transfer pricing workshop cairo 14-25 february 2010
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Transfer Pricing Workshop Cairo 14-25 February 2010. Intra-Group Services Management Fees Cost Contribution Arrangements (CCAs). Types of Intra-Group Services. Administrative, technical, financial and commercial services for a specific group member - PowerPoint PPT PresentationTRANSCRIPT
Centre for Tax Policy and Administration
Organisation for Economic Co-operation and Development
Transfer Pricing WorkshopCairo
14-25 February 2010
Intra-Group ServicesManagement Fees
Cost Contribution Arrangements (CCAs)
Administrative, technical, financial and commercial services for a specific group member
Management, coordination and control functions for the whole group
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Types of Intra-Group Services
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)
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Typical Arrangements
Parental service arrangements
Centralised service companies (group service centre) Cost centre Profit centre Specialized service centres
Cost contribution/sharing arrangements
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Typical Arrangements
Parental services
Provided by the parent company – often on cost recovery basis, i.e. with no profit element.
Examples are: Group finance Group tax Legal
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Parental services
Management fees
Provision of services
Typical Arrangements
Centralised 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
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Centralised services
Management feeProvision of services
Typical Arrangements
Cost contribution/sharing arrangements
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
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Allocation of costs
Provision of services
Cost contribution arrangement
3 Key Issues re. Intra-Group Services
1) Determining whether an intra-group service has been rendered
2) Identifying actual arrangements for charging for intra-group services
3) Calculating the arm’s length price
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Rendering of intra-group services
Activity Service No Service
R&D administration
Management of interest and exchange risks
Issuance of parent’s shares
IP protection
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
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Activity performed must provide to the recipient with economic or commercial value o 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
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Rendering of intra-group services
Existence of an actual payment is useful, but does not prove that the service has been actually rendered
Notation of “management fee” is not prima facie evidence of management services
Absence of payment does not necessarily mean that no services have been rendered
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Rendering of intra-group services
Types of services:
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Planning Assistance in production, buying or distribution
Coordination Marketing
Budgetary control Recruitment
Financial advice R&D administration
Accounting IP protection
Auditing Market research
Legal advice Contract R&D *
Factoring Computer services
Financial services Provision of guarantees15
Rendering of intra-group services
Activities not constituting services:
Shareholder activities
Duplication of services
Incidental benefits
Passive association
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Rendering of intra-group services
Shareholder activities:
–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.
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Rendering of intra-group services
Duplicative services:
–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.
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Rendering of intra-group services
Incidental benefits:
–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.
–OECD examples in para. 7.12 - 7.13
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Rendering of intra-group services
On call services–Use frequency
–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.
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Rendering of intra-group services
special considerations
Activity Service No Service
Business operation management through weekly television conferences
Collect monthly financial, product and sales data of subsidiaries in order to make parent company’s internal reports
Review budget plans drafted by subsidiaries
Parent company’s internal auditor visit subsidiaries and give suggestions on business operations
Check data transferred from subsidiaries for parent company’s consolidated accounts
Check contract documents made by subsidiaries with third parties, and give legal advice
External auditors attend subsidiaries audits for parent company’s consolidated accounts
Develop and maintain IT system, which can deal with client complaints and connect the parent company and subsidiaries
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Rendering of intra-group services
Allocation of costs
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
Value added strategic services v. routine support services and low margin services
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Allocation of costs
Direct cost allocation
Indirect cost allocation
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Allocation of costs
Direct cost allocation– 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•Trademark violation in a specific market that was dealt by
the legal department24
Allocation of costs
Indirect 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/keys
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 (in proportion) with actual or expected benefit of service recipient 25
Cost allocation keys
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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 services
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An 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
ProviderHow much does the service cost?
RecipientHow much is the service worth?
How much would it cost to provide the service in-house?
How much would an external service provider charge?27
The arm’s length price
The arm’s length price
Arm’s Length Price Setting
Minimum price acceptable for provider
Maximum price acceptable for recipient
Range of AL prices
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Applicable transfer pricing methods
Chapters II and III OECD TP Guidelines:
Comparable Uncontrolled Price (CUP)
Cost Plus
Combination of methods or TNMM
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CUP– Preferable when:
There is a comparable service provided between independent enterprises in recipient’s country
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!
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Applicable transfer pricing methods
Cost Plus Method
Applicable in the absence of a CUP where activities, assets and risks are comparable
Cost base is very important (often more material than mark-up)
Mark-up: special considerations
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Applicable transfer pricing methods
Cost Plus (Profit) Mark-up?
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
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Cost Plus Method
Cost Plus (Profit) Mark-up?
Speaking Notes continued
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Cost Plus Method
Cost base very important
Cost base often more material than mark-up
Functional analysis important – take into account both immediate and long-term impact of service
Example in OECD Guidelines para. 7.36: mere intermediary/agency service – profit mark-up limited to intermediary/agency activities
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Cost Plus Method
Step 1: Which services have been performed?
Step 2: Identify shareholder´s activities
Step 3: Determine which income or cost to be chargedStep 4: Determine the arm´s length price or “service
fee”
Step 5: Identify costs that could be charged directlyStep 6: Determine allocation key for charging indirect
costs
Step 7: Put together the total base of allocation
Procedure:
Intra-Group Services
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Centre for Tax Policy and Administration
Organisation for Economic Co-operation and Development
COST CONTRIBUTIO
N ARRANGEMEN
TS
Cost Contribution Arrangements (CCA)
Framework agreed among business 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
CCA should exist prior to development of the asset/service
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Cost Contribution Arrangements
Examples Joint development of intangibles – each
participant receives a right to exploit the resulting IPLegal ownership versus economic ownership
No royalties
Joint provision of services that each entity provides and receivesSeparate service company rewarded on an arm’s
length basis – generally not a participant
Acquisition of property for mutual use
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Cost Contribution Arrangements (CCA)
Cost Contribution Arrangement (CCA) vs. Cost Sharing Agreement (CSA)
• Scope•Burden•Participants•Activity•Output
CCA vs. Service Agreement •Burden of costs and risks
•Ownership of the benefits
CCA vs. License or Sales Agreement •Timing acquisition of rights
•Type of responsibility
CCA vs. Partnership Agreement •Existence of a separate legal entity
•Object of the joint undertaking39
Key issues in CCA
Participants
Contributions vs. benefits
Ownership
Amount of participant’s contribution
Buy-in/Buy-out payments
Termination
Non arm’s length character of CCA
Structuring CCAs
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Participants
Participants: entity with a reasonable expectation that it will benefit from the CCA activity itself.
Exploitation and use can be done directly or indirectly
Question: Participants to a CCA may engage a separate entity to perform part of all of the activities is this separate entity a participant in the CCA?
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In a CCA, each participant’s proportionate share of the contributions to the arrangement must be consistent with his share of expected benefits.
Each participant would be entitled to exploit its interest, without paying a royalty or other compensation.
In a CCA there is always an expected benefit that each participant seeks from his contribution; his interest in the results of the CCA activity should be established from the outset.
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Joint development of a new product and intangible property derived from it
A typical CCA
CCA: Contributions vs. Benefits
- Participants’ Shares -
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CCA
Participant Participant
Participant
Contributions Benefits
Contributions Benefits
Contributions Benefits
CCA: Contributions vs. Benefits
- Illustration -
Benefits may be known in advance or uncertain, e.g. R&D
Some may be immediate, e.g. services or over a longer term, e.g. R&D
Always expected benefit
Skills are pooled and the consideration is towards the reasonable expectation of mutual benefit
Similar to a Joint Venture
However, the activity does not need to be successful
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Contributions vs. Benefits
Ownership
Each participant’s interest in the results of a CCA activity should be established from the outset, even where the interest is interlinked with that of other participants
Participants in the arrangement jointly own the developed asset No need to pay a royalty for the use of the asset/service
Legal v. economic ownership: Multiple beneficial or economic owners Usually, one legal owner, e.g. because legal
ownership of developed intangible property is vested in only one of them but all of them have effective ownership interest.
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Amount of participant’s contribution
Under the arm’s length principle, the value of each participant’s contribution should be consistent with the value that independent enterprises would have assigned to that contribution.
Use of cost and market prices as measuring tool
Requires case-by-case determination
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Is the allocation appropriate?Objective: estimate the shares of benefit to be obtained
by each participant and allocate contributions in the same proportion
Estimation of benefits (projections!): Anticipated additional income generated Anticipated costs saved
Price charged in sales of comparable assets and services
Allocation key or combination of allocation keys– Sales; units used, produced, or sold; gross or operating profit;
number of employees; capital invested; etc.
Adjustments to allocation keys may be necessary!
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Amount of participant’s contribution
Contributions can be in cash, property and services
Sometimes difficult to assess the participant’s contribution of property and services to the CCA or subsidies and tax incentives
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Amount of participant’s contribution
A participant may be required to make a payment to other participants to adjust its proportionate 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
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Amount of participant’s contribution
Balancing Payments
Buy-in/Buy-out payments
Buy-in/buy-out payments should reflect the value of current intangible property owned
Buy-in payment: payment made by a new entrant to an existing CCA for acquiring an interest in the results of prior activities of the CCA
Buy-out payment: payment made to a departing member of an existing CCA
Payments must be arm’s length!
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CCA termination
Each participant receives a beneficial interest in the results of the CCA activity consistent with its proportionate share of contribution,
or
A participants could be compensated by one or more participants for surrendering its interest in the results of the CCA
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What if a CCA is not arm’s length?
When the consideration received by a participant is inadequate, and that received by another participant is 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
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Recommendations for structuring CCAs
A CCA at arm’s length normally would meet the following conditions:
a) Participants include only enterprises expected to derive benefit from the CCA activity itself.
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.
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Centre for Tax Policy and Administration
Organisation for Economic Co-operation and Development
EXAMPLES
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Example 1
AusCo. Is a member of a MNE group
AusCo. Manufactures and sells the products itself and has licensing arrangements with other group members to use the technology to manufacture the products for sale in their local markets
AusCo is about to commence intensive R&D to enhance the technology for the next generation of the products
The risk of this R&D being unsuccessful is considered relatively low
AusCo has the necessary resources, expertise and financial capacity to perform the R&D and exploit any new technology produced.
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Example 1 (cont’d)
The MNE board decides that the new R&D will be performed under a CCA, together with ForCo, a newly established non-resident group company.
AusCo's contributions will be in the form of existing technology and ongoing R&D services
ForCo's contributions will be cash. In return, ForCo will have the right to license the new technology to group members other than AusCo to manufacture the product for sale in their local markets.
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Example 1 (cont’d)
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AusCo. ForCo.
CCATechnology
development
Existing technology + ongoing R&D services
Cash
License to group members
Example 2
Ausco, parent ForCo and several affiliates are members of a MNE group operating in automotive industry.– Each produces vehicles for sale in local market
– Each operates its own R&D centre responsible for all aspects of design and technology for its locally produces vehicles
Technology information is contained in a database to which all members have unlimited access
Any centre may use technology developed by other centres
Costs and risks of operating the R&D centres are pooled and shared amongst the participants based upon expected benefits from use of R&D results in the production of vehicles
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