Transfer Pricing / Tax Planning Opportunities

Baker & McKenzie: Ken Okawara, Richard Weisman, Monique van Herksen,

Marc Levey, Moises Curiel-Garcia

Yulchon: Soo Jeong Ahn

Transfer Pricing / Tax Planning

Opportunities

2009 Asia Pacific Transfer Pricing Conference

10 February 2009, Korea Chamber of Commerce & Industry, Seoul

Transfer Pricing / Tax Planning Opportunities

© 2009 All rights reserved. 2

I. Hot Topics - Korea

1. Planning Opportunities based on Tax Rate Cuts/ NOL

Carryover Extension

• Tax Rate Cuts:

– The maximum corporate income tax rate is reduced from 25% to 22%

from 2008, and will be further reduced to 20% from 2010.

– Withholding tax rates applicable to dividends, interests, royalties or

other income paid to nonresidents or foreign corporations will be

reduced from 25% to 20%. For capital gains, the applicable rate will be

the lesser of 10% of the total sales proceeds or 20% (reduced from

25%) of the capital gains.

• Extension of NOL Carry-Forward Period:

– The current net operating loss (NOL) carry-forward of 5 years will be

extended to 10 years. This change would be applicable in respect of

NOLs generated from the fiscal year beginning on or after January 1,

2009.



I. Hot Topics - Korea

2. Introduction of Consolidated Tax Return Filing Regime

• The consolidated tax return filing regime will come into effect in

2010.

• A parent company and its 100%-owned subsidiaries are eligible for

the consolidated tax return filing (exceptions for employee stock

ownership plan).

– After aggregating the respective amounts of taxable income of member

companies for the concerned fiscal year, additional adjustments (e.g.

elimination of the gain/loss from inter-company transactions,

recalculation of the tax limit for donation/entertainment expenses, etc.)

should be made to calculate the consolidated taxable income.

• A consolidated tax return would provide companies with more

flexibility in structuring business entities as well as an alleviation in

tax burdens



I. Hot Topics - Korea3. Contemporaneous TP Documentation Rules

• Amendment of LCITA Enforcement Decree Art. 23:

– Exemption from the 10% penalty for underreporting income: available for

a taxpayer who fully complies with the contemporaneous documentation

requirement and substantiate the reasonableness of the selected TP

method.

• Contemporaneous Documentation Requirement in Other Countries:

– China: Guoshuifa (2009) No.2 Implementation measures for special tax

adjustments; came into effect in 2009, retroactively applicable to FY 2008.

– USA: TITLE 26, Subtitle F, CHAPTER 68, Subchapter A, PART II, Sec.

6662; effective since 1994

• Where a Korean parent company has manufacturing and selling

affiliates in other countries, e.g., China, USA, Canada, etc.

– Can minimize the overall compliance costs as well as potential tax penalty

in Korea by preparing one set of TP study or contemporaneous

documentation for intercompany transactions to satisfy the penalty-

exemption requirement of both jurisdictions.



II. Hot Topics – Mexico

• Increased focus on related party transactions, transfer

pricing compliance and customs valuation issues

– Tax return format now requires additional and more

detailed information

• Audit programs to increase tax collections

– Calculation of estimated tax payments

– Maquiladoras

– Taxation of tax incentives granted in prior years



II. Hot Topics – Mexico

• Single Rate Tax –Interest payments

– Impact of currency gains on maquiladora operations

• Maquiladoras are required to calculate taxable income based on any of the transfer pricing alternatives applicable to maquiladoras –

– Transfer pricing study

– Safe harbor

• Foreign currency account receivable balance from foreign principal may trigger a significant amount of currency gains, which should be added to taxable income determined under transfer pricing rules

• Companies operating under the transfer pricing study alternatives may switch to the safe harbor alternative in order to minimize impact – Need to run tax impact scenarios



III. Use of Foreign Beneficial Taxation

• Interim holding companies (e.g. Dutch COOP)

• UK dividend tax exemption

• Other useful schemes in other region?




1. New Japanese Foreign Dividend Exemption Regime

• Currently credit mechanism for dividends

• New foreign dividend exemption regime as of April 1,

2009:

– Only for dividends (not for capital gains)

– 95% exemption

– 25% minimum shareholding

– Minimum 6 month holding period



Japan

BV

(NL)

Spain FranceGermany

5% Dutch

dividend

withholding tax

28% average

European CIT




Japan

Cooperative

(NL)

Spain FranceGermany

No Dutch dividend

withholding tax

28% average

European CIT





• UK Dividend Tax Exemption rule:

• Full exemption for foreign dividends received (both UK

and foreign source) which fall into 1 of 5 categories of

―exempt distribution‖:

– Where recipient company ―controls‖ the payor

– Distributions in respect of non-redeemable ordinary shares

– Where the recipient owns 10% or less of the payor

– Where the dividends are derived from transactions not

designed to reduce tax (anti-avoidance rule)

– In respect of shares accounted for under GAAP as loan

relationships



UK Dividend Exemption Regime

• Exemption does not apply where:

– The distribution is deductible for (foreign) payor under

local law

– The distribution falls within one of certain categories

targeted by anti-avoidance rules, e.g. where the CFC

rules are being ―manipulated‖

• Non-exempt dividends remain taxable under simplified

foreign tax credit regime



UK Dividend Exemption Regime

• Welcome change with no grandfathering, minimum

shareholding or holding period requirements

• Avoids administrative burden/uncertainty of foreign tax

credit system

• May cause foreign WHT issues if ―subject to tax‖ test in

DTT

• Query whether this will cause issues for UK sub-groups

of Japanese groups due to Japanese CFC rules



IV. Planning Opportunities

• Assessing Current Transfer Price

– Allocation of Restructuring Costs

– Utilization of NOLs

• Possible IP Migration



IV. Planning Opportunities1. Restructuring Cost Allocation

• Which companies should (can) deduct the costs of

support and restructuring

– Company which benefits from restructuring?

– Utilization of NOLs of the liquidating subsidiary for tax

purposes



• Utilization of NOLs

– Global tax planning with NOLs in Japan and other

countries

– Possibility of deferred tax assets realization (for

accounting purposes)

• Japan：deferred tax accounting rule

• USA：FAS109

– Feasibility by transfer pricing strategy

IV. Planning Opportunities2. NOL Utilization



IV. Planning Opportunities2. NOL Utilization

<Example>

【Before changing the transfer pricing policy】• Consolidated income before taxes 70

• Total amount of tax payments 44

【After change in transfer pricing policy】• Consolidated income before taxes 70

• Total amount of tax payments 19.2

• Utilization of NOLs

Japan （tax rate 42%）

Income before taxes 100

Tax payments 42

Ireland （tax rate 10%）


Tax payments 2

US（tax rate 32%）

Income before taxes -50

Tax payments 0

Japan （tax rate 42%）


Tax payments 13

Ireland （tax rate10%）


Tax payments 3

US （tax rate32%）


Tax payments 3.2



IV. Planning Opportunities3. Possible IP Migration

Goals of IP Migration Structure

• Reduce effective tax rate by earning profits from IP in a lower taxed jurisdiction

• Move existing rights at an appropriate transfer price

• ―Do no harm‖ to IP legal ownership and right to protect IP




Why Consider IP Migration in a Down Economy?

• Current and future value of existing IP has likely gone

down under a variety of methodologies (especially for

marketing intangibles)

• Creates opportunity for the ultimate turn-around

(assuming it comes)

– Have to balance possibility of potentially negative results if

profits don’t increase




Options for Structuring an IP Migration

• Cost Sharing

• Licensing Model

– With Contract R&D Services

– With Marketing Intangibles

• Sale (under option)




• Cost Sharing (US)

– Requires a buy-in (or recognition of new ―platform

contributions‖) of existing technology, but R&D costs are shared

at cost based on expected benefits for each participant

– Was historically advantageous

– Current Challenges:

• 2005 Proposed Regulations

• Coordinated Issue Paper

• Aggressive Audits

• New temporary & proposed regulations issued December 31, 2008

– Improved, but still challenging



• Existing Cost Sharing Agreements Grandfathered

– Continue to be governed by 1996 cost sharing regulations

• CSA must be amended to comply with certain administrative

requirements of new regulations

• Amendment must be complete by July 6, 2009

– Not required to change divisional interests

– Termination of grandfathered status only if material change in

scope

– Prior change in control provision eliminated

<Highlights of US 2008 Temporary Regulations>




• Four Primary Requirements for a qualified CSA:

– Share intangible development costs in proportion to

expected benefits

– Comply with detailed administrative requirements

– Pay for existing intangibles used in development efforts

– Acquire non-overlapping exclusive and perpetual interests

in intangibles





• Sharing of Intangible Development Costs (―IDCs‖)

– Broadly defined to include all costs in cash or kind that are

directly identifiable with, or reasonably allocable to, an Intangible

Development Activity (―IDA‖)

– Includes stock based and executive compensation

– IDA includes all activities that could reasonably be anticipated to

contributed to developing the cost shared intangibles





• Reasonably Anticipated Benefits (―RAB‖) Shares

– Must be estimated over the entire period of the

exploitation of cost shared intangibles

– Must be updated to account for changes in economic

conditions

– May be different for different product lines if separate

CSAs entered into




© 2009 All rights reserved. 26© 2009 Baker & McKenzie 26

• Examples of allocation bases for RAB Shares:

– Units used, produced or sold

– Sales

– Operating Profit

– Other





• Existing Intangibles: Platform Contribution Transaction

(―PCT‖)

– Although terminology has changed, the theory is the same

– Broadly defined as any resource, capability or right

reasonably anticipated to contribute to the development of

cost shared intangibles

– Each participant contributing a PCT must be

compensated (the ―buy-in‖ of existing intangibles)





• Existing Intangibles: Platform Contribution Transaction (con’t.)

– A PCT obligation continues even if it has not or ceases to contribute to developing intangibles under a CSA

– Presumed to be exclusively for the development of intangibles

• Rebuttable presumption with subsequent proration

– Rights to exploit (make or sell) existing intangibles cannot be PCTs





• Examples of PCTs

– Source code for software development

– Existing software for future development

– A research team with existing expertise

– Clearly not limited to Code section 936(h)(3)(B)

intangibles





• Divisional Interest Requirement

– Non-overlapping perpetual and exclusive rights division

– Expands 2005 regulations requirement which only allowed

territorial divisions

– Can be by territory, field of use or other division if certain

requirements are met

• Place of manufacture provided as an example of another

potentially qualifying division


IV. Planning Opportunities

3. Possible IP Migration



• PCT Valuation Methodologies (the ―Buy-In‖)

– Requires comparison to alternatives realistically available to cost sharing participants

– Appropriate discount rates must be used to determine net present value calculations

• No longer refer to WACC or hurdle rates

• Rates different with different risk profiles

– Different input parameters may be relevant to a particular methodology (routine returns, royalty rates, etc.)





• PCT Valuation Methods (the ―Buy-In‖)

– Comparable Uncontrolled Transactions

– Income

– Acquisition Price

– Market Capitalization

– Residual Profit Split

– Other Methods

– Basically unchanged from the 2005 proposed regulations






• Service Cost Sharing (China)

– The difficulty of paying a service fee out of China (without taking

a tax hit) is a common complaint by global tax directors. The

Final STA Measures endorse the concept of service cost

sharing (for group marketing and procurement services) but

unfortunately one crucial area has not been clarified namely the

business tax and corporate income tax treatment associated

with a service cost sharing payment. Service fees paid out of

China are subject to such taxes if a PE exists and the question

is whether a cost sharing payment would be exempt from such

taxes.




• Licensing and Contract R&D

– Similar to cost sharing

• Requires license of existing technology

• Contract R&D arrangement in place to pay R&D service

provider (cost plus markup)

– Primary Benefit

• Cost sharing regulations do not apply

• Some troubling examples in the regulations seem to give

IRS latitude in deciding to apply cost sharing regulations in

similar transactions




• Licensing

– Viable if licensee can earn residual profit after payment of

royalties

• Reliable CUTs that leave profit for the licensee

• Residual profit split where licensee brings significant IP to

the table

– Marketing IP may offer more opportunity for licensing

than technology IP

• Values may be currently depressed

• Potentially shorter shelf life may imply steep decay rate




• Marketing IP: Migration Advantages

– Lower risk of failure than tech investments

– Potentially shorter lives and higher RoR

– Third parties routinely split the excess profits

– Shift functions and risks to migrate profit

– Less visible than shifting technology income

– Does not require a change in IP ownership

– Wording and intent of 2006 Regs are favorable




• Licensing of Marketing Intangibles

– Goal: Move 40%–60% of trademark profits by shifting functions and risks, not ownership

– Divide income stream for trademarks

• Licensor earns low-risk fixed annuity

• Licensee earns residual profit for assuming risk of investing in advertising and marketing

– Exit charges from the HQ jurisdiction may be minimal

– Caution: some ―marketing intangibles‖ may not fit this profile (e.g., customer contracts, service/maintenance relationships)




• Contract R&D

– License of existing IP under Treas. Reg. § 1.482-4

– R&D service fee under new services regs

– Alternative approaches

• Simple—1 party funds 100%

• Complex––Each party funds own R&D with R&D service fee

balancing payment

– Implied cost sharing arrangement?

– Potential withholding tax issues

• Possible gross–up of royalty free cross–license



What Should Taxpayers Consider?

• Cost sharing if each participant has non-routine

contributions to make at the outset

• If that is not the case, licensing/contract R&D model is

likely best

• Remember to think about valuation opportunities in

difficult economic times (perhaps even with IRS-blessed

methodologies)



What Should Taxpayers Consider?

• Existing business model

• Ability to properly implement and maintain structure

• Appetite for risk / risk management alternatives

Baker & McKenzie: Ken Okawara, Richard Weisman, Monique van Herksen,

Marc Levey, Moises Curiel-Garcia

Yulchon: Soo Jeong Ahn

Transfer Pricing / Tax Planning

Opportunities

2009 Asia Pacific Transfer Pricing Conference

10 February 2009, Korea Chamber of Commerce & Industry, Seoul

Documents

Transfer Pricing / Tax Planning Opportunities