Transfer Pricing: Issues, Risks & Opportunities for … Tax...1. UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison 2. Intangibles: Tax Controversies, Enforcement

Transfer Pricing: Issues, Risks & Opportunities for Multinationals

8-9 May 2013

Chair: Mukesh Butani – Taxand India

Panelists:

Shiv Mahalingham – Taxand UK

Clemens Thym – Standard and Poor

Sam Sim – Standard Chartered

Steven Carey – Quantera Global

1. UN Manual & the Acceptance of Arm’s Length Principle – an

OECD Comparison

2. Intangibles: Tax Controversies, Enforcement & Litigation in

Asia

3. The OECD BEPS Study & the “Grey Area” Definition

4. Valuation in Business Restructurings: the Different Approaches

of Tax Authorities

5. Developments in Policy on Advance Pricing Agreements

6. Intercompany Loans Focus

7. Managing TP In-House Across Asia-Pacific

8. Taxand’s Take

9. Key Contacts & About Taxand

Contents

UN Manual & the Acceptance of Arm’s Length Principle & OECD

8-9 May 2013

UN Manual was prepared by the Subcommittee

on Transfer Pricing, constituted in 2009

Developed with a purpose to provide a practical

manual on transfer pricing for developing

countries

Manual covers aspects starting from

methodologies to documentation to dispute

resolution. It also covers country specific

chapters on Brazil, China, India and South Africa

UN Manual, Arm’s Length Principle & OECD 3 1 UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison

Issues to be debated:

Discussions on important aspects covered in India and China chapter

Comparison with OECD Guidelines

Implications on non-OECD member countries

UN Manual, Arm’s Length Principle & OECD 4 1 UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison

Key topics covered in the India Chapter of UN Manual include:

Location savings

India provides ‘Location Specific Advantages’ (LSA) in addition to location savings

LSAs include access to market, skilled manpower, large customer base, information and distribution networks

Quantification and allocation of location savings and location rent (in case of LSA) to be an important area of concern

Use of Profit Split Method endorsed by Indian Revenue (in case of absence of Comparable Uncontrolled transactions)

UN Manual - India Chapter 5 1 UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison

Intangibles

Marketing intangibles and co-branding activities -

particularly relevant for India owing to unique

market characteristics

Enhancement of brand, creation of efficient supply

chain, conducting market research identified as

factors relevant to creation of marketing intangible

Ways of compensation for creation of marketing

intangibles eg: Reimbursement of extra-ordinary

expenses, with a mark-up; or share of

profits in relation to marketing intangible


R&D related intangibles

Remuneration received by captive providers

should commensurate to functions performed and

risks assumed

Routine and low cost plus mark up perceived to

be insufficient – day to day decision making and

operational risks lie in India

Additional compensation on account of creation

of intangibles and ‘more than’ routine

functions / risks required


Intra-group services

Categorised as high risk area

Nature of allocation keys is a grey area

Non-receipt of mark-up on provision of

services considered as a ‘pain-point’ by Indian

Revenue

Use of contemporaneous data – relevance of

current year data re-emphasised


Allocation of risks between taxpayer and AEs –

contingent on core functions, responsibility and

decision making

Comparability adjustments

Burden to proof on taxpayers

Difficulty in undertaking risk adjustment

highlighted, however no guidance / solutions

provided in Manual


Lack of reliable local comparables

Location specific advantages (LSAs)

Location savings

Market premium

Very structured approach to defining and

calculating

UN Manual - China Chapter 10 UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison 1

Intangibles

General position that Chinese intangibles

under-compensated

Confidence in effectiveness of documentation

and audits to achieve compliance

UN Manual - China Chapter 11 UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison 1

Intangibles: Tax Controversies, Enforcement & Litigation in Asia

8-9 May 2013

Increased interest of tax authorities regarding:

Economic ownership vs legal ownership of

intangible

Attribution of benefits of intangibles to parties

OECD’s draft guidelines on intangibles (released

in June 2012) - emphasis on FAR for intangible

related returns

Intangibles 13 2 Intangibles: Tax Controversies, Enforcement & Litigation in Asia

Issues to be debated

Views of tax administrators and taxpayers on

intangibles and transfer pricing in relevant

jurisdiction

Recent tax controversies

Intangibles 14 2 Intangibles: Tax Controversies, Enforcement & Litigation in Asia

Legislative developments

Definition of intangibles introduced vide

Finance Bill 2012

New definition includes marketing, human

capital, customer related intangibles

Definition introduced retrospectively

Intangibles - India Perspective 15 2 Intangibles: Tax Controversies, Enforcement & Litigation in Asia

Disputes in India primarily focus on:

Creation of marketing intangibles by Indian

entities manufacturing / distributing branded

products

Contribution of Indian contract software

service providers to the overall product

development lifecycle

Recent Special Bench ruling in case of LG

Electronics

Intangibles - India Perspective 16 2 Intangibles: Tax Controversies, Enforcement & Litigation in Asia

The OECD BEPS Study & the “Grey Area” Definition

8-9 May 2013

BEPS – a debate gaining recognition across

BRICS and G20 nations

Meeting of G20 leaders in July 2012 and

November 2012 emphasised on “the need to

prevent base erosion and profit shifting”

OECD highlights the ‘grey area’ between tax

planning and tax evasion

The OECD BEPS Study - An Overview 18 3 The OECD BEPS Study & the “Grey Area” Definition

Joint Communiqué issued by BRICS identified

the following as primary reasons leading to

erosion of the tax base:

Abuse of tax treaty benefits

Incomplete disclosure of information between

tax administrations


Primary ways of cross-border profit shifting:

Pricing of international transactions between

two associated enterprises

Capital structuring / financing between

associated enterprises

Development of international standards,

improving access to data and information and

capacity building is ‘need of the hour’


Issues to be debated:

How to draw the line between tax planning and

tax evasion

Impact of BEPS on emerging economies

Learning from international best practices

Suggest improvements that may be made to

transfer pricing rules

Other ways to resolve BEPS (areas such as

GAAR, thin capitalization to be discussed)

The OECD BEPS Study 21 3 The OECD BEPS Study & the “Grey Area” Definition

Valuation in Business restructurings & Tax Authorities

8-9 May 2013

Historical stand - transfer pricing provisions do

not apply to cross-border business restructuring

if there is no bearing on taxable income

Important amendment introduced (with

retrospective effect) in Budget 2012 –

‘business restructuring’ to be considered an

international transaction irrespective of its

bearing on taxable income (at the time of

transaction or in future years)

Valuation in Business Restructurings - India

23 4 Valuation in Business Restructurings: the Different Approaches of Tax Authorities

Transactions such as issuance, conversion, buy-

back of shares targeted

Discounted cash flow (DCF) preferred by Indian

Revenue

Valuation reports and methods such as DCF and

NAV likely to gain acceptance with introduction

of ‘Other Method’

Highly litigative area at present

Valuation in Business Restructurings - India

24 4 Valuation in Business Restructurings: the Different Approaches of Tax Authorities

Developments in Policy on Advance Pricing Agreements

8-9 May 2013

Developments in APAs - India Perspective 26 5 Developments in Policy on Advance Pricing Agreements

Guidelines notified on August 31, 2012

Taxpayer community reposing faith in the APA

regime

Encouraging response – about 150 pre-filings in

8 months

Approx 80% of the pre-filings are for unilateral

APA

Developments in APAs - India Perspective 27 5

Relationship between Indian – US Competent

Authority cause of concern

In absence of Art 9(2), bilateral APAs not

available

Transactions targeted – Royalty, Contract R&D,

software, management fees, contract

manufacturing, cost allocations

Developments in Policy on Advance Pricing Agreements

Proliferation of countries now with APA rules

Various countries such as HK growing DTA

network partly to support APAs

Indonesia and Vietnam now on steep learning

curve

HK IRD enthusiastic but only limited cases

underway so far

China focus on bilateral/multilateral due to

severe limitations on resources

28

Developments in APAs - Asia Perspective Developments in Policy on Advance Pricing Agreements 5

Intercompany Loans Focus

8-9 May 2013

Intercompany Loans Focus - India Perspective 30 6 Intercompany Loans Focus

Financial transactions such as loans and

guarantees – highly litigative area in Indian TP

arena

Expressly introduced in definition of international

transaction vide Finance Act 2012

CUP mostly relied upon as the most appropriate

method – PLR, LIBOR typically used for

benchmarking

More sophisticated quantification techniques

gaining importance: Credit rating

comparison of borrower & its AEs

Managing TP In-House Across Asia-Pacific

8-9 May 2013

32 7 Managing TP In-House Across Asia-Pacific

Transfer Pricing is the Number One Challenge

Increasingly sophisticated tax authorities are utilising commercial

databases for risk- based audit selection, increasing the number of

audit and calculated adjustments

Lack of consistency from country to country pose added difficulties

Dispute resolution on undocumented cases is a very challenging

and potentially expensive problem

Business continues to change as a result of globalisation,

M&A and reorganisation

Importance of business aligned tax planning is rising

Response to a

Taxand survey of

tax professionals

Transfer Pricing – Managing the Challenge 33

Considerations in establishing best practice

Market rates for interest

Credit premium reflecting credit risk?

Quantifiable? (spreads, historical default information)

Comparables? (bonds, credit default swap spreads, liquidity issues)

Challenges in emerging markets

Sovereign intervention

Country risk

Resulting risk / pricing impact

Managing TP In-House Across Asia-Pacific 7

How do issues of ‘Transfer Pricing’ originate?

The process of producing a ‘Coke’

Coke

USA

Parent level

Coke

Mex

Concentrate Producing Sub

Coke

Chile

Bottler Sub

Secret Coke

Recipe

Funds &

Financial Flexibility

Coke

Concentrate

Tra

nsfe

r o

f

inta

ng

ible

s

Tra

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f

tan

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les

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f In

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ina

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Coke

USA

Parent level

Coke

Mex


Coke

Chile

Bottler Sub

Secret Coke

Recipe

Funds &


Coke

Concentrate

Tra

nsfe

r o

f

inta

ng

ible

s

Tra

nsfe

r o

f

tan

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les

Tra

nsfe

r o

f In

terc

om

pa

ny F

ina

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g

?



Coke

USA

Parent level

Coke

Mex


Coke

Chile

Bottler Sub

Secret Coke

Recipe

Funds &


Coke

Concentrate

Tra

nsfe

r o

f

inta

ng

ible

s

Tra

nsfe

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tan

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Tra

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Example: How do Intercompany Loan Issues Originate?

• CDS are good proxy for actual risk premium

• Most responsive market to changes in risk perception

• Very liquid market for parent company’s funding

• High credit quality, high liquidity => low spreads


Example: Credit Default Spreads at the Parent Level

Source: S&P Capital IQ, Standard & Poor’s Ratings

=*

* … broadly the same credit quality; within +/- 1 notch

Source: S&P Capital IQ, Standard & Poor’s Ratings

Standard & Poor’s Ratings

S&P Capital IQ – Credit Model

CMS - CDS Prices

?


Example: Using an Objective Model to Score Where no Risk Indicators are Available

The reliance on empirical basedapproaches assures transparencyand trustworthiness of the pricingapproach

• Build custom empirical yield curvesbased on actual historical data only,utilizing typical polynomial or moreadvanced approaches

• Pre-generated templates allow you toinstantly review relevant statistic onthe a custom yield curve

Note: Graph contains hypothetical data.

Building Robust Market Based Reference PricingCalculate Yield Curves for Custom Pool of Comparables

Empirical Term Structure

0

1

2

3

4

5

6

7

0 5 10 15 20 25 30

Term (years)

Yie

ld (

%)

Median

Upper Quartile

Lower Quartile

Exposure Weighted Average

Establishing a market

based comparable

requires:

Transparent

methodology

Appropriate

segmentation

(geography, industry,

credit rating, duration,

etc.)

Cover all risk factors

(sovereign risk, T&C)

Strong grounding on

empirical data

Credit Spread Models

7 Managing TP In-House Across Asia-Pacific

Alternatives in Establishing Effective Reference Prices

Sovereign Default

Risk

(LC / FC)

Transfer &

Convertibility Risk

“Country risk is the risk that economic, social, and political conditions

and events in a foreign country will adversely affect an institution’s

financial interests. […] Country risk includes the possibility of

nationalization or expropriation of assets, government repudiation of

external indebtedness, exchange controls, and currency depreciation

or devaluation.

Risk associated with the non-repayment

of a sovereign’s financial obligations

issued in local or foreign currency

Country Risk

Likelihood of sovereign interference in the exchange rate market to

prevent non-sovereign entities to repay their financial obligations in

foreign currency

The risk that a government will discriminatorily change the laws,

regulations, or contracts governing an investment—or will fail to

enforce them—in a way that reduces an investor’s financial returns is

what we call “policy risk.”

Policy Risk


Emerging Markets – Look Beyond Sovereign Risk

0

2

4

6

8

10

12

14

16

18

20

0 2 4 6 8 10 12 14 16 18 20

Co

un

try R

isk

Sc

ore

by S

&P

Ca

pit

al IQ

Sovereign Ratings by Standard & Poor’s

Greec

Irelan Iceland

Hungary

Latvia

Jamaica

Russia

China

Kuwait

Saudi Arabia

BotswanIndia

Chile

Turkey

Incongruity Between Country Risk Scores & Sovereign Ratings

Source: S&P Capital IQ Country Risk Framework and Rating information from Global Credit Portal (R) as of September 30, 2011 and provided for illustrative purposes.

Concentrating on Country Risk - Its Impact on Corporations


Malaysia Thailand China Cambodia

Country Risk

Score a a- bb+ b

Standalone

Score bbb- bb+ bb- b+

* FC… Foreign Currency

Country risk impacts the standalone score significantly and across a number

of countries with different risk, that leads to 4 notches difference

Sovereign

Rating FC* (as at 21 Jun 2012)

A- BBB+ AA- B

Credit Score bbb- bb+ bb- b

Where the sovereign rating is low (Cambodia), it would limit the

company’s ability to get a higher rating, even if the standalone score is

stronger

The range of scores, depending on industry and country selection is

from bbb- to b (5 notches)!

Scoring the same financial profile across different countries…


Impact of Sovereign & Country Risk Scores to Individual Co.s

Global consistency vs local customisation

Adapting Master-file to local circumstances

Preference for local methods, comparables

Reconciling different local studies

Optimal TP team structure & infrastructure

Governance

Engagement of key stakeholders (business, tax,

finance, legal/compliance) and local teams

Operational: embedding TP into BAU

Managing TP Risk In-house Across Asia-Pacific

41 Managing TP In-House Across Asia-Pacific 7

Taxand’s Take

8-9 May 2013

Financial transactions, intangibles gaining focus globally

Need for “glocal” documentation - MNEs should tailor

their global documentation to manage risks in complex

jurisdictions

Involvement of in-house tax department in operational

changes critical

Proactive approach towards controversy management

Convergence of global tax policies with local risks

Increased transparency and sharing of information - need

of the hour

Exploring alternate dispute resolution mechanisms

Taxand’s Take

43 Managing TP In-House Across Asia-Pacific 8

Key Contacts Key Contacts 44 6

Mukesh Butani

Taxand India

E. [email protected]

T. +91 124 339 5011

Clemens Thym

Standard and Poors


Shiv Mahalingham

Taxand UK

E.

[email protected]

T. +44 207 715 5234

Steven Carey

Quantera Global


http://www.taxand.com/events

Understanding and

managing the tax

consequences of cross-

border tax transactions

Considering organisational

(re)structuring options in

full awareness of the tax

implications

Realising tax, supply chain

and overall operational

efficiencies

Interpreting technical tax

provisions

Our Global Service Commitment 45 9 Key Contacts & About Taxand

Lowering effective tax

rates

Addressing and preventing

tax leakages

Ensuring tax compliance

Managing relationships

with tax authorities

Global Coverage Key Contacts & About Taxand 46 9

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Canada Malaysia Spain

Chile Malta Sweden

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Why Taxand? 47 9 Key Contacts & About Taxand

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Documents

Transfer Pricing: Issues, Risks & Opportunities for … Tax...1. UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison 2. Intangibles: Tax Controversies, Enforcement