TRANSFER PRICING CASE STUDIES WORKSHOP

SAN JOSE 31 MARCH - 4 APRIL 2014

6. Intra-Group Services and CCAs

OECD freely authorises the use of this material for non-commercial purposes. All requests for commercial uses of this material or for translation rights should be submitted to rights@oecd.org.The opinions expressed and arguments employed herein are those of the author and do not necessarily reflect the official views of the OECD or of the governments of its member countries.

• All business entities require administrative, technical, financial and other commercial services– Management, co-ordination and control functions for the

whole group may also be needed

• Such services may be provided by another entity within an MNE group, or

• An entity may perform the services itself (in-house), or

• An entity may acquire services from an independent party

2

Types of intra-group services

• Intra-group services usually include services ordinarily performed internally (central auditing, financing advice, training of personnel)

• Often include services that are typically available externally from independent enterprises (such as legal and accounting services)

3

Types of intra-group services

Parental service arrangements

Centralised service companies

Cost contribution/sharing arrangements

4

Typical Arrangements

• Provided by the parent company – often on cost recovery basis, i.e. with no profit element.

• Examples are:

• Group finance• Group tax• Legal

5

Parental services

6

Parental services

Parent company (Holdco)

Subsidiary A Subsidiary B Subsidiary C

Management fees

Provision of services

• Provided by a service company in the group – usually on a cost plus basis, i.e. including a profit element.

• Examples are:

• IT support• Technical• Finance and treasury

7

Centralised services

8

Centralised services

Parent company (Holdco)

Group Services company

Subsidiary A

Subsidiary B

Subsidiary C

Management feeProvision of services

• Provided by each group member for the benefit of the group as a whole always on a cost contribution basis commensurate with (expected) benefit.

• Examples are:• Research and development• Procurement

9

Cost contribution/sharing arrangements

10

Cost contribution/sharing arrangements

Parent company (Holdco)

Subsidiary A Subsidiary B Subsidiary C

Allocation of costs

Provision of services

1) Has an intra-group service has been rendered?

– Benefit test

– Shareholder activities?

– Duplication?

– Incidental benefits

2) If so, what is the arm’s length price for the services?

11

Key issues

Activity Service No service

R&D administration

Management of interest and exchange risks

Issuance of parent’s shares

Protection of intellectual property

Raising funds for own new acquisitions

Financial advice

Supervision of cash flows

Interview for director candidates of subsidiaries

Obtaining high credit rating for belonging to MNE group

12

Has an intra-group service been rendered?

• Activity performed must provide to the recipient with economic or commercial value to enhance its commercial position.

• Consider whether an independent enterprise would:– Pay for the activity if performed by an independent

enterprise; or– Perform the activity in-house– If not, no intra-group service

13

Benefit test

• Existence of an actual payment is useful, but does not prove that the service has been actually rendered

• Description as a “management fee” is not prima facie evidence of management services

• Absence of payment does not necessarily mean that no services have been rendered

• Consider what an independent party would pay, and what an independent party would charge

14

Rendering of intra-group services

15

Examples of services

Planning Assistance in production, buying or distribution

Coordination MarketingBudgetary control RecruitmentFinancial advice R&D administration

Accounting IP protectionAuditing Market research

Legal advice Contract R&D *Factoring Computer services

Financial services Provision of guarantees

• Activities not constituting services:

16

Not services

Shareholder activities

Duplication of services

Incidental benefits / Passive association

• Costs related to juridical structure of the parent company itself

• Costs related to reporting requirements of the parent

• Costs related to raising funds for the acquisition of its participations

17

Shareholder activities

• Covers those services already performed by the recipient or by an arm’s length party on its behalf.

• However, duplication could be accepted under certain circumstances, e.g. temporary duplication.

18

Duplicative services

– Covers services performed by one group member (e.g. shareholder or coordinating centre) for a particular group member or a set of group member, and incidentally provides a benefit to other group members.

– Examples in TPG para. 7.12 - 7.13

19

Incidental benefits / Passive association

• On call services– Frequency of use?– Degree of benefit obtained– Consider facts and circumstances

• Aggregation/segregation– E.g. higher price for products because R&D is embedded in

the product, rather than a separate service charge

20

Special considerations

Activity Service No Service

Business operation management through weekly television conferencesCollect monthly financial, product and sales data of subsidiaries in order to make parent company’s internal reportsReview budget plans drafted by subsidiaries

Parent company’s internal auditor visit subsidiaries and give suggestions on business operationsCheck data transferred from subsidiaries for parent company’s consolidated accountsCheck contract documents made by subsidiaries with third parties, and give legal adviceExternal auditors attend subsidiaries audits for parent company’s consolidated accountsDevelop and maintain IT system, which can deal with client complaints and connect the parent company and subsidiaries 21

Has an intra-group service been rendered?

• Arm’s Length Price Setting

22

The arm’s length price

Minimum price acceptable for provider

Maximum price acceptable for recipient

Range of AL prices

• Transfer pricing methods most commonly used for services:

Comparable Uncontrolled Price (CUP)

Cost Plus

Combination of methods or TNMM

23

The arm’s length price

• Preferable when:

There is a comparable service provided between independent enterprises in recipient’s market

The associated enterprise providing the service also renders it to independent enterprise in comparable circumstances.

• Examples: accounting, auditing, legal or computer services being provided.

• Careful! Service infrastructure might impact the price!24

CUP

• Management fees charged as percentage of sales of the service recipient, e.g. 5% of the sales of the service recipients, possible?

• Management fees should be based on the cost of service rendered– Actual vs. budgeted cost

• Direct and indirect allocation

25

Allocation of costs

– Group members are charged for specific services– Identify the costs incurred for a particular service to

a specific affiliate– Provides greater transparency to the tax authorities– Costs and time associated with supplying the services

will be straightforward to identify– Examples:

–R&D performed by central R&D department for a specific company or client

–Marketing from the central department provided for a specific market or region

26

Direct cost allocation

• Used where proportion of the value of services rendered to each entity cannot be exactly quantified

• Identify all relevant costs and allocate them among all recipients using a sensible allocation key(s)

• Indirect cost allocation method must:–Be sensitive to commercial features of individual case–Contain safeguards against manipulation–Follow sound accounting principles–Produce allocations of costs that are commensurate with

actual or expected benefit

27

Indirect cost allocation

28

Cost allocation keys

Intra-group service Cost allocation key?

Technology services

Central purchase of raw materials

Marketing support

CEO’s strategic advice

Personnel advice

Payroll services

Central R&D

Strategic product planning

Financing, accounting

Rental charges/property servicesAn indirect charge method may need some adjustments to achieve an arm´s length price. Combination of allocation keys is sometimes useful.

• Consider perspectives of both– Service Provider and– Service Recipient

• Provider– How much does the service cost?

• Recipient– How much is the service worth?– How much would it cost to provide the service in-house?– How much would a comparable enterprise pay for the

service?29

The arm’s length price

• Applicable in the absence of a CUP where activities, assets and risks are comparable

• Cost base is very important

• Mark-up: special considerations

30

Cost plus

• Normally mark-up (comparison with independent enterprises)– Factors to consider: nature, significance of the service,

efficiency of the service supplier…

• In some cases no mark-up required (OECD Guidelines paras. 7.33 - 7.37):– Group enterprise acting as an agent or intermediary– The costs are already equivalent to the market price– Unreasonable administrative burden– Safe harbours for service mark-up in some countries

31

Cost plus mark-up?

• Framework agreed among enterprises to share the costs and risks of developing, producing or obtaining assets, services, or rights, and to determine the nature and extent of the interests of each participant in those assets, services, or rights.

• A contractual arrangement rather than a judicial entity or permanent establishment

32

Cost Contribution Arrangements

• In a CCA, each participant’s share of contributions to the arrangement will be consistent with their share of expected benefits.

• Each participant would be entitled to exploit their interest, without paying a royalty or other consideration.

33

Participants’ Shares

Joint development of an intangible and associated product

A typical CCA

34

CCA: an illustration

CCA

Participant Participant

Participant

Contributions Benefits

Benefits

ContributionsBenefits

Contributions

• Resource and skills are pooled and the consideration is the reasonable expectation of mutual benefit

• Benefits may be – known in advance or uncertain

– immediate (e.g. services) or expected over a longer term (e.g. R&D)

Cost Contribution Arrangements

35

Types of Cost Contribution Arrangements

• Joint development of intangibles – each participant receives a right to exploit the resulting intangible property No royalties

• Joint provision of services that each entity provides and receives Separate service company rewarded on an arm’s length basis

– generally not a participant Acquisition of property for mutual use

36

• The expectation of mutual benefit is fundamental to the acceptance by independent enterprises of an arrangement for pooling resource and skills without separate compensation

• Each party’s contribution is determined by the expected benefits

• Benefits are expected, but the CCA may not be successful

37

Applying Arm’s Length Principle

• Estimating the share of benefits expected to be obtained by each participant, and allocating contributions in the same proportions. For instance: Based on the anticipated additional income generated or

costs saved by each participant. Using the price charged in sales of comparable assets and

services. Using an allocation key or a combination of allocation

keys (sales; units used, produced or sold; gross or operating profit; the number of employees; capital invested; etc.)

38

Is the allocation appropriate?

Balancing payments

• A participant may be required to make a payment to other participants to adjust its share of contributions

• Balancing payments are used to maintain the arm’s length nature of the CCA

• They do not constitute a royalty for the use of the intangible

• Generally treated as a cost to the payer and a reimbursement to the recipients

39

• A new participant to an existing CCA might obtain an interest in the results of prior CCA activity: any transfer of pre-existing rights from existing participants to a new entrant must be compensated a buy-in payment.

• A participant who leaves a CCA may dispose of its interest in the results of past CCA activity a buy-out payment.

• When a CCA terminates, each participant should receive a beneficial interest in the results of the CCA activity.

40

Entry, withdrawal, and termination

• When the consideration received / paid by a participant is inadequate, or excessive… The arm’s length principle requires an adjustment (often

through a balancing payment) In some cases, part or all of the terms of a CCA may be

disregarded if commercially the substance (reality) differs from the form

41

What if a CCA is not arm’s length?

a) Participants include only enterprises expected to derive benefit from the CCA activity

b) Arrangement specifies the nature and extent of each participant’s beneficial interest.

c) No payment other than CCA contributions, balancing & buy-in payments made for the beneficial interest.

d) Proportionate shares of contributions determined in a proper manner.

e) Arrangement allows for balancing payments or for the allocation of contributions to be changed prospectively.

f) Adjustment made as necessary upon entrance, withdrawal and termination of the CCA.

42

Arm’s length structuring of CCAs

CCA vs. Intra-group services

CCAs on services not creating IPAgreement to share costs, risks and benefits where all participants contribute in cash or in kind.

Intra-group servicesLimited to the provision or acquisition of a service by members of the MNE Group. The risk of not successfully and efficiently providing the service is generally borne solely by the service provider.

43

If participants join or leave a CCA, shares should be adjusted or rebalanced in accordance with the arm’s length principle.

Terminating or extending the service agreement to other participants has generally no implication on other service recipients.

CCA vs. Intra-group services

CCAs on services not creating IPAs all participants are contributing to a common activity and share costs and the contributions reflect the expected benefits; contributions are usually valued at cost.

Intra-group servicesThe profit element charged by the provider of the service is usually a key element as the provider will not share profits with the recipients.

44

The allocation of the costs is based on the expected benefits for each participant from the CCA.

The allocation key is based on the extent each company has requested / received or is entitled to the service.

Questions and/or comments?