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SAM SIM

Executive Board Member, Asia Chapter, TEI,Singapore

December 6, 2018

Plenary Session: 11.00 -11.30 AM

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Digital Disruption to the Global Value Chain and the Future of Transfer Pricing

All rights reserved 2018 Sam SIM

Disruption and Divergence

3All rights reserved 2018 Sam SIM

1. Financial Services & Technology Diverge in BEPS

Financial Services – Attribution of Profits to PE 2010

BEPS Actions 8-10

Functions Significant People’s Function (SPF), Key Entrepreneurial Risk-Taking Functions (KERT)

Development, Enhancement, Maintenance, Protection and Exploitation(DEMPE)

Assets (issue of mobile intangibles) Capital Intellectual Property

Risks Manage risks + financial capacity to assume losses

Manage & Control risks + financial capacity to assume losses

What is appropriate return to capital? Authorised OECD Approach – KERT in PE assume risk capital needed against the risk

Risk weighted returnRisk-free return

Allocation/Attribution of Income Attribution of Profits to PE Article 7 (Authorised OECD Approach)

Allocation to DEMPE Article 9


2. Disruption in the Digital SpaceHard Enough to Keep Consensus Post-BEPS and US Tax Reform

- Unilateral Actions & Interim Measures

- Diverted Profits Tax, MAAL

- Destination Based Taxation

- Equalization Levy; Digital Services Tax

- Digital Nexus: Significant Digital Presence, Active User Participation

➢Move beyond BEPS into allocating taxing rights

➢Blur the lines between income tax, indirect tax, PE, GAAR, Transfer Pricing

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BEPS + US Tax Reform


3. Trade War

• Global shift of supply chain out of China

• Tax/TP Impact

Change in business models and supply chain change in TP models and documentation (value chain and functional analysis) 6

All rights reserved 2018 Sam SIM Source: https://asia.nikkei.com/Economy/Trade-War/Trade-war-drives-Asian-manufacturing-out-of-China

4. Beyond Trade – Battle for the Tech Future – Issue: “Made in China 2025” plan including 5G, AI

- Jack Ma predicts a 20 year war

5G Wireless Standard – enabler for driverless cars, IoT- China to be world's largest 5G market by 2025, with 430 million 5G connections,

or 1/3 of global total- 5G: In early 2017, 10% of the 1,450 patents essential for 5G networks are Chinese owned Qualcomm owned 15% of 5G patents, Nokia 11% and Ericsson 8%.

- 4G: In 2011, Huawei and ZTE owned a combined 7% of 4G patents. Qualcomm owned 21%

- Huawei spent $800m on 5G R&D in 2018 and will increase R&D spending to between $10-20bn annually. Compare this with Ericsson at 4.5bn and Nokia at 5.3bn.

Source: https://www.nytimes.com/2018/03/07/technology/china-huawei-5g-standards.html; Report by the Global System for Mobile Communication Association (GSMA) and Global TD-LTE Initiative (GTI); https://www.lightreading.com/artificial-intelligence-machine-learning/huawei-dwarfs-ericsson-nokia-on-randd-spend-in-2017/d/d-id/741944


https://www.nytimes.com/2018/03/07/technology/china-huawei-5g-standards.html

Tale of Two Futures

• Harmonized global 5G standards and protocols

-Agreements on the Non-Standalone specifications (Dec 2017) and Standalone specifications (June 2018) completed the radio part of 5G Phase 1

• Sanctions, Export Controls and Block Deals:

>Qualcomm-NXP, ZTE, Fujian Jinhua Integrated Circuit

• Fragmented 5G standards and global value chain (Replay of GSM –CDMA?) China led group in Belt & Road Initiative countries in Asia vs US/European standards elsewhere.

• A fragmented 5G landscape could have repercussions beyond telecoms, forcing similar divisions in the AI, robotics, and integrated circuits sectors, among others.

Source: Beijing's global 5G ambitions threaten to disrupt telecoms, Nikki Asia Review August 31, 2018 8

OR

?


East is East and West and West,

and Never the Twain Shall Meet?


Covergence #1 - Financial Services & Technology

Francisco González, Executive Chairman & CEO, BBVA

1. “Our biggest competitors are not necessarily other banks. They are Amazon and Google. These are the companies setting the expectation of our customers”

2. “Artificial intelligence, together with big data, are the real game changer”

3. Difference between BBVA and startups: Startups only work on one part of the value chain, like payments, for instance, while “BBVA is a universal bank, with services like deposits, mortgages and funds, and more importantly, with a more important and broad relationship with our clients”

4. BBVA wants to be truly digital house10



US FinTech

1. US banks have participated in 81 fintechstart-ups deals since 2012, totaling nearly $4.1 billion in disclosed funding.

>JP Morgan paid 400m for WePay

2. Banks increasingly (i) build Fintech in-house apart from investing and (ii) partner with external start-ups

>JP Morgan - $10.8bn on technology, $5bn on new tech investments. 2,500 people in its digital technology team and is advertising for 1000 positions with the word “digital”.All 300 analysts in AM have to learn programming

>Goldman Sachs - 9,000 engineers/tech staff

>PhD-level programmers - $150k

China – Covergence between FS & Tech

1. 27 fintech “Unicorns” in the world, 9 Chinese, 12 American.

2. Focus is on mobile payments – Alipay and Tencent but mobile payments constitute just one of 7 key markets for China’s fintech industry. Other areas include online lending, consumer finance, online money-market funds, online insurance, personal financial management, and online brokerage.

3. PingAn Insurance

➢ Finance + Technology strategy

➢ 20,000 technological R&D staff members, over 500 big data scientists, over 3,000 international and national patent applications.

➢ OneConnect: Fintech SaaS provider of AI, Blockchain, Cloud, Biometrics based solutions to small and medium-sized financial institutions across front, middle and back office functions. Provided more than 2,300 financial institutions (including over 420 banks) with one-stop B2B FinTech solutions so far. Institutional platform has recorded transactions of more than RMB12 trillion. A round financing in early 2018 that raised US$650 million, valued at US$7.5bn. Possible IPO of US$3bn.


India – Similar Covergence between FS & Tech

“‘Nowadays, banks have to view their business models through the lens of digital technologies. We needed a network with fast connectivity and all the necessary digital applications to allow us to serve our customers better and increase employee productivity” Arundhati Bhattacharya, Chairman, State Bank of India

➢ Digital Banks - 811 (from Kotak Mahindra), Digi Bank (from DBS), State Bank of India launching SBI InTouch

➢ Emergence of Bitcoin exchange platforms like BTCX India, Coinsecure, Unocoin and Zebpay

➢ NASCOMM – 400 Fintech companies in 2015.


https://www.dimensiondata.com/believe-in-greatness/-/media/dd/corporate/global/pdf/state-bank-india-case-study-2017.pdfhttps://assets.kpmg.com/content/dam/kpmg/in/pdf/2018/09/Fintech_2018.pdf

➢ RBI recommends providing an environment for the development of fintech and testing APIs

➢ Institute for Development and Research in Banking Technology (IDRBT), RBI’s technology research arm: (i) proof-of-concept automation of Letter of Credit (LC) (ii) real-time automated tools for AML, and other customs and payments activities

➢ Andhra Pradesh Fintech Valley

https://www.dimensiondata.com/believe-in-greatness/-/media/dd/corporate/global/pdf/state-bank-india-case-study-2017.pdf

Convergence: Financial Services learn IP planning from Tech and

impart lessons on AOA attribution re KERT

Financial Services BEPS Actions 8-10

Additional Guidance on the Attribution of Profits to a Permanent Establishment under BEPS Action 7 (3/18)

Allocation to DEMPE Article 9Attribution of Profits to PE Article 7 (Authorised OECD Approach)

Financial Transactions Draft 2018 (7/18) Loans, Deposits, Cash Pooling, Guarantees, Insurance

Financial Services TP’s pre-BEPS Practices Ripe for a Rethink?- Global Dealing Proposed Regs 1.482-8 (6 March 1998), Notice 94-40 - OECD Attribution of Profits to PE 2010. Main IP that banks charge out are brand trademarks, marketing. - Cannot patent a tax structure, even trading algorithms does not figure Fintech- banks increasing acquire, own, self-develop, create via JVs with start-ups and exploit a lot of IP

Fintech and banking increasingly indistinguidable from the rest of

Technology industry ?

Banks moving from royalties/Trademark to full IP planning- licensing, DEMPE, HTVI; Value of Data; Nexus - Active User participation?

Non-financial services learn applying DEMPE from FS applying AOA to KERT 14


#2 US - China – India Interests Converge as

They Dominate the Global Digital Economy


What Value Data, Active User Participation?

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All rights reserved 2018 S SIM

https://www.statista.com/topics/2157/internet-usage-in-india/; https://www.ibef.org/uploads/industry/Infrographics/large/Ecommerce-Aug-2018.pdf

460m internet users, India is the second largest online market, ranked only behind China and above the US. Only 26% penetration with much greater growth potential

Number of Internet Users end 2017 (millions)

https://www.statista.com/topics/2157/internet-usage-in-india/

https://www.statista.com/statistics/262966/number-of-internet-users-in-selected-countries/

India to be Top 5 Scientific Power (STI policy)1. 47,857 patents FY18 by Indian scientists cf Apple’s 2,200 patents in 2017. 10th for patents (resident

applications only).

2. 6th position for scientific publications. 13th position at the Nature Index in 2017 - counts of high-quality research outputs in natural sciences.

3. 3rd largest technology startup hub with incorporation of 1,000 new companies in 2017. GridRaster Inc, working in the virtual and augmented reality space, has raised US$ 2 million as seed funding.

4. Engineering R&D and product development market in India is forecasted to grow at a CAGR of 20.55% to US$ 45 billion by 2020 from US$ 28 billion in FY18

5. 649 scientists returned to pursue R&D between 2012 and 2017

6. India’s R&D investments forecasted to increase to US$ 83.27 billion in 2018 from US$ 76.91 billion in 2017.

7. Science, Technology and Innovation (STI) Policy-2013, among other things, aspires to position India among the world’s top five scientific powers

1. Rs 1,000 crore for 2nd phase of Impacting Research Innovation and Technology (IMPRINT), a fund

2. Rs 1,650 crore (US$ 245.94 million) 'Prime Minister Research Fellows (PMRF)' scheme over 7 years

3. National Supercomputing Mission (Centre for Development of Advanced Computing) and Council of Scientific and Industrial Research (CSIR) laboratories to transfer tech to small-scale industries.

17All rights reserved 2018 S SIM Source: https://www.ibef.org/industry/science-and-technology.aspx

Foreign Investment Rising

• China as Net Capital Exporter-Outbound direct investment (ODI) USD 145.7bn exceeded inbound foreign direct investment (FDI) USD 135.6bn in 2015 for the first time

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India Smartphone Shipments Market Share (%)

2Q2018 per Counterpoint

Samsung 28%

Xiaomi 28%

Vivo 12%

Oppo 9%

Huawei 3%

Others 20%

• Digital Economy Businesses Expanding into Asia

- Alibaba US$1 bn in 2016 SE Asia online retailer Lazada Group.

- Didi Chuxing & SoftBank US$ 2bn in in ride hailing Grab in 2017.

- India – 23 start-up deals 2017 up from 8 in 2015 e.g. Paytm, Ola

- Xiaomi has 6 factors in India with 95% of smartphones sold locally assembled


United Nations Conference on Trade and

Development 2017 on India Outward FDI1. “Indian firms are turning into global players with a global market focus and are

undertaking overseas investments for international production, acquisition of foreign-created assets and foreign R&D activities.”

2. Between the 1990s and 2000s, OFDI increased more than 113-fold, reaching $79 billion in the 2000s. 7,793 in 2014 compared to 60 in early 1980s.

3. Manufacturing sector – 2 structural shifts: Widely spread across industries and increasingly led by comparatively technology-intensive industries.

4. Services sector has the largest number of firms – “Technological progress, improving telecommunication infrastructure and the availability of low-cost, highly skilled human resources are adding to the global competitiveness of India in broad areas of services covering information and communication technology (ICT), ICTenabled services, contract R&D, legal services, business services and the like.”

5. Surge in OFDI into developed economies especially Europe. 19All rights reserved 2018 S SIM Source: https://unctad.org/en/PublicationChapters/diaeia2017d3a2_en.pdf

Where is Value Created (4G iPhone) IPlytics GmbH - IP analytics (18 Jul 2018)

1. Top 5G Patent HoldersApplicant/assignee Estimated 5G SEP family share

1 Qualcomm 8.60%

2 Huawei 7.92%

3 LG Electronics 7.38%

4 Ericsson 6.74%

5 SamSung 5.77%

6 ZTE 4.10%

7 Nokia 3.48%

8 Intel 3.04%

9 NTT Docomo 2.61%

10 Alcael-Lucent (acquired by Nokia) 2.06%

source: https://www.iam-media.com/who-will-be-technology-leader-5g-part-two

2. Top 10 technology contributing companies for 5G standard

Technology contributing company Share contributions submitted to 5G

1 Huawei 11.93%

2 Nokia 10.31%

3 Hisilicon 9.68%

4 Ericsson 8.16%

5 ZTE 5.84%

6 Qualcomm 5.06%

7 Intel 3.62%

8 Samsung 3.47%

9 LG Electronics 3.07%

10 China Mobile 3.03%

Source: https://www.iam-media.com/who-will-be-technology-leader-5g-part-one


Source: http://pcic.merage.uci.edu/papers/2011/Value_iPad_iPhone.pdf

TP Disruption – The Asian Entrepreneur/Principal

How is it Different This Time?

1. First, standard setting; Second, creating, acquiring, owning and managing a portfolio of IP offshore in overseas investments goes beyond merely creating IP on a limited risk basis, it means first, performing more of the critical D E M P E functions and second, actually taking risks that is deserving of a share of profits, not just routine returns

> Time to Re-examine Contract R&D at cost plus ?

2. What if Asia leads the application of global profit split and retains the residual?

> IP co. to hold the EMEA, Americas economic right/license to enable manufacturing or services in the US, Europe, SAAR and rest of world

> Asian led Cost Sharing Arrangements, APAs? 21All rights reserved 2018 Sam SIM

“Green Shoots” of an East-West Consensus?

1. Asian alignment as Capital Exporter and Enterpreneur➢ Align with the global OECD principles instead of pushing alternative source country norms

location savings, market premium, excessive marketing spending

➢ History - Japanese acceptance of HQ royalty charges once their MNEs start to offshore manufacturing to Asia and charging royalties as HQ

➢ More radical aspects of draft China Circular 2 in 2015 not adopted

➢ New Digital tax measures that Secretary Mnuchin decries as “unilateral and unfair” are not from Asia

2. Alignment as to digital presence, value of data/user participation?


China- India as “Responsible Stakeholders”…working with

the US to sustain the international [tax] system?

borrowing from former Deputy Secretary of State Robert Zoellick

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Deputy Secretary of State Robert Zoellick used the term "responsible stakeholder" in 2005 to address how China should wield its growing power and influence. Zoellick stated that after a 30-year policy of integrating China into the international system, "we now need to encourage China to become a responsible stakeholder in the international system. As a responsible stakeholder, China would be more than just a member--it would work with us to sustain the international system that has enabled its success."


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