The LCN Interview: Jinkan Khatadia

Jinkan Khatadia has over thirteen years of experience in transfer pricing. He is currently a Senior Manager at Grant Thornton's Manhattan office in New York.

How did you get into transfer pricing?

Of my thirteen years of transfer pricing experience, two years is in academia. I was pursuing a master's degree in Economics at Texas A&M College, and I got introduced to transfer pricing through a friend. He was studying transfer pricing, and he asked me whether I'd be interested in taking the subject. (In fact, at that point in time A&M College was one of the few institutions, if not the only one, that was offering transfer pricing as an academic specialisation.)

I looked it up, did some research on it, and it seemed pretty interesting. It was all about microeconomics, about the behaviour of companies, how they set different pricing, negotiation economics, and so on. And it intrigued me quite a bit: what kind of issues there are, what kind of solutions are provided.

I met with the Professor, Dr Lorraine Eden, a very prominent figure in the world of transfer pricing. I sat in her class, and I really liked it. And then I also got an opportunity to intern with Walmart for my summer credits. I got to learn transfer pricing from my early mentors Burton Mader (CPA) and Todd Ludeke (Lawyer). Both of them provided a different perspective of transfer pricing within the multi-disciplinary context, which pretty much sealed the deal for me that this is the field I should really try to pursue my career in.

So that’s when it went from being an academic study to a practical career for you?

Correct. When I was pursuing my Masters, you get credits for doing an internship. The first course I had taken was multinational enterprises. Then I took the internship. And then came the transfer pricing course. So that was the combination: understanding multinational enterprises, doing the internship and getting some practical exposure (obviously not a lot), and then learning about transfer pricing in my final semester. That’s what made me decide that this is the career path I want to take because I could see the overall picture of what kinds of challenges (and potential solutions) lay ahead of me in this field.

Is there a big difference between the academic study and the practical implementation?

I would say that from a practical standpoint, pretty much any field is going to be different from the theories that you learn. However, if you don’t understand the underlying theories, it will be very difficult for you to understand the nitty gritty details of your field. Especially if that field is transfer pricing.

For example, in a lot of countries transfer pricing is done by accountants. In India (where I was born and raised), it is supposed to be signed off by charted accountants. This is despite the fact that accounting is a very small portion of transfer pricing. 99% of it is economics: understanding the behaviour of firms and so on (of course, I am being biased because I am an economist myself). So without that theoretical background (i.e. an understanding of how economic principles can be applied in transfer pricing), it becomes very difficult to do apply transfer pricing practically.

Now, at the end of the day when it comes to practical application, in 80%, 90% of the cases that you deal with you end up applying a CPM/TNMM. That’s ‘Comparable Profits Method’ under the US transfer pricing regulations, and ‘Transactional Net Margin Method’ under the OECD transfer pricing guidelines. These methods have pretty much become a default choice in the world of transfer pricing, which may not necessarily do justice to the underlying economics of the intercompany transactions. Well, who doesn’t like an easier and more practical approach, right?

That is a single-sided method where you are one picking one entity and targeting a fixed profitability for that one entity. All the residual profit would go back to the other entity. That's the practical consideration.

However, in order to arrive at that practical consideration, you need to justify it with theories. Without that, you simply cannot do transfer pricing. At the end of the day, it is all about functions, assets and risks. How you transfer risks from one entity to another. Whether or not that entity is going to be able to bear the risks. Whether it has the funding, the decision-making authority, etc. So there's a lot of considerations that go into it, even when applying a rather simple method, which is what you end up doing most of the time.

LCN is very passionate about spreading the message that transfer pricing, and the legal implementation of transfer pricing through intercompany agreements, has to be a cross-functional process. Do you think that that message is widely understood, or is there still a long way to go?

It depends on the kind of multinational we are talking about. For a very small multinational company – a start-up, say – tax is not really an issue because they are loss-makers. So they do not really consider transfer pricing to be an issue, although it really is, because of the issues it may create in the future.

At the next level up – small and medium-sized – they want to do the right thing, but often do not have the manpower within the organisation to be able to do so. It also depends on who their consultants are. If it's a consultant without expertise in transfer pricing, and if the issues are not really that serious or complex in nature, it's probably alright for them to just have a one-dimensional approach. For example, you apply the CPM/TNMM I mentioned before, target a fixed profitability for one entity and you'd be good. Intercompany agreements may not matter so much because of the immaterial exposure.

But for the larger organisations, I would say it is definitely very cross-functional. Especially after seeing all these court cases, with Coca-Cola being the most recent one, where intercompany agreements are really the centre of the litigation. That makes sense because there is no better way to formalise the intentions of the related parties than laying out the terms and conditions in intercompany agreements. That’s what unrelated parties would do, and transfer pricing is all about that – what would unrelated parties do?

So it depends on the size of the organisation. The larger it is, the more important collaboration and cross functionality become.

You said that smaller companies often don’t think tax is an issue but for them but that it really is: why?

Imagine that a company has been around for five years, ten years, whatever, and they haven't truly considered transfer pricing in all the years of their existence. That makes things difficult for them. Because in all that time that they’ve been operating, certain functions have been performed and intellectual property has been created. Certain risks have been borne by various entities within the organisation, and that's what essentially puts them at risk. The past that cannot be reversed, unfortunately, even though it has created a situation that is extremely unfavourable to them.

Now, as an adviser, what to do for those kind of taxpayers? It's always going to be concerning, because no company is going to be sophisticated enough to worry about taxes first, especially when they're in the startup mode. The company is not in the business of paying taxes. They're in the business of doing business, and taxes is something that they think about when they become profitable.

By the time they start thinking about it, it’s too late. They are going out and raising funds from investors, taking out larger loans, going public, looking to get acquired, etc. That's when every single investor, or any counter-party, would want to know what is going on within the company. ‘Is your tax all settled? The valuation you're putting into place, is it justifiable? if there are any significant tax issues arising then are they defensible or not?’ Then the tax authority comes in and says, ‘Oh, by the way, you owe us $1billion in taxes.’ The investors are going to flee the company because of the uncertainty it creates, and the value of the company may potentially go down. Think of the likes of Warren Buffet: they are never going to invest in companies whose tax is uncertain.

We recently saw the US tax court’s response to Coca-Cola's request to reconsider that judgment, which could fairly be described as ‘a very firm No’. Were you surprised by that?

Honestly, there were some issues with the case overall. Transfer pricing is a very grey area to deal in. There are rules and regulations, but because it's not black and white it becomes very difficult to hang your hat on any particular regulation. So I think we need to hear out both sides, so that professionals like us get more clarity on what needs to be done in similar situations for other taxpayers whom we are serving.

Transfer pricing is obviously global in nature. Over the last 20 years the number of countries that have implemented any kind of transfer pricing rules has increased exponentially. But some countries are way ahead of others in terms of their understanding of transfer pricing. In the US, they took the first steps towards legal rules on transfer pricing in the early 1900s. There are indirect references to transfer pricing in the regulations dating back to 1917, and they began formally applying the arm’s length standard in 1934. Whereas many countries didn’t start doing that until about ten years ago.

So, imagine that you’re looking at a transaction involving the US and India. On the US side, you put policies in place that state the transaction is arm’s length so, logically, it has to be arm’s length from the Indian side as well. But India comes up with a different rule and regulation. There is a ‘safe harbour’ rule in India, which requires you to target, say, 20% profit for example.

But the US may not recognise that. Because from the US side it's all about economics, and from an economic standpoint when you do the comparable study you have 10% profit margin. So that kind of thing creates a natural friction between tax authorities. Depending on the countries and tax authorities you’re dealing with, it can be a bit challenging, depending on how advanced they are in their understanding of transfer pricing. And obviously sometimes it’s just policy-driven.

So I was a little bit surprised. But at the same time, because it's not black and white – some people may give more deference to a particular fact pattern than other people would – we'll see what happens.

Did you think there might be more to come?

Maybe. The same thing happened with Altera in the past. So we'll see what happens. If there are other hearings, if they re-open it, and if it does progress and this gives more certainty to everybody, that would be great. If not, the importance of the legal aspects of transfer pricing is only going to increase in future.

Everybody wants to tax the taxpayer fairly. Every tax authority wants to get their fair share of taxes. Every taxpayer is using all the facilities provided by the government of that country, and therefore everybody needs to pay their fair share of taxes. However, each tax authority is going to look after generating more revenues for themselves, and because of the grey area that we are dealing in, you’ll often see stances being taken that are beneficial to the tax authority (location savings, access to prime markets, etc.)

The best example of that is marketing intangibles for a market like the US. Otherwise, there would be a cost-plus arrangement, or a limited risk distribution.

But in case of GlaxoSmithKline, the IRS argued that there needed to be some kind of additional returns provided to the US for the marketing intangibles owned by the local entity, despite the fact that the local entity was treated within the organisation as a limited risk distributor. Obviously there were certain holes within the arrangement as well – intercompany agreements being one of them.

And not just the US. There have been examples in other countries as well, where the tax authorities have taken a stance that is more beneficial to them. And again, because of the grey area in transfer pricing, it gives you that flexibility to support only the fact pattern that works in your favour.

Is this complexity and inconsistency just an inherent and unsolvable problem with transfer pricing, due to its global nature?

The OECD has made a lot of effort to tackle this with the Pillar 2 initiative, which is going to essentially lead to some sort of alternative minimum tax. But this is really for the very big organisations, where how they split their taxes matters a lot to certain smaller and developing countries.

But for the small and medium enterprises, this particular issue is still going to happen because of – again – the grey area that we are all dealing in. As a result, you'll see more and more mutual agreement procedures happening: discussions with competent authorities to ensure you're not getting double-taxed because a particular jurisdiction has assessed additional taxes because of transfer pricing issues.

One of the things that could really make things better is for the tax authorities to sit at the table and then discuss certain common fact patterns that we see very often happening in those situations and providing guidance to taxpayers for such fact patterns. That would make it easier for the taxpayers.

Just make a decision: ‘These are the models that could potentially work under these circumstances.’ That way, it becomes easier for us as professionals to provide some kind of certainty to the taxpayers as well. And our clients, the taxpayers, need certainty.

In your career, have you had any particular mentors?

Yeah, absolutely. Starting with Dr Lorraine Eden. She's always been there, helping me to understand the nitty gritty details and all the intricacies of the transfer pricing world, followed by Burton Mader and Todd Ludeke at Walmart during my internship.

From a practical standpoint, when I started my full time job at a small tax consulting boutique firm, Dan Falk, a partner and Allen Brandsdorfer, my manager, provided me with a lot of practical exposures and insights into this field.

And most importantly, a colleague who was working with me at the same level: Ryan Finlay. He is a lawyer, and helped me immensely with understanding the law side of it, and still does. He also happens to be my grammar teacher.

Because I always thought transfer pricing to be, as I mentioned previously, 99% economics. I still do! As an economist, you would think about the behaviour of unrelated parties and apply that behaviour for the related parties. You would not worry about what's written in the rules and regulations. Later on, once you've determined the economics, you can go to the rules and regulations to see what is and is not allowed.

That’s when things can end up in litigation. Because economics alone cannot dictate what your transfer pricing looks like. Ultimately, it also needs to be justified by the law written by the respective countries. That's the element that Ryan helped me understand better, which was very important for my career.

What would be your ideal job if you didn't work in transfer pricing?

I'd be a chef, and I'd have my own restaurant. I absolutely love cooking for other people. I do it as a stressbuster now. I pretty much cook anything. I'll ask my friends what they want to eat, and if there's anything thrown at me which is extremely new to me, I just look it up online, see some videos, get the ingredients, and do it.

What else do you do to relax?

I'm a big movie buff, so I watch a lot of Netflix. I read about politics quite a bit. And then I have a two-and-a-half-year-old daughter. So she is pretty much keeping me occupied these days.

How would you describe yourself in three words?

Jovial, logical and practical.

What actor should play you in the film of your life story?

It’s a difficult one. I don't know. The combination of fun, logical, practical… it's a difficult one to find.

But if you were to ask me what movie character I relate to, I'd say I'd fit very well for Captain America. The approach I like to take in my life: things that I tell people to do, things that I follow myself, doing the right thing, following principles all the time, etc.

Who would be your ideal guests at a dinner party?

Mahatma Gandhi. Just to understand how one man was able to inspire an entire country to fight for what was right. And that would be a very, very, very long discussion, I presume.

So many others. Maybe Abraham Lincoln too. Same thing. Pretty much every prominent figure who has been able to inspire and motivate an entire country to take certain course of action, and the entire country has stood up and taken that course of action. In this world of bipartisanship, we absolutely need leaders who can unite people.

So it would be good to see what kind of approach these people followed. I'm pretty sure that they used the whole concept of things being in a grey area, and the natural diplomacy that their character allowed them to use.