By Sagar Wagh
“You say You want a Revolution? Here it is….
The application of Blockhain technology in multinational transfer pricing aiding MNEs to efficiently execute inter-company transactions and simultaneously meeting the arm’s length standard will be revolutionary indeed. This is first international concept paper on this subject. The applications of Blockchain/DLT in Multinational Transfer Pricing as discussed below are futuristic in nature. The DLT/Blockchain as a technology is at very nascent stage and it may take few years before the applications discussed in this paper are brought into practice”
Several friends do complain that the concept of Blockchain is ‘Greek & Latin’ to them and while they see several articles on Blockchain technology being published on internet on day to day basis, it is impossible to understand the concept as a layman.
To begin with, it is important to divorce the concept of Blockchain from Bitcoin. Blockchain is a platform on which the bitcoin network runs. However, Blockchain as a platform is wider than Bitcoin and such platform has several applications which may be beyond Bitcoin or other cryptocurrencies. Author is of the view that, Blockchain technology will have a transformational effect on all industries and will bring real supply chain refinement.
In common man’s language, Blockchain or Distributed Ledger Technology (DLT) is a distributed ledger or shared ledger which is a ledger distributed/shared over computers of several parties who might be participants of particular transaction or arrangement. Such parties may become DLT participants. Accordingly, the DLT participants share a common ledger.
Accountants who are reading this blog will be well aware about the term ‘ledger’. Ledger is a book in which transactions are recorded by the company. However, DLT is not just a financial ledger. It can be understood to be a multipurpose ledger which may record operational, financial, qualitative or quantitative aspects of particular transactions/arrangement.
Enter Blockchain/DLT concept: the transactions are recorded with timestamp in distributed ledger simultaneously across several computers which may belong to participants of DLT. The transactions once recorded on DLT are irreversible or unalterable. Any attempt to modify recorded transaction will require a particular participant of DLT to pass a new entry or block on DLT in addition to original block. Such attempt will be evident to all the participants in the DLT. Hence, a transaction on DLT is permanent in nature and it is technically impossible to alter a recorded transaction.
As DLT is spread over several computers on internet, a single system crash/failure does not result in loss of records.
At a particular point of time, the view of distributed ledger is same for all the participants on DLT. The immutable nature of DLT and ability of all the parties in arrangement to access all the ledger records on real time basis provides a promise of end to end transparency and security.
Each participant in DLT may be able to broadcast and record the attributes of a particular transaction on the ledger.
Further, DLT can programmed with business logic to validate only certain type of transactions and automate such transactions, if conditions are met (smart contracts). Also, the payments for transactions can be automated in case the programmed conditions are satisfied (smart payments). The ability of DLT to execute smart contracts and enable smart payments will be major application for MNE groups in their cross border transfer pricing apart from fact that DLT may bring supply chain transparency and ensure robust internal controls.
How DLT will applied in Multinational Transfer Pricing?
As per United Nations Transfer Pricing (TP) Manual, about 30% of global trade is intra-firm trade.
Each country has transfer pricing regulations in its tax law which require cross border transactions between related parties (commonly referred as associated enterprises or AEs) to adhere to arm’s length price. Arm’s length price is the fair price which would mirror the price applied or proposed to be applied between non-associated enterprises/unrelated parties in uncontrolled conditions in open market.
The DLT which will be applied for MNE transfer pricing purposes will be private DLT/Blockchain. This is because, the ledger will be closed shared ledger with participants who are parties to intra-group arrangement/transactions rather than, open public Blockchain network which may accessible to general public (i.e. by parties having no connection to the transactions/arrangement).
DLT can serve as very important platform in cases where the supply chain participants in respect of particular end product/service consists only of AEs i.e. AEs are supply chain participants from point of procurement to point of sale. In such cases where entire supply chain of product/service consists of AEs (i.e. entities of group across the world are raw material procurement service provider, logistics support service provider, contract manufacturer, distributor etc. in relation to single product/service), all such AEs would be participants/nodes of a private DLT. The DLT ensures that movement of goods across entire supply chain is tracked and also journey of product through supply chain life cycle (i.e. stages of raw material procurement, manufacturing, logistics, distribution, marketing & promotion etc.) is broadcasted and recorded on distributed ledger which is visible to all parties in MNE group’s product supply chain. Such transparency will lead to operational efficiency. The operational efficiency is achieved because of recording and tracking of transactions and related operational aspects across the supply chain which ensures that, internal controls in relation to arrangement/transaction are adhered to (for e.g. : whether particular procedure is followed or not to abide by prescribed manufacturing standards would need to be broadcasted to DLT with evidence). Any lapse in controls will be clearly recorded and evident to all the participants of DLT. Further, each participant may broadcast the attributes of the goods (i.e. current state of goods, quantity [inventory calculation] etc.) to DLT which may be recorded on such distributed ledger.
Readers may note that, setting up DLT platform with all the unrelated parties or combination of AEs and non-AEs in a product/service supply chain to record the transactions in distributed ledger is very much feasible and practically achievable. While it may not be feasible to broadcast the information on financial dealings between two parties on such distributed ledger, such distributed ledger with unrelated parties as participants on DLT may help in achieving supply chain transparency and operational efficiency. However, currently certain software giants are aiming at introducing functionality in DLT platform which would create an exception where financial transactions may be recorded only between dealing parties on their ledger and may not be broadcasted among all the parties. The other parties would only be made available with the detail that, payment for the transaction took place. At this stage, for the purpose of this blog we will not go into debate as to whether such functionality is moving away from very concept of distributed ledger and whether the all the participants would agree to such exception as very foundation of distributed ledger is trust between parties.
Coming again to situation where all the distributed ledger participants/nodes are AEs who are parties to the product/service supply chain – apart from ensuring operational efficiency and supply chain transparency in arrangement, the distributed ledger will be highly effective for inter-company transfer pricing as the MNE group will be in position to program certain business logic in the DLT in advance on account of which the TP policy and terms and conditions of the inter-company transactions will be programmed on DLT. The DLT will operate on ‘if – then’ condition i.e. contracts between parties will be executed only if the ‘if – then’ conditions are satisfied. For e.g. : Company A requires 1000 tonnes of bearings from Company B, the contract will be executed only if Company B is able to broadcast that, it has 1000 tonnes of bearings available in its inventory. Further, the payments will processed automatically only if the transaction is recorded as per pre-determined TP policy. For example: Company B which is contract manufacturer has to charge cost + 15% on goods manufactured as per MNE Group’s TP policy. ‘Company B’ will raise invoice on ‘Company A’ providing details of its costs and associated mark-up as per group TP policy. In case the invoice and details broadcasted on ledger meets group TP policy, the payment will be automatically released from ‘Company A’ to ‘Company B’. This is how concept of smart contracts and smart payments will be executed in case of inter-company transactions. The legal experts/lawyers have been questioning the legal sanctity of smart contracts and associated validity in court of law. However, transfer pricing professionals would admit that, contracts/agreements between AEs can be entered smartly through DLT. This is because, the probability of legal disputes between AEs is close to nil. The contracts in paper form may be relevant only for demonstrating the terms and transaction to tax authorities during tax audit. However, we are speaking about future where DLT would have reached maturity stage and tax authorities may be given access to distributed ledger records to audit the transactions. Further, presence of paper contract may be relevant to unrelated acquirer who may enter into transaction of acquiring particular entity of the group which may be part of such supply chain.
However, we should not view the utility of DLT with narrow eyesight. DLT platform may be highly relevant in case of MNE groups with several subsidiaries and highly active intra-group trade. In this case, it may be difficult for headquarters (HQ) entity/country to centrally have a complete picture and control of all the intra-group transactions. Further, implementing a common TP policy for the entire group may be highly desirable but difficult to achieve on account of expanded nature MNE group.
So how can we use DLT in these cases?
Consider a multinational enterprise (MNE) group which has about 500+ subsidiaries across the world and intra-MNE trade is very active. In this case, we can build DLT to have all the 500+ entities as participants on the distributed ledger. TP policy of MNE group is designed based on ex-ante (before undertaking transaction) transfer pricing analysis of the transactions so as to ensure that any transactions between AEs meet arm’s length test when ex-post (after undertaking transaction) transfer pricing analysis. In case under consideration, a global TP policy of the group may be designed and programmed into DLT. As discussed earlier, the transaction the will be undertaken and validated only if they adhere to the TP policy, other terms & conditions of the transaction and accordingly meet consensus among all the node participants.
In countries like India, where interest is levied by tax authorities on receivables/outstanding balances in respect of inter-company transactions, the smart automated payments on account of DLT may eliminate the TP controversy in respect of outstanding receivables in entirety, as the payment will be released once the business logic programmed into DLT platform is met.
One of the limitation of DLT is the case where TP policy applicable for different group entities is different and the HQ entity may not wish to infuse transparency among all the group participants. In such case the HQ entity may choose that financial aspects of transactions may be recorded only between dealing parties and HQ on their ledger and may not be broadcasted among all the parties. However, we all are conscious of the fact that, transparency is the new ‘mantra’ in transfer pricing on account of introduction of Action 13 Master File requirements which requires the MNE enterprises to disclose its TP policy, intangibles, supply chain, value chain details etc. Hence, in new world of transfer pricing transparency, hiding details of TP policy among group participants may be extremely difficult.
Another inter-company arrangement which is novel in nature but may have high potential for DLT platform is cash pooling arrangement. Without going into technical aspects and types of cash pooling arrangements, author would just touch upon basic aspects. A cash pooling arrangement enables MNE group to combine its credit and debit positions in various accounts spread across group entities into one account. Such one account may be maintained by cash pool leader entity. Cash rich entities in the group may deposit funds with leader in return of the interest income. Part of such funds are then provided to group entities in need of funds as loans and interest is charged. The difference between the interest receipts on deposits and interest payments on loans may be spread earning for cash pool leader. Also leader may deposit the cash with third party banks on which it may earn interest. It is important that, all interest payments and interest receipts among group participants should adhere to arm’s length. Further, any interest spread earned by leader over and above arm’s length may be allocated among cash pool participants in predetermined ratio, as it may important from transfer pricing standpoint that benefits of the arrangement are shared among participants. In this case, the distributed ledger would ensure that, all the payments and receipt among parties to the cash pooling arrangement adhere to arm’s length and there is complete transparency and record of movement of funds across the group. Further, the DLT platform may be programmed to achieve last leg of cash pooling arrangement i.e. split of excess spread among the cash pool participants.
Taking the above concept of splitting excess spread to a different tangent, the distributed ledger may be programmed with predefined logic (residual/contribution profit split mechanism or process contribution analysis) to achieve split of profits in different type of transactions i.e. the DLT may be instrumental to achieve arm’s length profit split.
While author is not supporter of cryptocurrencies, the author would like to bring the perspective on table where cash pooling arrangement may be structured among AEs using cryptocurrency removing the need of intermediary i.e. bank whereby all the entities in cash pool arrangement financially transact with each other only by using the cryptocurrency (which do not require need for bank account, bank clearance and deposit) rather than using physical money. However, it should be borne in mind that, cryptocurrencies are not regulated, do not have legal acceptance and exchange rates of such currencies highly fluctuate. Further, for this to be practically implementable, we are envisaging the world were cryptocurrencies will be widely accepted as tender of exchange between parties to the business arrangements on part with fiat currencies.
The next question is, do tax advisors (accounting firms) of company have a role? The answer is ‘Yes’.
The tax advisors/accounting firms may be participants of such distributed ledger along with the AEs. The role of the tax advisors may be to conduct real time audit of inter-company transaction to verify whether they actually adhere to arm’s length by performing TP analysis and validate them in DLT. In this case, the payment would be released automatically only if the arm’s length pricing requirement is validated and confirmed.
The last section of this blog is turning towards super futurism by considering involvement of tax authorities in such MNE Group’s DLT. Consider a future where tax authorities are one of participants of distributed ledger which may enable them to do real time transfer pricing audit of inter-company transactions. This may require change in tax regulations and creation of necessary infrastructure on part of government. Further, the concerns on confidentiality of data do remain in such case as tax authorities (government) may not sign non-disclosure agreement with taxpayers.
(Sagar Wagh is international thought-leader in the areas of international tax and transfer pricing based in London, United Kingdom. Sagar is also Blockchain enthusiast and supply chain specialist. The views expressed in the article/blog are his personal views. Sagar can be reached at email@example.com)
 Sagar Wagh is a Blockchain Enthusiast, Supply Chain Specialist and International Tax thought-leader based in London. He can be reached at firstname.lastname@example.org. The views expressed by author in this article are his own views