Matthew DeMello: We were talking about the heart of the matter here being getting developing countries on board with country–by–country reports specifically. But inevitably of course, this is going to mean increased documentation requirements for countries either adopting regimes close to, or completely in line with, the OECD’s BEPS Action 13. To what extent do you think multinationals should be preparing on those fronts?
Dr. Ednaldo Silva: Well, it is correct what you’re saying, but this has already been anticipated by the BEPS Action 13, the country-by-country report. So that is a reality. So if any tax jurisdiction wants to have access to that important document, which can be used to find the candidates for audit, you have to comply with the terms of the OECD.
So I think that, again, this document solves to say that country-by-country [reporting] comes with a series of auxiliary institutions or rules among the seven that I have listed. I mean, there are more, but those were the ones that came to mind.
So I don’t believe that this implies any further burden for multinationals, but it does imply now that we have an obligation on the part of the multinationals to prepare this country-by-country [reporting]. And you can already imagine that it would be one of the conditionalities of the IMF if countries fail to pay the interest on that debt, that they are fulfilling the obligation of having a institution that administrates country-by-country reporting.
Matthew DeMello: Of course. And then it comes down to the matter of enforcement. Is there a particular set of scenarios or challenges that countries incur in those first years of actually enforcing these rules that is provided for in the [Practical Tool Kit to Support the Successful Implementation by Developing Countries of Effective Transfer Pricing Documentation Requirements] or otherwise?
Dr. Ednaldo Silva: Well, there is the issue of the penalties, which is, I think, it’s the insistence on penalties is a maybe that is the only thrill? ..
Matthew DeMello: [Laughs.]
Dr. Ednaldo Silva: … Or that a little thrill… that is coming? And I think it is a preamble to this enforcement or repressive operators.
And here, let me say to you as a footnote, that there are two organizations of States in developing countries that are well organized – well, for those that have assemblance of enduring institutions – one is the military and the other one is the tax authorities.
So for example a few years ago, I went to a transfer pricing meeting in South Africa in Johannesburg. And I met authorities from different countries in Africa and they are impressive. So the idea that we have, you know, that the tax organized administration in this countries have a low capacity.
I think it’s, it’s misinformed.
Matthew DeMello: Of course.
Dr. Ednaldo Silva: For example, Africa, Kenya, Nigeria, you know these are very sophisticated tax administrations and they have an important, a discerning sense of countries. And even though, as I have said, they know they have this Faustian [bargain of the] soul…
Matthew DeMello: Right.
Dr. Ednaldo Silva: One is whatever the part in from the other one wants to be part of the OECD, but on the other one does not want to relegate local rules to a group of bureaucrats sitting in Paris, right. Or sitting in Washington, D.C. at the IMF or the World Bank. So that is a soul-searching activity.
Matthew DeMello: Of course. And I think you really highlight just how fraught and loaded the term developing countries can be. We’re about to bring up Columbia and to represent them as a developing country, in a colloquial context, with regard to any of their neighbors [laughs] that’s a stark contrast, as opposed to, when you’re talking about Columbia on the world’s stage and a lot gets lost with where we’re putting the microscope or the telescope for that matter… before I get too lost in analogies.
But for what we’re seeing in terms of those challenges in terms of implementation, what are the challenges for transfer pricing executives doing transfer pricing in developing countries? Especially in the capacity that these countries will have to investigate, or that these countries will be in a position to investigate multinationals?
Dr. Ednaldo Silva: Yes. Well, I think the biggest challenge is venues for, for dispute resolution…
Matthew DeMello: Right.
Dr. Ednaldo Silva: … Because – and here I’m going to give my impression, it’s not a position that has been studied a result of study, and my view here is clouded, but by my Brazilian upbringing [tells me] because of the fear of corruption: tax administrations are not given leeway to negotiate it.
It’s a very, very different contrast to the United States in which the exam division has a lot of latitude to negotiate a tax position with the corporations. And if that fails, you have an appeals division. And if that fails, you have the court system to settle a dispute but only a few cases get to that level. But there is a substantial discretion at the level of exam to resolve disputes with respect to how you characterize the transaction, how you select the comparables, how you select a method, et cetera.
When you go to developing countries, the tax administrations don’t have this kind of latitude. So they have an enforcement role without a negotiating role. And I think this is going to be very complex for the OECD to establish, or to impose rich country rules in an environment that has built historically protective belts against corruption at the level of the tax administration. And one of the elements of the protective belt is not to allow the tax collector or the tax administrator to make deals…
Matthew DeMello: Right?
Dr. Ednaldo Silva: … so everything’s statutory. And I think that the OECD must, and not only do I see it, but I think that tax administration of corporations have this problem, because I think that’s the most frustrating. The most frustrating thing of dealing with tax administration in developing countries is their inability to negotiate and the inexistence of venues in which one can show discord to the tax administration except in court proceedings.
And court proceedings are primarily legal proceedings. They are not designed as they are designed in United States in which there is a lot of discovery and fact gathering. And there is a lot of dispute over what is fact and what is fiction.
So I think this is the most challenging aspect of disseminating OECD rules, in which this document is a practical toolkit to make sure that these rules are implemented. So the most challenging aspect to both corporations and the gang of four is to [ask] “How are you going to relax the local rules to prevent corruption by disabling negotiating in appeals provisions and allow these flexibilities to exist?”
Matthew DeMello: Of course, and I know we were talking a bit about this dynamic before in terms of the enforcement, but I think maybe a question on everyone’s mind at this point might be, what about the lack of local comparables and how that’s going to impact audits? How do you see this, or how have you seen this play out in terms of transfer pricing history?
Dr. Ednaldo Silva: Well, I like your question because it’s very, it’s very pointed.
You know, it is clear that we are going to move to a terrain of safe harbors. It is clear that the concept of arm’s length based on comparables is defunct and only people who have no experience in audit can be Talmudic about it.
So I think we are going to move to a regime, in fact, you know, that is pretty Valiant developing countries, which is a regime of limits to deduction. For example, if you have intercompany interest payment, that is a limit. If you have a intercompany royalty payments, that is a limit of deduction. If you have intercompany management fees, you have a limit to there to deduction. Or the regime of safe harbors, which Brazil already has they call ‘presume the profit.’ It’s an alternative regime – which says That if you’re going to be a distributor it doesn’t matter if you are, if you are a foreign owned or domestic owned you have to produce 8 percent of your revenue is profit as taxable profit. So it’s a regime of safe harbors. A regime, which they call a presume profit. So I think we are going to move away from searching for comparables, and maybe we’ll have the regime of comparables as if you have it, we use it; if you don’t have it, we will use the default, we use the safe harbors.
Matthew DeMello: It’s going to be very interesting of course, to, to see it all play out.
I know I mentioned before that Columbia just became the 37th member of the OECD and is considered a developing country. What can other developing countries learn from its transfer pricing regulation implementation process, as it’s been kind of a current events story over the last year or so? What are the key takeaways?
Dr. Ednaldo Silva: Well, I’m not so familiar with the implementation of the OECD guidelines in Colombia, except to say in very general terms to say, well, Columbia is a country of about 50 million people with a per capita income of $6,000 per year – or $ 6,500 per year. So it’s a towards mid-income, low income countries. But you know, Columbia has a history of acquiescing with international rules. I mean, Columbia for a long time acquiesced to US foreign policy, in which it equated, it accepted this phony equation in which any kind of public discontentment is equated to drug trafficking.
Matthew DeMello: Yes. [Laughs.]
Dr. Ednaldo Silva: And it accepted the US, like Mexico – and it’s not coincidental that Mexico, Chile and Colombia and Latin America were the first countries to be part of this regime because they have history of acquiescing to [the US.]
You know, they are smaller countries. I mean, Mexico was not small. I mean, Mexico had the revolution and if you go to Mexico and you go to other countries, not America will know that Mexico had the revolution. It is distinct, [though] it has lost a lot of its way. But my point is that it is easier in places that they have a history of cooperation, farcical cooperation, or truthful cooperation with international regimes of oppression … you know, which to me is what the OECD represents.