MODULE 3.03 TRANSFER PRICING OPTION

Transcription

1 THE ADVANCED DIPLOMA IN INTERNATIONAL TAXATION June 2018 MODULE 3.03 TRANSFER PRICING OPTION ADVANCED INTERNATIONAL TAXATION (THEMATIC) TIME ALLOWED 3¼ HOURS This exam paper has three parts: Part A, Part B and Part C. You need to answer five questions in total. You must answer: Both questions in Part A (25 marks each) One question from Part B (20 marks) Two questions from Part C (15 marks each) Further instructions All workings should be made to the nearest month and in appropriate monetary currency, unless otherwise stated. Start each answer on a new page and clearly indicate which question you are answering. If you are using the on-screen method to complete your exam, you must provide appropriate line breaks between each question, and clearly indicate the start of each new question using the formatting tools available. Marks are specifically allocated for presentation. The time you spend answering questions should correspond broadly to the number of marks available for that question. You should therefore aim to spend approximately half of your time answering Part A, and the other half answering Parts B and C. The first 15 minutes of the exam consists of reading time. You will be allowed to annotate the question paper during this time; however, you will not be permitted to start writing or typing your answer. The Presiding Officer will inform you when you can start answering the questions. Although references and short quotes from the OECD Transfer Pricing Guidelines can be included in your answer, you will not benefit from any extra marks by copying from the OECD Transfer Pricing Guidelines directly.

2 PART A You are required to answer BOTH questions from this Part. The following facts apply to both Questions 1 and 2 The Global Dash Cam Group (GDC) is a multinational group headquartered in Country A by ParentCo. ParentCo has a small office with approximately ten employees engaged in logistics, purchasing and invoicing functions, including its chief executive officer and board members. GDC s core business is the manufacture and sale of motor vehicle dashboard cameras. ParentCo has a subsidiary, Dash Cam 1 (DC1), which is resident in Country B and performs a contract manufacturing function. DC1 purchases high quality raw materials from Dash Cam 2 (DC2), a related party resident in Country C, and a slightly lower grade of raw materials from Cam Components (CC), an independent party resident in Country D. DC1 manufactures two brands of camera, Dashcam Delux and Dashcam Standard, using the raw materials purchased from DC2 and CC respectively. GDC uses a related party distributor, Dash Cam 3 (DC3), and an independent party distributor, Cam Supplier 1 (CS1), to sell the final products to third party end customers in Country E. DC3 and CS1 are both resident in Country E, and possess warehouses in which their respective products are stocked prior to sale. DC3 assumes warranty, product liability and foreign exchange risk while CS1 does not. ParentCo previously owned all intellectual property, including trademarks, relating to Dash Cam products sold in Country E. However, ParentCo has recently transferred this intellectual property to DC4, a related party, resident in a lower tax jurisdiction (Country F). It is unknown how many staff, if any, are employed by DC4. DC3 pays a royalty to ParentCo for the use of the tradename on the products distributed in Country E, but CS1 does not. This royalty became payable to DC4 upon transfer of the intellectual property and the royalty rate (percentage of sales) was increased, on the basis that DC3 is distributing a higher quality product which may command a premium price in Country E in comparison to the product distributed by CS1. DC3 and CS1 both perform intensive marketing and sales functions in Country E in building the brand and market share for the products sold. Dash Cam 5 (DC5), resident in Country G, performs routine administrative, information systems management and human resources functions on behalf of ParentCo and other affiliates. It is unknown how many staff, if any, are employed by DC5. There exist a number of competitors selling similar products to those distributed by CS1 and DC3 in Country E. Following extensive research and development conducted by DC4 and ParentCo, a new dashboard camera product has recently been developed. DC4 and ParentCo have entered into a cost sharing arrangement relating to the intellectual property developed and patented for this new product. It is anticipated that ParentCo will contract the manufacture of the new product to DC1, and then sell it in Country A. GDC has recently begun selling the Dashcam Delux and Dashcam Standard online to customers of Country E, booking all sales in Country A in ParentCo s name. Page 2 of 7

3 1. You have been approached by the Tax Manager of the GDC Group, to provide transfer pricing advice in relation to the arrangements described opposite. 1) Perform a functional analysis for the GDC Group and discuss practical approaches to the undertaking of a functional analysis. (15) 2) Explain how you would characterise each of the entities within the GDC Group. (5) 3) Discuss any potential transfer pricing issues in relation to the OECD BEPS 2015 Final Reports (Actions 8-10) which may be relevant to the GDC Group. (5) Total (25) 2. 1) Discuss each of the OECD recommended transfer pricing methods in relation to the GDC Group, highlighting the relative strengths and weaknesses of each method with regard to the arm s length principle. (15) 2) Explain the significance of a comparability analysis, and discuss how this may be applied to the GDC Group. Discuss any issues or other factors to be considered with regard to comparability. (10) Total (25) Page 3 of 7

4 PART B You are required to answer ONE question from this Part. 3. The Bonnie Group (Bonnie) is a multinational group of companies which is a market leader in the premium hair dye business. Bonnie s parent company (Bonnie Corp) is based in Country A, in which until recently it undertook research and development (owning all group intellectual property), manufactured all of the group s products for sale around the world, prepared all marketing materials to provide to subsidiaries, provided technical expertise to subsidiaries, and made sales in Country A. Bonnie Corp also sold finished product to five subsidiaries based in different countries. The corporate income tax rate in Country A is 38%. Bonnie recently engaged a global adviser to implement a supply chain transformation project. The project was implemented a year ago, with the following material changes made to the Bonnie group: A new subsidiary (Sub Z) was established in Country Z and instructed to undertake all manufacturing for the Bonnie Group, including the sale of finished products to Bonnie Corp and five additional related companies. Sub Z legally acquired all intellectual property, including manufacturing know how, patents, trademarks and marketing material. No consideration was paid by Sub Z. Bonnie Corp provided funds, on an interest-free basis, to Sub Z in order to finance the construction of a new manufacturing facility. A small number of key operational staff in the areas of manufacturing, research and development, global marketing and technical experts relocated to Country Z and became employees of Sub Z. Bonnie Corp s manufacturing operations in Country A were shut down, with most of the plant and equipment scrapped. Bonnie Corp s senior management team and Board of Directors remained based in Country A and employed by Bonnie Corp. As a result of this business restructure, Bonnie Corp incurred significant staff redundancy costs which contributed to a significant loss recorded by Bonnie Corp in Country A during the first year following the implementation of the project. Bonnie Corp is now classified as a low risk distributor. Sub Z made a significant profit in its first year of operation. The income tax rate in Country Z is 15%. You are a transfer pricing auditor in Country A and have recently begun a compliance audit of Bonnie Corp. 1) Identify the key transfer pricing issues and risks relating to the above activities. (15) 2) Advise what an arm s length outcome would be for the tax administration of Country A, regarding Bonnie Corp s business restructure with reference to the OECD guidelines. (5) Total (20) Page 4 of 7

5 4. Albo Corp (Albo) is a company resident in Ardalia, and will shortly commence business operations in Bothland through the establishment of a branch. Albo manufactures cigar products in Ardalia, and will sell these products through its Bothland branch to independent customers based in Bothland. A Double Taxation Agreement (DTA) exists between Ardalia and Bothland, based on the OECD Model Tax Convention. Both countries also have transfer pricing legislation based on the OECD Transfer Pricing Guidelines. Two options for the implementation of the proposed arrangement are currently under consideration by Albo: 1) Option 1: Profits derived from the sale of products through the branch in Bothland will be treated as profits belonging to Albo. An income tax return will not be lodged in Bothland. 2) Option 2: The branch will be treated as a separate legal entity in Bothland, and Albo will set the transfer price of the cigars charged to the branch as the cost of manufacture to Albo plus an uplift of 7.5%. This will result in a guaranteed profit to the Bothland branch in relation to the sale of cigars. 1) Explain, in your own words, the concept of a branch or permanent establishment, including how the transfer pricing provisions will apply. (7) 2) Which of the above options would you recommend to Albo s management board? In your response, you should refer to any relevant provisions of the DTA that might apply, with explanation of how the provisions relate to each option, and explain how any transfer pricing rules will apply to the options proposed. (13) (Total 20) Page 5 of 7

6 PART C You are required to answer TWO questions from this Part. 5. You are the taxation adviser to the Pineapple Group, a multinational group which carries out business in multiple jurisdictions. Pineapple s directors have asked you to provide written responses to the following questions: 1) What is an Advanced Pricing Arrangement (APA)? Outline the benefits of an APA for the Pineapple Group. (3) 2) Are all members of the Pineapple Group required to enter into an APA? (2) 3) What impact is the OECD s Base Erosion and Profit Shifting (BEPS) initiative likely to have, in relation to a new APA for the Pineapple Group? (4) 4) In what circumstances can the Pineapple Group request Mutual Agreement Procedures (MAP)? (3) 5) If an APA is in place, will this reduce the likelihood of the Pineapple Group securing a future MAP? (3) 6. You are required to produce a report on the following transfer pricing matters: 1) Explain the concept of a transfer pricing safe harbour, with specific reference to its practical application and including a specific example. (5) 2) Explain why Country by Country documentation is important, from a tax administration s perspective. (5) 3) Advise why is it important for a multinational group to prepare good quality contemporaneous transfer pricing documentation? (5) 7. Your international tax partner has asked you to develop advice for a new multinational client operating in the pharmaceutical industry. 1) Explain each of the following concepts, which are both means to develop Intellectual Property: a) Contract research and development; and (4) b) A cost contribution arrangement or cost sharing arrangement. (4) 2) Describe, in your own words, the concept of the arm s length principle, and what this means from a practical perspective, including appropriate references. (7) Page 6 of 7

7 8. The following cases have been cited as examples of important decisions in the practice of transfer pricing: GSK Canada [2010 FCA 201] Netherlands/Starbucks state aid [SA.38374] Ireland/Apple state aid [SA.38373] You are required to choose one of these cases, and explain: 1) The applicable facts of the case; 2) The issue which was contested; 3) The decision made by highest court deciding the case; and 4) Any broader implications which have arisen from the decision. (15) 9. You are reviewing the file of Sargent Ltd, a large multinational company, in your role as a Tax Officer. You have a risk hypothesis that the large volume of tax losses recorded by the group is largely the result of tax planning through intra-group financial transactions. Upon further examination and exchanges of information with other tax administrations, there may be some instances in which Sargent is not paying tax in multiple jurisdictions due to various financing arrangements involving hybrids. Some of the transfer pricing documentation notes significant intra-group loans with different currencies, various financial instruments, use of credit rating analyses and a cash pooling arrangement. There is also an analysis having regard to intra-group financing and thin capitalisation. 1) Discuss the potential transfer pricing issues in relation to the intra-group financing of Sargent Ltd. (10) 2) Discuss potential intra-group financing transfer pricing risks for Sargent Ltd, with to relevant OECD Base Erosion and Profit Shifting (BEPS) Project action items. (5) Page 7 of 7