If Economics is an inexact science, Transfer Pricing is alchemy.
A recent court case involving the sale of describe-them-anyway-you-like intangibles by an Israeli company to its US multinational parent was a cautionary tale to anybody thinking of selling or gifting an asset to a foreign relative – be it a son, niece, Elon Musk, or Jeff Bezos.
The case was a rather simple one – in fact I have nothing much to add to the description above, its only distinguishing feature being the number of zeros in the sale price.
Not surprisingly, the Israeli tax authority decided to audit the transaction, concluding that the intangibles were underpriced resulting in noughts missing in the amount of capital gains tax paid. The Israeli company appealed and, boy, was there what to be learnt from everybody washing their dirty linen in public.
Firstly, the number ‘decided’ by the tax authority was interesting. The valuation placed by the Israeli company was NIS 111,300,000. The tax authority went for NIS 667,000,000. Nice round numbers. Now, I was not privy to the calculations of either party, but I do know (I think) that the company’s number was known to the tax authority when it had a go. While the tax authority number may have been the result of highly scientific (inexact tending to alchemy) analysis, the first lesson in schoolboy cheating – at least when I went to school – was never to show any connection to the work you are cheating off. The number presented by the tax authority was exactly six times the company’s number rounded down (how friendly) to the nearest million. Coincidence? Although not stated explicitly by the judge, the judgement sounded quite critical of the tax authority’s methods in general. FIRST LESSON – WHEN THE TRANSFER PRICING PEOPLE AT THE TAX AUTHORITY HAVE YOU ON THE ROPES – DO NOT ASSUME THEY WILL BOX ACCORDING TO MARQUIS OF QUEENSBURY RULES. IT IS A TOUGH WORLD OUT THERE.
Secondly, the Israeli company appeared to have forgotten that, while its valuation of the assets was based on their expected obsolescence, they went on to tell a different government department, from which they were hoping to receive grants and benefits, that the future was looking very rosy. SECOND LESSON – IF YOU INSIST ON MAKING IT UP AS YOU GO ALONG (NEVER A GOOD IDEA), AT LEAST REMEMBER WHAT YOU SAID LAST WEEK.
Thirdly, and – most critically – the Israeli company failed to provide sufficient documentation when demanded by the tax authority and, it appears, sufficient evidence of transfer pricing method. THIRD LESSON – IF YOU CAN’T BEAT THEM, JOIN THEM. HOWEVER ALCHEMICAL YOU MAY THINK TRANSFER PRICING IS, IN NOT PROVIDING ALL DOCUMENTATION AND A DETAILED TRANSFER PRICING STUDY, THE ONUS OF PROOF IS SHIFTED FROM THE TAX AUTHORITY TO THE ASSESSEE BY LAW.
The result of the case was that the onus of proof rested with the Israeli company, they had not made a good case for their number, and the tax authority won – even though the judge was clearly not happy with the outcome.
The bottom line in this cautionary tale is that, had the Israeli company taken their transfer pricing requirements more seriously, the rampant tax authority would have had to provide convincing proof for a number which didn’t even appear to convince the judge.
TAKEAWAY: TRANSFER PRICING STUDIES MATTER.