Transfer Pricing
Transfer Pricing Methods
© Hugo Vollebregt
Purpose of today’s session
After today you will have a better understanding of:
•
The arm’s length standard
•
Alternatives to the arm’s length standard
•
Transfer pricing methods
Slide 2
Contact details
Hugo Vollebregt
Amsterdam, The Netherlands
hugo.vollebregt@gmail.com
Slide 3
Introduction
Transfer pricing
•
Taxable income per group entity
•
Prices in transactions between related companies
•
Pricing, not allocating consolidated group profit to affiliates
•
Hard bargaining among group companies is not an OECD approved
transfer pricing method
5
Transfer pricing jargon
•
Related companies
•
Related transactions
•
Affiliates
•
Intercompany transactions
•
Subsidiaries
•
Controlled transactions
•
Group companies
•
Controlled companies
6
Transfer pricing?
Costs
Which transactions:
•
Supply of products by one group
company to another
Plant
Transfer price
Sales
office
Market
Slide 7
Transfer pricing?
Costs
Which transactions:
•
Services by one group company to
another group company
•
Services by head-offices
•
Shared
services
center
Transfer price
Sales
Services by shared services centers
office
Market
Slide 8
Transfer pricing?
Which transactions:
•
Making intangibles available to other
group companies
•
Brands, technology or know how
•
Royalties
•
Art 12 OECD MTC
R &D Center
Transfer price
Plant
Slide 9
Transfer pricing?
Which transactions:
•
Making funds available to other group
companies
•
Loan amount
•
Interest rate
•
Guarantee
•
Art 11 OECD MTC
Treasury
Transfer price
Plant
Slide 10
OECD Transfer Pricing Guidelines (2010)
•
Guidance for setting transfer prices for
- Products: +++
- Services: ++
- Royalties: +
- Loans, interest and guarantee: - / -
11
The arm’s length standard and fair share
The international standard
Article 9 OECD Model Tax Convention
ASSOCIATED ENTERPRISES
1.
Where …conditions are made or imposed between the two enterprises
in their commercial or financial relations which differ from those which would
be made between independent enterprises, then any profits which would, but
for those conditions, have accrued to one of the enterprises, but, by reason of
those conditions, have not so accrued, may be included in the profits of that
enterprise and taxed accordingly.
Slide 13
The arm’s-length principle / separate entity approach
•
Treat members of an MNE as separate entities rather than as inseparable
parts of a single business
•
Members of an MNE are supposed to enter into transactions among
themselves as if they were independent companies
•
Compare conditions of controlled transactions to those of uncontrolled
transactions
The arm’s-length principle / separate entity approach
•
Starting point is a price for a controlled transaction
- In theory: transactional approach
- Exception: profit split method of the OECD
•
Compare a controlled transaction to an uncontrolled transaction
 Goods and services
 Functional analysis
 Contractual terms
 Economic circumstances (markets)
 Business strategies
Alternatives to the arm’s length principle
Why do we use the arm’s length principle?
•
Equal treatment of controlled transactions to uncontrolled transactions
•
It works!
•
Acceptance by many countries
•
OECD TPG para 1.8 en 1.9
Challenges with the arm’s length principle
•
ALP / “separate entity approach” and synergy
- Which group company should earn synergy advantages?
•
Can we find comparable uncontrolled transactions?
- Transactions are unique
- Growth of i/c transactions thus less comparability data (70%)
- Lack of public (financial) data on uncontrolled transactions
Alternatives to the arm’s length principle
•
Formulary apportionment
-
•
-
•
Allocate consolidated profit
Formula (allocation keys)
Consolidation:
-
•
Accounting principles of the parent (home
state taxation)
Common accounting principles (CCCTB)
Formulary apportionment
-
•
Does not meet the ALP
Explanation
Profit split method of the OECD
-
Meets the ALP
Explanation
Allocation keys:
-
Local sales
Local fixed assets
Local people (number or salaries)
Slide 19
Transfer pricing methods
Costs
Plant
Transfer price
Sales
office
Market
Slide 21
Costs
•
•
OECD: “most appropriate transfer
pricing method to the circumstances of
the case”
Plant
Transfer price
US: “best method rule”
Sales
office
Market
Slide 22
Costs
Traditional transactional methods:
• Comparable Uncontrolled Price
Method (CUP)
• Resale Price Method (RPM)
• Cost Plus Method (CP)
Transactional profit methods
• Profit Split (PS)
• Transactional Net Margin Method
(TNMM)
Plant
Transfer price
Sales
office
Market
Profit Methods
Profit split: Nice and easy
•
Allocate consolidated profit using
relevant allocation keys:
•
Agreement between countries on:
- Allocation keys
- Relative weight of allocation keys
- Accounting principles
•
Difference with other OECD methods:
- Allocate consolidated profit vs
transactional approach
- Synergy advantages shared
Example:
A
Sales 60
FTE
B
Σ
40 100
90
10 100
Asset 30
70 100
Income A:
[1/3*60/100 + 1/3*90/100 + 1/3*30/100] *
group profit
Slide 24
Traditional Transactional Methods
Comparable Uncontrolled Price (CUP)
Internal CUP
External CUP
Plant
Plant
Sales office
Client (3)
Sales office
Client (3)
Competitor
Slide 25
Cost Plus Method
P&L of the plant
Sales to group companies
110 = transfer price
Costs of goods sold
100
Gross margin
10
Operational expenses
Operating income
Interest, dividends, etc
Tax
Pre-tax income
Slide 26
Resale Price Method
P&L of the sales office
Sales to third parties
100
Costs of goods sold
90 = transfer price
Gross margin
10
Operational expenses
Operating income
Interest, dividends, etc
Tax
Pre-tax income
Slide 27
Transactional Net Margin Method (TNMM)
US: Comparable profit method
•
TNMM sets the mark up at the Cost Plus Method and the minus at the
Resale Price Method
•
Economic analysis, comparability analysis or benchmark study
•
Analysis:
- How profitable are comparable independent companies?
- Cost plus: what is the mark up earned by comparable, independent
plants?
- Resale price: what is the margin earned by comparable, independent
sales offices?
Slide 28
When cost plus and when resale price minus?
“Least complex” (routine) entity :
“Entrepreneur” or “principal”:
•
•
•
•
•
•
No key value drivers
Routine activities
Routine profit
Key value drivers
Management, decisions, authority, etc
Residual profit
Slide 29
When cost plus and when resale price minus?
Step 1
Identify key value drivers
Step 2
If: Key value drivers at sales office
Step 3
Plant is least complex entity
Plant earns routine profit
Step 4
Select cost plus method
Step 5
Select mark up thru TNMM
When cost plus and when resale price minus?
Step 1
Identify key value drivers
Step 2
If: Key value drivers at plant
Step 3
Sales office is least complex
Sales office earns routine profit
Step 4
Select resale price method
Step 5
Select minus thru TNMM
Transfer pricing methods summary
Method
Example of application
CUP (external or internal)
All type of activities, if uncontrolled transaction
exists
Resale Price Method
Distribution activities are least complex
Cost Plus Method
Manufacturing activities are least complex
Profit Split
Highly integrated business; synergy; ALP thru
selection and weighting of allocation keys
TNMM
Sets margins in RPM and in Cost Plus Method
GSK revisited
GSK US 2006
H
R &D
Plant
UK
Sales office
US
34
Specific cases
GSK US 2006
Step 1
Taxpayer on KVD
Identify key value drivers
•
R &D and manufacturing
If: Key value drivers at plant
•
In UK
Step 3
•
US Sales office routine reward
Step 2
Sales office is least complex
Sales office earns routine profit
Step 4
Select resale price method
Step 5
Select minus thru TNMM
Slide 35
Specific cases
GSK US 2006
H
R &D
Plant
UK
Sales office
US
36
Specific cases
GSK US 2006
Step 1
Identify key value drivers
Step 2
If: Key value drivers at sales office
Step 3
Plant is least complex entity
Plant earns routine profit
Step 4
Select cost plus method
IRS on KVD
Step 5
Select mark up thru TNMM
•
Marketing and premium market
•
In US
•
US Sales office residual profit
Slide 37
Specific cases
GSK US 2006
H
R &D
Plant
UK
Sales office
US
38
Specific cases
GSK US 2006
Taxpayer position
IRS position
H
R &D
Plant
UK
Sales office
US
39
Contact details
Hugo Vollebregt
Amsterdam, The Netherlands
hugo.vollebregt@gmail.com
Slide 40