Transfer Pricing: Risky Business (Part I)

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2 Transfer Pricing: Risky Business (Part I)

3 Panelists Karine Uzan-Mercie, Vice President, Tax & Corporate Initiatives, Coca-Cola Enterprises Paul Morton, Head of Group Tax, RELX Group Mike McDonald, Financial Economist, U.S. Treasury Andrew Hickman, Head of Transfer Pricing Unit, OECD Centre for Tax Policy and Administration

4 Topic The risk control framework in revised Chapter I of the Guidelines Implications for current work on attribution of profits to PEs and financial transactions

5 . Report on Actions 8-10 Revisions to Guidelines I II V VI VII VIII Delineation of the actual transaction, risk Recognition of the accurately delineated transaction Local market characteristics, assembled workforce, group synergies Commodity pricing Transactional profit split method TP Documentation, including CbC reporting Intangibles, including HTVI, Implementation of HTVI Low value-adding services, Implementation of LVAS Cost Contribution Arrangements Financial transactions Attribution of profits to permanent establishments Conforming changes (e.g. Ch IX) 5

6 Clarifying the fundamentals In framing BEPS Transfer Pricing Actions, tax administrations concerned that changing pieces of paper changed allocation of profits without changing business reality Action Plan required consideration of how to deal with risk, capital, legal ownership, and arrangements not seen between independent parties In responding the Final BEPS Reports focused on fundamentals of any transfer pricing analysis: rigorous determination of what is actually happening accurately delineating the actual transaction analytical framework for determining where risk is assumed, provides approach to determine substance of risk allocation

7 Risk Increased assumption of risk Increase in expected return Now have an analytical framework to determine the substance requirements for assuming risks It is not based on numbers of people, or on organisational hierarchy, but on qualitative, specific decision-making functions relating to a transaction Paper allocations of risk cannot override actual decision-making capability and performance Identifying SPECIFIC risks IN A TRANSACTION that are ECONOMICALLY SIGNIFICANT goes hand-in-hand with identifying functions and assets

8 TP location of risk The contract tells us how parties have allocated risk on paper Do the parties follow that allocation in reality? Does the party control its risk? The Guidelines assert that a party does not assume a risk it does not control

9 Risk analysis framework (1.60) 1. Identify risks 2. Contracts 3. Functional analysis 4(i) Does conduct follow contract? NO Test 4(ii) based on conduct YES 4(ii) Control & financial capacity? NO 5. Allocate to party with control & financial capacity YES 6. Price 9

10 Exercising control over risk (1.65) Capability and actual performance: i. Decisions to take on, lay off or decline a risk-bearing opportunity ii. Decisions on whether and how to respond to the risks associated with the opportunity iii. Mitigate risk: to take measures that affect risk outcomes or, if risk mitigation is outsourced, Set objectives Hire, asses and, if necessary, fire the provider

11 Financial capacity to assume the risk (1.64) Access to funding to take on the risk or lay off the risk, to pay for the risk mitigation functions and to bear the consequences of the risk if the risk materialises Takes into account the available assets and the options realistically available to access additional liquidity, if needed, to cover the costs anticipated to arise should the risk materialise

12 In most cases a simple test (1.94) Does the party assuming a risk under the contract exercise control? If it does, and has financial capacity, it assumes the risk If other parties also exercise control, then that function should be compensated appropriately, but those other parties do not take on the risk

13 Transactional risk-taking not policy setting (1.66, 1.76) Control over risk is NOT Formal approval Signing of documents Policy setting The Board or committees may set policies, but this is not a decision to take on, lay off, decline, or mitigate the specific risk in the transaction. It is not control.

14 The assumption of risk dictates the appropriate pricing method (1.81) No inference should be drawn from the pricing adopted that risks are borne in a particular manner It is the determination of how the parties control risks that determines risk assumption, and consequently the selection of the most appropriate transfer pricing method.

15 Discussion

16 Digital publishing (illustration) Business: Sweden Business: Denmark Contributors are third parties One of several publishing companies Platform development: Netherlands Review board: Various countries Publisher: UK Production: Philippines Datacentre: US Software coding: India Review board members are third parties The publisher has unique knowledge and is responsible for this database Contracts with all global customers Contracting entity: Netherlands Customer: Italy User on secondment: Japan Sales office: France Sales support Normally uses publications In Japan The platform cost $500 million and was cost shared by five publishing companies UK, US, Australia, Netherlands and Japan User on holiday: Hawaii Actually uses publications In Hawaii but using the Japanese VPN but his Italian subscription agreement

17 Technology platform development Year 1: Operating companies in US, UK, France, Netherlands and Japan contract to jointly develop a new platform Year 2: Development begins led by a team in the UK, on US servers, with coding undertaken in India Year 3 5: Development continues Year 6: First roll out in US Year 7: First roll out in UK Year 8: Year 9: First roll out in France Japan decides that the platform is no longer required for the Japanese market

18 Discussion

19 Additional guidance on Attribution of Profits to PEs Does the transfer pricing work related to intangibles, risk and capital affect application of Article 7? For Dependent Agent PEs where the Dependent Agent Enterprise is an associated enterprise, the risk framework under Article 9 may allocate risk to the DAE, and therefore the resulting profits would no longer be profits of the non-resident to be attributed to the DAPE. The risk framework under Article 9 may determine that the functions performed by the DAE do not lead to the assumption of risk by the DAE under Article 9 (for example, the non-resident contractually assumes risk and exercises control), but which are significant people functions relevant to the attribution of risk to the DAPE. Any return to capital to fund an asset under Article 9 may be attributed to the DAPE if the asset is economically attributed to the DAPE under Article 7.

20 Financial Transactions Does the transfer pricing work on synergistic benefits, risk and capital lay useful foundations for the guidance on transfer pricing aspects of financial transactions? Relationship between risk and capital in an unregulated MNE Group Role of funding activities in an MNE Group, and control of risks The relevance of the procurement model to certain funding arrangements

21 Discussion