1. 1 Seminario-taller sobre Precios de Transferencia CIAT/OCDE CIAT/OECD Seminar- Workshop on Transfer Pricing Ecuador – 2010

2. 2 Case-study on Advance Pricing Agreements (APAs) The Automotive Group case

3. 3 Case-study on Advance Pricing Agreements (APAs) The Automotive Group case

4. 4 AGENDA 1. Portuguese Legal framework 2. Presentation of the case-study 3. Topics for discussion

5. 5 1 - Portuguese Legal framework The Portuguese legal framework on APA follows the report complied by the EU Joint Transfer Pricing Forum in the field of dispute avoidance and resolution procedures and on Guidelines for Advance Pricing Agreements within the EU, issued in 2007

6. 6 1 - Portuguese Legal framework Article 128.º-A of the Corporate Income Tax Code Decree n.º 620-A/2008, of 16 July - which regulates the process for entering into an Advance Pricing Agreement.

7. 7 1 - Portuguese Legal framework It´s the legal framework that outlines the steps and procedures for the negotiation of an advance pricing agreement (APA) between taxpayers and the Portuguese tax authorities.

8. 8 1 - Portuguese Legal framework # Kind of agreements: Unilateral agreement Bilateral/multilateral agreements

9. 9 1 - Portuguese Legal framework # Scope of APAs: The agreement would apply for a maximum period of three years, renewable at the end of that term # Rollback: Prospective with no possibility of rollback

10. 10 1 - Portuguese Legal framework Advantages Tax Admin Exemption of inspecting function Greater certainty in determining the tax revenues Enhancer factor of Foreign Investment Reduction of disputes between taxpayers and tax administrations Better knowledge about taxpayers’ activity Disadvantages Tax Admin Need for allocation of resources Lack of experience in this matter Advantages Taxpayer Assurance of taxable income; Better planning of economic activity Reduction of disputes between taxpayers and tax administrations Reduction of compliance costs Disadvantages Taxpayer Payment of filing fee Possibility of not completing the APA APA

11. 11 1 - Portuguese Legal framework Conduct of the APA process: a)Pre-filing/Informal application stage b)Formal application for APA c)Evaluation and negotiation of the APA d)Formal agreement of APA

12. 12 a) Pre-filing/Informal application stage: Only limited information is provided Aims to obtain an informal and non- binding assessment by the Tax Authorities on: –The adequacy of the proposed transfer pricing approach; –The level of data and information to be provided upon submitting the proposal; and –Any specificity inherent to the negotiation with foreign tax authorities.

13. 13 a) Pre-filing/Informal application stage: In this stage is very important to perform several meetings with taxpayer, because that allows all parties to asses the likely success of the APA 50% of APAs are rejected in this stage

14. 14 b) Formal application for APA: Corresponds to the effective submission of the proposal for the conclusion of an APA with the tax authorities

15. 15 b) Formal application for APA: Based on the Decree, the following information should be submitted: (1) Identification of the related parties involved in the controlled transactions under analysis as well the nature of the special relations Business description of the related parties’ involved in the controlled transactions Detailed description of the controlled transactions, from the technical, economic, financial and legal perspective.

16. 16 b) Formal application for APA: Based on the Decree, the following information should be submitted: (2) Identification and explanation of the transfer pricing method(s) selected to perform the economic analysis for the pricing proposed for the controlled transactions, as well as the necessary reasoning for its selection Identification of the databases used for the economic analysis Identification of internal/external comparables selected, as well a detailed description of the selection criteria and adjustments performed

17. 17 b) Formal application for APA: Based on the Decree, the following information should be submitted: (3) Price or market range. Indication of the profit/loss apportionment methodology resulting from the application of the transfer pricing method. The period covered by the APA. Description of any unilateral or multilateral APA’s signed with other countries by both parties. Identification of the competent tax authorities of the non- resident contracting party.

18. 18 b) Formal application for APA: Based on the Decree, the following information should be submitted: (4) Confirmation of the contemporary submittal of the APA proposal in both jurisdictions. Declaration of collaboration with the Portuguese Tax Authorities, namely regarding the provision of additional information required by tax authorities as well as access to database used.

19. 19 b) Formal application for APA: Based on the Decree, the following information should be submitted: (5) Supporting documentation to be presented: –Shareholder’s structure including the parties under analysis. –Industry and market trends which may influence the taxpayer operating activities. –Business strategy for the upcoming years (include the strategic plans comprising relevant areas such as purchases, production, marketing, R&D, budgets and reports on competitors) and, if different from the previous years, identification of the responsible for the commercial/management strategy.

20. 20 b) Formal application for APA: Based on the Decree, the following information should be submitted: (6) Supporting documentation to be presented: –Functional and risk analysis of the contracting parties. –Detailed analysis of the comparability studies (including the benchmarking steps). –General facts and assumptions regarding the proposed pricing methodology. –Demonstration of the method proposed.

21. 21 b) Formal application for APA: Based on the Decree, the following information should be submitted: (7) Supporting documentation to be presented: –Supporting documentation regarding controlled transactions under analysis, namely agreements. In case some controlled transactions are excluded of the APA proposal, further explanation must be provided. –Potentially comparable agreements settled with independent parties.

22. 22 b) Formal application for APA: Based on the Decree, the following information should be submitted: (8) Supporting documentation to be presented: –Financial statements for the three previous years for the parties under analysis as well as any other documents which may provide some support to the proposed pricing for the controlled transactions. –Statement renouncing to the corresponding adjustments according to the article 9 of the Decree.

23. 23 c) Evaluation and negotiation of the APA: This stage of the process is the real negotiation of the APA. It implies several meetings between the taxpayer and all the Tax Authorities involved Particular importance should be attributed to the critical assumptions

24. 24 d) Formal agreement of APA: The agreement must include the following data, at a minimum: (1)  companies and transaction(s) included in the agreement;  a description of the agreed upon transfer pricing method(s) and other information, such as the list of the comparables and the expected arm´s length range;  a list of the critical assumptions for the applied method(s) on which the applicability of the agreement relies;

25. 25 d) Formal agreement of APA: The agreement must include the following data, at a minimum: (2)  facts and circumstances that may trigger a review, expiration, or revocation of the agreement;  the taxpayer's obligations, including the preparation of an annual report to demonstrate compliance with the APA;  documentation to be kept by the taxpayer, and deadlines to report any relevant changes to the tax authorities;

26. 26 d) Formal agreement of APA: The agreement must include the following data, at a minimum: (3)  a waiver for correlative adjustments, for the transaction(s) covered by a bilateral/multilateral APA (article 9, no. 3);  circumstances that trigger the review or dissolution of the agreement;  the term and date of entering into force of the APA;  the binding nature of the agreement for the tax authorities; and  a confidentiality clause.

27. 27 1 – Legal framework In Portugal the negotiation of the APAs is one of Transfer Pricing Team attributions. This team belongs to the Department of Tax Inspection on Large Companies Service (DSIT). Is it an advantage the negotiating of the APAs to be performed by the tax inspection?

28. 28 2 - Presentation of the case-study The Automotive Group

29. 29 2 – The facts The main activity of Taxpayer is contract manufacturing of motor-vehicles and related spare parts Taxpayer develops its activity within the global structure of the Automotive Group Taxpayer buys auto parts from related and unrelated parties, assembles the motor vehicle and sells the finished products to the Principal under the contract manufacturing agreement

30. 30 2 – The facts The contract manufacturer supplies MPV (Multi-purpose vehicle) to the Principal The products supplied by the Taxpayer to the Principal have the purpose of sale and distribution by entities further ahead on Automotive Group's value chain The Principal takes the key entrepreneurial functions and risks

31. The Business Model Principal Vehicles Price = MTC + x% Taxpayer Other Group companies Materials + Services € Materials + Services

32. 32 2 – The facts # Pricing methodology: The price to be charged by Taxpayer to the Principal will be determined on a cost plus basis methodology, based on Automotive Group Guidelines + Cost of the operative business (full costs except interest result and extraordinary, non-recurrent expenditures/revenue) + Profit Margin = Total charge to the Principal Total Manufac turing Costs Transfer Price

33. 33 2 – The facts # Transactions covered by the APA: Only the sale of vehicles from the contract manufacturer to the Principal

34. 34 2 – The facts # Controlled transactions not covered by the APA:  Acquisition of production material and services received by the Taxpayer  Financial transactions: Treasury loans granted to X for the maximum amount of € 100 million Long term loan granted to X Finance, totalling the amount of € 150 million

35. 35 2 – The facts # Profit level indicator selected: The profit level indicator selected was the Net cost plus margin defined as: NCPM = Operating Profit Total Operating costs # The most appropriate transfer pricing method: The most appropriate method for the analyses to be conducted was the TNMM (Transactional Net Margin Method)

36. 36 # Tested-party: The contract manufacturer was selected as the tested-party 2 – The facts

37. 37 # Governmental subvention: As a consequence of the launch of this new business unit in 2008, it was assigned to the contract manufacturer a governmental subvention of 30 millions 2 – The facts

38. 38 # Arm’s length range: The arm’s length range (statistic range) calculated by the taxpayer with resource to the 10 manufacturer contracts provided the follow results: Net Cost Plus(2007-2009) Minimum value2% Maximum value8% 1st quartile3% Median4% 3rd quartile5% 2 – The facts

39. 39 3 – Topics for discussion

40. 40 i) What should be the arm’s length transfer price?  How should the transfer pricing be calculated? 1.Transfer pricing should be calculated by applying a mark-up of x % to the manufacturing total costs; 2.It doesn’t matter which is the mark-up applied if the taxpayer’s profit indicator selected (Net cost plus) is inserted in the arm's length range  Which manufacturing total costs to consider? –Budgeted, standard or real manufacturing costs? –Which entity should earn the efficiency gains? –Which entity should bear the inefficiency costs? 3 – Topics for discussion

41. 41 i) What should be the arm’s length transfer price?  What mark-up should be applied? Any value of the statistic range (between 2% and 8%) Any value inserted in the interquartile range Only the median value Other 3 – Topics for discussion

42. 42 3 – Topics for discussion ii) Which benchmarking should be considered? 1.The benchmarking will not be updated during the three years of the APA (same benchmarking) 2.The taxpayer should make a new benchmarking every year of the APA (new benchmarking) 3.The APA’s benchmarking will be updated with the economic values of the selected comparable entities, related to the 3 years immediately preceding (same entities) 4.The benchmarking will be updated only if any change occur in the economic conditions established (e.g. considerable variations in the turnover)

43. 43 3 – Topics for discussion iii) The Governmental subvention received by the Portuguese company should be excluded from the cost basis? For example: Total manufacturing costs = 120 Grants received by the contract manufacturer = 20 Mark-up = 3% No, because in this case, the Portuguese Government would be supporting the Principal, instead of the Portuguese Contract Manufacturer (Taxpayer) Without exclusion: Transfer Pricing = (120) * 103% = 123,6

44. 44 3 – Topics for discussion iii) The Governmental subvention received by the Portuguese company should be excluded from the cost basis? Yes, because it is a grant investment and if the incentives and grants were not excluded, the Portuguese Contract Manufacturer (Taxpayer) would not be able to practice competitive prices With exclusion: Transfer pricing = (120 – 20) * 103% = 103 or With exclusion, but with the mark-up applied to manufacturing total costs: Transfer pricing = (120) * 103% - 20 = 123,6 – 20 = 103,6

45. 45 3 – Topics for discussion iv)Insertion of clause relative to correlative adjustment renounce, in case of positive primary adjustment made in the home country of the material and service suppliers (since those controlled transactions are excluded from the APA scope)? No, those transactions are not covered by the APA Yes, that adjustment will change the manufacturing total cost

46. The Business Model Principal TP = MTC + x% Taxpayer Other Group companies Materials + Services 100 110 121

47. 47 Obrigado Muchas Gracias Thank you for your attention