transfer pricing overview and leading practices - … 2012/presentations...(i.e., transfer pricing...
TRANSCRIPT
Transfer Pricing Overview and Leading Practices
HLB North America Tax ConferenceNovember 29, 2012
Page | 2
Contents
• Introduction to WTP Advisors
• Overview of transfer pricing
• Why is transfer pricing important?
• Leading practices and approaches
• Transfer pricing risk and opportunity drivers
• Sample projects
Page | 3
Circular 230
Any tax advice contained in this document is not intended or written to be used, and cannot be used, by any taxpayer for (i) the avoidance of penalties that may be imposed by any relevant tax authority, or (ii) for promoting, marketing or recommending the matters discussed herein to any third party.
Page | 4
Introduction to WTP Advisors
• International tax specialty services firm — Over thirty international tax and transfer pricing specialists located
throughout the U.S.— Affiliates located throughout the world
• Private Company International Tax Services— International Structuring— International Tax Compliance— Foreign Tax Credit Utilization— Repatriation Planning— Foreign Earnings & Profits— Inbound Tax Planning— Expense Allocation and Apportionment
Page | 5
Introduction to WTP Advisors (Con’t)
• International Tax Services— IC‐DISC Export Incentives
• Formation• Commission Optimization• Compliance
– Qualification– Tax Returns
— Domestic Production Deduction Incentive— Transfer Pricing
• Planning• Compliance• Tax Controversy Support
Page | 6
Introduction to WTP Advisors (Con’t)
• How does WTP work with CPA firms?• Whatever works best for the CPA and its clients
— Provide full international tax support— Supplement existing international internal resources— Direct contact— “Backroom support”— Quality Control— Work with our network or work with your network, whatever makes
the most sense
Page | 7
Overview of WTP’s transfer pricing practice
• Senior members with over fifteen years of experience• Global network• Subscribe to various company and license agreement
databases for benchmarking• Flexible, collaborative team
Page | 8
Overview of transfer pricing
• Transfer pricing (TP) is the price paid in transactions between related parties
• Most countries require companies to demonstrate that their intercompany transactions are arm’s length
• Primary concern: whether the taxable entities operating in the country are recognizing their fair share of operating profit
Page | 9
Arm’s length standard / principle
• Adopted by most OECD countries
• When the price paid between related parties is the same as the price that would have been paid between unrelated parties under the same or similar economic circumstances
Entity A Entity B
Company X Company Y
P1
P2
P1 = P2
Arm’s LengthTransaction
Page | 10
Main types of intercompany transactions
• Tangible property• Intangible property• Services• Financing
Page | 11
Tangible property
Manufacturing Entity
Related‐Party Distributor
Sale of Product
Page | 12
Intangible property (IP)
IP Owner IP ExploiterLicense of IP
Typical intercompany license agreements:• Patents• Technology• Know‐how• Methods• Data• Trademarks / Tradenames
Page | 13
Intercompany services
Service Provider
Service Recipient
Services
Typical intercompany services:• Management• Finance / accounting• Research and development• Marketing
• Supply chain / logistics• Sourcing / purchasing / procurement• Information technology (IT)• Technical services• Human resources management
Page | 14
Intercompany financing
• Loans
• Guarantees
Key factors:• Credit rating of the borrower (with and without any parent guarantee)• Duration / term of the loan• Currency• Existing financing arrangements (third parties and intercompany)• Market rates
Page | 15
Why is transfer pricing important?
• Tax— Tax planning: For many companies, transfer pricing is a key driver for
managing the effective tax rate — Tax risks: Inadequate attention to TP can expose companies to risks of
double taxation and non‐deductible penalties and interest
• Beyond Tax— Managerial issues / performance measurement / production management /
compensation plans — IP protection/exploitation— Regulated entities— Minority interests— Joint ventures— Acquisitions and spin‐offs / impact on valuation
Page | 16
Some of the most active countries
• United States• Canada• UK• Germany• France• Italy• Poland
• Australia• Japan• China• India• Brazil• Mexico• Argentina
Page | 17
Areas of concern by tax authorities
• Intercompany services— Are service provider entities undercharging for services?— Are service charge recipient entities overpaying for services?
• IP migration /cost sharing / buy‐in payments— Is IP being transferred below arm’s length value?— Are the entities that funded up front R&D costs appropriately remunerated
for the risks they undertook?
• Guarantee fees— Are parent companies appropriately charging out guarantee fees in situations
when subsidiaries benefit from favorable credit ratings?
• Supply chain restructurings• Permanent establishments
Page | 18
IRS transfer pricing IDR
How will your client respond to the following IDR?
Please provide within 30 days of this request any principal documentation outlined in Treas. Reg. Section 1.6662‐6(d) (2) (iii) (B) that has been prepared to support your transfer pricing methodologies for all years under examination. This information would generally be provided in the form of a study; however all principal documentation outlined under the Code and associated Treasury Regulation which was prepared for the years under examination, regardless of form, is requested. This documentation should include all internal and/or external studies.
It should be so noted that any documentation prepared by the taxpayer pursuant to Section 6662(e) must be in existence when the return was filed in order to meet the documentation requirement. In addition, if this documentation is not provided within 30 days of this request, and if there are significant adjustments to your transfer price as determined under IRC Section 482, a penalty may be applicable under IRC Section 6662(e) or (h).
Page | 19
Overview of US penalties
• Section 6662 ‐ accuracy related penalty on underpayments ‐penalties that correspond to Treas. Reg. Section 482 —Section 6662(e) – substantial valuation penalty— Section 6662(h) – gross valuation penalty
• Two different penalties— Transactional penalty – pertaining to a transaction between related
parties— Net adjustment penalty
• To reduce the risk of a penalty taxpayers:— Establish the arm’s length nature of its intercompany pricing policies— Create and maintain contemporaneous documentation
Page | 20
Transactional Penalty Does Not Apply
Transactional penalty
Price > 400 percent or < 25 percent of Correct Price?
Reasonable cause/acted in good faith?
Price > 200 percent or < 50 percent of Correct Price?
Gross Valuation MisstatementPenalty of 40 percent of Tax Underpayment Plus Interest
Substantial Valuation Misstatement Penalty of 20 percent of Tax Underpayment Plus Interest
Yes
No Yes Yes
No No
Underpayment of Tax Attributable to an IndividualValuation Misstatement
Page | 21
Net adjustment penalty
Net Adjustment Penalty Does Not Apply
Net Adjustments > $20Mor > 20 percent ofGross Receipts?
Contemporaneous6662 Documentation
in Place?
Net Adjustments > $5M or > 10 percent of Gross Receipts?
No Yes Yes
NoYes No
Gross Valuation MisstatementPenalty of 40 percent of Tax Underpayment Plus Interest
Substantial Valuation Misstatement Penalty of 20 percent of Tax Underpayment Plus Interest
Underpayment of Tax Attributable to One or MoreValuation Misstatements
Page | 22
Section 6662 TP documentation requirements
Principal Document1 An overview of the taxpayer's business, including an analysis of the economic and legal factors that affect the pricing of its property or
services;
2 A description of the taxpayer's organizational structure (including an organization chart) covering all related parties engaged in transactions potentially relevant under section 482, including foreign affiliates whose transactions directly or indirectly affect the pricing of property or services in the United States;
3 Any documentation explicitly required by the regulations under section 482;
4 A description of the method selected and an explanation of why that method was selected;
5 A description of the alternative methods that were considered and an explanation of why they were not selected;
6 A description of the controlled transactions (including the terms of sale) and any internal data used to analyze those transactions. For example, if a profit split method is applied, the documentation must include a schedule providing the total income, costs, and assets (with adjustments for different accounting practices and currencies) for each controlled taxpayer participating in the relevant business activity and detailing the allocations of such items to that activity;
7 A description of the comparables that were used, how comparability was evaluated, and what (if any) adjustments were made;
8 An explanation of the economic analysis and projections relied upon in developing the method. For example, if a profit split method is applied, the taxpayer must provide an explanation of the analysis undertaken to determine how the profits would be split;
9 A description or summary of any relevant data that the taxpayer obtains after the end of the tax year and before filing a tax return, which would help determine if a taxpayer selected and applied a specified method in a reasonable manner; and
10 A general index of the principal and background documents and a description of the recordkeeping system used for cataloging and accessing those documents.
Page | 23
Typical projects
• Transfer pricing planning / restructuring— Intangibles planning and cost sharing arrangements— Intercompany services cost allocation studies
• Audit / controversy assistance• Documentation• Benchmarking and valuation
— CPM / TNMM tested party analysis— Valuation of intangibles— 367(d) – deemed royalty— Interest rate on intercompany loan
Page | 24
Leading practices
• Be proactive, not reactive• Approach transfer pricing from all countries involved
(i.e., transfer pricing is usually not a one‐sided analysis)• Prepare a transfer pricing model• Identify the company’s intangibles and the entities that own
them• Consider using transfer pricing to facilitate tax planning
— Profit centers in favorable tax jurisdictions — Revenue / cost centers in high‐tax jurisdictions
• Identify the business case for any changes
Page | 25
Overview of our approach
Collect and Aggregate Data Analyze Data Prepare
Recommendations
• Information request• Interviews• Press releases / public information
• Transaction diagrams• Financials (historical and projections)
• Financial analysis• Functional analysis• Consider requirements and perspectives of countries involved
• Consider available comparables data and transfer pricing methods
• Transfer pricing approach
• Documentation plan
Page | 26
Functional analysis
• A key part of the transfer pricing study• Describes key economic factors in the transactions under
review— Functions (people – roles and responsibilities)— Risks (contracts)— Assets (intangibles)
• The functional analysis is a critical element in the transfer pricing process — Gather the data required for the transfer pricing analysis— Tell the story
Page | 27
Overview of US transfer pricing methods
Tangibles Services* IP
Transactional methods
CUP CUSP CUTCost plus Cost of services plusResale price GSMM
Profit‐basedmethods
CPMProfit split methods
Unspecified methods Unspecified methods
*The new US service regulations include the services cost method (SCM) under which certain transactions may qualify to be charged at cost without a markup
Page | 28
Overview of OECD transfer pricing methods
Tangibles Services IP
Traditionaltransactionmethods
CUPCost plus
Resale price
Transactional profit methods
TNMMTransactional profit split method
Page | 29
Best method rule (U.S.)
• The method that, under the facts and circumstances, provides the most reliable measure of an arm’s‐length result (Treas. Reg. Section 1.482‐1(c)1)
• No strict hierarchy• Reliability factors
— Comparability (e.g., industry, functions, risks, contractual terms, market level)
— Quality of data— Reliability of assumptions— Sensitivity of results to deficiencies in the data and assumptions
Page | 30
Best method rule (continued)
• Comparability factors— Functions— Contractual terms— Risks— Economic conditions— Property or services
• Contractual terms— Respected if consistent with economic substance— The IRS has the authority to impute an agreement
Page | 31
Global supply chain illustration
Contract Manufacturer
RoutineDistributor
Third Party Suppliers
Principal Company
Physical Product FlowTitle Flow (when different than physical product flow)
Third Party Customers
Key responsibilities include:• Sourcing / purchasing• Working capital• Inventory risk• Warranty risk• Intangibles (own and manage)
Page | 32
Comparables search and analysis
• Transactional comparables— Transactions between unrelated parties
(e.g., transactions between the company and a third party, license agreements, spot prices in the open market)
• Company comparables— Companies that perform activities that are similar to the tested party
in the transaction under review
• Profit split comparables
Page | 33
Profit level indicators (PLIs)
• Financial ratios— Operating margin (OM) or Return on sales (ROS)— Markup on total costs (MTC)— Berry ratio
Operating profit / operating expenses
• Asset‐based PLIs— Return on assets (ROA)
Operating profit / operating assets— Return on capital employed (ROCE)
Operating profit / (operating assets – accounts payable)
Page | 34
Arm’s length range
• The OECD Guidelines and Treas. Reg. Section 482 indicate that it may be appropriate to define a range of values as arm’s length as opposed to a single data point
• Defining the arm’s length range— The interquartile range (IQR) is the statistical technique widely used by tax authorities
to determine an arm’s length range— The range is defined as the middle 50% of comparable data points— The purpose of the IQR is to eliminate outliers
— Some tax authorities prefer to consider the full range of comparable data points and select the comparables that most closely meet the comparability with the tested party or transaction
LQ / 25% Median / 50% UQ / 75%
Arm’s Length Range
Page | 35
Sample benefits of TP planning and documentation
• Identify planning opportunities
• Develop a key line of defense against adjustments and potential risk of double taxation
• Protect against non‐deductible penalties and interest
• Promote understanding of transfer pricing policy within the company
Page | 36
Transfer pricing risk and opportunity drivers
• Growth— Entering new markets— Changing value chain— Launching new products or lines of businesses— Executing mergers and acquisitions
• Intangible property— Developing new IP that represent competitive advantages— Lacking clarity of which entities within the company own — Changing R&D activities
• Centralizing or decentralizing activities• Recognizing losses in certain jurisdictions and profits in others
Page | 37
Examples of projects we performed with other firms
• Sample tangible goods transactions— Canadian distributor of US‐based construction materials supplier— US distributor of Italian‐based automotive products supplier— US distributor of Canadian‐based agricultural company— US distributor of German‐based electrical systems manufacturer— Japan distributor of US‐based industrial products manufacturer— Sale of raw materials from European‐based steel producer to US manufacturing affiliate
• Sample intangibles and services transactions— Brands and know‐how licensed from US‐based restaurant franchisor to UK affiliate— Technology and marketing intangibles licensed from US‐based service company to
Singapore and Canadian affiliates— Technology and services from US‐based software company to UK affiliate— Technical services from India affiliate to US parent— Technology and trademarks from European‐based steel producer to US affiliate— Management services from European‐based parent to US affiliate
Page | 38
Contact information
Dave Wain Brian Schwam Guy Sanschagrin
Office: + 1 763.390.4094 +1 866.963.2917 +1 952.955.6677
Mobile: +1 763.742.5400 +1 414.839.5525 +1 952.217.1289
Email: [email protected] [email protected] [email protected]
www.wtpadvisors.com