Transfer Pricing Essentials. Steven C. Wrappe KPMG LLP Washington, D.C.

Transcription

1 Transfer Pricing Essentials Steven C. Wrappe KPMG LLP Washington, D.C.

2 Notice The following information is not intended to be written advice concerning one or more Federal tax matters subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. 2

3 Outline What is Transfer Pricing? Why is it Different/Important? Conceptual Framework Transfer Pricing Methods Intangibles Services Penalty Rules Transfer Pricing Controversy 3

4 What Is Transfer Pricing?

5 What is Transfer Pricing? Transfer pricing refers to pricing of transactions between related parties for: Tangible property Intangible property Services Rents Loans 5

6 What is Transfer Pricing? Related party aspect of the transactions suspends the normal laws of supply and demand Without governmental restraint, related parties could use transfer pricing to artificially shift income to achieve tax benefits IRC 482 and similar statutes in other countries prevent related parties from artificially shifting income to achieve tax benefits 6

7 What is Transfer Pricing? Opportunity Transfer Pricing Planning Opportunity Parent (Country A) Sub (Country B) Consolidated Total profit reported on tax return ,000 Tax rate 40% 10% Tax liability before change to transfer price Global Effective Tax Rate ( ETR ) 31% Effect of Transfer Pricing Change on ETR Total profit after using transfer pricing to shift 400 of income ,000 Tax rate 40% 10% Tax liability after change to transfer price Global ETR 19% 7

8 What is Transfer Pricing? Exposure Exposure to Double Taxation Parent (Country A) Sub (Country B) Consolidated Total profit reported on tax return ,000 Tax rate 40% 10% Tax liability before Country B transfer pricing adjustment Global Effective Tax Rate ( ETR ) 19% Double taxation effect on ETR Total profit after adjustment (increase in profits) by Country A of 400 (assumes no correlative relief in B) ,400 Tax rate 40% 10% Tax liability after Country A transfer pricing adjustment (penalties and interest not included) Global ETR 35% 8

9 What is Transfer Pricing? The Accounting Perspective Manufacturer Distributor Total Sales Transfer Price 15,000 15,000 COGS < 10,000 > < Transfer Price > < 10,000 > Gross Profit ( %) ( %) 5,000 S, G & A < 1,750 > < 1,250 > < 3,000 > Net Operating Income ( %) ( %) 2,000 9

10 What is Transfer Pricing? The Tax Perspective Section 482 In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses. In the case of any transfer (or license) of intangible property (within the meaning of Code Sec. 936(h)(3)(B)), the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible. 10

11 Why Is Transfer Pricing Different/ Important?

12 Why is Transfer Pricing Different/Important? Subjective application of the rules Potentially large adjustments and penalties Procedural options Double taxation exposure Figures prominently in financial statement disclosure (FIN 48) 12

13 Why is Transfer Pricing Different/Important? Transfer Pricing In the News Glaxo litigation FIN 48/UTP Form implications OECD Base Erosion and Profit Shifting Project Inversions produce transfer pricing issues 13

14 The Public Debate Starbucks paid just 8.6M in U.K. tax over 14 years. BBC News, October 16, 2012 There is a technical term economists like to use for behavior like this. Unbelievable chutzpah. Edward Kleinbard, former Chief of Staff of the Congressional Joint Committee on Taxation, on Apple s efforts to avoid paying taxes. New York Times, May 21, [Google s] highly contrived tax arrangement has no purpose other than to enable the company to avoid U.K. corporation tax. Margaret Hodge, Chair of U.K. PAC, June 12, 2013 From now on I ll be putting away my Kindle and feeding my caffeine addiction somewhere other than Starbucks. We know that Amazon, Google and Starbucks are raking in profits from their economic activity in Britain but using a range of devices to avoid paying their fair share of corporation tax. U.K. Observer, November 18, 2012 Apple pays just 2% U.K. tax as Amazon and Google face questioning. International Business Times, November 5, Google caught in crossfire over French tax planning. Le Figaro, October 19, 2012 Dolce and Gabanna to face trial over tax evasion Milan prosecutors allege the fashion had sold their D&G and Dolce & Gabbana brands to a holding company they set up in Luxembourg in 2004 in order to avoid paying high taxes in Italy. The Telegraph, June 11, 2012 International retailers that have lowered U.K. tax by holding trademarks in the Netherlands include not only Starbucks and IKEA but also SABMiller, Nike, Bacardi- Martini, Zara, Speedo and Volkswagen. Het Financieele Dagblad, 15 November 2012 Rampant corporate tax avoidance may not be illegal, but that doesn t make it right or fair. NY Times Editorial, May 25, 2013 Google insists its Irish headquarters are more than just a post box. Le Figaro, November 6,

15 Global Introduction of Transfer Pricing Rules < Argentina Aruba Argentina Australia Austria Argentina Australia Austria Belgium Brazil Canada Argentina Australia Austria Belgium Brazil Canada Chile China (People Republic of) Colombia Argentina Australia Austria Belgium Brazil Canada Chile China (People Republic of) Colombia Czech Republic Denmark Ecuador Egypt Estonia Australia Austria Belgium Brazil Canada Chile China (People Republic of) Colombia Croatia Czech Republic Denmark Ecuador Egypt Estonia Finland France Germany Greece Hong Kong Belgium Chile Czech Republic Finland Hungary Argentina Argentina Australia Austria Brazil Canada Chile Argentina Australia Austria Brazil Canada Chile China (People Republic of) Brazil Canada Chile China (People Republic of) Colombia Czech Republic Denmark Estonia France Germany China (People Republic of) Colombia Czech Republic Denmark Ecuador Egypt Estonia France Germany Hungary Denmark Ecuador Egypt Estonia France Germany Hungary India Indonesia Israel Italy France Germany Greece Hong Kong Hungary India Indonesia Israel Italy India Indonesia Ireland (Republic of) Israel Italy Japan Kazakhstan Kenya Korea (Republic of) Australia China (People Czech Republic Hungary India Japan Japan Latvia Austria Republic of) Denmark India Indonesia Korea Korea (Republic Lithuania Argentina Brazil Czech Republic Estonia Indonesia Italy (Republic of) of) Luxembourg Australia Canada Denmark France Italy Japan Latvia Latvia Malawi Argentina Austria Chile Estonia Germany Japan Korea Lithuania Lithuania Malaysia Australia Brazil China (People France Hungary Korea (Republic of) Luxembourg Luxembourg Mexico Argentina Australia Austria Austria Brazil Canada Chile Canada Chile China (People Republic of) Republic of) Czech Republic Denmark Estonia Germany India Indonesia Italy India Indonesia Italy Japan (Republic of) Latvia Lithuania Luxembourg Latvia Lithuania Luxembourg Malaysia Malaysia Mexico Montenegro Netherlands Malaysia Mexico Montenegro Netherlands Montenegro Netherlands New Zealand Norway Brazil China (People Czech Republic France Japan Korea Malaysia Mexico New Zealand New Zealand OECD Australia Austria Brazil Canada Chile China (People Republic of) Republic of) Czech Republic Denmark France Denmark Estonia France Germany Germany India Indonesia Italy Korea (Republic of) Latvia Luxembourg (Republic of) Latvia Luxembourg Malaysia Mexico Montenegro Netherlands New Zealand Montenegro Netherlands New Zealand OECD OECD Peru Philippines Poland OECD Peru Philippines Poland Peru Philippines Poland Portugal Chile Czech Republic Germany Indonesia Japan Mexico Mexico OECD Peru Portugal Portugal Romania Australia Czech Republic Denmark France France Indonesia Italy Italy Japan Korea (Republic of) Montenegro Netherlands Montenegro Netherlands Peru Philippines Philippines Poland Romania Russia Romania Russia Russia Serbia Austria Germany Germany Japan Korea Latvia New Zealand New Zealand Poland Portugal Serbia Serbia Singapore Australia Czech Republic Indonesia Indonesia Korea (Republic of) Mexico OECD OECD Portugal Romania Singapore Singapore Slovak Republic Czech France Italy Italy (Republic of) Latvia New Zealand Peru Peru Romania Russia Slovak Slovak Republic Slovenia Republic France Germany Indonesia Japan Korea Japan Korea Latvia Mexico Mexico New Zealand OECD Peru Philippines Poland Philippines Poland Russia Serbia Serbia Singapore Republic Slovenia Slovenia South Africa South Africa Spain Australia Germany Italy (Republic of) (Republic of) New Zealand OECD Philippines Portugal Portugal Singapore Slovak South Africa Spain Sri Lanka Czech Indonesia Japan Latvia Latvia OECD Philippines Poland Russia Russia Slovak Republic Spain Sri Lanka Sweden Republic Italy Korea Mexico Mexico Philippines Poland Russia Serbia Serbia Republic Slovenia Sri Lanka Sweden Switzerland France Germany Japan Latvia (Republic of) Latvia New Zealand OECD New Zealand OECD Poland Russia Russia Singapore Serbia Singapore Singapore Slovak Singapore Slovak South Africa Sweden South Africa Sweden Sweden Taiwan Switzerland Taiwan Taiwan (Republic Indonesia OECD OECD Philippines Philippines Singapore Slovak Slovak Republic Republic Taiwan Taiwan (Republic (Republic of China) Italy Philippines Philippines Poland Poland Slovak Republic Republic South Africa South Africa (Republic (Republic of China) of China) Thailand Japan Poland Poland Singapore Singapore Republic South Africa South Africa Sweden Sweden of China) of China) Thailand Thailand Turkey Poland Singapore Singapore Slovak Singapore Slovak Slovak Republic Slovak Republic South Africa Sweden Sweden Ukraine Sweden Ukraine Thailand Ukraine Thailand Ukraine Thailand Ukraine Thailand Ukraine Ukraine United Turkey Ukraine Ukraine United Kingdom Slovak Republic Republic South Africa South Africa Ukraine United United United United United United Kingdom United Kingdom United States Republic South Africa South Africa Sweden Sweden United Kingdom Kingdom Kingdom Kingdom Kingdom Kingdom United States United States Venezuela Sweden Sweden Sweden Ukraine Ukraine Kingdom United States United States United States United States United States United States Venezuela Venezuela Vietnam United States United States United States United States United States United States Venezuela Venezuela Venezuela Venezuela Venezuela Venezuela Vietnam Vietnam Zambia 15

16 Conceptual Framework

17 Conceptual Framework Control Arm s length standard Best method rule Comparability Arm s length range Transfer pricing methods 17

18 Conceptual Framework Control Controlled - Reg (i)(4) includes any kind of control, direct or indirect, whether legally enforceable or not, and however exercisable or exercised, including control resulting from the actions of two or more taxpayers acting in concert or with a common goal or purpose. It is the reality of control that is decisive, not its form or the mode of its exercise. A presumption of control arises if income or deductions have been arbitrarily shifted. 18

19 Conceptual Framework The Arm s-length Standard An intercompany transaction is arm s length if results are same as results realized by uncontrolled taxpayers engaged in same transaction under same circumstances Identical uncontrolled transactions generally not available; appropriate to consider comparable uncontrolled transactions Analysis of independent, uncontrolled comparable transactions is at center of all transfer pricing analysis The arm s-length standard is fundamental basis of worldwide transfer pricing regulations 19

20 Conceptual Framework Best Method Rule No hierarchy of methods specified Best method provides most reliable measure of arm s-length result Best method varies depending on facts and circumstances If no clear best method, convergence of results 20

21 Conceptual Framework Transfer Pricing Methods Tangible property Intangible property Services (Temporary) CUP (Comparable Uncontrolled Price Method) RPM (Resale Price Method) Cost Plus (Cost Plus Method) CPM (Comparable Profits Method) (cf. to TNMM in OECD Guidelines) (Transactional Net Margin Method) CPS (Comparable Profit Split Method) PSM (Profit Split Method) RPS (Residual Profit Split Method) CUT (Comparable Uncontrolled Transaction Method) CPM / TNMM (Commensurate with income rules) PSM CUSP (Comparable Uncontrolled Services Price Method) GSM (Gross Services Margin Method) CSPM (Cost of Services Plus Method) CPM PSM CPS RPS CPS RPS SCM (Services Cost Method) Unspecified Methods Unspecified Methods/ Cost Sharing 21

22 Conceptual Framework Comparability Purpose- uncontrolled transactions must be sufficiently similar to controlled transactions to provide a reliable measure of the arm s-length result (i.e., allow taxpayer to characterize tested party in order to find comparables) Five Factors: Functions performed Contractual terms Risks assumed Economic and financial conditions Nature of property or services transferred Each transfer pricing method places priority on different factors 22

23 Conceptual Framework The Arm s-length Range In most cases it is not possible to identify a single price that would occur between unrelated parties Arm s-length range results from use of two or more uncontrolled transactions of similar reliability and comparability No adjustment if results of controlled transaction are within arm s-length range 23

24 Transfer Pricing Methods

25 Transfer Pricing Methods Overview Tangible property Intangible property Services (Temporary) CUP (Comparable Uncontrolled Price Method) RPM (Resale Price Method) Cost Plus (Cost Plus Method) CPM (Comparable Profits Method) (cf. to TNMM in OECD Guidelines) (Transactional Net Margin Method) CPS (Comparable Profit Split Method) PSM (Profit Split Method) RPS (Residual Profit Split Method) CUT (Comparable Uncontrolled Transaction Method) CPM / TNMM (Commensurate with income rules) PSM CUSP (Comparable Uncontrolled Services Price Method) GSM (Gross Services Margin Method) CSPM (Cost of Services Plus Method) CPM PSM CPS RPS CPS RPS SCM (Services Cost Method) Unspecified Methods Unspecified Methods/ Cost Sharing 25

26 Transfer Pricing Methods Comparable Uncontrolled Price ( CUP ) General Observations Based on direct observation of market price Internal comparables most common Always the best method if comparable transactions are available Concerns: Degree of comparability Information is limited regarding intermediate products Differences in design, intangibles, volumes, timing, terms, functions, and geographic markets affect price Reliable and complete data 26

27 Transfer Pricing Methods CUP (cont.) Internal CUPs Related party buys from or sells to 3 rd party Generally good comparability and data External CUPs 3 rd party-to-3 rd party transactions Generally found by searching publicly available data Comparability and data concerns Seldom used due to data needs 27

28 Transfer Pricing Methods Resale Price Method General Observations Typically used for distributors Functional comparables with similar risks and routine intangibles Application of Resale Price Method Gross profit margin ( GPM ) derived from uncontrolled transaction as a percentage of sale Subtract appropriate GPM from end user resale price to arrive at transfer price 28

29 Transfer Pricing Methods Cost Plus Method General Observations Routine manufacturing and service operations Generally not used for distributors Assures constant return to manufacturer; shifts general risk to the distributor Application of Cost Plus Method Prices based on gross profit markup ( GPM ) earned by functional comparables, over fully absorbed costs Note: General industry GPM may be used absent transactional data Concerns: Comparables need similar Functions, risks & routine intangibles Production process Cost structure Accounting consistency is essential Gross profit data typically difficult to obtain for non-u.s. based companies 29

30 Transfer Pricing Methods Comparable Profits Method ( CPM ) Operating margin most often used Typically applied to test routine distribution or manufacturing functions Relies on functional comparability; product comparability is less important Common use: Product comparables not found, or accounting comparability is not assured One affiliate performs routine functions Comparables identified with general similarity of products and functions OECD has Transaction Net Margin Method (TNMM) 30

31 Transfer Pricing Methods CPM (cont.) Profit Level Indicators Operating margin = operating profit / sales Return on assets = operating profit / assets actively employed in the business (usually tangible assets) Berry ratio = gross profit / operating expenses 31

32 Transfer Pricing Methods CPM (Operating Margin) Manufacturer Distributor Total Sales 15,000 15,000 < COGS > < 10,000 > < > < 10,000 > Gross Profit ( %) ( %) 5,000 S, G & A < 1,750 > < 1,250 > < 3,000 > Net Operating Income ( %) ( 3 %) 450 2,000 32

33 Transfer Pricing Methods Profit Split Profit Split Methods Residual profit split Comparable profit split General Conditions for Use Each party must have valuable, non-routine contributions that contribute significantly to profits Significant transactions to establish comparability Administrative requirements 33

34 Intangibles

35 Intangibles Definition Asset with substantial value independent of services of any individual and derives its value not from its physical attributes but from its intellectual content or other intangible properties Common examples: Patents, inventions, formulae, processes, designs, patterns, or knowhow Copyrights and literary, musical, or artistic compositions Trademarks, trade names, or brand names Franchises, licenses, or contracts Methods, programs, systems, procedures, campaigns, studies, forecasts, estimates, customer lists, or technical data Other similar items 35

36 Intangibles Ownership/Consequences Ownership of intangible is important because owner is entitled to compensation for transfer or license of intangible Legally protected intangible: legal owner or holder of rights treated as owner Not legally protected intangible: controlled taxpayer who has control of intangible treated as owner Multiple ownership of intangible property: no longer subdivided Controlled taxpayers who assist owner in development or enhancement of intangible are entitled to arm s length compensation 36

37 Intangibles Methodologies Comparable Uncontrolled Transaction ( CUT ) Method: generally most direct and reliable measure of arm s length result if same intangible is transferred in controlled and uncontrolled transaction CUT method may also provide most reliable measure of arm s length result in situations with an inexact CUT Comparable Profits Method ( CPM ): evaluates whether amount charged in a controlled transaction is arm s length based on objective measures of profitability Profit Split Method ( PSM ): compares allocation of combined operating profit or loss attributable to controlled transactions to relative value of each controlled taxpayer s contribution Comparable Profit Split Method Residual Profit Split Method 37

38 Intangibles Commensurate with Income 482 amended in 1986 to require related party payments re: intangibles to be commensurate with income Periodic adjustments: consideration charged is subject to an annual adjustment Exceptions 38

39 Intangibles Cost Sharing Alternative Primary tax benefit of cost sharing is all participants considered owner of an interest in the intangible, precluding the transfer pricing rules for intangibles Cost sharing is a practical alternative to cross-border licensing New cost sharing regulations significantly limit the use of a cost sharing 39

40 Intercompany Services

41 Services Definition Any activity by one member of a group of controlled taxpayers that results in a benefit to one or more other members of controlled group Activity is defined broadly to include: Performance of functions Assumption of risks Use by a renderer of tangible or intangible property or other resources, capabilities, or knowledge Making available any property or other resources of the renderer 41

42 Services Specified Methods Services cost method (SCM) Comparable uncontrolled services price Gross services margin similar to Resale Price Cost of services plus similar to Cost Plus Comparable profits Profit split 42

43 Penalty Rules

44 Section 6662 Penalty Transactional Net Adjustment Substantial Valuation (20% penalty) Price or value is 200% or more (50% or less) than the correct amount Net adjustment exceeds the lesser of $5 million or 10% of gross receipts Gross Valuation (40% penalty) Price or value is 400% or more (25% or less) than the correct amount Net adjustment exceeds the lesser of $20 million or 20% of gross receipts 44

45 Section 6662 Penalty Contemporaneous Documentation Requirements Ten principle documents required to fulfill contemporaneous documentation requirements: 1. Overview of taxpayer s business 2. Description of organizational structure 3. Documentation explicitly required under Section 482 (such as license agreements) 4. Description of method selected and reason for selection 5. Description of alternative methods not used and reason for not using them 6. Description of controlled transactions and internal data 7. Description of comparables and adjustments (if any) 8. Explanation of economic analysis and projections used 9. Description of data obtained after tax year and before filing return 10.General index of documents 45

46 Section 6662 Penalty Good Faith Exclusion Valuation misstatement penalties may be waived if taxpayer can show good reason to believe the company was following the arm s-length standard in application of the transfer prices. Net adjustment penalty- may only be satisfied by documentation Two elements are required for the Good Faith Exclusion : Reasonable effort (to establish the arm s-length nature of prices) Reasonable belief (that the transfer pricing methodology produced an arm s-length result) A taxpayer may gain reasonable belief through reliance on a professional tax advisor. 46

47 Transfer Pricing Documentation Factual analysis Taxpayer s Group Industry Transactions Functions Risks Intangibles Economic analysis Transfer Pricing Methodology Comparable Search Adjustments 47

48 Transfer Pricing Controversy

49 TP Dispute Procedural Flowchart File Return Consider obtaining an Advance Pricing Agreement (APA) pursuant to Rev. Proc T/P return selected for Examination IRS issues Form 4564 Informal Document Request (IDR) If CIC* Audit, are there any issues which should be sent to Appeals. Early Referral to Appeals (Pursuant to Rev. Proc ) No IRS issues 30-day letter Preliminary Notice of Deficiency. Form 4665, Publication 5. Pub. 586A Does T/P want to settle issue in Appeals? Yes No After 30 days expires, IRS Issues 90 day letter Notice of Deficiency or Statutory Notice Consider CA**/SAP***, pursuant to Rev. Proc IRS issues either initial contact letter or initial telephone contact Pre-opening or Opening conference: Start of Examination IRS starts detailed Transfer Pricing Examination 1. Consider extending Statute of Limitation; 2. T/P considers information to be provided to IRS and IRS tools for obtaining the information. IRS issues Form 5701 Notice of Proposed Adjustments. Does T/P agree? IRS and/or T/P should consider if any issue requires Field Service Advice or Technical Advice; Consider CA**/SAP***, pursuant to Rev. Proc ; Consider whether IRS Examination may resolve open issues, pursuant to Del. Ord. 236 (Rev. 3). Consider Fast-Track Guidance under Rev. Proc Yes Docketed Appeals: May have case reviewed by Appeals Officer Sign Form 5701 as agreed and proceed to close Examination Consider correlative and corresponding adjustments; Consider refund request in foreign jurisdiction. No Previous Appeals review? Yes Docketed Tax Court Consider Docketed Mediation; Consider Tax Court Rule 124 (Voluntary Binding Arbitration). Does T/P petition Tax Court? No No T/P pays tax deficiency; does T/P agree? Yes Proceed to close case and consider CA** T/P files for refund; Refund granted? Proceed to close case, Consider CA** Yes No T/P consider mediation, pursuant to Rev. Proc or arbitration under Rev. Proc ; Agreement reached? KEY *CIC Coordinated Industry and Industry Case Program ** Competent Authority *** Simultaneous Appeals/Competent Authority Procedure Proceed to close case, consider CA** Yes Agreement at Appeals? Yes Proceed to close case, consider CA** May request additional time to file protest in writing generally IRS will grant an additional 30 days. No Yes Yes Proceed with Tax Court Case Decision may be Appealed to Circuit Court of Appeals Decision may be appealed via grant of cert. to Supreme Court Yes T/P accepts; proceed to close case, consider CA** No Yes No Go to Appeals for review, consider SAP*** Refund Appeals: Agreement reached? T/P files with District Court or Federal Claims Court Proceed to close case, consider CA** Appeals issue 90 day letter; Agreement reached? No T/P and IRS agree to a resolution In Appeals? Non-Docketed Appeals: (a) file written protest within 30 day period; (b) do not pay tax consider cash bond; (c) consider SAP***. No Does T/P require Additional time to prepare and file protest with IRS?

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