Former Treasury Official Critiques OECD White Paper

Former U.S. Treasury Associate International Tax Counsel David Ernick spoke with Bloomberg BNA Transfer Pricing Report's Kevin Bell last month about the OECD's white paper on documentation. Below is a shortened version of the story.


The biggest potential change to the Organization for Economic Cooperation and Development's transfer pricing guidelines is likely to result from the OECD's July 30 white paper on transfer pricing documentation, rather than from the revised discussion draft on intangibles issued the same day, former U.S. Treasury Associate International Tax Counsel David Ernick said.

The most significant portion of the July 30 white paper, he said, “is the discussion of the importance of a ‘big picture' analysis of the corporate value chain, and the analysis of where profits are reported globally in comparison to where the entity's employees, assets, or sales are located.”

Ernick, who left Treasury Feb. 4 to join PricewaterhouseCoopers as a principal, said that although the discussion is only a few paragraphs long, “this section foreshadows the introduction of country-by-country reporting requirements” as outlined in the July 19 OECD action plan to combat base erosion and profit shifting.

The chair of OECD Working Party No. 6 said Aug. 1 that there is tremendous political momentum behind the OECD's project to develop new transfer pricing documentation rules that would require multinational enterprises to document their global allocation of the income, economic activity, and taxes paid.

 Laudable Goals

The OECD white paper is part of the organization's work to simplify the transfer pricing rules.

Ernick said the OECD recognizes that rapidly spreading local transfer pricing documentation requirements and the complexity of the rules result in significant compliance costs that may not be commensurate with the benefits created. “The OECD sees potential for standardization to reduce compliance costs for taxpayers,” he said.

That is, Ernick said, if the documentation requirements were uniform across countries, then multinationals would be relieved of the burden of preparing a different transfer pricing study for each country in which they do business.

While the OECD's goals are laudable, Ernick said, it remains to be seen how these rules will eventually develop and be implemented.

“The concern here would be that such rules could result in more pressure on taxpayers to align profits and taxes paid with the location of employees, assets, or sales,” he said.

“The importance of the functional analysis and a nuanced focus on the facts and circumstances of a particular transaction may be receding in favor of a more blunt focus on whether global allocation of profits aligns with the location of employees, assets, or sales,” he said. “That goes a long way towards formulary apportionment.”

Country-by-country Reporting

Ernick was asked why country-by-country reporting would not be useful as a risk-assessment tool. Wouldn't it allow governments more transparency into taxpayers' tax affairs, and wouldn't it help tax examiners to be able to compare in which jurisdictions a multinational reports its income and pays taxes in relation to where it earns the bulk of its revenue, or where its employees or assets are located?

Ernick replied, “That's exactly what's wrong” with country-by-country reporting. “That's exactly what a tax examiner would do with that information,” he said.

In a country with a large consumer market and significant sales, there would be pressure to align income and taxes paid proportionally with sales. “It would be single-factor formulary apportionment on the basis of sales,” he said.

In a country without a big customer base but where many employees were located who did the manufacturing for the multinational, Ernick said, there would be pressure to align income and taxes paid proportionately with the number of employees or payroll expense.

“It would be a system designed to create disagreements.”

Ernick said every country using formulary apportionment would make its own claim as to which factor in the formula—sales, assets, or employees—was more important in the corporate value chain, and the result would be double taxation, with no way to relieve it.

Big Picture

Ernick pointed out that the white paper notes that such information would be more “big picture” in nature.

Transfer pricing is not “big picture,” Ernick asserted. “It's small picture.”

Transfer pricing always involves a determination based on the individual facts and circumstances, he said.

“Country-by-country reporting is like looking through a telescope when you should be looking through a microscope,” Ernick said. “You have to look at individual transactions, or at least groups of similar transactions, to determine if pricing is arm's-length. You can't just say that there are a lot of sales in one country but not a lot of profits there, so something must be wrong with the transfer pricing. There could be many different legitimate reasons for that.”

Implementing the white paper's proposals could also impose a large compliance burden on business without any corresponding benefit for tax administrations, Ernick said. “It's very unusual that this was addressed in the white paper on documentation, which was part of the transfer pricing simplification project. Country-by-country reporting is the opposite of simplification.”

U.S. Position

Asked about the U.S. position on country-by-country reporting, Ernick said, “I don't think the U.S. was the driving force behind country-by-country reporting.”

Ernick pointed out that he does not speak for the U.S. government nor does he have any inside information on what the U.S. positions would have been at the OECD. However, he said, there has always been a concern that country-by-country reporting is really a stalking horse for formulary apportionment.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub. L. No. 111-203) introduced country-by-country reporting in the U.S. for extractive industries, but not for transfer pricing purposes. The measure was more for anti-corruption purposes, for which it makes more sense, he said.

“I imagine the U.S. would not support expanding country-by-country reporting outside of the extractive industries, and certainly not for transfer pricing purposes.”

A U.S. Treasury official said in May that there is enormous political pressure worldwide to provide tax administrations with more information about the activities, and location of profits and income, of multinationals to help in risk assessment.


Ernick said the United States may have been the only opponent to country-by-country reporting, which has significant support among other countries, particularly in Europe.

After the United States imposed the Foreign Account Tax Compliance Act (FATCA) on the rest of the world, Ernick said, it may have been hard to argue credibly against more transparency under country-by-country reporting requirements.

Asked about potential transparency initiatives that would be useful in preventing transfer pricing abuses, Ernick pointed out that the United States already has adopted Schedule UTP, which requires disclosure of uncertain tax positions, including transfer pricing issues.

“I'm not advocating that as a solution here, but it certainly seems to be much more narrowly targeted. It would be direct evidence of transfer pricing risk, whereas the information from a country-by-country reporting regime would be weakly circumstantial at best, and generally irrelevant.”

Formulary Apportionment

Ernick was asked whether formulary apportionment is still on the table given the white paper on documentation and the OECD's statement in the BEPS action plan that it may be necessary to implement “special measures” that go beyond the arm's-length principle for pricing intangible assets.

He responded, “It's not really clear at this point.”

In the BEPS action plan, he said, “the OECD says that formulary apportionment is not the answer, and they've also said publicly that they want to maintain the consensus around the arm's-length principle as the international standard for transfer pricing rules. And yet the action plan also says that they are willing to go beyond the arm's-length principle. That's a troubling statement.”

Some of the substantive changes the OECD may be making, such as implementing country-by-country reporting and the rules for determining who is entitled to the returns from intangibles, the effect seems to be a significant step in the direction of using formulas to allocate profits globally, Ernick said.

“Their commitment to the arm's-length principle may be wavering,” he said.


Kevin Bell, Senior Reporter, Transfer Pricing Report