Going after the dodgers
By : Anna Kocinska
The Polish taxman will soon have the authority to crack down on tax evasion by multinational firms abusing transfer pricing rules.
Poland's transfer pricing regulations have lagged far behind other countries in Europe, analysts said. But starting Jan. 1, new legislation will give tax inspectors access to documentation on internal transactions made by multinational companies with subsidiaries in Poland.
"Tax offices proved that there was transfer pricing abuse in 50% of over 100 audits they made by the end of 1999," said Jozef Banach, head of the team for international tax cooperation at the Finance Ministry. "We are talking about huge amounts of money the budget might be losing. While the U.K., for instance, loses £1.5 billion-£2 billion yearly, Poland might be losing comparatively as much."
As a result of increasing globalization, many multinationals minimize their global tax burdens by applying transfer prices on their internal transactions, which are different from market prices. The procedure helps companies transfer their incomes to other countries with lower taxes. This affects the tax revenue of countries from which profit is transferred. Poland, where corporate taxes are high, is particularly vulnerable to transfer pricing abuse.
"There is obviously an impetus for multinationals to minimize profit in that jurisdiction and transfer pricing is often the easiest method to use," said Garry J. Mills, deputy director of transfer pricing at Ernst &Young in London.
"While the tax rate is not the only criterion used by multinationals, I agree that if tax rates were lower in Poland we would be more competitive," Banach said.
In early 1996, the Organization for Economic Cooperation and Development (OECD) initiated a project on harmful tax practices, which led the OECD to adopt a 1998 report on guidelines on harmful tax practices. According to the report, tax competition is damaging unless it is transparent and aimed at attracting real activities and not minimizing taxation strategies or the evasion of tax in other countries.
Nations that defend themselves against transfer price abuses accept the so-called "arm's length" principle, under which trade terms between related parties should be based on market conditions. But according to Ernst & Young, it's not easy to draw a clear line between abuse and compliance with regulations.
"Multinationals will feel that it is only pricing between one company it owns and another company it owns, and it can set pricing the way it wants," Mills said. "That is the dilemma here.
"There is always an assumption on the part of (tax) inspectors that profit has been minimized and adjusted for reasons other than an 'arm's-length' pricing reason, but a company might have very good commercial reasons, too."
One of the most frequently audited transactions within a multinational group is a management charge made by the head office for supporting the subsidiary. Information technology is often not itemized and sometimes a subsidiary doesn't know what it is paying for, which, according to Mills, makes it more open to challenge from a fiscal authority.
"At the same time, the head office would usually expect a larger charge to be made since it provides HR, legal and other services to its subsidiary," he said. "So, you have both sides of the transaction thinking that the amount is wrong, but in the opposite direction."
Another reason why multinationals prefer to transfer profit to the firm's headquarters is that "they might have dividend requirements and need cash back in their home office," Mills said. "Or it might simply be in the culture. The Japanese tend to think that profit from Japanese multinationals ought to be in Japan."
According to Ernst &Young's 1999 Polish survey, many companies might be underestimating the potential risks of the new law. While 64% of respondents do expect a transfer inspection in the next two years, only 32% of surveyed companies have conducted internal audits for transfer pricing regulations and only 39% of companies plan to order external audits for transfer pricing.
"I am pretty sure that some companies still ignore the capacity of tax offices in Poland," said the ministry's Banach. "While it takes time, more inspectors are doing this type of auditing and doing it well. So more companies will realize that our offices are not a complete tabula rasa."
While the president of Fiat Polska, Enrico Pavoni, said the company is not conducting any internal audit regarding transfer pricing, it is preparing for the new regulations. "We are preparing to be able to provide documentation on transactions among Fiat's companies," Pavoni said. He said documents will cover not only transactions between the parent company and its subsidiaries, but also transactions among Fiat's 15 entities operating in Poland.
The world's fiscal authorities woke up to the problem of transfer pricing after the United States introduced regulations in 1994 under which multinationals had to provide documentation on internal transactions between related parties. Penalties were then introduced for those companies not complying.
"They (other countries) felt profit was leaking to low-taxed countries (Bahamas, Ireland) and they were even more worried that there was a leakage of profit to countries that police their rules more effectively," Mills said. "Gradually, Denmark, France, Australia, the U.K., Germany, for instance, were all introducing their own rules with teeth."
