Tax Analysts Blog

The European Predictability Paradox

Posted on Nov 12, 2015

There’s a familiar saying, “It is better to ask for forgiveness afterward than for permission before.” The reasoning is that if you seek permission and it’s denied, and you do it anyway, you have knowingly broken the rules. But if you don’t seek permission and do it, and then find out you shouldn’t have, you just made an innocent mistake – for which you will offer a “sincere” apology.

The world of complex tax planning, however, rejects that notion. Planners nearly always seek permission in advance, especially before doing a deal whose tax consequences might not be supported by controlling precedent. The reasons are obvious. For prudent managers and investors, an iffy tax position adds an element of risk that is nearly impossible to quantify. For parties on opposite sides of a negotiated transaction, the chance that the tax administration in any country might at any time take issue with the purported tax consequences will clearly affect the pricing of the deal. Moreover, uncertainty creates doubt, which can lead to a lack of trust, neither of which is good for business.

Transfer pricing is one area in which uncertainty abounds. Long after a transaction is structured and the elements of production located in various jurisdictions, and the income and expenses are reported on filed returns, a revenue authority can come along and upset the apple cart simply by exercising its broad authority to reject the taxpayer’s pricing, or recharacterize the transaction altogether.

Thus transfer pricing presents an ideal opportunity for related parties to seek and obtain advance rulings about pricing methods and the factual assumptions that underlie them. If a multinational enterprise can get an advance ruling from a national tax administration, establishing where the elements of the value chain should be taxed, and what the arm’s-length price should be between related parties in that value chain, the taxpayer can remove a major element of uncertainty from its tax liability and, concomitantly, its balance sheet. And if the MNE can get rulings from multiple tax administrations affected by the issue, approving those prices, that should represent certainty squared.

Except in Europe. There, the members of the European Union signed a treaty in which they all agreed not to confer preferential economic benefits on particular businesses when those benefits were not generally available to all. And now, for the first time, the concept of state aid is being extended to tax rulings, threatening thousands of advance rulings granted by some EU countries.

Last month the European Commission issued rulings determining that Luxembourg and the Netherlands illegally conferred state aid on Fiat and Starbucks, respectively, in the form of favorable advance tax rulings. If upheld on appeal – which is certain to come – the MNEs will have to repay millions in tax benefits that they had claimed after prudently obtaining advance rulings. And in that event, it is entirely possible that the repayments will not represent deductible expenses, smacking the taxpayers with a double whammy.

It could be years before the outcome of these rulings and hundreds of similar state aid investigations is known. But if they stand, they will upend the notion that – at least in Europe – advance rulings are preferred in matters involving transfer pricing. Paradox will rule the European tax world, in which certainty will become uncertain and the predictability accorded by advance rulings will become entirely unpredictable.

Read Comments (1)

AMTbuffNov 12, 2015

The core idea of the rule of law is that society benefits immensely when all
parties know in advance what is permitted and what is not.

Abandoning this proven concept for the sake of a short-term gain in tax revenue
is one of the stupidest ideas I can imagine.

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