Background

Over the last twenty-five years the European Union has instigated two major initiatives aimed at producing a more coherent direct tax framework for Europe in order to support its key objective of creating a single economic market.

In 1990 the European Commission asked a Committee of Independent Experts on Company Taxation, under the chairmanship of Onno Ruding (Ruding Committee) to determine whether differences in business taxation among Member States led to major distortions which might affect the functioning of the single market, and to examine possible remedial measures. The Report, which was produced in 1992, made a large number of recommendations for improvements in the functioning of business taxation across the EU, including such then far-reaching ideas as cross-border loss relief, but for a variety of reasons, many of them perhaps associated with the desire for the retention of sovereignty over direct tax policy prevalent in many Member States, very little progress was made on any of the key recommendations.

Introduction

In December 1985 the Tax Commission, an advisory body to the Prime Minister, submitted its report on the revision of the tax system for 1986, recommending as follows:

Based on this recommendation, the Japanese international transfer pricing rules were enacted and codified as article 66-5 (later renumbered as article 66-4) of the Special Taxation Measures Law (STML) on 28 March 1986, with two principal purposes: to cope with the shifting of income abroad and to put Japan's tax system on a common ground with those of other nations.

Introduction: the Israeli tax sphere

Modern Israeli income tax law developed within an archaic British colonial statutory framework. Israel's Income Tax Ordinance (New Version), 1961 (the ‘Ordinance’) originated in an ordinance enacted in 1941 (and later amended in 1947) by the British Mandate government, based on a Model Income Tax Ordinance prepared by the Inter-departmental Committee on Income Tax in the Colonies not Possessing Responsible Government. The Mandatory Tax Ordinance continued to apply after Israel's independence in 1948. In 1960, it was redrafted in Hebrew, without changing the substance. Since then, this ‘new version’ has been the basis for frequent amendments of the Ordinance (195 to date). At the beginning of the twenty-first century, major fiscal reforms resulted in the modernisation of the Ordinance. A residency-based tax system replaced the earlier territorial-based system. New provisions were enacted, addressing participation exemption, taxation of REIT funds, taxation of trusts, transfer pricing for international transactions, a pre-ruling mechanism, CFCs, and more. Tax rates and various capital gains exemptions were frequently updated to attract foreign investment and human capital.

On the international side, as of August 2012, Israel is signatory to fifty-one tax treaties which were ratified and are in effect. In addition, Israel has signed a new tax treaty with Malta, and renewed several old treaties, all of which are yet to be ratified. Most of Israel's treaties are based on the OECD Model Convention, and Israel is now acting to adjust its tax treaties to the revised 2008 OECD Model Convention.

A transfer pricing dispute

Pharmaceutical companies need to have a continuing supply of good research developments to maintain their future profits. Their ability to profit from this research depends on exploiting patents based on the results of the research, but patents expire after a number of years, allowing other companies to compete with the developer, and some drugs are simply superseded by later developments.

In the 1960s, one major US pharmaceutical company had developed a number of valuable patents. The company naturally wanted to limit the amount of tax it would have to pay to exploit these patents. So in 1965 it established a subsidiary in Puerto Rico (a United States' dependency). At the time, US tax law permitted the transfer of patents to a Puerto Rican subsidiary tax free, and Puerto Rico offered tax haven treatment on the returns from exploiting the patents. The US parent therefore transferred the patents to the subsidiary without receiving any payment or royalties in return. The subsidiary relied on the patents in manufacturing the drugs they covered, and sold the products to the US parent.

Introduction

The economic and business environment in Russia changed significantly following the fall of communism in 1991. Free market reforms (instead of transacting at predetermined regulated prices), opening foreign trade (which was monopolised by the government until then) and introduction of the modern tax system played very important roles in this transition, exposing Russia to the forces of globalisation shaping the modern economic system. Transfer pricing becomes especially important in this context.

However, it would be surprising if transfer pricing in Russia would be a developed concept given that the tax system, in the Western sense of the expression, has only a twenty-year history in modern Russia. However, transfer pricing is an important feature of the Russian tax and political landscape, especially given the commodity bias of the Russian economy.

Following this introduction, this chapter covers the following topics: (ii) economic and institutional context; (iii) historical background of transfer pricing legislation; (iv) overview of the key aspects of the Russian transfer pricing legislation; (v) administrative procedures to resolve transfer pricing disputes; (vi) trends in the domestic court practice on transfer pricing issues; (vii) bilateral and multilateral approaches to transfer pricing disputes; (viii) recent developments in the area of transfer pricing; and (ix) concluding remarks, including the author’s opinion on the likely routes for future developments in this area.

Introduction

The objective of this chapter is to discuss the development of transfer pricing legislation in Brazil, analysing the law as well as the leading cases on transfer pricing disputes. It is important to keep in mind that the Brazilian transfer pricing legislation was enacted only in 1996 (Law no. 9.430/96). Since its enactment, there have been significant changes in the Law, fiscal authorities' interpretation and courts' decisions. This signifies that Brazilian transfer pricing rules are evolving gradually. However, there are still significant deviations between the Brazilian transfer pricing law and the arm's length principle. The arguments presented in this chapter will demonstrate that further reforms are necessary if Brazil wants to adopt rules that are closer to the international standard implemented by the OECD's member countries.

This chapter is structured as follows: (i) the economic context; (ii) the historical background of transfer pricing legislation; (iii) the main aspects of the Brazilian transfer pricing legislation; (iv) the domestic approach to transfer pricing disputes; (v) administrative procedures to minimise transfer pricing disputes; (vi) bilateral and multilateral approaches to transfer pricing disputes; (vii) recent developments in the Law; (viii) concluding remarks. Sections 13.3, 13.4 will present the economic context, historical background and the main aspects of the Brazilian transfer pricing legislation. Section 13.5 will present some leading cases on transfer pricing disputes. Sections 13.6 and 13.7 will discuss the administrative procedures adopted to minimise transfer pricing litigation, including the feasibility of adopting the advanced pricing agreement (APA) or implementing a mutual agreement procedure (MAP) through double taxation conventions (DTCs). Section 13.8 will briefly analyse the recent changes introduced by Provisory Measures no. 472/09 and 478/09 and whether they reduced the gap between the Brazilian legislation and the international standard. Last, in section 13.9, we will conclude by demonstrating the importance of further adjustments in the Brazilian transfer pricing legislation in order to converge to the international standard, i.e. arm's length principle.

Introduction

Imagine the following scenario. A French multinational (FM) manufactures cars in France and owns a valuable intangible: the specific industry know-how in marketing its cars. FM is willing to expand its business to country X, where intellectual property rights are not properly enforced. In order to minimise the transaction costs in safeguarding the rights, FM decides to create a wholly-owned subsidiary in X which will be in charge of selling its vehicles (FM Sub.), instead of supplying its intangible know-how to an independent reseller in country X (Indep Co.). This strategy allows FM to expand its business to country X, minimising the risk of compromising its intangible via internalisation of these transactions costs.

This example shows that FM is able to replace the FM–Indep Co. relationship with the FM–FM Sub. model. More generally, this way, multinational enterprises (MNEs) are able to replace the arm's length market (the external market) for products and services with an internal market of inputs.

Introduction

Until recently, transfer pricing was not an issue for the Spanish taxpayers operating internationally, at least not a serious one, even if it was problematic for those operating on a domestic plane. This started to change radically in 2006, when a new regime, including its particularly burdensome documentation requirements, came into force. The first tax filing following the new transfer pricing rules took place in July 2010.

For this reason the year of writing, 2011, is either a perfect year to write about transfer pricing in Spain – as there is a great deal of room for speculation, given that there is virtually no case law on the new rules – or, for the same reason, a terrible year. I will assume it is the first possibility and dedicate the following pages to report what has happened until now; how the law of transfer pricing has actually been implemented and what may happen in the following years, considering the substantial changes that transfer pricing in Spain has undergone.

The relevance of the OECD and UN Model Conventions and their Commentaries for the interpretation of Italian tax treaties

Introduction

This chapter aims to provide a comprehensive overview of the degree of consistency of the treaties to avoid double taxation concluded by Italy with the OECD Model Tax Convention on Income and Capital and the United Nations Model Double Taxation Convention between Developed and Developing Countries (respectively the OECD Model and the UN Model). It is worth pointing out from the very outset that all the treaties are generally modelled on the OECD Model but also that the treaties are, in large part, consistent with both Models, due to the similarity between the OECD Model and the UN Model. However, as will be shown in this chapter, there are cases in which all or some of the treaties comply with the UN Model but not with the OECD Model.

In some cases, these variations are due to several relatively recent modifications of the OECD Model. Indeed, modifications to the OECD Model over recent years have reduced the degree of consistency between the OECD Model and the treaties, which have not been modified accordingly.

In most other cases, all or some of the treaties comply only with the UN Model due to a choice made by Italy to adopt clauses that are divergent from the OECD Model.

The analysis of the points of convergence and divergence from the Models will adhere to the numerical listing of the different articles of Italy’s treaties. Therefore, in respect of each clause, this chapter indicates convergence or divergence, with the result that such a schematic structure should clarify which of the clauses included in the Models can be considered as ‘standard clauses’ of the treaties. The term ‘standard clause’ will be italicized when it can be inferred that a clause of the Models has been adopted by Italy in the vast majority of its treaties, thereby constituting a kind of deliberate policy choice.

The relevance of the OECD and UN Model Conventions and their Commentaries for the interpretation of Norwegian tax treaties

Introduction

Norway has a relatively broad tax treaty network with treaties with about eighty-five jurisdictions. The first tax treaty was signed with Sweden as early as 1913, only eight years after the splitting of the union between Norway and Sweden. This first tax treaty was a treaty specifically designed to cover the relations between Norway and Sweden in the north regarding the mining industry.

The first ‘ordinary’ tax treaties were those signed in 1946 with Denmark and in 1947 with Sweden. After this, Norway signed tax treaties with its most important trading partners. Thus, it signed a tax treaty with the UK in 1951 and with the USA in 1952. The first treaty with the Netherlands was signed in 1952.

Tax treaties have also been concluded with jurisdictions as a result of foreign aid policy and due to the significant number of immigrants from a jurisdiction.

The tax treaty with the Nordic countries (Nordic Convention)2 is a multilateral tax treaty. All other tax treaties are bilateral treaties. The treaties are mainly based on the OECD Model Tax Convention on Income and on Capital (OECD Model). In some situations, where Norway has entered into tax treaties with developing countries, these treaties are influenced by the United Nations Model Double Taxation Convention between Developed and Developing Countries (UN Model), in which more taxing rights are allocated to the source country.

The relevance of the OECD and UN Model Conventions and their Commentaries for the interpretation of Spanish tax treaties

On 30 May 2010 Spain had tax treaties in force with seventy-six countries. Some of these are the result of the application of the tax treaties previously signed with Czechoslovakia (the Czech Republic and Slovakia), the former USSR (Azerbaijan, Belarus, Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan, Ukraine and Uzbekistan) and Indonesia (Indonesia and Timor). Moreover, Spain has negotiated some other tax treaties, of which nine are awaiting signature (Albania, Armenia, Barbados, Georgia, Germany, Namibia, Pakistan, Panama and Syria) and the other eight are pending publication in the official journal of the signatory countries (Bosnia, Costa Rica, Kazakhstan, Kuwait, Nigeria, Peru, Senegal and Uruguay), which makes a total of ninety-one countries involved in the tax treaty process with Spain. Of the tax treaties previously signed, Denmark gave notice of termination of its tax treaty on 10 June 2008 and since 1 January 2009 it is no longer applicable.

Spain has tax treaties in force with all Member States of the EU (except Cyprus and Denmark), plus other European countries, such as Belarus, Croatia, Georgia, Iceland, Macedonia, Moldova, Norway, Russia, Serbia, Switzerland, Turkey and Ukraine. Its treaties in force with Asian countries include those with the Central Asian republics previously mentioned (Azerbaijan, Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan and Uzbekistan), China, India, Indonesia, Iran, Israel, Japan, Korea, the Philippines, Saudi Arabia, Thailand, Timor, United Arab Emirates and Vietnam. In the Americas Spain has treaties in force with Argentina, Bolivia, Brazil, Canada, Chile, Colombia, Cuba, Ecuador, El Salvador, Jamaica, Mexico, Trinidad and Tobago, the USA and Venezuela. In Africa Spain has treaties in force with countries including Algeria, Egypt, Morocco, South Africa and Tunisia, and Australia and New Zealand in Oceania.

The relevance of the OECD and UN Model Conventions and their Commentaries for the interpretation of Colombian tax treaties

Colombia's entrance into the double taxation agreement world has been fairly recent and thus its involvement with the existing Model Conventions is limited to a few treaties and even fewer administrative and judicial decisions. The decision to begin the creation of a double taxation treaty network was promoted by President Álvaro Uribe Vélez in 2004, after a long period of non-treaty policy implemented under the philosophy of protecting the Colombian tax base. President Uribe's policy of creating a competitive business environment for investors caused the re-evaluation of Colombia's position regarding double taxation agreements. Both DIAN (the Colombian Tax Administration) and the Colombian Ministry of Finance gave up their reluctance to negotiate treaties, convinced by the idea that revenue loss caused by the concessions granted in a treaty by a capital importing state like Colombia would be compensated by the increase in foreign direct investment (FDI) that the treaty would be thought to bring.

In 2005 the Ministry of Trade thus issued a priority list of major trading partners for the parallel negotiations of bilateral investment treaties (BITs) and treaties. Based on this list, the Colombian Ministry of Finance created a team of public employees (a DIAN director and two other DIAN employees in charge of domestic audits) for the immediate negotiation of a treaty with Spain. Due to the urgency of negotiations, Colombian officials decided to implement the OECD Model Tax Convention on Income and on Capital (OECD Model) as the only available tool for negotiating with OECD Member countries. Although Colombia was at the time – and still is – a party to the Andean Community of Nations (CAN), the government decided not to implement the source-based CAN Model, as none of the other Members had applied it in their treaties and it was a known fact that most OECD Member countries would not even consider the CAN Model as a reference for negotiating a bilateral treaty with Colombia. Furthermore, the difficulties associated with integration in South America were often reflected in the lack of application of Andean Community Decision 578. The withdrawal of Chile and Venezuela left only Bolivia, Colombia, Ecuador and Peru, and most of the above were constantly discussing whether the decision would be applicable without a domestic law to adopt it.

The relevance of the OECD and the UN Model Conventions and their Commentaries for the interpretation of Lebanese tax treaties

Introduction

Lebanon has a network of twenty-nine tax treaties in force and is negotiating with an additional twenty countries. Until 1995, the only existing tax treaty was with France. Since the end of the war in 1990, one of the pillars of Lebanese government policy has been the improvement of the investment climate. Hence, the Ministry of Finance has focused on the negotiation of tax treaties as one of the main legal tools contributing to the enhancement of the business climate.

This policy, however, was not given the necessary resources in terms of human and financial capital. In 1996 an external consultant was hired by the Ministry of Finance to take charge of the negotiations of tax treaties. This consultant was to collaborate with the Head of the Revenue Directorate – who is mandated by law to negotiate tax treaties – and train civil servants. To date, no unit dedicated to the negotiations and the implementation of tax treaties has been created within the revenue administration, leading to a limited experience in this field among civil servants.

This situation accurately reflects the limited extent of the knowledge and understanding of tax treaties within the business community and the tax consulting firms and among lawyers and judges. In this context, it is not surprising that there is no precedence of applying tax treaties in the Lebanese jurisprudence of the Council of State. The cases covered in this chapter mainly concern administrative cases and some queries answered by the tax administration over time.

The relevance of the OECD and UN Model Conventions and their Commentaries on the interpretation of Brazilian tax treaties

Tax treaties are not a frequent issue in Brazilian courts, particularly if one considers the judicial decisions. Specifically concerning interpretation, one could recall a recent decision about the application of Article 7 to services (instead of Article 21, as claimed by tax authorities), but even this case has not yet been concluded.

As a matter of fact, several tax cases do not even reach the judicial courts, since Brazilian law has an Administrative Review Procedure whereby taxpayers may bring their claims to the so-called Administrative Council of Administrative Appeals (Conselho Administrativo de Recursos Fiscais (CARF)), which replaced the Taxpayers' Council that existed until 2009. CARF is a very specialized group of experts, chosen among both tax authorities and taxpayers, which is supposed to review tax assessment in a way similar to a judicial procedure.

CARF has recently made some interesting decisions concerning tax treaties, particularly since Brazil adopted a full-transparency regime on its worldwide taxation, which is claimed to be against Article 7 of Brazilian tax treaties. In some cases, CARF understood that Article 7 would prevail before Brazilian legislation and, in others, that the treaty would not be applicable.

The relevance of the OECD and UN Model Conventions and their Commentaries for the interpretation of US tax treaties

General comments

The USA is currently a party to about sixty bilateral double income tax treaties that apply with respect to approximately sixty-five countries (because the old treaty with the USSR continues to apply to certain members of the Commonwealth of Independent States).

The USA has a rather peculiar history with the development of model treaties within the framework of the OECD and the UN. A US professor was one of the team of international tax experts that developed the famous study of international tax policy under the auspices of the League of Nations, even though the USA never became a member of that organization. US representatives and experts have been heavily engaged in the development of model treaties by both the OECD and the UN. However, the US Treasury has declined fully to embrace either Model as the basic treaty negotiating position of the US government when endeavouring to establish double tax treaties with potential and existing treaty partners.

The attitude of the US government in this respect is not unique to tax treaty matters. The phenomenon is sometimes referred to critically as ‘US exceptionalism’. For example, US members of the International Law Commission were deeply involved in the negotiation of the Vienna Convention on the Law of Treaties (Vienna Convention) and consulted regularly with attorneys and other officials of the US government. However, the USA has never acceded to the Vienna Convention and is not a party to it. Nonetheless, US representatives have sometimes made reference to the Vienna Convention on the ground that, at least in certain situations, it represents the ‘best evidence’ of customary international law with respect to treaty interpretation and administration. As indicated later in this chapter, such a position is similar to pronouncements made periodically with respect to the US attitude to the model treaties developed by the OECD and the UN.

The relevance of the OECD and UN Model Conventions and their Commentaries for the interpretation of Finnish tax treaties

Most of Finland's tax treaties are directly based on the OECD Model Tax Convention on Income and on Capital (OECD Model), whereas tax treaties concluded with developing countries may have certain elements taken from the United Nations Model Double Taxation Convention between Developed and Developing Countries (UN Model). Due to the limited number of treaties partly based on the UN Model, this section focuses mainly on the OECD Model and its Commentaries. Finland has been a Member country of the OECD since 1969 and currently has around seventy bilateral double tax treaties and one multilateral tax treaty. The Nordic Convention (Nordic Tax Treaty) covers Denmark, the Faroe Islands, Finland, Iceland, Norway and Sweden. Most Finnish tax treaties are based on the 1977 version of the OECD Model. New treaties are generally based on the latest version of the OECD Model. In addition to the double tax treaties, Finland has furthermore concluded other tax-related agreements with a number of countries and has negotiated around forty tax information exchange agreements with tax haven countries.

There are only a few court cases, articles and books where the relevance of the OECD Model and its Commentaries has been briefly commented on. Furthermore, very little has been written about the legal status of the UN Model and its Commentaries. Because of the limited material concerning the role that the Commentaries play in the interpretation of tax treaties, their status cannot be considered to be completely clear. Therefore, some opinions expressed in this chapter reflect only the personal opinions of the authors. There is, however, a consensus amongst legal scholars that the Commentaries are in practice regarded as having a great value when interpreting Finnish tax treaties. This assumption has been supported by the Supreme Administrative Court in its decision KHO 2002:26. The Supreme Administrative Court stated that: ‘Even though the Commentaries to the Model Tax Convention are not a formally binding source for interpretation, it has relevance as a tool of interpretation, especially in situations where the tax treaty follows the systematic laid down in the OECD Model Convention.’