Ethics in transfer pricing : a study of transfer pricing professionals in Eastern Europe

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Ethics in transfer pricing.

A study of transfer pricing professionals in Eastern Europe

Student: Iulia Maria Suciu Student number: 10874771 Date: 22nd_{of June, 2015}

Word count: 23.637

Program: MSc Accountancy and Control, variant Control

Institution: Faculty of Economics and Business, University of Amsterdam Supervisor: PhD Candidate Conor Clune

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Statement of originality

This document is written by Iulia Maria Suciu who declares to take full responsibility for the contents of this document.

I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it.

The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.

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Abstract

Purpose - The purpose of this paper is to provide an understanding of the transfer pricing professionals’ perception of ethics.

Design/methodology/approach - This paper’s aim is addressed through a case study that examines the meaning and place of ethics in a specific transfer pricing context. Relevant information for this case study was gathered from nine semi-structured interviews with transfer pricing professionals and documentary analysis. The theoretical framework used for the mobilization of this study refers to a synthesis of factors that generate ethical dilemmas in a tax environment. Additionally, the ethical perceptions of transfer pricing specialists were explained using Jones’ issue-contingent model of ethical decision making.

Findings - The case study unveils that the focus of transfer pricing professionals is oriented towards defending their clients, as this ensures their firm’s survival. There is no place for ethics in transfer pricing area, as it is surrounded by subjectivity and lack of clear rules, but there is a clear commitment to the legislation. The ethical behavior of the transfer pricing professionals is impeded by three factors: the artistic nature of transfer pricing, regulatory issues and professional body issues. Moreover, there is a strong concern for risk management procedures as these help them to maintain a good reputation. Both risk management and reputational concerns were associated with a higher degree of ethical behavior.

Research limitations - The main limitation refers to the low degree of transferability of the findings to another contextual setting as the transfer pricing professionals perceptions are undoubtedly influenced by the context in which they operate. Moreover, the findings may suffer from subjectivity issues since the data was analyzed by a single coder.

Originality/value - This paper is the first to analyze transfer pricing professionals’ perceptions of ethics. It offers an in-depth empirical analysis of transfer pricing consultants’ view of ethics, focusing on the factors that generate ethical dilemmas.

Keywords ethics, transfer pricing, risk management, transfer pricing professionals, perception of ethics

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List of abbreviations, tables and figures

List of abbreviations

Abbreviation Definition

TCO Tax consultancy organization

BEPS Base Erosion and Profit Shifting

TP Transfer pricing

OECD The Organization for Economic Co-operation and Development

List of tables

Table 1. Moral intensity components ... 15 Table 2. Overview of interviews undertaken ... 23

List of figures

Figure 1. Jones’ issue-contingent model of ethical decision making in organizations ... 17 Figure 2. Theoretical framework - factors that trigger ethical dilemmas ... 21 Figure 3: Summary of the findings ... 50

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1. Introduction

In the recent past globalization has shaped the economic world. According to OECD today more than 70% of world trade takes place within multinationals (Tax Research UK, 2010). The price at which companies from various jurisdictions and from the same multinational group (under common control and with common interest) trade goods and services is referred to as transfer pricing. Transfer pricing is a controversial topic being in the attention of tax authorities around the world due to a series of scandals about its malicious use in the process of tax minimization by multinational giants such as Google, Starbucks and Amazon. Transfer pricing is the most significant tax avoidance mechanism used to exploit gaps and grey areas in tax rules to artificially shift profits to low or no-tax locations from high-tax jurisdictions, resulting in little or no overall corporate tax being paid. In this regard, the United States were first to acknowledging the matter at hand back in the 1917 when the IRS was authorized to allocate income and deductions among affiliated corporations. Latest developments on the issue include the OECD project named Base Erosion and Profit Shifting which is planning to limit these aggressive tax strategies by providing the regulatory instruments needed to address this issue.

Most of the transfer pricing research has focused on discussing the transfer pricing methods (Pfeiffer et al., 2011; Sahay, 2003), the managerial problems encountered due to divisional transfer pricing (Baldenius et al., 2004) or the malicious role of transfer pricing in depriving the rightful revenue to the countries entitled to receive it (Bartelsman and Beetsma, 2003; Christian Aid, 2005, 2009; Sikka and Wilmott, 2010). Furthermore, a recent handful of few studies have argued that multinationals play an unethical and anti-social role in their efforts to maximize profits and that the tax practitioners are providing help by acting as local facilitators (Otsunaya, 2011; Sikka and Hampton 2005; Sikka and Wilmott, 2013). This raises important questions regarding the ethical concerns of the tax professionals, topic which has not been highlighted in the transfer pricing field, while there is just a little work done on ethics in tax practice (Doyle et al., 2009). Specifically, the ethical aspects of transfer pricing have been addressed just by a few papers which merely discuss the ethical implications of transfer pricing (Jeffers et al., 2008; Mcgee, 2010), outline types of harms (Mehafdi, 2000) or present transfer pricing ethics using the concept of tax ethics - tax practitioners must comply with the laws – and moral ethics - tax practitioners should do what is right – (Hansen et al., 1992). None of the previous papers have presented case data regarding the perceptions of transfer pricing professionals in an organizational context.

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The motivation for this paper consists of three reasons. Firstly, recent years have witnessed an increased societal attention to the transfer pricing practices and their role in enriching the multinationals and their facilitators while impoverishing the societies (Mehafdi, 2000; Sikka and Wilmott, 2010). Developing an understanding of the perceptions of ethics of the transfer pricing professionals can provide a valuable insight and facilitate policy makers and professional bodies with appropriate responses. Secondly, given the subjective nature of transfer pricing, the fact that it “is not an exact science” (OECD, 2010) and the current development of BEPS project by OECD, this research can provide a better understanding of the issues in the transfer pricing field and the factors that enable the design of aggressive schemes. Thirdly, this is to my knowledge the first empirical study to engage in case-based work examining the ethical perceptions of transfer pricing professionals.

This paper aims to provide an understanding of the ethical perceptions of transfer pricing professionals. Using a theoretical framework that presents factors that give rise to ethical pressures, it presents the most important factors that raise issues in the transfer pricing field as well as field specific characteristics. Given the fact that the ethical perceptions revolve around ethical dilemmas and their approach, this framework facilitates the reveal of these professionals’ viewpoints and provides a complete picture of the ethical environment of the transfer pricing professionals through their specific lenses. In addition to the theoretical framework, this study adopted a theory on ethical decision making process to unveil the defective stages in practice. This mobilization of theory is pursued as it is a comprehensive theory which allows theorizing the findings.

This paper’s aim is addressed through a case study that examines the meaning and place of ethics in transfer pricing activity. Specifically it involves conducting semi-structured interviews with transfer pricing professionals from a professional services firm specialized in provision of transfer pricing services in Eastern Europe, which situates among the top providers of transfer pricing services in its operating country according to revenue and reputation. This paper focuses on the Eastern European for three reasons. Firstly, there is a lack of academic research into Eastern European context. Secondly, transfer pricing is a relatively new practice in this context, hence it is an interesting topic to investigate as it is probably to develop in the near future. Thirdly, taking into consideration that Eastern Europe is a developing area and that transfer pricing is more daunting in developing countries, perceptions from a developing context may be more insightful and revealing than in a more developed context. Lastly, there is a limited capacity of revenue authorities to conduct transfer pricing audits in this area, hence it is important to understand the ethical perceptions of the consultants within this environment to be able to react properly.

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This paper contributes to prior research on ethics in tax practice in two ways. First, it seeks to empirically advance prior research by examining the tax practice in Eastern Europe, thereby responding to calls to empirically research the tax practice field (Special Issue of Critical Perspectives on Taxation, 2010; European Accounting Review Special Issue on Tax Research, 2015). Specifically this paper reveals how ambiguity in the tax law, multiple stakeholders issue, risk management and reputational issue impact on the operationalization of this practice. Moreover this paper brings a second novel contribution to the prior literature by scrutinizing the perceptions of ethics of transfer pricing professionals, thereby answering to calls for research for further insights into tax professionals’ ethical decisions (Shafer and Simmons, 2008) and to the “the need for empirical studies that specifically address TP ethics” (Mehafdi, 2000, p.369). In this case, I found that the artistic nature of transfer pricing empowers professionals to engage in creative data management, use argumentation and professional judgment to fulfill their main duty of defending their clients, hence engaging themselves in what could possibly be unethical behavior. Regulators and professional bodies seem to enable this behavior through lack of appropriate control. In contrast with the ethical commitment, risk management procedures are quite important to protect the firm’s reputation and implicitly its survival.

The remainder of this paper is organized as follows. First, the literature review on tax avoidance, ethical aspects of tax avoidance and Jones’ issue contingent ethical decision making model will be discussed concluding with presenting the theoretical framework employed for outlining the findings. Next, the research methodology will be illustrated presenting information regarding data collection, data analysis and case context. This is succeeded with a discussion of the case narrative examining the transfer pricing consultants’ perceptions of ethics. The discussion section employs Jones’ issue contingent ethical decision model to unveil the ethical decision making process and its flaws. The final section concludes and provides suggestions for further research.

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2. Literature review

The literature review is structured in two sub-sections. First, it starts with a broad discussion on tax avoidance then specifically address the ethical aspects of tax practice. Prior literature lists common ethical issues in tax practice and describes the ethical decision making process as a complex and step divided process that can often be influenced by individual or organizational factors. Next, the Jones’ issue-contingent ethical decision making is presented. The second sub-section presents the theoretical framework, which consists of eleven factors that generate ethical pressure in the tax practice environment.

2.1. Tax avoidance

This sub-section is divided in three parts. First the tax avoidance concept is addressed and relevant prior literature about tax avoidance is discussed. Next the field of tax ethics is examined concluding with the Jones’ issue contingent ethical decision making model.

2.1.1. Introduction to tax avoidance

In the recent years there has been increasing discussion surrounding tax avoidance. It is a common topic among governments, media, society or universities. Tax avoidance is one of the biggest elements of the tax gap and needs to be tackled. (HM Treasury, 2011). Tax avoidance is a difficult term to define and there are a lot of interpretations. By aggregating those definitions one can say that tax avoidance is the practice of using techniques to minimize tax liability while following the letter of the law. A more formal definition of tax avoidance provided by HMRC (2012, p. 1) is:

“Tax avoidance is bending the rules of the tax system to gain a tax advantage that Parliament never intended. It often involves contrived, artificial transactions that serve little or no purpose other than to produce a tax advantage. It involves operating within the letter – but not the spirit – of the law. Tax avoidance is not the same as tax planning. Tax planning involves using tax reliefs for the purpose for which they were intended.”

A notable distinction has to be made between tax evasion, which is illegal and tax avoidance, which is not. Tax evasion refers to the practice of hiding or ignoring the tax liability. The HMRC 2014 report on tax gap estimates for the period 2012-2013 claims that the tax gap is 6,8% of the total tax liabilities (£34 billion) and that tax evasion, respectively tax avoidance is responsible for 12%, 9% of it.

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Studies have shown that tax avoidance can be reduced by increasing tax enforcement. Hoopes et al. (2012) reported that US public firms undertake less aggressive tax positions when tax enforcement is stricter. Going to a different level of power, from the regulator to the management team of a company, Dyreng et al. (2010) found out that top executives have a significant role in determining the level of tax avoidance that firms undertake. This can be explained through the fact that reputational concerns affects the degree to which managers engage in tax planning (Graham et al., 2014). Moreover, Hardeck and Hertl (2014) examined the link between corporate tax strategies and corporate social responsibility and reported that aggressive corporate tax strategies are related with damaged corporate reputation, while on the contrary responsible corporate tax strategies enhance the corporate success measured through corporate reputation, consumer purchase intention, and willingness to pay. Regarding corporate social responsibility, Lanis (2015) found out that there is a direct and negative relationship between corporate social responsibility and tax avoidance. This result is supported by Hoi et al. (2013), who concluded that firms with irresponsible CSR activities are more likely to engage in tax avoidance activities and greater discretionary/permanent book-tax differences. Moreover, Ylönen and Laine (2014) presented a qualitative case study of the tax planning arrangements of a multinational using transfer pricing as a tax avoidance tool, and argue on the fact that corporate taxation needs to be considered as a CSR issue and require a careful examination of what corporations actually say in their tax disclosures. The corporate social responsibility is enhanced through proof of ethical behavior. In the tax literature, tax avoidance is incorporated into the field of tax ethics (Frecknall-Hughes, 2007). Next there will be a discussion about the ethical facets of tax avoidance.

2.1.2. Ethical aspects of tax avoidance

Before discussing the ethical aspects of tax avoidance, a proper introduction to ethics has to be made. Morals are the norms, values and beliefs that govern which actions are right or wrong and ethics is the study of morality. Ethics “is concerned with understanding what determines whether something is good or bad, right or wrong” (Lewis and Unerman, 1999, p. 522) and enlighten clear rules and principles which determine the right and wrong for any situation. During this paper the terms of ethical and moral are considered equivalent and will be used interchangeably. In the business environment, the concept of business ethics is defined in a variety of ways. In this regard, Lewis (1985, p. 381) reviewed and examined the literature on business ethics and provided the following definition of business ethics: ”rules, standards, codes or principles which provide guidelines for morally right behavior and truthfulness in specific situations". He argues that although the definition provided is

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abstract, it highlights the common concepts used by business writers and professionals – moral rules, standards, codes and principles governing individual behavior. Although the definition provided by Lewis (1985) is a simple one and in connection with the general definition of ethics, in practice things may not work like they are supposed to. According to Gill (2009, p.112) in a corporation everyone “operates in a different moral environment comparable to that described in the corporate context”. In other words, even if in a corporation there are specific guidelines, rules to follow in order to assure a proper and ethical behavior, often there are interests in organization that do not fit in the ethical norms. This is the case that Gill accentuates when citing a former vice-president of a large firm:”What is right in the corporation is what the guy above wants from you. That’s what morality is in the corporation” (p. 112).

As tax environment is a technical and complex area, it is characterized by the presence of ethical pressures. Marshall et al. (1998) presented a list of ethical issues in terms of perceived frequency occurrence and importance to tax practitioners. Failure to make reasonable enquiries when information or documentation provided by a client is incomplete or inaccurate is the most frequently cited ethical issue, while the most important ethical issue is failure to ensure confidentiality regarding client information. When combining high frequency with high occurrence ethical issues they found as ethical issues: failure to make reasonable enquiries when information is incomplete or inaccurate, failure to maintain an adequate level of technical competence, continuing to act for a client in circumstances where incorrect or inaccurate information is not corrected by the client, conflicts generated by having to differentiate legitimate tax planning from tax avoidance, failure to conduct adequate research, concealing limitations in a tax practitioner’s technical competence. Therefore, Marshall et al. (1998) revealed that area of competence, credibility and professional competence represent issues of overriding concern to tax practitioners in carrying out their duties. Moreover, client pressure was identified as the most difficult ethical problem faced by tax practitioners (Cruz et al., 2000). The study investigated professional tax practitioners' ethical judgments and behavioral intentions in cases involving client pressure indicated that ethical decision making is mainly influenced by the moral equity dimension (which includes items relating to philosophies of justice (fair/unfair, just/unjust), followed by the contractualism (which includes two deontological items – violates/does not violate an unspoken promise, violate/does not violate an unwritten contract) dimension.

The act of ethical decision making is a complex one and still not completely understood. Rest (1986) presented a model of moral decision-making that involves four steps: moral sensitivity (recognition of an ethical issue), moral judgment or reasoning, moral motivation or intent and moral

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character (engaging in moral action). Regarding the first step in this ethical decision making process, Yetmar and Eastman (2000) employed a study to examine the role of ethical sensitivity in ethical decision-making by examining the decisions of tax practitioners. They found that there is a positive relationship between ethical sensitivity and job satisfaction for a tax practitioner, and a negative relationship between role conflict (i.e. degree of incompatible expectations communicated to an employee of an organization by others within and outside the organization) and ethical sensitivity. Yetmar and Eastman (2000) argue that in the relationship found regarding job satisfaction and ethical sensitivity, there might be some degree of causation, in both direction as it is not unlikely that the more ethical is the tax practitioner the more job satisfaction he experiences. Furthermore, Doyle et al. (2013) examined tax consultants’ moral reasoning in a societal and tax context using Kohlberg’s six stages of development theory. They found out that tax consultants reason at lower level in tax contexts than when considering social context ethical dilemmas. Based on the reviews made on empirical ethical decision making in the literature made by Ford and Richardson (1994), O’Fallon and Butterfield (2005) and Craft (2012) covering the prior literature from 1972 until 2011, there are no studies on ethical decision making that cover moral intent on tax / accounting professionals. Regarding the last step of the decision process, moral character, Shapeero et al. (2003) found that the probability of senior and staff-level accountants to engage in unethical behavior is lower than in the case of supervisors or managers.

Along this ethical decision making process, there are many factors that can intervene. In the literature they are divided in two main categories: individual and organizational factors.

Various studies found out that individual factors have an influence upon ethical / unethical behavior. Examples of individual factors are: age, ethical judgment, gender, Machiavellianism, work experience or philosophy orientation. O’Fallon and Butterfield (2005) presented in their literature review that the intentions to engage in unethical behavior are influenced by attitudes. They have also reported that assumptions about ethics, deontology and teleological have influence upon intentions. Machiavellianism is a predictor of professional judgment towards aggressive tax minimization. (Shafer and Simmons, 2008), a finding that is similar with the fact that Machiavellians are less ethically-oriented than non-Machiavellians (Rayburn and Rayburn, 1996). Weeks et al. (1999) also discussed the importance of experience in ethical judgment, as it seems that individuals in the latter years of their career have higher ethical judgment. In addition relativism oriented individuals are more likely to make unethical decisions (Callanan et al., 2010).

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As Elango et al. (2010) argued, along with individual factors there are also organizational factors that influence ethical decision-making. Elango et al. (2010) found out that managers take decisions based on their own experiences and values, but they are also influenced by the ethical standards and practices observed within the firm. Examples of organizational factors are ethical climate, code of ethics, organizational climate, opportunity, rewards, sanctions, significant others or training. The ethical climate has a direct and positive effect upon ethical decision making of auditors (Shafer, 2008). This is further supported by a study on tax practitioners, which found out that dimensions of ethical culture (i.e. low ethical norms and incentives that supported unethical behavior) had highly significant effects on intentions to engage in aggressive tax minimization strategies (Shafer and Simmons, 2008). Ethical climate may refer to either peer influence, superior pressures or tone at the top. There is compelling evidence that peer influence, manager influence, supervisors’ expectations influence ethical behavior. (Beams et al., 2003; Jones and Kavanagh, 1996; Sims and Keon, 1999). Bobek et al. (2010) reported a difference between partner and non-partner perceptions regarding ethical environments of their firms and occurrence of ethical dilemmas, with partners having a more optimistic view regarding the overall firm and firm leadership as acting more ethically.

Another organizational factor is represented by the existence of codes of conduct. There is no consensus on the influence of code of ethics upon the behavior of the employees of an organization. Empirical studies found out that codes of ethics do not influence ethical behavior nor judgment (Douglas et al., 2001) while other studies found that professionals working within firms that have a code of conduct behave more ethical than professionals within firms without codes of conduct (McKinney et al., 2010). Hume et al. (1999) reported that most of the certified public accountants follow the Statements on Responsibilities in Tax Practice (SRTPs) when making ethical decisions regarding tax return preparation and compared to unlicensed accountants they follow the SRTPs more often on half of the issues tested. Furthermore, organizational factors consist of rewards or sanctions. Perceived likelihood of rewards influence individuals to engage in unethical behavior (Shapeero et al., 2003). Shafer and Simmons’ (2011) findings also support this results. They found out that an organizational culture that rewarded ethical behavior reduced the chances that tax practitioners will engage in aggressive tax minimization strategies. Returning to the Rest’s (1986) moral decision-making model composed of four steps, the discussion continues with the presentation of a model founded on Rest’s theory, the issue-contingent model of ethical decision making introduced by Jones (1991).

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2.1.3. Jones’ issue-contingent model of ethical decision making in organizations

In this sub-section Jones’ (1991) issue contingent model of ethical decision making is introduced and will be used in the discussion section to help understand the findings. This issue-contingent theory uses Rest’s (1986) four-component model as a foundation and completes the model by synthetizing the previous ethical decision-making models: Trevino (1986), Dubinsky and Loken (1989), Ferrel and Gresham (1985) and Hunt and Vittel (1986). Trevino (1986) presented a general theoretical model, while Ferrell and Gresham (1985), Hunt and Vitell (1986), and Dubinsky and Loken (1989) presented models that focus on marketing ethics. This theory is adopted due to its extensiveness, since it integrates previous ethical decision models. In addition it introduces the concept of moral intensity to include the characteristics of the moral issue. The ethical decision making model is depicted in figure 1.

Jones starts its discourse by defining moral issue, moral agent and ethical decision. A moral issue is present when a person’s actions or decisions have consequences for other people and involve choice on behalf of the decision maker. The moral agent refers to the person that takes the moral decision with or without recognizing the moral issue. A decision is ethical if it is legal and morally acceptable to the larger community.

The foundation of this ethical decision model stays in Rest’s four component ethical decision making theory. Rest presented a four processes plan for ethical decision making. In order for an individual to engage in an ethical decision making and behavior, he must prove moral sensitivity (i.e. recognize the moral issue), make a moral judgment, establish moral intent (moral motivation) and act on the moral concerns (moral behavior). Each component of this ethical decision making is specific and success in one step does not mean success in the others steps.

The first step involves recognizing the moral issue and is mandatory to be able start the ethical decision making process, as if an individual can not distinguish the moral issue then it is no ethical decision making involved. This step involves two elements: an individual must admit that his or her decisions will have consequences for other people and that some choice is involved.

Next a moral judgment is made which is dependent of the individual’s cognitive moral development. The moral development of an individual is addressed by Kohlberg’s (1976) six stages of moral development theory. According to this theory there are three levels of moral reasoning, namely pre-conventional, conventional and post-conventional level. Each level is divided in two stages, resulting in six stages of moral development an individual can grow through. The first level of moral reasoning - pre-conventional level - implies that individuals judge the morality of an action by its direct

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consequences. The second level of moral development – conventional level – implies that individuals judge the morality of an action by comparing it to the society’s views and expectations. The third level of moral development – post-conventional level – implies that individuals see themselves as separate entities from society and have their own principles which may be inconsistent with society rules. The third level is the most advanced level of moral reasoning and suggests that individuals do no longer see the rules as absolute and start questioning them forming their own ethical principles based on life, liberty or justice.

In the moral motivation stage the individual must decide the course of action. In this step of the process the individual will balance moral factors against other factors. One must not confuse the decision about what is “right” to do with the decision to act on that judgment (i.e. to establish moral intent). This establishment of the moral motivation is crucial to the ethical decision making process as intentions are important determinants of behavior. The last component of the process refers to engaging in the ethical behavior.

None of the previous existent ethical decision models included the characteristics of the moral issue itself, therefore Jones included in his model the moral intensity variable. He argued that the previous models that did not contain a moral intensity variable assumed that the moral decision making of individuals in organizations is identical for all moral issues. Jones argue that people are inclined to be more bothered by moral issues that affect those who are close to them compared to those with people that have little or no contact. Moreover, people usually react more strongly to damages that have immediate effect compared to those that have effect only in the future.

The moral intensity is positively related to every step in the ethical decision making process and mainly focuses on the moral issue. Moral intensity is composed of six components: magnitude of consequences, social consensus, probability of effect, temporal immediacy, proximity and concentration of effect. The following table summarizes these components:

Table 1. Moral intensity components

Component Definition

Magnitude of consequences

The sum of the harms (or benefits) done to the victims (or beneficiaries) of the moral act in question.

Example: An action that makes 1,000 people to suffer an injury is of greater magnitude of consequence than one that causes 10 people to suffer the same injury

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Component Definition

Social consensus

Degree of the social agreement that a proposed act is evil (or good).

Example: The evil act involving discriminating minority job candidates has a greater social consensus than the evil act involving refusing to act affirmatively on behalf of minority job candidates.

Probability of effect

A joint function of the probability that the act in question will take place and the act in question will actually cause the harm (benefit) predicted.

Example: The act of selling a gun to a known armed robber has a greater probability of harm than selling a gun to a law-abiding citizen.

Temporal immediacy

The length of time between the present and the consequences of the questioned action (a smaller amount of time means greater immediacy).

Example: the act of releasing a drug that will cause harm to 1% of the people that use it have a nervous reaction in a short timeframe after they ingest it has greater temporal immediacy than releasing a drug that will cause harm to 1% of the people that use it have a nervous reaction in 20 years time.

Proximity

The feeling of closeness – social, cultural, psychological or physical – that the moral agent has for the victims (beneficiaries) of the evil (beneficial) act questioned. Example: Layoff in a person’s work unit have greater proximity than layoffs in a remote plant.

Concentration of effect

The inverse function of the number of people affected by an act of a given magnitude. Example: The act of denying coverage of 10 people with claims of €10.000 has a greater concentrated effect than denying coverage to 10.000 people with claims of €10.

The moral agents are challenged in their decision making by organizational factors. These factors appear in the majority of the used ethical decision models. They may refer to organizational climate, rewards, sanctions, ethical codes of conducts, or significant others.

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Figure 1. Jones’ issue-contingent model of ethical decision making in organizations

2.2. Theoretical framework: factors that generate ethical dilemmas

In this sub-section is discussed the theoretical framework that comprise eleven factors that generate ethical dilemmas. This theoretical framework is employed as it facilitates the understanding of tax professional environment which is characterized by factors that create ethical pressures. According to the American Institute of Certified Public Accountants the ethical dilemmas related to tax issues are perceived by its members as the most difficult ethical problem (Fin et al., 1988), thus focusing on the factors that trigger ethical dilemmas this paper will be able to show a complete picture of the tax professionals’ view of these ethical dilemmas and encapsulate their perceptions regarding these factors, hence also about their ethical environment. Also, these factors are used to describe the tax environment through a tax professional’s lenses.

Figure 2 depicts a summary of the theoretical framework. This theoretical framework was built and presented by Doyle et al. (2009) through aggregating prior literature.

Ambiguity in the tax law

Tax legislation is a system of rules regarding tax enforced to control behavior. The tax law has been designed by government and as any human decision process the act of creating the laws has flaws, specifically in a developing and changing world. Therefore the tax law does not present in a clear and concise manner how certain situations should be dealt with and lets this to the professional

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judgment of the tax practitioner. Hence, in choosing among the alternatives a tax practitioner may face an ethical dilemma due to this ambiguity (Hume et al., 1999).

Multiple stakeholders

Today’s tax practitioner must be an agile tightrope walker, able to balance a host of divergent demands. Maintaining one’s equilibrium is indeed difficult as a clamour of voices shout conflicting demands…In light of this obstacle-laden course, contemporary tax practitioners are bound to encounter ethical dilemmas as they attempt to cross this often obscure pathway. (Dox, 1992, p. 71)

As highlighted by the previous quote, when taking decisions tax practitioners face multiple and different demands from their stakeholders: clients, revenue authority, colleagues, superiors, professional bodies or society. Due to their contradictory interests and the perceived need of the tax practitioner to fulfill all these demands, ethical conflicts will arise (Yetmar et al., 1998; Yetmar and Eastman, 2000).

Client pressure

Fin et al. (1998) conducted a study on the American Institute of Certified Public Accountants and found out that the “client proposals of tax alteration and / or tax fraud” represent the most difficult ethical issue for the respondents. This pressure to adopt aggressive positions put the tax practitioners in a troublesome situation as they may face either a client loss or the burden of engaging in unethical activities.

Tax practitioner aggressiveness

Tax aggressiveness has been described by Carnes et al. (1996) as the likelihood of a tax professional to take a pro-taxpayer position for a situation that other tax consultants would not approve. Milliron (1988) discussed about the relationship between this tax aggressiveness and the ethical attitude of the tax professional. However, it is not known whether the tax aggressiveness of a tax professional induce a lowering of ethical standards or if the tax aggressiveness comes from a precise ethical attitude.

Business managers

In addition to their duty of giving advice to the clients from their position as tax professionals, tax professionals also have the duty of managing or work within a company, which bring additional

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ethical dilemmas (Yetmar et al., 1998). Prior literature concluded that the pressure to compromise personal ethical standards is usually met at the middle or lower management levels.

Reputational issues

Doyle et al. (2009) argue that due to high criticism on the ethical profile of the accounting profession, it is a need to improve this perception and the ethical behavior of the individuals operating in this field. For this, an important aspect that has to be addressed is to develop a thorough understanding of how individual practitioners perceive ethics.

Competition

Prior literature assert that in the case of strong competition, practitioners may be motivated to misstate their capabilities and accept work for which they lack knowledge or skills (Yetmar et al., 1998). Thus, competition can cause individuals to neglect ethical aspects (Lewis, 1985). Having also in mind that tax professionals activate in a highly competitive environment that puts pressure on their struggle to attract new customers, this may lead to lowering ethical standards of tax professionals due to their endeavor to maintain and attract clients.

Stress

Tax professionals environment is stressful due to above mentioned highly competitive world, the amount of money involved in transactions they have to advice on, the multiple and contradictory expectations and many others. Weick (1983) discussed about the importance of stress in accounting practice. Weick argues that distress – a great amount of stress that makes performance to be reduced – can be pointed out by certain behaviors. These behaviors may refer to reduction in the amount of time given to each task, obstruct new information, appearance of cave in or superficial involvement and/or negative or sarcastic attitude towards clients. All these are causing decreased ethical behavior. Moreover, Yetmar and Eastman (2000) assert that a tax professional proves reduced ethical behavior through arriving at a tax decision after an insufficient analysis for an investigation and defense of a gray tax issue and subsequently ignoring important evidence that would reverse the original decision. Also the reduced care and advocacy shown to a client by failing to legally minimize the client’s tax liability is mentioned as a reduced ethical behavior by Yetmar and Eastman (2000).

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Public expectation

In the accounting profession there is a recognition that true professionalism consists not only of high technical skills but also adherence to ethical standards due to the belief that concern for ethical conduct singularize the profession. Therefore there is a public expectation that these professionals (including tax professionals) demonstrate a high technical competence and ethical standards.

The privilege of self-regulation

Doyle et al. (2009) argued that due to various professional bodies and their multiple codes of ethics, tax practitioners have the privilege of self-regulation.

Risk management

Additionally to their role of generating ethical dilemmas for tax practitioners, the factors presented above also make tax practice a risky environment. To reduce the risks, firms implement risk management procedures. There are considerable resources spent by firms of all sizes to design and improve risk management procedures. These are very important as litigation can be very expensive and a firm may lose its reputation. Hart (2000) argues that good risk management is beneficial also for the public interest as it leads to higher quality advice, clarity in clients’ expectations and closer meeting of these expectations. Doyle et al. (2009) explain that a proper definition of risk management in tax practice is the “careful identification and assessment of risks before committing a firm to provide particular tax services”. In addition risk management also refer to the settlement and organization of accepted projects in a manner that controls and minimize the risks.

Nowadays there is an increased importance of reputational risk due to shift in the paradigm of the business – the value is created more through intangible assets – and a damage of reputation may imply a business discontinuity.

To summarize, this theoretical framework presents eleven factors that give rise to ethical pressures in a tax environment. These factors are presented in figure 2 and refer to ambiguity in the tax law, multiple stakeholders, client pressure, tax practitioner aggressiveness, business managers, reputational issue, competition, stress, public expectation, the privilege of self regulation and risk management. These factors will be used to capture the ethical perceptions of the transfer pricing professionals. In addition Jones’ issue-contingent ethical decision making model will be employed to explain and understand the ethical decision making process. Jones described an issue-contingent model for ethical decision making that comprise four steps of moral decision making: moral sensitivity,

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moral judgment, moral intent and moral character. All four steps are influenced by the moral intensity issue while organizational factors influence moral intent and moral character.

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3. Methodology

3.1. Data collection and analysis

In accordance with the purpose of this paper - to provide an understanding of the transfer pricing professionals’ perceptions of ethics - and given that this subject has not been studied in depth before, the research methodology employed is qualitative research method. As indicated by Bryman (2008, p. 366) in interpretative qualitative research “the stress is on the understanding of the social world through an examination of the interpretation of that world by its participants”. There are five research methods under the concept of qualitative research: experiment, archival analysis, history, survey and case analysis. A case study is chosen for this research proposal as according to Yin (2009, p. 2) case studies are the preferred method when “(a) ‘how’ or ‘why’ questions are being posed, (b) the investigator has little control over events, and (c) the focus is on a contemporary phenomenon within a real-life context.”

The empirical materials used to design this case study consist of semi-structured interviews conducted with transfer pricing professionals supplemented with documentary analysis. The analyzed documents consisted of internal documents, the national legislation, the ethical code of conduct of tax practitioners in the national context as well as the ethical code of conduct of the Chartered Institute of Taxation from United Kingdom as a comparable document, transfer pricing history reports, OECD and United Nations transfer pricing reports.

The interviews were conducted at a non-Big 4 transfer pricing consultancy firm in Eastern Europe. Access to this organization (“tax consultancy organization” or “TCO”) was granted through an acquaintance with one of the partners of the company. Through this access there have been conducted nine semi-structured interviews with transfer pricing professionals in order to allow a flexible discussion and collection of data regarding the view of the interviewees (Bryman, 2008, p. 438). Table 2 provides a summary of the interview records. The professionals interviewed were at the level of senior, manager, director or partner, with three to seventeen years of experience in the tax practice. Due to the fact that within TCO only seven employees fulfilled the conditions to be interviewed there have been contacted and interviewed two other professionals. The first one was a former director within TCO, former Director of the Transfer Pricing Unit within the Tax Authority and actual sole practitioner. The second one is a sole practitioner and lecturer to the main economics university in the country. They were selected due to their expertise in the actual practice and their vast experience in the field. In addition one person interviewed from TCO is involved only in provision

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of tax consultancy and is a former Big 4 manager. She was selected due to her connection with TCO as well as with additional knowledge to the current situation within the tax profession.

Table 2. Overview of interviews undertaken

Interviewee Position Expertise area Experience Duration

I1 Partner TP 14 years 70 min

I2 Partner TP 8,5 years 43 min

I31 _{Sole practitioner} _Tax _{12 years} _{45 min}

I4 Manager TP 5 years 50 min

I5 Senior staff TP 4 years 63 min

I6 Director Tax 14 years 56 min

I72 _{Former Director -}

Sole practitioner

Tax and TP 17 years 67 min

I8 Senior staff TP 3 years 22 min

I9 Manager TP 6 years 62 min

Notes: 1 & 2. I3 and I7 were not part of TCO at the moment of conducting the interviews

In order to ensure consistency between the interviews and to increase the reliability of findings, an interview protocol was followed, that consisted of various rules that guided the administration and implementation of the interview. Before conducting the interviews all participants were contacted through e-mail or phone-call through which they were informed about the purpose of the interview, the approximate duration of the interview and were asked to agree upon a place and time. An interviewee guide was sent prior to the interviewees to inform them about the themes that will be discussed during the interview.

At the beginning of each interview, interviewees were asked for consent to record the interview. It was explained that the information is confidential and that the no other party except the UvA professors will have access to the data. All interviewees agreed to record the interview. Then, the objective of the study was presented, followed by collection of face sheet information. Every interviewee was asked a warm up question “Imagine that you can go back in time X years. Would you chose practicing transfer pricing / tax again?” in order to allow the interviewee to relax and start discussing on something he/she is passionate about. Then the questions from the interview guide were completed by additional questions that arose during the discussion. In the end I concluded with asking them if they had further questions that were not addressed during the interview and asked them

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if further questions are allowed. All agreed to help me further in any additional issues that may appear during the data analysis.

The interviews were conducted during the period April 1 – April 20. All interviews were conducted face to face in an office environment. Face to face interviewing is considered to be the most appropriate method of interviewing as the researcher is able “to observe body language to see how interviewees respond in a physical sense to questions.” (Bryman, 2008, p. 457).

Average interviewee duration was 53 minutes with outliers of 22 minutes and 70 minutes. In order to obtain the interviewees personal opinions, open ended questions were developed and structured in an interview guide, presented in the Appendix 1. The interview guide was developed from studying prior literature and in connection with the theoretical framework. Given the fact that interviews were semi-structured I “ask[ed] new questions that follow up interviewees’ replies” (Bryman, 2008, p. 437). The interviews were recorded and transcribed later verbatim, resulting in 100 pages (58.927 words) of transcribed interview data.

Data analysis was conducted manually. As this was my first qualitative research project, I printed the transcribed interviews keeping a wide right-hand margin for writing codes and notes and coded on the hard-copy printouts by using highlighters and pencils, as this gives more control and ownership of the work (Saldana, 2009). Moreover this is consistent with the recommendations of Graue and Walsh: “Touch the data. Handling the data gets additional data out of memory and into the record. It turns abstract information into concrete data” (Graue and Walsh, 1998, p. 145).

The first cycle of coding was aimed at identifying the significant passages of text and capture the key themes that were noted in a separate notebook and eliminate those that were not applicable to the research. The second cycle of coding focused more on the interview data allowing subthemes to emerge that were linked in a separate notebook in order to create a structure and to form a bigger picture of the data. The last cycle of coding was made in order to ensure the consistency of the themes and subthemes obtained. The next sub-section describes the case context.

3.2. Case context

The interviews were performed at a non big-4 transfer pricing advisory firm that operates in a city based in Eastern Europe. TCO was set up by a former Big 4 manager and is a top player in the local market in terms of revenues from transfer pricing work. TCO is also an outsourcing service provider for large transfer pricing advisory international networks and in the recent years it obtained recognition from respectable publications in the financial consulting word.

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TCO provides transfer pricing services that refer mainly to transfer pricing documentation, transfer pricing policies, transfer pricing reviews, audit defense and benchmarking studies. The major part of the client work refers to transfer pricing documentation and benchmarking studies. During the course of a year TCO conducts on average approximately 120 transfer pricing documentation projects and around 200 profitability benchmarking studies.

Unlike transfer pricing policies, where the consultants advise the clients on the transfer prices that should be used in related party transactions, in transfer pricing documentation files the consultants are contacted fait accompli. Given the fact that in Eastern Europe there is no major presence of multinationals headquarters and that transfer pricing policies are established at the mother company level, transfer pricing consultants in Eastern Europe do not deal with transfer pricing policy on a day to day basis, thereby they have to do most of their work in drafting transfer pricing documentation files and preparing profitability benchmarking studies.

Transfer pricing documentation file is a post-factum analysis of the transfer prices used by a company in the transactions with a related party. It is a defense mechanism that consists of a report with five chapters: presentation of the company, presentation of the group to which the company belongs, functional analysis of the company where there are presented functions performed, risks assumed and assets used, overview of the intra-group transactions and analysis of the transactions. In conclusion TCO is generally hired by the local company of a multinational group to help them defend the transfer prices applied ex-ante in front of the local regulator. The TCO work is consisting of writing down the facts and making various price/profitability analyses in what is known as a transfer pricing file. The client shall never write by its own in the transfer pricing file, but rather can review the final file and give its recommendations on what it does not agree with. When handing down the final transfer pricing file the TCO sends also to the client a management memorandum highlighting the technical approaches undertaken in defending transfer prices and the risks that within a tax audit, the tax auditors may not agree with the approaches undertaken.

TCO team includes 12 transfer pricing consultants among which some are ADIT (Advanced Diploma in International Taxation) certified. Transfer pricing specialists are not required to obtain a certification in accounting. TCO specialists played a major role in implementing the OECD standards in the tax legislation within the region.

The professional body governing the tax practice in the discussed context is relatively new. In order to obtain a certification from this body and obtain the quality of certified tax consultant, one must fulfill certain conditions: to have a bachelor’s degree in the economic field and to have 5 years

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of experience in financial area. The last piece in certification process is an exam organized by this professional body.

TCO does not have an ethical code of conduct given its small size. Nonetheless, the values of the companies are passed down by word of mouth.

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4. Findings

This section presents the case findings and is structured into four sections. The first sub-section sets the scene by introducing the reader in the transfer pricing world and address the terminology of ethics in the transfer pricing professionals’ view. The other three sub-sections are built upon the theoretical framework and present my interpretation of the transfer pricing professionals’ perceptions of ethics. The theoretical framework presented eleven factors that give rise to numerous ethical pressures in a tax environment. Nevertheless, as a result of the data analysis only four factors seemed to be important, thereby the discourse would focus solely on the ambiguity in the tax law, multiple stakeholders issue, reputation and risk management. Reputation and risk management will be presented in a single section. In what follows the insights will be structured on the basis of these factors and extensive quotes from interviews are included “to allow the reader to hear the interviewees’ voices…[and to]… allow the richness of the data to shine through” (O’ Dwyer, 2004, p. 403).

4.1. Introduction to the case

As transfer pricing is a complex and unknown subject for the people outside the transfer pricing area, an introduction to the concept of transfer pricing and the important terms will be presented in order to serve as a basis for understanding the results. In the second part of this sub-section the place of ethics in transfer pricing practice will be discussed.

4.1.1. Short tale on transfer pricing

The history of transfer pricing can be traced back to 1917, when IRS was authorized to allocate income and deductions among affiliated corporations and required them to file consolidated returns (CliftonLarsenAllen, 2013). Later on, in 1930 was introduced the notion of “arm’s length principle” that refers to the determination of transfer prices based on analysis of pricing in comparable transactions between two or more unrelated parties dealing under comparable circumstances. This principle is still the basis of transfer pricing regulations. The first notable transfer pricing debates at European level were started in 1979 when OECD originally published its report: Transfer Pricing and Multinational Enterprises (OECD Guidelines) that were also referring to the arm’s length principle.

In 1995 OECD released the OECD Transfer Pricing Guidelines following the previous reports in transfer pricing in 1979 and 1984. The United States also released transfer pricing regulations (26 USC 482) in 1994 after previous transfer pricing guidelines with a White Paper in 1988. Both OECD and United States updated the transfer pricing regulations with more comprehensive guidelines.

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OECD updated the transfer pricing guidelines in the years 1996 and 2010 and currently is working on the BEPS project that wants to address the flaws in the current transfer pricing regulations.

In the analyzed country within Eastern Europe the transfer pricing practice is relatively young. Albeit the transfer pricing legislation appeared later, the transfer pricing consultants were engaged in completing projects for multinationals that expected an introduction of transfer pricing regulations.

“I started doing tax because in 2006 when I started [to work] the transfer pricing team did not exist…it was created around that time. At that moment there was not legislation nor documentation requests. Transfer pricing documentation files were prepared only for multinationals that came from outside and knew that they will need this.” (I2, Partner)

Transfer pricing is a complex and dynamic subject to which transfer pricing professionals were not acquainted until being hired by a professional company in the tax department. There are no “transfer pricing courses [in undergraduate studies] and somehow you learn how to do things from the others, which can be ethical or not necessarily ethical.” (I5, Senior Staff). Transfer pricing is presented as a concept during taxation courses, thus transfer pricing consultants are prepared internally by the firms through trainings and on a daily basis through explanations by senior staff. A brief view into what the field of transfer pricing means is highlighted below by one of the interviewees: “Transfer pricing is a very dynamic field in which you cannot get bored, it is linked to many sciences such as accounting, taxation, statistics, industry particularities, country specifics, microeconomics, macroeconomics and now it starts to be linked even with the corporate social responsibility part and to give something back.“(I1, Partner)

In transfer pricing the important part is how to determine the right price. OECD states four times in its 2010 Guidelines that “transfer pricing is not an exact science” and thus “it will not always be possible to determine the single correct arm’s length price; rather […] the correct price may have to be estimated within a range of acceptable figures.” Also one must bear in mind that transfer pricing “require the exercise of judgment on the part of both the tax administration and taxpayer”.

Regarding the determination of whether the prices applied ex-ante are arm’s length prices, the OECD Guidelines present five methods. There are three traditional methods: comparable uncontrolled price method, resale price method, cost plus method and two transactional methods: transactional profit split method and transactional net margin method. One must attempt to apply the methods in a consecutive order. To jump over a method a rationale must be presented and justified in the report. The two most used methods in the transfer pricing practice are comparable uncontrolled

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method and the transactional net margin method.

In applying comparable uncontrolled method, transfer prices practiced between related party transactions are compared to prices practiced between independent party transactions. In order to be able to apply the comparable uncontrolled method, the transaction occurring between two related parties must also occur between unrelated parties. However, making the comparison requires sometimes adjustments as there is unlikely probable that exact conditions (i.e. delivery conditions, payment terms, purchased volume etc.) will be encountered in the same transactions. The most common case of applying comparable uncontrolled method is when a related party that sells goods to another related party also sells the same goods to independent parties.

According to the transactional net margin method, a profit level indicator (i.e. operating margin, mark-up on total costs, return on assets, return on capital employed or berry ratio) is compared to a range derived from profit level indicators of identified comparable companies (i.e. in case of the analyzed country and most of OECD countries the range is considered to be inter-quartile range from the 25th to the 75th percentile of the results derived from the comparable companies profit level indicators).

Examples of how these methods are used in practice will be presented in the following section. Now we move the discussion to the terminology of ethics in transfer pricing practice.

4.1.2. The ethical concept meaning

In order to understand the transfer pricing consultants’ perceptions of ethics, first we must view what ethics mean to practitioners. Therefore, a particular question addressed to the interviewees was how they would describe the concept of ethics. The most interviewees defined ethics as “fairness”, “transparency” (I1, Partner), “honesty” (I9, Manager) and the act of being ethical as “the ability to sleep well in the night with yourself” (I2, Partner), which can also be put under the capacity to have the consciousness clean. This is a subjective definition so follow-up questions were put in order to reach to the actual meaning and whether they consider ethics in performing their job. Another notable definition of ethics is highlighted by the following quote:

“If you want to be ethical, this means to have a good image in front of the clients. If you have a good image and you have credibility in this market this means that you succeeded in sending a message and that it is heard.” (I9, Manager)

A peculiar finding from this exercise was that instinctively the interviewees started to describe the concept from the point of view of the consultant - client relationship as emphasized by the following:

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“To be fair in a way that I would not harm the other one, [...] the ones with whom I interact, in the same time it can be a client or my colleagues.” (I4, Manager)

“Honesty among us, honesty in the relationship with the client and always play by the rules.” (I9, Manager)

Further, an analysis of whether a distinction between ethics and law exists was made. All interviewees agreed that the letter of the law may be sometimes unethical and that ethics is a smaller part comprised in the law. They all recognized that there is a grey part out there which is legal but unethical and referred to this as the interpretative side of the law. As the discussion progressed, interesting insights were revealed on the real framework that guides the practitioners’ activity:

“Again the connection between morality and legality. It is moral not to pay your taxes? Yes, probably it is immoral, but as long as the legislation allows, why won’t you?” (I6, Senior Manager) “As long as the opportunity exists legally I don’t know if it is necessarily unethical, I mean it is there because the business environment sees it but also because the tax authority sees it. If you don’t want it there, take it out, you can’t blame someone, the one that benefits from a relaxed legislation that the rule exists.” (I4, Manager)

“The thing is that business models develop faster than the legislation, which gives you a corridor where you can create, everything in an approximate legal framework, on the principle that if the law does not forbid, it allows.” (I1, Partner)

It seems that the letter of the law is the book of reference for professionals which is particularly interesting as they all recognized a difference between legality and ethics. The following quote is clearly revealing the commitment of practitioners to the law:

“I don’t have a problem in giving tax optimization solutions, so I don’t have a problem with this but for example if a client to whom I have identified tax issues asks me to do the supporting documents, to do the contract backdated and to sign and stamp it, I will never do this.“ (I1, Partner)

“I don’t think anyone expects from you to be moral, I told you, I interact with systems […] and these systems play you. It is clear that if you come with emotional opinions and explain them, they will either fire you or laugh at you, in any way you don’t succeed in deliver. Their expectations are definitely related to legislation.” (I7, Sole Practitioner)

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In summary, this section discussed about the concept of transfer pricing which is not an exact science, its short history and the most common methods to determine the transfer prices. Then the discourse revealed that ethics means fairness, honesty mostly in relation to clients and colleagues. Further inquiries about the distinction on ethics and legality showed that although there is a perceived difference of practitioners between these two concepts, they do not act upon it as the legal provisions are their preference, as are their clients’ expectations also. The transfer pricing consultants are therefore somewhat limited to the law given that if they would say that the transfer prices are not correct and adjustments should be performed, then their clients would come and ask the legal grounds before making the requested adjustments, legal grounds that are of course almost always in the grey area given the artistic nature of transfer pricing.

4.2. Ambiguity in the law

In this sub-section I analyzed how the ambiguity in the transfer pricing legislation stands on the creative side of transfer pricing and thus bounds practitioners to “letter of the law” thinking, which provides some sort of flexibility. Next, the additional reasons for this flexibility are presented under the form of regulators and professional bodies.

4.2.1. The artistic side of transfer pricing

In the previous section it was mentioned that transfer pricing is not an exact science. In this part I will explain why there is a claim for this and provide examples of how this aspect of transfer pricing is represented in practice.

The interviewees outlined that transfer pricing is a dynamic and highly technical field, and that legislation does not cover well its particularities, nor does provide specific rules to create a pattern on handling with certain things. The subjective nature of transfer pricing was brought into discussion due to the lack of relevant information to make an objective analysis. The practice of transfer pricing was allegorized to an art due to its permissiveness for creativity of transfer pricing professionals.

“In countries where TP documentation is made mostly and [TP] planning only on rare occasions, the ethics does not come around so often, even more as TP is quite subjective, the informational market is not developed enough that you can find the perfect comparable. You can find at this moment some information to compare one company to another, but you can’t find information with the perfect comparable and yet there are no mathematical methods so you can be able to say that this is the exact price at which you should have sold [some goods to a related party] without

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making any error… it’s extremely subjective, it’s more artistic.” (I5, Senior Staff)

It can be observed that due to the transfer pricing subjectivity, generally no one can tell for sure what is right or wrong, implying that there is no place for ethics in this area, consistent with the claims made by Doyle et al. (2009) that there is no place for ethics in tax area. Also the artistic nature of transfer pricing and lack of exact regulations leads the transfer pricing specialists to do their best in order to defend their clients’ interests:

“The beauty of transfer pricing comes from the fact that it is not an exact science and then if you can argument well that the respective transaction was incidental, that the cost was this and that you can’t compare with x,y,z because they are at a different development cycle and that you have to compare with a,b,c, and you manage to defend them, I am fine, I do not have any ethical problem with this stuff, as long as I can argument and can defend my work in front of tax authorities.” (I1, Partner)

The artistic part of transfer pricing mentioned by the interviewees refers to the fact that taking into consideration the complexity of business models and country specifics, the regulators were not able to form a specific legislation. Rather they formed general guidelines (i.e. OECD Guidelines) that are sometimes included in Member states legislation or, as in the case of the analyzed country as a reference for all other issues that are not comprised in the legislation. These guidelines provide general advice, but do not list rules or specific methods of computation, which leaves enough room for creativity and professional judgment.

In the previous section it was mentioned that in transfer pricing practice two methods for determining the arm’s length price are used on a more frequent basis: comparable uncontrolled method and transactional net margin method. The first method seems straightforward but can also leave room for creativity. In applying the comparable uncontrolled method a comparison is made between the transactions occurred between two related parties and the transactions between two independent parties in order to verify if the related party transactions are at arm’s length. The arm’s length principle is defined in the Article 9 of the OECD Model Tax Convention:

where “conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly.”

Ethics in transfer pricing : a study of transfer pricing professionals in Eastern Europe