Transfer Pricing: Issues,
Risks & Opportunities for
Multinationals
8-9 May 2013
Chair: Mukesh Butani – Taxand India
Panelists:
Shiv Mahalingham – Taxand UK
Clemens Thym – Standard and Poor
Sam Sim – Standard Chartered
Steven Carey – Quantera Global
Contents
1.
UN Manual & the Acceptance of Arm’s Length Principle – an
OECD Comparison
2.
Intangibles: Tax Controversies, Enforcement & Litigation in
Asia
3.
The OECD BEPS Study & the “Grey Area” Definition
4.
Valuation in Business Restructurings: the Different Approaches
of Tax Authorities
5.
Developments in Policy on Advance Pricing Agreements
6.
Intercompany Loans Focus
7.
Managing TP In-House Across Asia-Pacific
8.
Taxand’s Take
9.
Key Contacts & About Taxand
UN Manual & the Acceptance of
Arm’s Length Principle & OECD
8-9 May 2013
UN Manual, Arm’s Length Principle & OECD
1
UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison
UN Manual was prepared by the Subcommittee
on Transfer Pricing, constituted in 2009
Developed with a purpose to provide a practical
manual on transfer pricing for developing
countries
Manual covers aspects starting from
methodologies to documentation to dispute
resolution. It also covers country specific
chapters on Brazil, China, India and South Africa
3
UN Manual, Arm’s Length Principle & OECD
1
UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison
Issues to be debated:
Discussions on important aspects covered in
India and China chapter
Comparison with OECD Guidelines
Implications on non-OECD member countries
4
UN Manual - India Chapter
1
UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison
Key topics covered in the India Chapter of UN Manual
include:
Location savings
India provides ‘Location Specific Advantages’ (LSA)
in addition to location savings
LSAs include access to market, skilled manpower,
large customer base, information and distribution
networks
Quantification and allocation of location savings and
location rent (in case of LSA) to be an important area
of concern
Use of Profit Split Method endorsed by Indian
Revenue (in case of absence of Comparable
Uncontrolled transactions)
5
UN Manual - India Chapter
1
UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison
6
Intangibles
Marketing intangibles and co-branding activities particularly relevant for India owing to unique
market characteristics
Enhancement of brand, creation of efficient supply
chain, conducting market research identified as
factors relevant to creation of marketing intangible
Ways of compensation for creation of marketing
intangibles eg: Reimbursement of extra-ordinary
expenses, with a mark-up; or share of
profits in relation to marketing intangible
UN Manual - India Chapter
1
UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison
7
R&D related intangibles
Remuneration received by captive providers
should commensurate to functions performed and
risks assumed
Routine and low cost plus mark up perceived to
be insufficient – day to day decision making and
operational risks lie in India
Additional compensation on account of creation
of intangibles and ‘more than’ routine
functions / risks required
UN Manual - India Chapter
1
UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison
8
Intra-group services
Categorised as high risk area
Nature of allocation keys is a grey area
Non-receipt of mark-up on provision of
services considered as a ‘pain-point’ by Indian
Revenue
Use of contemporaneous data – relevance of
current year data re-emphasised
UN Manual - India Chapter
1
UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison
Allocation of risks between taxpayer and AEs –
contingent on core functions, responsibility and
decision making
Comparability adjustments
Burden to proof on taxpayers
Difficulty in undertaking risk adjustment
highlighted, however no guidance / solutions
provided in Manual
9
UN Manual - China Chapter
1
UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison
Lack of reliable local comparables
Location specific advantages (LSAs)
Location savings
Market premium
Very structured approach to defining and
calculating
10
UN Manual - China Chapter
1
UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison
Intangibles
General position that Chinese intangibles
under-compensated
Confidence in effectiveness of documentation
and audits to achieve compliance
11
Intangibles: Tax Controversies,
Enforcement & Litigation in Asia
8-9 May 2013
Intangibles
2
Intangibles: Tax Controversies, Enforcement & Litigation in Asia
13
Increased interest of tax authorities regarding:
Economic ownership vs legal ownership of
intangible
Attribution of benefits of intangibles to parties
OECD’s draft guidelines on intangibles (released
in June 2012) - emphasis on FAR for intangible
related returns
Intangibles
2
Intangibles: Tax Controversies, Enforcement & Litigation in Asia
Issues to be debated
Views of tax administrators and taxpayers on
intangibles and transfer pricing in relevant
jurisdiction
Recent tax controversies
14
Intangibles - India Perspective
2
Intangibles: Tax Controversies, Enforcement & Litigation in Asia
Legislative developments
Definition of intangibles introduced vide
Finance Bill 2012
New definition includes marketing, human
capital, customer related intangibles
Definition introduced retrospectively
15
Intangibles - India Perspective
2
Intangibles: Tax Controversies, Enforcement & Litigation in Asia
Disputes in India primarily focus on:
Creation of marketing intangibles by Indian
entities manufacturing / distributing branded
products
Contribution of Indian contract software
service providers to the overall product
development lifecycle
Recent Special Bench ruling in case of LG
Electronics
16
The OECD BEPS Study & the
“Grey Area” Definition
8-9 May 2013
The OECD BEPS Study - An Overview
3
The OECD BEPS Study & the “Grey Area” Definition
BEPS – a debate gaining recognition across
BRICS and G20 nations
Meeting of G20 leaders in July 2012 and
November 2012 emphasised on “the need to
prevent base erosion and profit shifting”
OECD highlights the ‘grey area’ between tax
planning and tax evasion
18
The OECD BEPS Study - An Overview
3
The OECD BEPS Study & the “Grey Area” Definition
Joint Communiqué issued by BRICS identified
the following as primary reasons leading to
erosion of the tax base:
Abuse of tax treaty benefits
Incomplete disclosure of information between
tax administrations
19
The OECD BEPS Study - An Overview
3
The OECD BEPS Study & the “Grey Area” Definition
Primary ways of cross-border profit shifting:
Pricing of international transactions between
two associated enterprises
Capital structuring / financing between
associated enterprises
Development of international standards,
improving access to data and information and
capacity building is ‘need of the hour’
20
The OECD BEPS Study
3
The OECD BEPS Study & the “Grey Area” Definition
Issues to be debated:
How to draw the line between tax planning and
tax evasion
Impact of BEPS on emerging economies
Learning from international best practices
Suggest improvements that may be made to
transfer pricing rules
Other ways to resolve BEPS (areas such as
GAAR, thin capitalization to be discussed)
21
Valuation in Business
restructurings & Tax Authorities
8-9 May 2013
Valuation in Business Restructurings - India
4
Valuation in Business Restructurings: the Different Approaches of Tax Authorities
Historical stand - transfer pricing provisions do
not apply to cross-border business restructuring
if there is no bearing on taxable income
Important amendment introduced (with
retrospective effect) in Budget 2012 –
‘business restructuring’ to be considered an
international transaction irrespective of its
bearing on taxable income (at the time of
transaction or in future years)
23
Valuation in Business Restructurings - India
4
Valuation in Business Restructurings: the Different Approaches of Tax Authorities
24
Transactions such as issuance, conversion, buyback of shares targeted
Discounted cash flow (DCF) preferred by Indian
Revenue
Valuation reports and methods such as DCF and
NAV likely to gain acceptance with introduction
of ‘Other Method’
Highly litigative area at present
Developments in Policy on
Advance Pricing Agreements
8-9 May 2013
Developments in APAs - India Perspective
5
Developments in Policy on Advance Pricing Agreements
Guidelines notified on August 31, 2012
Taxpayer community reposing faith in the APA
regime
Encouraging response – about 150 pre-filings in
8 months
Approx 80% of the pre-filings are for unilateral
APA
26
Developments in APAs - India Perspective
5
Developments in Policy on Advance Pricing Agreements
Relationship between Indian – US Competent
Authority cause of concern
In absence of Art 9(2), bilateral APAs not
available
Transactions targeted – Royalty, Contract R&D,
software, management fees, contract
manufacturing, cost allocations
27
Developments in APAs - Asia Perspective
5
Developments in Policy on Advance Pricing Agreements
Proliferation of countries now with APA rules
Various countries such as HK growing DTA
network partly to support APAs
Indonesia and Vietnam now on steep learning
curve
HK IRD enthusiastic but only limited cases
underway so far
China focus on bilateral/multilateral due to
severe limitations on resources
28
Intercompany Loans Focus
8-9 May 2013
Intercompany Loans Focus - India Perspective
6
Intercompany Loans Focus
30
Financial transactions such as loans and
guarantees – highly litigative area in Indian TP
arena
Expressly introduced in definition of international
transaction vide Finance Act 2012
CUP mostly relied upon as the most appropriate
method – PLR, LIBOR typically used for
benchmarking
More sophisticated quantification techniques
gaining importance: Credit rating
comparison of borrower & its AEs
Managing TP In-House Across
Asia-Pacific
8-9 May 2013
Transfer Pricing is the Number One Challenge
7
Managing TP In-House Across Asia-Pacific
32
Response to a
Taxand survey of
tax professionals
Increasingly sophisticated tax authorities are utilising commercial
databases for risk- based audit selection, increasing the number of
audit and calculated adjustments
Lack of consistency from country to country pose added difficulties
Dispute resolution on undocumented cases is a very challenging
and potentially expensive problem
Business continues to change as a result of globalisation,
M&A and reorganisation
Importance of business aligned tax planning is rising
Transfer Pricing – Managing the Challenge
7
Managing TP In-House Across Asia-Pacific
Considerations in establishing best practice
Market rates for interest
Credit premium reflecting credit risk?
Quantifiable? (spreads, historical default
information)
Comparables? (bonds, credit default swap
spreads, liquidity issues)
Challenges in emerging markets
Sovereign intervention
Country risk
Resulting risk / pricing impact
33
Flexibility
Transfer of
intangibles
Parent level
Transfer of Intercompany Financing
Example:
How
do‘Transfer
Intercompany
Loan
Issues Originate?
How
do issues
of
Pricing’
originate?
How do
issues
of
‘Transfer
Pricing’
originate?
7The
Managing
TP In-House
Across
Asia-Pacific
process
of producing
a ‘Coke’
he process
of producing
a Coke
‘Coke’
Transfer of
of tangibles
Mex
Concentrate Producing Sub
Coke
Coke
Coke
Chile
Bottler Sub
Coke
Transfer of
tangibles
Coke
Coke
ConcentrateConcentrate
Transfer of
tangibles
USA
USA
Parent level
Parent level
Transfer
intangibles
Transfer of
intangibles
Funds
& Coke Secret Coke
Secret
Financial
Recipe
Recipe
Flexibility
Transfer of Intercompany Financing
Transfer of Intercompany Financing
Funds &
Financial
Flexibility
Coke
Concentrate
Coke
Coke
Mex
Mex
Concentrate
Sub
Concentrate
ProducingProducing
Sub
Coke
Chile
Chile
Bottler SubBottler Sub
?
Example: Credit Default Spreads at the Parent Level
7
•
•
•
•
Managing TP In-House Across Asia-Pacific
CDS are good proxy for actual risk premium
Most responsive market to changes in risk perception
Very liquid market for parent company’s funding
High credit quality, high liquidity => low spreads
Example: Using an Objective Model to Score Where no
Risk Indicators are Available
7
Managing TP In-House Across Asia-Pacific
S&P Capital IQ – Credit Model
Standard & Poor’s Ratings
?
CMS - CDS Prices
Source: S&P Capital IQ, Standard & Poor’s Ratings
*
=
Source: S&P Capital IQ, Standard & Poor’s Ratings
* … broadly the same credit quality; within +/- 1 notch
Building Robust
Market Based
Refere
Alternatives in Establishing Effective
Reference
Prices
Calculate Yield Curves for Custom Pool of Co
7
Managing TP In-House Across Asia-Pacific
The
app
and
app
Empirical Term Structure
7
6
• B
b
u
a
5
Yield (%)
Establishing a market
based comparable
requires:
Transparent
methodology
Appropriate
segmentation
(geography, industry,
credit rating, duration,
etc.)
Cover all risk factors
(sovereign risk, T&C)
Strong grounding on
empirical data
4
3
Median
2
• P
in
th
Upper Quartile
Lower Quartile
1
Exposure Weighted Average
0
0
5
10
15
20
Term (years)
Credit Spread Models
Note: Graph contains hypothetical data.
25
30
Emerging Markets – Look Beyond Sovereign Risk
7
Managing TP In-House Across Asia-Pacific
Sovereign Default
Risk
(LC / FC)
Risk associated with the non-repayment
of a sovereign’s financial obligations
issued in local or foreign currency
Policy Risk
The risk that a government will discriminatorily change the laws,
regulations, or contracts governing an investment—or will fail to
enforce them—in a way that reduces an investor’s financial returns is
what we call “policy risk.”
Transfer &
Convertibility Risk
Likelihood of sovereign interference in the exchange rate market to
prevent non-sovereign entities to repay their financial obligations in
foreign currency
Country Risk
“Country risk is the risk that economic, social, and political conditions
and events in a foreign country will adversely affect an institution’s
financial interests. […] Country risk includes the possibility of
nationalization or expropriation of assets, government repudiation of
external indebtedness, exchange controls, and currency depreciation
or devaluation.
Concentrating on Country Risk - Its Impact on Corporations
7
Managing TP In-House Across Asia-Pacific
Incongruity Between Country Risk Scores & Sovereign Ratings
20
Country Risk Score by S&P Capital IQ
18
16
14
Russia
India
12
Botswan
China
10
Saudi Arabia Chile
Jamaica
8
Kuwait
Greec
Turkey
6
Latvia
4
Hungary
2
Irelan
Iceland
0
0
2
4
6
8
10
12
14
Sovereign Ratings by Standard & Poor’s
16
18
Source: S&P Capital IQ Country Risk Framework and Rating information from Global Credit Portal (R) as of September 30, 2011 and provided for illustrative purposes.
20
Impact of Sovereign & Country Risk Scores to Individual Co.s
7
Managing TP In-House Across Asia-Pacific
Scoring the same financial profile across different countries…
Malaysia
Thailand
China
Country Risk
Score
Cambodia
a
a-
bb+
b
Standalone
Score
bbb-
bb+
bb-
b+
Sovereign
Rating FC*
A-
BBB+
AA-
B
bbb-
bb+
bb-
b
(as at 21 Jun 2012)
Credit Score
* FC… Foreign Currency
Country risk impacts the standalone score significantly and across a number
of countries with different risk, that leads to 4 notches difference
Where the sovereign rating is low (Cambodia), it would limit the
company’s ability to get a higher rating, even if the standalone score is
stronger
The range of scores, depending on industry and country selection is
from bbb- to b (5 notches)!
Managing TP Risk In-house Across Asia-Pacific
7
Managing TP In-House Across Asia-Pacific
Global consistency vs local customisation
Adapting Master-file to local circumstances
Preference for local methods, comparables
Reconciling different local studies
Optimal TP team structure & infrastructure
Governance
Engagement of key stakeholders (business, tax,
finance, legal/compliance) and local teams
Operational: embedding TP into BAU
41
Taxand’s Take
8-9 May 2013
Taxand’s Take
8
Managing TP In-House Across Asia-Pacific
43
Financial transactions, intangibles gaining focus globally
Need for “glocal” documentation - MNEs should tailor
their global documentation to manage risks in complex
jurisdictions
Involvement of in-house tax department in operational
changes critical
Proactive approach towards controversy management
Convergence of global tax policies with local risks
Increased transparency and sharing of information - need
of the hour
Exploring alternate dispute resolution mechanisms
Key Contacts
6
Key Contacts
44
Mukesh Butani
Taxand India
E. mukesh.butani@bmradvisors.com
T. +91 124 339 5011
Shiv Mahalingham
Taxand UK
E.
smahalingham@alvarezandmarsal.com
T. +44 207 715 5234
Clemens Thym
Standard and Poors
E. Clemens_Thym@spcapitaliq.com
Steven Carey
Quantera Global
E. s.carey@quanteraglobal.com
Our Global Service Commitment
9
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45
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9
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47
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