Tax Transfer Pricing Intra-group financing and management fees 18 September 2013
May 06, 2015
Tax Transfer Pricing
Intra-group financing and management fees
18 September 2013
Speakers
18 September 2013 2
Sandra Hazan
Partner, Paris, France
D +33 1 42 68 47 85
Theodor J. van Stephoudt
Economist, New York, United States
D +1 212 768 6863
Jules Lewy
Partner, Toronto, Canada
D +1 416 367 6810
Table of Contents
18 September 2013 3
• Introduction
• Intra-Group Financing
• Management Fees
• Summary
• Questions & Answers
Introduction Current view of transfer pricing in the U.S.A.
4
• 40 page memorandum released Monday, May 20 by the Senate's
Permanent Subcommittee on Investigations on Apple.
• Apple also uses two conventional offshore tax practices typical of
multinational companies' tax-avoidance strategies, the report said.
• Multinational corporations value goods and services moving across
international borders from one corporate unit to another. Known as
"transfer pricing," these moves are frequently managed to reduce
corporations' global tax costs.
18 September 2013
Introduction General Overview - France
5
• Applicable Rules
• OECD Transfer pricing guidelines
• OECD’s Draft Handbook on Transfer Pricing Risk Assessment – April 30, 3013
• Section 57 of the French Tax Code (“FTC”)
• French administrative guideline
• French case law
18 September 2013
Introduction OECD’s Draft Handbook on Transfer Pricing Risk Assessment – April 30,
2013
6
• “Another indication is whether the taxpayer makes large payments to
related parties that have the result of eroding the local country tax base.
The types of payments that raise such issues could include large royalty
and rental payments, large management fees and other payments for
related party services, payments to related parties for insurance,
potentially transactions involving financial derivative contracts, and
large payments of deductible interest.”
18 September 2013
Introduction General Overview – Canada
7
• Canadian transfer pricing policies are administered by the Canada
Revenue Agency (“CRA”).
• CRA has over 400 dedicated transfer pricing auditors, economists and
senior analysts.
• Over 2000 transfer pricing audits annually.
18 September 2013
Introduction General Overview – Canada
18 September 2013 8
• Since 1998 – S. 247 of Canadian Income Tax Act.
• (Before 1998 – s. 69 of Canadian Income Tax Act.)
• S. 247
• Utilizes arm’s length principle
• GlaxoSmithKline (2012 SCC 52) – Supreme Court of Canada – range of
reasonable amounts
• Transfer pricing adjustment
• 10% penalty
• Secondary adjustment
Introductions CRA publications on transfer pricing
18 September 2013 9
• Information Circular IC 87 – 2R
• Transfer Pricing memorandum TPM – 14 (updates IC 87 – 2R)
• Other CRA Publications
• Information Circular IC 71-17R5 (Competent Authority)
• Information Circular IC 06 - 1 (Customs Valuations)
• Information Circular IC 94 – 4R (Advance Pricing Arrangements (“APA”))
• Information Circular IC 94 – 4R (SR) (Small Business APA)
• 14 Transfer Pricing Memoranda
• Web site: www.cra-arc.gc.ca
Intra-Group Financing
Guarantee fees – Canada
18 September 2013 10
• General Electric Capital Canada Inc. decisions 2010 FCA 344 (Federal
Court of Appeal) affirming 2009 TCC 563 (Tax Court of Canada)
• Involved deduction of $136 Million in guarantee fees paid to GE Capital,
the taxpayer’s parent during the taxpayer’s 1996 – 2000 taxation years.
• Issue of implicit guarantee
• Method to determine fee – “yield” method approved
Intra-Group Financing Issues related to guarantee fees – Canada
18 September 2013 11
• Several additional guarantee fee cases are being litigated, including
additional GE case and Burlington Resources Finance Co.
• McKesson – discount rate for factoring accounts receivable – Tax Court
of Canada trial ended in February 2012
• Legal Costs of Appealing (General Electric Capital Corporation – 2010
TCC 490 (Tax Court of Canada))
• No guarantee fee required if guarantee by a Canadian corporation in
respect of a borrowing by its controlled foreign affiliate if borrowing used
in connection with the active business of the controlled foreign affiliate
Intra-Group Financing Guarantee fees - France
18 September 2013 12
• No specific rules provided under French law
• Case law is the only source regarding the tax treatment of guarantee
fees in France
Explicit Guarantees
Implicit Guarantees
Should the guarantee be remunerated? • According to French case law, a guarantee granted by
a French company to its foreign subsidiaries should
generally be duly remunerated (CE, 9 mars 1979,
n°10454; CAA Paris 6 avril 1993 n°91-699, MetalEurop; CE
17 février 1992, n°81690-82787, Carrefour)
How the remuneration should be fixed? • No rules or guidance for the determination of an arm’s
length remuneration for guarantees
• Existing case law tend to refer to the rule of thumb for
the determination of an acceptable remuneration for
guarantee
Witholding tax issues • If higher than an arm’s length remuneration, the
payment may be characterized as a deemed
distributed income and subject to the French
withholding tax
• It is generally considered that implicit guarantees
are not remunerated at arm’s length (paragraph
7.13 of the OECD guidelines)
• Neither French courts nor French tax authorities
had taken position on this matter.
Intra-Group Financing Guarantee fees - France
18 September 2013 13
• Case law
Carrefour CE, 17 February 1992
It is deemed to be abnormal act of
management to provide a financial
guarantee free of charge, unless direct
actual benefit for the entity providing
this support can be justified.
The French supreme court suggested a
rate of 0,25% for this service, while the
FTA was seeking 1%.
The remuneration asked for this service
should be commensurate with the risk
incurred as well as with the market
value of this service.
CE, 7 March 1979
The fact that a parent company
provide a guarantee to it foreigner
subsidiary without receiving
payment for this service has to be
considered as an indirect transfer
of profit abroad.
Thus, FTA is allowed to reintegrate
as taxable benefits the amount
related to the advantage provided
to the subsidiaries.
Intra-Group Financing Guarantee fees - France
18 September 2013 14
• Case law
Additional decision Metal Europ, CAA Paris 6 April 6 1993
The advantage given by the parent company to its Brazilian subsidiaries without payment in return had
been qualified as an abnormal act of management even though such compensation is prohibited under
the Brazilian law where the subsidiary was located even if these subsidiaries are not allowed to pay the
guarantee given by The parent company doesn’t prove the existence of a consideration for this
advantage.
The only reason given by the company is that it was necessary to maintain important commercial
opportunities (which according to the court is not a direct consideration serving its own commercial
interest).
Lainière de Picardie, CE march 17 1992
In this case, a group of companies had to face a similar problem (compensation for guarantee is
prohibited under Brazilian law where the subsidiary is located).
In such case the compensation can take the form of consideration agreed at the time of another matter.
A huge increase in the subsidiary’s sales can be considered as a direct consideration serving its own
commercial interest.
Intra-Group Financing Loans and advances – difficulties relating to comparable transactions -
France
18 September 2013 15
• Loans and advances granted by a French company to a foreign affiliate
should bear arm’s length interest
• The interest rate to be charged between related parties is the one the
company could have obtained from a financial institution for a similar
investment (CE, 7 October 1988, 8ème et 7ème s.-s.,n°50-256; CE, 31 July 2009, no. 301935 and
301935)
Intra-Group Financing Loans and advances – difficulties relating to comparable transactions -
France
18 September 2013 16
• Perspective from a French borrower
• Interest rate paid by the French borrower should generally be assessed by
reference to the French borrower’s market rate
• Various parameters can be relevant
Evaluate key terms of the loan
Estimate credit rating of the
borrower
Determine arm’s length
interest rate
Some key terms of a loan :
Principal amount
Currency
Interest rate basis
Security
Etc…
Some commonly used methods :
Use Moody’s RiskCalc/ S&P’s
Credit Model
Create a model using rating
agencie’s guidance
Benchmarking analysis :
Identify interest rates in comparable
loan/bond transactions
Intra-Group Financing Loans and advances – difficulties relating to comparable transactions -
France
18 September 2013 17
• Perspective from a French lender
• According to French case law, the interest rate applied by the lender should not
be assessed by reference to the lender’s own funding costs but rather on the
compensation that it could have obtained from a bank if the amount were
invested in a financial institution under similar conditions as the loan (CE, 31 July
2009, no. 301936 and CAA Paris, 29 Sept. 2009, no. 08PA00082; CAA Douai, 13 Jan.
2011, no. 9DA01423 )
• The interest rate of variable or reimbursable advances cannot be fixed at the
same rate as fixed term investments or as the interbank exchange rate (CAA
Lyon, 5 February 1997, n°94-427, société Montlaur Sakakini). The interest rate
charged to a subsidiary by a French entity must be comparable with the interest
rate the French entity would receive from a French bank for an investment
similar in terms and risk.
Intra-Group Financing Loans and advances – difficulties relating to comparable transactions -
France
18 September 2013 18
• From a practical point of view, the French tax authorities are departing from their traditional
stand-alone approach and require that the rating obtained for the borrowing entity be
aligned to the parent company or overall group rating
• This news position seems to be inspired by the GE decision in Canada
Decision of the Canadian Court : - GE Capital Canada could not have raised the necessary
funds at the low interest rates it benefited from without the
explicit guarantee from GE. The guarantee was necessary
in order for the subsidiary to run its business plan.
- Correct methodology : - Estimating a stand-alone or status-quo credit rating and
then analysing that credit rating for the effect on the
parent-subsidiary relationship
- Looking at the spread in corporate bond yields between
the parents credit rating of AAA and the estimated credit
rating of GE Capital Canada
- The parent-subsidiary relationship must be considered in
determining the credit rating of subsidiary, but that is not
reasonable to expect that implicit support would equalise
the subsidiary’s credit rating to that of its parents
Intra-Group Financing Cash-pooling
18 September 2013 19
Cash-pooling entity should receive an arm’s length remuneration for the services
it provides to the cash pool members on the basis of a functional analysis
Transfer of a cash-pooling activity – Nestlé case :
France Switzerland
Parent company
Nestlé enterprises
Subsidiary
1
Subsidiary 2
Nestlé Finance
France
Treasury
function
activity
Transfer of Cash
pooling function
Nestlé group
Does a transfer of cash pooling activity
without consideration constitutes an
indirect transfer of earnings ?
Intra-Group Financing Loan guarantees are covered by the U.S. regulations for services
18 September 2013 20
• Applies to Controlled Services Transactions (“CST”)
• Definition of CST:
• An “activity” that is performed by one controlled group member that results in “benefit” to
other members of the controlled group
• “Activity”-
• Performance of functions
• Assumptions of risks
• Use by a renderer of tangible or intangible property or other resources, capabilities or
knowledge
• Making available to the recipient any property or resources
• Comment: New definition is much broader than the prior regulations. Clearly applies to
loan guarantees, performance guarantees, insurance.
• However, not yet any guidance on how to calculate loan guarantee fees (future IRS project)
- various approaches available
• Query whether this definition impacts withholding taxes on loan guarantees
Management Fees Stewardship expenses in the U.S.A
18 September 2013 21
• Activities that do not provide a benefit:
• Activities that recipient would not be willing to pay to uncontrolled party because benefits
are so indirect or remote
• Activities that would duplicate an activity of the recipient, unless an additional benefit
• Shareholder activities: if the sole effect of the activity is either to protect the renderer’s
investment or facilitate compliance with regulatory requirements of renderer
• Benefits from “passive association” (i.e., benefit results from the controlled taxpayer’s
status as a member of the controlled group)
• Twenty-one examples provided:
• Sub has Legal Dept. and Parent’s Legal Dept. also reviews transaction documents; Sub
has received a benefit since risks of transaction are reduced
• Parent’s Internal Audit Dept. reviews Sub’s adherence to policies and US anti-bribery
laws; activities are for Parent’s protection of investment and own compliance
Management Fees U.S. methods for services
18 September 2013 22
• Methods to Determine Arm’s Length Amount:
1. Services Cost Method (SCM)
2. Comparable Uncontrolled Services Price Method (CUSP)
3. Gross Services Margin Method (GSM)
4. Cost of Services Plus Method (CSM)
5. Comparable Profits Method (CPM)
Note: This is the method we typically use for “total cost plus” arrangements
6. Profit Split Method (PSM)
7. Unspecified Methods
Management Fees SCM requirements in the U.S.A.
23
• The Business Judgment Test must be met
• Taxpayer must reasonably conclude in its business judgment that such services do not
contribute significantly to key competitive advantages, core capabilities, or fundamental risks of
renderer, recipient, or both; AND
• Services must qualify as “covered services”-
• Specified covered services – on a list provided by IRS (Announcement 2006-50 and Rev. Proc.
2007-13); OR
• Low margin covered services – median markup on total services costs is less than or equal to
7%; AND
• Not an excluded category of high value services (manufacturing; production; extraction,
exploration or processing of natural resources; construction; reselling, distribution, acting as a
sales or purchasing agent, or acting under a commission or other similar arrangement; research,
development, or experimentation; engineering or scientific; financial transactions, including
guarantees; and insurance or reinsurance); AND
• Taxpayer maintains documentation.
• Comment: G&A, marketing not excluded; some sales expenses probably OK, too, depending on
facts
18 September 2013
Management Fees SCM requirements in the U.S.A.
18 September 2013 24
• Comment: Rev. Proc. 2007-13 provides a list of 101 qualifying activities, which cover
typical G&A type functions. Each major category of activities also includes “Other similar
activities.” Therefore, it is likely taxpayers will take the position that all activities within most
(if not all) G&A departments qualify for the SCM.
• Best practice suggestion: Transfer pricing documentation should link individuals or
departments with the appropriate item from the list of 101 activities.
• Comment: Rev. Proc. 2007-13 does not cover sales or marketing activities. Marketing
activities will likely qualify for the 7% or below median “low margin covered services”
category, assuming an appropriate marketing comparables set is developed by the
taxpayer. The IRS does not intend to maintain comparables sets for taxpayers.
• Comment: The IRS may take the view that sales activities are an excluded category of
high value services, and therefore do not qualify for the SCM.
• Comment: Is there an inference that a taxpayer’s mark-up for excluded, high value
service activities (e.g., R&D) should be more than 7%?
• Comment: Stock option expense must be included in the cost base. Either GAAP 123R
method or tax-based spread-at-exercise method may be used.
Management Fees Actual charging mechanism of a multinational enterprise – U.S.A.
18 September 2013 25
Other Costs
IT P&C Costs
Other Costs
IT P&C Costs
SRZ Total
Costs
Master Recharge
Agreement
Master Recharge
Agreement
Recharge QuestionnaireRecharge Questionnaire
Pricing of Services
Cost Drivers
Unit Costs
Relevant Entities
Pricing of Services
Cost Drivers
Unit Costs
Relevant Entities
Invoicing/CollectionInvoicing/Collection
Input From Operations
Amendments
AB
A
B
Management Fees General principles - France
18 September 2013 26
• OECD
According to the OECD guideline, when a company makes services available to its members,
it is necessary to determine whether the amount of the charge, if any, is in accordance with the
arm’s length principle.
• Section 57 of the FTC - transfer pricing rules
“To determine the income tax owed by companies that either depend on or control enterprises
outside France, any profits transferred to those enterprises indirectly via increases or decreases in
purchase or selling prices, or by any other means, shall be added back into the taxable income
shown in the companies’ account. The same procedure shall apply to company that depend on
enterprise or a group that also controls enterprises outside of France”
• Transfer pricing penalties
• Adjustment of the taxable profits for corporate income tax purposes
• Withholding tax (depends on the relevant tax treaty)
• The new 3% tax on dividend distributions
• Late interest payment of 4,8% a year and potentially bad faith penalties (40%) or fraud
penalties (80%)
Management Fees Allocation method
18 September 2013 27
• To set out an allocation key for a service we take into account:
• The nature of the service
• The subsidiaries which benefited from this service
• A relevant indicator (turnover, assets, gross profit,..)
Once the key is determined, it must be :
• Steadily applied to subsidiaries;
• Justified to Tax Authorities in the occurrence of a tax audit
• Burden sharing between different group entities presents obvious practical problems which led
the French supreme court and the FTA to accept the use of lump sum methods.
• The least controversial method in this respect is the allocation of common charges by applying
the ratio existing between the turnovers (CE 25 avril 1960, 45089)
• Turnover as a common rule for all services can be questioned :
• Particularly true if the company does not have satisfactory supporting documentation to
justify the magnitude of services rendered
• Authorities can also question the relevance of certain services when the benefiting company
has in-house qualified resources (recent case law in domestic management fees framework
for directors)
Management Fees Case law - France
18 September 2013 28
TA Montreuil, 5 Jan. 2012, no. 1001410, Office Dépôt France
Facts : a US company recharged to its French company a portion of audit costs relating to a report
meant to check the efficiency of internal control within the group in compliance with the Sarbannes-
Oxley legislation.
FTA & Judges positions : Such costs were incurred in the interest of the of the US company only and
were accordingly not tax deductible in France
CE, 21 Nov. 2012, no.348864 and 348865, PricewaterhouseCoopers
Expenses incurred for network development are deductible in France since the French company
benefits from its membership (according to the court the French company had a personal interest
because of the renowned network, training and technical assistance of the latter)
CAA Paris Eduard Kettner, 29 March 2012, n°10PA04193
Facts : a French distributor had been charged with services fees from its German parents company
FTA : these fees were not commensurate with the service received and were able to show
discrepancies in the invoicing and a lack of supporting information for expenses charged back to the
French distributor
Court : the FTA did not demonstrate a transfer of profit abroad because it did not make any
comparison with independent companies in order to show to which extent the fees paid for the
services were excessive and did not meet the arm’s length character
Management Fees Summary - France
18 September 2013 29
Type of
Intra-group service
In the interest of the shareholder Excluded
In the interest of the Group as a whole
Indirect allocation?
Cost Plus ?
CUP ?
TNMM ?
In the interest of specific members of the Group ("on call services")
Direct charge ?
CUP ?
Cost plus ?
Transfer of intangible
(e.g. know-how) Royalty?
Management Fees General Principles – Canada
18 September 2013 30
• CRA generally follows OECD Commentary
• See: Part 6, Information Circular IC 87 – 2R
• Two Part Test
• Is any charge justified – must have a benefit for recipient of service.
• If charge is justified, charge should be determined in accordance with arm’s
length principle (from point of view of both the supplier and the recipient)
• Note: Acting as agent vs. providing services directly
• Direct charge method vs. Indirect charge method.
Management Fees Issues Related to Management Fees - Canada
18 September 2013 31
• Mark-up applied to the costs
• Charge all management fees
• Do not use “ball-park” numbers or percentage of charges based on
revenue unless supportable
• Reg 105 – 15% federal withholding (+ 9% Quebec) if services rendered
in Canada by a non- resident. (Different requirements if non-resident
employees rendering services in Canada).
Summary
18 September 2013 32
• Parent companies or regional headquarters provide administrative or
other general services for members of the Group.
• Even when such services are charged at cost or at cost plus a small
mark-up, questions may arise as to whether the level of the overhead
charge is appropriate to the size of the subsidiary.
• Intercompany services can be difficult to value and are very often not
fully documented.
• As services are growing in general, the transfer pricing aspects of
intercompany services, including intercompany financial services, are
increasingly complex and the documentation aspects are not
standardized yet.
• Management fees and financial instruments are viewed as a key transfer
pricing risk by the CRA, the OECD and the IRS.
Thank you
© 2013 Dentons
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