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 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
UN Manual - India Chapter 6 1 UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison
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
UN Manual - India Chapter 7 1 UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison
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
UN Manual - India Chapter 8 1 UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison
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
UN Manual - India Chapter 9 1 UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison
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
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
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
The OECD BEPS Study - An Overview 19 3 The OECD BEPS Study & the “Grey Area” Definition
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’
The OECD BEPS Study - An Overview 20 3 The OECD BEPS Study & the “Grey Area” Definition
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
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 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 - 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
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
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inta
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ible
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Tra
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r o
f
tan
gib
les
Tra
nsfe
r o
f In
terc
om
pa
ny F
ina
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g
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
nsfe
r o
f
tan
gib
les
Tra
nsfe
r o
f In
terc
om
pa
ny F
ina
ncin
g
?
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
nsfe
r o
f
tan
gib
les
Tra
nsfe
r o
f In
terc
om
pa
ny F
ina
ncin
g
Managing TP In-House Across Asia-Pacific 7
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
Managing TP In-House Across Asia-Pacific 7
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
?
Managing TP In-House Across Asia-Pacific 7
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
Managing TP In-House Across Asia-Pacific 7
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
Managing TP In-House Across Asia-Pacific 7
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…
Managing TP In-House Across Asia-Pacific 7
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
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
T. +91 124 339 5011
Clemens Thym
Standard and Poors
Shiv Mahalingham
Taxand UK
E.
T. +44 207 715 5234
Steven Carey
Quantera Global
Understanding and
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consequences of cross-
border tax transactions
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(re)structuring options in
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and overall operational
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Interpreting technical tax
provisions
Our Global Service Commitment 45 9 Key Contacts & About Taxand
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Global Coverage Key Contacts & About Taxand 46 9
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