Value chain perspectives and their increased importance under BEPS, tax policy and technological change February 22, 2017 FOR DISCUSSION PURPOSES ONLY
Disclaimer This material has been prepared for general informational and educational purposes only and is not intended, and should not be relied upon, as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. The views expressed by the presenters are not necessarily those of Ernst & Young LLP. Page 2
Speakers Jay L. Camillo, Americas Operating Model Effectiveness Leader Direct: +1 404 817 5035 Email: jay.camillo@ey.com Lonnie Brist, Southwest Region Transfer Pricing Leader Direct: +1 408 421 2275 Email: lonnie.brist@ey.com Page 3
Objective The objective of today s session is to outline a framework and better understand the differences that may arise in understanding the gap between a company s view of where value is created and the view of value creation through a BEPS lens, a local country tax authorities lens or a consumer lens. Page 4
Agenda Value chains, BEPS and TP Potential implications of US tax reform Questions Page 5
Value chains, BEPS and TP Page 6 1 January 2014 Presentation title
Observations BEPS Actions 8-10 Local countries have differing views as to what specifically constitutes intangible property, for example: India professional labor Italy design intangibles The final report on BEPS Actions 8-10 recognized that countries value things differently based on their existing strengths and industrial makeup Depending on the industry sector and other facts specific to a particular case, exploitation of intangibles can account for either a large or small part of the [multinational enterprise s] value creation. Page 68, 6.10, BEPS Actions 8-10 Final Report To ensure that intangibles are captured correctly, the OECD explained that [a] thorough functional analysis, including an analysis of the importance of identified relevant intangibles in the MNE s global business, should support the determination of arm s length conditions. Page 68, 6.12 BEPS Actions 8-10 Final Report This requires an analysis of the value chain and the contributors of value along that chain Page 7
Example: consider all the points in the oil & gas value chain Page 8
Action 8 OECD Guidance: DEMPE functions & entitlement to intangible return Action 8 focus is on DEMPE functions relating to intangible assets Development of intangible asset Enhancing value of intangible asset Maintenance of intangible asset (e,g.: quality control) Protection of intangible asset against infringement Exploitation There is no automatic return on account of mere legal ownership of intangible Requirement to directly perform or to control the performance of DEMPE functions and related risks Return retained by an entity in group depends on the contributions it makes through DEMPE functions to the anticipated value of intangible relative to contributions made by other group members What the OECD doesn t emphasize: Role of risk Role of capital Role of assets Under the OECD Guidelines, DEMPE activities are arguably all that matters Fundamental questions this raises Is there a gap between returns actually realized and what a people-focused DEMPE analysis suggests? How can an enterprise account for nonpeople based value contributions that exist in the value chain? Page 9
These considerations support an iterative approach to the OECD s value chain analysis Fact Finding Interview business Delineate material transactions Review data and other information Document facts Monitor Facts BEPS Value Chain Analysis Approach Value Chain Analysis Ongoing business interviews Re-assess facts Re-evaluate positions Update findings Parallel vs. sequential integration Sharing of risks and outcomes Common control Unique and valuable intangibles Page 10
Potential implications of US tax reform Page 11 1 January 2014 Presentation title
What the US is considering? Border Adjustment Cash Flow Tax (BACFT) The BACFT collects tax on US sales / provides a deduction against tax for US costs and hence impacts US taxpayers with: Significant imports of goods, services and IP (negative) Significant exports of goods, services and IP (positive) Discourages migration of activities outside the US However, tax-effective operating models involve cross-border tax structuring Allocation of income to US vs non-us Differential effective tax rates Overall tax result will depend upon how the supply chain profit is allocated between different tax jurisdictions post BEPS Page 12
BACFT example Procurement company - Services/Commission fee US taxation under current law for US Co Procurement Company Interfaces with suppliers Third-party Suppliers Gross income 100 Less expense for raw materials purchase (40) Less sourcing fee (20) Commission for sourcing services of USD 20 Sale of raw materials for USD 40 Less Local costs (10) Net income 30 US taxes @ 35% 10.5 US Co Customers (US) Sale of goods for USD 100 Local costs of USD 10 US taxation under BACFT proposals for US Co Payment for the sourcing services is treated as an import and hence payment is not deductible Payment for the purchase of imported products is treated as an import and hence payment is not deductible Questions to consider: What could be the DEMPE / TP implications of the shift from current taxation framework to BACFT? On planning On CbC / Master File / Local File On US documentation On potential MAP positioning On the underlying value chain Gross income 100 Less expense for raw materials purchase 0 Less sourcing fee 0 Less Local costs (10) Net income 90 US taxes @ 20% 18 Page 13
Potential US tax reform Possible considerations related to IP profile Receipt of royalties from outside the US for US-owned IP Treated as an export and income tax exempt US expenses deductible - Non US expenses non-deductible Potential for perpetual NOL position for exporter. Withholding taxes paid on exempt royalties unlikely to be creditable Payment of royalties from the US to a foreign owner of IP Treated as an import and payment is not deductible No proposed change to US withholding tax provisions Cost sharing arrangements to which the US is a party Costs incurred for R&D activities performed in the US will be deductible Costs incurred for R&D activities performed outside the US (including to a non-us cost-share participant) will be non-deductible Presumably, the net payment in or out will be the only amount BACFT impacted Payments received by the US from non-us cost share participant tax exempt Page 14
Questions? Page 15
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