Issue 3/2019 3rd Quarter 2019
The United States and Spain include an Arbitration Procedure in the amendment of the Double Tax Treaty
On 27 November 2019, the 2013 Protocol amending the 1990 Double Tax Treaty between Spain and the United States will enter into force after completing an eventful ratification process in the United States Congress.
Although the Protocol includes many developments in the tax treatment of transactions between Spain and the United States, the most relevant from a transfer pricing point of view is the incorporation of binding arbitration in the mutual agreement procedure (MAP) if the competent authorities of both countries do not reach an agreement within two years to resolve a double taxation case raised by a taxpayer. In this respect, it should be noted that, according to statistics on MAP’s recently published by the OECD, at the end of 2018, five of these procedures between Spain and the United States were pending of resolution, and all five concerned transfer pricing disputes.
The regulation of the arbitration procedure can be found in the new paragraphs 5 and 6 of Article 26 of the Treaty and the new wording of paragraph 21 of its Additional Protocol.
According to paragraph 5, the arbitration phase of the mutual agreement procedure cannot be accessed in the following cases:
- tax returns have not been filed with at least one of the Contracting States with respect to the taxable years at issue in the case;
- both competent authorities of the Contracting States agree, before the date on which arbitration proceedings would otherwise have begun, is not suitable for resolution through arbitration;
- A decision with respect to such case has already been rendered by a court or administrative tribunal of either Contracting State;
- the case involves a determination of the residence of a company by mutual agreement;
- all the conditions for the beginning of an arbitration proceeding have been satisfied.
These conditions for the beginning of an arbitration proceeding are as follows:
- two years have elapsed after the date on which the information necessary to undertake substantive consideration for a mutual agreement procedure has been received by both competent authorities (unless both competent authorities have agreed to a different date);
- the taxpayer submits a written request to that competent authority for a resolution of the case through arbitration;
- all concerned persons and their authorized representatives or agents agree in writing not to disclose to any other person any information received during the course of the arbitration proceeding from either Contracting State or the arbitration panel;
- all legal actions or suits pending before the courts of either Contracting State concerning any issue involved in the case are suspended or withdrawn.
The aspects relating to the development of the arbitration phase shall be agreed by the competent authorities at the beginning of the phase.
The arbitration panel shall consist of three individuals, which cannot be employees nor have been employees within the twelve-month period prior to the date on which the arbitration proceeding begins, of the tax administration, the Treasury Department or the Ministry of Finance of the Contracting State which identifies them.
The taxpayer is permitted to submit for consideration by the arbitration panel a paper setting forth its analysis and views of the case.
The arbitration proceeding and the mutual agreement procedure with respect to a case shall terminate if at any time before the arbitration panel delivers a determination:
- the competent authorities of the Contracting States reach a mutual agreement to resolve the case;
- the taxpayer withdraws the request for arbitration;
- any concerned person, or any of their representatives or agents, willfully violates the written statement of nondisclosure and the competent authorities of both Contracting States agree that such violation should result in the termination of the arbitration proceeding; or
- any concerned person initiates a legal action or suit before the courts of either Contracting State concerning any issue involved in the case, unless such legal action or suit is suspended.
The arbitration panel shall deliver a determination in writing to the competent authorities of the Contracting States. The determination reached by the arbitration panel in the arbitration proceeding shall be limited to one of the proposed resolutions for the case submitted by one of the competent authorities of the Contracting States for each adjustment or similar issue and any threshold questions, and shall not include a rationale or any other explanation of the determination.
Unless the competent authorities of both Contracting States agree to a longer time period, the taxpayer shall have 45 days after receiving the determination of the arbitration panel to notify, in writing, of his acceptance of the determination.
The fees and expenses of the members of the arbitration panel, as well as any costs incurred in connection with the arbitration proceeding by the Contracting States, shall be borne equitably by the competent authorities of Contracting States.
On 18 September, Law no.119/2019 amended Portugal’s almost 20-year old transfer pricing and penalties regimes. The following changes are made to the transfer pricing and penalty rules:
- The type of transactions under the scope of the regime is broader and detailed, considering that restructuring transactions, such as changes in business structures, substantial termination or renegotiation of existing contracts – with special focus on situations entailing transfer of intangible or tangible assets, intangible property and compensation for emerging damages or lost profit – are now deemed as controlled transactions;
- No hierarchy will apply for selecting a transfer pricing method, and taxpayers may adopt methods other than those set out in the current transfer pricing rules for transactions with unique characteristics or where there is a lack of information about comparable transactions between unrelated parties;
- The transfer pricing rules will be aligned with the new reporting obligations specified in Ministerial Order No. 35/2019, i.e. the new annual tax and accounting return, and specifically appendix H that requires transfer pricing information;
- “Large taxpayers” will be required to prepare and submit transfer pricing documentation to the Portuguese tax authorities by the 15th day of the seventh month after the tax year end (i.e. by 15 July of the following year for taxpayers with a 31 December tax year);
- Advance pricing agreements (APAs) (unilateral or bilateral) will be valid for up to four years (currently three years). Additionally, the terms and conditions of an APA will be exchanged with other countries under Portugal’s tax cooperation agreements; and
- The current penalty that applies to failures to timely submit transfer pricing documentation and the country-by-country (CbC) report (i.e. EUR 1,000 to EUR 20,000 for legal entities (EUR 500 to EUR 10,000 for individuals required to prepare transfer pricing documentation) plus 5% for each day that the failure continues) will be extended to failures to timely submit the CbC notification form.
The new rules will apply as from 1 October 2019.
On 2 September, the Irish Department of Finance published a Feedback Statement on Ireland’s Transfer Pricing Rules, and proposing a series of changes to the existing TP regime:
- Scope of the TP rules is broadened to include not only trading income and expenses for companies in Ireland but also non-trading income and expenses taxed at 25% and arrangements relating to the acquisition and disposal of chargeable assets (such as tangible and intangible assets).
- Recharacterization of transactions would be allowed for transfer pricing purposes when the form of a financial or commercial arrangement is inconsistent with the substance of the relations between related parties transacting with each other.
- OECD’s 2017 TP Guidelines and subsequent works (guidance on hard-to-value intangibles, application of profit-split methods) would be applicable as from 1 January 2020.
- The exemption of the TP rules for the so-called “grandfathered” arrangements (entered into before 1 July 2010) would be removed as from 1 January 2020. However, those grandfathered arrangement entered into between two Irish tax resident parties would remain exempt of TP documentation.
- Small and medium-sized enterprises (SME) would be included under the scope of the TP rules:
- Small-sized companies would be subject to the valuation obligations, but exempt from the documentation requirements; and
- Medium-sized companies would be subject to both valuation and documentation obligations (with simplification).
- OECD’s TP documentation package is adopted, and Irish taxpayers should prepare master file and local file when the following thresholds are exceeded:
- Master file: consolidated revenue exceeds €250 million;
- Local file: consolidated revenue exceeds €50 million.
- The TP documentation should be contemporaneous to the filing of the corporate income tax return (generally, nine months after the tax year-end), and should be provided to the Irish Revenue upon request in writing by Irish Revenue within 30 days of the request.
These changes may be introduced in Finance Bill 2019 and to come into force from the beginning of 2020.
On 28 August, the Australian Tax Office (ATO) released draft guidance contained in Practical Compliance Guideline (PCG) 2019/D3, on applying the arm’s length debt test contained in Division 820 of the Income Tax Assessment Act 1997, Australia’s thin capitalization statutory provisions. The application of the arm’s length debt test is currently a key focus of the ATO. Once finalised, the guidance will have a retroactive effect from 1 July 2019.
The arm’s length debt test is one of the statutory provisions available to determine an entity’s maximum allowable debt for Australian thin capitalisation purposes. The test can be used when an entity does not satisfy the safe harbour and worldwide gearing tests and, in such a case, the test must be applied on an annual basis. Hence, annual testing could result in a debt amount that was supportable in the initial income year, but not supportable in subsequent periods.
The arm’s length debt test, where satisfied, allows entities to support debt deductions for commercially sustainable debt levels in excess of that otherwise allowable under the thin capitalisation provisions.
The definition of debt includes both commercial third-party and related-party debt. However, the ATO is of the general view that related-party debt significantly increases an entity’s tax risk profile.
Applying the arm’s length debt test is dependent on the facts and circumstances of a particular business, and further reinforcing the need for robust quantitative and qualitative analysis, as well as thorough documentation thereof. In this regard, the options available to the borrower and the optimal capital structure for the Australian business must be addressed.
As stated by the ATO, the analysis undertaken and documented must support the conclusion that the relevant debt amount (on arm’s length terms and conditions) would ‘reasonably be expected’ under the borrower’s test and the independent lender’s test.
Similar to other PCGs, the ATO provides taxpayers with a clear colour coded risk assessment framework. The PCG provides insight into whether the arrangement is likely to be high on the ATO radar and whether the ATO resources are likely to be allocated for additional review or follow up. It also provides insight into the types of arrangements that may be considered low risk.
On June 19, Sweden’s Supreme Administrative Court ruled in favour of the Swedish company in a transfer pricing dispute, agreeing that the full range of results in a benchmarking study could be applied and a multiple-year analysis of the tested party data could be used to support an arm’s length result.
In 2007, the Swedish company sold its products to its US subsidiary, which had the right to distribute these products in the US market. The Swedish Tax Agency adjusted the taxable income for the fiscal year 2007, claiming that the Swedish company underpriced the products sold to its US subsidiary.
The Swedish company argued that a multiple-year analysis covering 2007-2008 should be used to determine the arm’s length nature of the intra-group transactions since the Company had announced in 2006 that it would be acquired by an external party in 2008 which affected the US subsidiary’s profit in 2007. The company made a corresponding pricing adjustment in 2008 as a result of the US subsidiary’s increased profit in 2007. During the two-year period (2007-2008) the US subsidiary earned a weighted average operating margin within the full range of results as illustrated by comparable companies in a benchmarking analysis.
However, the Swedish Tax Agency challenged this treatment, based on their analysis of the US subsidiary’s local file for the tax year 2007, where the transactional net margin method was applied to analyse the intra-group transaction. The US subsidiary’s three-year (2005–2007) weighted average operating margin was above the upper quartile of the benchmarking analysis and it was therefore concluded in the US local file that the subsidiary had not paid higher prices than what would have been applied between independent parties. The Swedish Tax Agency, therefore, concluded that the subsidiary had not paid an arm’s length price for the products and increased taxable income in Sweden for the fiscal year 2007.
The Swedish Supreme Administrative Court concluded that the Swedish Tax Agency did not fulfill the burden of proof and ruled in favour of the taxpayer. Referring to an earlier ruling by the Supreme Administrative Court, the Court concluded that multiple-year analyses could be applied. The Court said that the appropriateness of a multiple-year analysis is determined on a case-by-case basis. The Court also concluded that the Swedish Tax Agency did not prove that the comparable companies, that had operating margins outside the interquartile range did not indicate an arm’s length pricing.
On 13 August 2019, Bulgaria introduced mandatory transfer pricing documentation requirements for transactions entered into as from 1 January 2020.
Bulgarian resident companies and permanent establishments of non-resident companies must prepare a local file. Those companies belonging to a multinational group must also have a master file for the tax year, prepared by the ultimate parent company or a designated affiliate.
Taxpayers that as of 31 December of the prior year did not exceed the following thresholds are exempt from preparing the local file:
- BGN 38 million (USD 21.5 million) in asset net book value; and
- BGN 76 million (USD 43 million) in net sales revenue; or
- An average number of 250 personnel for the reporting period.
Entities that are exempt from corporate taxation and those that are subject to alternative taxation under the Corporate Income Tax Act, as well as entities that enter into domestic related-party transactions only are exempt from the obligation to prepare a local file.
There is no obligation to include in the local file the controlled transactions with individuals, except for transactions with the sole owner.
The local file must be prepared for transactions that exceed the following annual thresholds:
- Sale of goods – BGN 400,000;
- Loans – Principal of over BGN 1 million or interest and other revenues and expenses related to the loan of over BGN 50,000; and
- All other transactions – BGN 200,000.
The local file must be prepared by 31 March of the following year (the same as the due date for filing the corporate income tax return), whereas the master file must be available by 31 March of the year after that deadline. For example, the local file for 2020 must be prepared by 31 March 2021 (with a possible extension until 30 September 2021 if an amended corporate income tax return is submitted), whereas the master file for 2020 must be available by 31 March 2022.
The local file must be prepared on an annual basis, but if there are no significant changes in the comparability factors, the analysis can be updated once every three years. The financial data for the comparable transactions or entities should be updated annually.
There is no requirement to submit the transfer pricing documentation to the tax authorities. The transfer pricing documentation (both the local file and the master file) should be kept by the taxpayer and provided to the tax authorities upon request.
Tax penalties would be imposed for noncompliance with the new transfer pricing documentation requirements:
- A taxpayer that is obligated to prepare a local file and fails to do so may be subject to a penalty of up to 0.5% of the total value of the transactions that should have been documented. For loans granted or received, the total value of the transaction is the principal amount of the loans.
- An entity that is required to provide a master file and fails to do so may be subject to a penalty between BGN 5,000 and BGN 10,000.
- The penalty for providing incorrect or incomplete data in the transfer pricing documentation ranges from BGN 1,500 to BGN 5,000.
The amount of the penalties may be doubled in case of repeated failure to comply with the transfer pricing documentation requirements.
On 12 September, Denmark’s Ministry of Taxation published a draft bill including a requirement to submit transfer pricing documentation together with the corporate income tax return.
The timing for the preparation of TP documentation has been recently controversial in Denmark. Under the existing legislation, taxpayers are only required to submit transfer pricing documentation upon request and the date of preparation, in principle, was not relevant.
In practice, however, Danish tax inspectors often argued that TP documentation needed to be prepared contemporaneously to the filing of the corporate income tax return.
The rules on contemporaneous documentation were most recently amended for tax years as from 1 January 2019, by requiring taxpayers to prepare their TP documentation before submitting their corporate income tax return. TP documentation needs only be submitted upon request, with a minimum deadline of 60 days. This position is consistent with the recommendation of the 2017 OECD transfer pricing guidelines. If TP documentation is not prepared in a timely manner, the Danish tax administration may estimate a taxpayer’s taxable income under the arm’s length principle. Penalties may also be levied.
However, a recent decision of the Supreme Court (SKM2019.136HR) has cast doubt on the application of the legislation effective as from 1 January 2019.
Under the proposed changes, the Danish tax administration would be entitled to estimate the taxable income if TP documentation is not prepared and submitted together with the corporate income tax return.
Similarly, penalties may be levied based on the fact that TP documentation is not submitted together with the corporate income tax return. Subsequent preparation and submission of TP documentation can no longer be considered timely compliance.
If the draft bill is presented to parliament and enacted, the proposed effective date is 1 January 2020.