transfer pricing: an introduction to the rules & documentation september 8, 2016 · ·...

Transfer Pricing: An Introduction to the Rules & Documentation September 8, 2016

Overview

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What is Transfer Pricing?

A mechanism for setting prices in transactions between related parties

Based on the Arm’s Length Principle – related parties should transact with other on same terms as if they were independent of each other, i.e.. “at arm’s length”

Applies to international and domestic transactions

What is Transfer Pricing? (continued)

Taxpayers’ perspective Important tool in the global

economy Impacts business decisions Helps to avoid penalty and/or

double taxation A necessary component of

effective tax structures

Tax authorities’ perspective Important tool in the global

economy New revenue sources Focal point in increased

governmental scrutiny

1994 1995 2000 2005 2007 2014 Now

United States

Australia South Africa United States

Italy Belgium Argentina Canada United Kingdom China Slovakia Brazil New Zealand Mexico South Korea France Australia South Africa United States

Over 100 Countries

Taiwan Peru Germany Hungary Denmark Columbia Venezuela Portugal Russia Japan Poland India Netherlands Italy Belgium Argentina Canada United Kingdom China Slovakia Brazil New Zealand Mexico South Korea France Australia South Africa United States

Transfer Pricing Legislation

38 Countries

75 Countries

U.S. Transfer Pricing Regulations

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Intercompany Transactions

Covered by Internal Revenue Code Section 482 regulations:

Loans and advances (§1.482-2(a))

Transfers of tangible property (§1.482-3)

Transfers of intangible property (§1.482-4)

Cost Sharing Arrangements (§1.482-7)

Services (§1.482-9)

U.S. Documentation Rules

Transfer pricing adjustments are key focus of IRS (and foreign tax authorities)

IRC §1.6662

Commissioner may impose accuracy-related penalty on any portion of an underpayment of tax

To obtain penalty protection, transfer pricing documentation must be in place at the time of tax return filing

10 Principal documents and other “background documents” should be maintained by tax payers to document and support their TP policies

Index of 10 principal documents showing the location of each document

Transfer pricing documentation report has to be contemporaneous with filing of a tax return.

U.S. Documentation Rules (continued)

Principal and Background Documents: An overview of the taxpayer's business A description of the taxpayer's organizational structure Any documentation explicitly required by the regulations under Section 482 A description of the TP method selected and an explanation of why it was

selected A description of the different methods that were considered and an explanation

of why they were not selected A description of the controlled transactions and any internal data used to analyze

those transactions A description of the comparables that were used, how comparability was

determined, and what (if any) adjustments were made An explanation of the economic analysis and projections relied upon in

developing the method A description of any important data that the taxpayer acquires after the end of

the tax year and before filing a tax return A general index of the principal and background documents relied upon.

Transactional Net Adjustment

Substantial Valuation (20% penalty)

Price or value is 200% or more (50% or less) than the correct amount

Net adjustment exceeds the lesser of $5 million or 10% of gross receipts

Gross Valuation (40% penalty)

Price or value is 400% or more (25% or less) than the correct amount

Net adjustment exceeds the lesser of $20 million or 20% of gross receipts

Transfer Pricing Penalties

To avoid penalties, taxpayer must

Reasonably select and apply a transfer pricing method,

Prepare contemporaneous documentation, and

Presentation of documentation to IRS within 30 days of request.

Summary

OECD Transfer Pricing Guidelines

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BEPS and Transfer Pricing

OECD – non-governmental organization consisting of 34 members Transfer pricing guidelines offer recommendations to signatory countries’

governments when crafting transfer pricing related legislation Follows the U.S. transfer pricing regulations Adopts the Arm’s Length Standard BEPS – Base Erosion and Profit Shifting

Governments, OECD, and the United Nations have taken notice of “smart tax restructuring exercises” and “double non-taxation”

The BEPS Project aims to prevent tax planning strategies that exploit mismatches in tax regulations by moving profits to low tax jurisdictions. The 15 Actions provide governments with domestic and international tools and framework to address these tax avoidance issues

OECD - BEPS Action Point 8,9, 10, and 13 specifically focus on Transfer Pricing (more on this to follow)

Transfer Pricing Projects

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Planning Studies

Ideal for expanding in new jurisdictions or engaging in new transactions in existing jurisdictions

Offer detailed functional, financial, and economic analyses Use projections / estimates - Do not qualify as documentation Used to monitor and correct any inconsistencies between the actual

pricing and the proposed/target pricing

Documentation Studies

Ideal for supporting actual transfer prices Provide detailed factual, functional, financial, and economic analyses Evaluate any extraordinary events, company, product, or industry specific reasons impacting transfer prices (e.g., losses due to business cycles, under-utilization of capacity, inefficiencies, etc.) Absolutely essential in case of a cost share arrangement or a cost contribution arrangement

Benchmarking Analysis

Similar to a Planning Analysis Ideal for start-up companies Offers limited analysis at a high level Does not qualify as documentation Monitor and correct any inconsistencies between pricing terms in intercompany

agreement and actual pricing

Functional and Risk Analysis

Economic Analysis and Documentation

Information and Data Gathering

Transfer Pricing Project Process

Information and Data Gathering

• Business and industry overview • Functions & Risks – Who does what and where? What risks are

undertaken by related parties in the transaction? • Selection of the best method and rejection of other methods • Benchmarking analysis • Intercompany agreements (must resemble third-party agreements) • Prepare memo or report documenting analysis

Transfer Pricing as a Business Tool

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When to Think About Transfer Pricing?

As a business planning tool: Establishing new subsidiaries Shut down existing entities Restructuring (moving of functions across different entities and jurisdictions) Transfer of intellectual property across different entities and jurisdictions

As a due diligence tool: Enables taxpayers to gauge the ground reality prior to

• Undertaking business restructuring (M&A, IPO, Divestitures, JVs, etc.) • Commencing/adding a new business activity having transfer pricing

implications

As a documentation/penalty protection tool: Prior to filing of tax return If under audit by tax authority

Value Chain/Supply Chain Design

Enables taxpayers to simplify global supply chains to achieve Operational efficiency; tax planning

Need to keep in mind

Operational substance Capacity to bear risk Migration of existing, high value intangibles

Purchasing Manufacturing Research & Development & Marketing

Distribution Sales & Services

Research & Development & Marketing


Full-risk Factory China

Full-risk Factory Canada Full-risk

Factory Mexico

Full-risk Factory Vietnam

Full-risk Factory France

R&D Center UK

R&D Center India

R&D Center Australia

R&D Center Japan

Distributor Germany

Distributor US

Distributor Japan

Distributor France

Distributor Thailand

Turn this…

Product

Product Product

Product

Product

Product

Product

Product

Product

Product

Royalty

Royalty

Royalty

Royalty Royalty

Royalty


Contract Manufacturer

China


Canada


Mexico


Vietnam


France

Contract R&D Center UK

Contract R&D Center India

Contract R&D Center

Australia

Contract R&D Center Japan

Limited-Risk Distributor Germany

Limited-Risk Distributor

US


Japan


France


Thailand

…into this

Manufacturing Principal (risk taker)

Singapore

R&D Principal (Intellectual Property

Holder) Ireland

Product

Product

Royalty

R&D Services

BEPS and CBC Reporting

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What is BEPS?

BEPS – Base Erosion and Profit Shifting

OECD BEPS Project aims to prevent exploitation of mismatches in tax regulations by moving profits to low tax jurisdictions

The 15 Actions provide governments with domestic and international tools and framework to address these tax avoidance issues

The OECD’s 15-Point Action Plan is Outlined under Three Subheadings

Establish international coherence of corporate income taxation:

• Action 1: Address the tax challenges of the digital economy • Action 2: Neutralize the effects of hybrid mismatch arrangements • Action 3: Strengthen CFC rules • Action 4: Limit base erosion via interest deductions and other financial

payments • Action 5: Counter harmful tax practices more effectively, taking into account

transparency and substance

Restore full effects and benefits of international standards through realignment of taxation and relevant substance:

• Action 6: Prevent treaty abuse • Action 7: Prevent the artificial avoidance of PE status • Action 8, 9, 10: Assure that transfer pricing outcomes are in line with value

creation – focusing on intangibles (8), risks and capital (9) and high risk transactions (10)

Ensure transparency while promoting increased certainty and predictability:

• Action 11: Establish methodologies to collect and analyse data on BEPS and the actions to address it

• Action 12: Require taxpayers to disclose their aggressive tax planning arrangements

• Action 13: Re-examine transfer pricing documentation • Action 14: Make dispute resolution mechanisms more effective • Action 15: Develop a multilateral instrument

GLOBAL DOCUMENTATION: Three Tiered Approach

Master File

Economic Analysis & Local File

CbC Reporting

GLOBAL DOCUMENTATION: Master File

Master file provides: high-level information about global operations and TP policies clear understanding of MNE’s operations

Focus on attributes that may indicate significant risks Current documentation requirements do not provide a big picture of risk Master file contains:

Organizational structure of legal ownership and geographic locations Map of supply chain for products and services Functional analysis for individual entities List of intercompany service arrangements Description of business restructuring List of IP, IP ownership, and intercompany IP arrangements Description of financing arrangements and APAs Tax rulings related to allocation of income among regions Annual consolidated financial statements

GLOBAL DOCUMENTATION: Economic Analysis & Local File

Requires detailed transactional support and transfer pricing documentation specific to each country. These files will contain:

Related party transactions

Specific amounts involved in transactions

The company’s analysis of the transfer pricing determinations

Relevant financial information

A description of the comparability analysis of most appropriate TP method and methodology

Local management structure, organizational chart, business strategy, related-party payments, receipts for products and services, and key competitors

Local entity financial statements, reconciliation of financial expenditure, summary of relevant financial data, R&D and intangible policies, and details of important transfers

Mapping to local transfer pricing requirements

Global Documentation: CbC Reporting

The CbC Report is the final tier of the OECD’s three-tiered standardized approach to transfer pricing documentation.

To be filed annually and for each tax jurisdiction in which the MNE operates.

The new report requires:

Reporting number of employees, stated capital, retained earnings, and tangible assets in each jurisdiction

Identifying the different entities within their group and the business activities undertaken by each entity

Displaying the amount of revenue, profit before income tax, and income tax paid and accrued by large MNEs

Outlining the core activities per entity

CbC Reporting in the United States

IRS issued CbC regulations in June 2016

Applicable to US multinationals with annual revenues of $850M or more

Applies to tax years that begin on or after the date of final regulations (for example, for a multinational with calendar year end, the first CbC report must be filed with the 2017 tax return)

Follows the model template of the OECD

CbC report is NOT a substitute for a transfer pricing study and will not form the sole basis for taxable income adjustments. However, the CbC report may be used as a basis for further inquiry into a multinational group’s transfer pricing practices

Contain several confidentiality safeguards

CbC Reporting Worldwide

MCAA – Mutual Competent Authority Agreement on the exchange of CbC reports

sets forth rules and procedures for automatic exchange of CbC reports as filed with the local tax authority

44 Countries committed to CbC reporting and signed the CbC MCAA:

Argentina, Australia, Austria, Belgium, Bermuda, Canada, Chile, Costa Rica, Curaçao, Czech Republic, Denmark, Estonia, Finland, France, Georgia, Germany, Greece, Iceland, India, Ireland, Israel, Italy, Japan, Korea, Liechtenstein, Luxembourg, Malaysia, Mexico, Netherlands, New Zealand, Nigeria, Norway, People's Republic of China, Poland, Portugal, Senegal, Slovak Republic, Slovenia, South Africa, Spain, Sweden, Switzerland, United Kingdom, Uruguay

CbC Reporting Worldwide (continued)

14 Countries already implemented CbC: Australia Belgium Denmark France Ireland Italy Japan Mexico Netherlands Poland South Africa Spain United Kingdom United States

CbC Reporting Worldwide (continued)

17 Countries have begun implementation but the completion date not certain yet:

Canada China Estonia Finland Germany Greece India Luxembourg New Zealand Norway Romania Russia Singapore Slovakia South Korea Sweden Switzerland

Intercompany Agreements and CbC Reporting

The new guidance prescribes specific documentation to be compiled by multinational enterprises to support their structuring and pricing of intercompany transactions.

Calls for taxpayers to include a list of "important agreements" pertaining to intangibles in the master file and copies of all "material intercompany agreements" in the local transfer pricing documentation files of their worldwide affiliates.

Globally, rules regarding intercompany agreements vary widely. Although it is a leading practice, U.S. transfer pricing rules generally do not require intercompany agreements to be in place in order for related party transactions to be respected by the IRS. However, other jurisdictions require agreements, particularly to support intercompany charges that result in local deductions.

Key Aspects to Intercompany Agreements

Are the parties correctly described? It is generally better to use company registration numbers in addition to the company names, as names may be more likely to change.

Check that the terms of the agreement are aligned with the functional analysis underlying the transfer pricing policies which the group intends to operate. This includes: Subject matter: the nature of the goods, services or finance to be provided;

Warranties and indemnities: including service levels, warranties as to standard of care or specification of goods, etc; and

Limitations on liability: the presence or absence of any limitations on the recourse of one party against the other.

Check the proposed date for the agreement, and any termination date or provisions for terminating the arrangements on notice. Notice periods should achieve an appropriate balance between allowing the group flexibility to vary the structure in the future, while also reflecting arrangements which are commercially justifiable for all participating entities.

If the agreement deals with or relies on pre-existing intellectual property (such as rights in technology or trademarks), ascertain where the legal and beneficial ownership of that intellectual property actually resides.

Key Aspects to Intercompany Agreements (continued)

Check that ownership of intellectual property created in any arrangement is clearly stated, and that the identity of the owner is consistent with the group’s intellectual property objectives.

Where the agreement forms part of a chain of supplies of goods, services or licenses, check that the draft agreement is consistent with what is happening in the chain above and below the agreement. This includes the ultimate supply of goods, services or IP licenses to customers where relevant.

The agreement should contain a clear choice of law provision, and that legal advice has been obtained on any areas of uncertainty as to formal requirements.

Check that the arrangements as a whole make commercial sense from the individual perspectives of each of the participating entities.

Contact Us: Veena Parrikar, PhD BDO USA, LLP Principal – Transfer Pricing 408-352-3534 [email protected] Eliot L. Kaplan Perkins Coie LLP Partner 602-351-8385 [email protected]

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