Last fortnight, the 61st International Fiscal Association (IFA) Annual Congress was hosted by the IFA’s Japan Branch in Kyoto. Attended by over 1,200 tax and fiscal experts, comprising academicians and revenue officers from across 50 countries, IFA Congress sessions are an opportunity to debate on cross-border tax issues of contemporary relevance.
The IFA was established in 1938 with its headquarters in the Netherlands. It is the only non-governmental and non-sectoral international organisation dealing with fiscal matters. Its objectives include the study and advancement of international and comparative law with regard to public finance, particularly international and comparative fiscal law and the financial and economic aspects of taxation.
This year’s scientific topics for discussion were ‘Transfer pricing and intangibles’ and ‘Conflicts in the attribution of income’. The topic ‘Transfer pricing and intangibles’ attracted the most attention due to the increasing cross-border transactions and the concomitant success of technology intensive sectors. Over 22 country experts submitted the findings on this important topic. Amongst those, few are chosen to debate.
The empanelment for last fortnight’s Congress session on ‘Transfer Pricing and Intangibles’ drew speakers from the US, Germany, Brazil, China, Japan, the OECD and (not surprisingly) India to ensure a truly global representation. The panelists discussed threadbare a gamut of issues pertaining to ‘Transfer Pricing and Intangibles’, ranging from the definitional aspect to the impact of the GlaxoSmithkline settlement, labelled as the mother of all tax litigations.
Transfer pricing concerns the determination of fair market value of cross-border transactions between related parties. Since intangibles by nature are unique, the problem of ascertaining the correct arm’s-length price is particularly challenging when the transactions are between related parties. The difficulty is equally pronounced in determining the arm’s-length royalty rates for licensing of intangibles. Drawing from practical experience, the panelists focused attention on complex issues encountered by MNCs in conducting their cross-border business activities.
A fundamental point of debate was the definition of intangibles. An interesting question was whether the definition of intangibles should be broadened to include business processes (such as efficient management systems, procurement systems, inventory control systems etc).
In the Indian context, intellectual property law does not recognise business processes as intangibles. Japan makes a case by case determination of an intangible and is more flexible in this regard. Divergence on this issue was identified as a problem; particularly where one country would characterise receipt from the licensing of a business process as income, while another country would not consider it as an expense. The panel concluded that inconsistency between countries on the definition aspect, posed danger of economic double taxation.
A related issue pertained to ownership of intangibles. Determining ownership of intangibles is important as it, in turn, determines how income from such intangibles should be allocated. Countries are divided on the issue of who should be recognised as the owner of an intangible; whether the party that holds the legal title to the intangible or the one that has made the maximum contribution towards its development (referred to as ‘economic ownership’ in tax jargon). USA recognises both kinds of ownership, though legal ownerships undoubtedly has precedence.
Lack of clarity and contrary positions have often led to prolonged debate between countries over taxing rights on royalty income — the GlaxoSmithkine case is a case in point, wherein the US and UK locked horns over the right to tax income from the sale of Zantac (a pharmaceutical drug). While UK contended that the success of the drug was due to scientific research conducted in UK, US stressed on the role of marketing efforts (undertaken in the US). Ultimately, the case was settled for a whopping amount of $3.4 billion — the largest in the history of US tax litigation.
Another important issue, debated at the Congress, relates to valuation of intangibles. It is difficult if not impossible to find similar or comparable transactions in the market to arrive at an estimate of the intangible’s value. Unsuccessful efforts have led to the use of alternative approaches, often also used in commercial transactions.
For example, the discounted cash flow method or the multiple of future earnings method. Currently, Indian law on transfer pricing does not permit use of such alternate methods, given that the taxpayer is restricted to the use of 5 specified methodologies. This places the taxpayer in an awkward position, when it comes to justifying the transaction price.
Most countries, particularly the US, prescribe usage of the un-specified methodology, which gives the requisite flexibility to use such alternate methods. It is time to debate if India should consider the sixth unspecified methodology.
The session concluded by addressing several other important issues relating to intangibles; particularly where intangibles have been transferred and a determination has to be made on ‘sale’ versus ‘licence’ (the case of ‘packaged software’), whether human capital can be considered as intangible, and finally the alternative channels for dispute resolution that can be explored for addressing such tax disputes.
While the discussions did not necessarily aim at providing definitive answers to most problems, they highlighted tax planning pitfalls and other considerations germane to cross-border transfer of intangibles. The presence of over 50 Indian experts, including the chief of Indian Revenue Services and president of the Tax Tribunal highlights the importance of this subject.
That India was represented in the panel discussion is in itself testimony of its relevance in the Indian context. With double-digit growth in the services sector, there is no gainsaying that the importance of intangibles is bound to increase. In the background of India’s recognition as an R&D hub and a booming technology sector, it would bode well for the tax administration to fine-tune and clarify the law on transfer pricing of intangibles. Hopefully the message has already reached — loud and clear.
The author is a partner at BMR & Associates and the views expressed are that of his own
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