the summer months. It receives parental seed from global planners in the US and other countries and then multiplies these seeds in Chile on its own or third-party farms. The seeds are then harvested, processed and shipped to locations specified by global planners. Following an audit of FY 2009-2010 an adjustment was issued related to the profitability obtained in the operations of the “Production” segment (sale of semi-finished products to related parties) and “Research and Development” carried out on behalf of related parties abroad. The adjustment was determined by the tax authorities using the a Net Margin method. The tax authorities found that the income obtained under the production segment and in the research and development business line, did not provide a reasonable return to the local company, since in the production segment the operating margin over costs and expenses (ROTC) obtained by Monsanto Chile amounting to -5.87% was lower than the ROTC obtained by comparable companies which were in a range between 4.573% and 12.648%, with a median of 11.216%; and in the research and development segment the ROTC obtained by Monsanto Chile was -6.54%, whereas the arm’s length ROTC determined by the tax authorities was in a range between 7.93% and 12.48%, with a median of 10.21%. An assessment was issued in 2013 where an adjustment of $2,422,378,384 had been determined in regards to the production segment, and an adjustment of $38,637,909 had been determined in regards to the Research and Development segment, in total resulting in additional taxes of $862,958,963. Monsanto was of the opinion that the assessment was bared due to statues of limitations, and that the transfer pricing analysis conducted by the tax authorities in regards to both the production segment and the research and development segment was erroneous. Monsanto also held that the added fine was unfounded. Decision of the Tax court The decision of the Tax Court was largely in favour of the tax authorities. “That the claim filed in the main part of page 1 by Mr. Manuel Jiménez Pfingsthorn, RUT N°7.021.291-9, on behalf of MONSANTO CHILE S.A., is partially accepted, RUT N°83.693.800-3, against the Assessment N° 38, carried out on 28 August 2013, by the Large Taxpayers Directorate of the Internal Revenue Service, only insofar as the fine established in article 97 N°11 of the Tax Code is left without effect, as stated in recital 35°), being rejected for the rest. III. That the Director of the Large Taxpayers’ Directorate of the Internal Revenue Service shall arrange for administrative compliance with the above decision, for which purpose he must carry out a tax re-calculation.“ Following the decision of the tax court, an appeal has been filed by Monsanto Chile to the Court of Appeal where the appeal is still pending. Click here for English translation CH vs M14-9-0000002-3 ...

A Swiss company manufactured and distributed pharmaceutical and chemical products. The Swiss company was held by a Dutch parent that held another company in France. R&D activities were delegated by the Dutch parent to its French subsidiary and compensated with cost plus 15%. On that basis the Swiss company had to pay a royalty to its Dutch parent of 2.5% of its turnover for using the IP developed. Following an audit the Swiss tax authorities concluded that the Dutch parent did not contribute to the development of IP. In 2006 and 2007, no employees were employed, and in 2010 and 2011 there were only three employees. Hence the royalty agreement was disregarded and an assessment issued where the royalty payments were denied. Instead the R&D agreement between the Dutch parent and the French subsidiary was regarded as having been concluded between the Swiss and French companies Judgement of the Supreme Court The Court agreed with the decision of the tax authorities. The Dutch parent was a mere shell company with no substance. Hence, the royalty agreement was disregarded and replaced with the cost plus agreement with the French subsidiary. The Court found that it must have been known to the taxpayer that a company without substance could not be entitled to profits of the R&D activities. On that basis an amount equal to 75% of the evaded tax had therefore rightly been imposed as a penalty. Click here for English translation Click here for other translation 2C_11-2018 ...

Tax penalties/fines had been issued following a transfer pricing adjustments in regards of controlled transactions exempt from Spanish TP documentation requirements. An appeal was filed by the taxpayer claiming to be excluded from the Spanish penalty regime. The appeal was dismissed by the lower courts. Judgement of the Supreme Court The Supreme Court upheld the decision of the lower courts and dismissed the appeal of the taxpayer. The Court ruled that the specific transfer pricing penalty regime in Spain is only applicable to the related-party transactions subject to transfer pricing requirements and that controlled transactions exempt from Spanish TP documentation requirements can trigger tax penalties where adjustments have been issued by the tax authorities. In cases, where the taxpayer is exempt from TP documentation requirement, art. 16.10.4 of the TRLIS (the exclusion from penalties) does not apply. The exclusion from penalties provided for in paragraph 4 of art. 16.10 TRLIS is only applicable when the following three circumstances apply: (a) the taxpayer has not failed to comply with the formal obligation to keep the corresponding documentation ex art. 16. 2 TRLIS; (b) that the value declared by him in his tax return coincides with that stated in the documentation of the related-party transaction; and (c) that, despite the existence of this documentary coincidence, the normal market value attributed to the related-party transaction is incorrect and has required a valuation correction by the tax authorities. Only where these three cumulative circumstances are met, the conduct of the taxpayer will not be punishable either in accordance with the specific penalty regime contained in art. 16.10.1 and 2 TRLIS or in accordance with the general penalty regime established in the LGT. Hence, If the taxpayer is exempt from the formal transfer pricing documentation obligations, the tax authorities may adjust the transfer price of the related-party transactions and apply the general penalty regime provided for in the General Tax Law. “The logical consequence of the foregoing can be none other than the dismissal of the appeal lodged by the legal representation of Mr. Matías, as the court decision under appeal has correctly interpreted the legal system by considering (a) that article 16.10.4 TRLIS is not applicable because the appellant is exempt from the formal obligation to keep and maintain at the disposal of the tax authorities the documentation relating to related-party transactions established in article 16.2 TRLIS and developed in article 16.2 TRLIS. 16.2 TRLIS and developed by Royal Decree 1777/2004, and (b) that, in the absence of the application of the special penalty regime established in art. 16.10 TRLIS, it is appropriate to apply the general penalty regime established in the LGT and, in particular, in this case, art. 191 LGT, provided that the objective and subjective elements of the type of offence that we have established in our case law are present, as the Court of First Instance has found and is not the subject of controversy.” Click here for English translation Click here for other translation Spain TP doc Penalty STS_3632_2018 ...

The Tax authorities considered that the financial loans made by YPF S.A. to the controlled companies YPF Gas S.A.; Maleic S.A. and Operadora de Estaciones de Servicio constituted a “disposition of income in favor of third parties”, since in the first two cases (loans granted to YPF Gas S.A. and Maleic S.A.) the agreed interest was lower than that provided for in the aforementioned regulations, while in the last case (operation carried out with OPESSA) no interest payment had even been stipulated. Likewise, it estimated that the transfer prices corresponding to gas oil, propane butane exports made to Repsol YPF Trading and Transport S.A. were below the first quartile. Consequently, it made an adjustment to the taxable income. Furthermore, a fine equivalent to 70% of the allegedly omitted tax was issued. At issue before the Supreme Court was only the fine which was set aside. Click here for English Translation YPF FALLO CAF 040460_2012_1_RH001 ...

ICL ESPAÑA, S.A., ICL Packaging Coatings, S.A., were members of the Tax Consolidation Group and obtained extraordinary profits in the financial years 2000, 2001 and 2002. (AKZO NOBEL is the successor of ICL ESPAÑA, as well as of the subsidiary ICL PACKAGING.) On 26 June 2002, ICL ESPAÑA, S.A. acquired from ICL Omicron BV (which was the sole shareholder of ICL ESPAÑA, S.A. and of Elotex AG and Claviag AG) 45.40% of the shares in the Swiss company, Elotex AG, and 100% of the shares in the Swiss company of Claviag AG. The acquisition was carried out by means of a sale and purchase transaction, the price of which was 164.90 million euros, of which ICL ESPAÑA, S.A. paid 134.90 million euros with financing granted by ICL Finance, PLC (a company of the multinational ICL group) and the rest, i.e. 30 million euros, with its own funds. On 19 September 2002, ICL Omicron BV contributed 54.6% of the shares of Elotex AG to ICL ESPAÑA, S.A., in a capital increase of ICL ESPAÑA, S.A. with a share premium, so that ICL ESPAÑA, S.A. became the holder of 100% of the share capital of Elotex AG. The loan of 134,922,000 € was obtained from the British entity, ICL FINANCE PLC, also belonging to the worldwide ICL group, to finance the acquisition of the shares of ELOTEX AG. To pay off the loan, the entity subsequently obtained a new loan of €75,000,000. The financial burden derived from this loan was considered by ICL ESPAÑA as an accounting and tax expense in the years audited, in which for this concept it deducted the following amounts from its taxable base – and consequently from that of the Group: FY 2005 2,710,414.29, FY 2006 2,200,935.72, FY 2007 4,261,365.20 and FY 2008 4.489.437,48. During the FY under review, ICL ESPAÑA SA has considered as a deductible expense for corporate tax purposes, the interest corresponding to loans obtained by the entity from other companies of the group not resident in Spain. The financing has been used for the acquisition of shares in non-resident group companies, which were already part of the group prior to the change of ownership. The amounts obtained for the acquisition of shares was recorded in the groups cash pooling accounts, the entity stating that “it should be understood that the payments relating to the repayment of this loan have not been made in accordance with a specific payment schedule but rather that the principal of the operation has been reduced through the income made by Id ESPAÑA SA from the cash available at any given time”. Similarly, as regards the interest accrued on the debit position of ICL ESPAÑA SA, the entity stated that “the interest payments associated with them have not been made according to a specific schedule, but have been paid through the income recorded by ICL ESPAÑA SA in the aforementioned cash pooling account, in the manner of a credit policy contract, according to the cash available at any given time”. The Spanish tax authorities found the above transactions lacked any business rationale other than tax avoidance and therefor disallowed the interest deductions for tax purposes. This decision was appealed to the National Court. Judgement of the National Court The Court partially allowed the appeal. Excerpts “It follows from the above: 1.- The purchase and sale of securities financed with the loan granted by one of the group companies did not involve a restructuring of the group itself. The administration claims that the transfer of 100% ownership of the shares of both Swiss companies is in all respects formal. And it is true that no restructuring of the group can be seen as a consequence of the operation, nor is this alleged by the plaintiff. 2.- There are no relevant legal or economic effects apart from the tax savings in the operation followed, since, as we have pointed out, we are dealing with a merely formal operation, with no substantive effect on the structure and organisation of the Group. 3.- The taxation in the UK of the interest on the loan does not affect the correct application of Spanish tax legislation, since, if there is no right to deduct the interest generated by the loan, this is not altered by the fact that such interest has been taxed in another country. It is clear that the Spanish authorities cannot make a bilateral adjustment in respect of the amounts paid in the United Kingdom for the taxation of the interest received. For this purpose, provision is made for the mutual agreement procedure under Article 24 of the Convention between the Kingdom of Spain and the United Kingdom of Great Britain and Northern Ireland for the avoidance of double taxation and the prevention of fiscal evasion in relation to taxes on income and on capital and its Protocol, done at London on 14 March 2013 (and in the same terms the previous Instrument of Ratification by Spain of the Convention between Spain and the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion in respect of Taxes on Income and on Capital, done at London on 21 October 1975, Article 26 ).” “For these reasons, we share the appellant’s approach and we understand that the non-compliance with the reinvestment takes place in the financial year 2004 (as the start of the calculation of the three-year period is determined by the deed of sale dated 29 June 2001), and that therefore the regularisation on this point should be annulled because it corresponds to a financial year not covered by the inspection.” “Therefore, and in the absence of the appropriate rectification, this tax expense would be double-counted, firstly because it was considered as a tax expense in 1992 and 1999, and secondly because it was included in seventh parts – in 2003 and in the six subsequent years – only for an amount lower than the amount due, taking into account the proven ...

Another way for countries to encourage taxpayers to fulfil transfer pricing documentation requirements is by designing compliance incentives such as penalty protection or a shift in the burden of proof. Where the documentation meets the requirements and is timely submitted, the taxpayer could be exempted from tax penalties or subject to a lower penalty rate if a transfer pricing adjustment is made and sustained, notwithstanding the provision of documentation. In some jurisdictions where the taxpayer bears the burden of proof regarding transfer pricing matters, a shift of the burden of proof to the tax administration’s side where adequate documentation is provided on a timely basis offers another measure that could be used to create an incentive for transfer pricing documentation compliance ...

Care should be taken not to impose a documentation-related penalty on a taxpayer for failing to submit data to which the MNE group did not have access. However, a decision not to impose documentation-related penalties does not mean that adjustments cannot be made to income where prices are not consistent with the arm’s length principle. The fact that positions are fully documented does not necessarily mean that the taxpayer’s positions are correct. Moreover, an assertion by a local entity that other group members are responsible for transfer pricing compliance is not a sufficient reason for that entity to fail to provide required documentation, nor should such an assertion prevent the imposition of documentation-related penalties for failure to comply with documentation rules where the necessary information is not forthcoming ...

Documentation-related penalties imposed for failure to comply with transfer pricing documentation requirements or failure to timely submit required information are usually civil (or administrative) monetary penalties. These documentation-related penalties are based on a fixed amount that may be assessed for each document missing or for each fiscal year under review, or calculated as a percentage of the related tax understatement ultimately determined, a percentage of the related adjustment to the income, or as a percentage of the amount of the cross-border transactions not documented ...

Many countries have adopted documentation-related penalties to ensure efficient operation of transfer pricing documentation requirements. They are designed to make non-compliance more costly than compliance. Penalty regimes are governed by the laws of each individual country. Country practices with regard to transfer pricing documentation-related penalties vary widely. The existence of different local country penalty regimes may influence the quality of taxpayers’ compliance so that taxpayers could be driven to favour one country over another in their compliance practices ...

This compliance objective may be supported in two important ways. First, tax administrations can require that transfer pricing documentation requirements be satisfied on a contemporaneous basis. This would mean that the documentation would be prepared at the time of the transaction, or in any event, no later than the time of completing and filing the tax return for the fiscal year in which the transaction takes place. The second way to encourage compliance is to establish transfer pricing penalty regimes in a manner intended to reward timely and accurate preparation of transfer pricing documentation and to create incentives for timely, careful consideration of the taxpayer’s transfer pricing positions. Filing requirements and penalty provisions related to documentation are discussed in greater detail in Section D below ...

This chapter provides guidance for tax administrations to take into account in developing rules and/or procedures on documentation to be obtained from taxpayers in connection with a transfer pricing enquiry or risk assessment. It also provides guidance to assist taxpayers in identifying documentation that would be most helpful in showing that their transactions satisfy the arm’s length principle and hence in resolving transfer pricing issues and facilitating tax examinations ...

Since penalties are only one of many administrative and procedural aspects of a tax system, it is difficult to conclude whether a particular penalty is fair or not without considering the other aspects of the tax system. Nonetheless, OECD member countries agree that the following conclusions can be drawn regardless of the other aspects of the tax system in place in a particular country. First, imposition of a sizable “no-fault” penalty based on the mere existence of an understatement of a certain amount would be unduly harsh when it is attributable to good faith error rather than negligence or an actual intent to avoid tax. Second, it would be unfair to impose sizable penalties on taxpayers that made a reasonable effort in good faith to set the terms of their transactions with associated enterprises in a manner consistent with the arm’s length principle. In particular, it would be inappropriate to impose a transfer pricing penalty on a taxpayer for failing to consider data to which it did not have access, or for failure to apply a transfer pricing method that would have required data that was not available to the taxpayer. Tax administrations are encouraged to take these observations into account in the implementation of their penalty provisions ...

It is generally regarded by OECD member countries that the fairness of the penalty system should be considered by reference to whether the penalties are proportionate to the offence. This would mean, for example, that the severity of a penalty would be balanced against the conditions under which it would be imposed, and that the harsher the penalty the more limited the conditions in which it would apply ...

Because cross-border transfer pricing issues implicate the tax base of two jurisdictions, an overly harsh penalty system in one jurisdiction may give taxpayers an incentive to overstate taxable income in that jurisdiction contrary to Article 9. If this happens, the penalty system fails in its primary objective to promote compliance and instead leads to non-compliance of a different sort – non-compliance with the arm’s length principle and under-reporting in the other jurisdiction. Each OECD member country should ensure that its transfer pricing compliance practices are not enforced in a manner inconsistent with the objectives of the OECD Model Tax Convention, avoiding the distortions noted above ...

Improved compliance in the transfer pricing area is of some concern to OECD member countries and the appropriate use of penalties may play a role in addressing this concern. However, owing to the nature of transfer pricing problems, care should be taken to ensure that the administration of a penalty system as applied in such cases is fair and not unduly onerous for taxpayers ...

It is difficult to evaluate in the abstract whether the amount of a civil monetary penalty is excessive. Among OECD member countries, civil monetary penalties for tax understatement are frequently calculated as a percentage of the tax understatement, where the percentage most often ranges from 10% to 200%. In most OECD member countries, the rate of the penalty increases as the conditions for imposing the penalty increase. For instance, the higher rate penalties often can be imposed only by showing a high degree of taxpayer culpability, such as a wilful intent to evade. “No-fault” penalties, where used, tend to be at lower rates than those triggered by taxpayer culpability (see paragraph 4.28) ...

Civil monetary penalties for tax understatement are frequently triggered by one or more of the following: an understatement of tax liability exceeding a threshold amount, negligence of the taxpayer, or wilful intent to evade tax (and also fraud, although fraud can trigger much more serious criminal penalties). Many OECD member countries impose civil monetary penalties for negligence or willful intent, while only a few countries penalise “no-fault” understatements of tax liability ...

Although some countries may refer to a “penalty”, the same or similar imposition by another country may be classified as “interest”. Some countries’ “penalty” regimes may therefore include an “additional tax”, or “interest”, for understatements which result in late payments of tax beyond the due date. This is often designed to ensure the revenue recovers at least the real time value of money (taxes) lost ...

Some civil penalties are directed towards procedural compliance, such as timely filing of returns and information reporting. The amount of such penalties is often small and based on a fixed amount that may be assessed for each day in which, e.g. the failure to file continues. The more significant civil penalties are those directed at the understatement of tax liability ...

There are a number of different types of penalties that tax jurisdictions have adopted. Penalties can involve either civil or criminal sanctions – criminal penalties are virtually always reserved for cases of very significant fraud, and they usually carry a very high burden of proof for the party asserting the penalty (i.e. the tax administration). Criminal penalties are not the principal means to promote compliance in any of the OECD member countries. Civil (or administrative) penalties are more common, and they typically involve a monetary sanction (although as discussed above there may be a non-monetary sanction such as a shifting of the burden of proof when, e.g. procedural requirements are not met or the taxpayer is uncooperative and an effective penalty results from a discretionary adjustment) ...

Care should be taken in comparing different national penalty practices and policies with one another. First, any comparison needs to take into account that there may be different names used in the various countries for penalties that accomplish the same purposes. Second, the overall compliance measures of an OECD member country should be taken into account. National tax compliance practices depend, as indicated above, on the overall tax system in the country, and they are designed on the basis of domestic need and balance, such as the choice between the use of taxation measures that remove or limit opportunities for noncompliance (e.g. imposing a duty on taxpayers to cooperate with the tax administration or reversing the burden of proof in situations where a taxpayer is found not to have acted in good faith) and the use of monetary deterrents (e.g. additional tax imposed as a consequence of underpayments of tax in addition to the amount of the underpayment). The nature of tax penalties may also be affected by the judicial system of a country. Most countries do not apply no-fault penalties; in some countries, for example, the imposition of a no-fault penalty would be against the underlying principles of their legal system ...

Penalties are most often directed toward providing disincentives for non-compliance, where the compliance at issue may relate to procedural requirements such as providing necessary information or filing returns, or to the substantive determination of tax liability. Penalties are generally designed to make tax underpayments and other types of non-compliance more costly than compliance. The Committee on Fiscal Affairs has recognised that promoting compliance should be the primary objective of civil tax penalties. OECD Report Taxpayers’ Rights and Obligations (1990). If a mutual agreement results in a withdrawal or reduction of an adjustment, it is important that there exist possibilities to cancel or mitigate a penalty imposed by the tax administrations ...

This section describes three aspects of transfer pricing compliance that should receive special consideration to help tax jurisdictions administer their transfer pricing rules in a manner that is fair to taxpayers and other jurisdictions. While other tax law compliance practices are in common use in OECD member countries – for example, the use of litigation and evidentiary sanctions where information may be sought by a tax administration but is not provided – these three aspects will often impact on how tax administrations in other jurisdictions approach the mutual agreement procedure process and determine their administrative response to ensuring compliance with their own transfer pricing rules. The three aspects are: examination practices, the burden of proof, and penalty systems. The evaluation of these three aspects will necessarily differ depending on the characteristics of the tax system involved, and so it is not possible to describe a uniform set of principles or issues that will be relevant in all cases. Instead, this section seeks to provide general guidance on the types of problems that may arise and reasonable approaches for achieving a balance of the interests of the taxpayers and tax administrations involved in a transfer pricing inquiry ...

The taxpayer is registered and incorporated in the Republic of South Africa and carries on business in the petrochemical industry. It has some of its subsidiaries in foreign jurisdictions. Business activities include the importation and refinement of crude oil. This matter concerns the analysis of supply agreements entered into between the XYZ Corp and some of its foreign subsidiaries. It thus brings to fore, inter alia the application of the South African developing fiscal legal principles, namely, residence based taxation, section 9D of the Income Tax Act 58 of 1962 and other established principles of tax law, such as anti-tax avoidance provisions and substance over form. Tax avoidance is the use of legal methods to modify taxpayer’s financial situation to reduce the amount of tax that is payable SARS’s ground of assessment is that the XYZ Group structure constituted a transaction, operation or scheme as contemplated in section 103(1) of the Act. The structure had the effect of avoiding liability for the payment of tax imposed under the Act. The case is based on the principle of substance over form, in which event the provisions of section 9D will be applicable. Alternatively the respondent’s case is based on the application of section 103 of the Act. XYZ Group denies that the substance of the relevant agreements differed from their form. It contends that both in form and substance the relevant amounts were received by or accrued to XYZIL from sale of crude oil by XYZIL to SISIL. XYZ Group states that in order to treat a transaction as simulated or a sham, it is necessary to find that there was dishonesty. The parties did not intend the transaction to have effect in accordance with its terms but intended to disguise the transaction. The transaction should be intended to deceive by concealing what the real agreement or transaction between the parties is. Substance over form: If the transaction is genuine then it is not simulated, and if it is simulated then it is a dishonest transaction, whatever the motives of those who concluded the transaction. The true position is that „the court examines the transaction as a whole, including all surrounding circumstances, any unusual features of the transaction and the manner in which the parties intend to implement it, before determining in any particular case whether a transaction is simulated. Among those features will be the income tax consequences of the transaction. Tax evasion is of course impermissible and therefore, if a transaction is simulated, it may amount to tax evasion. But there is nothing impermissible about arranging one’s affairs XYZ as to minimise one’s tax liability, in other words, in tax avoidance. If the revenue authorities regard any particular form of tax avoidance as undesirable they arefree to amend the Act, as occurs annually, to close anything they regard as a loophole. That is what occurred when s 8C was introduced. Once that is appreciated the argument based on simulation must fail. For it to succeed, it required the participants in the scheme to have intended, when exercising their options to enter into agreements of purchase and sale of shares, to do XYZ on terms other than those set out in the scheme. Before a transaction is in fraudem legis in the above sense, it must be satisfied that there is some unexpressed agreement or tacit understanding between the parties. The Court rules as follows: The question is whether the substance of the relevant agreements differs from form. The interposition of XIXL and the separate reading of “back-to-back” agreements take XIXL out of the equation. Regrettably no matter how the appellant’s witnesses try to dress the contracts and their implementation, the surrounding circumstances; implementation of the uncharacteristic features of the transaction point to none other than disguised contracts. The court can only read one thing not expressed as it is; tax avoidance. Based on the evidence the court concludes that the purpose of relevant supply agreements was to avoid the anticipated tax which would accrue to XYZIL, a CFC if it sold the crude oil directly to XYZ. The court has concluded that the whole scheme and or the implementation of supply agreements is a sham. The court, therefore cannot consider the facsimile argument in isolation to support the averment that the contracts were concluded in IOM. Furthermore there is nothing before court to the effect that XYZIL has an FBE with a truly active business with connections to South Africa being used for bona fide non- tax business purposes. There is not even a shred of evidence alluding to the existence of an FBE. Section 76 (2) empowers SARS with a discretion to remit a portion or all of the additional tax assessment in terms of section 76 (1). Additional tax prescribed in Section 76(1) is 200% of the relevant tax amount. The appeal is dismissed. The assessments by the South African Revenue Services for 2005, 2006 and 2007 tax years as well as interest and penalties, are confirmed. LAPD-DRJ-TC-2017-06 - TCIT 13065 JHB 30 June 2017 ...

The Bundesfinanzhof confirmed the statutory authority of the tax authorities to issue penalties where a taxpayer have not fulfilled transfer pricing documentation requirement. Click here for English translation Click here for other translation BFH v 28 06 2011 - X B 37-11 ...

Since penalties are only one of many administrative and procedural aspects of a tax system, it is difficult to conclude whether a particular penalty is fair or not without considering the other aspects of the tax system. Nonetheless, OECD member countries agree that the following conclusions can be drawn regardless of the other aspects of the tax system in place in a particular country. First, imposition of a sizable “no-fault” penalty based on the mere existence of an understatement of a certain amount would be unduly harsh when it is attributable to good faith error rather than negligence or an actual intent to avoid tax. Second, it would be unfair to impose sizable penalties on taxpayers that made a reasonable effort in good faith to set the terms of their transactions with associated enterprises in a manner consistent with the arm’s length principle. In particular, it would be inappropriate to impose a transfer pricing penalty on a taxpayer for failing to consider data to which it did not have access, or for failure to apply a transfer pricing method that would have required data that was not available to the taxpayer. Tax administrations are encouraged to take these observations into account in the implementation of their penalty provisions ...

It is generally regarded by OECD member countries that the fairness of the penalty system should be considered by reference to whether the penalties are proportionate to the offence. This would mean, for example, that the severity of a penalty would be balanced against the conditions under which it would be imposed, and that the harsher the penalty the more limited the conditions in which it would apply ...

Because cross-border transfer pricing issues implicate the tax base of two jurisdictions, an overly harsh penalty system in one jurisdiction may give taxpayers an incentive to overstate taxable income in that jurisdiction contrary to Article 9. If this happens, the penalty system fails in its primary objective to promote compliance and instead leads to non-compliance of a different sort – non-compliance with the arm’s length principle and under- reporting in the other jurisdiction. Each OECD member country should ensure that its transfer pricing compliance practices are not enforced in a manner inconsistent with the objectives of the OECD Model Tax Convention, avoiding the distortions noted above ...

Improved compliance in the transfer pricing area is of some concern to OECD member countries and the appropriate use of penalties may play a role in addressing this concern. However, owing to the nature of transfer pricing problems, care should be taken to ensure that the administration of a penalty system as applied in such cases is fair and not unduly onerous for taxpayers ...

It is difficult to evaluate in the abstract whether the amount of a civil monetary penalty is excessive. Among OECD member countries, civil monetary penalties for tax understatement are frequently calculated as a percentage of the tax understatement, where the percentage most often ranges from 10 percent to 200 percent. In most OECD member countries, the rate of the penalty increases as the conditions for imposing the penalty increase. For instance, the higher rate penalties often can be imposed only by showing a high degree of taxpayer culpability, such as a wilful intent to evade. “No-fault” penalties, where used, tend to be at lower rates than those triggered by taxpayer culpability (see paragraph 4.28) ...

Civil monetary penalties for tax understatement are frequently triggered by one or more of the following: an understatement of tax liability exceeding a threshold amount, negligence of the taxpayer, or wilful intent to evade tax (and also fraud, although fraud can trigger much more serious criminal penalties). Many OECD member countries impose civil monetary penalties for negligence or wilful intent, while only a few countries penalise “no-fault” understatements of tax liability ...

Although some countries may refer to a “penalty”, the same or similar imposition by another country may be classified as “interest”. Some countries’’ “penalty” regimes may therefore include an “additional tax”, or “interest”, for understatements which result in late payments of tax beyond the due date. This is often designed to ensure the revenue recovers at least the real time value of money (taxes) lost ...

Some civil penalties are directed towards procedural compliance, such as timely filing of returns and information reporting. The amount of such penalties is often small and based on a fixed amount that may be assessed for each day in which, e.g. the failure to file continues. The more significant civil penalties are those directed at the understatement of tax liability ...

There are a number of different types of penalties that tax jurisdictions have adopted. Penalties can involve either civil or criminal sanctions – criminal penalties are virtually always reserved for cases of very significant fraud, and they usually carry a very high burden of proof for the party asserting the penalty (i.e. the tax administration). Criminal penalties are not the principal means to promote compliance in any of the OECD member countries. Civil (or administrative) penalties are more common, and they typically involve a monetary sanction (although as discussed above there may be a non-monetary sanction such as a shifting of the burden of proof when, e.g. procedural requirements are not met or the taxpayer is uncooperative and an effective penalty results from a discretionary adjustment) ...

Care should be taken in comparing different national penalty practices and policies with one another. First, any comparison needs to take into account that there may be different names used in the various countries for penalties that accomplish the same purposes. Second, the overall compliance measures of an OECD member country should be taken into account. National tax compliance practices depend, as indicated above, on the overall tax system in the country, and they are designed on the basis of domestic need and balance, such as the choice between the use of taxation measures that remove or limit opportunities for noncompliance (e.g. imposing a duty on taxpayers to cooperate with the tax administration or reversing the burden of proof in situations where a taxpayer is found not to have acted in good faith) and the use of monetary deterrents (e.g. additional tax imposed as a consequence of underpayments of tax in addition to the amount of the underpayment). The nature of tax penalties may also be affected by the judicial system of a country. Most countries do not apply no- fault penalties; in some countries, for example, the imposition of a no-fault penalty would be against the underlying principles of their legal system ...

Penalties are most often directed toward providing disincentives for non-compliance, where the compliance at issue may relate to procedural requirements such as providing necessary information or filing returns, or to the substantive determination of tax liability. Penalties are generally designed to make tax underpayments and other types of non-compliance more costly than compliance. The Committee on Fiscal Affairs has recognised that promoting compliance should be the primary objective of civil tax penalties. OECD Report Taxpayers’ Rights and Obligations (1990). If a mutual agreement between two countries results in a withdrawal or reduction of an adjustment, it is important that there exist possibilities to cancel or mitigate a penalty imposed by the tax administrations ...

Since penalties are only one of many administrative and procedural aspects of a tax system, it is difficult to conclude whether a particular penalty is fair or not without considering the other aspects of the tax system. Nonetheless, OECD Member countries agree that the following conclusions can be drawn regardless of the other aspects of the tax system in place in a particular country. First, imposition of a sizable “no-fault” penalty based on the mere existence of an understatement of a certain amount would be unduly harsh when it is attributable to good faith error rather than negligence or an actual intent to avoid tax. Second, it would be unfair to impose sizable penalties on taxpayers that made a reasonable effort in good faith to set the terms of their transactions with related parties in a manner consistent with the arm’s length principle. In particular, it would be inappropriate to impose a transfer pricing penalty on a taxpayer for failing to consider data to which it did not have access, or for failure to apply a transfer pricing method that would have required data that was not available to the taxpayer. Tax administrations are encouraged to take these observations into account in the implementation of their penalty provisions ...

It is generally regarded by OECD Member countries that the fairness of the penalty system should be considered by reference to whether the penalties are proportionate to the offence. This would mean, for example, that the severity of a penalty would be balanced against the conditions under which it would be imposed, and that the harsher the penalty the more limited the conditions in which it would apply ...

Because cross-border transfer pricing issues implicate the tax base of two jurisdictions, an overly harsh penalty system in one jurisdiction may give taxpayers an incentive to overstate taxable income in that jurisdiction contrary to Article 9. If this happens, the penalty system fails in its primary objective to promote compliance and instead leads to non-compliance of a different sort — non-compliance with the arm’s length principle and under-reporting in the other jurisdiction. Each OECD Member country should ensure that its transfer pricing compliance practices are not enforced in a manner inconsistent with the objectives of the OECD Model Tax Convention, avoiding the distortions noted above ...

Improved compliance in the transfer pricing area is of some concern to OECD Member countries and the appropriate use of penalties may play a role in addressing this concern. However, owing to the nature of transfer pricing problems, care should be taken to ensure that the administration of a penalty system as applied in such cases is fair and not unduly onerous for taxpayers ...

It is difficult to evaluate in the abstract whether the amount of a civil monetary penalty is excessive. Among OECD Member countries, civil monetary penalties for tax understatement are frequently calculated as a percentage of the tax understatement, where the percentage most often ranges from 10 percent to 200 percent. In most OECD Member countries, the rate of the penalty increases as the conditions for imposing the penalty increase. For instance, the higher rate penalties often can be imposed only by showing a high degree of taxpayer culpability, such as a wilful intent to evade. “No-fault” penalties, where used, tend to be at lower rates than those triggered by taxpayer culpability (see paragraph 4.28) ...

Civil monetary penalties for tax understatement are frequently triggered by one or more of the following: an understatement of tax liability exceeding a threshold amount, negligence of the taxpayer, or wilful intent to evade tax (and also fraud, although fraud can trigger much more serious criminal penalties). Many OECD Member countries impose civil monetary penalties for negligence or wilful intent, while only a few countries penalise “no-fault” understatements of tax liability ...

Although some countries may refer to a “penalty”, the same or similar imposition by another country may be classified as “interest”. Some countries’ “penalty” regimes may therefore include an “additional tax”, or “interest”, for understatements which result in late payments of tax beyond the due date. This is often designed to ensure the revenue recovers at least the real time value of money (taxes) lost ...

Some civil penalties are directed towards procedural compliance, such as timely filing of returns and information reporting. The amount of such penalties is often small and based on a fixed amount that may be assessed for each day in which, e.g. the failure to file continues. The more significant civil penalties are those directed at the understatement of tax liability ...

There are a number of different types of penalties that tax jurisdictions have adopted. Penalties can involve either civil or criminal sanctions – criminal penalties are virtually always reserved for cases of very significant fraud, and they usually carry a very high burden of proof for the party asserting the penalty (i.e. the tax administration). Criminal penalties are not the principal means to promote compliance in any of the OECD Member countries. Civil (or administrative) penalties are more common, and they typically involve a monetary sanction (although as discussed above there may be a non-monetary sanction such as a shifting of the burden of proof when, e.g., procedural requirements are not met or the taxpayer is uncooperative and an effective penalty results from a discretionary adjustment) ...

Care should be taken in comparing different national penalty practices and policies with one another. First, any comparison needs to take into account that there may be different names used in the various countries for penalties that accomplish the same purposes. Second, the overall compliance measures of an OECD Member country should be taken into account. National tax compliance practices depend, as indicated above, on the overall tax system in the country, and they are designed on the basis of domestic need and balance, such as the choice between the use of taxation measures that remove or limit opportunities for non- compliance (e.g. imposing a duty on taxpayers to cooperate with the tax administration or reversing the burden of proof in situations where a taxpayer is found not to have acted in good faith) and the use of monetary deterrents (e.g. additional tax imposed as a consequence of underpayments of tax in addition to the amount of the underpayment). The nature of tax penalties may also be affected by the judicial system of a country. Most countries do not apply no-fault penalties; in some countries, for example, the imposition of a no-fault penalty would be against the underlying principles of their legal system ...

Penalties are most often directed toward providing disincentives for non-compliance, where the compliance at issue may relate to procedural requirements such as providing necessary information or filing returns, or to the substantive determination of tax liability. Penalties are generally designed to make tax underpayments and other types of non-compliance more costly than compliance. The Committee on Fiscal Affairs has recognized that promoting compliance should be the primary objective of civil tax penalties. OECD Report Taxpayers’ Rights and Obligations (1990). If a mutual agreement between two countries results in a withdrawal or reduction of an adjustment, it is important that there exist possibilities to cancel or mitigate a penalty imposed by the tax administrations ...