Business Restructuring OECD Guidelines

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1 Business Restructuring OECD Guidelines Bipin Pawar

2 Presentation Outline Introduction Business Restructuring OECD Guidelines Questions PwC 2

3 Introduction PwC 3

4 Introduction Business restructuring, defined by the OECD TP Guidelines as the cross border deployment by a multi-national group of functions, assets, or risks. Primary reasons for restructuring: maximise synergies and economies of scale, to streamline the management of business lines, improve the efficiency of supply chain. Typically (though not always) this will result in a reduction in the affected company s profitability, and a consequent reduction in the tax base of its country of residence. As a result, tax authorities will often attempt to attach a tax liability onto this transfer (an exit charge ). PwC 4

5 Examples of Business Restructuring The transfer of manufacturing from the affected company for instance, the closure of manufacturing in India, and the commencement of manufacturing in a (perhaps lower cost) overseas territory. The conversion of the affected company from a full risk manufacturing or distribution operation to limited risk status (for instance, a contract or toll manufacturer; a limited risk distributor, agent, or commissionaire). PwC 5

6 Business Structuring OECD Guidelines PwC 6

7 OECD Guidance - TP aspects of Business Restructuring Final Report Released on 22 July 2010 (Ch.IX of TP Guidelines with 4 Parts) Guidance Special considerations for risks Arm s length compensation for restructuring itself Remuneration of post restructuring controlled transactions Recognition of the actual transactions undertaken PwC 7

8 Part I: Special considerations for risks Contractual terms Whether the conduct of the associated enterprises conforms to the contractual allocation of risks; Whether the allocation of risks in the controlled transaction is arm s length; and What the consequences of the risk allocation are. Compliance Issues PwC 8

9 Part II: Arm s length compensation for the restructuring itself Cont d Understanding the restructuring itself Understanding the restructuring transactions: functions, assets and risks before and after the restructuring; Understanding the business reasons for and the expected benefits from the restructuring, including the role of synergies; Other options realistically available to the parties. Reallocation of profit potential as a result of a business restructuring Profit potential; Reallocation of risks and profit potential; Transfer of something of value (e.g. an asset or an ongoing concern) PwC 9

10 Cont d Part II: Arm s length compensation for the restructuring itself Indemnification of the restructured entity for the termination or substantial renegotiation of existing arrangements Whether the arrangement that is terminated, non-renewed or substantially renegotiated is formalized in writing and provides for an indemnification clause; Whether the terms of the arrangement and the existence or nonexistence of an indemnification clause or other type of guarantee (as well as the terms of such a clause where it exists) are arm s length; Whether indemnification rights are provided for by commercial legislation or case law; Whether at arm s length another party would have been willing to indemnify the one that suffers from the termination or re-negotiation of the agreement. PwC 10

11 Part III: Remuneration of post-restructuring controlled transactions Business restructurings versus structuring General principle: no different application of the arm s length principle; Possible factual differences between situations that result from a restructuring and situations that were structured as such from the beginning; Application to business restructuring situations: selection and application of a transfer pricing method for the postrestructuring controlled transactions Relationship between compensation for the restructuring and post-restructuring remuneration Comparing the pre- and post-restructuring situations Location savings PwC 11

12 Part IV: Recognition of the actual transactions undertaken Transactions actually undertaken. Role of contractual terms. Application to business restructuring situations Non-recognition only in exceptional cases; Determining the economic substance of a transaction or arrangement; Determining whether arrangements would have been adopted by independent enterprises; Determining whether a transaction or arrangement has an arm s length pricing solution; Relevance of tax purpose; Consequences of non-recognition. PwC 12

13 Business restructurings Case studies Cont d Conversion of full-risk manufacturer into Contract Manufacturer Pre restructuring Company A Entrepreneur manufacturer -Owns IP Export sales Export sales India Outside Distribution Co. X Distribution Co. Y PwC 13

14 Cont d Business restructurings Case studies Post restructuring Company A Contract manufacturer India Contract Manufacturing Transfer of IP and Functions Outside Company Z Entrepreneur Owns IP Export sales Export sales Distribution Co. X Distribution Co. Y Restructuring carried out to achieve centralized management & control in a regional headquarter PwC 14

15 Macro Issues How restructuring operations make sense for Company A and Z? What is the commercial rational? What are expected benefits from restructure to Company A and Z? Would independent parties agree to similar reallocation of functions, assets and risks? Are there any realistic options available to Company A? Does Company Z have decision-making capability and can assume and manage the risk it is allocated? Does Company Z have capabilities to assume and mange IP ownership risk? Is any comparable uncontrolled data available in public domain? Would the restructure give rise to a compensation payment, if the parties were independent? Is there any transfer of assets? Does Company A have a right for compensation? PwC 15

16 Part I: Allocation of Risks Steps Post restructuring Contract Conduct Comparables Hypothesise India Outside Company A Contract manufacturer Contract Manufacturing Company Z Entrepreneur Owns IP Transfer of IP and Functions PwC Control Financial Capacity Economic significance of Risks Export sales Distribution Co. X Export sales Distribution Co. Y 16

17 Part II: Compensation for restructuring Profit Potential Post restructuring Compensation required when transfer of rights and / or assets No compensation for mere reduction in profit India Company A Contract manufacturer Contract Manufacturing Transfer of IP and Functions To determine compensation Review of FAR before and after restructuring Evaluate Business reasons Outside Export sales Company Z Entrepreneur Owns IP Export sales Consider options realistically available Distribution Co. X Distribution Co. Y PwC 17

18 Part III: Post Restructuring Apply normal TP principles to avoid competitive distortion Identify relationship between: - Compensation for restructuring and - Compensation for postrestructuring India Outside Post restructuring Company A Contract manufacturer Contract Manufacturing Export sales Company Z Entrepreneur Owns IP Export sales Transfer of IP and Functions Distribution Co. X Distribution Co. Y PwC 18

19 Good and Worrisome Impact of OECD s Guidance - Tax authority to respect commercially rational restructuring transactions that have economic substance - Restructuring may be disregarded in exceptional situation - Non-arm s length behaviour to be addressed through price adjustment - Restructuring to be evaluated not from group s perspective but each entity s perspective PwC 19

20 Good and Worrisome Impact of OECD s Guidance (contd..) - Post restructuring to be addressed under normal TP rules - Tax authorities may want to look at entirety of arrangements - Presence of Tax motive is not sufficient for non-recognition - Documentation requirements are stringent PwC 20

21 Questions PwC 21

22 Thank You! 2011 PricewaterhouseCoopers Pvt. Ltd. All rights reserved. In this document, PwC refers to PricewaterhouseCoopers Pvt. Ltd. which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity. PwC 22

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