Ireland: Transfer Pricing Rules Regarding Transactions Involving Low-Tax Countries

by Dan McSwiney, David Caraher, and Michelle Louw* — KPMG Ireland

* Dan McSwiney and David Caraher are Directors, Michelle Louw is a Senior, all at KPMG’s Tax Practice in Dublin, Ireland.

This article discusses Irish tax legislation and case law relevant to transfer pricing, particularly with regard to transactions between Irish tax residents and tax haven residents, as well as specific measures taken by the European Union and the OECD to encourage the exchange of information between countries. In addition, Ireland's reaction to the introduction of e-commerce and the growing tendency to apply shared service concepts within multinational enterprises are also considered.

1. Introduction

International transfer pricing has become an increasingly significant aspect of international tax due in part to the continuous increase in global trade and investment. Transfer pricing becomes particularly relevant when a tax resident enters into transactions in goods or services with a related party that is resident in a so-called tax haven, as related parties would have an added incentive to overstate profits in the tax haven country while understating profits elsewhere.

This article will discuss Irish tax legislation and case law relevant to transfer pricing, particularly with reference to transactions between Irish tax residents and tax haven residents. Furthermore, given the difficulties regularly encountered by tax authorities in obtaining information from tax havens when trying to enforce transfer pricing provisions, this article will also briefly consider specific measures taken by the European Union and the OECD to encourage the exchange of information between countries, as Ireland is a member of both of these organizations. A final consideration will be Ireland's reaction to the introduction of e-commerce and the growing tendency to apply shared service concepts within multinational enterprises.

2. Transfer Pricing Rules

2.1. Generally

Ireland does not have a separate statutory transfer pricing regime and there is currently no requirement to prepare transfer pricing documentation from a purely Irish perspective. Furthermore, Ireland has not passed any thin capitalization or controlled foreign company (CFC) rules of general application into its domestic legislation. Moreover, tax law does not differentiate between transactions between Irish residents and residents of tax havens.

However, although no transfer pricing regime of general application is in place, certain provisions of the Taxes Consolidation Act 1997 (TCA) do specifically require that transactions be entered into on an arm's length basis. Although many of these provisions are aimed at transactions between residents, they may still find application where a resident transacts with a person resident in a tax haven.

No specific legislation has been enacted and Irish Revenue (Revenue) has not published any guidelines regarding how it would determine whether a transaction has been entered into on an arm's length basis. Revenue has indicated, however, that when establishing an arm's length price, Revenue would follow the principles laid down in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines).

The various applicable TCA provisions, as well as relevant case law are considered below.

2.2. Transactions between residents and non-residents where the non-resident controls the resident

Sec. 1036 is derived from a 1918 provision and is the oldest "transfer pricing" provision in the TCA. This provision applies where:

• a non-resident person which is closely connected with and exercises substantial control over a resident person, carries on business with that resident person; and
• the course of business between the resident person and non-resident person is arranged such that the business carried out by the resident person in pursuance of that person's connection with the non-resident person produces to the resident person either no profits or less than ordinary profits which might be expected to arise from that business.

Where the above conditions are met, the non-resident person will be assessable and chargeable to income in the name of the resident person as if the resident person were an agent of the non-resident person.

According to Charles Haccius¹, Revenue believes the section to be ineffective for reasons including the following:

• the section applies only if a non-resident has "substantial control" over a resident, and does not apply where the resident has control over a non-resident. In addition, it doesn't apply where both the resident and non-resident are under the control of a third company resident in another state;
• the section applies only to a non-resident that is "neither a citizen of Ireland" nor "an Irish firm or company". Consequently, it may violate the non-discrimination provisions of an applicable tax treaty between Ireland and the non-resident's state of residence².

As a result of the above shortcomings, Sec. 1036 is not commonly used by Revenue in practice and is therefore of limited importance in the current context.

¹ C. Haccius, Ireland in International Tax Planning (Amsterdam: IBFD, 1995) at 987.
² Art. 24(1) OECD Model Treaty.

2.3. Transactions to avoid liability to tax

Sec. 811 of the TCA provides that where the Revenue Commissioners are of the opinion that a transaction is a tax avoidance transaction, they may make all such adjustments and do all such acts as are "just and reasonable" so that the tax advantage is withdrawn or denied to any person concerned. More specifically, the Revenue Commissioners may allow or disallow, in whole or in part, any deduction or other amount that is relevant in computing tax payable; allocating or denying the taxpayer any deduction, loss, abatement, relief, allowance, exemption, income or other amount, or any part thereof; or recharacterizing for tax purposes the nature of any payment or other amount. Sec. 811 therefore may allow the Revenue Commissioners to substitute a price actually agreed between parties with a price that they believe to be just and reasonable where the Revenue Commissioners are of the view that the transaction is a tax avoidance transaction.

Sec. 811 is one of the most significant transfer pricing mechanisms available in the TCA, and where the Revenue Commissioners are of the view that an Irish company has entered into a transaction that cannot be considered to be arm's length, they are most likely to invoke this provision over the other provisions mentioned in this article (assuming the requirements of Sec. 811 are met).

2.4. Disallowance of deduction where disbursement or expenditure was not incurred for purposes of trade

Sec. 81 of the TCA provides that no deduction will be allowed where a disbursement or expense was not wholly and exclusively laid out or expended for the purposes of trade of that company. Although this provision does not explicitly require that transactions be entered into at arm's length, the power granted to the Revenue Commissioner to deny a deduction in effect allows the Revenue Commissioner to adjust the price paid by the company for the goods or services. Therefore, where an Irish company incurs expenditure for the benefit of another group company resident in a tax haven (or for the benefit of the group of companies as a whole), the Revenue Commissioner may deny the deduction claimed in respect of this expenditure on the basis that the expenditure was not incurred wholly and exclusively for the purposes of trade of the Irish company.

This principle was clearly illustrated in the UK High Court decision of Marshall Richards Machine Co, Ltd v. Jewitt³, where a UK company formed a wholly owned subsidiary in the United States to act as its agent there. The UK company subsequently entered into an agency agreement with its subsidiary under which it agreed to pay the subsidiary a minimum annual sum towards its operating expenses. This expenditure was disallowed by the Inspector of Taxes on the basis that the expenditure did not represent expenditure wholly or exclusively laid out or expended for the purpose of trade. The case came before Upjohn J⁴, in the Chancery Division. Upjohn J noted that where a disbursement is laid out wholly and exclusively for the purposes of the trade of the parent company, the disbursement will be allowed, although where a disbursement is laid out wholly and exclusively for the purposes of the trade of a subsidiary company or partly for the parent company and partly for the subsidiary, the parent company will not be entitled to a deduction.

³ 36 TC 511 (1956).
⁴ 36 TC 511 at 526.

2.5. Corporation tax rate of 10%

Certain manufacturing companies benefit from a reduced corporate tax rate of 10%. The only companies that still qualify for this reduced rate are manufacturing companies that commenced trading before 23 July 1998 and those that entered into a grant agreement with an industrial development agency before 23 July 1998, but did not commence trading until after 31 July 1998. The 10% rate will cease for these companies on 31 December 2010.

In order to ensure that profits are not shifted from a company subject to a higher tax rate to a company qualifying for the 10% tax rate, Sec. 453 regulates transactions entered into between companies claiming the preferential 10% tax rate and their associated companies.

2.6. Tax-exempt patent royalty income

Sec. 234 of the TCA provides an exemption from income tax and corporation tax for qualifying patent income. In order for patent income to qualify for the exemption, either (1) it must be paid for the purposes of a manufacturing activity or (2) the payer must not be connected to the payee. Where an exemption is claimed on the basis that the qualifying patent income is paid for the purposes of a manufacturing activity, only that portion of the royalty that does not exceed an arm's length amount will be exempt.

2.7. Capital gains tax

In certain instances, a person is deemed to acquire an asset for its market value irrespective of the price actually paid, including where the person acquires the asset other than by way of a bargain made at arm's length and where the asset is acquired from a "connected person". These provisions could find application in the current context should a resident company dispose of an asset to a connected person in a tax haven for a lower consideration in order to decrease the amount of capital gains tax payable. Although these provisions deem the person to acquire the asset for "market value" and not for an "arm's length price", it is submitted that, in practice, there is little difference between the two concepts.

2.8. Petroleum tax

Sec. 696 of the ITA provides that where a person disposes of petroleum, acquired by virtue of petroleum activities carried on by the person, for a price that is not arm's length, the disposal of the petroleum and its acquisition will be treated as having been made for a consideration equal to the market value of the petroleum at the time the disposal was made. The market value is defined as the price which the petroleum might reasonably be expected to fetch on a sale of that petroleum at that time if the parties to the transaction were independent parties dealing at arm's length.

2.9. Case law

In Belville Holdings Ltd v. Cronin⁵, the principles of the UK Court of Appeal case in Petrotim Securities Limited v. Ayres⁶ were followed. In Petrotim, the taxpayer was a company dealing in securities. The taxpayer entered into a transaction with its parent company whereby it sold investments with a realizable market value of GBP 836,000 for the sum of GBP 205,000. The UK Court of Appeal determined that the actual sales price of GBP 205,000 had to be substituted with the realizable market value of GBP 836,000 for tax purposes.

In Belville Holdings, the Petrotim holding was applied to a case involving a company that provides services to a related company. In this regard, Ms Justice Carroll stated that:

… services are also a marketable commodity and therefore the principle is the same. The Appeal Commissioner was entitled to find that the situation was similar and accordingly that the transaction was so outside the ordinary course of business of any trade that it was not done in the course of trade⁷.

⁵ 3 ITR 340.
⁶ 41 TC 389.
⁷ 3 ITR 340 at 348.

In Belville, the taxpayer was a holding company also engaged in managing subsidiary companies and providing them with finance. For the period in question, the taxpayer charged only part of its direct operating expenses to the subsidiaries, and the remainder was charged to its own trade, thereby causing the taxpayer to suffer a loss. For the same period, two of the subsidiaries made profits which were paid to the taxpayer as dividends.

The Appeal Commissioner determined that in computing the taxable profits or losses of the taxpayer, a deduction should be made for notional management fees equivalent to the market value of the services provided to the subsidiaries. As a result, the loss claimed by the taxpayer was reduced. The matter was subsequently referred to the High Court by way of case stated. The High Court held that the Appeal Commissioner was entitled to find that the transactions in question were so far outside the ordinary course of business of any trader that they were not done in the course of trade. However, although the High Court agreed that the Commissioner was correct in his view that notional management expenses should be charged, it was not satisfied with the manner in which the Appeal Commissioner had determined the quantum of the fees charged.

The decision could indicate that a pricing adjustment may be made where either goods or services are sold or provided at prices so significantly below their value that they do not comprise transactions within the ordinary course of trade. However, the decision has been strongly criticized because the conclusion of the Appeal Commissioner was not based on any statute. By introducing Petrotim, a British case decided by the UK High Court, the Appeal Commissioner sought to introduce the concept of notional receipts for services and introduced a new charge to tax in Ireland without any statute to support it. In addition, it has been argued that the Petrotim decision was based on a very different set of facts and that all the attributes which characterized the Petrotim decision were not present in the Belville Holdings case, as there was no trading stock or actual sale in Belville Holdings⁸. It is therefore expected that should the Supreme Court be forced to review the Belville Holdings decision, the decision will be overturned. As such, this decision may be of limited importance in the current context.

⁸ Suzanne Kelly, March 2006, Obscure Cases Revisited (4), Irish Tax Review, at 172.

3. EU and OECD Measures Regarding Exchange of Information

One of the principal problems encountered by jurisdictions in enforcing transfer pricing legislation involves obtaining accurate and relevant information regarding transactions between residents and non-residents. While tax treaties usually include an exchange of information clause, where a jurisdiction is a "tax haven", it is unlikely that a tax treaty would have been entered into. Although the EU Mutual Assistance Directive⁹ and the Savings Directive¹⁰ allow Revenue to request information from other EU Member States in many instances, these directives would generally not be of assistance because the relevant tax haven would in all likelihood not be a member of the European Union.

⁹ 77/799/EEC.
¹⁰ 2003/48/EC.

In 2002, the OECD published a model agreement on the exchange of information, the OECD Model Agreement on Exchange of Information in Tax Matters. The OECD website states that the purpose of the model agreement is to promote international cooperation in tax matters through the exchange of information. It highlights that the working group that developed the model agreement included representatives from the OECD member countries as well as delegates from jurisdictions traditionally considered to be tax haven countries, including Aruba, Bahrain, Bermuda, the Cayman Islands, Cyprus, Isle of Man, Malta, Mauritius, the Netherlands Antilles, the Seychelles and San Marino.

Whilst Ireland has not yet entered into any exchange of information agreements based on this model, communication by the Revenue Commissioners indicated that the Revenue has initiated discussions with its counterparts in the Isle of Man, Jersey and the Cayman Islands in this regard. It is notable that countries including Australia, the Netherlands, New Zealand and the United States have already entered into exchange of information agreements with countries traditionally viewed as tax haven countries, including Bermuda, the Isle of Man and Jersey.

4. Shared Service Concepts and E-Commerce

Ireland has proved to be an attractive jurisdiction for the location of shared service centres, the holding of intellectual property (IP) and for e-commerce due to its relatively low tax rate applicable to trading companies, robust legal system, skilled workforce and sophisticated infrastructure. In addition, as detailed below, Ireland has implemented various incentives for companies to locate these functions in Ireland.

In order to encourage companies to license their IP out of Ireland, Ireland offers generous incentives to these companies, including:

• the availability of a 12.5% tax rate where the IP company qualifies as a trading company. According to the Irish Development Agency (IDA), activities which may indicate that an IP company qualifies as a trading company includes the development of IP, legal protection and contracts; financial management and taxation; administration and billing; trademark/brand enhancement; marketing and promotion; licensing and business development;
• no tax on earnings from IP where the underlying research and development (R&D) is carried out in Ireland;
• an R&D tax credit to act as an incentive for foreign and local Irish companies to undertake new and/or additional R&D activities in Ireland; and
• no stamp duty on the transfer of certain IP to Ireland. For purposes of this exemption, IP includes any patent, trademark, copyright, registered design, design right, invention, domain name, supplementary protection certificate or plant breeders' rights.

In addition to the above-mentioned tax incentives, R&D funding is also available in terms of several schemes including the Research Technology and Innovation scheme and the Innovation Partnership Initiative.

The IDA mentions Alliance Atlantis, a Canadian media company, as an example of a company which successfully manages its IP out of Ireland¹¹.

Companies running their shared service centres out of Ireland include Accenture, Black & Decker, Colgate and Dell, to name a few¹². The IDA mentions Ireland's knowledgeable and innovative workforce, advanced telecommunications infrastructure, low-risk business environment and favourable corporate tax rate as reasons for companies locating their shared service centres in Ireland.

¹¹ See IDA website.
¹² See IDA website.

In a speech by the Chairman of the Revenue Commissioners at the 2001 Second World Tax Conference, the importance of e-commerce was highlighted as an issue high on the agenda for the Irish tax authorities. The Irish tax authorities' publication titled "Electronic Commerce and the Irish Tax System" states as follows with regard to the importance of e-commerce in Ireland:

… electronic commerce (e-commerce) is rapidly transforming the way business is conducted throughout the world. E-commerce has the potential to be one of the great economic developments of the 21st century, boosting growth and employment. Ireland is now competing on an instantaneous global market where the traditional constraints of time, distance and location are becoming more and more irrelevant. E-commerce, thus, presents significant opportunities for the development of Irish enterprises and employment.

It is evident from the above that the Irish government views the rapid increase of e-commerce in a positive light and that it presents a significant opportunity for the Irish economy. It therefore aims to make Ireland a key international centre for e-commerce. To this end, many government departments and bodies have launched initiatives in this area, including the Department of Public Enterprise; the Department of Enterprise, Trade and Employment; the Department of the Taoiseach and the Information Society Commission. The success of these initiatives is reflected by fact that Ireland has managed to attract several major Internet companies to its shores, including Google, eBay and Overture.

From a tax perspective, Revenue has adopted the approach that while it will strive to ensure that tax rules do not stifle the development of e-commerce in Ireland, Revenue will also aim to ensure that the growth in business on the Internet does not take place at the expense of national revenues. As such, Revenue will aim to ensure that tax rules and tax compliance is neutral between e-commerce and other forms of commerce.

Revenue also highlights in its publication on e-commerce that, unlike many traditional taxation issues, the tax environment for e-commerce must have a global perspective, and therefore Ireland will also look to studies undertaken by the European Union and the OECD in developing its domestic legislation. Furthermore, the publication also notes that where there is an increase in intra-group activity arising out of Internet-based technologies, transfer pricing issues will become more common, and that pricing within an international group should be on an arm's length basis, so as to avoid the possibility of profit adjustments being sought by tax authorities. In this regard, it is important to note that the publication mentions that although Ireland does not have any detailed transfer pricing legislation, the arm's length principle is implicitly applicable to the determination of taxable profits. Therefore, it is clear that Revenue expects companies operating out of Ireland to transact with related parties on an arm's length basis, failing which it may invoke the provisions of either Sec. 81 (expenditure not laid out or expended for the purposes of trade) or Sec. 811 (transaction to avoid liability to tax) of the TCA, as discussed above.

5. Conclusion

Although Ireland does not have any general transfer pricing, CFC or thin capitalization rules in place, there are several TCA provisions that require application of the arm's length principle, regardless of whether the tax resident is transacting with another tax resident or with a resident of a low-tax jurisdiction. As tax law does not discriminate between transactions entered into between Irish residents and between Irish residents and residents of a low-tax jurisdiction, there is no difference with regard to the allocation of the burden of proof between situations in which the target country must be classified as a tax haven or alternatively as a preferential tax regime.

The provisions that are most likely to find application in relation to transactions between Irish residents and companies resident in a tax haven are the anti-avoidance provisions of Sec. 811 and the power of the Revenue Commissioner to disallow expenditure not incurred wholly and exclusively for the purposes of trade under Sec. 81 of the TCA. These provisions in effect allow the Revenue Commissioner to adjust the taxpayer's taxable income where there has been a shifting of profits between related companies. It is submitted that the Belville Holdings decision is of limited significance, as it is likely that the decision would be overturned by the Supreme Court if that Court were ever requested to consider it.

Although Ireland has not entered into exchange of information agreements with any tax havens thus far, based on indications from Revenue, one can expect such agreements to be reached in the future, thereby allowing Revenue to enforce transfer pricing legislation (where applicable) with increasing ease.

Ireland has embraced the increasing tendency for companies to locate shared service centres, the holding of IP and the running of e-commerce businesses in low-tax jurisdictions, and has actively encouraged such companies to relocate to Ireland through various private and government initiatives. While Ireland has actively encouraged these companies to relocate to Ireland, Revenue's publication on e-commerce makes it clear that any transactions entered into between the companies and their related companies must be on an arm's length basis.

For more information, contact a tax professional with KPMG’s Global Transfer Pricing Services Group in Ireland:

Dan McSwiney, +353 (1) 410 1693, dan.mcswiney@kpmg.ie

David Caraher, +353 (1) 410 2684, david.caraher@kpmg.ie

Michelle Louw, +27 (11) 647-8740, michelle.louw@kpmg.co.za