The “GILTI Conscience” podcast team, led by partners David Farhat and Nate Carden, hosted Clark Armitage of Caplin & Drysdale for an in-depth conversation on the various methods for resolving cross-border transfer pricing disputes. Associates Eman Cuyler and Stefane Victor joined the discussion as well.
“Transfer pricing, itself, is more of an art than a science. There's a lot of gray area in many, many aspects of transfer pricing,” says Clark Armitage.
In this episode of the “GILTI Conscience” podcast, Skadden attorneys Nate Carden, David Farhat, Eman Cuyler and Stefane Victor, are joined by guest Clark Armitage of Caplin & Drysdale. The group dives into a comprehensive discussion about the intricacies of ICAP, MAP and APA in cross-border transfer pricing issues. They consider the application of each as a tool, debating their benefits and potential drawbacks in aiding taxpayers.
The panel also discusses how a Pillar Two-world could bring additional questions to already complex pricing practices.
Key Points
- ICAP Evaluation: While the MAP and APA processes are seen as more traditional, delivering more certainty for a taxpayer, the group thoughtfully assesses ICAP as a tool and discusses who it might be right for, as well as if it might be a better fit in a Pillar Two world.
- Selecting ICAP Participants: The discussion suggests that ICAP may not be the best choice for all taxpayers. Participants should likely have a middle-of-the-road transaction and not be operating on the very edge of what is acceptable, indicating the need for careful selection of ICAP participants.
- Pillar Two's Impact on Transfer Pricing: Pillar Two poses an anticipated layer of complexity to transfer pricing regulations. The panel speculates on its profound impact.
Voiceover (00:02):
This is GILTI Conscience: Casual Discussions on Transfer Pricing, Tax Treaties, and Related Topics, a podcast from Skadden that invites thought leaders and industry experts to discuss pressing transfer pricing issues, international tax reform efforts, and tax administration trends. We also dig into the innovative approaches companies are using to navigate the international tax environment and address the obligation everyone loves to hate. Now your hosts, Skadden partners David Farhat and Nate Carden.
Nate Carden (00:36):
Hi, everybody. Nate Carden here as always with David Farhat, Eman Cuyler, Stefane Victor. Welcome to GILTI Conscience. Today we're going to talk about different ways of resolving transfer pricing disputes across borders, and we're very happy to be joined by Clark Armitage at Caplin & Drysdale to talk about MAP, APA, ICAP, and all the other different ways that those out there that have cross-border disputes can potentially get them resolved. Clark, welcome to the show.
J. Clark Armitage (01:04):
Thanks for having me.
Nate Carden (01:05):
For those that are less familiar with all of these processes, could you just start by giving folks an overview of the MAP process and the APA process, which I'll call the traditional ways of resolving things? Then we'll get into some of the alternatives.
J. Clark Armitage (01:20):
Sure. Great. The MAP process is based on bilateral treaties, for the most part bilateral, between two countries that allow for two competent authorities to come together to resolve a transfer pricing dispute. Typically, one country might make an adjustment to a transaction that flows between the two countries, they want 10 more dollars of income maybe, and the taxpayer brings that transaction to MAP and asks the other competent authority to come to the table with the adjusting country and reach a resolution on what the right price should be. Maybe the first country withdraws the $10 adjustment, maybe the countries agree that it's appropriate and keeps the full 10 or maybe they agree somewhere in the middle. Typically it's somewhere in the middle. That is a backward-looking process. The year was closed, an adjustment was made.
(02:16):
About 25 years ago countries came to realize that, "Maybe we have enough understanding of how transfer pricing methodologies work that we can agree to a method prospectively." They came up with the idea of advanced pricing agreements, APAs, and that agreement typically is for five years. The goal is to cover future years. A lot of times the negotiations take a long time and it ends up only covering a couple of future years, but what that APA prescribes, instead of a particular amount you'll adjust by seven or nine or two, it prescribes a methodology for how to price the transaction, so country B will get cost plus 10% and we'll agree to that for a period of five or six or seven years or whatever the particular transactions and methodology are. Those are pretty tried and true. Most developed countries have both a robust MAP process and an APA process now. A lot have come online in the last few years. Still some countries don't have them, but I think the OECD activities over the past decade or so are really pushing countries to come into this process, and so it's getting more and more robust all the time.
David Farhat (03:26):
Clark, what you described is very straightforward. Can you give us some of the complexities that can come about with these programs, both the APA and the MAP?
J. Clark Armitage (03:34):
Yeah. I mean, I think the biggest complexity is transfer pricing itself as more of an art maybe than a science. I think what that means is that there's a lot of gray area in many, many aspects of transfer pricing. We're going to talk later about ICAP. ICAP has tried to tackle five different transfer pricing topics. Well, one is not transfer pricing, it's whether a PE exists, so pricing for intangibles, pricing for debt, pricing for services, pricing for tangible goods. As you can imagine, the most complex transactions to price are intangibles. You've got to assess profit potential. You're normally looking at what sort of public comparables, other IP that looks like the IP that you're trying to price, are yielding in terms of royalties and returns and getting things to look the same. Comparability is a very challenging area in intangibles.
(04:31):
I think also financial transactions are very challenging because you get into questions about the rating of an individual subsidiary of a multinational group or do you apply a group rating, is there something called passive association where you sort of afford the subsidiary the benefit of the parent's good credit, and how do you price all those different things for maybe one tranche of debt among multitranches cross-border? Those two have proven pretty difficult for governments to address through transfer pricing. Not impossible, but difficult transactions.
David Farhat (05:07):
Basically you're taking all of the complexity of transfer pricing and throwing it into this process, so you have to deal with all of that. One of the complaints we get from clients talking about kind of adjustments and dealing with the governments, and it seems the governments are more kind of results-based and not necessarily about the technical or the proper transfer pricing. Do we see that in APA and MAP or does that process kind of help mitigate some of that sometimes?
J. Clark Armitage (05:33):
I absolutely think we see that, but it's very wide-ranging. I think some negotiations, specific negotiations, are held on a very principled basis, and some countries I think do a pretty good job of being very principled. I was in the US APA program. I thought we were pretty principled. Some might debate that. Part of the reason that I think we were principled is we had a court system that is rigorous in terms of how it evaluates IRS adjustments to transfer pricing. The IRS wins some, they lose some. When you have that backdrop, you have to yield to that as an agency in terms of staking out your position with a foreign competent authority. If the taxpayer could do better in court, that's what they're going to do. If the litigation, if the jurisprudence in your jurisdiction is favorable to the taxpayer, ordinarily over time you're going to get more realistic principle discussions.
(06:27):
I also think personalities matter. You get an individual or a team of individuals that have a particular bent and sometimes they can drive pricing, nothing to do with the government as a whole, nothing to do with the factual backdrop or the transfer pricing rules, just this is what that person thinks the answer is. Normally in a good administrative setting, when you have, like the US has, multiple levels of review, that's going to be taken care of over time but at least initially can cause the direction of your case to go somewhere you might not like.
David Farhat (07:01):
Awesome. You mentioned ICAP a little bit. Can we get into the particulars of it a little bit? I think I've gone on record and gotten in trouble before for saying I'm not too much of a fan of the process, but before we get into my kind of complaints can we talk about how it works, what it looks like, and kind of which governments are pushing it?
J. Clark Armitage (07:20):
Yeah. I mean, the first thing I'll say is that I have no direct personal experience with ICAP. I've just been following it closely out of great interest. I haven't recommended it to a client because I don't think any client would be receptive to it. That's not to say it's not the right process for some taxpayers, and a few brave taxpayers have opted in maybe four, maybe three, four, five. It's hard to know exactly how many from some recent statistics that OECD published about this, but the process is that a taxpayer elects in, somewhere between three and nine countries in the cases that have been handled so far come to the table for that particular taxpayer, and they identify issues that they like to resolve, partly with the taxpayers prompting and I think partly at the direction of the governments where they might be able to dictate to the taxpayer or want to dictate whether certain transactions are covered or maybe they're not willing to cover some transactions because they're too complicated, too difficult to get done in this forum.
(08:24):
The governments, however many there are, let's say five, come together on an issue and maybe it's an intangible transfer pricing issue and four countries are the countries that are paying royalties and one country's receiving them. Those five countries might sit down and hash out what they think the risk is of that price being wrong. If the price is viewed as being relatively low risk that it's wrong, it looks reasonable based on our understanding of the particular experiences of the individuals at the table, they will give a... The typical expectation is you get a low risk letter. It says, "We don't see a lot of risk in this particular case, this IP transaction."
(09:06):
In the statistics, they did note that for at least some particular cases--and a case is not one taxpayer, it's one situation of one taxpayer so IP with four countries might be one situation, services with eight countries might be another--and they have reached agreement between the countries on changes in the transfer prices. There's not a lot of detail on how that was done, whether it was done with a unilateral APA, a bilateral APA or whether it was done with just sort of both sides going to their respective audit teams and having the change made or the taxpayer making it at their own initiative. It's unclear, but some agreements were reached in a very relatively short order. The average timeframe was a little more than a year. Does that answer your question, Dave?
David Farhat (09:53):
Yeah, most definitely. One of the things I want to unpack about ICAP is at the start of the process, both for MAP the issue's determined by the adjusting jurisdiction, for APA the issue is really determined by the taxpayer because you come in with the request and the government can expand, contract or agree to look at it, but it seems like for ICAP, the issue that's covered... How's that determined? Is it really all on the taxpayer? Do the, in your scenario, the five governments kind of say, "This is what we want to cover?" Is it an open book? How do you get to what's covered?
J. Clark Armitage (10:25):
I had the expectation that it would be taxpayer-driven, it's a voluntary process and either you elect in or you don't, and presumably the act of electing should be the scope as well. In fact, if you look at the report that OECD published, it suggests that the tax administrations could influence what transactions get covered. It's a little unclear whether that was purely cutting back on what the taxpayer had proposed or whether it was expanding what the taxpayer had proposed. I would say if you're a taxpayer and you're thinking about ICAP, you should be prepared to have the government say, "We want to cover this or that that you haven't put on the table because it's of interest to us."
Nate Carden (11:07):
That's not that different from APA, right?
J. Clark Armitage (11:09):
Yeah.
Nate Carden (11:09):
The governments will make suggestions, "Include this, don't include that." That part sounds like it's down the middle of the fairway.
J. Clark Armitage (11:19):
I think that's right. One thing that's a little different is that normally when the governments in an APA wants you to add a transaction, it's because it's closely tangential, right on the edge of the body of transactions you're covering and they think it's relevant to pricing of those transactions. That doesn't have to be the case in ICAP. They can go wherever they want, presumably.
Eman Cuyler (11:38):
Can you talk a little bit about the guidance that the IRS issued last year basically saying in considering whether they'll accept APAs, they will also evaluate whether the specific facts are relevant for an ICAP and how that has out since it's been issued?
J. Clark Armitage (11:55):
Yeah. I mean, I've had two or three touch points on this in my own career, and one of them where we had a client that we talked to them about coming in at pre-file level and they said, "We don't think that's a good use of our resources for that unilateral APA situation." The feedback we got on that was that they thought there were other transactions that were more risky for us and not the particular transactions we were presenting. We'd had a couple of foreign audits on the scope of coverage, but that was not enough. We were a little surprised by that, but you don't have feedback until you get it so that was the feedback we got.
(12:30):
The other touch points, one is that MAP is off the table. MAP is [inaudible 00:12:36]. I heard that from someone at ATMA yesterday that if you come in with MAP, they're not going to make a judgment that there's not enough risk there or that they don't have enough engagement with that country to take it. They're going to take it. The one area that I think is an interesting question, and I don't have any experience with this, is what about sort of a... There's a lot of simple distribution APAs that the US enters into where distributions in the US and it's a foreign principal and you're getting a 1 to 3 or 2 to 4% return on sales in the US. Are those risky enough to merit handling even though they might be bilateral? My sense is the answer's yes, that they're not going to... If you come in bilaterally, they're going to keep you, but I don't have any specific experience to support that. I don't know, David. Anyone else have experience on that?
David Farhat (13:24):
No, I haven't seen them pushing folks away. I've seen a lot more questions on the front end than maybe back in the day, but I haven't seen them say, "No, we're not going to do this one." But I think the intro has been a bit few more questions.
Nate Carden (13:38):
Right. I would put it along the lines of, "Are you sure you want to do this? Is it really worth the effort?" There's going to be a lot of diligence, just generally suggesting, "Hey, this is not the kind of risk profile that maybe you should be worried about." But I haven't myself experienced any "we're not going to take you" level of pushback.
David Farhat (14:02):
With a lot of those APAs, the issue isn't the US risk. As you mentioned, it might be a simple transaction from the US perspective but you're worried about the other country, so you want to kind of get that locked in to protect yourself that way. I think honestly on the US side when we have conversations about competent authority, sometimes that's missed. It's not a big transaction, it's not a lot of risk on the US side. Honestly, that's a question I have about ICAP. Are you going to get all the folks in the room that will see the transaction as risky? Also, do you run the risk of, "Okay, I have five countries in the room. Four of them say it's low risk. Number five wants to open a full audit?" What happens at that point? Do they kind of go to APA or something like that?
J. Clark Armitage (14:47):
I think we know we're not going to get all the countries at the table because only 23 are signed up at this point. I think India's not one of them, if my memory's correct. I'm pretty sure that's right, but... India obviously is a big source of transfer pricing controversy in the world. I heard a statistic that 70% of audits in the transfer pricing space have been conducted in India in the past X years, so if India's not at the table you're missing a major player in a lot of these transactions.
(15:16):
I do think that if you get the right players at the table that there's a process there where they can reach agreement much in the same way that a MAP or APA, and in a more robust way. I've always been pretty skeptical about multilateral APAs beyond about three parties global dealing kind of cases, and when I was in the program I inherited a case that had started as an octolateral APA and that broke down real quick and they ended up with one unilateral and several bilaterals. I think it's very hard to get multiple parties at the table, but if they can do it in a softer way and give some comfort to a taxpayer that at least with maybe six of the seven or eight jurisdictions they're okay and they don't need to worry too much about audit, that will allow the taxpayer to focus their resources on particular countries and particular transactions.
Nate Carden (16:08):
It gets back to the theme with ICAP, at least it seems to me, of when is good enough good enough and is it a tool that can be used to essentially take a number of issues off the table without necessarily requiring the governments to go through the entire process of reaching an agreement? It sounds like you're relatively optimistic about that as a practical, if not formally legally binding, tool in complex multilateral cases. Is that fair or is it overstating?
J. Clark Armitage (16:41):
No, I think that's fair, but the setting has to be correct. By that I mean if you have an edgy transaction where you've been moving a relatively high part of the arm's length range of profits into relatively low, it's hard to say anything's relatively low tax anymore, but if you're on the edge maybe you're not the right taxpayer for that, but if you have a down the middle transaction and you're in 10 high tax jurisdictions and you just want to jump ball, whoever wants to take it go ahead, then it strikes me as a pretty decent process. One thing that you get out of it is you get all the countries at the table at the same time. I remember maybe eight or 10 years ago, I heard about a tax director who had a spreadsheet and when he sat down in front of a competent authority, he would say, "Okay. If I give you 10 more dollars, where's it coming from? Who's going to give it up?" What you're doing with this process is essentially putting all of those governments at the table at the same place, looking hard at each other across the table and making a decision.
Nate Carden (17:40):
I'm glad you raised that because that was one of my questions, is ICAP a better program in a post-Pillar Two world? Because fundamentally you're more worried about double taxation rather than the kind of high-tax spreads that I think historically have made up a lot of our practices.
J. Clark Armitage (18:01):
Yeah. I absolutely agree with that. As I was thinking through... One of the items you put on the agenda was to talk about Pillar Two this morning, and I do think that having a bunch of countries at the table in some ways is almost necessary depending on the profile of the taxpayer. If you don't have six or seven countries at the table that might be the country that wants to get a top-up, group of countries that are most likely to seek that, ignoring UTPR, then you don't have all the players that you need, so multilateral Pillar Two makes a lot of sense to me.
David Farhat (18:36):
Maybe then it's just too early for ICAP right now because I think one of my biggest criticisms with the program... Well, twofold. One, if you have one of those issues that's a jump ball or right down the middle, you can look at that and say you don't have a lot of risks, so why kind of go through the process and do that? The other thing is if there's an outlier country possible, unlike MAP and APA where you kind of have a binding agreement, there's nothing binding other than this is low risk so you can have a lot of havoc raised by that one outlier.
J. Clark Armitage (19:09):
I thought that the 23 now countries that went into ICAP would have an eye on their reputation and that there would not be outlier countries because it's very visible what you're doing. It's one thing to do it with one country negotiations in an APA or MAP. It's another thing to have the other six countries who are 90% of your trade sitting across the table and evaluating your behavior. As a result, I thought there would not be outlier countries, but there have been in most of the cases. It just proves that some people can't be embarrassed. It doesn't matter how much you try to.
David Farhat (19:45):
Well, that's the tricky part about sovereignty, unfortunately.
J. Clark Armitage (19:47):
Yeah.
Stefane Victor (19:48):
Is the primary difference between ICAP and APA is the level of certainty they provide taxpayers?
J. Clark Armitage (19:54):
Yeah, I think that's right. I think it's also temporal. ICAP I believe is just going to give you a check for a year, and meaning a check the box for a year, and that check will be more limited than the APA check. It doesn't necessarily say that you're not going to get an adjustment. There is an exception to that because the report indicates that they did actually make adjustments and agree to adjustments as part of the process. If that [inaudible 00:20:22] what's happening in ICAP, it will grind to a halt I think because it'll be just like the APA program. Not to a halt, but to a very slow crawl. I agree with you that there's less certainty and there's also less time covered.
Nate Carden (20:36):
Yeah, that surprised me as well because I guess the way I was thinking about it was, just as Stefane said, there's less certainty, greater speed, but also with less certainty presumably should come less diligence on the part of the governments. You look at it, you'd say, "Okay, maybe this is not what we would formally agree to but we'll send out a low risk letter or we'll agree to a low risk letter with the parent jurisdiction because we might reserve the right to go after it, but we don't necessarily have to." If they're in the business of adjusting, then I guess I don't know how it doesn't become a big diligence exercise and, as you said, just grind to a halt.
J. Clark Armitage (21:20):
Yeah. I agree with that. It might be helpful to talk about their timeframes. I think they're supposed to target 52 weeks. APAs are supposed to target two years. The US is, I don't know, double that or something, and maybe not to their own fault they have a lot of treaty partner work that's difficult, but it does take a long time. This first group of ICAP cases, 20 cases, and again not 20 taxpayers, 20 situations, were resolved on average in I think 62 weeks, something like that, 63 weeks. They kind of stayed within the timeframes. There are three different phases of the evaluation. The first is, "Let's agree on what the issues are and what we're going to talk about." The second is the diligence phase, and that's the meat of it, three quarters, two thirds, three quarters, and then an agreement phase. Each of those went a little too long. The agreement phase was the least over time, but none of them was so over time that it was out of bounds. However, they just started, you know?
David Farhat (22:18):
Yeah.
J. Clark Armitage (22:19):
You would think that the first ones should be right out of the gate, "Let's get it done." That didn't happen in the timeframes that might be expected.
David Farhat (22:27):
Clark, what happens when there isn't general agreement around the riskiness of the issue? What happens with the ICAP program if an issue comes up, everyone looks at it and everyone goes, "This isn't low risk?"
J. Clark Armitage (22:40):
There's some statistics about how many countries for each case didn't agree that it was low risk and there were outlier countries. That was pretty clear. Something like 80% of cases had only one country that disagreed, so it's an outlier situation in the vast majority of the particular cases. If it's 20, that's 16 cases where only one country disagreed. If 80% is your likely outcome and you have to deal with one country, okay, go deal with the one country. Decide maybe in an APA process how to deal with that. Maybe you wait for a MAP or local litigation, whatever it is.
(23:13):
On the other transactions, I think it was unclear. They have some data about whether it was intangibles that presented the problem or not and I'm forgetting which one was the most challenged, but I think it was probably intangibles. Intangibles involve I think the fewest number of cases that were in the situations, and I think part of that is self-selection. The government said, "That will take too long. That's too hard. We're not going to do it." That also should make you think about what kinds of situations I want to take into ICAP, if any. That sort of uncertainty about that one country doesn't strike me as a great reason not to go. In fact, maybe that's a reason to go because you're now isolating that country, you're getting sign-off everywhere else, you've gained a lot of certainty in 80% of the situations. Move on and deal with that one country.
David Farhat (24:06):
That's what we've seen. My question is a little different. It's kind of anticipating worst case scenario. In this one you have one outlier, so say you do your scenario with five countries, say two say low risk, three say we're not sure or all five agree this isn't low risk. What's the proposed next step for ICAP? Do they tell you to do an APA? Do you go into...
J. Clark Armitage (24:30):
I said this twice. I'll say it a third time. I think if you have a down the middle transfer pricing and your tax rate differentials are not material on that transaction, then maybe you don't care a lot about what happens if the ICAP process doesn't work exactly as you'd hoped. You take those cases to MAP or APA and get them resolved. That's a little glib, I admit, because you have put yourself in front of these tax administrations, identified an issue, and now they've got it in their sights and it's hard to look away.
(25:02):
The other point on that is, again, I thought when ICAP stood up that governments would work very hard not to do that because by doing that, they're causing taxpayers not to want to use this elective process that they're all pushing on taxpayers. If the word gets out that, "If you don't get your soft letter, no risk, low risk letter out of ICAP, we're going to audit the heck out of you," no one's coming back. I think that's true, but there's no support for that, there's no data on that as far as I know, so I think you have to wait for time to tell.
Nate Carden (25:37):
I'll be even more glib. If I was a head of tax listening to all this, I guess my question would be, "Look, you're telling me that hard issues they're probably going to decline or at very least I'm going to have a hard time getting a no risk letter down the middle of the fairway transfer pricing. Frankly, I think I can talk the individual countries out of or if I need to, I'll go to MAP, APA." Why isn't this just raising my hand and subjecting myself to another layer of audit for no reason?
J. Clark Armitage (26:09):
I think that's the hardest comment to address and if I'm trying to be a proponent of ICAP, that's the hardest thing to cover is that point right there. I think that, like I said, I haven't proposed ICAP to any of my clients. There's a reason for that, and it's a difficult process to be willing to be a guinea pig on, and that's essentially what your concerns tease out.
Eman Cuyler (26:33):
Clark, following up on Nate's point can you talk a little bit about what are some of the considerations when you're talking to clients about whether to just go to appeals or go to court versus MAP or APA or ICAP? Can you talk a little bit about the different factors that you usually consider?
J. Clark Armitage (26:51):
Well, I'm not a litigator. I think the IRS drives litigation. They make the decision. Taxpayers don't want to spend tens or even more millions of dollars going into litigation and experts, and they'd much rather resolve it through something simpler like a MAP process or an APA process or at appeals if at all possible. ICAP is yet softer again and probably materially less expensive, so maybe it's best thought of as sort of one end of the spectrum of adversarial negotiations and cost.
David Farhat (27:24):
The one thing that you guys I think have won me over with on the ICAP thing is in a Pillar Two world, it becomes a very different conversation. I think if the governments are gearing up ICAP, I think that's a selling point for it, "Hey, we're going to be able to do this because your transfer pricing underpins your GloBE calculations." That might cut out some of the controversy there, but right now kind of going in and I'm looking at my choices, wait for MAP, go to APA or ICAP, find it hard to pick the ICAP point even though I empathize with why the governments are pushing it. If I put my IRS hat back on, it's a brilliant program. I don't have to start my audit procedures. Taxpayer comes in, I can talk with my treaty partners to see where there'll be some tension, I look at this, and I can say I like it or I don't like it and my hands aren't tied. I think it's a brilliant program from the government perspective, but I think they've got to put a bit more carrot in there for the taxpayer. Pillar Two thing might help, but I think it needs something to kind of encourage people to get in there.
Nate Carden (28:29):
I agree with that. When I think about ICAP, there's at least three big trends that I see over the last 10 years of transfer pricing. One is the rise of the GILTI system and Pillar Two and the evening of rates. The second is the increased complexity that's created by the DEMPE framework. The third is, frankly, the rise of, quote, unquote, "on-shoring transactions" as people have moved away from SCS, Dutch CV, zero tax type structures and now have a lot more treaty cases than what they had before. Frankly, there's just a lot more transfer pricing.
(29:14):
What I think countries need to do if they're going to make their systems work, and I think ICAP can do it, is accept a broader range of what is low risk. It's not just distributor cases. There actually are intangibles cases where you can look at it and say, "Reasonable parties could differ, but we're going to go ahead and move forward with this thing because we ultimately think you're getting to a reasonable result. There's not that much tax at stake. The taxpayer is trying to avoid double tax, et cetera." I'm optimistic that ICAP can do its job, but I do think for anyone out there who has a government role and might be listening that we do need the governments to add that carrot in part by just recognizing that we're not in a 2005 world. The stakes here are just lower.
David Farhat (30:07):
Need a sweetener.
J. Clark Armitage (30:09):
Well, yeah. The flip side of the sweetener is if I'm in the government and I'm evaluating how to bring on the sweetener, I need to know that I'm sweetening without creating too much risk for myself, which means I need to have a much more comprehensive understanding of the universe of transactions that are out there and how various transactions stack up on a relative risk basis. Now, maybe that is what comes out of an ICAP process. I'm not sure taxpayers really want that because that involves an awful lot of information sharing and knowledge among multiple governments of a taxpayer's setup, but maybe that's where it's headed. If you get a much better handle on all the transactions that you might be confronting and your resources are such that you can cover 8% of them, you're going to select carefully.
(30:59):
There's a group called the Transfer Pricing Council. Various functions within the IRS came together 2008 to '10, "What's the problem with our transfer pricing enforcement?" One of the problems was we didn't see the transactions. Another was, by the way, that it's too hard to keep. You're constantly chasing them on audits and you can't quite get up to speed, but the point was, "How do we get statistics to assess what the real risk of this particular transaction is for this particular taxpayer?" That was very, very hard. The data just were not available. Maybe ICAP is... Maybe part of the goal of ICAP is to gather that data.
David Farhat (31:33):
No, absolutely. That's where I was going to push back a little bit on the sweetener because at the end of the day, the letter doesn't tie the government's hands. It's low risk or not low risk. Even if you say low risk, it doesn't mean you're never going to look at this again, so I don't think you need to increase the amount of diligence to add that sweetener. It's just kind of as Nate is saying, broaden it, look at some of these, and say, "Hey, listen, okay. It's only for a year." "Okay, well, we're good with this for now." Kind of make it look like the CAP program a little bit like, "Okay, we can be comfortable with this now. We might want to take a look at it later."
Stefane Victor (32:09):
Can you guys discuss whether MAP or ICAP are the best option for Pillar Two?
David Farhat (32:15):
That's a good one. I think it depends. I think it's a similar conversation to APA and MAP. I think ICAP may get you ahead of a situation and MAP comes in once you have that adjustment. I think with Pillar Two, some of these transfer pricing adjustments may wreak havoc on what you're doing because it may cause you to recalculate your GloBE and kind of going into MAP. Now you're not going into MAP, as Clark was saying earlier, being willing to compromise, but you're going into MAP for a fight to say, "No, I need this withdrawn because of all the knock-on consequences." Then the timing of that, you may have several adjustments that don't all come out at the same time, so I think to directly answer your question ICAP may be better because you get more countries around the table than you would in kind of a basic bilateral MAP situation.
Eman Cuyler (33:07):
I do think it's very interesting that Pillar Two is becoming a reality and these questions are still outstanding.
David Farhat (33:14):
Yeah, absolutely.
J. Clark Armitage (33:16):
I had a couple things in response to both your questions. One was CAP we all know has said, "Transfer pricing is too hard for us, so go to the APA program. But on CAP, all you have to do is add an I and we're fine." The other thing was that I was trying to think of how would you use a, quote, "MAP process" in a Pillar Two world to address Pillar Two issues. What is a Pillar Two issue? A Pillar Two issue is not really a change in the underlying transfer pricing. I know there's his substance-based carve-out whatever and maybe you could deal with that, but once you get beyond that, aren't we just back in transfer pricing land and then it's a question of did you tax them enough? Is MAP really a good process for evaluating that? I don't know. There was one other thing.
David Farhat (34:07):
So what you're saying, it's just transfer pricing but longer.
J. Clark Armitage (34:11):
Well, that's an interesting point because I think Nate was just talking about that, which is your MAP process can influence your GloBE outcomes. If you put $50 in low tax jurisdiction then you're breaking GloBE, but if you put 100 you're not and there're credits and marginal rates and whatever. There's one other thing that I thought was worth bringing up, which is the question of subsidies. Foreign tax credits, they influence your effective rate, but subsidies maybe they don't. When do subsidies impact your rate? If someone's dumping cash on somebody and charging them a 25% rate but will give it all back to you in local incentives, then your effective rate is zero. The question is when does that become part of your income for purposes of GloBE?
(34:59):
Pillar Two does speak to this, and I think it talks about sort of traditional IFRS-like accounting rules for when is a subsidy part of the income tax return. I don't really know what those rules are, but it strikes me there's going to be a ton of play in that area. If there is, that might be something that a MAP process could attempt to address. I would think that government A might look at that subsidy and say, "That's a tax. We're going to impose our top-up tax on that situation." Then the governments might come together to debate whether that in fact is a subsidy that should be income tax recognized.
David Farhat (35:36):
Clark, this was an absolutely amazing discussion. Any final thoughts before we wrap up?
J. Clark Armitage (35:41):
Thank you so much for inviting me. Really interesting discussion. The questions were great. I really enjoyed this conversation. APAs and MAPs, my bread and butter. I love that stuff. I would really love to tackle ICAP and see what it's like. I have the sense that you're getting engagement with the very best people in the government, and I think it'd be a very interesting process to get tasked with.
David Farhat (36:04):
Absolutely. With that, everyone, this has been GILTI Conscience. Thank you very much.
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