high value adding services e-commerce
TRANSCRIPT
Institute for Austrian and International Tax Law www.wu.ac.at/taxlaw© WU TPC 2015
High Value-Adding Services; E-Commerce
Global Transfer Pricing Course (Adv. Topics), Oct.10,2016
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CONTENTS
• Contemporary trends in services
• Low value services
• Types of high value services
• Location savings
• E-Commerce
• Case studies
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Contemporary trends in Services
Low value and high value services – With increasing flow of services within MNEs, the debate of value attributable to services between entities is gaining focus
Location of performance of services – Services performed out of developing economies and low cost locations give rise to Locational advantages
Taxable presence - Permanent establishment (“PE”) issues
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Contemporary trends in Services
Core and non-core services - While developed nations are taking a view that non-core services should be attributed a lower return and have introduced safe harbours for such services, various developing nations like India on the other hand expect a higher return for support services on the premise that they create significant value for the group (through location savings, talent pool etc.)
Concept of hard to value intangibles – Services that have an element of intangible embedded in it and for which reliable comparables’ data is not available in public domain
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Contemporary trends in Services
Increasing focus on substance – Substance of an intercompany arrangement is being scrutinised during audits thereby going beyond the legal flow in order to arrest any erosion of tax base
Growth of Digital economy – Growth in transactions through e-commerce poses new challenges in understanding the elements in the virtual supply chain and thereby the taxing rights of countries involved
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Country measures
Countries are increasingly adopting the following to provide guidance to taxpayers on profitability expected from services
Safe harbours (e.g. US, Singapore, India) Circulars providing guidance on services (e.g. India) Advance Pricing Agreements
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Country measures
OECD efforts to develop action plans to tackle Base Erosion and Profit Shifting
Identify and address arrangements which involve use of intangibles, risks, capital and other high risk transactions that result in artificially shifting profits from one jurisdiction to another
Counter treaty abuse resulting in double non-taxation
Address various tax issues relating to digital economy, intangibles, strengthening CFC rules and tackle aggressive tax planning schemes
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Service models in an MNE set up (illustrative)
Administrative support services Routine technology development services
Joint development arrangements
Returns
Contract R&D services
Full fledged R&D
KPO services
Functions Risks
Assets
Procurement services
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Low value services (Action Plan 10)
Services performed by one member or more than one member of MNE group on behalf
of one or more members of MNE group which (i) are of a supportive nature (ii) not a part
of core business activities (iii) do not require use of or lead to creation of unique or
valuable intangibles (iv) do not involve assumption or control or (creation) of (to)
substantial or significant risks
Examples of Services that would qualify as low value added intra-group services:
Accounting and auditing;
Processing and management of accounts receivable and accounts payable;
Human Resources activities,
General services of an administrative or clerical nature, etc
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Outsourcing of services in an MNE set up – the drivers
Business decision
points
Outsourcing of activities/functions
Achieve a cost-efficient supply chain
Focus on core competencies
Leverage on talent,infrastructure and
resources
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Fiscal effects of outsourcing
Location savings: Identification and allocation
Withholding tax: Application in the State of the service provider on the fees paid by the service recipient on:
– Service fees– Royalties
Benefit of double tax treaty: Advantage to claim the benefit of a double tax treaty between the State of the service recipient and the State of the service provider– Avoid the withholding tax– Reduce the withholding tax rate– Avoid potential double taxation
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Location savings – defined
Net cost savings from relocation to a low cost jurisdiction
All factors and associated costs to be considered (e.g. termination costs for the existing operation, possibly higher infrastructure costs in the new location, possibly higher transportation costs if the new operation is more distant from the market, training costs of local employees etc)
Economically significant functions resulting in creation of location savings
Location specific advantage
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Location specific advantages (“LSAs”) Location savings (i.e. cost savings) coupled with the following additional
geographical/business advantages can lead to creation of LSAs:
Highly specialised skilled manpower and knowledge;
Closeness to market;
Large customer base
Developed infrastructure
Market premium
Incremental profits derived from LSAs lead to “location rent”
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The location savings (“LS”) issue – identification and allocation
Whether locationsavings exist?
Determine quantum of LS?
Whether LS retained by MNE or passed on to
customers
How would independent parties allocate LS under arm’s length conditions
• Market and industry factors to be considered for establishing existence of LS
• In contract manufacturing and services arrangements, an adjustment for LS may not be warranted where reliable local market comparables are available for determination of arm’s length returns for these arrangements
• Allocation of LS, if any, according to relative bargaining strength of the respective entities – depends on their access to LSAs
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Location savings - illustrated
Entity A (high cost jurisdiction)
Cost of manufacture US$100
End customerSelling price = US$ 150
Scenario BEFORE outsourcing
Entity B – Contract manufacturer
Cost of manufacture US$60
End customer
Selling price = US$ 150
Scenario AFTER outsourcing
Entity A – Outsourcer
High cost jurisdiction
Selling price = US$ 80
Location savings for the Group: US$ (150 – 60 = 90)Location savings for Entity A: US$ (150 – 80 = 70)
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Location savings – the jurisprudenceOECD
The OECD first acknowledged and addressed the issue of location savings in the new Ch IX on TP issues associated with business restructurings
Acknowledges the presence of LSAs in MNE operations whose quantification and allocation should be in accordance with arm’s length principle
Sharing of LSAs between group companies is best done through comparability analysis if the savings are not passed on to third party customers
UN
Views consistent with the OECD.
Concludes that allocation of benefits will depend on competitive factors relating to access to LSAs, alternatives available to the parties and their relative bargaining power
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Guidance as per OECD – BEPs Action plan 8-10 Final Report
Do location savings and / or other local
market features affect the prices or margins or provide
other market advantages or
disadvantages, vs the foreign
comparables ?
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Location savings – the jurisprudenceUS
Recognises the concept in its transfer pricing regulations
If the comparable company operates in a different geography, adjustments required for difference in cost of resources
Consistent with OECD and UN view that they are not separately compensable but should be dealt with as part of comparability analysis
India and China
Income arising from LSAs should mostly accrue to Indian and Chinese entities
Premise that foreign corporations benefit from highly specialised manpower, knowledge, market and large customer base
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Location savings – the jurisprudence US Court decision in the case of Sundstrand Corp. v Commissioner
Sundstrand US engaged in the manufacture of a wide variety of products including the Constant Speed Drive (“CSD”)
It had set up a wholly owned subsidiary in Singapore for production of CSDs in order to leverage from the lower labour costs, availability of English speaking workers and certain tax and other incentives
On the issue of allocation of location savings, the Court concluded that the location savings should remain with the Singapore subsidiary based on the relative bargaining powers of the entities involved
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Location savings – the jurisprudence
In the United Nations Transfer Pricing Manual for Developing Countries (India Chapter), the Indian authorities have advocated that, in the quantification and allocation of location savings amongst the parties, the profit split method (PSM) can be used wherein the functional analysis and bargaining power of the parties to the transaction would be relevant factors for consideration – benchmarking against local comparables does not take into account the benefit of location savings.
The OECD, UN and US transfer pricing regulations on the other hand are of the view that location savings cannot be said to exist where there are comparables
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India ruling - GAP International • Facts
– Taxpayer (“GAP India”) was engaged in facilitating sourcing of apparel from India for its group companies and received a service fee for the sourcing support services
– Primary activity of GAP India involved providing assistance in identification of vendors, inspection and quality control and coordination with vendors to ensure delivery of goods to group companies without taking title to goods
– GAP India adopted transaction net margin method (“TNMM”) to benchmark the service fee determined at full cost plus 15 per cent from its group company
Group
GAP India
Outside India
India
Facilitate/ co-ordinate between Group entities and third party vendors for sourcing of apparel from IndiaCompensated at cost plus 15 per cent for the services rendered
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India ruling - GAP International
• Issues– During TP audit, Transfer pricing officer (“TPO”) disregarded
functional, asset and risk (“FAR”) profile and characterisation of GAP India by assuming that its FAR profile was substantially higher than those of limited risk support service providers
– As per the TPO, the form of remuneration did not take into account substantial intangible assets, like human asset, supply chain and location savings, owned by taxpayer
– TPO concluded that GAP India ought to have earned a commission of around 5 per cent on free on board (“FOB”) value of goods procured by group companies, thereby making a TP adjustment.
Group
GAP India
Outside India
India
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India ruling - GAP International
• Contentions of the Revenue– GAP India performed all critical functions, assumed
significant risks and used unique intangibles developed by it over a period of time.
– Functions like quality management, involve great care to be taken at sourcing stage and any defect may result in huge adverse impact on whole supply chain.
– GAP India had proprietary information of supply chain, such as knowledge of vendors, products and designs, acquisition and supply, quality control, storage and logistic involved
Group
GAP India
Outside India
India
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India ruling - GAP International
• Contentions of the Revenue (contd)– Independent enterprises, for similar services, would use a
charging basis as a percentage of value of goods procured rather than cost plus.
Group
GAP India
Outside India
India
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India ruling - GAP International
• Contentions of GAP India– GAP India operated as a limited risk bearing sourcing
support service provider, for its group entities, performs routine/ low value-adding activities and does not bear any key business risks.
– Goods sourced by AEs from India are directly sold by third party vendors to overseas AEs.
– GAP India had no role to play in several key and critical activities in Group’s value chain and merely operates as per requirements prescribed by overseas AEs.
Group
GAP India
Outside India
India
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India ruling - GAP International
• Contentions of GAP India (contd)– Location savings generated by Group entities are
passed on to end customers in the form of lower prices
– Due to lack of comparable sourcing support service providers in databases, taxpayer had to identify distributor companies and make suitable working capital adjustment
– TPO selected same comparables and merely
changed the PLI, without appreciating that the intensity of functions of such comparables were more than that of taxpayer
Group
GAP India
Outside India
India
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India ruling - GAP International
• Tribunal ruling– Determination of ALP to be based on
characterisation of GAP India and its Group entity
– Location savings arise to the industry as a whole and not taxpayer alone. The objective of sourcing from low cost countries is to survive in stiff competition by providing a lower cost to its end-customers
– Procurement support service providers work on various models and remuneration model followed would depend on the facts.
Group
GAP India
Outside India
India
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India ruling - GAP International
• Tribunal ruling– GAP India did not assume any significant business
risks, no human resource or supply chain intangibles were developed
– On the basis of the above, the PLI as a percentage of FOB value of goods procured by AE (as applied by the TPO for computing the TP adjustment) resulted in absurd and distorted results.
– Based on the characterisation of GAP India and the facts of the case, the cost plus form of compensation adopted by GAP India was upheld
Group
GAP India
Outside India
India
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India High Court case – Li & Fung • Facts
– Li & Fung India was engaged in rendering sourcing support services to its Hong Kong based Group entity, for which it received a remuneration of cost plus 5 percent
– Li & Fung India applied TNMM to determine the ALP of such remuneration, considering Operating Profit/Total Cost (OP/TC) as the PLI.
Group
Li & Fung India
Hong Kong
India
Render sourcing services from India
Compensated at cost plus 5 per cent for the services rendered
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• Issue involved– The TPO, while accepting that TNMM was the most
appropriate method for determination of ALP and accepting the comparable companies selected by Li & Fung India, held that cost for the purpose of the 5 percent mark-up should include the FOB value of exports (by an Indian manufacturer to overseas third parties) that have been facilitated by Li & Fung India
Group
Li & Fung India
Hong Kong
India
Render sourcing services from India
Compensated at cost plus 5 per cent for the services rendered
India High Court case – Li & Fung
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• Question before the High Court– Whether assessment of Revenue authorities of ALP
applying the TNMM method was contrary to the provisions in the Indian TP law?
– Whether the TPO’s apportionment by considering the cost plus mark up of 5 percent on FOB value of goods transacted between third party enterprises, sourced through the taxpayer, is in compliance with the law?
Group
Li & Fung India
Hong Kong
India
India High Court case – Li & Fung
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• Contention of the Revenue– Li & Fung India was involved in performing all crucial
functions, bore all significant risks and developed unique intangibles
– The procurement services offered cost and operational advantages to the Group, but the group entity had neither quantified location savings nor attributed any part of it to Li & Fung India
– Since Li & Fung India was performing critical functions with the use of tangible and unique intangibles the markup should be based on the FOB value of the exports
Group
Li & Fung India
Hong Kong
India
India High Court case – Li & Fung
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• Contention of Li & Fung India– Rendered buying or sourcing support services and
operated with limited risk.
– Did not develop any unique intangibles or undertake supply chain management
– Location savings is attributed to the end purchaser only. The transaction of export of finished goods is being undertaken by third party vendors neither taxpayer nor the Group entity were parties to such contracts and none of them have gained any advantage on account of location saving
– TPO’s application of TNMM is contrary to provision of law
Group
Li & Fung India
Hong Kong
India
India High Court case – Li & Fung
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• High Court verdict– Li & Fung India operated as a low risk contract
service provider exclusively rendering sourcing support to its group entities. It did not bear any significant operational risks for its functions.
– TPO’s determination of the arm’s length price for sourcing support services based on markup on FOB value contrary to the provisions of the law.
– of law
Group
Li & Fung India
Hong Kong
India
India High Court case – Li & Fung
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India Tribunal – Watson Pharma• Facts
– Watson Pharma India engaged in provision of contract manufacturing and contract R&D services for its parent company – Watson Labs, US
– Watson Pharma India reported an operating mark up on cost of 17.43% and 15.66% for contract R&D services and contract manufacturing services respectively
– The TPO determined the arm’s length mark up at a higher rate and proposed a TP adjustment for the contract R&D services segment
Watson Labs
Watson Pharma
US
India
Render contract R&D services and contract manufacturing
Compensated with service fee
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India Tribunal – Watson Pharma• Facts
– In respect of the contract manufacturing and contract R&D segment, the TPO also made an adjustment for location savings
– Adjustment for LS computed on the basis that the transfer of manufacturing process from US and Europe to India resulted in cost savings
– The Revenue relied upon international research publications stating cost differentials for similar activities between countries to support the LS adjustment
Watson Labs
Watson Pharma
US
India
Render contract manufacturing and contract R&D services
Compensated with service fee
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India Tribunal – Watson Pharma• Ruling by Tribunal
– The companies – both the Indian company and the US Co operated in a perfectly competitive market
– If at all there were location savings, they were passed on to customers
– Any attribution to the Indian company of a share of the location savings (rent) should be on the basis of relative bargaining power and characterisation
– Where local comparables are available for similar services, no adjustment for LS required
Watson Labs
Watson Pharma
US
India
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High value services
Customer delivery and relationships
Local market insights
Administration
Commercial risk
Business analysis and solutions
Commercial judgement/experience
IP (Brand etc)
Routine return(Cost plus return)
High value return
Shared return
Potentially involvingHigh value services
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Allocation of profits
Tested party
Return attributable to functions, assets and risks
Service Provider
Cost+
Principal
Residual
Profi
t
Control of capital Economically significant functions
Contractual risks
Management of Assets and Risks
Key determinants for arm’s length reward• Key people functions – economically significant functions• Supervision and control• Capital funding• Investment of economically significant assets
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High value services?
Procurement services
Research and development services
KPO/LPO services
Engineering design services
Brand/market promotion
Financial services
Technical services
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Procurement
Vendor identification
and assessment
Price/termsnegotiation/agreement
with vendors
Liaising with vendors to ensure
timely delivery
Quality management
Procurement company/hub
Supply chain planning
Vendor evaluation/audits
Inventory management
Quality control
Logistics management
Terms/price negotiation
Contracting management
Buy sell
Purchase on confirmed requirements
Limited inventory management
Quality control
Terms/price negotiation
Procurement services
No title to goods
Provides information on vendors
Liaison between supplier and customer
Inventory management and
warehousing
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R&D activities
Customer identification and
requirementsanalysis
Prototype design and innovation
Outsourced services – testing,
standard processes
Commercialisation of output/
registering of IP
R&D Principal
Conceptualisation and strategy formulation for R&D pipeline
IP ownership, protection and management
Provide direction and oversight of R&D outsourced services
Investment of capital and assumption of risks
Joint development (e.g. cost sharing
arrangements)
Requirement defined by customer or in anticipation
of market demand
Joint development of output
Exposed to commercial risks
Joint development and owning of IP
Contract R&D services
Requirement specified by the Principal
Process implementation and output
Insulated of commercial risks (market, credit or
capacity risks)
IP belongs to Principal
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Issues on R&D services
Relative role of entities involved in the services i.e. conduct of parties
Legal v Economic ownership
Value creation and location savings
Comparables
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Circular 6/2013 in relation to contract R&D services - India
Performance of Economically significant functions – core services vis-
à-vis non-core services;
Employment of Funds/ Capital and other economically significant
assets including intangibles;
Level of control and supervision
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Circular 6/2013 in relation to contract R&D services - India
Strategic decision making capability and overseeing /monitoring
activities performed;
Assumption of Risks;
Ownership rights (legal or economic) of outcome of
research/development/spend
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Circular 6/2013 in relation to contract R&D services - India
Economically significant functions would include the following:
Conceptualization and design of a product/solution;
Providing strategic direction and framework in relation to an R&D
activity
Key people functions
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Circular 6/2013 in relation to contract R&D services - India
The following functions may also be considered to be illustrative of
economically significant functions:
Research into new products/applications either collaborative with
the Principal or independently;
Significant people functions in relation to planning and execution of
design/development of a solution independent of any direction or
supervision of a foreign principal.
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Circular 6/2013 in relation to contract R&D services - India
Usage of Funds/ Capital and other economically significant assets including intangibles – responses to the following questions would help:
Whether the operations involve significant R&D and innovation?
Whether there are investments leading to creation or development of any intangibles;
What is basis of compensation to the entity performing the services – compensation should reflect contribution
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Marketing/brand promotion
Market research and pre-sales
activities
Conceptualization of advertising and market promotion
campaigns
Implementation of market
promotion plans
Brand management and registering of IP
Principal/Brand owner
Formulating strategy for brand management
Provide direction and oversight for brand promotion activities
Managing and assuming brand budget
Investment of capital and assumption of risks
IP protection and management
Exposed to commercial risks
Distributor/licensed manufacturer
Participation in developing and implementing market
promotion plans
Customization of brand/products for local
markets through advertising and packaging
Spend in brand promotion activities
Exposed to commercial risks
Contract market support services
Contracted to the Principal
Market research support and sharing local market insights on a need-basis
Insulated of commercial risks (market, credit or
capacity risks)
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Issues on marketing/brand promotion
Assessment of excessive advertising, marketing promotional expenses relative
to comparables – bright line test;
Distributors and licensed manufacturers – key considerations
Whether sufficient to be compensated in an aggregated manner (i.e. as a
reduction in import price of products) or separate compensation required for
AMP services?
Will any compensation be due upon termination of intercompany agreement?
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Technical services
• Model conventions do not contain a specific Article for fees for technical services (“FTS”).
• Taxability of FTS has to be considered either under Article 7 or Article 14 or Article 21, depending on facts.
• For example, most Indian tax treaties have specific provision for taxing FTS with common operating provisions as for “royalties”.
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Technical services
Consideration (including lump sum) for rendering
Managerial Technical Consultancy
Provision of services
of other personnel
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Technical services
Contemplates high value service to the service recipient due to knowledge and
human involvement
The service must be one which requires skills/acts which is to be performed
when the service is being performed
Distinguished from administrative, commercial support services
Technical services vis-à-vis technology driven services
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Case study 1
Facts:
C Ltd in India is a 100 percent subsidiary of a C Plc, a UK based company
C Ltd engaged in the business of manufacturing pumps for industrial and agricultural use.
C Plc provides support to C Ltd in matters pertaining to corporate strategy, financial management, accounting, tax, legal, procurement, vendor development and overall customer relationship management.
C Plc
C Ltd.
UK
IndiaProvision of services
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Case study 1
Facts (contd. )
C Plc has been charging a sum of GBP 10 million per annum to C Ltd by way of management service fees.
C Plc and C Ltd have an intercompany agreement for provision of services. One of the clauses in the agreement indicates that the services would be provided on “request”.
In the course of the TP audit, the Revenue asks C Ltd to produce documentary evidence in support of the “high” or “low” value of the services.
C Plc
C Ltd.
UK
IndiaProvision of services
How would you go about with setting out the information request for the Company management for the evaluation process?
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Hard to value intangibles
Public discussion draft issued by the OECD on BEPS Action Plan 8 defines HTVI as
intangibles or right in intangibles involved in a transaction of transfer between
associated enterprises;
Where no comparable transactions exist in public domain;
Lack of reliable financial projections to estimate future probable cash flows;
Assumptions used in valuation of intangibles are highly uncertain
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Hard to value intangibles
HTVI in the context of services may be seen in the following arrangements within
an MNE Group:
Joint development of a breakthrough IP by entities within an MNE involved in
R&D services;
Partially developed IP (say technology) at the time of a transfer between
entities within an MNE
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CONTENTS
• What is e-commerce?
• Tax and transfer pricing considerations
• Work done internationally
• Case studies
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What is E-Commerce?
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E-commerce - defined
Referred to as use of electronic means to buy / sell goods or services - settlement may or may not happen electronically
Australian Taxation Office has defined e-commerce narrowly as ‘the buying and selling of goods and services on the internet’
Scope of e-commerce is constantly enlarging as more and more sectors adopt ICT – Retail, Financial Services, Education, Healthcare…
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Scoping e-commerce…
•Commercial transactions involving both organisations and individuals that are based upon the processing and transmission of digitized data, including text, sound and visual images and that are carried out over open networks (like the Internet) or closed networks (like AOL or Minitel) that have a gateway onto an open marketOECD•Commercial transactions in which the order is placed electronically and goods are delivered in tangible or intangible form and there is ongoing commercial relationshipIFA•All business activity conducted using a combination electronic communication and information processing technology
The Asia Pacific Economic Cooperation
•The process of using electronic methods and procedures to conduct all forms of business activity
The United Nations Economic and Social Commission for
Asia and the Pacific
•Transactions where both the offer for sale and acceptance of offer are made electronicallyNASSCOM
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Some global statistics
10-15 billion devices connected to the internet – less than 1% of total devices that could be ultimately connected
E-commerce is nearing upto 20% of the total turnovers in certain economies – Finland, Sweden, Czech Republic
B2C e-commerce sales in 2014 exceeds US$ 1 trillion
B2B e-commerce forecasted to reach US$ 6.7 trillion by 2020
Size of global retail e-commerce market was nearly $2 trillion in 2015
Internet advertising reached US$ 150 billion in 2015
Total revenue from app store purchases = US$ 58 billion in 2015
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Flow of e-commerce
Developing countries are generally capital importing and buy more from developed countries; are net importers of e-commerce
Income flows largely balanced in favour of developed countries Developing countries rely heavily on consumption taxes Difficulty in applying source based taxation Emergence of origin based taxation
Disproportionate effect on the developing economies– Challenge to protect revenue base
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Some business contructs
E-commerce
Sale and purchase of goods and services
conducted over computer networkse.g. Amazon, E-bay
App Stores
Digital distribution platform for software
Free model / Premium model / Freemium
model
Online Advertising
• Display of ads• Appear amongst
search results• Free digital content to
view paid ads• Ads on social media
sites
Cloud Computing
Standardised, on-demand, online
computer servicese.g. Google, Cisco,
Parallels
Payment services
• Cash payment solutions (settlement agencies)
• E-wallets (Bitcoin)• mobile payment
solutions for in-app payments
High frequency trading
Huge volume of trades conducted at high speed through complex computer
algorithms (co-location)
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Adaptive business models in e-commerce
Manufacturing:
Outsourcing and remote monitoring of manufacturing activities
Direct just-in-time sales
Electronic web based inventory management and ordering
Sales/distribution:
Outsource logistics to specialists for faster deliveries
Cash flow improvements through online payments
Marketing, customer relationship management:
Digital marketing
Call centres
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Adaptive business models in e-commerce
Technology services:
Licensing of e-commerce technologies
E-learning and interactive training
Storage of proprietary information
Application service providers - Software as a service
E-invoicing and payment
Online auctions and shopping portals
Financial services:
Shared services and removal of intermediaries
Lower cost of operations encourages entry of smaller players
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Tax considerations
New business models
Online market – digitized market place
Taxability of services vis-à-vis product sales
Place of business – permanent establishment issues
Assessment of market factors having a bearing on intercompany
transaction prices/results
Intangibles – technology, content and marketing
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Transfer pricing issues
Functional analysis
Allocation of economically significant functions and risks
Identification of key value drivers
Understanding of supply chain
Characterization
Application of transactional approach to determination of arm’s length price
Identifying the actual transaction and similar third party transactions
Assignment of risks between entities
Comparability factors
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Transfer pricing issues
Intangibles
Who/what creates value?
Legal and economic ownership of intangibles
Technological obsolescence raises questions on intangible valuation
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Taxable presence in e-commerce
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Taxable presence in e-commerceReduced need of physical presence and human intermediaries
E-commerce activity with no substantial presence - only offices undertaking activities (purchase, storage) falling within preparatory and auxiliary
No need for branch offices staffing people – interaction can be undertaken remotely
People replaced by software – eg co-location
Artificial avoidance
Locating server in low-tax jurisdiction
Splitting of automated functions to different locations / servers – all within the threshold of ‘preparatory and auxiliary’
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Taxable presence in e-commerceAvoiding taxable presence (noted in BEPS)
Remote interaction
Reliance on automated processes
Artificial segmentation of activities
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Taxable presence in e-commerce
Is there a need to reconceptualize source for e-commerce? Is source-based taxation justifiable for income arising in e-commerce environment?
Should source countries have right to tax business income only if they have physical presence (PE)?
Where should income be regarded to be generated if all the value of what is sold is created in the residence country, but the customers that determine that value are in the source country?
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Google tax
UK introduced levy on company profits that are routed through “contrived arrangements”
Popularly known as “google tax”
Tax at 25 percent of taxable diverted profits
Australia similar to UK levied tax and penalty focusing on arrangements that attempt to avoid establishing PE in australia
Equalisation levy
India recently introduced an equalisation levy on online advertising revenue earned by non-resident e-commerce companies from India
Rate of tax is 6 per cent on the consideration received from online advertising by a non-resident from a resident or non-resident having a PE in India
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OECD BEPS initiative
Public Discussion Draft – BEPS Action 1: Address the tax challenges of the digital economy (March 2014 – April 2014)
Action 1: 2014 Deliverable – Addressing the Tax Challenges of the Digital Economy (September 2014)
Public Discussion Draft - BEPS Action 7: Preventing the Artificial Avoidance of PE status(October 2014 – January 2015)
Discussion Draft for Public Consultation – International VAT/GST Guidelines (December 2014 – February 2015
Revised Discussion Draft – BEPS Action 7: Preventing the Artificial Avoidance of PE status (May 15, 2015 to June 12, 2015)
Final Report – BEPS Action Plan 1 and 7 (October 2015)
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Key tax challenges of Digital business models
Nexus
Ability to operate in source country without extensive physical presence – digital infrastructure is sufficient
Are current rules which hinge on physical presence sufficient? Is there a need for reformulation?
Usage of data cross border
Businesses have developed ways to collect, analyse and ultimately monetize data
Self created intangibles usually not accounted for
Value attribution to such data – challenging to anlayse the functions, assets and risks
Characterisation
Development of new products and services and new means to deliver these products and services
No clarity or precedents on characterization – especially payments for cloud computing
Levy of value added tax
Challenges related to where goods, services and intangibles are acquired by private consumers from suppliers abroad
No international framework for VAT collection
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BEPS Initiative: Options Proposed for Digital Economy
No ring fencing
Digital economy is becoming the economy itself
Isolating digital economy will involve drawing arbitrary lines
The challenges faced by digital economy are also faced in traditional economy – only risk in digital economy is exacerbated due to its very nature
Modification to Exception from PE status [Article 5(4)]
Exceptions no longer serve their intended purpose
Make all activities referred to in Article 5(4) subject to the overall exception of being “preparatory or auxiliary” or remove exceptions in 5(4) completely
Report on Action Plan 7 proposes that all activities be made subject to the overall exception
New nexus based on Significant digital presence
Targeting those businesses which require minimal physical elements
An enterprise undertaking “fully dematerialized digital activities” could be deemed to have a taxable presence
Fully dematerialized digital activities could include (eg – core business is to sell digital goods and services, contracts generally concluded remotely, payments generally made online, websites are the only means of relationship with consumers).
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BEPS Initiative: Options Proposed for Digital Economy
Creation of a withholding tax on digital transactions
Impose a final withholding tax on certain payments made by residents of a country for digital goods and services to a foreign e-commerce provider
Introducing equalization levy
Levy on transactions concluded with in-country customers. Applicable only where business maintains significant business presence
Feasible only where no / low tax in home jurisdiction or availability of credit against corporate tax
Transfer pricing rules
Appropriate allocation of profits – not based on legal ownership but performance of important functions and contribution of important assets
CFC rules • Definition of CFC income to include income from Digital economy• Income from Digital economy to be taxable in ultimate home jurisdiction
The Task Force on Digital Economy will monitor developments in the digital economy and other Action Plans and will determine if future work on 3 options is required, viz, equalisation levy, significant digital presence and withholding tax. The report on outcome of the
continued work will be presented in 2020
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Summary
Growth in services and e-commerce are creating new challenges for taxpayers and tax administrations seeking certainty of tax policy and its administration
Stratification of services into various categories – low value/high value, core/non core
In the post-BEPS era, MNE businesses are expected to focus even more on substance and conduct
New approaches to comparability and profit attribution
…..its a small world after all….
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Case study - 2
U Co based in UK is engaged in research, development and manufacturing of forrmulated medicines at its UK facility.
Due to availability of talent and competitive pressures, it seeks to locate the research activity in India and China continuing its manufacturing operations in the UK;
Having done the feasiblity studies in these locations, U Co organises the research centre through acquisition of third party manufacturing/research entities in India and China thereby forming its subsidiaries - I Co (India) and C Co (China) which would be engaged in contract research services for U Co
U Co
I Co
UK
Contract research services
C Co
Contract research services
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Case study - 2
I Co and C Co were existing businesses in India and China respectively which were historically manufacturing for third party customers in their respective markets
Whilst I Co and C Co would undertake contract research services for U Co‘s portfolio of products, they would also continue to carry out manufacturing activity for their erstwhile third party customers
The feasibility analysis shows that U Co has been able to achieve significant cost savings on account of the shifting of the research activity to India and have been able to achieve a faster pipeline growth of R&D product portfolio and patent applications
U Co
I Co
UK
Contract research services
C Co
Contract research services
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Case study - 2
In order to ensure that I Co and C Co follow the U Co way of business, the following support services are provided by U Co to I Co and C Co:
Monthly guidance and strategic direction for manufacturing process improvements
Quality inspection of the manufactured products of I Co and C Co by experts identified by U Co
Global customer account support whereby I Co and C Co are able to penetrate into new customer accounts and leverage on the global customer relationships held by U Co
Installation of new IT system at I Co and C Co for U Co to be able to monitor the performance and reporting of the respective companies
U Co
I Co
UK
Contract research services
C Co
Contract research services
Provision of business services
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Case study - 2
Troubleshooting support for IT systems to I Co and C Co on a regular basis
Supplier team at U Co provides support to I Co and C Co helping them with identifying vendors for procurement of critical components
Providing legal and accounting support services to I Co and C Co either from the legal and accounting teams at U Co or having the same obtained from third party service providers
U Co
I Co
UK
Contract research services
C Co
Contract research services
Provision of business services
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Case study - 2
Issues for consideration:
Whether I Co and C Co can be said to be entitled to a share of the location savings generated by U Co as a result of the shift of the research activities from the UK to India and China?
How would you categorise the nature of services provided by I Co and C Co to U Co as well as the services received by them from U Co?
What pricing policy can be considered as an appropriate compensation to the parties for the services?
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Case study - 3
Facts
E Co headquartered in the US provides online training and exams in the field of engineering, medical and management. Its course includes the following:
Access to online study material
Facility of online interactive chart with other students, faculty and external experts
Appearing for online tests
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Case study - 3
Issues for consideration:
Whether payments made can be considered to be in the nature of royalties, FTS or
Business Profits?
Difference between online training courses and retrieval or access to online
database
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Case study - 3
Variation in facts
E Co establishes a subsidiary in India – I Co and wholesales the bundled
services to I Co which in turn onward sells to Indian customers
Can I Co be considered to be a “reseller” of services? What would be the other
considerations from a business, tax and regulatory standpoint?