nestle transfer pricing final

NestléTransfer Pricing Report

For Fiscal Year Ended 2015

The Real Deal for Discussion Purposes

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Table of Contents Draft for Discussion Purposes

Table of Contents

1. Executive Summary

2. Company Overview / Functional Analysis

3. Industry Analysis

4. Section 482 Regulations

5. Selection of Best Transfer Pricing Method

6. Economic Analysis

7. Summary

Appendix A: Financial information of the comparable companies20

Appendix B: Business descriptions of the comparable companies21

Appendix C: Acceptance and rejection matrix of the comparable companies 22

Appendix D: Glossary of statistical terms 23

NestléTransfer Pricing Report (FY15) 1

Economic Analysis Draft for Discussion Purposes

1. Executive Summary

This report has been prepared for Nestlé to provide an analysis of comparable company data that may be used as a benchmark for returns earned by Nestlé N.A. in the general food and beverage production in the United States.

A search has been performed to find a set of independent companies which may be used to provide a benchmark for returns earned in the general food and beverage in United States. The search process involved the analysis of the companies in IBIS, the elimination of unsuitable companies and the selection of those companies which are considered to be appropriate to provide a benchmark for returns earned in the general food and beverage in United States.

As a result of the search, a comparable set of 20 independent companies has been identified. This comparable set may be used to provide a benchmark for returns earned in the general food and beverage in United States. Appendix B contains summary information on the companies identified.

Return on Sale has been used as the transfer pricing benchmark for the results. The key results for the 7 companies over a three year period are set out below. Summary results are presented in Section 3. Detailed results are presented in Appendix A.



Nestlé

Company Name Return of Revenue or Return on Sales

AVG

1 Mars, Inc. 6% 6% 5% 6%2 Mondelez International 17% 16% 13% 15%3 Hershey 14% 14% 19% 16%4 Lindt and Sprungli 14% 14% 13% 14%5 Unilever 6% 7% 8% 7%6 Dean Foods Co. 3% 2% 2% 2%7 ConAgra Foods Inc. 7% 7% 7% 7%

2016 2015 2014Minimum 3% 2% 2% 2%Lower Q 6% 6% 5% 6%Median 7% 7% 8% 7%Upper Quartile 14% 14% 13% 15%Maximum 17% 16% 19% 16%

Nestle 17% 16% 15% 16%

There were 7 companies identified in the final set of comparable food and beverage companies. Over the three-year period from 2014-2016, the comparable companies earned a Return on Sale of (insert). For the same period, Nestle earned insert, which is within the arm’s length range.



2. Nestlé Overview / Functional Analysis12

Nestlé

Nestlé is a Swiss transnational food and beverage company headquartered in Vevey, Vaud,

Switzerland.

It is the largest food company in the world measured by revenues. Nestlé’s products include baby

food, medical food, bottled water, breakfast cereals, coffee and tea, confectionery, dairy products, ice

cream, frozen food, pet foods, and snacks.

Twenty-nine of Nestlé’s brands have annual sales of over $1.1 billion, including Nespresso, Nescafé,

Kit Kat, Smarties, Nesquik, Stouffer’s, Vittel, and Maggi. Nestlé has 447 factories, operates in 194

countries, and employs around 339,000 people.

It is one of the main shareholders of L’Oreal, the world’s largest cosmetics company.

The main countries of organization are Switzerland, the U.K. and the United States.

The company estimates to earn 91.6 billion (2016) of revenue.

The main competitors of Nestle are Keurig, Glencore, Mars, and Hershey. Nestle’s main customer

base ranges from underdeveloped countries for baby formula, to children for candy bars.

1 "Nestle SA: Company Profile." Bloomberg.com. Bloomberg. Web. 19 Apr. 2016.2 "Company Profile from Hoover's." Nestlé S.A. Web. 19 Apr. 2016.



3. Industry Analysis3

A more in-depth analysis of the industry provides some

troubling news for Nestle. The company is currently having some

difficulty with their line of Maggi noodles. In May 2015, Food Safety

Regulators from India found that samples of Nestlé's leading

noodles, Maggi, had up to 17 times beyond permissible safe limits

of lead in addition to monosodium glutamate. On 5 June 2015,

Food Safety and Standards Authority of India (FSSAI) orders

banned all nine approved variants of Maggi instant noodles from

India, terming them "unsafe and hazardous" for human

consumption. In June 2015 Nepal indefinitely banned Maggi over

concerns about lead levels in the product. This area of the world is

the largest market per capita for prepackaged noodles.

Another problem that Nestle is encountering is that many of

their resources for major products such as their Nespresso and

Nestle brand chocolates come from South America. South America

is experiencing peculiar turmoil politically. Nestle is able to deal with

these fluctuations by substitutions of different cocoa sources in the

world. However, the increasing disposable income in countries like

China and India are driving demand up for confectionaries and

3 "Market Research Reports | Procurement Research Reports | Ibisworld US". Clients1.ibisworld.com. N.p., 2016. Web. 3 May 2016.



candies. Another issue with their cocoa supply is that cocoa

plantations are starting to cut back on supply. This increases the

costs to companies like Nestle.

Nestlé Water’s sales distribution share in the U.S. and Canada

are now currently at 40.2%. Their ice cream confectionaries are at

approximately 15%. Their chocolate brand holds a very small stake,

only 11.2%, due to Hershey and Mars holding almost 65% of the

market.

In December 2012, Swiss company Nestlé S.A. acquired Pfizer

Nutrition for $11.85 billion, increasing Nestlé’s position in the child

nutrition market. Nestlé estimated the acquired business’ 2012

sales at $2.4 billion, and said that 85% of Pfizer Nutrition’s sales

are in emerging markets, including many with large, fast-growing

populations. This means that they have an even firmer grasp on the

child formula market in growing economies.

Countries that Nestle operates in have remarkably stable

governments. The largest being the entire European continent, and

North America. The other countries that Nestle work in are usually

well established.



Very few market risks for Nestle in the world. Company only

has to maintain quality control on their products. There is very

inelastic demand for the company’s goods, such as water, baby

formula, and chocolate. Incidents of quality control in both India and

Africa in pre-packaged foods raise concerns that some divisions

may be more concerned with profit over quality. Profitability has not

been heavily depended on, but in order to sustain growth in

developing countries, many divisions are strapped for quick cash.

Euro is very weak vs. the dollar. Company should maintain as

many dollars as possible and hold onto them. The UK is

considering dropping out of the Eurozone, which would drive the

Euro even lower. Nestle is located in Switzerland, which is usually

impervious to economic fluctuation. However, the Swiss have been

effected by the European bailouts, as it has affected the capital

markets.

Chocolate has been fluctuating in price pretty wildly since the

incidents that have occurred. There is also the concern that

because cocoa plantations deplete the nutrients of the soil, many of

the cocoa plantations that are currently running will eventually have

the difficulty of sustainability. This is a large factor in the increasing

price of cocoa. Many of the problems are that the demand for

cocoa related products are growing steadily faster than the



plantations can do without mass deforestation of South American

rainforests, especially the Amazon River basin. Other sources,

such as Columbia, are depleting their soil without any reciprocation,

leading to a lower quality product.

Possible striking in future in South America. Cost of labour may

increase as a result. Many emerging countries such as China are in

increasing demand for products produced by Nestle. Possible new

geographic locations for resources are Indonesia and Borneo for

possible cocoa extraction, thus reducing the impact of the issue of

depleting cocoa reserves.



4. Section 482 Regulations

This section discusses the arm's length standard, the best method rule, and the various transfer pricingmethods available to analyze the reasonableness of the intercompany pricing.

4.1. Arm's length standard4

The Section 482 Regulations provide that " the purpose of section 482 is to ensure that taxpayers clearly reflect income attributable to controlled transactions, and to prevent the avoidance of taxes with respect to such transactions" by placing "a controlled taxpayer on a tax parity with an uncontrolled taxpayer by determining the true taxable income of the controlled taxpayer."

The Section 482 Regulations are based on the arm's length standard. The Section 482 Regulations provide that "the standard to be applied in every case is that of a taxpayer dealing at arm's length with an uncontrolled taxpayer. A controlled transaction meets the arm's length standard if the results of the transaction are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances …."

The key concept underlying application of the arm's length standard is comparability: comparing the results of the related party transaction in question to the results of comparable transactions between uncontrolled parties under comparable circumstances. The analysis in this report is based exclusively on that standard. Set forth below are the general guidelines for use in applying the arm's length standard to sales of tangible property.

4.2. Best method rule5

The Section 482 Regulations require that the "best method" be employed to determine the arm's length pricing for each intercompany transaction. The standard for determining the best method is that the result obtained for the controlled transaction using that method must produce the most reliable measure of an arm's length result under all of the facts and circumstances of that transaction. Among the factors to be taken into account in determining the best method are "the degree of comparability between the controlled transaction (or taxpayer) and any uncontrolled comparables, and the quality of the data and assumptions used in the analysis."

4.3. Alternative pricing methods for tangible property The arm's length character of a controlled transaction may be determined by applying one of the methods specified in the Section 482 Regulations. Where the controlled transactions under review are sales of tangible goods, the specified methods for the tangible products include the five methods described below.6

4 Treas. Reg. § 1.482-1.5 Treas. Reg. § 1.482-1(c).6 A taxpayer may select a method that is not specified in the regulations, provided the taxpayer can demonstrate that theunspecified method provides the most reliable measure of an arm's length result. See Treas. Reg. § 1.482-1(e)(1).



4.3.1. Comparable uncontrolled price method7

Under the comparable uncontrolled price ("CUP") method, the arm's length price for the transfer of tangible property between related parties is determined by reference to the consideration paid for the same or similar property in a transaction between unrelated parties. The standard of comparability required under the CUP method is high. A transaction is considered comparable only if both the tangible property and circumstances surrounding the controlled transaction are substantially the same as those of the uncontrolled transaction.

Additional factors for determining comparability are the quality of the product, the volume of sales, the level of the market, the geographic market in which the transaction takes place, the date the transaction takes place, and the alternative commercial arrangements realistically available to both parties. Minor differences can be taken into account if adjustments can be made for such differences, and these adjustments have a reasonably ascertainable effect on the price.8

4.3.2. Resale price method9

The resale price method ("RPM") tests the arm's length character of a transfer price in a controlled transaction by reference to the gross profit margin (i.e., gross profit divided by net sales) realized in a comparable uncontrolled transaction. The RPM measures the value of functions performed and ordinarily is appropriate in cases involving the purchase and resale of tangible goods in which the buyer/reseller does not add substantial value to the goods by physically altering them or by using non-routine marketing intangible assets. Under the RPM, comparability is dependent primarily on the similarity of the functions performed and the risks assumed by the controlled and uncontrolled parties, and is less dependent on the similarity of the tangible goods bought and resold.

4.3.3. Cost plus method10

The cost plus ("CP") method tests the arm's length character of a transfer price in a controlled transaction by reference to the gross profit mark-up (i.e., gross profit divided by costs) realized in a comparable uncontrolled transaction. The CP method measures the value of functions performed and ordinarily is appropriate in cases involving the manufacture or assembly of tangible goods that are sold to a related party. The gross profit mark-up provides both compensation for the performance of manufacturing and/or assembly functions and a return on capital invested and risks assumed by the manufacturer. Thus, under the CP method, "comparability" is dependent primarily on the similarity of the functions performed and the risks assumed by the controlled and uncontrolled manufacturers, and is less dependent on the similarity of the tangible goods produced.

4.3.4. Comparable profits method11

The comparable profits method ("CPM") tests the arm's length character of transfer prices in a controlled transaction by comparing the profits earned by one of the parties engaged in the controlled transaction to the profits earned by uncontrolled parties engaged in similar business activities. The CPM measures the total return derived from the controlled taxpayer's most narrowly defined business activity for which reliable data incorporating the controlled transaction under review is available. Comparability under the CPM, therefore, is dependent primarily on the similarity of capital invested and risks assumed by the controlled and uncontrolled parties with respect to such activities. Under the CPM, comparables need to be

7 Treas. Reg. § 1.482-3(b).8 Treas. Reg. § 1.482-3(b)(2)(ii)(A).9 Treas. Reg. § 1.482-3(c).10 Treas. Reg. § 1.482-3(d).11 Treas. Reg. § 1.482-5.



only broadly similar, and significant product diversity and some functional diversity between the controlled and uncontrolled parties is acceptable.

The CPM establishes an arm's length result based on the use of an appropriate PLI. A variety of profit level indicators can be calculated in any given case. Specifically, the Section 482 Regulations identify two types of PLIs: (i) the rate of return on capital employed, and (ii) financial ratios. As examples of financial ratios, the Section 482 Regulations identify the ratio of operating profit to sales and the ratio of gross profit to operating expenses. The use of a PLI depends on the nature of the activities of the tested party (i.e., the tested party is the participant in a related party transaction whose prices or profits will be tested using the arm's length standard), the reliability of the available data, and the extent to which it is likely to produce a measure of the income that the tested party would have earned if dealing with an unrelated party. PLIs normally should be derived from several years of data in order to provide a reasonable measure of the profitability of the uncontrolled comparable firms.

4.3.5. Profit split method12

The profit split method ("PSM") evaluates whether the allocation of the combined operating profit or loss attributable to one or more controlled transactions is arm's length by reference to the relative value of each controlled taxpayer's contribution to that combined operating profit or loss. The relative value of each controlled taxpayer's contribution to the success of the relevant business activity must be determined in a manner that reflects the functions performed, risks assumed, and resources employed by each participant in the relevant business activity. Two forms of the PSM are specified methods under the Section 482 Regulations: (i) the comparable profit split method, and (ii) the residual profit split method.

4.3.5.1. Comparable profit split method

The comparable profit split method divides the total operating income of the buyer (or licensee) and the seller (or licensor) in the controlled transaction in a manner that is consistent with the way comparable unrelated parties divide their operating income in similar transactions. As with the CPM, discussed above, comparability under this method is especially dependent on resources employed and risks assumed. Comparability is also particularly dependent on the degree of similarity of the contractual terms of the controlled and uncontrolled transactions. The comparable profit split method may not be used if combined returns on operating assets differ significantly. It is generally expected that the use of this method will be limited because (i) it will be difficult to find two independent parties each having risks, functions, and intangibles comparable to those of the controlled parties, and (ii) data delineating how the independent parties shared the combined profits from a comparable transaction will rarely exist. These constraints on the comparable profit split method make it likely that most profit split analyses will be applied using the residual profit split method discussed below.

4.3.5.2. Residual profit split method

Under the residual profit split method, the combined operating profit or loss from the relevant business activity is allocated between the controlled taxpayers in a two-step process. The first step requires that a market return for routine contributions be allocated to each party under one of the other specified methods. Routine contributions ordinarily include contributions of tangible property, services, and intangibles that generally are owned by uncontrolled taxpayers engaged in similar activities.

Income allocated under the first step, however, will not reflect profits attributable to the controlled group's valuable intangible property where similar property is not owned by the uncontrolled taxpayers from which the market returns are derived. In cases where such intangibles are present, there normally will be an unallocated

12 Treas. Reg. § 1.482-6.



residual profit. Under the second step of the residual profit split method, the residual profit generally is divided among the controlled taxpayers based on the relative values of their contributions to the relevant business activity other than their routine contributions. Comparability and reliability considerations for the first step of the residual profit split method are those of the other specified methods used to value the parties' routine contributions. To the extent that the second step generally does not rely on market data of comparable companies or transactions, the reliability of the results under this method is reduced. Therefore, the reliability of the residual profit split depends mainly on factors other than comparability, including the reliability of cost and income allocations, the consistency of accounting methods, and the reliability of the data used in valuing the intangible property contributed by the parties.

4.3.5.3. Unspecified methods13

A method not specified in the Section 482 Regulations may be used to evaluate whether the amount charged in a controlled transaction is arm's length. Any unspecified method must be applied in accordance with the general rules applicable to all specified methods. Thus, an unspecified method will not be applied unless it provides the most reliable measure of an arm's length result under the principles of the best method rule. To the extent that a method relies on internal data rather than uncontrolled comparables, its reliability will be reduced. The reliability of the method will also be affected by the reliability of the data and assumptions used in applying the method.

4.4. Alternative pricing methods for intangible propertyThe arm's length character of a controlled transaction may be determined by applying one of the methods specified in the Section 482 Regulations. Where the controlled transactions under review are for intangible property, the specified methods for intangible property include the three methods described below.14

4.4.1. Comparable uncontrolled transaction method15

Under the comparable uncontrolled transaction ("CUT") method, the arm's length price for the transfer of intangible property between related parties is determined by reference to the consideration paid for the same or similar property in a transaction between unrelated parties. The standard of comparability required under the CUT method is high. A transaction is considered comparable only if both the intangible property and circumstances surrounding the controlled transaction are substantially the same as those of the uncontrolled transaction.

Additional factors for determining comparability are the contractual terms surrounding the arrangement, economic conditions, the intangible being used in connection with similar products or processes within the same general industry or market, and the intangible having similar profit potential. Minor differences can be taken into account if adjustments can be made for such differences, and these adjustments have a reasonably ascertainable effect on the amount charged.16

4.4.2. Comparable profits method17

13 Treas. Reg. § 1.482-3(e).14 A taxpayer may select a method that is not specified in the regulations, provided the taxpayer can demonstrate that theunspecified method provides the most reliable measure of an arm's length result. See Treas. Reg. § 1.482-4(d).15 Treas. Reg. § 1.482-4(c).16 Treas. Reg. § 1.482-4(c)(2)(ii).17 Treas. Reg. § 1.482-5.



The comparable profits method ("CPM") tests the arm's length character of transfer prices in a controlled transaction by comparing the profits earned by one of the parties engaged in the controlled transaction to the profits earned by uncontrolled parties engaged in similar business activities. The CPM measures the total return derived from the controlled taxpayer's most narrowly defined business activity for which reliable data incorporating the controlled transaction under review is available. Comparability under the CPM, therefore, is dependent primarily on the similarity of capital invested and risks assumed by the controlled and uncontrolled parties with respect to such activities. Under the CPM, comparables need to be only broadly similar, and significant product diversity and some functional diversity between the controlled and uncontrolled parties is acceptable.

The CPM establishes an arm's length result based on the use of an appropriate PLI. A variety of profit level indicators can be calculated in any given case. Specifically, the Section 482 Regulations identify two types of PLIs: (i) the rate of return on capital employed, and (ii) financial ratios. As examples of financial ratios, the Section 482 Regulations identify the ratio of operating profit to sales and the ratio of gross profit to operating expenses. The use of a PLI depends on the nature of the activities of the tested party (i.e., the tested party is the participant in a related party transaction whose prices or profits will be tested using the arm's length standard), the reliability of the available data, and the extent to which it is likely to produce a measure of the income that the tested party would have earned if dealing with an unrelated party. PLIs normally should be derived from several years of data in order to provide a reasonable measure of the profitability of the uncontrolled comparable firms.

4.4.3. Profit split method18

The profit split method ("PSM") evaluates whether the allocation of the combined operating profit or loss attributable to one or more controlled transactions is arm's length by reference to the relative value of each controlled taxpayer's contribution to that combined operating profit or loss. The relative value of each controlled taxpayer's contribution to the success of the relevant business activity must be determined in a manner that reflects the functions performed, risks assumed, and resources employed by each participant in the relevant business activity. Two forms of the PSM are specified methods under the Section 482 Regulations: (i) the comparable profit split method, and (ii) the residual profit split method.

4.4.3.1. Comparable profit split method

The comparable profit split method divides the total operating income of the buyer (or licensee) and the seller (or licensor) in the controlled transaction in a manner that is consistent with the way comparable unrelated parties divide their operating income in similar transactions. As with the CPM, discussed above, comparability under this method is especially dependent on resources employed and risks assumed. Comparability is also particularly dependent on the degree of similarity of the contractual terms of the controlled and uncontrolled transactions. The comparable profit split method may not be used if combined returns on operating assets differ significantly.

It is generally expected that the use of this method will be limited because (i) it will be difficult to find two independent parties each having risks, functions, and intangibles comparable to those of the controlled parties; and (ii) data delineating how the independent parties shared the combined profits from a comparable transaction will rarely exist. These constraints on the comparable profit split method make it likely that most profit split analyses will be applied using the residual profit split method discussed below.

4.4.3.2. Residual profit split method18 Treas. Reg. § 1.482-6.



Under the residual profit split method, the combined operating profit or loss from the relevant business activity is allocated between the controlled taxpayers in a two-step process. The first step requires that a market return for routine contributions be allocated to each party under one of the other specified methods. Routine contributions ordinarily include contributions of tangible property, services, and intangibles that generally are owned by uncontrolled taxpayers engaged in similar activities.

Income allocated under the first step, however, will not reflect profits attributable to the controlled group's valuable intangible property where similar property is not owned by the uncontrolled taxpayers from which the market returns are derived. In cases where such intangibles are present, there normally will be an unallocated residual profit. Under the second step of the residual profit split method, the residual profit generally is divided among the controlled taxpayers based on the relative values of their contributions to the relevant business activity other than their routine contributions.

Comparability and reliability considerations for the first step of the residual profit split method are those of the other specified methods used to value the parties' routine contributions. To the extent that the second step generally does not rely on market data of comparable companies or transactions, the reliability of the results under this method is reduced. Therefore, the reliability of the residual profit split depends mainly on factors other than comparability, including the reliability of cost and income allocations, the consistency of accounting methods, and the reliability of the data used in valuing the intangible property contributed by the parties.

4.4.3.3. Unspecified methods19

Methods not specified in the Section 482 Regulations may be used to evaluate whether the amount charged in a controlled transaction is arm's length. Any unspecified method must be applied in accordance with the general rules applicable to all specified methods. Thus, an unspecified method will not be applied unless it provides the most reliable measure of an arm's length result under the principles of the best method rule. To the extent that a method relies on internal data rather than uncontrolled comparable, its reliability will be reduced. The reliability of the method will also be affected by the reliability of the data and assumptions used in applying the method.

19 Treas. Reg. § 1.482-4(d).



5. Selection of Best Transfer Pricing Method

5.1.1. Comparable uncontrolled price method

Where applicable, the CUP method generally will result in the most accurate measure of an arm's length price. The CUP method, however, relies heavily on close comparability, which implies that the property transferred and the underlying circumstances must be "identical" or so nearly identical that either any difference would have no effect on price or such differences could be reflected by a reasonable number of adjustments.

Nestlé supplies raw materials, such as cocoa, to Nestlé and its other related food producing companies for use in the manufacture of food and other consumables. Nestlé does not sell these raw materials to unrelated third parties nor does Nestlé purchase the same type of raw materials from unrelated parties at the same volumes. Since there are no reliable internal or external comparable uncontrolled transactions, the CUP method cannot be reliably used to evaluate the arm’s length nature of the transfer prices between Nestlé and Nestlé S.A. related to this transaction.

5.1.2. Resale price method

The RPM tests the arm's length character of a transfer price in a controlled transaction by reference to the gross profit margin (i.e., gross profit divided by net sales) realized in a comparable uncontrolled transaction.

The RPM can reliably be applied when the related party purchaser does not add significant value to thegoods before reselling to third parties and has fewer and less valuable functions and intangibles than the related party seller. With regard to the controlled transaction, Nestlé purchases raw materials from Nestlé and uses the materials in the manufacture of brake linings and pads. The RPM cannot be utilized as the best method to evaluate the transfer prices in the controlled transaction because Nestlé substantially alters the raw materials purchased by Nestlé in the manufacturing process.

5.1.3. Cost plus method

The CP method tests the arm's length character of a transfer price in a controlled transaction by reference to the gross profit mark-up (i.e., gross profit divided by costs) realized in a comparable uncontrolled transaction.

In Transaction #1, We did not identify any cost plus margins for similar raw materials development activities performed by Nestlé at a similar market level. Nestlé’s raw materials are highly proprietary and are not sold to unrelated parties. Moreover, if such cost plus margins could be identified, difficulty in capturing the appropriate costs that would be reflected in the cost of goods sold would arise due to the proprietary processes employed in developing raw material formulas. Therefore, the CP method was not selected as the most reliable method to evaluate the transfer prices in the controlled transaction.



5.1.4. Profit split method

The PSM evaluates whether the allocation of the combined operating profit or loss attributable to one or more controlled transactions is arm's length by reference to the relative value of each controlled taxpayer's contribution to that combined operating profit or loss.

The allocation of profit and loss under the PSM may be made in accordance with either of two methods, the comparable profit split or the residual profit split.30 To properly employ the comparable profit split method, a transaction between two uncontrolled parties would have to be identified which is sufficiently similar to the controlled transaction with regard to all economic circumstances to establish an arm's length profit split. No transactions sufficiently similar to the transaction under study were identified. The residual profit split method applies in situations where both transacting parties contribute valuable intangible assets to the controlled transaction under review. NESTLÉ does not own valuable non-routine intangible assets with respect to this transaction. Therefore, the residual profit split method was not selected as the best method.

5.1.5. Comparable profits method

The CPM tests the arm's length character of transfer prices in a controlled transaction by comparing the profits earned by one of the parties engaged in the controlled transaction to the profits earned by uncontrolled parties engaged in similar business activities.

Extensive searches of the public databases were conducted to identify independent companies with manufacturing activities that are functionally similar to those performed by NESTLÉ. Because such companies could be identified, the CPM was selected as the most reliable method for evaluating the arm’s length nature of Nestlé’s manufacturing activities.

Having rejected the CUP method, the RPM, the CP method, and the PSM, the CPM was selected as the best method to analyze Nestlé’s results. The choice of the CPM is based on (i) the degree of comparability between NESTLÉ and the uncontrolled comparables, and (ii) the relative reliability of the available data regarding the comparables. The reliability of the CPM depends primarily upon the comparability of the resources employed and risks assumed.



6. Economic Analysis

The intention of the search has been to identify a set of independent companies engaged in the general food and beverage in United States. The source of data for the search was the IBIS database. IBIS is a database that provides research reports on industries in the United States, the United Kingdom, Australia and China.20 These companies formed the starting point for the search.

6.1 The IBIS searchThe first stage in the search process was to use the IBIS search engine to identify a broad set of companies for further analysis. There were two steps in this first stage of the search process.

Firstly, companies that are registered in one of the following countries were selected: United States, United Kingdom, and the European Union. Companies based in countries that are not included in the above list were rejected. Many companies that were listed were small, regional European companies, and were then determined to not be directly international competition with Nestle. As a result of this step, 6 companies were rejected, and the remaining 14 companies were accepted.

Secondly, a combined industry code and word search strategy was used to identify companies engaged in the general food and beverage. The criteria used to identify companies in each of these categories were as follows: Companies classified in the following industry code activity codes were selected: chocolate, and

food production Companies whose business descriptions contained any of the following word stems were

selected: water, chocolate, food, and beverages.

As a result of this step, 7 companies were accepted and the remaining 6 companies were rejected.

For the chocolate industry, IBIS outputted Hershey, Mars Inc., Mondelez, and Lindt & Sprungli. British Consolidated Foods and Birdseye Frozen Foods were either focused on one specific geographic area or market concentration, and not the snack food industry as a whole.

Appendix C details and records the steps taken in the IBIS to identify the 7 companies. Further selection criteria were then applied to these remaining companies.

6.2 Further selectionThe first step in the further selection process was to identify non-independent companies, since the results of controlled or dependent companies could be distorted by transactions with their affiliates. Therefore, companies identified in IBIS as being non-independent were rejected.21 As a result of this step, 0 companies were rejected, leaving 6 companies.

20 Further information about the [database name] is contained in Appendix F.21 Further information on the approach to independence is presented in Appendix G.



Second, companies were rejected which failed to report data in at least 1 of the last 3 years. As a result of this step, 0 companies were rejected, reducing the set to 7. These companies were eliminated for two reasons: Where companies fail to report consistently each year, the data they supply may be unreliable The use of multiple year data takes into account the cyclical nature of businesses. The OECD

Guidelines recognize the importance of using multiple years of data when presenting an arm’s length result.22

The third step in the search process was the rejection of companies which reported 3 years of consecutive loss over a period of 3 years. As a result of this step, 0 companies were rejected and the remaining 7 companies were accepted.

The fourth step in the search process was the rejection of companies which reported an average loss over the 3 year period. As a result of this step, 0 companies were rejected and the remaining 7 companies were accepted.

The next stage in the selection process involved the individual analysis of IBIS business descriptions for the 7 companies which remained.

Companies were rejected if: Their business description indicated that they performed functions inconsistent with the food and

beverage production activities of Nestle They appeared to be principally engaged in the production of products not similar to those

production by Nestlé’s business, including but not limited to food distribution, frozen vegetables, and flavored waters.

They appeared not to be independent.23

As a result of this analysis of individual Nestlé data presented in IBIS, 1 company were rejected, leaving a comparable set of 7 companies engaged in the general food and beverage industry.

Further information on the selection and rejection of companies is presented in Appendix C.

6.3 Final comparable company setAs a result of the analysis, a final set of 7 companies were identified as engaged in the general food and beverage which may be used to provide an appropriate benchmark for returns earned in the general food and beverage in United States. Appendix B contains summary information on the comparable Nestlé set.

The results for the final set of 7 companies are presented in the following section as well as detailed results in Appendix A.

6.4 Final comparable company set results

22 The OECD ‘Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations’ (The Guidelines), paragraph 1.50.23 See Appendix G for details of the way in which Nestlé data is reviewed for independence.



There were 7 companies identified in the final set of comparable food and beverage companies. Over the three-year period from 2014-2016, the comparable companies earned a Return on Sale of (insert). For the same period, Nestle earned insert, which is within the arm’s length range.


Summary Draft for Discussion Purposes

7. Summary

This report has been prepared for Nestlé to provide an analysis of comparable company data that may be used as a benchmark for returns earned by Nestlé N.A. in the general food and beverage production in the United States.

A search has been performed to find a set of independent companies which may be used to provide a benchmark for returns earned in the general food and beverage in United States. The search process involved the analysis of the companies in IBIS, the elimination of unsuitable companies and the selection of those companies which are considered to be appropriate to provide a benchmark for returns earned in the general food and beverage in United States.

As a result of the search, a comparable set of 20 independent companies has been identified. This comparable set may be used to provide a benchmark for returns earned in the general food and beverage in United States. Appendix B contains summary information on the companies identified.

Return on Sale has been used as the transfer pricing benchmark for the results. The key results for the 7 companies over a three year period are set out below. Summary results are presented in Section 3. Detailed results are presented in Appendix A.


Summary Draft for Discussion Purposes

Nestlé

Company Name Return of Revenue or Return on Sales

AVG

1 Mars, Inc. 6% 6% 5% 6%2 Mondelez International 17% 16% 13% 15%3 Hershey 14% 14% 19% 16%4 Lindt and Sprungli 14% 14% 13% 14%5 Unilever 6% 7% 8% 7%6 Dean Foods Co. 3% 2% 2% 2%7 ConAgra Foods Inc. 7% 7% 7% 7%

2016 2015 2014Minimum 3% 2% 2% 2%Lower Q 6% 6% 5% 6%Median 7% 7% 8% 7%Upper Quartile 14% 14% 13% 15%Maximum 17% 16% 19% 16%

Nestle 17% 16% 15% 16%

There were 7 companies identified in the final set of comparable food and beverage companies. Over the three-year period from 2014-2016, the comparable companies earned a Return on Sale of 7%. For the same period, Nestle earned 16%, which is within the arm’s length range.


Appendices Draft for Discussion Purposes


Appendices Draft for Discussion Purposes

Appendices

AppendicesAppendix A: Financial information of the comparable companies

Appendix B: Business descriptions of the comparable companies

Appendix C: Acceptance and rejection matrix of the comparable companies

Appendix D: Glossary of statistical terms


Business descriptions of the comparable companies

Draft for Discussion Purposes

Appendix A: Financial information of the comparable companies

Detailed financial results for the comparable set of companies are presented here.

Nestlé

Company Name Return of Revenue or Return on Sales AVG Revenue AVG Operating Income AVG

2016 2015 2014 2016 2015 2014

1 Mars, Inc. 6% 6% 5% 6% 3672 3543.3 3461.8 3559.033333 209.4 194.9 186.9 197.0666667

2 Mondelez International 17% 16% 13% 15% 1697.3 1716.9 1682.9 1699.033333 282.2 272 223.7 259.3

3 Hershey 14% 14% 19% 16% 4983.1 4893.2 4797.3 4891.2 703.6 687.5 899.9 763.6666667

4 Lindt and Sprungli 14% 14% 13% 14% 1224.1 1174.8 1145.7 1181.533333 177.1 160.8 147.0 161.6333333

5 Unilever 6% 7% 8% 7% 1751.1 1583.6 1616.5 1650.4 108.9 115.9 136.4 120.4

6 Dean Foods Co. 3% 2% 2% 2% 848.8 836.3 802.5 829.2 24 17.6 17.5 19.7

7 ConAgra Foods Inc. 7% 7% 7% 7% 4573.7 4519.5 4335.5 4476.233333 333.8 314.2 282.1 310.0333333

2016 2015 2014

Minimum 3% 2% 2% 2% 848.8 836.3 802.5 829.2 24 17.6 17.5 19.7

Lower Q 6% 6% 5% 6% 1224.1 1174.8 1145.7 1181.533333 108.9 115.9 136.4 120.4

Median 7% 7% 8% 7% 1751.1 1716.9 1682.9 1699.033333 209.4 194.9 186.9 197.0666667

Upper Quartile 14% 14% 13% 15% 4573.7 4519.5 4335.5 4476.233333 333.8 314.2 282.1 310.0333333

Maximum 17% 16% 19% 16% 4983.1 4893.2 4797.3 4891.2 703.6 687.5 899.9 763.6666667

Nestle 17% 16% 15% 16% 1724.6 1717.3 1802.1 1748 289.3 277 273.3 279.8666667




Appendix B: Business descriptions of the comparable companies

Business descriptions and other information for the comparable set of companies are presented here.

Nestlé

Nestlé S.A. is a holding Nestlé of the Nestlé Group, which comprises of subsidiaries, associated companies and joint ventures across the world. The Nestlé operates through five segments: Zone Europe; Zone Americas; Zone Asia, Oceania and Africa; Nestle Waters and Nestle Nutrition. It offers powered and liquid beverages; water; milk products and ice creams; Nutrition and Health Science; Confectionery, PetCare and unallocated items. The Nestlé’s other business activities include the operations of Nestle Professional, Nespresso, Nestle Health Science and Nestle Skin Health. It operates in approximately 197 countries around the world. The Nestlé has sales in various countries, including the United States of America, Greater China Region, Brazil, Germany, United Kingdom, Mexico, Philippines, Italy, Canada and Switzerland, among others. It offers over 2,000 brands of products around the world.

Mars, Incorporated

Mars knows chocolate sales are nothing to snicker at. The company makes global brands M&M's, Snickers, and the Mars bar. Other confections include 3 Musketeers, Dove, Milky Way, Skittles, and Twix. Its products portfolio also boasts Seeds of Change organic food, the Klix and Flavia beverage systems, Combos and Kudos snacks, Uncle Ben's rice, and pet food made under the Pedigree, Sheba, and Whiskas labels. Mars owns the world's largest chewing gum maker, Wm. Wrigley Jr. Company, as well. The Mars family -- including siblings and chairman John Franklyn Mars, VP Jacqueline Badger Mars, and former CEO Forrest Mars Jr. -- owns the highly secretive company, making the family one of the wealthiest in the US.

Mondelez International, Inc.

Mondelez International (formerly Kraft Foods Inc.) makes what it takes to survive a global snack attack. The company's pantry of billion-dollar brands includes: Cadbury and Milka chocolates; LU, Nabisco, and Oreo biscuits; Trident gum; Tang powdered beverages; and Jacobs coffees. Mondelez International comprises the global snacking and food brands of the former Kraft Foods, whose North American operations were spun off to form Kraft Foods Group in 2012. Mondelez, with about $35 billion in annual sales, operations in more than 80 countries, and sale in about 165 countries, is the larger of the two businesses.




Hershey Company

The Hershey Company is a producer of chocolate and non-chocolate confectionery. The Company's principal confectionery offerings include gum and mint refreshment products; pantry items, such as baking ingredients, toppings and beverages, and snack items, such as spreads, meat snacks, bars, and snack bites and mixes. The Company operates through two segments: North America, and International and Other. The Company's North America segment is responsible for its chocolate and sugar confectionery business, as well as its grocery and snacks business, in the United States and Canada. Its International and Other segment includes all other countries where the Company manufactures, imports, markets, sells or distributes chocolate and non-chocolate confectionery, and other products. The Company markets, sells and distributes its products under approximately 80 brand names in over 70 countries across the world.

Lindt & Sprungli

Chocoladefabriken Lindt & Spruengli AG is a Switzerland-based and globally active holding company developing, producing and selling chocolate products. The Company’s products are sold under the brand names Lindt, Ghirardelli, Caffarel, Hofbauer and Kufferle. The Company has six production sites in Europe and two in the United States. The Company sells its products mainly in countries within Europe and the North American Free Trade Agreement (NAFTA) countries. In September 2014, it announced the placement of 1 billion Swiss francs worth of bonds issues to finance Russell Stover Candies takeover. The Company’s subsidiaries include Chocoladefabriken Lindt & Sprngli (Schweiz) AG, Chocoladefabriken Lindt & Sprngli GmbH, Lindt & Sprngli SAS, Lindt & Sprngli (UK) Ltd, Lindt & Sprngli (Poland) Sp. z o.o., L&S (Brazil) Holding Ltd and Lindt & Sprngli (Asia-Pacific) Ltd., among others.

Unilever

Unilever PLC is a supplier of food, home and personal care products. The Company's portfolio ranges from nutritionally balanced foods to indulgent ice creams, soaps, shampoos and household care products. The Company operates through four segments: Personal Care, Foods, Home Care and Refreshment. The Personal Care segment includes sales of skin care and hair care products, deodorants and oral care products. The Foods segment includes sales of soups, bouillons, sauces, snacks, mayonnaise, salad dressings, margarines and spreads. The Homecare segment includes sales of home care products, such as powders, liquids and capsules, soap bars and a range of cleaning products. The Refreshment segment includes sales of ice cream and tela-based beverages. The Company has approximately 400 brands found in homes around the world, including Persil, Dove, Knorr, Domestos, Hellmann's, Lipton, Wall's, PG Tips, Ben & Jerry's, Marmite, Magnum and Lynx. The Company operates in over 190 countries.

Dean Foods Company




Dean Foods Company is a food and beverage company. The Company processes and distributes fluid milk and other dairy case products in the United States. The Company operates through manufacturing, marketing, selling and distributing a wide variety of branded and private label dairy case product segment. It manufactures, markets and distributes a variety of branded and private label dairy case products, including fluid milk, ice cream, cultured dairy products, creamers, juice, tea, ice cream mix and other dairy products to retailers, distributors, foodservice outlets, educational institutions and governmental entities across the United States. The Company delivers its products to customer locations in refrigerated trucks or trailers that it owns or leases. Its products are sold on a local or regional basis through its local and regional sales forces. It operates approximately 70 manufacturing facilities in over 30 states located based on customer needs and other market factors.

ConAgra Foods, Inc.

ConAgra Foods, Inc. operates as a packaged food company. The Company offers branded and private branded food to households, as well as commercial foods, which serves various restaurants and foodservice operations. The Company operates in three segments: Consumer Foods, Commercial Foods and Private Brands. Its brands include Banquet, Chef Boyardee, Egg Beaters, Healthy Choice, Hebrew National, Hunt's, Marie Callender's, Orville Redenbacher's, PAM, Peter Pan, Reddi-wip, Slim Jim and Snack Pack, among others. The Company sells its products under private brand labels in grocery, convenience, mass merchandise, club and drug stores. Additionally, ConAgra Foods supplies frozen potato and sweet potato products, as well as other vegetable, spice, bakery, and grain products, to restaurants, commercial and foodservice customers. It has international manufacturing facilities in Argentina, Mexico and interests in ownership of international manufacturing facilities in India and Mexico.




Appendix C: Acceptance and rejection matrix of the comparable companies




Appendix D: Glossary of statistical terms

A glossary of statistical terms is presented here.

Lower decile The value below which 10% of the set falls. In a set of all the numbers from 0 to 100, the lower decile is 10.

Lower quartile The value below which 25% of the set falls. In a set of all the numbers from 0 to 100, the lower quartile is 25.

Maximum The highest value in the comparable set.Mean The mean, along with the median, is one of several indices of central tendency. The

mean is defined as the arithmetical average of a set of numbers. It is calculated by summing the values of all the observations and dividing by the number of observations. For example, the mean of the set [–10, 0, 3, 4, 5, 7, 8, 9, 100] is 14. The mean can be distorted by extremely high or low results within the comparable set.

Median The median, along with the mean, is one of several indices of central tendency. The median is defined as the middle value, or mean of the two middle values, of a set of numbers arranged in order of magnitude. The median of the set [–10, 0, 3, 4, 5, 7, 8, 9, 100] is 5 with an equal number of observations on either side. The median is not distorted by extremely high or low results within the comparable set.

Minimum The lowest value in the comparable set.Observation The number of times a ratio occurs within a set or sub–set.Standard deviation The standard deviation (“SD”) is a measure of ‘dispersion’. It shows the variability

of a distribution. When used in conjunction with the mean, the standard deviation can be used to estimate the likelihood that an observation will be within a range of values. Approximately 95% of all observations will tend to lie within +/– 2 SDs of the sample mean provided (i) the sample size is large enough, and (ii) the underlying distribution of observations can be approximated by a normal distribution.

Upper decile The value above which 10% of the set falls. In a set of all the numbers from 0 to 100, the upper decile would be 90.

Upper quartile The value above which 25% of the set falls. In a set of all the numbers from 0 to 100, the upper quartile is 75.


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