Tax treaties need a safety valve
Transfer Pricing is a hotter topic than ever before. Norwegian Tax Authorities scrutinize intra-group transactions, and often claim that the taxpayer has applied incorrect transfer prices. Income taxable to Norway is increased accordingly.
The basics are simple: The price applied in intra-group transactions shall be an “arm’s length price” – a “market price”. This is where the simplicity ends, however. A Norwegian company experienced this the hard way just before Christmas last year.
The company had received support from a related entity in the UK. People in the UK supplied actual services from their offices there.
The Tax Office and the Norwegian Appeals Board denied deductions for 60 to 90 per cent of the service fees paid by the Norwegian company. Thus, the company was allowed to deduct merely approx. 10 to 40 per cent of the fees, while the British entity had to book 100 per cent of the same fees as income in the UK. This entailed double taxation of an amount of several million NOKs.
The tax treaties shall contribute to the avoidance of double taxation
The tax treaties entered into by Norway include a mechanism for the avoidance of double taxation, a “Mutual Agreement Procedure” (MAP). An afflicted company in one of treaty countries can request that the Competent Authority in its country review the case. If the Competent Authority fails to solve the issue unilaterally, it has an obligation to raise the issue with the Competent Authority in the other treaty country.
The two respective Competent Authorities then have a duty to seek a bilateral solution which avoids double taxation.
The Norwegian Company made such a request to the Norwegian Ministry of Finance in 2014.
Service provision is a straightforward activity. Hence, one would expect that the Tax Authorities in two neighboring countries with rather similar economic systems would be able to agree on a “market price” applicable for tax purposes in both countries. This was not the case.
Double taxation nevertheless
More than three years later, the Ministry of Finance notified the company that Norwegian and British Tax Authorities were unable to agree on a “market price” for the services in question. Arbitration was not an option, as the current UK/Norway tax treaty came into effect after the income years under review.
The reasoning behind MAP rulings is not made available to the taxpayer. Following this case, one could reasonably ask how Norwegian Tax Authorities can justify many of their attacks on taxpayers’ transfer prices, when the Tax Authorities’ supreme bodies (and presumably most competent persons) are unable to arrive at a “market price” – even for specific services – acceptable to others than themselves.
Typically, a “market price” does not constitute a specific amount. Rather, there is a range of “market prices”. One would therefore assume that Norwegian and British Tax Authorities would at least be able to agree on a reduction of the amount subjected to double taxation.
Income from petroleum extraction activities on the Norwegian Continental Shelf is taxed at 78 per cent. When the company is denied deductions for the costs, while the related entity in the UK is taxed for the income, the total effective tax rate quickly exceeds 100 per cent for part of the income.
One would therefore assume that the two countries’ Tax Authorities would have an added incentive for reducing the difference between their respective positions.
What is next?
A taxpayer is not bound by a MAP ruling. The taxpayer may try its tax case before the courts, but this is a long, costly and risky path. When even the supreme bodies of the Tax Authorities are unable to reach agreement on a “market price”, it seems unfair to expect that a legal “all-rounder” on the bench will be able to decide whether a transfer price is correct, without randomness playing a significant part in the decision. Assistance from specialist co-judges will rarely facilitate the decision.
Mandatory arbitration should therefore be introduced as a safety valve in all tax treaties Norway is party to, so that a MAP has to lead to an actual solution. Currently, this is included only in the UK/Norway and the Netherlands/Norway tax treaties, respectively.
As part of its tax initiatives (BEPS), the OECD has established a series of tools that allow for existing tax treaties to be amended without a complete renegotiation. Mandatory arbitration in MAP cases is among the important tools offered. It seems like the Ministry of Finance opts out of this tool, however, despite the fact that arbitration is long established as the standard inside the EU system.
Mandatory arbitration will ensure that the same price is applied for tax purposes in both countries, thereby avoiding double taxation of the same income and the risk of an overall tax of 100 per cent or more.
This should be high on the agenda of any nation that seeks to come across as a modern state governed by law, with an attractive business environment.
The article was first published by Dagens Næringsliv 31 January 2018 by Øystein Andal (PwC) and J. Christian Grevstad (The Law Firm Harboe & Co AS)
Jeg heter Øystein Andal og er advokat i Advokatfirmaet PwC. Med bakgrunn fra bl.a. Oljeskattekontoret og Advokatfirmaet Harboe & Co AS, har jeg mange års erfaring innen nasjonal og internasjonal bedriftsbeskatning.
Mine spesialområder er internprising og petroleumsskatt, og jeg bistår både store og små bedrifter i problemstillinger innenfor norsk og internasjonal skatterett.
Ta gjerne kontakt om du har spørsmål, kommentarer eller innspill.
My name is Øystein Andal, and I am an attorney with PwC. With a background from the Oil Taxation Office and the Law Firm Harboe & Co AS, I have several years of experience in national and international corporate taxation.
My specialties include Transfer Pricing and Petroleum Taxation, and I support both small and large businesses on issues related to national and international tax law.
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