Transfer Pricing: Theory & Practice

Transcription

1 Transfer Pricing: Theory & Practice TEI Houston Chapter Your Auditor and Transfer Pricing Randy G. Price, Deloitte Tax LLP Rupesh R. Vadapalli, Deloitte Tax LLP March 1, 2018

2 Agenda Impact of International Tax/Transfer Pricing on Financials Pressures from External Stakeholders Financial Statement Auditor Considerations Q&A

3 Impact of International Tax & Transfer Pricing on the Financial Statements

4 Relevance of Transfer Pricing Key effective tax rate driver Influence on earnings per share (EPS) Critical to tax effective/efficient global expansion Comparative advantages Potentially part of management KPIs

5 What are Relevance of US Tax Reform people Rate reconciliation table talking FDII about? 163(j) Disclosures 59A: 162(m): 163(j): 168(k): 172(a): Base erosion and anti-abuse tax (BEAT) Limitation on excessive employee remuneration Interest expense limitation Temporary 100% expensing for certain assets NOL deduction limitations APB 23 assertions memos and disclosures Non-GAAP financial measures Internal controls Transition tax payments 245A: 250: 267A: 904(d): 951A: 965: Deduction for certain foreign source dividends Deduction for FDII and GILTI No deduction for certain related party hybrid payments New FTC limitation baskets GILTI income inclusion Deferred foreign income on transition

6 Relevance of International Tax & Transfer Pricing

7 Stakeholder Pressures

8 Intensified Focus on Transfer Pricing Uncertain Tax Positions Typically a transfer pricing methodology meets the MLTN threshold. Uncertainty generally relates to the transaction s valuation or pricing, which is addressed in the measurement process of an uncertain taxposition. The need for a valuation allowance may e overcome y the existence of sufficient future taxable income, whichcan e directly affected by transfer pricing arrangements. Further, valuation allowances are affected by tax-planning strategies that are prudent and feasible. A tax planning strategy can be directly impacted by the transferpricing. Measuring Deferred Taxes on Foreign Earnings Transfer pricing Transfer can affect the amount of deferred taxes related to the company s indefinite reinvestment assertion. This could also impact the amount of deferred taxes on repatriation plans. Pricing Tax Authorities PCAOB SEC Companies will frequently redeploy or reevaluate business operational structures, which are directly impacted by transfer pricing methods. Acquirers

9 Tier 3 Tier 2 Tier 1 OECD Guidance on Transfer Pricing Documentation and Country-by-Country Reporting New guidelines adopt 3-tiered approach COUNTRY-BY-COUNTRY REPORT Aggregate tax jurisdiction-wide information 2 main tables + 1 for additional information Available to each relevant tax administration / Filing Process to be agreed To be finalized maximum 1 year following the last day of FY of the Ultimate Parent MASTER FILE Blueprint of the Group as a whole Available to each relevant tax administration / Filing Process to be agreed LOCAL FILE Information on local entity s business and intercompany transactions To be delivered directly to local tax administrations To be finalized no later than the due date for the filing of the local tax return Information on the global allocation of income, the taxes paid and certain indicators of the location of economic activity among tax jurisdictions in which the Group operates List of entities per tax jurisdiction Provide a high level overview on Group business, including: Important value drivers Development, ownership and exploitation of IP Financing activities Supply chain Provide more detailed information relating to all local intercompany transactions Requires local comparables if available Allows re-runs of comparables every three years if circumstances have not changed: subject to local rule adoption & still must update financial data for the comparables

10 House Ways & Means: Transfer Pricing Hearings October 5, 2015: OECD issued final report on Aligning Transfer Pricing Outcomes with Value Creation, Actions 8-10

11 Unrecognized tax benefits and Transfer Pricing PCAOB sample comments Need to prove Company followed the policy, not just tested policy tie results to trial balances Document how firm reached conclusions based on its testing Evaluate and test controls Income taxes will remain a key priority item

12 Unrecognized tax benefits and Transfer Pricing SEC sample comments Boiler plate language should be avoided with respect to income tax disclosures Please describe in detail how tax benefits will be achieved from the restructuring of your foreign affiliates Please provide details of reference to tax holiday and disclose/explain dollar amount and per share impacts on financial statements Provide more details regarding tax uncertainties, including operations in foreign jurisdictions

13 Unrecognized tax benefits and Transfer Pricing Acquisitions increased focus on TP Old approach High level review Subject matter expert not necessarily involved Less transparency, less focus New approach Integrated part of due-diligence Formal requests for TP reports, etc. TP team brought in for review Quantification of exposure/risk areas common

14 Transfer Pricing: Financial Statement Auditor s Perspective TP Specialist Role

15 What is the financial statement auditor considering? Transfer Pricing Transfer pricing relates to the pricing of intercompany and related-party transactions (collectively, related-party transactions ) involving transfers of tangible property, intangible property*, services, or financing between affiliated entities. Related-party transactions include transfers between domestic and international entities, such as: (1) U.S.-to-foreign, (2) foreign-to-foreign, (3) U.S. to U.S. and (4) U.S. state-to-state transactions. Population of related-party transactions identified/evaluated Transfer pricing documentation in place that supports results Economic results make sense given functions, risks & assets of participants Agreement(s) in place that adequately document transactions Assessment of uncertain tax positions related to transfer pricing *HR1 amended Section 936 to expand definition of IP applicable to Section 482 to included workforce in place, goodwill and going concern value.

16 Unrecognized tax benefits and Transfer Pricing Identification typical procedures Source Documents Obtain a list of all intercompany transactions, by size and category (tangible goods, intangible property, services, loans/guarantees) Obtain copies of most recent TP reports Obtain copies of APAs, RARs, etc. Verify/match transaction coverage in TP reports to inventory of controlled transactions Evaluate company s control process for identification of transactions Consider potential of missing transactions (e.g. management fees or IP use) R&D performed by local affiliate and not reimbursed by principal per TP policy Categorize transactions into risk groups based on size, tax differential (or lack of CA relief) Copy of uncertain tax positions ( UTP )

17 Unrecognized tax benefits and Transfer Pricing Identification challenges Systemic challenges and risks Difficult to find information on certain risk areas: undocumented transactions or uncharged transactions Nature of complex multinational Management, operations, etc. don t appreciate or recognize legal entities Ex post v. ex ante nature of evaluation Transfer pricing is inherently uncertain Most transfer pricing reports are written at reasonable basis, not more likely than not Double tax relief are not automatic Competent authority ( CA ) relief must be applied for Deadlines for requesting CA vary by treaty Full relief may not be achieved Company committed to CA process Agreements not in place Terms, pricing, responsibilities not specified Heightened risk

18 Unrecognized tax benefits and Transfer Pricing Concern Risk Areas - maintenance Common risk issues Operational reality v. ex post documentation Intercompany agreements and associated cost pool disconnect Benefits conferred but not charged out Tax/legal structure integrity not maintained Principal Co & IP structures Lack of sufficient substance Integrity of approvals, contracts, etc. G/L captures flows correctly TP documentation lacking Simply not prepared, but policy in place Analysis not updated Countries not covered Certain transactions not included Loans Guarantees Management Fees

19 Concern Risk Areas - operational results Ultimately, do the transfer pricing results support the financial statement position? Functions, risks, assets OECD: control & financial capacity per delineation of risk And risk of double tax. Even more work needed to keep EPS/cash tax flat. Agreements and financials reflect these realities ASC 740 Current position Value chain challenge (some profits now taxed in higher rate territories) Double Tax MFG MFG MFG IP Warehouse Warehouse 15% Margin Distribution IP Distribution IP Distribution Principal Principal Principal

20 Transfer Pricing: Financial Statement Auditor s Perspective Tax Accounting Specialist View

21 Why does your financial statement auditor care?

22 Financial Statements Considerations Impact of transfer pricing in financial reporting Uncertain Tax Positions Typically a transfer pricing methodology meets the MLTN threshold. Uncertainty generally relates to the transaction s valuation or pricing, which is addressed in the measurement process of an uncertain taxposition. Valuation Allowances The need for a valuation allowance may e overcome y the existence of sufficient future taxable income, whichcan e directly affected by transfer pricing arrangements. Further, valuation allowances are affected by tax-planning strategies that are prudent and feasible. A tax planning strategy can be directly impacted by the transferpricing. Measuring Deferred Taxes on Foreign Earnings Transfer pricing can affect the amount of deferred taxes related to the company s indefinite reinvestment assertion. This could also impact the amount of deferred taxes on repatriation plans. Business Restructurings Companies will frequently redeploy or reevaluate business operational structures, which are directly impacted by transfer pricing methods. Other issues Carve-outs, interim reporting, M&A, Disclosures, stock based compensation

23 What is the financial statement auditor considering? Transfer Pricing The general transfer pricing principle is that the pricing of a related-party transaction should be consistent with the pricing between independent entities engaged in a similar transaction under similar circumstances (i.e., an arm s length transaction). An entity s exposure to transfer pricing primarily occurs when the entity does not include in its tax return the benefit received from a related-party transaction that may not be considered arm s length. By not including the benefit in its tax return, the entity has potentially created a FIN 48 [ASC 740] liability for additional taxes related to a transfer pricing adjustment which might be imposed by the IRS or other taxing authorities as a result of an audit. Transfer pricing exposures should be considered for all transactions that provide a benefit to another related entity, even if no consideration is currently charged. In addition to transfer pricing adjustments, in many jurisdictions transfer pricing tax audits may also result in transfer pricing penalties and interest.

24 What is the financial statement auditor s process? Transfer pricing lens Planning the audit understand if the Company operates in multiple jurisdictions and what internal and external factors impact the Company s tax provision. Controls understand the Company s control environment and controls addressing transfer pricing. Evaluate the design and implementation of the controls. Risk of Material Misstatement determine the risk of material misstatement related to transfer pricing and develop substantive audit procedures and control testing procedures Testing test the operating effectiveness of the controls addressing transfer pricing. Perform substantive tests on the Company s application of its transfer pricing methodologies. Conclude based on substantive audit procedures and testsof controls

25 What could go wrong? Transfer Pricing Risks - Examples Accounting function of a multinational company posts a top-side entry at the parent level (i.e. not recorded at the legal entity level). Risk: Pre-tax book income on a legal entity basis is incorrect due to lack of relevant, sufficient, and reliable data necessary to calculate and record tax provision. After the financial statements are issued and tax returns filed, a multinational company is audited in a jurisdiction and an assessment is issued. Risk: Uncertain tax positions are not recognized in a timely manner. Risk: Interest and penalties are not recorded when uncertain tax positions have been taken in a filed tax return. A multinational company has an indefinite reinvestment assertion and has disclosed that if it were to repatriate earnings, such earnings would result in an incremental tax. Risk: Management incorrectly computes the APB 23 representation disclosure due to misapplication of transfer pricing considerations and impact on FTC. US Tax Reform challenges: Implications for keeping representation in place Complexities of computations for eligible amount of APB 23 rep

26 Financial statement controls

27 How does the auditor actually test transfer pricing? Summary: Substantive Audit Procedures Obtain management s schedule summarizing all related-party transactions, including details of the type of transaction, the parties involved, and the value or volume of the transaction flows. Obtain management s schedule of amounts recorded for unrecognized tax benefits related to transfer pricing and test for completeness, including whether the entity included those uncertain tax positions for which there are not amounts recorded for unrecognized tax benefits. Obtain and read documentation in the entity s tax files regarding significant tax matters that may have an effect on transfer pricing and related tax exposure. Determine whether the transfer pricing study can be used for purposes of testing the amounts recorded for unrecognized tax benefits with respect to the related-party transactions selected for testing. Perform tests of details. Evaluate results of the tests of the gross transfer pricing adjustment (and applicable penalties) for which the entity has recorded an unrecognized tax benefit and the Competent Authority relief for which the entity has recorded a FIN 48 [ASC 740] asset.

28 Transfer Pricing Value Map Profit Segmentation TP Perspective Arm s Length Profit Function Risk Assets Financing Activity Synergy Location / Others Strategic Others PP&E Intangible WC/ Others Operational Long- Term Short- Term Others Routine Risk Premium Return / Residual Finance Return In post-beps world, taxpayers must analyze and describe the detail of the value chain components by functions risks assets financing This is a core component of the post-beps Masterfile as proposed by the OECD

29 Q&A

30 This presentation contains general information only and the respective speakers and their firms are not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. The respective speakers and their firms shall not be responsible for any loss sustained by any person who relies on this presentation. About Deloitte Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee ( DTTL ), its network of member firms, and their related entities. DTTL and each of its member firms are legally separate and independent entities. DTTL (also referred to as Deloitte Global ) does not provide services to clients. Please see for a detailed description of DTTL and its member firms. Please see for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. Certain services may not be available to attest clients under the rules and regulations of public accounting. Copyright 2017 Deloitte Tax LLP. All rights reserved. 36 USC Member of Deloitte Touche Tohmatsu Limited