Latam Mining & Metals Tax Forum Transfer Pricing An Evolving Landscape

Transcription

1 Latam Mining & Metals Tax Forum Transfer Pricing An Evolving Landscape Sean Kruger May 2017

2 Latest on the OECD s BEPS initiative Page 2

3 OECD / G20 BEPS Project What is BEPS? According to the OECD, BEPS refers to tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity, resulting in little or no overall corporate tax being paid. Artificially shifting profit between countries leading to erosion of the tax base where the economic activity to create the profit occurred Global problem requiring global solutions Page 3

4 Brief overview of final BEPS deliverables Action 14: Making dispute resolution mechanisms more effective Action 15: Develop a multilateral instrument for amending bilateral tax treaties Final reports on Actions 8-10 and Action 13 were formally adopted by the OECD Guidelines on 23 May 2016 Action 11: Establish methodologies to collect and analyse data on BEPS and actions addressing it Action 12: Require taxpayers to disclose their aggressive tax planning arrangements Action 13: Re-examine transfer pricing documentation Action 1: Address the tax challenges of the digital economy Action 2: Neutralise the effects of hybrid mismatch arrangements Action 3: Designing effective CFC rules Action 4: Limit base erosion via interest deductions and other financial payments Action 5: Counter harmful tax practices more effectively, taking into account transparency and substance Action 6: Prevent treaty abuse Action 8: Consider transfer pricing for intangibles Action 7: Prevent the artificial avoidance of permanent establishment status Action 9: Consider transfer pricing for risks and capital Action 10: Consider transfer pricing for other high-risk transactions Page 4

5 Action 13: Transfer pricing documentation and country-by-country reporting Redefined New Master file High-level information about a MNC s business, transfer pricing policies and agreements with tax authorities in a single document available to all tax authorities where the MNC has operations Country-by-country report High-level information about the jurisdictional allocation of revenues, profits, taxes, assets and employees of a multinational corporation (MNC) to be shared with all tax authorities where the MNC has operations Local file Detailed information about a MNC s local business, including relatedparty payments and receipts for products, services, royalties, interest and so on Redefined Tax authorities will have access to taxpayers global tax footprint via CbC reporting data, master file and the local file Page 5

6 Action 13: Country-by-country reporting Country-by-country reporting: What happened Reporting required by MNCs with revenue of Euro 750 million or more To be implemented for fiscal years beginning on or after 1 January 2016 Generally to be filed in country of tax residence of ultimate parent entity and shared with other countries through automatic exchange of information Aggregate country information on revenues, profits, cash taxes, accrued taxes, stated capital, accumulated earnings, employees and tangible assets Status Approximately 44 jurisdictions have adopted or have legislation in draft to adopt CbC reporting Approximately 29 jurisdictions have adopted or have legislation in draft to adopt notification requirements, with the first requirements due on December 31, 2016 for Denmark, Ireland and Spain Approximately 57 jurisdictions have signed the Multilateral Competent Authority Agreement for the automatic exchange of CbC reports Page 6

7 CbC report What it is: A new information reporting requirement, required for fiscal years starting in 2016, in the form of a table showing data, aggregated by country, on an MNC group s revenues, profits, taxes, assets and employees. Table is to be shared with all countries where MNC operates. Master file Local file CbC report What it is not: Not intended as a substitute for a full transfer pricing analysis. Also not intended for use in making formulary apportionment-based adjustments. Preparing for CbC reporting Why this is an early focus: Because of the complexities involved with cross-border transactions and data collection and management, many companies should begin preparing now by testing and validating processes and technologies. This allows time to take mitigating steps e.g., ensuring profit margin consistency and minimizing potential controversy. Page 7

8 R & D Holding or managing IP Purchasing or Procurement Mfg or production Sales, marketing or distri. Admin., Mgmt or support services Provision of services to unrelated parties Internal group finance Regulated financial services Insurance Holding shares or other equity instruments Dormant Other Country-by-Country Report Detailed information about MNE s local business, including related party payments and receipts for products, services, royalties, interest, etc. High level information about jurisdictional allocation of profits, revenues, employees and assets. Tax Jurisdiction Unrelated party Revenues Related party Total Profit (loss) Before Income Tax Cash Tax Paid (CIT and WHT) Current Year Tax Accrual Stated capital Accumulated earnings Tangible Assets other than Cash and Cash Equivalents Number of Employees Tax Jurisdiction Constituent Entities resident in the Tax Jurisdiction Tax Jurisdiction of organization or incorporation if different from Tax Jurisdiction of Residence Main business activity(ies) Page 8

9 Where is your organization? Phase 3 Phase 1 Assessment Country-by-Country Reporting Assessment Tool Data mapping Systems gap analysis Assess existing reporting suitability Road map, timeline and business case Implementation Solution design utilizing Country-by-Country Reporting Management Suite Tax sensitization Data gathering Analytics and reporting Controls Phase 2 Workflow solution Reporting Preparation and maintenance of reports with audit trail Consistency among master and local files and country-bycountry reporting outputs High level of finance and tax coordination Operational compliance management Page 9

10 Country-by-Country Report Key data points: Current understanding of definitions Related party revenue Income tax accrued (current year) Includes: related party revenues from net sales revenues, services fees, royalties income, interest and other finance income Excludes: intercompany dividends and gains on disposal of assets (unless that is part of the entities general operations) Use Transfer Pricing Guidelines definition of associated to determine related parties Unrelated party revenue Includes: unrelated party revenues from net sales revenues, services fees, royalties income, interest and other finance income Excludes: gains on disposal of assets (unless that is part of the entities general operations) Profit (loss) before income tax Earnings (profit or loss) before income tax for tax purposes, including extraordinary items For the sake of consistency when analyzing profit margins, intercompany dividends received should be excluded. Income tax paid Amounts paid by the reporting entity to the residence tax jurisdiction and all other tax jurisdictions, as well as taxes withheld by other entities on income received by the reporting entity The tax charge in the P&L relating to the current year Should not include deferred taxes or provisions for uncertain liabilities Stated capital Sum of the stated capital for all reporting entities Accumulated earnings Sum of all accumulated earnings for all reporting entities as of the end of the year Number of employees The total number of employees on a full-time equivalent (FTE) basis May be reported based on year-end number, average employment levels for the year, or on any other basis consistently applied across countries and from year to year Include full-time equivalent independent contractors Tangible assets other than cash & cash equivalents Includes: tangible assets such as plant, property, machinery, fixtures and fittings, computer equipment and inventory Excludes: cash and cash equivalents and financial assets Treatment of software would depend on group treatment (i.e., sometimes a tangible asset sometimes an intangible) Page 10

11 BEPS Current Issues Page 11

12 Action 13 Current Issues Matrix Country-by-Country Reporting ( CbC ) CbC Required Threshold for CbC Due Date Penalties Notification Requirements Ultimate Parent Entity Surrogate Parent Entity Constituent Entity Notification Date Master file / Local file ( MF/LF ) MF/LF Required Threshold for MF/LF MF/LF requirements different from those outlined in Action 13 Due Date (if no MF/LF is required, then the due date corresponds to the date of local TP documentation within that specific country) Due date for FY2016 (FYE: December 31, 2016) Penalties Page 12

13 The latest on BEPS OECD s Additional Guidance The OECD released additional guidance on April 6, 2017 covering the following: 1) Issues relating to the definition of items reported in the template for the CbC report 2) Issues relating to the entities to be reported in the CbC report 3) Issues relating to the filing obligation for the CbC report 4) Issues relating to the sharing mechanism for the CbC report (EOI, surrogate filing and local filing) Page 13

14 OECD s Additional Guidance Definitions Revenues Extraordinary income and gains from investment activities are to be included in "revenues Related parties For the third column of Table 1 of the CbC report, the related parties, which are defined as associated enterprises in the Action 13 report, should be interpreted as the Constituent Entities ( CE ) listed in Table 2 of the CbC report Page 14

15 OECD s Additional Guidance Definitions The Related Parties reflected in Table 1 correspond to the Constituent Entities reflected in Table 2 Page 15

16 OECD s Additional Guidance Entities to be reported in the CbC report 1) Determining the existence of and membership of a group Page 16 The guidance specifies that a group can use the consolidation rules of accounting standards already used by the group if the equity interests of the UPE are traded on a public securities exchange Other options are provided for in cases where equity interests of the UPE are not publicly traded, here jurisdictions may allow the MNE to choose to use either local GAAP of the jurisdiction of the UPE or the IFRS as its governing accounting standard 2) How to apply CbC rules to investment funds Governing principal is to follow the accounting consolidation rule 3) How to treat a partnership which is tax transparent (no tax residency) Governing principal is to follow the accounting consolidation rule (rules that would apply for partnerships) If the entity is not a tax resident and not a PE, the entity should be included in a line for Table 1 and 2 for stateless entities Where the partnership is a UPE, to determine where to file, use the jurisdiction under whose laws the partnership was formed (if there is no jurisdiction for the tax resident)

17 OECD s Additional Guidance Entities to be reported in the CbC report 4) Minority interests held by unrelated parties in a CE: (i) to determine 750 million threshold, do you include 100% of CE revenue or pro-rata; and (ii) do you include 100% of CE financial data in CbC report or pro-rata If accounting rules in the jurisdiction of the UPE require a CE to be fully consolidated then 100% of the CE s revenue should be included If 100% of the CE s revenue is included in (i) then 100% of the CE s financial data should be included in the CbC Report Page 17

18 OECD s Additional Guidance The filing obligation for the CbC report 1) Impact of currency on 750 million filing threshold If Country A is using a domestic currency equivalent of EUR 750 million for its filing threshold, Country B is using EUR 750 million for its filing threshold, and as a result of currency fluctuations Country A's threshold is in excess of EUR 750 million, can Country B impose its local filing requirement on a Constituent Entity of an MNE Group headquartered in Country A which is not filing a CbC report in Country A because its revenues, while in excess of EUR 750 million, are below the threshold in Country A? Provided that the jurisdiction of the Ultimate Parent Entity has implemented a reporting threshold that is a near equivalent of EUR 750 million in domestic currency as it was at January 2015, an MNE Group that complies with this local threshold should not be exposed to local filing in any other jurisdiction that is using a threshold denominated in a different currency Page 18

19 OECD s Additional Guidance The filing obligation for the CbC report 2) To determine total consolidated group revenue for the threshold test, do you include extraordinary income and gains from investment activities Yes, if those items are presented in the UPEs consolidated financial under the applicable accounting rules Page 19

20 OECD s Additional Guidance Sharing mechanism for the CbC report 1) Can MNE Groups with an Ultimate Parent Entity resident in a jurisdiction whose CbC reporting legal framework is in effect for Reporting Periods later than 1 January 2016 voluntarily file the CbC report for fiscal periods commencing on or from 1 January 2016 in that jurisdiction? What is the impact of such filing on local filing obligations in other jurisdictions? Gives rise to a transition issue. Jurisdictions that are not be able to implement CbC from 1 January 2016 may be able to accommodate voluntary filing for UPE residents in their jurisdiction. This is referred to as parent surrogate filing since it is a form of surrogate filing and the framework is set out in the Action 13 Report No impact re: local filing obligations (subject to 5 conditions) Following jurisdictions have confirmed that they will have parent surrogate filing available for UPE residents in their jurisdictions: Hong Kong & China Japan Liechtenstein Nigeria Russian Federation Switzerland United States Page 20

21 Upcoming Deadlines Action 13 Country Documents Due Date(s) CbCR Notification deadline: April 30, 2017 MF: December 31, 2017 LF: July 1, 2017 Sweden Finland CbCR, LF CbCR, MF/LF Prepared at the time of the submission of the annual income tax return. In terms of Sweden local TP doc, final documentation should be available upon request from the Swedish Tax Agency. Such a request is possible from the date the income tax return is filed. CbCR Notification deadline: May 31, 2017 MF / LF deadline: Within 60 days of a request by the tax authorities, but not earlier than six months after the end of the financial period (for example, deadline is June 30 assuming a Dec 31 year end) Portugal CbCR CbCR Notification deadline: May 31, 2017 Page 21

22 Upcoming Deadlines Action 13 Country Documents Due Date(s) China MF/LF, CbCR CbCR: To be filed together with the annual tax return (due 31 May). MF/LF deadline: Upon request. MF should be ready within 12 months after the close of the financial year of the ultimate parent company. LF should be ready before 30 June of the following year (assuming Dec 31 year end). Indonesia Colombia MF/LF, CbCR CbCR Caveat: If the UPE is filing in another country, don't have to follow China's CbCR deadline CbCR: Must be filed along with the corporate income tax return. MF/LF deadline: 4 months after fiscal year end CbCR Notification deadline: May 31, 2017 MF/LF deadline: July 1, 2017 Turkey MF/LF MF/LF deadline: July 25, 2017 Page 22

23 BEPS Action 10 Commodity Transactions Page 23

24 Action 10 Transfer Pricing for other high risk transactions: Commodity Transactions The use of the CUP method for pricing commodity transactions and the use of quoted prices in applying the CUP method is recommended CUP method would generally be the most appropriate transfer pricing method for determining the arm s length price for controlled commodity transactions The arm s length price for the controlled commodity transaction can be determined, not only by reference to comparable uncontrolled transactions, but also by reference to a quoted price. The term quoted price refers to the commodity price in the relevant period that is obtained from an international or domestic commodity exchange market. A quoted price also includes prices obtained from recognized and transparent price reporting, statistical agencies or from governmental price-setting agencies, where such sources are used as a reference by unrelated parties to determine prices. A relevant factor in determining the appropriateness of using a quoted price is the extent to which such price is widely and routinely used in the industry to negotiate prices between third parties. For the CUP method to be reliably applied, the economically relevant characteristics of the controlled transactions and the third party transactions represented by the quoted price need to be comparable. Page 24

25 Action 10 Transfer Pricing for other high risk transactions: Commodity Transactions The economically relevant characteristics that need to be considered to establish comparability include: Physical features and quality of the commodity The contractual terms of the controlled transaction, such as volumes traded, period of the arrangements, timing and terms of delivery, transportation, insurance, and foreign currency terms Certain economically relevant characteristics may lead to either a premium or a discount. Adjustments should be made to ensure that the economically relevant characteristics of the transactions are comparable. The final guidance includes the very important statement that when applying a CUP, contributions made in the form of functions performed, assets used and risks assumed by other entities in the supply chain should be compensated in accordance with the guidance provided in the TP Guidelines. Although the remuneration of other parties in the value chain in practice can be significant, limited guidance is provided on how to apply this in practice. Page 25

26 Action 10 Transfer Pricing for other high risk transactions: Commodity Transactions Deemed pricing date for commodity transactions When using quotations to price the commodity transaction, the pricing date is a particularly relevant factor. When the taxpayer can provide reliable evidence of the pricing date agreed in the controlled transaction at the time the transaction was entered into and this is consistent with the actual conduct of the parties, the tax administrations should determine the price for the commodity transaction by reference to the pricing date agreed by the associated enterprises. If the pricing date agreed by associated enterprises is inconsistent with the actual conduct of the parties or with other facts of the case, tax authorities may determine a different pricing date consistent with the evidence provided by those other facts. In the absence of reliable evidence of the actual pricing date agreed by the associated enterprises, tax administrations may deem the pricing date for the commodity transaction to be the date of shipment as evidenced by the bill of lading or equivalent document. Page 26

27 Assessing risk in your existing operating model given BEPS Page 27

28 Actions 8 10 Aligning transfer pricing outcomes with value creation Six interlinked sections all of which impact risk management Guidance for applying the arm s-length principle Guidance on commodity transactions Guidance on the transactional profit split method Guidance on intangibles Guidance on low value-adding intra-group services Guidance on cost contribution arrangements Page 28

29 Actions 8 10 Summary Assure that transfer pricing outcomes are in line with value creation Action 8: Intangibles Action 9: Risk and Capital Action 10: Other high-risk transactions Wider and clearer definition of intangibles Introduction of a six step framework to analyse transfer pricing aspects of intangibles Legal ownership alone does not generate a right to the return generated by the exploitation of an intangible Focus on Development, Enhancement, Maintenance, Protection and Exploitation ( DEMPE ) functions Hard-to-Value Intangibles ( HTVIs ) Cost-Contribution Arrangements ( CCAs ) Focus on conduct of parties and their capability and functionality to manage risks. Assumption of risk without control over that risk is likely to be problematic Separate consideration regarding an appropriate return to any cash investment Introduction of a six step framework to analyse risks for transfer pricing purposes Intra-group services / low valueadd services Profit Splits (additional discussion draft issued in 2016) Recognition of transactions Commodity transactions Page 29

30 Actions 8 10 Revisions to Section D of Chapter I of the TP guidelines following Actions 9 and 10. Key guidance includes: Guidance for applying the arm s-length principle Assess reasonableness of transfer pricing based on the actual conduct of the parties versus contractual terms and conditions Detailed guidance six-step approach on analyzing risks as integral part of a functional analysis Cash boxes will attain no more than a risk-free return at best In exceptional circumstances of commercial irrationality, a tax administration may disregard the actual transaction Areas for immediate risk assessment Shift from the legal form to the economic reality of a transaction: where the economically relevant characteristics of a transaction are inconsistent with contractual terms, the actual transactions should in general be identified based on conduct of parties Contractual allocation of risk without sufficient control will not be regarded at arm s length Page 30

31 Actions 8 10 Guidance on commodity transactions Framework for the analysis of commodity transactions from a transfer pricing perspective Clarifications on the application of the CUP method for commodity transactions Guidance regarding the pricing date Guidance on the transactional profit split method ( PSM ) Confirms the use of the PSM as appropriate to align profits with value creation Outlines the revised scope of further work to be completed Draft guidance to be developed by WP6 in 2016 and finalized in 2017 Areas for immediate risk assessment Expectation that quoted prices will increasingly be used to determine the transfer pricing for commodity transactions Profit splits may be used to divide residual income after paying a cost plus remuneration to limited function entities using production capacity, headcount and value of production to split Page 31

32 Actions 8 10 Section A: Defining intangibles for TP purposes Intangible definition unchanged from 2014 Report new definition for marketing intangibles Section B: Ownership of intangibles and transactions involving DEMPE Mere legal ownership does not by itself confer any right to the return from its exploitation Economic return from IP and costs will be allocated to entities that perform and control the DEMPE functions Functional management, as well as contractual assumption, of risk required to allocate financial consequences of risk-bearing to an enterprise Section C: Transactions involving the transfer of intangibles Section D: Supplemental guidance on pricing intangibles transactions Guidance on intangibles Guidance on how to determine arm s-length conditions for intangibles transactions unchanged New definition of Hard to Value Intangibles (HTVIs) Allowance for tax administrations to use ex-post evidence for evaluating ex-ante pricing arrangements Page 32

33 Actions 8 10 Guidance on intangibles Areas for immediate risk assessment DEMPE functions who is entitled to any intangible related return? Legal ownership and funding the development of an intangible alone insufficient for full return on intangibles exploitation Legal owners who outsource key DEMPE functions not entitled to (all) IP returns If DEMPE contributors are remunerated on a one-sided basis, reliability of transfer pricing reduced Allows for a risk-adjusted rate of return to pure funders, but funder must manage the financial risks Need to align IP with DEMPE functions More focus on substance, comparability and functionality and documentation (legal agreements) Page 33

34 Key risk areas for operating models involving IP Potential reporting and transactional mapping errors Accounting, billing, reporting processes may need adjusting ERP systems may need reconfiguring Business processes and KPIs may need redefining and documenting Reputational risk arising from media coverage Increased audit scrutiny Failure to comply with substance requirements that underpin tax rulings resulting in reallocation of profits via transfer pricing (TP) adjustments between operating model legal entities Lack of supporting documentation business process manuals, TP documentation, ways of working, governance to support TP methodology/profit allocation Repayment of multiple years of tax benefits if illegal EU State Aid Failure to comply with local country filing requirements including PE/VAT Under declaration and payment of income tax and/or VAT interest and penalties Page 34

35 The impact of BEPS on IP structures High Offshore Cash box IPCo Plus Regular, substantive Board of Directors meetings Potential IP or risk management committee or branch operations Funding of IP Decisions made remotely from IPCo Offshore IPCo with limited functions Tax risk Onshore IPCo with limited functions Plus Management of all relevant commercial risks, including active oversight of IP development, protection and exploitation Plus Tax resident IP owner (e.g., entitled to amortization) Local management of certain functions, such as supply chain operations or regional sales Onshore IPCo with commercial risk management functions Low Low Post-BEPS profit attribution High Offshore IPCo refers to an entity that is located in a tax haven or otherwise not a tax resident. Page 35

36 In the Courts Page 36

37 Trends in transfer pricing cases Significant Canadian disputes in the courts include: Cameco - $2.2 billion CRA reassessment Silver Wheaton - $600 million CRA reassessment Cameco CRA challenged the sale of uranium to a related party in Switzerland, for a fixed 17 year term at $10 US a pound approximately the spot price at the time the contract was signed The price spiked to approximately $130 a pound in 2007 and trades at approximately $30 currently The CRA has challenged whether arm s length parties would have entered into this type of agreement and has put profits back into Canada Page 37

38 Trends in transfer pricing cases Silver Wheaton (see more in the deck below) CRA challenged the use of related party special purpose entities to enter into streaming contracts, contending that all the value of the contracts was created in Canada and not in Barbados and the Cayman Islands The CRA re-characterised the inter-company transactions and placed the revenue streams from the various streaming contacts back to the Canadian legal entity resulting in an approximate $600 million reassessment Also, shareholders of the company are understood to have filed a class action lawsuit claiming that Silver Wheaton failed to properly disclose information of the tax structure in its annual financial report As part of the law suit, three senior executives are also understood to have been named Page 38

39 Chevron Australia Holdings v Commissioner (2017) Australian case Page 39

40 Chevron Australia Holdings v Commissioner (2017) Australian case Facts and issue CAHPL is indirectly wholly-owned by Chevron Corporation (CVX), a US-based oil and gas company listed on the New York Stock Exchange. CAHPL effected an internal refinancing, including to fund CAHPL's acquisition of Texaco Australia Pty Ltd, by entering into a 'Credit Facility Agreement between CAHPL and its US subsidiary Chevron Texaco Funding Corporation (CFC), established for the sole purpose of raising money through the issue of commercial paper in the US Under the Credit Facility Agreement, CFC on-lent these funds to CAHPL at an interest rate of approximately 9% and CAHPL drew down, on two separate occasions, a total of the Australian dollar equivalent of US$2.45 billion The Credit Facility Agreement was not consistent with the Chevron external financing borrowing policy i.e. no security provided. In addition, there was no guarantee in respect of the loan CAHPL claimed tax deductions in Australia for the interest it paid to CFC. The income it received from CFC, by way of dividends, was treated as non-assessable non-exempt income. Thus, CAHPL reduced its Australian taxable income through the deductions claimed, whilst CFC made significant profits which were not taxed in either the US or Australia. The issue whether the interest paid by CAHPL to CFC exceeded an arm s length price for the borrowing. Page 40

41 Chevron Australia Holdings v Commissioner (2017) Australian case Findings and implications On 21 April 2017 the Full Federal Court (Court) delivered its judgement. The Court concluded that, when considering the interest rate applicable to a borrowing from a related company, it was reasonable to assume that, in a hypothetical arm s length scenario, the ultimate parent company would have provided a security and covenants to the loan arrangement and the arm s length interest rate should be assessed on the basis of such a guarantee being in place, thus resulting in a lower interest rate. Thus the borrower was not treated as a stand-alone/orphan company. Chevron may apply for special leave to appeal to the High Court. Page 41

42 McKesson (2013) Tax Court of Canada (seminal case) Page 42

43 McKesson (2013) Tax Court of Canada (seminal case) Facts MCC is the principal Canadian operating company and the indirect wholly owned subsidiary of McKesson Corporation (McKesson US), the largest United States public health care company. The McKesson corporate group specializes primarily in the wholesale distribution of above-the-counter pharmaceutical and medical products The group accounted for roughly one-third of the US and Canadian pharmaceutical distribution market shares during McKesson s customers in the United States and Canada include pharmacies, grocery and department store chains, hospitals, as well as health and long-term care institutions The disputed factoring transaction was originally put in place on 16 December 2002, when MCC sold all of its eligible third-party trade receivables (approximately $460 million) to MIH under a five-year intercompany factoring contractual arrangement consisting of the Receivables Sales Agreement (RSA) and an accompanying Servicing Agreement. Under the RSA, MCC sold eligible trade receivables to MIH daily at a specified discount from the receivables face value Under the Servicing Agreement, MCC was retained as a service provider to MIH and was responsible for performing day-to-day monitoring, collection and recording activities associated with the factored receivables Page 43

44 McKesson (2013) Tax Court of Canada (seminal case) Facts The total face value of outstanding factored accounts receivable remained above the minimum initial contractual limit of $460 million during FY2003 The RSA included a provision whereby MIH had the right to return the unpaid bad receivables to MCC at a 25% discount, which would later be adjusted downward to the amount actually collected by MCC This provision effectively shifted the liquidity risk of non-performing receivables from MIH back to MCC, but did not protect MIH from default risks on non-performing receivables The RSA also gave MIH early termination rights which it could exercise in specified circumstances, including the actual or anticipated material deterioration in the credit-risk quality of MCC and the factored receivables MIH borrowed all funds from one of its Irish indirect parent entities to finance its purchases of factored receivables. This loan was fully guaranteed by another Luxembourg indirect parent entity Page 44

45 McKesson (2013) Tax Court of Canada (seminal case) Facts and Issue During FY2003, MCC sold its receivables at the 2.206% contractual discount from the receivables face value, which amounted to an annualized effective rate of roughly 27%, given the receivables average of approximately 30 days outstanding The discount rate under the RSA was calculated as the sum of three components, a Yield Rate, a Loss Discount and a Discount Spread The Yield Rate, intended to reflect a baseline risk-free borrowing rate, was set equal to the 30-day CDOR interest rate The Loss Discount, intended to reflect the risk of non-payment by obligors, was fixed in the RSA at the weighted average rate of 0.23% for FY2003, subject to an annual recalculation, although MIH had the option to request recalculation on a monthly basis In its transfer pricing audit of MCC s FY2003 factoring transactions, the CRA challenged that the discount rate on the receivables sold by MCC to MIH was greater than the rate that would be provided to MIH in an arm s-length factoring transaction Page 45

46 McKesson (2013) Tax Court of Canada (seminal case) Finding For the Yield Rate, the Court accepted that the annual CDOR rate, adjusted to reflect the much shorter period over which receivables would be collected (referred to as Days Sales Outstanding, or DSO), was appropriate. However, the Court concluded that DSO should be floating, recomputed every three or four months, rather than fixed at days for the entirety of the RSA The Court also concluded that DSO for the original $460 million of receivables purchased on 16 December 2002 should not have been averaged over the entire fiveyear term of the RSA. The Court concluded that the appropriate DSO was 30 days throughout FY2003 (based on a four-month rolling average). Page 46

47 McKesson (2013) Tax Court of Canada (seminal case) Implications In interpreting Section 247 of the Act, the Court reiterated the importance of performing adjustments to account for material differences between intercompany contractual terms and conditions and the terms and conditions that arm s-length parties would normally agree to. Under paragraphs 247(2)(a) and (c), the Court is not limited to adjusting amounts, but can revise the terms and conditions to conform to what arm s-length parties would have agreed to. The Court specifically commented that there was no compelling reason to depart from the Supreme Court of Canada s approach and comments in seminal Canadian case GlaxoSmithKline: arm s-length persons should generally be assumed for purposes of section 247 to act neither irrationally nor unreasonably and should be expected to transact for products and services at amounts within the range of their fair market value having regards to all relevant circumstances. Page 47

48 General Electric Capital (2009) Tax Court of Canada (seminal case) Page 48

49 General Electric Capital (2009) Tax Court of Canada (seminal case) Facts During the years under appeal, General Electric Capital Canada Inc. (GE Capital, or, taxpayer) was a financial services company that carried on a number of businesses in Canada, including equipment, vehicle and real estate financing and technology management services GE Capital was a wholly-owned, indirect subsidiary of General Electric Capital Corporation (GECUS), a US corporation The taxpayer financed its operations by borrowing funds from capital markets through the issue of debt in the form of commercial paper and unsecured debentures GECUS began guaranteeing the taxpayer's debt in 1988, but only started charging guarantee fees calculated at a rate of 1% per annum of the principal amount of debt outstanding, in 1995 Page 49

50 General Electric Capital (2009) Tax Court of Canada (seminal case) Finding The Court allowed the taxpayer's appeal and vacated all of the Minister's assessments. The Court rejected the taxpayer's argument that the taxpayer's credit rating had to be determined on a stand-alone basis In reaching this conclusion, the Court considered relevant authorities on the meaning of arm's length and concluded that the concept refers to "how independent parties negotiating with each other in the marketplace would behave for the purpose of achieving the best terms" in respect of the purchase or sale of goods and services (para. 196). In this context, the "implicit support" of the parent company could not be ignored In determining the arm's-length price, the Court considered significant expert advice. These experts articulated that there were three alternative models that could be utilized to determine the arm's-length guarantee fee that would apply to the tested transactions, namely (i) the yield approach, (ii) the insurance approach and (iii) the credit default swap approach Page 50

51 General Electric Capital (2009) Tax Court of Canada (seminal case) Finding (cont d) The Court accepted that the "yield" approach put forward by the Crown to assess the guarantee's value was the most appropriate; however, it determined that the proper application of this approach, in consideration of the facts and circumstances of this case, favoured the taxpayer The Court concluded that the taxpayer's final credit rating without explicit support would be in the range of BBB-/BB+, significantly below AAA (the rating achieved with the guarantee in place), and one to two notches higher than the stand-alone credit rating (BB) excluding implicit support from GECUS. The interest cost savings to the taxpayer based on the differential between BBB-/BB+ and AAA was determined to be approximately 1.83% (based on one of the expert reports). Therefore, the 1% guarantee fee was found to be below an arm's length price in the circumstances. Page 51

52 General Electric Capital (2009) Tax Court of Canada (seminal case) Implications The "GE case has far reaching implications for multinational companies operating in Canada The decision in this case arguably challenges the Organisation for Economic Cooperation and Development's (OECD's) interpretation of the arm's-length principle. The decision may impact many aspects of the transfer pricing practice in Canada and beyond the narrow subject matter of financial guarantees between related entities, such as: Changes to OECD definition of "arm's length" Endorsement of yield approach for financial guarantee fees Endorsement of "halo" effect for financial guarantee fees Identifying the existence of implicit support is only the first step. The second step is to determine how much that implicit support is worth. In the present case, the judge decided that a third-party insurer would not attach much value to implicit support of a parent company. Facts and circumstances are paramount Page 52

53 Silver Wheaton Corporation and HMTQ, Court File No (IT)G case yet to be determined Page 53

54 Silver Wheaton Corporation and HMTQ, Court File No (IT)G case yet to be determined Understanding of Facts ("Silver Wheaton Canada") has foreign subsidiaries that enter into long-term contracts to purchase precious metal (in particular, silver and gold) in respect of mines located outside of Canada. Those foreign subsidiaries earned profits from the sale of precious metal acquired under such contracts. In reassessments under the Income Tax Act, RSC 1985 c. 1 (5th Supp.), (the "Act"), the Minister of National Revenue (the "Minister") has effectively: Issue (a) disregarded the existence of the foreign subsidiaries, (b) taxed the profits of the foreign subsidiaries as though they were taxable income of Silver Wheaton Canada, and (c) levied associated transfer pricing penalties. The issue in this appeal is whether the reassessments are correct Page 54

55 Silver Wheaton Corporation and HMTQ, Court File No (IT)G case yet to be determined Taxpayer s position In the Reassessments, the Minister, relying on paragraph 247(2)(d) or alternatively paragraph 247(2)(c) of the Act, attributed to Silver Wheaton Canada substantially all of the profits earned by Silver Wheaton Cayman and Silver Wheaton Luxembourg from the sale of precious metal they acquired under their Precious Metal Purchase Agreements M respect of foreign mines The object of subsection 247(2) is to require arm's length pricing for any transaction or series of transactions in which a taxpayer and a non-resident person with whom the taxpayer does not deal at arm's length are participants The only transactions relevant to this appeal in which Silver Wheaton Canada and a non-arm's length non-resident were participants were the provision of services by Silver Wheaton Canada to Silver Wheaton Cayman for fees The Minister's primary basis for those income inclusions is paragraph 247(2)(d), which applies when the conditions of paragraph 247(2)(b) are met Those conditions are met if a transaction or series of transactions in which a taxpayer and a non-arm's length non-resident are participants Page 55

56 Silver Wheaton Corporation and HMTQ, Court File No (IT)G case yet to be determined CRA s position The Transactions would not have been entered into by arm's length parties The Transactions can reasonably be considered not to have been entered into primarily for bona fide purposes other than to obtain a tax benefit, namely the reduction of Canadian income tax, which was achieved by having SW Caymans instead of SW Canada enter into the precious metal purchase agreements ( PMPAs ) in respect of mines located outside of Canada so that income from the sale of Precious Metal would be reported outside of Canada Page 56

57 DSG Retail Ltd v HMRC (2009) U.K. case Page 57

58 DSG Retail Ltd v HMRC (2009) U.K. case Undertsanding of Facts Dixons offered its customers, at point of sale, the opportunity to purchase extended warranty for replacement repair beyond the normal manufacturer s warranty Following the take-over of Currys by Dixons, the DSG group entered into an arrangement with Cornhill, a third-party insurer, whereby in-store personnel would arrange warranty insurance policies for customers with Cornhill Cornhill entered into a separate administration and repair contract arrangement with another DSG company Cornhill reinsured 95% of the risk with another DSG company, DISL (a wholly owned group company resident in the Isle of Man) and, accordingly, 95% of Cornhill s premium income was ceded to DISL Subsequently, the rate of applicable insurance premium tax (IPT) increased, and in response, the DSG Group came up with non-insurance-based contracts would be entered into instead of policies with consumers. ASL, an Isle of Man intermediary, subsequently became a third-party insurance broker ASL entered into an administration and repair arrangement with a DSG group company and reinsured 100% of its risk with DISL Page 58

59 DSG Retail Ltd v HMRC (2009) U.K. case Issue According to the HMRC, a benefit had been conferred upon DISL that would not have occurred had the parties been operating on an arm s-length basis The HMRC argued that the insurance/service warranty contracts between customers and independent third parties only occurred given the back-to-back arrangements with DISL. In this manner Cornhill, and the Isle of Mann intermediary, ASL, were mere conduits Page 59

60 DSG Retail Ltd v HMRC (2009) U.K. case Finding Even if no evidence about the level of risk to which DISL was exposed was agreed upon, the Special Commissioners found that DISL was extremely profitable HMRC s expert stated that where competition exists, eventually it will force higher returns down to a normal market level; however, if economic profits of this nature arise due to a lack of competition, these will be distributed between the parties according to the ability of each party to protect itself from normal competitive forces. The Special Commissioners found that DSG bore almost all the long-term bargaining power The point of sale advantage particularly gave DSG this ability, given DSG was the largest electrical goods retailer in the UK, in addition to the low cost of switching insurers, its access to data on past claims, and the fact that it possessed no need for an external brand to support its warranties In contrast, DISL was entirely dependent on the DSG group for its business. Overall, the Special Commissioners considered DISL possessing merely routine know-how, which DSG was able to procure for itself As such, DISL was entitled only to routine market return on economic capital All CUPS DSG put forward to support the commission received were rejected for market conditions and product characteristics Page 60

61 DSG Retail Ltd v HMRC (2009) U.K. case Finding (cont d) Furthermore, having rejected the CUP method, the Special Commissioners held that the appropriate method was the profit split, and that this should be based upon the capital asset pricing model used for calculating a return on capital The appropriate profit split would give the insurance company a return on its capital, but give the majority of the profit to the retailer for its intangibles Implications Increased scrutiny of financial services transactions Negotiating power may need to be be considered From an economic analysis perspective, there is high threshold of comparability required when CUPs are relied upon, especially if the profits cannot immediately be explained Where complex transactions appear to obscure the underlying economic reality, the profit split method approach would be appropriate Specific facts and circumstances need to be considered Page 61

62 Discussion and Questions? Page 62

63 Disclaimer 2017 Ernst & Young LLP. All rights reserved. This presentation contains information in summary form, believed to be current as of the date of publication, and is intended for general guidance only. It should not be regarded as comprehensive or a substitute for professional advice. Before taking any particular course of action, contact EY or another professional advisor to discuss these matters in the context of your particular circumstances. We accept no responsibility for any loss or damage occasioned by your reliance on information contained in this presentation. Page 63