Drafting Transfer Pricing Legislation: Taxes Covered

Depending on the design of a country’s tax system, application of the arm’s-length principle may be relevant in determining the taxable objects for one or more direct taxes (income tax, corporate tax, profits tax, etc.). Generally, most countries’ transfer pricing legislation has broad application across direct taxes. One notable exception being Ireland, where the transfer pricing legislation introduced in 2010 applies only to certain classes of income for direct tax purposes. 

Countries with other specific types of direct taxes governing specific sectors or transactions types (such as a mining income tax) may need to consider application of transfer pricing legislation to them. Typically, this would be achieved through separate provisions being inserted in the relevant taxing acts. However, where a consolidated tax code has been adopted, a single set of legislation may be possible. Transfer pricing provisions may also be necessary for other types of taxes such as a resources royalty particularly where the base or rate of the tax is linked to income, expenses, or profits, and the value of which may be impacted by controlled transactions.

General application of transfer pricing legislation designed for direct taxation purposes to indirect taxes (such as value added tax [VAT] and customs duties) is typically not appropriate. Customs legislation generally contains its own specific valuation methodologies, which in most countries will be based on the valuation agreement that is binding on World Trade Organization (WTO) members. Although sharing a similar objective to transfer pricing legislation, the customs’ valuation methodologies do not necessarily align with the arm’s-length principle upon which the direct tax transfer pricing legislation is generally based. This is due to how customs duties are levied on a transactional basis, at the time of import or export and the differing requirements stemming from international law. VAT is typically calculated based on the transaction price used by the parties or, as is often the case for imported goods, the customs value declared. Thus, in most circumstances the calculation of VAT does not require a substituted valuate based on objective criteria, except where special valuation rules for related party transactions exist.