The OECD’s BEPS Discourse and China’s new Transfer Pricing related Measures: The OECD starts reaping what it has sown
The OECD has kept repeating that its BEPS project was not aiming to replace the arm’s length principle (ALP) by a global formulary apportionment (GFA) approach or any of its forms (global unitary tax principle, etc.). At the same time, it has kept reiterating that the BEPS project was “just” aiming to ensure that the ALP would be applied so that profits would be attributed where “value creation” occurs. Well, with such a stance, the OECD has just got from China the response one could unfortunately expect its BEPS economic discourse would attract.
China’s new TP-related measures (described here in one of our previous blogposts, on March 27) are just an admonitory example of the likely responses to the BEPS project’s professed underlying economic principles. And we should still witness many other such examples going forward.
As a reminder, regarding the subject of value and of its apportionment along a value chain, the fundamental dichotomy in economics and in its transfer pricing subdiscipline are the opposing concepts of:
- value creation on the one hand (the terms value being sometimes replaced by some authors by the term “rent” or “economic rent” and the term creation being sometimes replaced by the term “generation”, producing various names of the same concept, like “rent generation”, etc.), and
- value appropriation on the other hand (here, the term appropriation being sometimes replaced by some authors by the term “capture”, also producing various names of the same concept, like “economic rent appropriation” or “value capture”, etc.).
To make a long story short, the primary use of one or the other of those two concepts for the apportionment of value (or profits) along any value chains will obviously provide very different answers, considering that the elements or phenomena giving rise to their occurrence or existence, namely the locus of occurrence of value creation as opposed to the locus of existence of the legal or institutional capacity to appropriate created value, are usually not the same.
At its core and in principle, the ALP is based on the notion of freedom of contract (FOC) and its central tenet in respect of apportionment of profits along any value chains is the above-mentioned concept of value appropriation arising out of contractual and asset ownership rights and the risks and situational factors attached to the emergence of the value of those rights.
On the other hand, the GFA’s central tenet in respect of apportionment of profits along any value chains is the above-mentioned concept of value creation and, as a correlate, its deliberate disregard of legal value appropriation factors or capacities. The challenge of GFA is therefore always to determine the measurements or indicia that will best establish the locuses or locations where the creation of value occurs in order then to apportion the profits along the relevant value chain to each location in proportion to its relative importance in terms of value creation.
That reminder being considered and understood, one can better grasp that although the OECD’s BEPS transfer pricing discourse may have sounded somewhat sensible to its prime audiences (namely journalists, politicians, politicians’ constituencies and finally the international tax community at large), all serious transfer pricing economists have considered all along that the “A equals non A” discourse of the OECD was not making any sense whatsoever from an economic standpoint. Indeed, all have considered that the OECD’s discourse [“(…) We still want the ALP, absolutely, but with value creation as the front driver of profit attribution” ] amounted to an economic oxymoron that would not produce workable results, at least in theory if not in practice, with the OECD positioning its BEPS approach along the fuzzy conceptual continuum or void between the ALP and GFA, where basically anything goes and where, as far as transfer pricing and attribution of profits is concerned, you can say or think whatever pleases you.
One can also better grasp that on the issue, China has just cut, and rightly so given the OECD’s opening, the Gordian knot with a clear GFA agenda. All things considered, one should almost thank the Chinese fiscal authorities for having done so.
Regardless of the specifics of the Chinese measures, China’s approach has at least the virtue of avoiding the type of wishy-washy and contradictory thinking that the BEPS economic discourse conveys. China will therefore avoid the type of situation that the BEPS economic discourse might well perpetuate. A situation we have been witnessing in Canada for many years already. A situation where companies as well as the fiscal authorities, given the conceptual double binds and unclarity they face and despite affirming the importance of compliance on the one hand and of enforcement on the other, do not know or cannot figure out exactly which way to go with regard to transfer pricing compliance and transfer pricing audits and end up haphazardly complying on the one hand and sloppily enforcing on the other.
With its oxymoronic BEPS approach of expressly aiming to place value creation at the center of the ALP, the OECD paradoxically keeps on building the case for GFA (China’s thinking, apparently) and is on course to render transfer pricing as complicated and unfathomable in its application principles (just consider the OECD’s Special Considerations to intangibles’ valuation…) as quantum physics may be to the layman… Without any equivalent of decoherence theory for specialists on the transfer pricing side…
In this train of thought, if the OECD perseveres on its course to the conceptual black hole that constitutes its current BEPS economics approach, the post-BEPS ALP will ultimately be as coherent and useful as a guidance to transfer pricing and profit attribution as Shrodinger’s cat is real as a cat. And in all justice the ALP will then deserve at best the same fate as Shroedinger’s cat which, as the thought experiment goes and some of you may know, is dead and alive at the same time…
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