Creating Value Using Centralized Trading Centers. A practical guide to setting up a CTC

Transcription

1 Creating Value Using Centralized Trading Centers A practical guide to setting up a CTC

2 Contents 02 Introduction CTCs - Their Roles and Functions Market Trends Driving CTCs Hong Kong as a Gateway to China Tax and Transfer Pricing Considerations for CTCs Implementation Considerations Conclusion DRAFT 2014 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A., member FDIC, or its affiliates/subsidiaries is one of the offerors of the products and services featured within this document. All services are subject to applicable laws and regulations and service terms. Not all products and services are available in all geographic areas. Eligibility for particular products and services is subject to final determination by J.P. Morgan and/or its affiliates/subsidiaries.

3 2014 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A., member FDIC, or its affiliates/subsidiaries is one of the offerors of the products and services featured within this document. All services are subject to applicable laws and regulations and service terms. Not all products and services are available in all geographic areas. Eligibility for particular products and services is subject to final determination by J.P. Morgan and/or its affiliates/subsidiaries.

4 Introduction Trade continues to witness unprecedented growth with world trade growing twice as fast as world production in the past decade. In the last three decades, world merchandise and commercial services trade have increased by about 7% a year on average, reaching a peak of US$ 18 trillion and US$ 4 trillion respectively. Developing economies have been a major contributor towards this global trade growth. However, what distinguishes the growth spurt from the past is the rise to prominence of large developing economies and rapidly industrializing Asian economies. In 1980, developing economies accounted for 34% of world exports; by 2011, their share had risen to 47% Margaret Yao Managing Director Asia Pacific Regional Sales Executive Treasury Services MorganDRAFT 1. Surging exports from China has boosted its share of world exports from 1% in 1980 to 11% in 2011, making China the world s largest exporter in the world 2. It is no surprise that multinational corporations (MNCs) not only regard Asia as a manufacturing and sourcing hub, but increasingly as a growth market to cater to a growing customer base. The sizeable pools of highly educated, talented resources in these regions is making it possible for organizations to invest and position themselves for the future by establishing operations and networks to develop their businesses. With companies establishing deeper and larger operations globally, they are often burdened by regulation, reporting and tax requirements. This, in turn, is pushing them to scrutinize cost, optimize working capital and simplify business processes to stay relevant in an increasingly competitive marketplace. This has created a market with increased burden of regulation, reporting and tax obligations. As a result, organizations are looking for innovative ways to give them greater flexibility and scale without suffering any reduction in control or the ability to demonstrate control. Centralized Trading Centers (CTC) offer a way for organizations to consolidate, co-ordinate and demonstrate control and cost efficiency in a central location. KPMG and J.P. Morgan are proud to present this report, which sets out to discuss the use of CTCs and the benefits they provide global companies. It also provides a practical methodology to integrate the financial and the physical supply chain. Egidio Zarrella Clients and Innovation Partner Advisory KPMG China J.P September September 2013 Creating Value Using Centralized Trading Centers KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A., member FDIC, or its affiliates/subsidiaries is one of the offerors of the products and services featured within this document. All services are subject to applicable laws and regulations and service terms. Not all products and services are available in all geographic areas. Eligibility for particular products and services is subject to final determination by J.P. Morgan and/or its affiliates/subsidiaries.

5 CTCs - Their Roles and Functions In the past, CTCs were established with the intention to generate tax savings. The motives behind setting up these entities have changed dramatically over the past decade. More often, these entities are now structured to create genuine value-added contributions to the parent company and to better administer suppliers and supply chain management. In addition, it has helped to drive costs down and enable better management of working capital. Besides the basic functions, CTCs can be positioned as future Centers of Excellence for an organisation and can handle a host of functions such as demand management, design, risk management, quality control, and supply chain management. Understanding the objectives of CTCs The objective of a CTC is to consolidate functional activities across entities to leverage economies of scale. This is done by streamlining sourcing, procurement and payables activities across markets or by invoicing customers centrally to collect receivables more efficiently. A CTC is often a separate entity that takes titular ownership of the underlying goods. As is evident from the illustration below, having a CTC helps improve financial and operational efficiencies including management of Foreign Exchange (FX), liquidity and working capital. DRAFT 2014 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A., member FDIC, or its affiliates/subsidiaries is one of the offerors of the products and services featured within this document. All services are subject to applicable laws and regulations and service terms. Not all products and services are available in all geographic areas. Eligibility for particular products and services is subject to final determination by J.P. Morgan and/or its affiliates/subsidiaries. Creating Value Using Centralized Trading Centers 3

6 A CTC can also enable finance and treasury functions to reduce FX exposure, optimize working capital and provide flexibility to manage counterparty risk. The use and importance of a CTC varies according to business flows, industry and other stated objectives. Some of the activities prevalent in CTCs are: The CTC would operate as principal in the financial and physical supply chains Sourcing Center Centralized purchasing of raw materials, semi finished or finished goods from suppliers and sells to related entities for manufacturing and/or final sale to the end customer. Sales Center Titular ownership and centralized invoicing to related entities and 3rd parties. From a physical supply chain perspective, goods are shipped directly from the manufacturing entity to the end customer. Key activities CTC places orders with suppliers Suppliers invoice CTC for the purchases Suppliers ship goods to CTC customers (manufacturer /retailer) directly CTC invoices customer based on agreed terms and currency CTC pays suppliers based on agreed terms and currency Intercompany settlements completed (based on legal, tax, regulation and transfer pricing policies outlined) Key activities CTC receives orders from customers The order is placed by CTC with suppliers Customers (manufacturer/retailer) receives goods from CTC suppliers directly CTC invoices customer based on agreed terms and currency CTC pays suppliers based on agreed terms and currency Intercompany settlements completed (based on legal, tax, regulation and transfer pricing policies outlined) A CTC that takes titular ownership of the underlying goods can offer clients benefits of consolidated sourcing and invoicing DRAFT Creating Value Using Centralized Trading Centers KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A., member FDIC, or its affiliates/subsidiaries is one of the offerors of the products and services featured within this document. All services are subject to applicable laws and regulations and service terms. Not all products and services are available in all geographic areas. Eligibility for particular products and services is subject to final determination by J.P. Morgan and/or its affiliates/subsidiaries.

7 The evolving role of Treasury and benefits of CTC Rapid growth in Asia is prompting corporations to set up regional and in some cases, global CTCs. These CTC entities are being structured to create genuine value added contributions to business profitability and processing efficiency including supporting the disbursements, collections and liquidity management needs of the parent and group entities. Treasury s role of managing working capital needs and optimizing internal liquidity to fund deficit entities, can be driven by the CTC through changes in intercompany payment terms. This can also be extended to third party strategic vendors in exchange for better procurement terms. However, Treasury Transformation is not easy, particularly in Asia as it lacks the cohesive, co-operative and complementary currency regimes that are often the norm in developed regions like North America and Europe. As organizations embark on a transformation journey, it is imperative for Treasury to understand the benefits and identify areas where services of business partners can be leveraged. CTCs will establish synergies and drive discipline across the supply and financial value chains, establish common objectives to reduce cost of goods, manage risk and improve customer service and relationships Suppliers Material Supplier Build Distribute Retail Fund Inventory Pay Supplier Invest In P&P Finance Retailers Collect From Customers Financial Value Chain Working Capital Optimization Risk Management Raw Materials Finished Goods Production Payment Supplier Term Standardization / Extension Supplier Consolidation Payment Customer Term Standardization FX Netting / Consolidation Basis for Customer Credit Management Reduction In Supplier Financing Risk Physical Value Chain CTC Distribution Centre DRAFT Liquidity Management Cash Visibility & Control Goods Payment B2B B2C Sales Receipts Goods Customers Sales Receipts Goods Cash Concentration / Cash Pooling Optimize Trapped / Idle Cash Visibility of Positions Across Entities Consolidated View of Regional Cash Position Improve Cash Flow Forecast & Control 2014 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A., member FDIC, or its affiliates/subsidiaries is one of the offerors of the products and services featured within this document. All services are subject to applicable laws and regulations and service terms. Not all products and services are available in all geographic areas. Eligibility for particular products and services is subject to final determination by J.P. Morgan and/or its affiliates/subsidiaries. Creating Value Using Centralized Trading Centers 5

8 Case Study Technology Company Sets up a Pan-Asian CTC Company Background Leading technology developer of connectivity solutions that enables proliferation of data in automobiles, consumer devices and other applications. Headquartered in the US, the company operates across multiple footprints while maintaining core operating activities in the US. Client s Challenge Decentralized value chain - Accounts receivables activities managed out of the HQ including billing customers - Procurement and sourcing activities decentralized by entity & location impacting on the organization s ability to lower total cost of ownership - Non-commercial activities like inspection and testing concentrated in the US even though business partners reside in Asia Working capital inefficiencies - Lack of Days Payables Outstanding (DPO) optimization (i.e. non-standard supplier terms) - High Days Sales Outstanding (DSO) due to multiple customer billing terms - Inefficient Days Inventory Outstanding (DIO) Increased risk - Exposure to FX - Lack of intercompany netting CTC Solution Established a CTC in Hong Kong to support financial value chain activities Order to Cash - Accounts Receivables Centralize billing / invoicing to customers to facilitate collections, fund receipt and application Procure to Pay - Procurement Centralize purchasing activities across entities via an invoicing center - Accounts Payables Centralize invoicing to support settlement of disbursements to counterparties Relocation of Non Commercial Activities to Asia Closer proximity of non commercial activities to Asia supported by an integrated financial & physical value chain activities - Established Research & Development (R&D) Center in India - Established Testing Service Center in Taiwan Support material consignment to contract manufacturers in China Reduced DIO by performing testing in Asian time zone FX Risk Mitigation - Streamline transaction flow along fungible currency(s) - Ability to adopt leading and lagging techniques to reduce FX gains and losses - Centralized FX management across entities Streamline intercompany netting to facilitate transactions (i.e. royalties, operating expenses and commissions) Potential Corporate Benefits Improvement in Working Capital - Integration of physical and financial value chain activities - DSO - Ability to standardize terms with customers - DPO - Ability to standarize / extend terms with counterparties - DIO - Support inventory optimization objectives by performing quality control and testing in Asia time zone vis-à-vis conducting the performance in the US Optimized Tax Structure to Support Global Ambitions - Establishment of tax efficient centers of excellence to streamline operations - Establishment of robust and compliant transfer pricing structure Enhanced Operating Margins - Redeployment of resources to Asia to leverage labor arbitrage opportunities - Cost effective deployment of investment to Asia to support Asia expansion plans - Streamlined intercompany process to facilitate better integration across entities DRAFT Creating Value Using Centralized Trading Centers KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A., member FDIC, or its affiliates/subsidiaries is one of the offerors of the products and services featured within this document. All services are subject to applicable laws and regulations and service terms. Not all products and services are available in all geographic areas. Eligibility for particular products and services is subject to final determination by J.P. Morgan and/or its affiliates/subsidiaries.

9 2014 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A., member FDIC, or its affiliates/subsidiaries is one of the offerors of the products and services featured within this document. All services are subject to applicable laws and regulations and service terms. Not all products and services are available in all geographic areas. Eligibility for particular products and services is subject to final determination by J.P. Morgan and/or its affiliates/subsidiaries. Creating Value Using Centralized Trading Centers 7

10 Market Trends Driving CTCs The pivot towards Asia in terms of both exports and imports will increase the incentives for organizations to set up regional or global CTCs to operate as sales and procurement centers in Asia. The presence of an emerging China is seen as particularly key. Despite this, the Chinese Renminbi (RMB) is still ranked at 8th position (as at December 2013), moving up from 20th position in January The US dollar and the Euro continue to lead the world payments ranking consistently by dominating the top ranks. The RMB s position is far removed from its position as the world s second largest economy and the globally dominant role of China as a trading partner. Moreover, economic groups such as the RMB as world payments currency in value Jan 2012 EUR #1 USD #2 GBP #3 JPY #4 AUD #5 CAD #6 CHF #7 SEK #8 SGD #9 HKD #10 NOK #11 THB #12 DKK #13 RUB #14 ZAR #15 HUF #16 NZD #17 MXN #18 TRY #19 CNY #20 Source: SWIFT Watch 44.04% 29.73% 9.00% 2.48% 2.08% 1.81% 1.36% 1.05% 1.03% 0.95% 0.93% 0.82% 0.54% 0.52% 0.48% 0.34% 0.33% 0.31% 0.27% 0.25% In this graph, USD represents the payments settled through the SWIFT network only. It excludes the majority of the USD payments that are settled through the Fedwire and Clearing House Interbank Payments Systems (CHIPS) that are not on SWIFT. The lack of free currency convertibility creates a unique set of challenges and subjects the currency to fluctuations in currency value based on where it s domiciled i.e. CNY (onshore) vs. CNH (offshore). From a corporate Treasury standpoint, it creates a number of accounting headaches and significant uncertainty around RMB holdings as there is a lack of clarity of how DRAFT Association of Southeast Asian Nations (ASEAN) often better reflect existing differences and disparities in the region than commonalities and shared interests. Nonetheless, China and the RMB have become key factors for consideration as companies look to establish CTCs in Asia. Hong Kong continues to be a gateway to China due to the favorable business environment, proximity, cultural and language similarities to Mainland China. While the RMB is currently active on a regional basis rather than at an international level, its usage as a transacting currency is growing rapidly and predictions for the future of the RMB as a settlement currency are very optimistic. Dec 2013 USD #1 EUR #2 GBP #3 JPY #4 CAD #5 AUD #6 CHF #7 CNY #8 HKD #9 SEK #10 SGD #11 THB #12 NOK #13 PLN #14 RUB #15 DKK #16 MXN #17 ZAR #18 NZD #19 TRY # % 39.52% 33.21% 9.13% 2.56% 1.90% 1.89% 1.29% 1.12% 1.11% 0.96% 0.96% 0.80% 0.76% 0.54% 0.51% 0.48% 0.42% 0.39% 0.37% offshore RMB is backed and managed. This is in stark comparison to fully convertible and tradable currencies which are backed by their respective central banks which ensure the value of their currencies through periods of high stress. Regardless of the challenges, organizations are seeing benefits with the gradual liberalization of RMB and are re-evaluating their trade, treasury and cash management practices to encapsulate such changes. Below are key highlights of RMB internationalization that can potentially impact CTCs. Creating Value Using Centralized Trading Centers KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A., member FDIC, or its affiliates/subsidiaries is one of the offerors of the products and services featured within this document. All services are subject to applicable laws and regulations and service terms. Not all products and services are available in all geographic areas. Eligibility for particular products and services is subject to final determination by J.P. Morgan and/or its affiliates/subsidiaries.

11 Recent Developments I. Trade Settlement Expansion of RMB trade settlement scheme nationwide RMB recipient is no longer required to be a Mainland Designated Enterprise Trade-financing related RMB can be repatriated with valid supporting documents II. Foreign Direct Investments (FDI) channel, Capital Investments and Shareholders Loans III. RMB Denominated Cross-Border Intercompany Loans IV. Onshore RMB funds for Outbound Direct Investment (ODI) projects V. Capital Remittance Overseas companies seeking approval for RMB funding should establish a Foreign Investment Enterprise (FIE) in China RMB funding can be raised offshore through trade settlement, bond issuance or share sales with prior approval from the Ministry of Commerce People s Republic of China (MOFCOM) With a FIE established and funded, additional capital can be raised from overseas via Shareholder Loans. The amount of shareholder loans is linked to the Foreign Debt Quota together with Foreign Currency Debts, which is the difference between the approved total investment amount and registered capital Proceeds of RMB that are raised offshore can be used for direct investments capital contributions, or purchases of shares/equity interest. However, such proceeds cannot be used for investing in financial products (i.e. securities, derivatives), entrustment loans, real estate and wealth management products Onshore companies can appoint banks to support RMB cross-border intercompany loans to its overseas parent or affiliates Intercompany loan parameters (i.e. interest rate, tenor, and usage of the funds) can be determined by the lender and borrower on an arm s length basis Cross border loans cannot be used for investment (including real estate investment) or capital injection into China People s Republic of China (PRC) non-financial investors can remit onshore RMB funds out for investment in ODI projects Verification of the ODI projects must be obtained from the National Development and Reform Commission and Ministry of Commerce People s Republic of China (MOFCOM) Corporations in China can freely transact RMB dividend payout to overseas investors with the provision of relevant supporting documentation (e.g. board resolution and tax clearance certificate) Regulatory approval of foreign exchange purchase and remittance under direct investment items for income derived from share transfer, capital reduction, liquidation and early withdrawal of investments have been eliminated DRAFT Potential Impact Encourage use of RMB in international trade and greatly facilitate the settlement needs for overseas companies FDI and Shareholder Loans provide an efficient and effective method to meet onshore capital needs Ability to raise RMB offshore could encourage dim sum bond issuance Expanded channels will provide an ability to facilitate capital onshore and offshore; helping to normalize the spreads between CNY (onshore) and CNH (offshore) exchange rates Ability to enable a cross border intercompany sweep program in the near future Efficient use of onshore liquidity by potentially giving corporations an ability to participate in a global or regional liquidity program Use of idle cash in China to support overseas working capital requirements Enables PRC entities to participate in offshore projects Investors enjoy greater flexibility in capital movements between onshore and offshore entities Foreign investors may apply for foreign exchange purchase and remittance with their banking partners directly, after registration with the regulator 2014 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A., member FDIC, or its affiliates/subsidiaries is one of the offerors of the products and services featured within this document. All services are subject to applicable laws and regulations and service terms. Not all products and services are available in all geographic areas. Eligibility for particular products and services is subject to final determination by J.P. Morgan and/or its affiliates/subsidiaries. Creating Value Using Centralized Trading Centers 9

12 Hong Kong as a Gateway to China In China, local Chinese manufacturers have opted to set up global sales functions in Hong Kong to enable global expansion. It is also a simpler way to circulate international cash into the region. Conversely, a number of global MNCs in the apparel and fashion market have been establishing procurement hubs in Hong Kong. This enables them to stay close to the market and their suppliers, and leverage opportunities working with the RMB. Why Hong Kong? Interview with Simon Galpin Director-General at Invest Hong Kong DRAFT In response to the rapid growth of MNCs in Asia, Hong Kong has increasingly been seen as the natural hub for MNCs to set up regional CTCs. According to Simon Galpin, Director-General at Invest Hong Kong, these inherent advantages fall into a broad range of categories. One is the predictability of the tax and legal environment in Hong Kong, which is less apparent in other cities across Asia, along with the freedom of information over the internet and the world class IT infrastructure that Hong Kong offers. Hong Kong is one of the few places in the world where being a low tax jurisdiction is actually built into our constitution. Moreover, we have a remarkably stable and internationally renowned legal system that protects this status, said Simon. This is also supported by the signing of Comprehensive Double Taxation Agreements (CDTAs) with 29 countries and, most importantly a Double Taxation Arrangement with China that allows corporates in China to repatriate profits to Hong Kong at a 5 percent withholding tax as opposed to the global norm of 10 percent. Creating Value Using Centralized Trading Centers KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A., member FDIC, or its affiliates/subsidiaries is one of the offerors of the products and services featured within this document. All services are subject to applicable laws and regulations and service terms. Not all products and services are available in all geographic areas. Eligibility for particular products and services is subject to final determination by J.P. Morgan and/or its affiliates/subsidiaries.

13 Location is also important. While clearly part of China, Hong Kong is the international face of China and, even from a Pan-Asia perspective, is very much the center of Asia. It seems to be an understated fact, but Hong Kong is actually closer to key capital cities across Asia, including in ASEAN, than any other major city in the region, notes Simon. Moreover, freedom of movement is also a key draw card. By their very role in the procurement process, frequent travel is necessary for CTC employees. For Hong Kong citizens, having the benefit of visa-free travel in nearly every country in the region is not simply a luxury, but a core strategic advantage to meet the needs of an industry that is constantly on the move. DRAFT However, the most important relationship that Hong Kong brings to the table is that with China. The close proximity to China and the relative freedom of movement across the border means that a Hong Kong-based CTC could work seamlessly and in the same time zone with a shared services center based in Guangzhou. RMB is also the most important currency in the region and Hong Kong offers the largest pool of offshore RMB liquidity in the region. Moreover, it is the starting point for many mainland Chinese corporates finding their overseas footing. Hong Kong has already signed a number of memorandums of understanding (MOUs) with various cities in China and is working closely with a number of cities, particularly in the Pearl River Delta, on joint investment initiatives. Many people often underestimate how close this relationship with China is and what it actually means in practice. It has made Hong Kong one, if not the key hub, for services in Asia. To put this into perspective - if Hong Kong was a country, it would be the third largest recipient of foreign direct investment (FDI) in the world after the US and China, Simon explains. It shouldn t be a surprise that companies like Hitachi and Nissan are making Hong Kong their global procurement hub, even their global headquarters. China is the world s largest exporter and second largest importer. Hong Kong is in the unique position of having the right talent, rule of law, the tax incentives and the status of being a part of China to help companies truly tap into that opportunity KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A., member FDIC, or its affiliates/subsidiaries is one of the offerors of the products and services featured within this document. All services are subject to applicable laws and regulations and service terms. Not all products and services are available in all geographic areas. Eligibility for particular products and services is subject to final determination by J.P. Morgan and/or its affiliates/subsidiaries. Creating Value Using Centralized Trading Centers 11

14 Tax and Transfer Pricing Considerations for CTCs DRAFT Tax and transfer pricing are key factors in setting up an effective CTC. To realize the anticipated benefits from developing a CTC structure, the most appropriate and tax efficient location as well as the related tax-aligned operating model for the CTC would need to be determined. This process requires consideration for various tax and transfer pricing issues, such as availability of any tax incentives/specific regimes, profit repatriation strategies, transfer pricing and customs planning and managing, e.g., permanent establishment (PE), controlled foreign company (CFC) rules and indirect tax issues. A CTC structure is subject to a whole set of regional tax issues, covering the CTC jurisdiction (such as Hong Kong) as well as all the other jurisdictions where the transactional counterparties of the CTC are located. The key issue from a transfer pricing perspective is that both the business model / transaction structure and the actual intercompany pricing policies should be arm slength. An appropriate intercompany transactional structure and the corresponding pricing policies and arrangements should be established to ensure that the actual functionality of the CTC and its counterparties are properly reflected onto the intercompany pricing policies. It is very important that the CTC has economic substance and the actual practices are in line with the planned CTC structure (e.g., presence of people / management that are in charge of the centralized functions in the CTC, capital and control of risks). Also, if the CTC operates as a trading hub, customs duty considerations often enter into the mix and particularly when interacting with transfer pricing policies and adjustments, can increase the complexity of the structure. Equally, indirect taxes (VAT, GST) may apply to CTC transactions in various countries. Various CTC structures in the region can also entail tax incentives or particular benefits. For example, Hong Kong applies a source based taxation system and therefore, to the extent that the profits can deemed to be offshore sourced they are not subject to the Hong Kong profits tax. The critical consideration is whether the key profit generating activities are effected outside Hong Kong and the burden of proof is ultimately on the taxpayer to satisfy the IRD that the income is offshore sourced. Therefore, if it is intended to structure the CTC so that the trading profits are not taxable in Hong Kong, certain key procedures and operational protocols would need to be developed and followed in order to ensure that the key profit generating activities are effected outside of Hong Kong. In many Asia Pacific countries, issues such as location savings, market premiums and the recognition of foreign developed and/or owned intellectual property have become very pertinent transfer pricing issues, and China has been and continues to be one of the leading countries that is trying to adopt these issues to their respective transfer pricing regulations and practice. For example, Chinese tax authorities have been increasing their focus on defining and identifying key drivers for value creation in the CTC structure with an emphasis on functions, Creating Value Using Centralized Trading Centers KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A., member FDIC, or its affiliates/subsidiaries is one of the offerors of the products and services featured within this document. All services are subject to applicable laws and regulations and service terms. Not all products and services are available in all geographic areas. Eligibility for particular products and services is subject to final determination by J.P. Morgan and/or its affiliates/subsidiaries.

15 risks, people and physical assets. They have been explicitly advocating for profits to be allocated in accordance with value creation and are increasingly focusing on issues associated with location specific advantages, local intangibles and alternative transfer pricing methods (e.g., non-traditional profit splits), in an effort to increase taxable income attributable to Chinese entities within the value chain. As such, the CTC structure should be supported by a robust intercompany transfer pricing policy, legal agreements and appropriate economic analyses should be conducted to determine the arm s-length arrangements among the group of companies. Transfer pricing can be a very complicated area, but with appropriate planning and analysis, both tax efficiency and the increasing compliance and documentation obligations can be managed. Without a robust transfer pricing policy, rigorous implementation and supporting documentation, the purported benefits from setting up a CTC may not be sustained. Another consideration to be made would be for treasury related functions to be involved since the establishment of a CTC would often involve centralized intercompany settlements. To appropriately compensate the centralized treasury functions, for example, isolated investment activities or individual funding arrangements may need to be separately considered and benchmarked. For instance, short-term working capital funding, financing an M&A, structural finance or bespoke transactions such as structured subordinated debt arrangements can differ from day-to-day funding items. In particular, intercompany financing transactions are one of the areas many tax authorities in the region are currently focusing on. To come up with a sound mechanism to determine the group s inter- or intra-company transaction rates, specific market data would need to be analyzed to demonstrate that the company is depositing or borrowing at the rate that it is able to secure on a standalone basis. Applying a broad based group borrowing or lending rate may not necessarily be a good reflection of the individual entity required rates in many situations. Key areas Availability of incentives or special regimes/ exemptions Is there sufficient economic substance? Are the intercompany transactional structure and the arrangements in line with the actual functionality of the CTC? What are the key drivers for value creation? Increasing focus on intercompany treasury related transactions Other tax implications Considerations Can CTC profits be claimed offshore sourced based on key profit generating activities being undertaken outside Hong Kong? Level of personnel, capital and control of risks. A robust transfer pricing policy, implementation and supporting documentation should be in place to support the policies and the arrangements. Location specific advantages Local intangibles Alternative transfer pricing methods Potential investment or funding activities of the CTC should be properly considered and benchmarked to develop an appropriate transfer pricing policy. Withholding tax Thin capitalization CFC rules PE Profit repatriation Indirect taxes 2014 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A., member FDIC, or its affiliates/subsidiaries is one of the offerors of the products and services featured within this document. All services are subject to applicable laws and regulations and service terms. Not all products and services are available in all geographic areas. Eligibility for particular products and services is subject to final determination by J.P. Morgan and/or its affiliates/subsidiaries. Creating Value Using Centralized Trading Centers 13

16 Implementation Considerations The advantages of CTCs are clear and more importantly, evolving in line with the development of Asia as a pillar of the global economy. However, while the merits around setting up such an operation may well resonate with many MNCs, there are important considerations to take into account from a people, process and technology perspective. The bigger picture associated with such a change is significant. While management may often take the view that such a move is just a procurement project or simply something to do with treasury or cash management, there are substantial considerations to account for from a target operating model perspective. To get this right, an organization needs to take a step back and look at the impact on the operating model. By doing so, organizations can identify inefficiencies in existing functions and activities and derive maximum value. This is not a riskfree process though. The cost of getting this wrong can be substantial and there are observed instances of organizations that have ended up with a cost center that duplicates and unnecessarily complicates what were supposed to be streamlined processes. Therefore, finding the correct balance and integrating it into a business unique structure (physical, legal, and political) is paramount. Below are a few implementation considerations based on what we have seen in practice: CTC implementation considerations Banking structure 1. Account rationalization Consolidating bank accounts through an overlay structure allows Treasurers to concentrate cash and manage internal funding between the CTC and related companies. Bank Account Management will streamline and maintain control over key bank account ownership. 2. Information visibility and control With a single bank interface, a CTC can enhance real-time reporting of cash positions and enhance control over deployment of funds and intercompany positions. 3. Streamlining fund receipts and payments The value of streamlining bank accounts enables operations to standardize banking processes and achieve operational efficiency in payments and collections reconciliation. 4. Bank fees and costs Through bank account rationalization, a CTC can consolidate transaction flows and renegotiate or standardize fees and billings with service providers. Creating Value Using Centralized Trading Centers KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A., member FDIC, or its affiliates/subsidiaries is one of the offerors of the products and services featured within this document. All services are subject to applicable laws and regulations and service terms. Not all products and services are available in all geographic areas. Eligibility for particular products and services is subject to final determination by J.P. Morgan and/or its affiliates/subsidiaries.

17 People 1. Different skills in different regions Just like establishing a captive shared service center, organizations will need to scale up operations in a location that they are not necessarily familiar with. They will also need to find management talent in these locations. 2. Right-sizing locally The impact on the local operations allows the opportunity for reallocating skills internally or cost cutting. However, in the event of reallocation, there may be ramifications from a retention perspective. 3. People and cultural change management The structure of some of the operations may fundamentally change. This will impact working practices and activities and likely become a much larger and more complex undertaking than first envisaged. 4. Movement of power (organizational politics) The movement of internal roles and responsibilities will likely create internal power shifts. As a result, the change management and communication elements of the transformation will be of paramount importance. Process 1. Allow for standardization Many organizations have used this type of project to drive process standardization and to embrace process automation. In the purest sense, this allows organizations to re-engineer legacy processes and bring them up to date. 2. Thorough understanding of current state Clients have used this as an opportunity to cast the net wider to document and understand the interactions across the business again to identify efficiency and automation opportunities. However, the reality of this is that most businesses will not create such a far reaching project and will have to chunk the work up. This is not because it cannot be done but more a result of regional and local operations potentially pushing back given levels of complexity for in-country process requirements. We see businesses doing an initial quick scan to understand the landscape and subsequently prioritizing and building a logical and pragmatic plan. However, this can be a very costly exercise. There have been instances where businesses create stand-alone operations to prove the concept initially and then tackle the larger challenge once the benefits can be demonstrated. 3. Regulatory compliance Across the region, regulators are interacting with one another on a more frequent basis 2014 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A., member FDIC, or its affiliates/subsidiaries is one of the offerors of the products and services featured within this document. All services are subject to applicable laws and regulations and service terms. Not all products and services are available in all geographic areas. Eligibility for particular products and services is subject to final determination by J.P. Morgan and/or its affiliates/subsidiaries. Creating Value Using Centralized Trading Centers 15

18 and are adopting similar positions of transaction flows, domestic operations and the movement of jobs as well as the level of transparency that they expect. Setting up a CTC requires planning from a regulatory stand point. It is not insurmountable, but it needs to be addressed early so that regulatory and other external stake holders are kept abreast of your intentions. 4. Tax considerations Tax authorities are also an important external stake holder. Transfer pricing and direct tax are likely to have an impact on legal entity structures and pricing models. 5. Proper implementation takes discipline Creating the structure and procedures is the easy part. The challenge is in the implementation of the new structure and how the business adopts and adapts to the new operations. Success should be the adoption of repeated processes, which links back to the original business case, across people, process and technology. Technology 1. Know your vision Before looking at any change to your system architecture, there must be a clear understanding of your vision for the business. For a successful upgrade or new system implementation, you must have clearly defined business requirements, which articulate both expectations and the case for change. 2. Building on a legacy Rapid organic and inorganic growth in Asia has resulted in complex system architectures for established market players. New market entrants have a comparative advantage as leading technologies can be rapidly adopted and utilized without the need to interface with legacy systems. A robust CTC strategy should identify and incorporate such opportunities to streamline and enhance the current environment. 3. Technology as an enabler We are seeing a rapid evolution in treasury technology as mobile and Cloud capabilities start to shape the market. As momentum builds, we will see more CTC strategies leveraging Treasury Management Systems, as well as e-invoicing and ebam to drive further efficiencies from the model. 4. Data enrichment and Management Reporting As new technologies gain traction in the market, we see increasing demand for enhanced management reporting and data analytics. Accurate cash flow forecasting will be a key role for any CTC to deliver. We should not, however, underestimate the need for quality data at source in order to provide such analysis. 5. Impact of regulation on technology Regulation will be a key driver in defining your target operating model for CTC operations. To support this, systems will need to meet regulatory reporting requirements and provide adequate controls for the new CTC environment. Creating Value Using Centralized Trading Centers KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A., member FDIC, or its affiliates/subsidiaries is one of the offerors of the products and services featured within this document. All services are subject to applicable laws and regulations and service terms. Not all products and services are available in all geographic areas. Eligibility for particular products and services is subject to final determination by J.P. Morgan and/or its affiliates/subsidiaries.

19 Conclusion Establishing and operating a CTC requires careful planning, which needs to be done in close partnership with functional business partners to determine a future state that meets company strategy and objectives. Time and cost savings are often cited as an important reason. However, it does not always have to be about moving low value and non-judgement based activities centrally. In fact, best in class companies implementing a CTC are focused on consolidation and control of exposure risk, coupled with process efficiency and economies of scale. Such a dynamic transformation helps organizations to adapt to an ever connected world where companies managing global value chains are able to provide local autonomy, with adequate oversight at headquarters. The benefits and challenges of CTC are clear, but before embarking on your journey, you should consider the following questions: Have you clearly defined your strategy and target operating model for Asia? Are you able to articulate your business requirements and expectations for the CTC? Is there a clear understanding of the processes you would like to move to a CTC? Has a suitable location been identified for establishing a CTC? Have regulatory requirements been met and a robust control environment established? Are your strategic banking partners aligned with your vision for the CTC? Do you have adequate treasury and payment systems to meet the requirements of your CTC? Is there a clear case for change and roadmap for establishment of the CTC? 2014 KPMG, a Hong Kong partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A., member FDIC, or its affiliates/subsidiaries is one of the offerors of the products and services featured within this document. All services are subject to applicable laws and regulations and service terms. Not all products and services are available in all geographic areas. Eligibility for particular products and services is subject to final determination by J.P. Morgan and/or its affiliates/subsidiaries. Creating Value Using Centralized Trading Centers 17