Transfer Pricing Developments: Future Business Models for

Managing Global CompaniesSaturday December 5, 2015

Session 14.00 – 16.00

Chairman: Gautam Doshi, Reliance ADA India

Panel leader: Caroline Silberztein, Baker & McKenzie, France

Panellists:• Anis Chakravarty, Deloitte, India • Carol Dunahoo, Baker & McKenzie, USA• Daniel Erasmus, TRM, South Africa, Africa & USA • Sanjiv Malhotra, Baker & McKenzie, Singapore• T.P. Ostwal, T.P. Ostwal & Associates, India • Kamlesh Varshney, Tax Commissioner responsible for

APAs, India

1. “ASSURE THAT TRANSFER PRICING OUTCOMES ARE IN LINE WITH VALUE CREATION”

4

R&D, design

Source raw materials,

components

Make (process, package)

Market

Sell

Deliver (warehousing, inventory management,

transportation)

After sales services, returnsB

ack

offi

ce s

erv

ice

s, IT

sys

tem

sTransfer pricing questions at each step of the supply chain

Creation of value ?

Capital

Funding the acquisition and development of intangibles

Bearing entrepreneurial and financial risks

Labour

People functions (manufacturing, marketing, sales, R&D)

Strategic decisions, Control over risks

Location savings

Market

Consumers base

Growing demand

Buying power

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2. INTANGIBLES AND “DEMPE” FUNCTIONS

OECD-G20 Definition of intangibles for transfer pricing purposes

• Something which is not a physical asset or a financial asset, which is capable of being owned or controlled for use in commercial activities, and whose use or transfer would be compensated had it occurred in a transaction between independent parties in comparable circumstances.

• Not always an intangible asset for accounting purposes• Availability and extent of legal, contractual, or other

forms of protection may affect the value. • Separate transferability is not a necessary condition

for an item to be characterised as an intangible for transfer pricing purposes

• Differing country definitions / experiences ? 7

Rewarding contributions of affiliates to the creation of intangible value : the

“DEMPE” functions

• Determine, by means of a functional analysis, – which member(s) perform and exercise control over

development, enhancement, maintenance, protection, and exploitation functions (“DEMPE”),

– which member(s) provide funding and other assets, and

– which member(s) assume the various risks associated with the intangible,

• whether or not legal owner of the intangible.

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• entitled to all of the anticipated returns derived from the exploitation of the intangible

Performs and controls all of the DEMPE functions; provides all

assets, including funding, necessary to the DEMPE; and

assumes all of the risks related to the DEMPE

• generally only expect a risk-adjusted return on its funding

Provides funding and exercises control over the financial risk

associated with the provision of funding, without the assumption of, including the control over, any other

specific risk

• it will have no more than a risk-free return; even less if legal ownership is disregarded

Lacks the capability to control the risk associated with investing in

a riskier financial asset

In summary, where the legal owner…

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3. IP HOLDING COMPANY

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High tech company

Parent IP Co Existing IP / R&D

Market Co

Manufacturing

High tax; original IP

development

Low tax; intragroup

acquisition of IP

High tax / low tax; further IP development

1

4

3 2

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© 2015. For information, contact Deloitte Touche Tohmatsu Limited. 12

Legal owner of product intangibles: RoyaltiesBermuda cash box

Actions 8-10: Transfer pricing• Bermuda legal owner and funds

development• India performs

− Design and control of R&D program− Management and control of budget− Control over strategic development− Defence and protection− Ongoing quality control

• Three scenarios possible: − No management of funding risk:

entitlement to no more than risk-free return

− Management of funding risk: entitlement to risk adjusted return

− Management of funding risk and operational risk: not a cash box!

Parent

“Cashbox”Offshore

Subsidiary

Home country

Offshore

Contract R&D

Infusion of funds

• Legal owner of IP

• Funds R&D• Assumes risk of

funding

• Performs and controls all activities (DEMPE of IP), including management of operational risk

4. DIGITAL SUPPLIES

© 2015. For information, contact Deloitte Touche Tohmatsu Limited. 14

Digital supplies

Online auction platform, internet search and downloadable digital products

Actions 8-10: Transfer pricing issues• “Profits should be taxed where economic

activities deriving the profits are performed and where value is created.” [G20 Leaders’ Communiqué Brisbane Summit, 15-16 November 2014]

• Particular area of interest− Interplay with Action 1− “Demand” or “supply” creates value?

• Fragmented functions:− Who, in fact, controlling the activity?

Increased interdependencies create uncertainty

− Will “profit split” likely be viewed by some as a reliable method? Value of fragmented functions in the value chain may not be observable in transactions with independent parties

Source country

Principal

Services

Marketing services co.

Server co.

CommunicationServer

Customers

$$Services

$

Services

Multisided Business Models – Scenario 2 (from OECD 2014 draft on profit split)

R = Parent company- Original development and

funding of technology IP

Local subs : - Promote use of online services free of charge to

users- Generate demand and adapt advertising services

RCo Group provides Internet services to customers worldwide:• Advertising services ; fee based on number of users who click;• Online services free of charge to users; provides RCo with a substantial

amount of data

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5. SALES ORGANISATIONS

Principal and Sales

Principal

Low tax; centralise risks;

substance

IP co

Low tax; no people;

IP ownership Sales to custo-mers

Market Co

High tax;

sales support

Suppliers

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Unique and valuable contributions – Scenario 3

P = manufacturer of high tech equipment; - Extensive R&D; funding and ownership of

technology IP; - Global trademark; broad guidance to subs on

marketing strategy

S = sales and marketingClose relationships with customers, on-site services;

Extensive stock of spare parts;Highly proactive maintenance program; advice to customers

and adaptation to local conditions => Significant competitive advantage

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6. MARKETING

Example 5• Company P in Country A owns trademark.• It manufactures the products and sells them to Distributor in

Country B.• Distributor incurs Advertising, Marketing and Promotional

expenses in Country B.

Does Company P acquire / develop - a local marketing intangible ? - “economic ownership” of the trademark ? - co-ownership of the trademark ? Consider 3 cases :

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CASE 1 : ROS, no AMP refund

Sales revenue 1,000

COGS (Transfer Pricing) (550)

Advertising, Marketing, Promotion (AMP)

(100)

Other OPEX (300)

Return on Sales : 5% + 50

CASE 2: ROS, AMP refund

Sales revenue 1,000

COGS (Transfer Pricing) (650)

Advertising, Marketing, Promotion (AMP)

(100)

Other OPEX (300)

Reimbursement of AMP +100

Return on Sales : 5% + 50

CASE 3: ROS, partial AMP refund

Sales revenue 1,000

COGS (Transfer Pricing) (580)

Advertising, Marketing, Promotion (AMP)

(100)

Other OPEX (300)

Reimbursement of AMP +30

Return on Sales : 5% + 50

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7. MARKETING AND PROCUREMENT HUBS

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Marketing hub (Singapore)

Buy-sell affiliated

distributors

Plants

Physical supply

Sales transactions / Invoicing

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Marketing hub (Singapore)

Sales support

companies

Plants

Physical supply

Sales transactions / Invoicing

Sales support services

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Warehousing / distribution

platform (Singapore)

Sales support

companies

Plants

Physical supply

Sales transactions / Invoicing

Sales support services

Repatriation of excess profit to IP owner ?

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Marketing hub (Singapore)

Sales support

companies

Plants

Physical supply

Sales transactions / Invoicing

3 - Sales support services

Third party suppliers

1 – raw materials

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2 – finished products

2 – toll-manufacturing

8. LOCATION SPECIFIC ADVANTAGES

Parent (U.S.)

Principal (Singapore)

Manufacturer

(India)Manufacturer

(China)

Location Savings

How to quantify Location Savings: - Compare to whom,

what, and where ?- What if no relocation

of activity ?- What if products

evolve ?- What about “dis-

savings”?

How to attribute Location Savings ?

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Parent (U.S.)

Principal (Singapore)

Manufacturer (India)Manufacturer

(China)

Distributor

(China)Distributor

(EMEA)

Distributor

(India)

Market Premium

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9. CONCLUSIONS, Q&A

Thank you