Transfer Pricing: Future Trends HLB International Conference Mark Gasbarra 3 December 2010 U.S. Virgin Islands
International Tax Provisions in Fiscal Year 2010 Budget Reform of International Tax Provisions Defer Deductions of Expenses Related to Deferred Income ($60b Administration, $51b JCT) Determine Deemed Paid Foreign Tax Credits on a Blended Basis Dual Capacity Taxpayers Prevent Splitting of Foreign Income and Foreign Taxes ($25b Administration, $45b JCT) Reform Business Entity Classification rules for Foreign Entities ($87b Administration, $31b JCT) Limit Shifting of Income through Intangible Property Transfers (Transfer Pricing) Tax Compliance and Enforcement Issues Repeal 80/20 Company Rules 2
INTERNATIONAL TAX PROVISIONS IN FISCAL YEAR 2011 BUDGET Major changes from FY2010 Budget: Only interest expense would be deferred ($35.5b JCT) Abandon modification of the Check-the-Box rule New transfer pricing proposal that subject excessive returns of intangibles moved to low taxed affiliates to immediate U.S. tax ($10b JCT) Denial of deduction to U.S. insurance companies for certain excessive non-taxed reinsurance premiums paid to foreign affiliates ($2.3b JCT) 3
NOTEWORTHY EXTENDERS Provisions expired as of December 31, 2009 954(c)(6) Look Through treatment of payments between related CFCs under the foreign personal holding company rules. Estimated cost is $3.92B over 10 years. Exceptions for Active Financing Income under 954(h)(9). Estimated cost is $570M over 10 years. 4
Transfer Pricing as a Tax Issue Number One Global Tax Issue Goal is to achieve reasonable results and income based on sound economic and business principles, and to prevent tax evasion Concept of arm s length equivalent pricing Penalties and required documentation to avoid them 70 countries have OECD Guideline-like transfer pricing legislation and regulations Italy most recently introduced requirements Principles were established in July 2010 5
Transfer Pricing as a Business Issue Why are financial controllers interested in getting transfer pricing right? Better measurement of economic profits Establish appropriate incentives Facilitate resource allocation How can a transfer pricing study help to achieve superior operational results in a business? Identifies where you are today and where you would like to be going forward Identifies and describes the operations of the company, provides industry overview, identifies competitors, and outlines the basis of competition Benchmarks the company's financial performance relative to its peers 6
GLOBAL TRANSFER PRICING UPDATE Recent Global Updates Indonesian transfer pricing implementation regulations issued Italian Tax Authorities Impose Transfer Pricing Documentation Requirements UK Releases Draft Statement of Practice on APAs OECD publishes its final revision of Chapters I-III and IX of the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations The Next Phase of Transfer Pricing in Vietnam The EU Joint transfer pricing forum ("JTPF") released a report on low value adding intra-group services New Transfer Pricing Rules for Brazil in 2010 Tax Friendly Treatment of R&D Activities in The Netherlands Approved by Parliament 7
NEW OECD TRANSFER PRICING GUIDELINES New OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations First fundamental changes to the OECD Guidelines since 1995 Guidelines become a lot more descriptive (with the examples) and have more similarities with US Regs The OECD will start a new project on Intangibles revisiting Chapters VI and VIII New guidelines help to ensure that multinationals do not use transfer pricing to shift profits into low-tax jurisdictions while simultaneously avoiding double taxation. More detailed guidance on comparability analysis New guidance on how to select more appropriate transactional profit methods 8
NEW OECD TRANSFER PRICING GUIDELINES CONTINUED Main changes to the OECD Guidelines Small revisions to Chapter I, the Arm's Length Principle Former Chapter II and III (Transfer Pricing Methods) have been combined in the new Chapter II and the hierarchy of methods has been eliminated New Chapter III, Comparability New Chapter IX, Business Restructuring New examples and annexes Highlights Chapter I-III Abolishment of the pre-existing hierarchy of methods and introduction of the most appropriate method to the circumstances of the case. No preference between traditional transactional and profit-based methods. However, when both types of methods can be applied in an equally reliable manner, traditional transaction methods should be selected as most appropriate. 9
NEW OECD TRANSFER PRICING GUIDELINES CONTINUED Highlights Chapter I-III, continued The comparability analysis as brought about by the arm s length principle is still the central approach for the completion of reliable positions in transfer pricing disputes. In the final guidelines nine steps are described for a data search project. In addition attention is given to the requirements for applying adjustments to the comparables found. Also the relative value of internal and external comparables is discussed by the revised guidelines. Profit split methods should be more in line with the functional analysis and be capable of being measured in a reliable manner. Allocation keys are validated. The transactional net margin method is not to be applied if both parties to the transaction concerned deliver unique contributions. Other situations must be solved by applying the most appropriate method which is not of itself the transactional margin method. The selection of the net profit indicator is discussed. 10
NEW OECD TRANSFER PRICING GUIDELINES CONTINUED Highlights Chapter IX Addresses relationship between transfer pricing principles and business restructuring processes. The core issue in business restructuring boils down to how and whether compensation for (partly) close down of operations or relocation of assets should be addressed. Further the focus is set on risk allocation and/or control over risk. Finally alternative options for the attainment of the objectives set by the enterprise are considered. 11
Increased Attention Worldwide Stricter enforcement and regulatory burden Natural cycle of tax inspector enforcement Need for revenue enhancement Response to perceived corporate abuses of the 90s Information Sharing Tax inspectors increasingly share information Use of provisions in tax treaties gives greater connectivity Synergy of Approach - Taxpayers should expect simultaneous multi-jurisdictional tax audits - Allows both jurisdictions to look at the same taxpayer at the same time 12
Tax Authorities Increase Resources Broadening resource capabilities - New enforcement initiatives to raise revenue Increasing resources - Hire additional staff for increase in audits Focusing on better training - Developing deeper expertise in transfer pricing Developing better tools, processes and capabilities - Carrying out sophisticated audits 13
Importance of Documentation Contents of a Transfer Pricing Analysis Characterization of your company s functions and risks Choice of best method or methods for analysis, per the regulation Selection of comparable transactions of firms Application of transfer pricing test Benchmark/ test results against an arm s length range Establish arm s length range using internal or external data - Enhance MNC s long term relationship with tax inspector Important to avoid being characterized as non-compliant 14
Triggers for Transfer Pricing Audits Triggers for Transfer Pricing Audits Operating loss (especially multi-year losses) Large year-to-year shifts in the level of operating profits or losses Large dollar transactions with affiliates Presence of intercompany intangible transactions Presence of intercompany services transactions Transactions with companies located in tax havens, or low-tax countries Undertaken a business restructuring or change to existing policies Lack of transfer pricing documentation 15
Risk Management A transfer pricing study serves as a company's first line of defense in the case of a transfer pricing audit Assess exposure to potential transfer pricing adjustments and penalties in the U.S. and abroad Helps to minimize potential adjustments during audits Provides penalty protection Reduces the duration of tax audit and the associated costs Cost of preparing a formal transfer pricing study is less costly than tax and compliance cost that may result from a long/contentious transfer pricing audit Lack of documentation can result in additional taxes, interest, and possibly penalties Lack of documentation can also result in double taxation Cost of audit defense services are significantly greater when no documentation exists 16
Takeaways Transfer pricing is not a only compliance oriented task; it is a tool that allows a multinational group to manage risk and institute tax planning strategies to maximize net income on a global basis Adequately addressing transfer pricing issues prior to a transfer pricing audit may significantly reduce costs, in terms of additional tax liability, interest and penalties, and professional fees Mandatory disclosure for companies Proper analysis of transfer pricing issues is no longer an option countries So what do we as HLB do to help our clients and make the most of this global tax opportunity? 17