Value Chain Analysis. Roadmap to Being in Control

Transcription

1 JULY 2017 Reproduced with permission from BNAI European Tax Service Monthly Digest, Bloomberg BNA, 07/31/2017. Copyright 姝 2017 by The Bureau of National Affairs, Inc. ( )

2 Value Chain Analysis after BEPS The Roadmap to Being in Control Steef Huibregtse, Raymund Gerardu and Avisha Sood TPA Global Network, Amsterdam As Value Chain Analysis is now a mandatory part of the annual TP documentation exercise of MNEs, it can also serve as a pre-emptive tool to assess and mitigate (potential) risk areas. This enables the MNEs to move from staying out of trouble to being fully in control. Steef Huibregtse is the CEO and the Founding and Managing Partner, Raymund Gerardu is the CFO and the Managing Partner and Avisha Sood is an Associate of TPA Global, Amsterdam. Value Chain Analysis ( VCA ) has its origin dating back to 1985, when Michael Porter first introduced it in his book titled Competitive Advantage. In simplest of terms, VCA refers to the entire performance process of a company, which begins with the research and development and ends with the delivery to the end consumer. Value chain of a company takes into account all support and core activities carried out by related or unrelated parties in making the company function. See below a simplistic model of a value chain. From its conception as an area of interest for economists, VCA has gained the interest and attention of many. This is especially true in light of the latest regulations governing Base Erosion and Profit Shifting ( BEPS ). The latter is providing additional regulations in the area of related party transactions within multinational enterprises ( MNEs ), which accounts for the majority share of global trade. It is whilst interpreting the arm s length nature of related party transactions and ensuring that they are aligned with the MNE s operating, strategic and governance models, that the concept of VCA becomes a boardroom agenda item. Corporate Governance Perspective of Looking at a VCA OECD s Forum on Tax Administration ( FTA ) first conceptualized the idea of achieving an enhanced re- 2 07/17 Copyright 2017 by The Bureau of National Affairs, Inc. TPETS ISSN

3 The traditional view of the value chain was developed by Michael Porter: Support Processes Firm Infrastructure Human Resource Management Technology Development Inbound Logistics Operations Outbound Logistics Marketing Sales Service & After Sales Support Primary Processes Traditional view is predominantly focused on internal processes, similar to the current concept of supply chain management lationship between tax administrations and large business taxpayers during its meeting in Seoul in An aggressive attitude towards tackling all such arrangements is visible across the globe not only in the eyes of the tax authorities but also the general public. Examples include, Apple and Google arriving at effective tax rates of less than 5 percent on their non-u.s. income. This is why the traditionally clear line between tax avoidance and tax evasion is blurred and why governments as well as the public at large are insisting on the attributing of individual liability for criminal tax evasion to any responsible person within an MNE. An example of this thinning line can be seen in yet another dispute between Google and the French tax authority which is seeking more than 1 billion euros ($1.12 billion) from the search engine firm in back taxes. France s tax authority has been investigating Google since 2011 and is of the opinion that this high levy of tax is due to an aggressive tax evasion by the company over the years. The latest EU-member country to tighten its hold around tax evasion is Spain which is alleging the same aggravated tax fraud by Google as previously brought up by the French and Italian tax administrations. It is no surprise, that in the post-beps world MNEs are in a constant fear of arriving at disputes with the tax authorities in various countries. This fear has increased as a result of the introduction of number of new rules, which are currently subject to different interpretations by as many Tax authorities. As such, MNEs are increasingly focussing on pro-active tax risk management in an attempt to create certainty in advance and to avoid penalties and/or reputational damage. Some examples of new rules and/or approaches by different countries are listed below: s New Zealand s Inland Revenue department has proposed to implement a new standard for exchanging cross-border information about tax rulings in 2016 in respect of high-risk transactions. Transactions that are potentially scrutinized are amongst others unexplained tax losses returned by foreign-owned groups, cash pooling arrangements, payment of royalties at levels that are not sustainable, controlled foreign companies, etc. s Australian tax office has described a detailed process for case selection for an audit for companies engaged in the mining industry. s U.K. diverted profits tax is another such example enacted to curtail practices of tax avoidance and evasion. CFO s Perspective on Tax From a Chief Financial Officer s ( CFO ) perspective, tax structures should allow for: s easy entry; s easy exit; and s no reputational risk. Until 2015 tax often operated in silos, e.g. international tax versus transfer pricing compliance, whereas during 2015 and 2016, the BEPS project effectively integrated international tax and transfer pricing and pushed economic reality to be prevailing. This led to VCA being used by tax authorities and MNEs to comply with the increasing demand for full transparency on tax sensitive data. Thus, a holistic approach to taxation by MNEs is a must-have. The following visual captures (in color coding) this trend, where the holistic version of the VCA must be fully synchronized with the local share of the total profit pie (as reflected in the local tax return). Since Action 13 of BEPS has pre-defined that standard forms (such as masterfile, local file, CbCR and local TP forms) need to be seen as an appendix to the local tax return, tax inspectors suddenly have the total picture of their local company. As such they have a lot of VCA relevant data points to assess tax. This transparency is unprecedented. Value Chain Analysis - Holistic Taking control of the future Corporate Income Tax Return - Transactional - Master file - TP forms - Local file - Country-by-country Probability 10% Controversy Instruments - Disputes Negotiations Probability 5% Courts - Litigation Mediation In this day and age of tax disputes taking the priority in the boardroom of MNEs, the above picture captures the following trends applicable to MNEs in the post-beps world: (i) A holistic VCA supporting the intercompany TP policies of the MNE as documented in the masterfile, local country file, country-by-country report and TP forms will reduce the probability of disputes of the MNE with the tax authorities; (ii) In case a dispute with the tax authorities were to still arise, the use of controversy instruments such as APAs, negotiations, mediation etc., could further reduce the chances of such a dispute landing in the court; and (iii) Lastly, the use of controversy management instruments aligned with each step of the value chain of 07/17 Tax Planning International European Tax Service Bloomberg BNA ISSN

4 an MNE can help in defending the MNE s position in a court room in case of such a tax dispute landing in court. How to be in Control With the latest focus on VCA, being in control requires a company to align its strategy communicated to its stakeholders with operational conduct as well as their tax/transfer pricing reality. A few examples of steps involved in becoming fully in control are shown below. The following sub-sections explain how some tax authorities are, through law and regulations, making a VCA approach a part of their local TP documentation. China Perspective Regulatory Background of VCA OECD Perspective The OECD, in its BEPS project (under Actions 8, 9, 10) has opined that the VCA may be helpful in the process of determining the relevant factors to use in splitting profits, including determining the weighting of applicable profit splitting factors, in cases where more than one factor is used. A VCA should consider where and how value is created in the business operations, including in particular: (i) consideration of the economically significant functions, assets and risks, which party or parties perform the functions, contribute the assets and assume the risks, as well as whether and how the functions, assets, and risks of the parties may be interdependent or otherwise interlinked; (ii) how the economic circumstances may create opportunities to capture profits in excess of what the market would otherwise allow, such as those associated with unique intangibles, first mover advantages, or other unique contributions; and (iii) in considering where and how value is created, the analysis should also consider whether such value-creation is sustainable, for instance, whether market advantages are protected due to barriers to entry to potential competitors or the impact of valuable intangibles. On June 29, 2016, China s State Administration of Taxation ( SAT ) issued a new transfer pricing regulation Bulletin 42, that replaced sections 2 and 3 stipulated in previous TP regulation Circular 2 in relation to filling of related party transactions and contemporaneous TP documentation. Bulletin 42 also adopted the three-tiered TP documentation structure introduced by OECD BEPS Action 13, including the Master File, Local File and Country-by-Country report (which should be submitted as part of the related party transaction reporting form). The most important edit in Bulletin 42 compared to Circular 2 and BEPS Action 13 is the VCA requirement newly added to local file documentation. Bulletin 42 on VCA stipulates the inclusion of the following information into the local file: (i) Flows of business, goods and materials, and capitals within the group, including design, development, manufacturing, marketing, sales, delivery, billing and payment, consumption, after-sale service, recycling, other processes related to goods, services or other relevant underlying targets of the related party transactions and all the parties involved. (ii) Annual financial statements of each of the aforementioned parties for the immediately preceding fiscal year. (iii) Measurement and attribution of value creation contributed by location specific factors. (iv) Allocation policies and actual allocation results of the group s profits in the global value chain. On October 18, 2016, SAT issued another localized regulation Bulletin 64, which replaced the provisions in section 6 of Circulars 2 in relation to refining 4 07/17 Copyright 2017 by The Bureau of National Affairs, Inc. TPETS ISSN

5 the administration of advanced pricing arrangements ( APA ). Bulletin 64 emphasizes that the TP issue of particular concern in China include VCA and location specific advantages. Bulletin 64 stipulated the quality of VCA and analysis on location specific factors are the key factors for enterprise may be prioritized during the APA process. On March 17, 2017, the China SAT issued Bulletin 6 the Administrative Measures on Special Tax Investigation, Adjustment and Mutual Agreement Procedures. This bulletin replaced certain sections of Circular 2 in relation to TP methods and TP investigation and adjustments, also added guidance on intangibles and intra-group services. Bulletin 6 stressed the importance of location specific factors and intangibles. Bulletin 6 added the sixth function promotion ( P ) into the OECD s five functions in relation to intangibles (i.e. DEMPEP). Bulletin 6 did not provide any guidance on how to weight the six functions as such allowing more room for manoeuvring for the Chinese tax authorities to determine the weight of certain functions. As such they may have more means now to allocate more profits to the Chinese entity in the global value chain. The series of three bulletins (particularly Bulletin 42 and Bulletin 64) consistently stress the importance of VCA and location specific factors. It is clear that the China tax authority is aiming to use VCA to gain better insight into allocation of profits and allocation policies applied between related parties involved in the global value chain. Germany Perspective In 2005, the German Ministry of Finance issued a decree that stressed on the importance of a VCA in respect of preparing TP documentation and had stated that the following approach should be used to carry out a complete VCA: (i) firstly, the individual business processes for value creation within the Group must be identified; (ii) subsequently, the relative weighting of individual business processes to the whole value chain must be determined; and (iii) lastly, an analysis should be made of the contribution of the respective Group company to the individual business processes. More recently, in 2017, the Ministry of Finance issued a revised draft of the German regulation regarding the Documentation of Profit Allocations, which states that the functional and risk analysis should include: (i) information on the taxpayer and the persons performing functions and undertaking risks (as well as any changes in the same) within the framework of the business relations; (ii) the agreed terms of the contract and the significant market and competition; (iii) the names of the persons responsible for the business relations Decisions (decision-making authority); and (iv) description of the value-added chain and presentation of the value-added. South Africa Perspective In December 2016, South Africa s Minister of Finance published regulations implementing country-bycountry reporting, which closely follow the OECD s implementation guidelines. This, despite the fact that South Africa was one of a group of emerging market countries which argued for additional disclosure of transactional data on interest, royalty and service fee payments as part of BEPS Action 13. However, the South African Revenue Service ( SARS ) will have access to this additional information. It has included a number of additional questions in the tax return and requires disclosure of the value and jurisdiction of cross-border payments and receipts in a variety of transaction categories. South Africa has recently issued a draft public notice to introduce a filing requirement for TP master file and local file returns, although this notice is yet to be commented upon and finalised/issued before being imposed on the taxpayers. SARS has, in addition, issued a public notice setting out the duty to keep records, books of account or documents ( Public Notice ) in respect of potentially affected transactions (essentially, cross-border transactions between connected persons). The Public Notice does not contain an express requirement for a VCA, but requires companies whose potentially affected transactions exceed a specified aggregate value, to keep extensive records which would essentially allow SARS to perform a full VCA, including: (i) a summary of the business operations including a description of the business, an organogram, an industry analysis (including key value drivers) and the role of the company and its connected persons in the group s supply chain; (ii) a description of the functions performed, risks assumed and the assets employed in the potentially affected transactions, together with a description of any intangible assets involved; and (iii) operational and cash flows of the potentially affected transactions. When the information required in terms of the Public Notice is combined with country-by-country reports and the additional data from tax returns, SARS will have access to a powerful tool for detecting misalignments between a MNEs global value chain and its global profit allocations. Lessons Learned With the OECD s pressure on ensuring that a fair share of tax lands in the place of creation of value, local governments followed suit with local laws and regulations. This should put MNEs and their boards on a tax journey from staying out of trouble to being in control for which, a minimum set of steps need to be considered: s corporate governance should be read to also include corporate tax governance. This will ensure proper communication of honest, transparent and compliant conduct to all internal and external stakeholders in respect of tax and transfer pricing policies; 07/17 Tax Planning International European Tax Service Bloomberg BNA ISSN

6 s the local tax return should reflect the same legal, economic and financial reality and remuneration as reflected in the master file, local files and CbCR filed by the MNE (fully aligned compliance operations); s the financial (tax) data analytics should become an essential part of risk planning and management by the boards of MNEs; and s managing in-house challenges such as succession planning, IT and HR challenges should be considered a primary agenda point for Boards in order to create and ensure sustainable standardization and harmonization of (tax) relevant processes. This, in turn, will ensure a smooth transition on the road to success and being in control of the global tax function. Appendix Some examples of other Enterprise Risk Management efforts include: s The Volkswagen Group s responsible and forwardlooking approach to risks is supported by a comprehensive risk management and internal control system ( RMS/ICS ). This is based on the internationally recognized COSO Enterprise Risk Management Framework (Committee of Sponsoring Organizations of the Treadway Commission). It pursues a holistic, integrating approach that combines the risk management system, internal control system and compliance management system in single Governance, Risk & Compliance strategy. As a result, the RMS/ICS ensures full coverage of all potential risk areas. The central body responsible is the Group Board of Management, which is informed about risks and opportunities in connection with a wide variety of processes. The Supervisory Board s Audit Committee receives regular reports on the effectiveness of the RMS/ ICS. s The IKEA business is focussed on opportunities and Involves risk taking every day. In the IKEA Group, these risks are taken in a compliant and responsible way. Group Risk Management & Compliance leads, steers and supports the business to strengthen the IKEA values and improve the level of efficiency by Identifying, anticipating on, navigation through opportunities and risks. Together with effective monitoring and follow-up, this leads to practical business control. Risk Management & Compliance works closely together with the various management level and Provides support to ensure a safe and secure environment for visitors, customers and co-workers, strengthen the IKEA brand and protect its assets, maintain an overall risk aware culture and drive compliance activities. Steef Huibregtse is the CEO and the Founding and Managing Partner, Raymund Gerardu is the CFO and the Managing Partner and Avisha Sood is an Associate of TPA Global, Amsterdam. Special thanks to Ying van Galen-Wang (Director, TPA Global, Amsterdam), Carsten Schmid (Founding Partner, Transfer Pricing and Friends GmbH, Germany) and Jens Brodbeck (Tax Executive, ENS Africa, South Africa) for their contribution on country specific regulations relating to China, Germany and South Africa respectively. Transfer Pricing and Friends GmbH, Germany and ENS Africa, South Africa are Partners of the TPA Global Network. 6 07/17 Copyright 2017 by The Bureau of National Affairs, Inc. TPETS ISSN