Transfer Pricing Workshop Cairo 14-25 February 2010

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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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


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


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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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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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


Activities not constituting services:

Shareholder activities

Duplication of services

Incidental benefits

Passive association

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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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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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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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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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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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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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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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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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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



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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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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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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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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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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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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Documents

Transfer Pricing Workshop Cairo 14-25 February 2010