transfer pricing overview allegheny tax society november 16, 2009 todd izzo, deloitte tax llp jeff...
TRANSCRIPT
Transfer Pricing Overview
Allegheny Tax SocietyNovember 16, 2009
Todd Izzo, Deloitte Tax LLPJeff Mensch, Deloitte Tax LLP
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.2
Agenda
The Arm’s Length Standard
Transfer Pricing Methods
Managing Transfer Pricing Risk
Overview of Administration’s International Tax Proposals
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.
The Arm’s Length Standard
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.4
Transfer Pricing -- Overview
• Refers to a body of law designed to prevent the shifting of income between taxing jurisdictions
• It is a multi-disciplinary approach to determine whether cross-border transactions between related parties comply with established guidelines.
• Most tax authorities require taxpayers to comply with the “Arm’s Length Principle.”
• An integral part of an effective Global Tax and Treasury Strategy
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.5
Escalation of foreign rules and enforcement
2005 -20092003 -20042001 -20021999 -20001996 -19981995
Uruguay
Finland
Turkey
Vietnam
SingaporePolandNorwayKazakhstanIndonesiaEcuadorDenmarkTaiwanHungaryColombiaMalaysiaThailandPortugalPeruIndiaNetherlandsGermanyRussiaBelgiumVenezuelaArgentinaCanadaUKChinaSlovakiaBrazilJapanItalyNew ZealandMexicoKorea FranceAustraliaSouth AfricaUSA
TaiwanHungaryColombiaMalaysiaThailandPortugalPeruIndiaNetherlandsGermanyRussiaBelgiumVenezuelaArgentinaCanadaUKChinaSlovakiaBrazilJapanItalyNew ZealandMexicoKorea FranceAustraliaSouth AfricaUSA
ThailandPortugalPeruIndiaNetherlandsGermanyRussiaBelgiumVenezuelaArgentinaCanadaUKChinaSlovakiaBrazilJapanItalyNew ZealandMexicoKorea FranceAustraliaSouth AfricaUSA
GermanyRussiaBelgiumVenezuelaArgentinaCanadaUKChinaSlovakiaBrazilJapanItalyNew ZealandMexicoKorea FranceAustraliaSouth AfricaUSA
ChinaSlovakiaBrazilJapanItalyNew ZealandMexicoKorea FranceAustraliaSouth AfricaUSA
AustraliaSouth AfricaUSA
1
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.66
Transfer Pricing in the Headlines
• Glaxo Smith-Kline - $3.4 billion• Symantec/Veritas - $1 billion• Motorola - $800 million• Fiji Water - $3 million per day in export
losses• Google – recognizes tax benefit of $90
million due to successful APA • Wal-Mart – share prices climb upon
announcement of bilateral APA with China
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.77
Current Environment: The Past is no Guide
• Increased enforcement of transfer pricing regulations by U.S. and foreign tax authorities
• Recognition that transfer pricing permeates the financial statements of many taxpayers
• Emphasis on tying provision amounts to individual transfer pricing “red flags”
• More intense (sometimes contentious) discussions with auditors
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.88
Regulatory Background
• Sec. 482 and regulations• Sec 367(d) and regulations• Sec. 6662• OECD Guidelines• Foreign Law / Regulations
• 482 vs. OECD Guidelines
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.
Definition of Related Parties
•Direct or indirect participation in:– Management,– Control or– Capital
•By one entity in another; •By one entity or group of entities in both.
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.
Control
•Related Parties•A corporation and a controlling person•Any two corporations:
– Controlled by the same or related persons– Related directly or indirectly to the same third
corporation/party
•Unrelated Parties•Questions of Fact
• Common mind• Acting in concert• De Facto control
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.1111
Manufacturing
+
Distribution
Intercompany
Sale
MultinationalMultinational
GroupGroup
MARKET
Arm’s Length Standard
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.1212
Arm’s Length Standard
• The Tax Administrator’s “Market Creation” Problem is “solved” by use of the arm’s length standard
• Wording from IRS 1994 regulations:
– ...the standard to be applied in every case is that of a taxpayer dealing at arm’s length with an uncontrolled taxpayer.
– A controlled transaction meets the arm’s length standard if the results of the transaction are consistent with the results that would have been realized [by] uncontrolled taxpayers…
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.
Arm’s Length Standard
• An adjustment under Code §482 is applicable if transfer price charged is not “arm’s length.”
• The regulations authorize the IRS to adjust a taxpayer's income in any way necessary to conform to the arm’s length standard.
• Adjustments under Code §482 directly affect a taxpayer's U.S. taxable income and resulting U.S. federal income tax liability.
Bad motive is not a prerequisite for an adjustment.
13
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.
Service fee
Market power
Return for assuming inventory price risk
Inventory carrying cost
Sourcing fee Process know-how
Location savings
Return for assuming long-term volume risk
Return for assuming operating cost risk
Base toll manufacturing fee
Distributor profit
Trademark & technology intangibles
Each activity or enterprise receives a share of total profits that reflects the contribution of that activity or enterprise to earning those profits.
Profits Relate to Functions and Risks
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.
Transfer Pricing Methods
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.
Best Method Rule
•U.S. Rules require taxpayers to apply the “Best Method”
•There are four important factors in selecting the Best Method:– The degree of comparability between the
controlled transactions and uncontrolled comparables
– The quality and quantity of data– Assumptions used in the analysis– Sensitivity of results to data deficiencies
16
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.17
U.S. & OECD: Points of Contention
•OECD - professed dislike of CPM, possibly in deference to the low regard of some European and Asian members for it
•OECD - preference for transactions-based evidence, even if the evidence is not highly comparable to the tested transactions
•OECD - considers operating profit-based methods to be a last resort
•Note that, as practically applied, there is little difference between the TNMM and the CPM
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.
Classifying Transactions
•Tangible property•Intangible property•Services•Loans•Mixed Transactions
18
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.1919
Transfer Pricing Methods
Unit of Unit of measurementmeasurement
TangibleTangible IntangibleIntangible ServicesServices OECD OECD GuidelinesGuidelines
PricePrice CUPCUP CUTCUT CUSPCUSP CUPCUP
Gross Profit on Gross Profit on SalesSales
Resale Resale margin margin methodmethod
N/AN/A Gross services Gross services margin methodmargin method
Resale margin Resale margin methodmethod
Gross Profit on Gross Profit on CostsCosts
Cost plus Cost plus methodmethod
N/AN/A Cost of services Cost of services plus methodplus method
Cost plus Cost plus methodmethod
Net Profit of Net Profit of One PartyOne Party
CPMCPM CPMCPM CPMCPM TNMMTNMM
Net Profit of Net Profit of Both PartiesBoth Parties
Profit SplitProfit Split Profit SplitProfit Split Profit SplitProfit Split Profit SplitProfit Split
OtherOther UnspecifiedUnspecified UnspecifiedUnspecified SCM / SCM / UnspecifiedUnspecified
UnspecifiedUnspecified
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.20
OECD vs. 482 – Tangible Goods
• U.S. Regulations abandon hierarchy of methods in favor of best method rule
• Under U.S. best method rule, no preference for transactional methods over profit-based methods and no recognition of inherent limits of profit-based methods
• In audits, IRS uses CPM whenever possible• CPM also heavily used by taxpayers in preparing
documentation• CPM not a recognized methodology under the
OECD Guidelines, though practically often equivalent to TNMM
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.21
OECD vs. 482 - Intangibles
•U.S. rules require that payment for the acquisition or use of intangible property be “commensurate with the income to be earned from the use of the property”
•Under U.S. rules, legal ownership of intangibles matters
•IRS Cost Sharing Regs
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.22
OECD vs. 482 – Finance and Services
•OECD preference against safe harbors•IRS makes extensive use of mechanical rules
and safe harbors in these areas, e.g.:– Mathematical formula for computing permissible
number of interest-free days on intercompany trade receivables
– Safe harbor rates on dollar-denominated loans– Covered Services (Rev. Proc. 2007-13)– IRS requirement to include stock option expenses
in cost base of some methods for charging out services
Managing Transfer Pricing Risk
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.
U.S. Transfer Pricing Penalties
• Treas. Reg. §1.6662-6 provides for penalties of either 20 or 40 percent.
• The 20 percent penalty applies if: – 200 percent or more (or 50 percent or less) of the price
reported on the annual tax return; or– All transfer pricing adjustments are greater than the lesser of
US$ 5,000,000 or 10% of gross receipts.• The 40 percent penalty applies if:
– 400 percent or more (or 25 percent or less) of the price reported on the annual tax return; or
– All transfer pricing adjustments total an amount greater than the lesser of US$ 10,000,000 or 20% of gross receipts.
24
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.25
Documentation Requirements
• Penalties may not apply if maintain sufficient contemporaneous documentation.
• The documentation must include the following:1. Overview of the taxpayer’s business;2. Organizational structure;3. Any documentation explicitly required for the application of a
specific transfer pricing regulations;4. Selection of transfer pricing method5. Application/Rejection of alternative transfer pricing methods;6. Controlled transactions / Internal data7. Description of comparables8. Economic Analysis;9. Relevant data obtained after the tax year; and10. Index of principal and background documents.
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.26
Risk Management Considerations
• Integration of tax and business planning and objectives– Coordination of risk management & effective tax rate
• Centralization of transfer pricing decision-making– Global documentation/penalty issues: consistency
• Global planning, but focused risk management– Make effort appropriate to what’s at stake
• Defensible economics– Economic substance and procedural requirements
• Risk tolerance– Litigation averse?
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.27
Application of Risk Management Principles
• Determine issues and countries with greatest potential exposure– Level of activity– Complex, difficult issues– “Unusual” results– Exit tax issues– Aggressive tax authority
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.28
Top 10 toughest tax authorities for transfer pricing risk*
1. Japan2. Germany3. US4. Australia5. France
6. India7. Korea8. China9. Canada10. UK
* TP Week, global survey of tax directors and TP advisors, December 2007.
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.29
Determine whether to address highest-risk issues proactively or defensively
• Proactive Strategies– Amended returns or otherwise notify tax authority– Change policy or practice– Advance Pricing Agreement (“APA”)
• Defensive Strategies– Document internal decision-making– Transfer pricing (§6662) studies by third party– Backup support
• Protect institutional memory
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.30
After Implementation, It’s All About Maintenance
• Establish solid transfer pricing policy (set rules on intercompany transactions)– Modify transaction flow/scheme of tangible assets– Review intercompany policy on intangible assets– Assess allocation of head office expenses and other
intercompany service charges– Imbed TP policy in financial systems– Consider where decisions are made, economic substance
• Conduct periodic assessment of possible TP risks, and consider countermeasures
• Respond to each country’s documentation rules (prepare TP studies for documentation purposes)
• Take advantage of APA process
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.
Overview of President Obama’s International Tax
Proposals
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.
On September 14, 2009, JCT released their explanation of the international proposals in the Administration’s FY2010 Budget.
On September 8th and 9th, the Administration released their explanations related to the individual income tax, estate and gift tax, and business tax proposals.
JCT’s explanation of the Administration’s Budget is intended to aid members of Congress in their consideration of the Administration’s proposals.
JCT is a non-partisan committee with staff economists and tax lawyers that serves members of Congress in its consideration of tax legislation. It is not a policy making body.
In that role, JCT provides Congress with explanations of tax related budget proposals, the policy pros and cons of budget proposals, and comparisons of an administration’s proposals with other proposals to address a particular issue.
JCT Report
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.
• On August 25, 2009, OMB released a mid-session review of the budget for Fiscal Year 2010 with revised revenue estimates of the Administration’s international tax proposals.
White House5/2009 Projection
JCT 6/2009 ProjectionWhite House
8/2009 Projection
Reform check-the-box rules for foreign entities 86.5 31.1 36.5
Defer certain U.S. income tax deductions 60.1 51.5 52.9
Foreign tax credit reform: single pool of §902 credits
24.5 45.6 24.5
Foreign tax credit reform: matching foreign income and taxes
18.5 10.2 18.4
Foreign tax credit reform: dual capacity taxpayers
4.5 7.2 4.9
Definition of “intangible property” for §367(d) and §482 purposes
2.9 1.0 1.0
Repatriation of earnings in certain cross-border reorganizations
0.3 0.4 0.3
Repeal of 80/20 Company Rules 1.2 0.8 1.3
Earnings stripping 1.2 1.5 1.2
Prevent avoidance of dividend withholding taxes in equity swaps, securities loans, repos
1.4 1.2 1.2
Enforcement proposals (effective beginning after Dec 31 of year of enactment)
8.7 8.8 8.7
Total for all international proposals 209.8 159.3 150.9
Overview of Revenue Estimates
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.
Key Potential Legislative Changes
Proposal Application Practical EffectsJCT Recommendations
And Comments
Expiration of §954(c)(6)
Look through treatment on certain payments between related CFCs may no longer be available
Restricts efficient cross border financing and licensing transactions
The look-through rule can encourage indefinite deferral of U.S. tax on foreign income through continued reinvestment of foreign earnings. It may also affect the timing and utilization of foreign tax credits by facilitating the separation of high and low tax foreign source income.
Deferral of U.S. Income Tax Deductions
Foreign related deductions of U.S. person (e.g., interest expense) deferred unless foreign source income is taxed currently
Increases the cost of capital
Increases cost of performing SG&A in the United States
Encourages movement of jobs offshore
JCT noted that absent Section 864(f), the proposal would overcorrect for the “timing mismatch” between the U.S. deduction of interest expense and the taxation of foreign earnings such borrowing supports.
Single E&P and Tax Pool (for purposes of repatriation)
Deemed paid foreign tax credit computed based on a pro rata share of all foreign taxes of all foreign subsidiaries multiplied by the ratio of distributed foreign E&P to total E&P of all subsidiaries qualifying for the deemed paid credit
Increases the cost of repatriating earnings to the United States
Incentive for companies to retain more earnings abroad
JCT provides additional details regarding proposal ‘s scope, including that proposal applies to pre-effective date E&P and taxes of foreign subsidiaries. JCT raises questions regarding the separation of high and low tax pools through the use of branches and lower than sixth tier subsidiaries.
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.
Key Potential Legislative Changes
Proposal Application Practical EffectsJCT Recommendations
And Comments
Classification of Foreign Entities
Foreign eligible entities with a single member treated as corporations for U.S. tax purposes, unless: (1) entity and the single member are created or organized in, or under the laws of, the same foreign country; or (2) disregarded entity is a first-tier entity wholly owned by a U.S. person, except in the case of “U.S. tax avoidance”
Restricts efficient cross border financing transactions
Increases foreign tax imposed on U.S. multinationals
JCT suggests that Congress may consider the treatment of other hybrid entities, such as U.S. LLCs, DRCs and entities with tax residence outside of their country of organization
Repeal of 80 / 20 Companies
Full repeal of 80/20 Companies JCT suggests using a more targeted approach rather than full repeal.
Modification to section 356
Repeal of boot within gain limitation for purposes determining the income included following an asset reorganization
Restricts tax efficient repatriation
JCT suggests clarification is needed; for example what is the source of accumulated E&P from which the deemed dividend is generated (i.e., E&P of both the transferor and transferee, or only the transferor).
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.
Classification of Foreign Entities
36
Provision Classification of Foreign Entities
Revenue Raised $36.5 billion
Application
• Foreign eligible entities with a single member treated as corporations for U.S. tax purposes, except:
– entity and the single member are created or organized in, or under the laws of, the same foreign country; or
– disregarded entity (“DRE”) is a first-tier entity wholly owned by a U.S. person, except in the case of “U.S. tax avoidance”
Practical Effects
• Restricts efficient cross border transactions• Increases foreign tax imposed on U.S. multinationals
Significant Issues / Observations
• Conversion from DRE classification would be determined under current Treasury regulations and tax principles resulting in springing transactions – springing debt, 304 deemed dividends, deemed asset sales
• No definition provided for “U.S. tax avoidance” for U.S.-owned DREs
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.
Foreign Tax Credit Reforms
37
Provision Single Pool of Section 902 Credits
Revenue Raised $24.5 billion
Application
• Deemed paid foreign tax credit computed based on a pro rata share of all foreign taxes of all foreign subsidiaries multiplied by the ratio of distributed foreign E&P to total E&P of all subsidiaries qualifying for the deemed paid credit
Practical Effects
• Increases the cost of repatriating earnings to the United States
• Incentive for companies to retain more earnings abroad
• Potential incentive for the use of highly taxed branches
Significant Issues / Observations
• Foreign subsidiary E&P includes all companies qualifying for the §902 deemed paid credit (i.e., includes 10/50 companies)
• §901 credits would still be determined under current rules
• How to spring deferred 902 credits versus utilizing 904 credit carryforwards?
• High-tax exception determined on an entity by entity basis for Subpart F?
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.
Deferral of Certain U.S. Tax Deductions
38
Provision Deferral of Certain U.S. Tax Deductions
Revenue Raised $52.9 billion
Application
• Expenses allocated and apportioned to foreign source income deferred to the extent the foreign source income associated with the expenses is not currently subject to U.S. taxation.
• R&E expenses not subject to deferral
• Deferred deductions carried forward and not lost
Practical Effects
•Increases the cost of capital
•Increases cost of performing SG&A in the United States
Significant Issues / Observations
• Treatment of first-tier foreign branches/hybrid branches/export transactions?
• Foreign source income not currently subject to taxation includes all 10/50 companies and CFCs.
• Repeal of worldwide interest allocation rules (§864(f))?
• How are historical OFLs treated?
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.
Todd A. Izzo
• Partner, International Tax - Pittsburgh Office – Deloitte Tax LLP
– Experience: Todd specializes in international taxation, with a focus on global tax optimization, financial products and instruments, international mergers, acquisitions, reorganizations, tax treaties, foreign tax credit planning and other areas of U.S. corporate and international taxation. Prior to joining Deloitte & Touche in 2000, Todd worked in the area of international and corporate tax for five years in the Washington, D.C. office of Dewey Ballantine and served as a law clerk for one year in the chambers of Judge Ed Becker of the U.S. Third Circuit Court of Appeals.
– Education: Todd received a B.S. degree with highest distinction in accounting from Penn State University, a J.D. degree summa cum laude from the University of Pennsylvania Law School and an LL.M. in taxation summa cum laude from Georgetown University Law Center. Todd was awarded the May 1991 Alexander E. Loeb Gold Metal award for the high score in Pennsylvania on the CPA exam and the Elijah Watt Sells Award for one of the top scores in the U.S.
– Professional and Civic Affiliations: Pennsylvania and District of Columbia Bars; American Institute of Certified Public Accountants; Pennsylvania Institute of Certified Public Accountants; American Bar Association (Tax Division); Penn State Alumni Association; Pittsburgh Tax Club; Allegheny Tax Society.
•Office: (412) 338-7606
•E-mail: [email protected]
Copyright © 2008 Deloitte Development LLC. All rights reserved. Tax Learning & Performance Enhancement. Revised 3/08.
Jeffrey J. Mensch
• Senior Manager, International Tax - Pittsburgh Office – Deloitte Tax LLP
– Experience: Jeff specializes in international tax and transfer pricing, with a focus on global tax and treasury optimization through the coordination of legal and financing structures with the pricing of intercompany flows. Jeff has extensive experience assisting taxpayers to design, implement and execute structures within operational and treasury constraints that facilitate tax-efficient financing, intellectual property development and supply chain optimization. Jeff began his career working for six years in the Transfer Pricing group of Deloitte’s National Tax practice in Washington, D.C. Since 2001, he has been a member of the International Tax group in Deloitte’s Pittsburgh office.
– Education: Jeff received a B.S. in Economics with a concentration in Finance and Marketing from the University of Pennsylvania’s Wharton School of Business. He also has received his J.D. degree cum laude from the Georgetown University Law Center.
– Professional and Civic Affiliations: Pennsylvania Bar; American Bar Association (Tax Division); Leadership Pittsburgh; United Way Young Leaders Group.
•Office: (412) 338-7948
•E-mail: [email protected]