A Transfer Pricing Update BEPS & U.S. Tax Reform

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1 A Transfer Pricing Update BEPS & U.S. Tax Reform JANUARY 17, 2018 TO RECEIVE CPE CREDIT Participate in entire webinar Answer polls when they are provided If you are viewing this webinar in a group Complete group attendance form with Your printed name, signature & address All group attendance sheets must be submitted to training@bkd.com within 24 hours of live webinar Answer polls when they are provided If all eligibility requirements are met, each participant will be ed their CPE certificates within 15 business days of live webinar 1

2 PRESENTERS Will James Partner Elizabeth Hazzard Director Jason Eberhardt Senior Managing Consultant AGENDA Base Erosion & Profit Shifting (BEPS) Update Transfer Pricing Developments Overview of Base Erosion & Profit Shifting Initiative Intangibles & Operational Substance Action Item #13 Transfer Pricing Documentation Challenges & Opportunities for Businesses U.S. Tax Reform from a Transfer Pricing Point of View Pre-tax Reform Structure Post-Tax Reform Structure Post-Tax Reform Planning Ideas 2

3 Base Erosion & Profit Shifting (BEPS) Update Transfer Pricing Developments Overview of Base Erosion & Profit Shifting Initiative 3

4 OECD ACTION PLAN ON BASE EROSION & PROFIT SHIFTING Organisation for Economic Co-operation and Development s (OECD) Action Plan on Base Erosion & Profit Shifting What is the BEPS Action Plan? Action plan issued on July 19, different action items designed to curb practices that are perceived to allow multinational corporations to engage in aggressive tax planning & transfer pricing schemes to shift profits from high-tax to low-tax jurisdictions 62 countries (OECD & non-oecd) were directly involved in the BEPS Action Plan o Covers 90% of the global economy o NGOs & other stakeholders also were involved OECD ACTION PLAN ON BASE EROSION & PROFIT SHIFTING Three Tenets of BEPS Action Plan 1. New international standards must be designed to ensure the coherence of corporate income taxation at the international level BEPS issues may arise directly from existence of loopholes, as well as gaps, frictions or mismatches in interaction of countries domestic tax laws 2. A realignment of taxation & relevant substance is needed to restore the intended effects & benefits of international standards, which may not have kept pace with changing business models & technological developments Involvement of shell companies in third countries with little or no substance in terms of office space, tangible assets & employees undermines the prevention of double taxation through tax treaties involving two tax treaty countries 3. The actions to counter BEPS cannot succeed without further transparency, nor without certainty & predictability for business 4

5 OECD GUIDELINES BEPS & TRANSFER PRICING CHANGES The 1995 OECD Transfer Pricing Guidelines were updated in 2010 On October 5, 2015, BEPS action items related to transfer pricing were issued, causing the OECD Transfer Pricing Guidelines to be updated in 2017 The 2017 OECD Transfer Pricing Guidelines include the revised Chapter 5 that reflects the changes to transfer pricing documentation outlined in action items 8 through 10 & 13 of the BEPS initiative The Multilateral Competent Authority Agreement (MCAA) specifies details of information exchange during Competent Authority proceedings Currently the MCAA has 97 signatories (December 13, 2017) U.S. has not signed the MCAA, nor is it expected to do so in the future Intangibles & Operational Substance 5

6 OWNERSHIP OF INTANGIBLES Owners of intangible property (IP) must be involved in the DEMPE functions Development Enhancement Maintenance Protection Exploitation If legal owner is not performing, controlling &/or managing the DEMPE functions, but related parties are, then the related parties must be compensated for their contribution ( 6.32) Best practice: Document intercompany arrangements involving IP ( ) OPERATIONAL SUBSTANCE Entities should perform the functions outlined in intercompany agreements Ultimately the subject intercompany transaction described in the agreement should occur in substance Economic analysis should concern the factual substance of the subject intercompany transaction ( 1.120) Examine intercompany agreements compared to actual conduct of the parties 6

7 Action Item #13 Transfer Pricing Documentation ACTION ITEM #13 CHAPTER V DOCUMENTATION A Three-Tiered Approach Guidance on transfer pricing documentation & country-by-country (CbC) reporting includes the following sections Annex I Master File Annex II Local File Annex III CbC Report General instructions for Annex III to Chapter V of the OECD guidelines Specific instructions for Annex III to Chapter V of the OECD guidelines 7

8 ACTION ITEM #13 CHAPTER V DOCUMENTATION Master File Multinational enterprise s (MNE) organizational structure Description of MNE s business or businesses Supply chain description for products & services Description of intercompany services arrangements Revenue drivers Brief functional analysis Analysis of MNE s supply chain Information on MNE s intangibles IP strategy & policies, including R&D policies Listing of IP Information on MNE s intercompany financial activities Identifying important third-party & relatedparty lenders Information on MNE s financial & tax positions MASTER FILE ACTION ITEM #13 CHAPTER V DOCUMENTATION Local Country File Supplements Master File Focuses on local intercompany transactions Contains the following Local entity description Financial information related to local country transactions o Local accounts Economic analysis o Application of most appropriate method o Comparables analysis o Additional detail of functional analysis, if necessary LOCAL FILE MASTER FILE 8

9 ACTION ITEM #13 CHAPTER V DOCUMENTATION Country-by-Country Report CbC report provides information on entities involved in intercompany transactions Generally applicable for companies with 750 million in revenues o Countries choose revenue threshold; many use 750 million or equivalent o U.S. Treasury regulations use the minimum threshold of $850 million in revenues CbC REPORT LOCAL FILE MASTER FILE BEPS Induced Challenges & Opportunities for Businesses 9

10 CHALLENGES & OPPORTUNITIES FOR BUSINESSES Challenges Monitoring relevant countries adoption of BEPS guidelines & the compliance associated with the changes CbC reporting Opportunities Clean up global structures, as issues may be exposed via CbC reporting Train personnel to handle compliance & audits on a similar basis Look at tax policy & past planning & the need to modify because of BEPS Harmonize global transfer pricing policies for similar intercompany transactions U.S. Tax Reform from a Transfer Pricing Point of View 10

11 Pre-Tax Reform Structure Prior to tax reform, the U.S. tax structure was a worldwide tax system, i.e., all profits were taxed by the U.S., regardless of whether those profits were earned in the U.S. or in a foreign tax jurisdiction o Taxation of foreign-sourced income by the U.S. is deferred until those profits are repatriated back to the U.S. o Foreign tax credits (FTC), based on foreign taxes paid on non-u.s. sourced income, may be used to offset the U.S. tax liability Pre-Tax Reform Structure Most developed countries employ a territorial tax system; that is, earnings are taxed based on where those profits are earned & foreign-sourced income is not taxable o Among countries in the OECD, the U.S. was one of very few using a worldwide tax system (U.S., Chile, Greece, Ireland, Israel, Mexico & South Korea) o Among G-7 countries, the U.S. was the only country employing a worldwide tax system 11

12 Pre-Tax Reform Structure Among developed countries, the U.S. had the highest statutory federal corporate tax rate in the world at 35% Many other countries have decreased their statutory rates over the past several years in an effort to spur inbound investment & economic growth 12

13 Pre-Tax Reform Structure Previous tax system under the deferral system (pre-tax reform) provided incentive for U.S.-based companies to shift income from U.S. to low-tax jurisdiction, i.e., base erosion While the U.S. had the highest tax rate among the OECD member countries, it was among the least effective at generating tax revenues 13

14 Pre-Tax Reform Structure Common base erosion techniques o Corporate inversions o IP migration o Transfer pricing o Intercompany debt Including the pushdown of third-party debt Post-Tax Reform Structure U.S. corporate tax rate will decrease from 35% to 21%, effective January 1, 2018 U.S. moves to territorial tax system o U.S. multinational entities will only pay U.S. federal taxes on income originating in the U.S. o Taxpayers will receive a 100% participation exemption on dividends from foreign affiliates From specified 10% (or more) owned foreign corporations Only available to domestic C corporations (excludes real estate investment trusts, S-Corps and regulated investment companies) Subject to one-year holding period Hybrid dividends not eligible, i.e., dividends paid by foreign entity for which it received a deduction from another country o FTC provision ( 902) will be repealed with respect to future foreign-sourced income o Effective for last tax year beginning before January 1,

15 Post-Tax Reform Structure One-time deemed repatriation o Previously accumulated foreign earnings held offshore will be deemed repatriated to the U.S. & taxed based on the nature of the assets in which those earnings are stored Cash or cash equivalents 15.5% Illiquid assets 8% o Historical FTCs may be used to offset the repatriation tax FTCs will have 10-year carryforward o Taxpayers may use NOLs to offset the deemed repatriation income, or they may elect to forego the use of NOLs under 965(n) Post-Tax Reform Structure Deemed repatriation o Taxpayers will have the option to pay the repatriation tax over an eight-year period, subject to the following payment schedule Years one through five 8% of the tax Year six 15% of the tax Year seven 20% of the tax Year eight 25% of the tax 15

16 Post-Tax Reform Structure Anti-Inversion Provisions o If an entity becomes an expatriated entity within 10 years of the bill Taxpayer will be denied a participation deduction with respect to mandatory inclusion Taxpayer s mandatory inclusion would be subject to 35% tax rate (not the more favorable, new 21% tax rate) Taxpayer would not be able to utilize FTCs to offset U.S. federal tax Post-Tax Reform Structure Limitation on interest deductions o Interest expense is limited to 30% of adjusted taxable income For 2018 to 2021, adjusted taxable income is analogous to EBITDA Thereafter, adjusted taxable income is based on EBIT o Based on debt outstanding as of January 1, 2018 (no grandfathering provisions) o Allowed to carry forward disallowed interest expense (similar to 163(j)) o Similar to interest expense limitation provision in OECD s BEPS initiative 16

17 Post-Tax Reform Structure Global Intangible Low-Taxed Income (GILTI) o Targets companies with IP held offshore & sales & services with limited tangible assets o U.S. entities with controlled foreign corporations (CFC) will be required to include GILTI income similar to current treatment of subpart F income GILTI would be calculated based on CFC income over routine or ordinary return (calculated as 10% of foreign tangible property) GILTI = (foreign income (0.10 x foreign tangible assets)) o Deduction available at 50% of GILTI from 2018 until 2025; 37.5% thereafter ( 951A deduction) o 37.5% deduction for FDII (discussed in following slide) GILTI tax = 0.5(GILTI) 0.375(FDII) o Tax rate on GILTI would be 10.5% (50% of 21%) from 2018 to 2025; % (62.5% of 21%) thereafter Post-Tax Reform Structure Foreign-Derived Intangible Income (FDII) o FDII is deemed intangible income attributable to sales, licenses & leases of property & provision of services by U.S. corporations to foreign persons for use outside the U.S. o Taxpayers receive a deduction for all income above a normal return on depreciable assets (calculated as 10% of global assets) FDII = (foreign profit/global profit) income (0.1 x global assets) o Deduction available at 37.5% of FDII from 2018 until 2025; % thereafter ( 250 deduction) o Tax rate on FDII would be % from 2018 to 2025; % thereafter 17

18 Post-Tax Reform Structure Base Erosion & Anti-Abuse Tax (BEAT) o Imposes a minimum tax on certain deductible payments made to foreign affiliates Royalties Management fees Not applicable to fees charged based on services cost method (SCM) under the 482 regulations Interestingly, taxpayers may still be able to deduct the cost component of management fee, just not the profit element, i.e., markup Reinsurance payments o Domestic corporations with at least $500M of global gross receipts (three-year average period) & a base erosion percentage of 3% or higher, i.e., payments of 3% of total adjusted deductions o Does not apply to pass-through entities (S corporations, REITs, RICs) Post-Tax Reform Structure Base Erosion & Anti-Abuse Tax (BEAT) o Base erosion percentage calculation = base erosion tax benefits/aggregate amount of deductions allowable, excluding NOLs, participation exemption, deductions for FDII & GILTI & any payments that qualify for the SCM under the 482 regulations Tax Rates o 5% in 2018 o 10% in 2019 through 2025 o 12.5% thereafter 18

19 Post-Tax Reform Structure Transfer Pricing & Intangible Property Transfers o Scope of IP Expanded to include: workforce in place, goodwill & going concern value ( 936(h)(3)(B)) o IP Transfers Grants authority to secretary to determine which method must be utilized in the case of outbound transfers of IP & intercompany allocations Allows for aggregate basis valuation, i.e., non-asset specific Realistic alternative method POST-TAX REFORM PLANNING IDEAS Earnings & Profit (E&P) Studies Taxpayers should perform E&P studies to determine the magnitude of income to repatriate to the U.S. IP Location Decisions Due to new low tax rate & patent box-like treatment, taxpayers should consider locating their IP in the U.S. Legal Entity Consideration Taxpayers should re-evaluate their business & tax characteristics & the impact of the tax reform package in determining whether C corp or S corp is better fit Transfer Pricing Documentation Documentation will take on even greater importance after the passing of tax reform, as many of the new provisions are directly targeting intercompany transactions involving the flow of goods, services & intangible property between the U.S. & foreign affiliates o It will be critical to document the nature & details of U.S. taxpayers intercompany transactions to support tax positions o It also will be important to document the elements of management & administrative service fee payments to foreign affiliates There will be increased pressure from foreign tax jurisdictions, as certain new U.S. tax provisions will have the effect of reducing the income recognized by foreign affiliates, creating potential conflicts with U.S. treaty partners 19

20 Questions? CONTINUING PROFESSIONAL EDUCATION (CPE) CREDITS BKD, LLP is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted to the National Registry of CPE Sponsors through its website: The information contained in these slides is presented by professionals for your information only & is not to be considered as legal advice. Applying specific information to your situation requires careful consideration of facts & circumstances. Consult your BKD advisor or legal counsel before acting on any matters covered 20

21 CPE CREDIT CPE credit may be awarded upon verification of participant attendance For questions, concerns or comments regarding CPE credit, please the BKD Learning & Development Department at Contact Information Jason Eberhardt Senior Manager, Transfer Pricing BKD, LLP 375 N. Shore Drive Suite 501 Pittsburgh, PA United States Elizabeth Hazzard Director, Transfer Pricing BKD, LLP One Metropolitan Square 211 N. Broadway, Suite 600 St. Louis, MO United States Will James Principal, Transfer Pricing Leader BKD, LLP One Metropolitan Square 211 N. Broadway, Suite 600 St. Louis, MO United States

22 Thank You! 22