Transfer Pricing Challenges in the Cloud

INTRODUCTIONThe buzzword "cloud computing" is more than a technological fad. As businesses from all industries increasingly move their operations to the cloud, cloud computing has proven to be a key driver of electronic commerce and has already generated more than $150 billion in market sales annually. 1 Cloud computing, which generally refers to the provision of information technology ("IT") services in a virtual environment, allows a business to share computing resources, such as software, storage space, databases, IT personnel, hardware, and other infrastructure.2 It has become an attractive way of acquiring computing resources because it eliminates the need to manage captive IT infrastructure, provides scalable, on-demand service, and offers substantial cost savings, efficiencies, and other benefits to businesses.3 Although this movement to the cloud provides businesses with substantial benefits, it also raises novel international tax issues that present challenges for both businesses and tax administrations. This Article focuses on the significant challenges that arise in applying the transfer pricing rules to multinational enterprises ("MNEs") providing cloud services internally.4Every business that transacts internationally with related parties must take into account the transfer pricing rules. Transfer pricing is the price charged by one entity to a related entity for property or services.5 Therefore, where one or more members of an MNE group provide IT resources remotely to related members of the group, U.S. law, as well as the law of most other countries, dictates there must be an associated charge between the cloud service provider and the affiliate that is using those cloud computing services.6Transfer pricing is of significant concern to both taxpayers and tax administrations, because the transfer pricing rules affect how profits and losses are allocated among related entities in different jurisdictions that transact with each other. As a result, transfer pricing impacts the amount of tax revenue a particular taxing jurisdiction can collect, as well as the overall amount of after-tax profits the MNE group realizes. 7 To minimize intercompany price manipulation, the transfer pricing rules apply an arm'slength standard, which requires that the results of transactions between related taxpayers be consistent with the results that would have been realized if independent, unrelated parties had engaged in a comparable transaction under comparable circumstances.8 Cloud computing, however, exacerbates difficulties that already exist in determining an arm's-length price for many intercompany transactions in our global economy. 9 This Article evaluates these challenges in the context of cloud computing and argues that even though the current transfer pricing rules create significant compliance risks for companies that use an intercompany cloud in their operations, these rules also present significant tax planning opportunities.10In particular, with sufficient advance planning, companies can utilize the transfer pricing rules in a manner that will shift the MNE's income from the home jurisdiction to alternate low- or no-tax jurisdictions without a cor- responding change to their business operations.11 By doing so, the MNE can lower its overall worldwide tax liability with the possibility of some income completely escaping taxation. This type of tax planning presents tremendous challenges for governments worldwide as it artificially shifts profits away from the jurisdictions where the activities creating those profits take place to jurisdictions with favorable tax regimes. The manipulation of the transfer pricing rules in this manner has become one of the largest contributors to base erosion and profit shifting, commonly referred to as "BEPS."12Many people, from academics, policymakers, and governments to the public and media outlets, have taken notice of the severity of the BEPS problem and have called for reform of the international tax rules. …