This is part three of a three-part feature on combating base erosion and profit shifting. If you missed it, read part one now. And part two can be found here.

Underpinning the conversation about transfer pricing is the notion there are clearly circumstances when the complex transfer pricing arrangements put in place by multinational entities are obviously “too hot” and all that’s required to put an end to such practices is enough data and legislative muscle.

Lawyer Carmen McElwain cautioned against that view. A partner at Maddocks and the head of that firm’s national tax controversy team, she has advised both the ATO and clients who are in dispute with the tax office and says assessing whether a transfer pricing arrangement is too aggressive can be an exhaustive process.

“It usually only lands… after there is a lot of examination of the facts. And that can take a very long time during a risk review,” McElwain says.

“That’s part of the issue. These factors are very complex. You try and identify all of the facts and the conditions that apply between the parties and how those conditions take place and how the transactions take place. [Then] at the end of the day… the ultimate tax liability… is usually decided by economic experts at ten paces.”

Drinking the Kool-Aid

Professor of taxation at the University of Sydney Graeme Cooper agrees.

“Transfer pricing is a kind of cult,” Cooper says. “It’s a ghetto. It’s a whole bunch of self-referential people all talking to each other. They’ve all drunk the Kool-Aid. They all understand the transfer process. And then somebody from outside – let’s call them a judge – comes and looks at this and says: ‘I don’t understand why you’re taking the interquartile range and weighting it for movements in the commodity prices that occurred on Thursday and dividing by the number of bars in the National Anthem to get a range that goes from $8 to $637.’ That’s what transfer pricing is.

“There must be a better way,” Cooper says. “We are actually saying to a vertically-integrated multinational: ‘You’re not vertically integrated. Pretend you’re not.’ It’s just ridiculous. And until transfer pricing is kind of exploded, set on fire, reconceived from the ground up, we’re going to be having these fights all the time.”

Earlier this year in Sydney, the G20 finance ministers tried to cut through the complexity by signing up to the principle that “profits should be taxed in the place where the value is created or the economic activities occur”.

But in the digital economy that activity may not occur in a bricks and mortar office, but somewhere in “the cloud”.

Quantum mechanics and digital taxpayers

All of which leaves a revenue collector reaching for reference works on quantum mechanics when dealing with digital taxpayers, as Konza freely jokes.

“And their answer to me when I say, ‘Where do you do business?’ is ‘You know Heisenberg’s theory says we can’t define both the direction and location of a particle at any one point in time’.”

“This kind of exchange just kind of clearly raises the difficulty with [slogans],” says Cooper.

“We’re good with… slogans, you know: Stop the Boats, Scrap the Tax, Tax Economic Activity Where It Occurs. ‘Tax economic activity where it occurs’ is blancmange. You can’t attach any real meaning to that concept and so we are trying to breathe life into a creaky old corporate tax system that modern public finance theory says should not exist.

“One part of the OECD is saying: ‘We’ve got to preserve the corporate tax, we’ve got to do it through BEPS’, and another part of the OECD is saying: ‘By the way, taxes on corporate profits are really, really inefficient and destructive of growth’. And until we kind of bite the bullet on the fact that the corporate tax is probably a doomed species, it’s the betamax recorder in the world of the blu-ray.

Until we kind of bite the bullet ... it’s the betamax recorder in the world of the blu-ray.

"Until we bite the bullet on that and have, for example, serious property taxes or a marginal increase to our consumption tax base or we play with serious wealth and inheritance taxes then we are just going to keep having this fight about trying to keep the life support machine on.

“It’s giving us some money for the moment but God help us when it really finally collapses,” laments Cooper.

For Treasury’s Heferan and his political masters – working on a tax reform white paper to be delivered at the end of 2015 –  shoring up a leaking system that still delivers billions of dollars in corporate tax revenue every year is very much worthwhile.

“Corporate tax matters for us more than other countries because we collect so much. Much more than any other country relative to our tax base, our overall tax collection,” Heferan says. "So it’s a big deal for us. We can’t let it wander out the door."

Ellen Fanning is a leading Australian journalist. She moderated a panel discussion exploring the complexities of taxing multinational enterprises at the recent Public Sector Symposium held by Chartered Accountants Australia and New Zealand in Canberra.

This article was first published in the Oct 2014 issue of Acuity magazine.