Resolving transfer pricing controversies, handling audits and queries, and best practices in TP documentation: A practical guide

Transcription

1 Resolving transfer pricing controversies, handling audits and queries, and best practices in TP documentation: A practical guide Douglas Fone Global Partner, Transfer Pricing Associates 1 Content 1. Introduction to transfer pricing Slide 3 2. Key trends in Asia Pacific Slide 6 3. Practical approach to transfer pricing system design Slide Transfer pricing risk assessment Slide Mastering multiple demands for transfer pricing documentation Slide Dispute resolution process Slide Examples of key TP transactions - case studies Slide Key recommendations Slide Questions & answers Slide 37 2

2 Introduction to Transfer Pricing 3 What is transfer pricing and why is it important? Supply of raw materials Purchase of finished goods Supply of right to use group IP Supply of know-how Supply of services Supply of bank and credit guarantees Supply of loan finance Overseas MNE Subsidiary in Singapore Payment for raw materials Charge for sale of finished goods Payment of royalties Payment for know-how Payment of service fees Payment of guarantee fees Payment of interest 4

3 What is transfer pricing and why is it important? Pricing of all inter-company transactions Necessary in every multinational Determines profit allocation within multinational Regulations required to ensure fair and reasonable for all stakeholders: Tax authorities fair share of profit to levy tax CFO, FD, CEO, Heads of Tax etc shareholder value Current shareholders return on investment Potential investors future return on investment, corporate governance, proper valuation of the business Lending institutions corporate governance Employees performance measurement Boards of Directors corporate governance, shareholder value Competitors relative shareholder value 5 Key Trends in Asia Pacific 6

4 Key trends in Asia Pacific - Overview Growing importance of transfer pricing in Asia Tax authorities sharing knowledge and best practice Double tax treaties, APAs and MAP cases Less reliance on customs duties for fiscal revenue Increased competition as more countries introduce audit programs Developments in China New EIT law introduced wef 1 January 2008 Documentation requirements to be effective from 1 January 2008 Other countries forced to protect their tax bases Hong Kong (next DIPN will be re TP) Taiwan (documentation now compulsory) Singapore (guidelines and review program introduced) Vietnam (guidelines and audit program recently introduced) 7 Key trends in Asia Pacific - Singapore s new Transfer Pricing Consultation programme Issued 6 August 2008 Notice of IRAS questionnaires to be sent for fact gathering Selected taxpayers for a TPC will need to be able to show: Business structure Local activities and mode of operations, Explain how certain factors in its business or industry affect its operating results Nature, pricing and benchmarking of the related party transactions Documentation prepared. Outcome (1) IRAS opinion on level of taxpayer s transfer pricing risk, based on quality of documentation and commercial realism of results. Outcome (2) IRAS recommendations on how the documentation or methodology may be improved. 8

5 Key trends in Asia Pacific - Practical issues faced by multinationals Satisfying the increasing documentation compliance burden Managing the overall effective tax rate in face of increases in tax rates and greater enforcement of transfer pricing regulations Finding reasonable comparable data to support the arm s length nature of intercompany pricing Countering the use of secret comparables by certain tax authorities Dealing with the risk of aggressive and unpredictable audits in multiple countries Addressing the rapid development of transfer pricing in China and intra-china variations in approach Dealing with varied level of experience in different jurisdictions Is the existing transfer pricing system in Asia likely to withstand serious scrutiny? 9 Emerging trends in Asia Pacific Greater exchange of information between tax authorities Increased enforcement more audits/apas/ MAPs To counter evasion or money laundering FIN 48 implications corporate governance Increased interaction between tax authorities Need for transparency and fairness in application Increased resources required and more training Conflict with need to attract FDI reducing in importance Compliance burden for MNCs increasing Integration of customs and transfer pricing Business restructuring Financial Transactions Domestic transactions as well? Alleviate through Masterfile approach Acceptance of economic indicators/safe harbours? Exemptions for small and medium sized companies? Need for certainty and consistency in application Agreement on transaction or profit approach to prevent anomalies Emerging global issue more MAPs likely but double taxation in the meantime Common approach required from tax authorities Thin cap and transfer pricing interaction? Availability and definition of the thin cap safe harbour Guarantee fees GE case approach of tax authorities? 10

6 Practical Approach to Transfer Pricing System Design - Get it right from the start 11 Practical approach to system design - TPA s Transfer Pricing Process TPA s Transfer Pricing Process: COMPANY S BUSINESS OPERATIONS How to get from a business model to a manageable transfer pricing system? Transfer Pricing Process: 12

7 Practical approach to system design - TPA s Transfer Pricing Process INPUT: COMPANY S BUSINESS OPERATION OUTPUT: DEFENSIBLE/ WORKABLE TRANSFER PRICING SYSTEM IDENTIFICATION OF BUSINESS CONTEXT DESIGN & IMPLEMENTATION DOCUMENTATION RISK ASSESSMENT/ MANAGEMENT - Investigate industry and business context - Identify key business objectives of management e.g. market penetration - Analyse key functions/ activities performed - Identify assets and risks associated with activities - Analyse the nature of the current value chain and plans for the future - Identify responsibility centres - Determine appropriate TP methodology - Consider opportunities to minimize overall tax rate - Establish appropriate performance measurement / incentives - Legalise inter-company transactions agreements - Conduct comparability search to support result - Prepare Masterfile/local documentation - Prepare transfer pricing policy paper - Identify key risk countries country risk matrix - Introduce maintenance and disclosure manual - Ensure legal agreements in place and consistent - Prepare transfer pricing defence file - Tax risk assessment e.g. FIN 48 - Investigate possibility of APAs? - Risk ranking/screening for transfer pricing audit - Manage transfer pricing audits effectively - Explore avenues for arbitration - Consider availability of MAP 13 Practical approach to system design - Planning process DESIGN & IMPLEMENTATION Identify and analyse business context Determine existing responsibility centre profile Consider whether existing pricing model is arm s length If not, changes can be made to overall profit allocation by amending pricing to ensure it is arm s length If changes are made to the pricing model: Identify functions, assets and/or risks that can be moved/centralised Carry out financial and risk management scenario analyses Avoid business restructuring issues - ensure substance over form Prepare business case for change anti-avoidance rules Perform thorough economic analysis documentation Ensure legal agreements are consistent and in place Involve all parts of the business to ensure changes are practical eg are changes required to IT systems? 14

8 Practical approach to system design - Introduction to responsibility centres DESIGN & IMPLEMENTATION Remunerate companies based on responsibilities: Expense centre e.g. core research, strategic marketing actual costs (inc. variances) plus arm s length mark-up Cost centre - e.g. contract manufacturing, support services standard costs x actual volumes (maybe non-controllable variances as well) plus arm s length mark-up Revenue centre - e.g. limited risk distribution, commissionaire allocation of margin by way of commission on sales revenue Profit centre - e.g. full risk distribution, speculative treasury operations market price x actual volumes (net margin should provide adequate return) Investment centre - e.g. intellectual property owner and developer effectively residual profit split Economic substance and commercial reality drives the setting of inter-company prices 15 Practical approach to system design - Typical centralised business model DESIGN & IMPLEMENTATION Expense Center R&D services Investment Center IP owner/ parent company Contract R&D activities license Cost Center manufacturing services Profit Center sale of products Revenue Center Contract manufacturer Entrepreneur (principal) Sales/distribution subsidiaries 16

9 Transfer Pricing Risk Assessment - Know what to look out for Your bridge to world-wide transfer pricing services 17 Transfer pricing risk assessment - Likely weak spots RISK ASSESSMENT/ MANAGEMENT INPUT: COMPANY S BUSINESS OPERATION OUTPUT: DEFENSIBLE/ WORKABLE TRANSFER PRICING SYSTEM IDENTIFICATION OF BUSINESS CONTEXT DESIGN & IMPLEMENTATION DOCUMENTATION RISK ASSESSMENT/ MANAGEMENT A B C D Industry and business model not clear Legal, economic and accounting realities do not match Non-compliance or insufficient compliance Transfer pricing audit and conversion risks 18

10 Transfer pricing risk assessment - Tax authority approaches RISK ASSESSMENT/ MANAGEMENT OECD note in October 2006 re audit case selection ATO methodology Quality of documentation Commercial realism of results Common audit trigger factors, including: High risk transactions - royalties, service fees, financial transactions Aggressive tax planning structures eg transactions with tax havens Disclosure of unusual methodologies in Sch 25A or equivalent Lower profitability than the industry norm, varying levels of profitability Lack of responsiveness to queries poor corporate governance standards Poor compliance and tax payment record inadequate TP documentation Poor relationships/guanxi with tax officials 19 Transfer pricing risk assessment - Multinational approaches RISK ASSESSMENT/ MANAGEMENT Subsidiary of overseas parent company Single country risk assessment eg ATO approach Global MNC in respect of single transaction type Single transaction risk assessment e.g. HO service fees Based on specific risk factors for specific transaction Global MNC in respect of all transaction types FIN 48 approach Recognition of all transactions Are they more likely than not to withstand tax authority audit? Adopt objective measurement methodology Audit/APA history? Documentation/benchmarking available? Treaty/MAP protection? Tax rate differential? 20

11 Transfer pricing risk assessment - A practical tool RISK ASSESSMENT/ MANAGEMENT Type of Transaction Recharge of Costs Management/ Support Services Management/ Support Services Royalty Sale of Goods Sale of Goods to Loss-maker Number of countries involved Transaction amount US$1m US$10m US$50m US$50m US$500m US$100m Risk rating Documentation recommended: Invoice Legal agreement Summary TP report Masterfile country risk analysis maintenance & disclosure manual Localisation of MF Additional analysis other methodologies in depth industry analysis loss justification paper 21 Mastering Multiple Demands for Transfer Pricing Documentation Your bridge to world-wide transfer pricing services 22

12 Transfer pricing documentation - Masterfile documentation: What is it? DOCUMENTATION Preparation of core set of documents per best practice Maintained at head office for efficient updating Comprises OECD-compliant documentation in modular format, easy to leverage: Business context and industry analysis Functional analysis for each type of entity Classification of each type of entity - responsibility centre profiles Inter-company transactions Transfer pricing system design Global or regional benchmarking Also supporting documentation: Transfer pricing policy paper Country risk analysis Maintenance and disclosure manual 23 Transfer pricing documentation - Outline of Masterfile transfer pricing report DOCUMENTATION Basic outline of Masterfile transfer pricing report: Executive Summary Introduction and purpose of report Company and industry analysis global/regional Functional analysis regional Classification of companies responsibility centres Outline of transfer pricing policy for price setting Selection of methods per OECD for price checking Application of methods for each classification of company Conclusions Appendices, including OECD Guidelines, support for economic analysis, inter-company agreements etc. Satisfies 70-80% of local country requirements 24

13 Transfer pricing documentation - Masterfile documentation: Benefits DOCUMENTATION Benefits of Masterfile documentation Satisfies around 70%-80% of local requirements Reduces compliance costs - prevents duplication of effort Moves away from costly country by country approach Consistent classification of companies Consistent economic analysis selection, definition of PLIs etc MNCs take ownership of monitoring their TP issues Is it possible in Asia? Definitely! Convergence of acceptable methodologies Availability of regional financial data improving Useful risk management tool for MNCs Where are the exposures? Where are the opportunities? 25 Dispute Resolution Process - Tips for handling tax authority enquiries Your bridge to world-wide transfer pricing services 26

14 Dispute resolution process RISK ASSESSMENT/ MANAGEMENT Before notification of review/audit Ensure all legal agreements are in place Design your transfer pricing system in accordance with arm s length principle Ensure transfer pricing documentation is prepared in advance contemporaneous Carry out regular reviews of returns vs benchmarks Collect other relevant documentation eg Board minutes, evidence of negotiation Ensure documentation is up-to-date Be aware of risk areas Prepare additional documentation to cover significant exposures 27 Dispute resolution process RISK ASSESSMENT/ MANAGEMENT After notification of review/audit Appoint team to handle the queries, including technical advisers Respond promptly and fully to requests for information Assume tax office has full knowledge do not rely on non-disclosure! Keep full and accurate record of information provided Assume from the start that the dispute will go to Court Anticipate direction of tax office queries be one step ahead Know your strengths and weaknesses Consider availability of MAP and APA Carry out detailed scenario analyses what would it mean to you? 28

15 Dispute resolution process RISK ASSESSMENT/ MANAGEMENT During conduct of review/audit Suggest appropriate people for tax office interview Carry out test interviews to ensure clear communication Record the interviews tape or by note-taking Share file notes with tax officials to arrive at agreed version of discussions Co-operate with and show respect at all times to the tax officials Ensure everyone in the office is aware of the visit Accompany the tax officials at all times while on company premises Be clear of your facts and your preferred direction of enquiry 29 Examples of TP transactions - Case studies of key challenges 30

16 Case study I - Key transactions Luxury goods HK Procurement Italy Headquarters Legal ownership and development of brands/ trade names and design Company manufacture and determine global marketing strategy Principal / Manufacturer Distributors Local operation in 5 years of consecutive losses 31 Key considerations - International tax and TP issues Consecutive losses all TP related? Key reasons from industry and business challenges Practical solution Loss justification paper to draw out anomalies in the industry, key business challenges (potential argument may exist if problems specific to market or business) Ensure Transfer Pricing policy reflect functions, assets and risk. It will be difficult for principal entity to argue that it needs to be making profits when it drives all key decisions and assumes most risk Any start- up considerations? -Review pattern of losses and gains and conduct an average of profitability 32

17 Case study II - Key transactions Local and overseas third party suppliers Raw materials prices negotiated by HQ Sale of finished goods (price set by negotiation with Distributors based on forecast resale minus methodology) Manufacturer China producing on orders by HQ Cost recharge (based on units produced) HQ cost (inc brand development costs) recharge (based on relative EBIT) R&D Company under direction from HQ US Headquarters Legal ownership and development of brands/ trade names (no royalties) Marketer/Distributors Singapore Sale to third party customers at market price Third party Customers 33 Case study - Issues and consequences Current State China manufacturer Distributors R&D companies US headquarters Responsibility centre profile Current profitability Issues arising Consequences Cost centre Revenue/Profit centre Expense centre Profit and Investment centre High and variable, fluctuating Increase in overall ETR Local economic ownership of IP Low and variable, some losses Potential trapped losses causing high overall ETR Local economic ownership of IP Break even Loss of shareholder value Loss of shareholder value Loss of shareholder value Inability to pay Increase in transfer Increase in transfer dividends by HQ pricing audit risk pricing audit risk Future business restructuring issues and transfer pricing audit risk Break even at best, or losses No profit - lack of Losses - lack of commercial commercial reality reality Diverse ownership of group IP Loss of shareholder value Increase in transfer pricing audit risk throughout group 34

18 Key Recommendations 35 Key recommendations Apply best practice transfer pricing system design Proactive approach price-setting should be on an arm s length basis Use the responsibility centre concept for system design Let the business model drive the transfer pricing system Maintain contemporaneous TP documentation Adopt Masterfile approach to satisfy compliance burden Ensures higher quality documentation for good corporate governance Puts MNCs in control of their transfer pricing documentation Provides flexible framework for ongoing management of TP risks Risk management should be the trigger for tax planning Where are the exposures to avoid double taxation? Where are the opportunities to reduce overall effective tax? 36

19 Questions & Answers 37