Hi. Welcome to the fourth module, which is focused on transfer pricing. My name is Stefano Simontacchi, and I'm the director of the Transfer Pricing Reserve Center at the International Tax Center in Leiden. Transfer pricing for multinational enterprises is, is one of the most interesting areas within international tax law. With ongoing economic globalization, intergroup cross-bowler transactions are becoming increasingly important, and transfer pricing is now the key issue for profits allocation among multinational group companies. In this first video, we will illustrate this importance of transfer pricing, before we go into the specifics and the details in the videos to come. Let us look at the example to help us understand the importance of transfer pricing in terms of allocation of profits between countries and the impact on the effective low tax rates. Under case number 1, a manufacturer resident in country A sells finished product for an associated distributor, which is a group company resident in country B for a price of 110. The manufacturer having a cost of goods sold of 100, produces a profit to 10. Tax at a corporate income tax rate of 40%. The distributor sells the finished product to it's clients for 250 and has a profit of 140 taxed at a corporate income tax rate of 10%. As a consequence the consolidated profit for the group is equal to 150. On this profit the group pays 18 of taxes, suffering a 12% over rate. And the case number two. The transfer pricing changes from 110 to 200. The consequence is that the manufacturer profit increases from 10 to 100. And the distributor profit decreases from 140 to 50. The consolidated profit remains 150, but the overall tax rate increases from 12% to 30%. This basic example highlights our transfer pricing effects tax collection in relation to the allocation of taxable income among the relevant countries. In fact, under case number one, state a collects taxes for four. Whereas in the case number two state A collects taxes on 40, which is 10 times more. Transfer pricing may thus be used to shift income from one country to another. How can this practice be avoided? The answer is the arm's lenght principle which is the international standard adopted by the OECD and by many countries world wide. Tax authorities have become much more conscious of the key role of transfer pricing in determining the taxable profit of multinational groups. And are focusing more and more on this area. For many years, transfer pricing application was left in the hands of practitioners. The recent crisis and some scandals shed light on the risk that a certain way of applying transfer pricing was the arm's length principal itself. That's why a few years ago the OECD launched many projects on transfer pricing with the aim of redrafting the guidelines. In particular since 2008, the OECD has issued more than ten discussion drafts on transfer pricing. And also 4 out 15 bets action regard transfer pricing. Transfer pricing has become one of the main risks to be addressed and managed by corporate governant bodies of multinationals. For example, in 2006 Black Silk paid IRS 3.4 billion US dollar to settle with transfer pricing dispute. In short transfer pricing has entered a new phase of development. With old issue being revisited and reviewed, and issues that received little attention previously now coming into the spotlight. I hope you can now understand the importance of transfer pricing, and why a good understanding of transfer pricing is key, to appreciate the international tax planning debate. First however, we need to understand what exactly the arm's length principle is and how it is applied in practice? With that in mind in the next video, I will be explaining the key features of the arm's length principle. And in particular the five comparability factors. I hope you join us.
