Prof. Daniel N. Erasmus Assisted by Prof. Anneline Venter CA(SA) and Sebastien Gonnet NERA Economic Consultants.

TRANSFER PRICING

WORKSHOP, KUALA LUMPUR

Prof. Daniel N. ErasmusAssisted by Prof. Anneline Venter CA(SA)

and Sebastien Gonnet NERA Economic Consultants

Index DAY 1 Transfer Pricing References Glossary of transfer pricing terms SESSION 1: Introduction to Transfer Pricing: Oil & Gas Industry

• Oil & Gas Primer – Annexure A• Introduction – Transfer Pricing Abuses• Oil & Gas organogram• Intercompany Process Flows• Introduction – Placing Transfer Pricing into International Perspective

• Country Specific Transfer Pricing Regulations • DTA’s list • BIT’s list • Exchange of Information – OECD Exchange of Information Guidelines –

Annexure B / OECD TIES’s list – Annexure C SESSION 2: Basic Principles of Transfer Pricing by Prof. A Venter

• Presentation in the context of oil & gas – Annexure D• Bureau van Dijk TP Catalyst demonstration

SESSION 3: A CASE STUDIES: • (1) BRAND OIL

SESSION 4: DEVELOPING APPROPRIATE DOCUMENTATION IN TRANSFER PRICING

More notes at www.IITF.net

Index DAY 2 SESSION 1: Formalizing an effective record keeping & reporting process

• Theory• Bureau van Dijk TP Catalyst• CASE STUDIES:

• (2) CUREMAKER • (3) WIDGET WHOELSALE

SESSION 2: Adopting Transfer Pricing best practices• Presentation by NERA Economic Consultants – Annexure E• Intellectual Property• Management fees

SESSION 3: Pre-empting tax audits & Handling tax controversies in a proactive manner

SESSION 4: Gaining insight into different tax regulations on Transfer Pricing CASE STUDY (4): Virtual Profile Company


DAY 1

THURSDAY 6TH OF DEC 2012


Transfer Pricing References

OECD Transfer Pricing Guidelines UN Transfer Pricing Guidelines Global Transfer Pricing Study EY 2010/11 PwC Transfer Pricing Manual


Glossary of Transfer Pricing Terms TP = Transfer Pricing Cost plus method CUP = Comparable uncontrolled pricing RPM = Resale price method CPM = Comparable profits method TNMM = Transactional net margin method PLI = Profit level indicator CCA = Cost contribution agreement http://en.wikipedia.org/wiki/Transfer_pricing

http://en.wikipedia.org/wiki/Transfer_pricing

DAY 1

SESSION 1 Introduction to TP: the Oil &

Gas Industry


Oil & Gas Primer

Refer to “Transfer Pricing in the Oil & Gas Sector: A Primer” – Annexure A


Through transfer pricing, a taxpayer seeks to minimize income and maximize deductible expenditures in high-tax jurisdictions and vice versa in low-tax jurisdictions. Transfer pricing mechanisms that affect revenue in the oil and gas sector are:

• The creative use of price hedging mechanisms involving transactions between related parties, causing great difficulty in assessing whether hedging instruments are used for transfer pricing purposes rather than to reduce risk;

• The provision by related parties of highly leveraged debt finance at above-market interest rates;

• Claiming excessive management fees, deductions for headquarter costs, or consultancy charges paid to related parties;

• The provision of capital goods and machinery in leasing arrangements at above-market costs charged by a related-party lessor;

• If the petroleum tax rate is above the standard tax rate, there may be an incentive to establish a domestic shell firm that will on-lend financing capital from related parties to the oil company giving rise to an interest deduction at a higher tax rate than is charged on the interest earnings in the shell company.

Abusive transfer pricing can be very difficult to detect and prevent. SOURCE: Revenue from the Oil and Gas Sector: Issues and Country Experience, Emil M. Sunley, Thomas Baunsgaard and Dominique Simard

Introduction – Transfer Pricing Abuses


Home Country

TaxHavens

DevelopingCountries

UPSTREAM

MIDSTREAM

DOWNSTREAM


Intercompany Process Flows

Lega

lTa

xA

ccou

ntin

gT

reas

ury

Ope

ratio

ns


Country Specific Regulations (see next slide) OECD and UN guidelines (http://www.IITF.net and www.ErasmusOnTax.com)

International law• Double Tax Treaties – “DTA’s” 1 & 2

• Bilateral Investment Treaties - http://www.unctadxi.org/templates/DocSearch____779.

aspx

• Multilateral Treaties Constitutional & administrative law Information Exchange – TIEA’s - attached Annexures B & C

Introduction – placing TP into international perspective


http://www.IITF.net/

http://www.Erasmusontax.com/

http://www.unctadxi.org/templates/DocSearch____779.aspx

http://www.unctadxi.org/templates/DocSearch____779.aspx

Country comparisonsCountry TP Regs TP Docs? Tax Return Penalties

Thailand Y Recommend Y Up to 200%

Vietnam Y Recommend Y N

Taiwan Y Y Y Up to 200%

Singapore Y Recommend N Up to 200%

Pakistan N Anti-Av Recommend N N

Malaysia Y Recommend Y Up to 300%

Indonesia Y Y >Rp10m Y Up to 48%

India Y Y >INR10m Y Up to 300%

Hong Kong N Anti-Av Recommend N Up to 300%

China Y Y Y 5% no docs

Cambodia N Anti-Av Recommend N N

South Korea Y Recommend Y 10%


DAY 1

SESSION 2Basic principles of TP by

Prof. A Venter


Presentation by Prof. A Venter – Annexure D Basic principles in the context of the Oil &

Gas Industry A functional analysis QA

Basic Principles of TP


Home Country

TaxHavens

DevelopingCountries

UPSTREAM

MIDSTREAM

DOWNSTREAM


Home Country

TaxHavens

DevelopingCountries

UPSTREAM

MIDSTREAM

DOWNSTREAM

PetroCo

Drilling Asia

Refine

ThailandVietnamIndonesiaExplore

Ship

100%

100%

100%100%

TP Catalyst Bureau van Dijk - An introduction to TP Catalyst

• https://tpcatalyst.bvdep.com/201106/version-20111124163430/Login.serv?product=transferpricing

• http://www.bvdinfo.com/BvD-for-your-business/Transfer-pricing.aspx

IBFD Intro to Transfer Pricing


https://tpcatalyst.bvdep.com/201106/version-20111124163430/Login.serv?product=transferpricing




http://www.bvdinfo.com/BvD-for-your-business/Transfer-pricing.aspx



DAY 1

SESSION 3 A Case Study (1)


Brand A Oil

Brand A Oil(Malaysia)

650 units @

100K

Distribution

R&D, manufacturing, domestic sales

Brand B Oil

Resale under Brand B Oil Resale under

Brand A Oil

UK

Malaysia

125 units @

80K

132K

108K

Domestic sales to retailers

225 units @

133K

BRAND OIL case study

https://dl.dropbox.com/u/10753349/Lectures/Transfer%20Pricing%20Training%202012-11-30%2010.27%20AM.mov


CUP? Cost-plus? Resale minus? TNMM? Profit split?

22

WHAT METHODS MAY BE AVAILABLE HERE?


Brand A Oil Corporation sells goods to Brand A Oil (Malaysia) for $ 100K.

Potential comparables for this transaction are: Sales by Brand A Oil Corporation to domestic

customers - $133K each Sales by Brand B Oil to Brand A Oil (Malaysia) -

$80K each.

How reliable are these comparables likely to be?

23

COMPARABLE UNCONTROLLED PRICE

How reliable are the comparables?. Are the sales into the same level of the market?

Brand A Oil’s sales in UK appear to be to end customers. The controlled transaction is to a sales/distribution company.

Do they involve the same product as the controlled transaction? There appear to be marked differences between the products manufactured by Brand A Oil Corporation and by Brand B Oil

It is unlikely that there is sufficient product or functional comparability to allow the comparable uncontrolled price method to be reliably used in this case.

24

COMPARABLE UNCONTROLLED PRICE

The accounts of the independent manufacturer show a 66.7% mark-up on direct costs.

Does this provide a comparable that can apply to the manufacturing costs of Brand A Oil Corporation?

Functional analysis:• Brand A Oil owns 2 intangibles – brand and trade (R

& D expenditure); • Cost plus, which would involve testing Brand A Oil

Corporation, is unlikely to be suitable unless the independent has similar intangibles of similar value;

• We do not know this;• We also do not know the product mix in the sales of

the independent manufacturer – we need to identify the mark-up it achieves on the sale of goods to Brand A Oil (Malaysia).

25

COST PLUS METHOD

The gross margin earned by Brand A Oil Corporation on units purchased from the independent manufacturer is a potential comparable:

We know that, on units sourced from Brand A Oil, Branded A (Malaysia) Ltd earns a gross profit of 24% ((132-100)/132);

We know that on units sourced from the independent manufacturer, the gross margin is 26% ((108-80)/108).

A comparability analysis is necessary to establish whether this a sufficiently reliable comparable.

26

RESALE PRICE METHOD

Is TNMM available?

We know that Brand A Oil (Malaysia) earns a net margin of 10%;

However we do not know how this is split between the net margin earned on

goods sourced from Brand A Oil Corporation and that earned on goods

sourced from Brand B Oil;

That is, we do not have transactional information

Also ..

We know the net margin earned by Brand A Oil Corporation and that earned

by Brand B Oil;

But , again, we do not have the information available at a transactional level;

So TNMM is unlikely to be reliable in this case.

27

TRANSACTIONAL NET MARGIN METHOD

A potential comparable would be the split of profit between the independent manufacturer and Brand A Oil (Malaysia) derived from the manufacture and sale of the units produced by the independent manufacturer and sold to Brand A Oil (Malaysia).

If we used a profit split method, this would be compared to the split of profit between Brand A Oil and Brand A Oil (Malaysia), from the manufacture and sale of the units produced by Brand A Oil.

However, we do not have the information to enable us to do this on a transactional basis. We have only whole-company information on net profit.

Also, profit split is most appropriate where both of the parties to the transaction carry out non-benchmarkable functions. This would need to be tested.

28

PROFIT SPLIT METHOD

The tentative conclusion might be that the resale price method is available in this case.

However, we would need to carry out a comparability analysis to determine whether this method, and the chosen comparable transaction, are sufficiently reliable.

29

CONCLUSIONS

A comparability analysis focuses on five factors: Nature of product Contractual terms Functional analysis (including assets used

and risks assumed) Economic conditions Business strategy

30

COMPARABILITY FACTORS

You are asked to carry out a comparability analysis between the following transactions: a) purchases of units by Brand A Oil

(Malaysia) from Brand A Oil (Malaysia), and

b) purchases of units by Brand A Oil (Malaysia) from Brand B Oil.

31

COMPARABILITY ANALYSIS

Analysis shows that there is poor product comparability between the goods sourced by Brand A Oil (Malaysia) from Brand A Oil and Brand B Oil

But there is good functional comparability between the functions carried out by Brand A Oil (Malaysia) in respect of goods sourced from Brand A Oil and Brand B Oil

32


In this case, we would probably consider that there is good functional comparability between:

the functions performed by Brand A Oil (Malaysia) in respect of Brand A Oil sourced goods, and

The functions performed by Brand A Oil (Malaysia) in respect of Brand B Oil sourced goods

.. and that the resale price method is likely to be sufficiently reliable and that no transfer pricing adjustment is necessary.

33


DAY 1

SESSION 4 Developing appropriate

documentation in TP


Examining TP documentation requirements

Enabling documentation to defend TP data Implementing TP documentation to

mitigate possible tax disputes

SESSION 1: Developing appropriate documentation in TP (1)

INTRODUCTION: insights to in-house TP Policy development Wolters Kluwer Developing TP Policy

If a taxpayer can demonstrate that it has developed a sound transfer pricing policy in terms of which transfer prices are determined in accordance with the arm's length principle by documenting the policies and procedures for determining those prices, the Commissioner is more likely to conclude that its transfer pricing practices are acceptable and the risk of possible adjustments will be diminished.


On the other hand, preparing documentation is time-consuming and expensive. It will therefore not be expected of taxpayers to go to such lengths that the compliance costs related to the preparation of documentation are disproportionate to the nature, scope and complexity of the international agreements entered into by taxpayers with connected persons.


Documentation Guidelines: Chapter V OECD Guidelines Determined in accordance with “same prudent business

management principles … evaluating a business decision of a similar level of complexity and importance”

Commissioner expects retained documentation in accordance with this principle

Demonstrate compliance with arm’s length principles Will require some form of functional analysis and info

gathering of relevant entities Determine appropriate method then apply relevant data

to determine arm’s length


Commissioner expects process to be documented contemporaneously to justify why transfer prices are arm’s length

Commissioner will rely on documents created in ordinary course of business and of setting a transfer price, addressing following issues:• Identification of affected transactions• Copies of international agreements• Description of nature & terms of all affected

transactions• Functional analysis and appraisal of comparatives

of affected transactions…


Continued..• Reason why choice of method considered most

appropriate• Explanation of the process used to select and apply the

method used and why consistent with the arm’s length principle

• Information relied upon at arriving at arm’s length:• Commercial agreements with 3rd parties• Financial information• Budgets• Forecasts

• Details of any special circumstances influencing pricing


At TP review Commissioner expects taxpayer to identify:• Which goods/services most comparable• Its major competitors• Competitors considered most comparable• Methodologies used & why appropriate for taxpayer

Where inadequate contemporaneous doc’s of arm’s length international dealings, between connected parties, difficult to convince Commissioner of arm’s length

Availability of information for comparative purposes:• Data from Asia, Australia, UK, US, but assess impact of

geographical differences and other factors on price


Conclusion Taxpayers establish transfer prices comply with

the arm’s length principle and prepare documentation to evidence that compliance

Commissioner likely to determine prima facie that the taxpayers’ transfer pricing practices represent a lower tax risk

In contrast, taxpayers who give inadequate consideration to their transfer pricing practices are likely to receive greater scrutiny from the Commissioner


A summary of the broad guidelines suggested:• establish economic justification before the transaction

is entered into;• be satisfied that the consideration is an arm’s length

consideration;• prepare and retain contemporaneous documentation

to support the above matters and the assessment of market conditions at the time when the pricing decisions were made;

• justify the choice of method; and • establish and consistently follow a systematic process

for setting arm’s length international transfer prices.


DAY 2

FRIDAY7TH OF DEC

2012


DAY 2

SESSION 1

Formalising an effective record keeping and reporting process


• Analysing organisation structure so as to have conducive methods of document development and storage

• Standardising means of collating information and documentation in a manner that will reduce costs and duplication

• Backing up of documentation for efficient record recall • Conducting reviews of documentation and inter-

company agreements to reduce exposures to tax penalties

SESSION 1: Formalising an effective record keeping and reporting process (1)

The preparation of a functional analysis is an important tool that can assist in ensuring that an arm’s length consideration is determined in accordance with internationally accepted principles

A functional analysis can be performed with varying levels of detail and can serve a variety of purposes. The scope of the analysis will be determined by the nature, value and complexity of the matters covered by international dealings and the nature of the taxpayer’s business activities. These include the strategies that the enterprise pursues and the features of its products or services

SESSION 1: Formalising an effective record keeping and reporting process (Functional Analysis) (2)

Also, factors such as the pricing method that is used and availability of data will affect the extent to which the analysis can be conducted.

By determining the relevant functions to be priced, the functional analysis can assist in the selection of a transfer pricing method. It can also assist in the analysis of the level of comparability present in controlled and uncontrolled dealings and in an assessment of the relative contribution of the parties when a profit-split

method is used.


It is important, however, not to confuse the use of functional analysis with the determination of a transfer price. Functional analysis is not an alternative to searching for comparables. It is a means to establish what sort of comparables should be sought.

Annexure B sets out a four-step practical approach for determining transfer prices. The discussion in that annexure further considers functional analysis in a

practical context.


Step 1: Understand the cross-border dealings between connected parties in the context of the business

SESSION 1: Formalising an effective record keeping and reporting process (Four step practical approach) (5)

Step 2: Select the pricing method or methods


http://www.corbisimages.com/stock-photo/royalty-free/42-15529734/businessman-selecting-puzzle-piece

Step 3: Application of the pricing method or methods


SESSION 1: Formalising an effective record keeping and reporting process (Four step practical approach) (8) Step 4: Arriving at the arm's length amount and

introducing processes to support the chosen method

SESSION 1: Formalising an effective record keeping and reporting process (Steps in comparability - intangibles) (9) Pursuant to the recent modifications to the OECD

Guidelines, the steps to be undertaken in connection with a comparability analysis are:

• Step 1: Determination of years to be covered• Step 2: Broad-based analysis of the taxpayer’s

circumstances (e.g., industry, competition, economic factors)

• Step 3: Understanding the controlled transaction(s) under examination, based in particular on a functional analysis, in order to choose the tested party (where needed), the most appropriate transfer pricing method to the circumstances of the case, the financial indicator that will be tested (in the case of a transactional profit method), and to identify the significant comparability factors that should be taken into account

• Step 4: Review of existing internal comparables, if any

SESSION 1: Formalising effective record keeping and reporting process (Steps in comparability - intangibles) (10)

• Step 5: Determination of available sources of information on external comparables, where such external comparables are needed taking into account their relative reliability

• Step 6: Selection of the most appropriate transfer pricing method and, depending on the method, determination of the relevant financial indicator (e.g. determination of the relevant net profit indicator in case of a transactional net margin method)


• Step 7: Identification of potential comparables: determining the key characteristics to be met by any uncontrolled transaction in order to be regarded as potentially comparable, based on the relevant factors identified in Step 3 and in accordance with the comparability factors

• Step 8: Determination of and making comparability adjustments where appropriate

• Step 9: Interpretation and use of data collected; determination of the arm’s length remu

• tion


The updated Guidelines also address the selection and rejection of comparables in detail, & use of commercial databases. The key point articulated is that such searches must be “transparent, systematic, and verifiable.”

The OECD Guidelines recognize that, in circumstances where a range of results includes a sizeable number of observations, statistical tools that take account of central tendency to narrow the range (e.g., the interquartile range) may help to enhance the reliability of the analysis.


The OECD Guidelines recognize that multiple year data may improve reliability, particularly in cyclical industries.


Bureau van Dijk DEMONSTRATION Case Studies:

• CUREMAKER• WIDGET WHOLESALE

SESSION 1: Formalising effective record keeping and reporting process (Bureau van Dijk demonstration) (15)


CUREMAKER

CASE STUDY 2: Feinschreiber Transfer Pricing Handbook (1)

Transfer Pricing Handbook, 2 Volume Set, editor Robert Feinschreiber (available in Amazon.com Kindle) 11.2

Location 2409


CM -US

CM-EU

AP1

AP2 IndependentContractorCost +15%

Royalty5%

Imports ingredientsExports final product to

CM-US

Manufacturing

Integrated functions

Independent wholesalers

Diagram explained:

• CM-US has established a foreign subsidiary in Europe: Curemaker Europe (CM-EU), in a small principality where no tax will be assessed for 25 years;

• CM-US has transferred intangibles (patent rights) to the subsidiary for a royalty payment of 5% to cover research and development costs;

• CM-EU performs only manufacturing functions, and imports ingredients from the US; process them to final assembly (according to practices established by the parent) than resells final product back to the Parent, and to wholesalers in other European countries;

• CM-EU industrial plant is the most modern in the world;• CM-US manufactures the same product in two wholly owned assembly plants (no rights to

intangibles), no charge for use of intangibles (produce several products);• All functions are integrated and reported as such on tax return;• CM-US also uses the services of an independent manufacturer, by contract. Independent

contractor charges CM-US cost plus 15% for manufacturing services. Received ingredients from CM-US (no possession), resells final product to CM-US. Does no research, receives no special technology, pays no royalties;

• IRS: proposed this third-party contract as an comparable adjustable transaction;• CM-US under audit: price of transferred products and intangibles to CM-EU;• In year under audit: CM-EU reported substantial profits, while CM-US showed smaller profit

margins;• CM-US has at least 10 major competitors;• Industry in EU has higher profit margins than the industry in US.

EXAMPLE 1: Feinschreiber Transfer Pricing Handbook (2)

1. Classification:• Identify the issue under investigation: income of

US taxpayer• CM-EU income comes under scrutiny: receives

intangibles from US taxpayer and had higher profit margins than the Parent

• CM-EU classified as drug manufacturer (SIC #2833)


2. Finding Comparables• CM-EU:

• Direct comparables: may possibly be CM-US assembly plants or independent contractor used CM-US

• Indirect comparables: possibly other large integrated drug companies or smaller contract manufacturers

• Functions are closer to contract manufacturers, but incurs the costs and risks of operating in a foreign market place.


2. Finding Comparables: Direct comparables (transaction based)

• Assembly plants of CM-US: various product lines and integrated functions, difficult to separate one product line for comparison.

• Independent contractor: differences:• Patent rights: reduce COS with royalty payment• Market risks: no contract guarantee, foreign

market: difficult to quantify• Advanced physical facilities: difficult to identify

which operating expenses to add back


2. Finding Comparables: Indirect comparables (profit based)(public data needed)

• Integrated drug companies: owns intangibles and incurs risks like these companies, but do not have integrated functions

• Independent contract manufacturers: independent manufacturing, but not guaranteed by contract and owns intangibles.


3. Method used• CPM: more than one type of transaction, with no

direct comparables as to similar transactions• Intangibles transferred with effect on profitability• Profit methods reflects reasonableness• Transaction method used to ascertain appropriate

royalty rate


4. Arm’s length range• Profit Level Indicator (PLI) range: high-end of

large companies’ PLI’s and low end on contract manufacturer’s PLI’s.

• Adjust royalty rate to an arm’s length rate, by doing market research, scrutinizing third party contracts and independent transaction. This indicated that a proper rate should be increased to 25%


5. PLI’s used• Gross profit to operating expenses• Operating income on sales• Return on operating assets: good indicator for

manufacturers, but assets may vary quite extensively. Good PLI for CM-EU which owns intangibles and state of the art plant and equipment with one product for allocation purposes. Not so good for parent with various product lines, and previous investment in assets.

RETURN ON ASSETS ROYALTY CHANGED FROM 5 % TO 25%


Mean Maximum Minimum0%

5%

10%

15%

20%

25%

30%

35%

40%

Contr ManCM-EUCM-USDrug Co's

WIDGET WHOLESALE

CASE STUDY 3: Feinschreiber Transfer Pricing Handbook (1)

Transfer Pricing Handbook, 2 Volume Set, editor Robert Feinschreiber (available in Amazon.com Kindle) 11.3 WIDGET WHOLESALE (Kindle Location 2550). Kindle Edition.


WW

WW-US

FM1

FM2

Imports widgetsfrom WW

Distribution

Manufacturing

Independent distributors

CA

FM3

RetailersCA

Other Retailers

Diagram explained:

• Widget Wholesale-USA (WW-USA), is a subsidiary of a foreign manufacturer;• There are only 32 other Foreign Manufacturers of widgets and no domestic (US)

manufacturers;• WW products are specifically designed for the US market, and are not sold

anywhere else on the world, although WW also manufacture products specifically designed for its domestic market;

• WS-US does not participate in R & D;• WW owns the manufacturing intangibles, while WW-US developed and owns the

marketing intangibles;• WW-USA keeps inventory and resells to various independent retailers;• WW-USA also sells specially designed widget models to several independent

distributors in California where the widget market is most intense;• The independent distributors also sells normal models and also sells to retailers;• None of these firms are publicly traded;• WW-USA are under audit over the price of imported goods shipped to it from its

parent manufacturer;• The transferred property in question is tangible property, to which intangibles may

be attached.


1. Classification:• Identify the issue under investigation: income of

US taxpayer• Payments made to foreign parent for purchased

goods will be investigated• The question is whether an independent company

would be willing to pay the same prices for the goods, as WW-US is paying the foreign parent

• Business classification: WW-US is a pure importer/distributor

EXAMPLE 2: Feinschreiber Transfer Pricing Handbook (3)1. Classification (continued)

• Import consideration: in order to earn a profit importers need to limit costs and expenses, such as purchase price of goods; shipping and transport, import duties, storage , advertising and selling expenses

• Import contract: when dealing with independent manufacturer, the importer will negotiate a contract covering various issues

• Wholesale Relationship: wholesaler imports large quantities and makes profit from high turnover of products. Usually has a large marketing investment.


2. Finding Comparables• No independent importers of widgets• Numerous importers of other durable goods with

publicly available information • Widgets do not have separate SIC code• Wholesale trade category• Comparables: distributors of consumer durables

with motorised and electronic technology, used in the home (perceived product similarity)

• 100 companies over 5 years

EXAMPLE 2: Feinschreiber Transfer Pricing Handbook (5)3. Method used

• WW-USA needs to be adjusted to reflect arm’s length purchase price for goods imported

• Logic: distributors would not buy at prices it could not sell profitably.

• Only possible comparable for the transaction: resale of independent California Distributors, adjusted for differences for conditions of sale, models, market level, services provided etc.

• The Resale Price Method (RPM) can then be used to determine an arm’s lengthy price.

• CPM: reflects the effectiveness of applying the arm’s length price


4. PLI’s used

• Gross profit to operating expenses• Operating income on sales• Return on operating assets

GROSS PROFIT ON OPERATING EXPENSES

REFLECTING ADJUSTMENT OF PURCHASE PRICE


Y1 Y2 Y3 Y4 Y5

Mean less oneMean plus oneMeanWW adjustedWW-USA

1.7

1.6

1.5

1.4

1.3

1.2

1.1

1

0.9

0.8

0.7

CUREMAKER & WIDGET WHOLESALE case studies

https://dl.dropbox.com/u/10753349/Lectures/Transfer%20Pricing%20Examples%202%202012-11-30%202.46%20PM.mov


DAY 2

SESSION 2 Adopting transfer pricing

best practices


NERA Economic Consulting http://www.NERA.com - Case Study – Sebastian Gonnet and a colleague.

Presentation - ANNEXURE E

SESSION 2: Adopting transfer pricing best practices for streamlined and efficient tax activities


http://www.NERA.com/

INTANGIBLES – VI OECD GUIDELINES P

191


Intangibles can be protected or not• Examples: patent / know-how

They can be on the balance sheet or not• Examples: acquired / created and capitalised / created and

expensed

They can be remunerated or used free of charge by other group companies (often in good faith)

Where they are not protected and not on the balance sheet, identification and determination of ownership can be difficult

STARTING POINT: LEGAL AND FINANCIAL INFORMATION (BUT…)

It is not sufficient to rely on the balance sheet

It is not sufficient either to rely on the P&L accounts (in case the taxpayer omits to charge some valuable intangibles used by related parties):

Risk assessment forms which are filed with tax returns in some countries often prove insufficient in this respect

IDENTIFY INTANGIBLES, THOROUGH FUNCTIONAL ANALYSIS

Interviews

Historical background of the company

Financial information released for investors (e.g. IPOs)

IDENTIFY INTANGIBLES: THOROUGH FUNCTIONAL ANALYSIS

WHERE INTANGIBLES ARE USED IN CONTROLLED TRANSACTIONS: TAKE INTO ACCOUNT

In the functional analysis (functions performed taking account of assets used and risks assumed):

In the selecting of transfer pricing methods

Comparable controlled price

One-sided methods: cost plus, resale price, TNMM;

WHERE INTANGIBLES ARE USED IN CONTROLLED TRANSACTIONS: TAKE INTO ACCOUNT

“Two-sided” methods: profit split e.g. if both parties use unique, valuable intangibles):

In the selection of the “tested party” for a one-sided method: the less complex party to the transaction Comparable controlled price

In the selection of uncontrolled transactions that can be used as comparables (comparable means: no material difference or differences can be adjusted in a reasonably accurate manner

HOW TO DETERMINE OWNERSHIP:

• Economic vs. Legal ownership

• Centralized vs. Distributed

ownership

Legal ownership for registered intangibles (e.g. registered patent, trademark, copyright)

Economic ownership: who is entitled to the economic benefits?

For transfer pricing purposes, a party that bears the costs and risks of developing an intangible should be entitled to a corresponding beneficial interest, even if it is not the legal owner of the intangible.

OWNERSHIP: LEGAL VS. ECONOMIC

Reasons for taxpayers to segregate legal and beneficial ownership:• Handle all intangible registrations centrally

• Cost Contribution Arrangement (CCA) where economic ownership is shared but legal ownership cannot be under multiple names (para. 8.6 OECD TP Guidelines)

Taxpayer must provide sufficient documentation.


The OECD TP Guidelines recognise the difference between legal and economic ownership, and provide specific comments in this respect in relation to marketing intangibles (marketing activities performed by a party that does not own the trademark).


In the treaty context, useful (although different) notion of beneficial ownership• For the purposes of determining treaty benefits,

a conduit company cannot normally be regarded as the beneficial owner if, though the formal owner, it has, as a practical matter, very narrow powers which render it, in relation to the income concerned, a mere fiduciary or administrator acting on account of the interested parties.


Centralised ownership

• Single company in the group owns the intangibles, both beneficially and legally.

• License agreements with other group entities

need to determine arm´s length price

• Opportunity for tax planning

97

OWNERSHIP:CENTRALISED VS. DISTRIBUTED

Distributed ownership

• A number of companies (operating companies) would share ownership of intangibles on a pre-determined basis (e.g. geographic territory or product application)

• It always involves shared beneficial ownership

• Usually take the form of CCA

• Less tax driven

OWNERSHIP: CENTRALISED VS. DISTRIBUTED

Multinational enterprises have the freedom to fund and organise the development of intangible property, subject to:

• the legal form of the arrangement to be consistent with the substance of the transaction, and

• the arrangements, viewed in their totality, to be arm’s length (see in particular whether consistent with functional analysis and whether achieves an arm’s length allocation of risks)

Legal and economic ownership are increasingly disconnected from the location where R&D is performed. The location of legal and economic ownership of intangibles developed have huge transfer pricing consequences. This is a policy issue for fiscal attractiveness.

CONCLUSION

CONCLUSION Decision where to locate R&D activities is

generally based mainly on non-tax factors (e.g. skilled personnel),although tax factors (specific tax breaks for R&D activities) might help.

Depreciation, amortisation of developed or acquired intangible

Deduction of license fees Treaty network Withholding tax on inbound (and outbound) royalties Tax rate on benefits from exploitation (business

profits or royalties) Repatriation of earnings to shareholders Future disposal of intangibles (exit scenarios) Others (VAT, registration duties…)

LOCATING IP OWNERSHIP: TAX FACTORS TO CONSIDER

INTRA-GROUP SERVICES – VII OECD

GUIDELINES P 205


DAY 2SESSION 3

Pre-empting tax audits & Handling tax

controversies in a proactive manner


Core activities of a Tax Administration are centered around the implementation and enforcement of tax legislation and tax regulations.

104

WHAT IS TAX ADMIN ADMINISTRATION?

The objective of Tax administrations is to achieve the highest possible level of voluntary compliance with the laws, at minimal cost.

Why “voluntary” compliance?

- Tax administrations cannot enforce compliance from each & every taxpayer; they don’t have the resources.

- Governments will not provide more resources, which are both costly and intrusive.

- Voluntary compliance is the cheapest & most efficient means of administering a tax system.

105

VOLUNTARY COMPLIANCE

• Taxpayers’ ignorance of the law: I did not know! You did not tell me what I needed to do!

106

BARRIERS TO ACHIEVING VOLUNTARY COMPLIANCE

http://www.corbisimages.com/stock-photo/royalty-free/42-19879903/student-who-doesnt-know-the-answer

• Tax laws are often complex – I made an error!

107


• Tax laws & rules may put a high compliance burden on taxpayers- Its too costly / difficult to comply!

108


There are many barriers to achieving voluntary compliance (…continued)

• Some taxpayers have poor/ no records –They don’t know how to keep good records or can’t be bothered.

109


There are many barriers to achieving voluntary compliance (…continued)

• Some citizens and business are not prepared to comply- They deliberately don’t comply & are prepared to take a risk of being caught.

110


Effective taxpayer services help achieve voluntary compliance by:

- Improving taxpayers’ understanding of the law

- Making it easier and less costly to comply

- Informing taxpayers on what they need to do to

properly comply

- Discouraging taxpayers from non-compliance

111

TAXPAYER SERVICES

Political perspective (fiscal policy) Tax system (complexity, tax rates, etc) Social psychological perspective Mental (social) representations

• Tax knowledge and mental concepts• Attitudes: beliefs and evaluations• Norms:

• Personal norms• Social norms and identity• Societal norms

112

CLASSIFICATION OF DETERMINANTS OF TAX COMPLIANCE

http://www.corbisimages.com/stock-photo/royalty-free/42-24106415/creative-middleaged-man

Mental (social) representations (2)• Perceived opportunity to evade• Fairness perceptions:

• Distributive fairness• Procedural fairness• Retributive fairness

• Motivation to comply• Motivational postures• Tax morale

113

CLASSIFICATION OF DETERMINANTS OF TAX COMPLIANCE (…CONTINUED)

Decision making perspective• Rational decision making

• Audit probability, fines, tax rate and income• Psychological aspects of decision making

• Sequence of audits: learning processes• Heuristics, biases, frames• Withholding phenomena

Self-employment (paying out of pocket) Interaction between tax authorities and taxpayers

(Cops against robbers versus service for clients perspective)

114

CLASSIFICATION OF DETERMINANTS OF TAX COMPLIANCE (…CONTINUED)

Tax authorities who perceive taxpayers as robbers rather then as clients are likely to establish a command and control climate with taxpayers engaging in escaping the authorities by taking extensive (rational) decisions. Tax behaviour depends on audit probability and fines

Tax authorities who perceive taxpayers as clients and governments committed to responsive regulation are likely to establish a climate of cooperation and trust. Voluntary compliance depends on the taxpayers’ social representations of taxation.

115

INTERACTION WITH TAXPAYERS: THE CRUCIAL VARIABLE THAT DETERMINES TAX CLIMATE

Simple and understandable legislation Transparent and clear procedures Fast efficient processes Low compliance costs Treatment of the taxpayer as a client Taxpayer service (assistance, information) Visible supervision and fraud detection Use of third party information (banks etc.) Enforcement communication

116

IMPROVEMENT OF COMPLAINCE

Rights and obligations of the taxpayers Clear guidance in dealing with the Tax

Administration Ethical standards and rules of conduct Confidentiality of information Professional staff Feedback from stakeholders Performance measurement

117

PUBLIC CONFIDENCE

Explanation and protection of rights Explanation why information is asked Disclosure of information only on legal basis Professional service Representation Payment of only the correct amount of Tax

118

TAXPAYER RIGHTS AND OBLIGATIONS

Increasing acknowledgment that taxpayers have rights, as well as obligations.

Examples of (basic) rights: - to be informed, heard, and assisted;

- to pay no more than the correct amount of tax due;

- to appeal decisions of the tax body; and- to have certainty, privacy, and confidentiality

Examples of (advanced) “rights”- Services are comprehensive, easily

accessible, low cost to taxpayer, & timely.

119

EMERGENCE OF TAXPAYERS’ RIGHTS

Basic rights may be stated in countries legislation

Many tax administrations set out taxpayers’ rights in formal charters/ statements that are made public.

Charters reflect tax administrations’ vision for service delivery (e.g. services are comprehensive, accessible, fair, & timely).

Many tax administrations set service performance standards with time-bound objectives that are made public

120

TAXPAYERS’ RIGHTS

Eliminating possible issues that could prompt an audit

Determining the appropriate documentation needed to address an audit

Preparing defence to tax audit for and responding to tax authorities’ transfer pricing audits

Identifying possible impacts from the proposed transfer pricing legislation amendments that could lead to an audit

Review E&Y Global TP survey 2010/11

SESSION 3: Pre-empting tax audits (1)

Eliminating possible issues that could prompt an audit• Keep TP policies up-to-date• Don’t deviate from policies without amending• Control Exchange of Information via tax

authorities• Beware of other country TP audits• Revisit offshore center intermediary SubCo’s• Where is the sensitive information kept?


Determining the appropriate documentation needed to address an audit • Where is the sensitive information kept?• TP policy document – updated?• What documents must you bring in from other

jurisdictions?• Association clause in DTA• Mutual Assistance clause in DTA• Exchange Information clause in DTA


Preparing defense to tax audit for and responding to tax authorities’ transfer pricing audits • Presentation on preparing for tax audits – An

emerging market perspective


Structuring your company to be able to address potential controversies

Examining Intangible Property, Intragroup Services, Cost Contribution Arrangements, and Thin Capitalisation policies

Considering Mutual Agreement Procedures (MAPs) and Advance Pricing Agreements (APAs) to reduce your tax risk

Overcoming potential penalties and costly litigation arising from transfer pricing adjustments

Enforcing a defensible model to safeguard against tax audits and disputes

SESSION 3: Handling tax controversies in a proactive manner (1)

Structuring your company to be able to address potential controversies• Tax Intelligence Book

• 7 Habitual Tax Mistakes made by Companies• The summary book


http://www.erasmusontax.com/

Considering the following to reduce your tax risk:• Mutual Agreement Procedures (MAPs) – very

slow and outside control of taxpayer• Advance Pricing Agreements (APAs) – not

relevant in Africa GATT, GATS, State Responsibility and other

sundry procedures Other - such as monitoring ATAF


Overcoming potential penalties and costly litigation arising from transfer pricing adjustments• Up-to-date TP policy documents• Contemporaneous with tax returns• Control audits & exchange of information• Letters of findings• Opinions to mitigate interest & penalties


Enforcing a defensible model to safeguard against tax audits and disputes• Tax team• Regular tax risk meetings• Regular communication intra-group• Remember FEDEX info survey model


DAY 2

SESSION 4 Gaining insight into

different tax regulations on TP


Categorising groups of similar taxation laws Assessing these different tax regulations

group by group Highlighting documentation requirements in

various regions Exploring best practices to address transfer

pricing operations

SESSION 5: Gaining insight into different tax regulations


Country comparisonsCountry TP Regs TP Docs? Tax Return Penalties

Thailand Y Recommend Y Up to 200%

Vietnam Y Recommend Y N

Taiwan Y Y Y Up to 200%

Singapore Y Recommend N Up to 200%

Pakistan N Anti-Av Recommend N N

Malaysia Y Recommend Y Up to 300%

Indonesia Y Y >Rp10m Y Up to 48%

India Y Y >INR10m Y Up to 300%

Hong Kong N Anti-Av Recommend N Up to 300%

China Y Y Y 5% no docs

Cambodia N Anti-Av Recommend N N

South Korea Y Recommend Y 10%


Country Summaries

REFER to various country summaries download at www.IITF.net


http://www.IITF.net/

Home Country

TaxHavens

DevelopingCountries

UPSTREAM

MIDSTREAM

DOWNSTREAM

Home Country

TaxHavens

DevelopingCountries

UPSTREAM

MIDSTREAM

DOWNSTREAM

Home Country

TaxHavens

DevelopingCountries

UPSTREAM

MIDSTREAM

DOWNSTREAM

Home Country

TaxHavens

DevelopingCountries

UPSTREAM

MIDSTREAM

DOWNSTREAM

CASE STUDY 4: Virtual Profile Company


VPC Ltd

VIC

VPC (M)

ThirdParty

On-Line Clients

Wholesalers15 countries

Manufacturing costs: $ 2500GP: $ 2 500SP: $ 5 000

Purchase: $ 5 000Distribution cost: $500GP: $2 000SP: $ 7 500

Manufacturing costs: $ 1 000GP: $ 2 500SP: $ 3 500

Purchase: $ 3 500Distribution costs: $300GP: $ 3 700SP: $ 7 500

SP: $ 15 000 to end-user

Evaluation of methods CUP:

Branded product, not comparable to VIC brand

Cost Plus: Manufacturing intangible present, cannot

compare to manufacturing intangible of VIC brand (no info available for VIC)

Resale Price Method: VPC (M) sells to wholesalers, while Cayman Third Party sells to end-user

Evaluation of methods TNMM:

Would be difficult to find companies that are similar to RSA entity: R&D, Manufacturing, on-line selling, integrated company, owning a very unique brand

TNMM would not be appropriate Profit Split: all that is left

Used by taxpayer Based on cost contribution: development, manufacturing and

distribution (good objectively verifiable basis) Parent: manufacturing and R&D: $2 500 Sub: distribution cost: $500 Total cost: $3 000 Profit split: Parent: 83% (2500/3000); Sub: 17% (500/3000)

CONCLUSION Contact Details:

Prof D N Erasmus

+1 561 568 7115

[email protected]

www.taxriskmanagement.com


Prof. Daniel N. Erasmus Assisted by Prof. Anneline Venter CA(SA) and Sebastien Gonnet NERA Economic Consultants.

Documents

pricing slide

transfer pricing cost

transfer pricing mechanisms

transfer pricing purposes

abusive transfer pricing

transfer pricing case

slide oecd

oil gas sector