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Prof. Daniel N. Erasmus Assisted by Prof. Anneline Venter CA(SA) and Sebastien Gonnet NERA Economic Consultants.

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Presentation on theme: "Prof. Daniel N. Erasmus Assisted by Prof. Anneline Venter CA(SA) and Sebastien Gonnet NERA Economic Consultants."— Presentation transcript:

1 Prof. Daniel N. Erasmus Assisted by Prof. Anneline Venter CA(SA) and Sebastien Gonnet NERA Economic Consultants

2 Index DAY 1 Transfer Pricing References Glossary of transfer pricing terms SESSION 1: Introduction to Transfer Pricing: Oil & Gas Industry Oil & Gas Primer – Annexure A Introduction – Transfer Pricing Abuses Oil & Gas organogram Intercompany Process Flows Introduction – Placing Transfer Pricing into International Perspective Country Specific Transfer Pricing Regulations DTAs list BITs list Exchange of Information – OECD Exchange of Information Guidelines – Annexure B / OECD TIESs list – Annexure C SESSION 2: Basic Principles of Transfer Pricing by Prof. A Venter Presentation in the context of oil & gas – Annexure D Bureau van Dijk TP Catalyst demonstration SESSION 3: A CASE STUDIES: (1) BRAND OIL SESSION 4: DEVELOPING APPROPRIATE DOCUMENTATION IN TRANSFER PRICING More notes at www.IITF.net

3 Index DAY 2 SESSION 1: Formalizing an effective record keeping & reporting process Theory Bureau van Dijk TP Catalyst CASE STUDIES: (2) CUREMAKER (3) WIDGET WHOELSALE SESSION 2: Adopting Transfer Pricing best practices Presentation by NERA Economic Consultants – Annexure E Intellectual Property Management fees SESSION 3: Pre-empting tax audits & Handling tax controversies in a proactive manner SESSION 4: Gaining insight into different tax regulations on Transfer Pricing CASE STUDY (4): Virtual Profile Company More notes at www.IITF.net

4 DAY 1 More notes at www.IITF.net

5 Transfer Pricing References OECD Transfer Pricing Guidelines OECD UN Transfer Pricing Guidelines UN Global Transfer Pricing Study EY 2010/11EY 2010/11 PwC Transfer Pricing Manual PwC More notes at www.IITF.net

6 Glossary of Transfer Pricing Terms TP = Transfer Pricing Cost plus method CUP = Comparable uncontrolled pricing RPM = Resale price method CPM = Comparable profits method TNMM = Transactional net margin method PLI = Profit level indicator CCA = Cost contribution agreement http://en.wikipedia.org/wiki/Transfer_pricing

7 DAY 1 More notes at www.IITF.net

8 Oil & Gas Primer Refer to Transfer Pricing in the Oil & Gas Sector: A Primer – Annexure AAnnexure A More notes at www.IITF.net

9 Through transfer pricing, a taxpayer seeks to minimize income and maximize deductible expenditures in high-tax jurisdictions and vice versa in low-tax jurisdictions. Transfer pricing mechanisms that affect revenue in the oil and gas sector are: The creative use of price hedging mechanisms involving transactions between related parties, causing great difficulty in assessing whether hedging instruments are used for transfer pricing purposes rather than to reduce risk; The provision by related parties of highly leveraged debt finance at above-market interest rates; Claiming excessive management fees, deductions for headquarter costs, or consultancy charges paid to related parties; The provision of capital goods and machinery in leasing arrangements at above-market costs charged by a related-party lessor; If the petroleum tax rate is above the standard tax rate, there may be an incentive to establish a domestic shell firm that will on-lend financing capital from related parties to the oil company giving rise to an interest deduction at a higher tax rate than is charged on the interest earnings in the shell company. Abusive transfer pricing can be very difficult to detect and prevent. SOURCE: Revenue from the Oil and Gas Sector: Issues and Country Experience, Emil M. Sunley, Thomas Baunsgaard and Dominique Simard Introduction – Transfer Pricing Abuses More notes at www.IITF.net

10 Home Country Tax Havens Developing Countries UPSTREAM MIDSTREAM DOWNSTREAM More notes at www.IITF.net

11 Intercompany Process Flows Legal Tax Accounting Treasury Operation s More notes at www.IITF.net

12 Country Specific Regulations (see next slide)see next slide OECD and UN guidelines (http://www.IITF.net and www.ErasmusOnTax.com) OECDUNhttp://www.IITF.netwww.ErasmusOnTax.com International law Double Tax Treaties – DTAs 1 & 212 Bilateral Investment Treaties - http://www.unctadxi.org/templates/DocSearch____779.aspx http://www.unctadxi.org/templates/DocSearch____779.aspx Multilateral Treaties Constitutional & administrative law Information Exchange – TIEAs - attached Annexures B & CBC Introduction – placing TP into international perspective More notes at www.IITF.net

13 Country comparisons CountryTP RegsTP Docs?Tax ReturnPenalties ThailandYRecommendYUp to 200% VietnamYRecommendYN TaiwanYYYUp to 200% SingaporeYRecommendNUp to 200% PakistanN Anti-AvRecommendNN MalaysiaYRecommendYUp to 300% IndonesiaYY >Rp10mYUp to 48% IndiaYY >INR10mYUp to 300% Hong KongN Anti-AvRecommendNUp to 300% ChinaYYY5% no docs CambodiaN Anti-AvRecommendNN South KoreaYRecommendY10% More notes at www.IITF.net

14 DAY 1 More notes at www.IITF.net

15 Presentation by Prof. A Venter – Annexure DAnnexure D Basic principles in the context of the Oil & Gas Industry A functional analysis QAQA Basic Principles of TP More notes at www.IITF.net

16 Home Country Tax Havens Developing Countries UPSTREAM MIDSTREAM DOWNSTREAM More notes at www.IITF.net

17 Home Country Tax Havens Developin g Countries UPSTREAM MIDSTREAM DOWNSTREAM PetroCo DrillingAsia Refine ThailandVietnamIndonesia Explore Ship 100%

18 TP Catalyst Bureau van Dijk - An introduction to TP Catalyst https://tpcatalyst.bvdep.com/201106/version- 20111124163430/Login.serv?product=transferpricing https://tpcatalyst.bvdep.com/201106/version- 20111124163430/Login.serv?product=transferpricing http://www.bvdinfo.com/BvD-for-your-business/Transfer- pricing.aspx http://www.bvdinfo.com/BvD-for-your-business/Transfer- pricing.aspx IBFD Intro to Transfer Pricing More notes at www.IITF.net

19 DAY 1 More notes at www.IITF.net

20 Brand A Oil (Malaysia) 650 units @ 100K Distribution R&D, manufacturing, domestic sales Brand B Oil Resale under Brand B Oil Resale under Brand A Oil UK Malaysia 125 units @ 80K 132K 108K Domestic sales to retailers 225 units @ 133K

21 BRAND OIL case study https://dl.dropbox.com/u/10753349/Lect ures/Transfer%20Pricing%20Training%2 02012-11-30%2010.27%20AM.mov https://dl.dropbox.com/u/10753349/Lect ures/Transfer%20Pricing%20Training%2 02012-11-30%2010.27%20AM.mov More notes at www.IITF.net

22 CUP? Cost-plus? Resale minus? TNMM? Profit split? 22 More notes at www.IITF.net

23 Brand A Oil Corporation sells goods to Brand A Oil (Malaysia) for $ 100K. Potential comparables for this transaction are: Sales by Brand A Oil Corporation to domestic customers - $133K each Sales by Brand B Oil to Brand A Oil (Malaysia) - $80K each. How reliable are these comparables likely to be? 23

24 How reliable are the comparables?. Are the sales into the same level of the market? Brand A Oils sales in UK appear to be to end customers. The controlled transaction is to a sales/distribution company. Do they involve the same product as the controlled transaction? There appear to be marked differences between the products manufactured by Brand A Oil Corporation and by Brand B Oil It is unlikely that there is sufficient product or functional comparability to allow the comparable uncontrolled price method to be reliably used in this case. 24

25 The accounts of the independent manufacturer show a 66.7% mark-up on direct costs. Does this provide a comparable that can apply to the manufacturing costs of Brand A Oil Corporation? Functional analysis: Brand A Oil owns 2 intangibles – brand and trade (R & D expenditure); Cost plus, which would involve testing Brand A Oil Corporation, is unlikely to be suitable unless the independent has similar intangibles of similar value; We do not know this; We also do not know the product mix in the sales of the independent manufacturer – we need to identify the mark-up it achieves on the sale of goods to Brand A Oil (Malaysia). 25

26 The gross margin earned by Brand A Oil Corporation on units purchased from the independent manufacturer is a potential comparable: We know that, on units sourced from Brand A Oil, Branded A (Malaysia) Ltd earns a gross profit of 24% ((132-100)/132); We know that on units sourced from the independent manufacturer, the gross margin is 26% ((108-80)/108). A comparability analysis is necessary to establish whether this a sufficiently reliable comparable. 26

27 Is TNMM available? We know that Brand A Oil (Malaysia) earns a net margin of 10%; However we do not know how this is split between the net margin earned on goods sourced from Brand A Oil Corporation and that earned on goods sourced from Brand B Oil; That is, we do not have transactional information Also.. We know the net margin earned by Brand A Oil Corporation and that earned by Brand B Oil; But, again, we do not have the information available at a transactional level; So TNMM is unlikely to be reliable in this case. 27

28 A potential comparable would be the split of profit between the independent manufacturer and Brand A Oil (Malaysia) derived from the manufacture and sale of the units produced by the independent manufacturer and sold to Brand A Oil (Malaysia). If we used a profit split method, this would be compared to the split of profit between Brand A Oil and Brand A Oil (Malaysia), from the manufacture and sale of the units produced by Brand A Oil. However, we do not have the information to enable us to do this on a transactional basis. We have only whole-company information on net profit. Also, profit split is most appropriate where both of the parties to the transaction carry out non-benchmarkable functions. This would need to be tested. 28

29 The tentative conclusion might be that the resale price method is available in this case. However, we would need to carry out a comparability analysis to determine whether this method, and the chosen comparable transaction, are sufficiently reliable. 29

30 A comparability analysis focuses on five factors: Nature of product Contractual terms Functional analysis (including assets used and risks assumed) Economic conditions Business strategy 30

31 You are asked to carry out a comparability analysis between the following transactions: a) purchases of units by Brand A Oil (Malaysia) from Brand A Oil (Malaysia), and b) purchases of units by Brand A Oil (Malaysia) from Brand B Oil. 31

32 Analysis shows that there is poor product comparability between the goods sourced by Brand A Oil (Malaysia) from Brand A Oil and Brand B Oil But there is good functional comparability between the functions carried out by Brand A Oil (Malaysia) in respect of goods sourced from Brand A Oil and Brand B Oil 32

33 In this case, we would probably consider that there is good functional comparability between: the functions performed by Brand A Oil (Malaysia) in respect of Brand A Oil sourced goods, and The functions performed by Brand A Oil (Malaysia) in respect of Brand B Oil sourced goods.. and that the resale price method is likely to be sufficiently reliable and that no transfer pricing adjustment is necessary. 33

34 DAY 1 More notes at www.IITF.net

35 Examining TP documentation requirements Enabling documentation to defend TP data Implementing TP documentation to mitigate possible tax disputes

36 INTRODUCTION: insights to in-house TP Policy development Wolters Kluwer Developing TP PolicyWolters Kluwer Developing TP Policy If a taxpayer can demonstrate that it has developed a sound transfer pricing policy in terms of which transfer prices are determined in accordance with the arm's length principle by documenting the policies and procedures for determining those prices, the Commissioner is more likely to conclude that its transfer pricing practices are acceptable and the risk of possible adjustments will be diminished.

37 On the other hand, preparing documentation is time-consuming and expensive. It will therefore not be expected of taxpayers to go to such lengths that the compliance costs related to the preparation of documentation are disproportionate to the nature, scope and complexity of the international agreements entered into by taxpayers with connected persons.

38 Documentation Guidelines: Chapter V OECD GuidelinesChapter V OECD Guidelines Determined in accordance with same prudent business management principles … evaluating a business decision of a similar level of complexity and importance Commissioner expects retained documentation in accordance with this principle Demonstrate compliance with arms length principles Will require some form of functional analysis and info gathering of relevant entities Determine appropriate method then apply relevant data to determine arms length

39 Commissioner expects process to be documented contemporaneously to justify why transfer prices are arms length Commissioner will rely on documents created in ordinary course of business and of setting a transfer price, addressing following issues: Identification of affected transactions Copies of international agreements Description of nature & terms of all affected transactions Functional analysis and appraisal of comparatives of affected transactions…

40 Continued.. Reason why choice of method considered most appropriate Explanation of the process used to select and apply the method used and why consistent with the arms length principle Information relied upon at arriving at arms length: Commercial agreements with 3 rd parties Financial information Budgets Forecasts Details of any special circumstances influencing pricing

41 At TP review Commissioner expects taxpayer to identify: Which goods/services most comparable Its major competitors Competitors considered most comparable Methodologies used & why appropriate for taxpayer Where inadequate contemporaneous docs of arms length international dealings, between connected parties, difficult to convince Commissioner of arms length Availability of information for comparative purposes: Data from Asia, Australia, UK, US, but assess impact of geographical differences and other factors on price

42 Conclusion Taxpayers establish transfer prices comply with the arms length principle and prepare documentation to evidence that compliance Commissioner likely to determine prima facie that the taxpayers transfer pricing practices represent a lower tax risk In contrast, taxpayers who give inadequate consideration to their transfer pricing practices are likely to receive greater scrutiny from the Commissioner

43 A summary of the broad guidelines suggested: establish economic justification before the transaction is entered into; be satisfied that the consideration is an arms length consideration; prepare and retain contemporaneous documentation to support the above matters and the assessment of market conditions at the time when the pricing decisions were made; justify the choice of method; and establish and consistently follow a systematic process for setting arms length international transfer prices.

44 DAY 2 More notes at www.IITF.net

45 DAY 2 More notes at www.IITF.net

46 Analysing organisation structure so as to have conducive methods of document development and storage Standardising means of collating information and documentation in a manner that will reduce costs and duplication Backing up of documentation for efficient record recall Conducting reviews of documentation and inter- company agreements to reduce exposures to tax penalties

47 The preparation of a functional analysis is an important tool that can assist in ensuring that an arms length consideration is determined in accordance with internationally accepted principles A functional analysis can be performed with varying levels of detail and can serve a variety of purposes. The scope of the analysis will be determined by the nature, value and complexity of the matters covered by international dealings and the nature of the taxpayers business activities. These include the strategies that the enterprise pursues and the features of its products or services

48 Also, factors such as the pricing method that is used and availability of data will affect the extent to which the analysis can be conducted. By determining the relevant functions to be priced, the functional analysis can assist in the selection of a transfer pricing method. It can also assist in the analysis of the level of comparability present in controlled and uncontrolled dealings and in an assessment of the relative contribution of the parties when a profit-split method is used.

49 It is important, however, not to confuse the use of functional analysis with the determination of a transfer price. Functional analysis is not an alternative to searching for comparables. It is a means to establish what sort of comparables should be sought. Annexure B sets out a four-step practical approach for determining transfer prices. The discussion in that annexure further considers functional analysis in a practical context.

50 Step 1: Understand the cross-border dealings between connected parties in the context of the business

51 Step 2: Select the pricing method or methods

52 Step 3: Application of the pricing method or methods

53 Step 4: Arriving at the arm's length amount and introducing processes to support the chosen method

54 Pursuant to the recent modifications to the OECD Guidelines, the steps to be undertaken in connection with a comparability analysis are: Step 1: Determination of years to be covered Step 2: Broad-based analysis of the taxpayers circumstances (e.g., industry, competition, economic factors)

55 Step 3: Understanding the controlled transaction(s) under examination, based in particular on a functional analysis, in order to choose the tested party (where needed), the most appropriate transfer pricing method to the circumstances of the case, the financial indicator that will be tested (in the case of a transactional profit method), and to identify the significant comparability factors that should be taken into account Step 4: Review of existing internal comparables, if any

56 Step 5: Determination of available sources of information on external comparables, where such external comparables are needed taking into account their relative reliability Step 6: Selection of the most appropriate transfer pricing method and, depending on the method, determination of the relevant financial indicator (e.g. determination of the relevant net profit indicator in case of a transactional net margin method)

57 Step 7: Identification of potential comparables: determining the key characteristics to be met by any uncontrolled transaction in order to be regarded as potentially comparable, based on the relevant factors identified in Step 3 and in accordance with the comparability factors Step 8: Determination of and making comparability adjustments where appropriate Step 9: Interpretation and use of data collected; determination of the arms length remu tion

58 The updated Guidelines also address the selection and rejection of comparables in detail, & use of commercial databases. The key point articulated is that such searches must be transparent, systematic, and verifiable. The OECD Guidelines recognize that, in circumstances where a range of results includes a sizeable number of observations, statistical tools that take account of central tendency to narrow the range (e.g., the interquartile range) may help to enhance the reliability of the analysis.

59 The OECD Guidelines recognize that multiple year data may improve reliability, particularly in cyclical industries.

60 Bureau van Dijk DEMONSTRATIONDEMONSTRATION Case Studies: CUREMAKER WIDGET WHOLESALE

61 Transfer Pricing Handbook, 2 Volume Set, editor Robert Feinschreiber (available in Amazon.com Kindle) 11.2 Location 2409 More notes at www.IITF.net

62 CM -US CM-EU AP1 AP2 Independent Contractor Cost +15% Royalty 5% Imports ingredients Exports final product to CM-US Manufacturing Integrated functions Independent wholesalers

63 Diagram explained: CM-US has established a foreign subsidiary in Europe: Curemaker Europe (CM-EU), in a small principality where no tax will be assessed for 25 years; CM-US has transferred intangibles (patent rights) to the subsidiary for a royalty payment of 5% to cover research and development costs; CM-EU performs only manufacturing functions, and imports ingredients from the US; process them to final assembly (according to practices established by the parent) than resells final product back to the Parent, and to wholesalers in other European countries; CM-EU industrial plant is the most modern in the world; CM-US manufactures the same product in two wholly owned assembly plants (no rights to intangibles), no charge for use of intangibles (produce several products); All functions are integrated and reported as such on tax return; CM-US also uses the services of an independent manufacturer, by contract. Independent contractor charges CM-US cost plus 15% for manufacturing services. Received ingredients from CM-US (no possession), resells final product to CM-US. Does no research, receives no special technology, pays no royalties; IRS: proposed this third-party contract as an comparable adjustable transaction; CM-US under audit: price of transferred products and intangibles to CM-EU; In year under audit: CM-EU reported substantial profits, while CM-US showed smaller profit margins; CM-US has at least 10 major competitors; Industry in EU has higher profit margins than the industry in US.

64 1. Classification: Identify the issue under investigation: income of US taxpayer CM-EU income comes under scrutiny: receives intangibles from US taxpayer and had higher profit margins than the Parent CM-EU classified as drug manufacturer (SIC #2833)

65 2. Finding Comparables CM-EU: Direct comparables: may possibly be CM-US assembly plants or independent contractor used CM-US Indirect comparables: possibly other large integrated drug companies or smaller contract manufacturers Functions are closer to contract manufacturers, but incurs the costs and risks of operating in a foreign market place.

66 2. Finding Comparables: Direct comparables (transaction based) Assembly plants of CM-US: various product lines and integrated functions, difficult to separate one product line for comparison. Independent contractor: differences: Patent rights: reduce COS with royalty payment Market risks: no contract guarantee, foreign market: difficult to quantify Advanced physical facilities: difficult to identify which operating expenses to add back

67 2. Finding Comparables: Indirect comparables (profit based)(public data needed) Integrated drug companies: owns intangibles and incurs risks like these companies, but do not have integrated functions Independent contract manufacturers : independent manufacturing, but not guaranteed by contract and owns intangibles.

68 3. Method used CPM: more than one type of transaction, with no direct comparables as to similar transactions Intangibles transferred with effect on profitability Profit methods reflects reasonableness Transaction method used to ascertain appropriate royalty rate

69 4. Arms length range Profit Level Indicator (PLI) range: high-end of large companies PLIs and low end on contract manufacturers PLIs. Adjust royalty rate to an arms length rate, by doing market research, scrutinizing third party contracts and independent transaction. This indicated that a proper rate should be increased to 25%

70 5. PLIs used Gross profit to operating expenses Operating income on sales Return on operating assets: good indicator for manufacturers, but assets may vary quite extensively. Good PLI for CM-EU which owns intangibles and state of the art plant and equipment with one product for allocation purposes. Not so good for parent with various product lines, and previous investment in assets.

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73 Transfer Pricing Handbook, 2 Volume Set, editor Robert Feinschreiber (available in Amazon.com Kindle) 11.3 WIDGET WHOLESALE (Kindle Location 2550). Kindle Edition. More notes at www.IITF.net

74 WW WW-US FM1 FM2 Imports widgets from WW Distribution Manufacturing Independent distributors CA FM3 Retailers CA Other Retailers

75 Diagram explained: Widget Wholesale-USA (WW-USA), is a subsidiary of a foreign manufacturer; There are only 32 other Foreign Manufacturers of widgets and no domestic (US) manufacturers; WW products are specifically designed for the US market, and are not sold anywhere else on the world, although WW also manufacture products specifically designed for its domestic market; WS-US does not participate in R & D; WW owns the manufacturing intangibles, while WW-US developed and owns the marketing intangibles; WW-USA keeps inventory and resells to various independent retailers; WW-USA also sells specially designed widget models to several independent distributors in California where the widget market is most intense; The independent distributors also sells normal models and also sells to retailers; None of these firms are publicly traded; WW-USA are under audit over the price of imported goods shipped to it from its parent manufacturer; The transferred property in question is tangible property, to which intangibles may be attached.

76 1. Classification: Identify the issue under investigation: income of US taxpayer Payments made to foreign parent for purchased goods will be investigated The question is whether an independent company would be willing to pay the same prices for the goods, as WW-US is paying the foreign parent Business classification: WW-US is a pure importer/distributor

77 1. Classification (continued) Import consideration: in order to earn a profit importers need to limit costs and expenses, such as purchase price of goods; shipping and transport, import duties, storage, advertising and selling expenses Import contract: when dealing with independent manufacturer, the importer will negotiate a contract covering various issues Wholesale Relationship: wholesaler imports large quantities and makes profit from high turnover of products. Usually has a large marketing investment.

78 2. Finding Comparables No independent importers of widgets Numerous importers of other durable goods with publicly available information Widgets do not have separate SIC code Wholesale trade category Comparables: distributors of consumer durables with motorised and electronic technology, used in the home (perceived product similarity) 100 companies over 5 years

79 3. Method used WW-USA needs to be adjusted to reflect arms length purchase price for goods imported Logic: distributors would not buy at prices it could not sell profitably. Only possible comparable for the transaction: resale of independent California Distributors, adjusted for differences for conditions of sale, models, market level, services provided etc. The Resale Price Method (RPM) can then be used to determine an arms lengthy price. CPM: reflects the effectiveness of applying the arms length price

80 4. PLIs used Gross profit to operating expenses Operating income on sales Return on operating assets

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83 CUREMAKER & WIDGET WHOLESALE case studies https://dl.dropbox.com/u/10753349/Lectures/Tr ansfer%20Pricing%20Examples%202%20201 2-11-30%202.46%20PM.mov https://dl.dropbox.com/u/10753349/Lectures/Tr ansfer%20Pricing%20Examples%202%20201 2-11-30%202.46%20PM.mov More notes at www.IITF.net

84 DAY 2 More notes at www.IITF.net

85 NERA Economic Consulting http://www.NERA.com - Case Study – Sebastian Gonnet and a colleague.http://www.NERA.com Presentation - ANNEXURE EANNEXURE E More notes at www.IITF.net

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87 Intangibles can be protected or not Examples: patent / know-how They can be on the balance sheet or not Examples: acquired / created and capitalised / created and expensed They can be remunerated or used free of charge by other group companies (often in good faith) Where they are not protected and not on the balance sheet, identification and determination of ownership can be difficult

88 It is not sufficient to rely on the balance sheet It is not sufficient either to rely on the P&L accounts (in case the taxpayer omits to charge some valuable intangibles used by related parties): Risk assessment forms which are filed with tax returns in some countries often prove insufficient in this respect

89 Interviews Historical background of the company Financial information released for investors (e.g. IPOs)

90 In the functional analysis (functions performed taking account of assets used and risks assumed): In the selecting of transfer pricing methods Comparable controlled price One-sided methods: cost plus, resale price, TNMM;

91 Two-sided methods: profit split e.g. if both parties use unique, valuable intangibles ): In the selection of the tested party for a one- sided method: the less complex party to the transaction Comparable controlled price In the selection of uncontrolled transactions that can be used as comparables (comparable means: no material difference or differences can be adjusted in a reasonably accurate manner

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93 Legal ownership for registered intangibles (e.g. registered patent, trademark, copyright) Economic ownership: who is entitled to the economic benefits? For transfer pricing purposes, a party that bears the costs and risks of developing an intangible should be entitled to a corresponding beneficial interest, even if it is not the legal owner of the intangible.

94 Reasons for taxpayers to segregate legal and beneficial ownership: Handle all intangible registrations centrally Cost Contribution Arrangement (CCA) where economic ownership is shared but legal ownership cannot be under multiple names (para. 8.6 OECD TP Guidelines) Taxpayer must provide sufficient documentation.

95 The OECD TP Guidelines recognise the difference between legal and economic ownership, and provide specific comments in this respect in relation to marketing intangibles (marketing activities performed by a party that does not own the trademark).

96 In the treaty context, useful (although different) notion of beneficial ownership For the purposes of determining treaty benefits, a conduit company cannot normally be regarded as the beneficial owner if, though the formal owner, it has, as a practical matter, very narrow powers which render it, in relation to the income concerned, a mere fiduciary or administrator acting on account of the interested parties.

97 Centralised ownership Single company in the group owns the intangibles, both beneficially and legally. License agreements with other group entities need to determine arm´s length price Opportunity for tax planning 97

98 Distributed ownership A number of companies (operating companies) would share ownership of intangibles on a pre- determined basis (e.g. geographic territory or product application) It always involves shared beneficial ownership Usually take the form of CCA Less tax driven

99 Multinational enterprises have the freedom to fund and organise the development of intangible property, subject to: the legal form of the arrangement to be consistent with the substance of the transaction, and the arrangements, viewed in their totality, to be arms length (see in particular whether consistent with functional analysis and whether achieves an arms length allocation of risks) Legal and economic ownership are increasingly disconnected from the location where R&D is performed. The location of legal and economic ownership of intangibles developed have huge transfer pricing consequences. This is a policy issue for fiscal attractiveness.

100 Decision where to locate R&D activities is generally based mainly on non-tax factors (e.g. skilled personnel), although tax factors (specific tax breaks for R&D activities) might help.

101 Depreciation, amortisation of developed or acquired intangible Deduction of license fees Treaty network Withholding tax on inbound (and outbound) royalties Tax rate on benefits from exploitation (business profits or royalties) Repatriation of earnings to shareholders Future disposal of intangibles (exit scenarios) Others (VAT, registration duties…)

102 More notes at www.IITF.net

103 DAY 2 More notes at www.IITF.net

104 Core activities of a Tax Administration are centered around the implementation and enforcement of tax legislation and tax regulations. 104

105 The objective of Tax administrations is to achieve the highest possible level of voluntary compliance with the laws, at minimal cost. Why voluntary compliance? - Tax administrations cannot enforce compliance from each & every taxpayer; they dont have the resources. - Governments will not provide more resources, which are both costly and intrusive. - Voluntary compliance is the cheapest & most efficient means of administering a tax system. 105

106 Taxpayers ignorance of the law: I did not know! You did not tell me what I needed to do! 106

107 Tax laws are often complex – I made an error! 107

108 Tax laws & rules may put a high compliance burden on taxpayers- Its too costly / difficult to comply! 108

109 There are many barriers to achieving voluntary compliance (…continued) Some taxpayers have poor/ no records –They dont know how to keep good records or cant be bothered. 109

110 There are many barriers to achieving voluntary compliance (…continued) Some citizens and business are not prepared to comply- They deliberately dont comply & are prepared to take a risk of being caught. 110

111 Effective taxpayer services help achieve voluntary compliance by: - Improving taxpayers understanding of the law - Making it easier and less costly to comply - Informing taxpayers on what they need to do to properly comply - Discouraging taxpayers from non-compliance 111

112 Political perspective (fiscal policy) Tax system (complexity, tax rates, etc) Social psychological perspective Mental (social) representations Tax knowledge and mental concepts Attitudes: beliefs and evaluations Norms: Personal norms Social norms and identity Societal norms 112

113 Mental (social) representations (2) Perceived opportunity to evade Fairness perceptions: Distributive fairness Procedural fairness Retributive fairness Motivation to comply Motivational postures Tax morale 113

114 Decision making perspective Rational decision making Audit probability, fines, tax rate and income Psychological aspects of decision making Sequence of audits: learning processes Heuristics, biases, frames Withholding phenomena Self-employment (paying out of pocket) Interaction between tax authorities and taxpayers (Cops against robbers versus service for clients perspective) 114

115 Tax authorities who perceive taxpayers as robbers rather then as clients are likely to establish a command and control climate with taxpayers engaging in escaping the authorities by taking extensive (rational) decisions. Tax behaviour depends on audit probability and fines Tax authorities who perceive taxpayers as clients and governments committed to responsive regulation are likely to establish a climate of cooperation and trust. Voluntary compliance depends on the taxpayers social representations of taxation. 115

116 Simple and understandable legislation Transparent and clear procedures Fast efficient processes Low compliance costs Treatment of the taxpayer as a client Taxpayer service (assistance, information) Visible supervision and fraud detection Use of third party information (banks etc.) Enforcement communication 116

117 Rights and obligations of the taxpayers Clear guidance in dealing with the Tax Administration Ethical standards and rules of conduct Confidentiality of information Professional staff Feedback from stakeholders Performance measurement 117

118 Explanation and protection of rights Explanation why information is asked Disclosure of information only on legal basis Professional service Representation Payment of only the correct amount of Tax 118

119 Increasing acknowledgment that taxpayers have rights, as well as obligations. Examples of (basic) rights: - to be informed, heard, and assisted; - to pay no more than the correct amount of tax due; - to appeal decisions of the tax body; and - to have certainty, privacy, and confidentiality Examples of (advanced) rights - Services are comprehensive, easily accessible, low cost to taxpayer, & timely. 119

120 Basic rights may be stated in countries legislation Many tax administrations set out taxpayers rights in formal charters/ statements that are made public. Charters reflect tax administrations vision for service delivery (e.g. services are comprehensive, accessible, fair, & timely). Many tax administrations set service performance standards with time-bound objectives that are made public 120

121 Eliminating possible issues that could prompt an audit Determining the appropriate documentation needed to address an audit Preparing defence to tax audit for and responding to tax authorities transfer pricing audits Identifying possible impacts from the proposed transfer pricing legislation amendments that could lead to an audit Review E&Y Global TP survey 2010/11

122 Eliminating possible issues that could prompt an audit Keep TP policies up-to-date Dont deviate from policies without amending Control Exchange of Information via tax authorities Beware of other country TP audits Revisit offshore center intermediary SubCos Where is the sensitive information kept?

123 Determining the appropriate documentation needed to address an audit Where is the sensitive information kept? TP policy document – updated? What documents must you bring in from other jurisdictions? Association clause in DTA Mutual Assistance clause in DTA Exchange Information clause in DTA

124 Preparing defense to tax audit for and responding to tax authorities transfer pricing audits Presentation on preparing for tax audits – An emerging market perspective

125 Structuring your company to be able to address potential controversies Examining Intangible Property, Intragroup Services, Cost Contribution Arrangements, and Thin Capitalisation policies Considering Mutual Agreement Procedures (MAPs) and Advance Pricing Agreements (APAs) to reduce your tax risk Overcoming potential penalties and costly litigation arising from transfer pricing adjustments Enforcing a defensible model to safeguard against tax audits and disputes

126 Structuring your company to be able to address potential controversies Tax Intelligence Book 7 Habitual Tax Mistakes made by Companies The summary booksummary

127 Considering the following to reduce your tax risk: Mutual Agreement Procedures (MAPs) – very slow and outside control of taxpayer Advance Pricing Agreements (APAs) – not relevant in Africa GATT, GATS, State Responsibility and other sundry procedures Other - such as monitoring ATAF

128 Overcoming potential penalties and costly litigation arising from transfer pricing adjustments Up-to-date TP policy documents Contemporaneous with tax returns Control audits & exchange of information Letters of findings Opinions to mitigate interest & penalties

129 Enforcing a defensible model to safeguard against tax audits and disputes Tax team Regular tax risk meetings Regular communication intra-group Remember FEDEX info survey model

130 DAY 2 More notes at www.IITF.net

131 Categorising groups of similar taxation laws Assessing these different tax regulations group by group Highlighting documentation requirements in various regions Exploring best practices to address transfer pricing operations More notes at www.IITF.net

132 Country comparisons CountryTP RegsTP Docs?Tax ReturnPenalties ThailandYRecommendYUp to 200% VietnamYRecommendYN TaiwanYYYUp to 200% SingaporeYRecommendNUp to 200% PakistanN Anti-AvRecommendNN MalaysiaYRecommendYUp to 300% IndonesiaYY >Rp10mYUp to 48% IndiaYY >INR10mYUp to 300% Hong KongN Anti-AvRecommendNUp to 300% ChinaYYY5% no docs CambodiaN Anti-AvRecommendNN South KoreaYRecommendY10% More notes at www.IITF.net

133 Country Summaries REFER to various country summaries download at www.IITF.netwww.IITF.net More notes at www.IITF.net

134 Home Country Tax Havens Developin g Countries UPSTREAM MIDSTREAM DOWNSTREAM

135 Home Country Tax Havens Developin g Countries UPSTREAM MIDSTREAM DOWNSTREAM

136 Home Country Tax Havens Developin g Countries UPSTREAM MIDSTREAM DOWNSTREAM

137 Home Country Tax Havens Developin g Countries UPSTREAM MIDSTREAM DOWNSTREAM

138 More notes at www.IITF.net

139 VPC Ltd VIC VPC (M) Third Party On-Line Clients Wholesalers 15 countries Manufacturing costs: $ 2500 GP: $ 2 500 SP: $ 5 000 Purchase: $ 5 000 Distribution cost: $500 GP: $2 000 SP: $ 7 500 Manufacturing costs: $ 1 000 GP: $ 2 500 SP: $ 3 500 Purchase: $ 3 500 Distribution costs: $300 GP: $ 3 700 SP: $ 7 500 SP: $ 15 000 to end-user

140 Evaluation of methods CUP: Branded product, not comparable to VIC brand Cost Plus: Manufacturing intangible present, cannot compare to manufacturing intangible of VIC brand (no info available for VIC) Resale Price Method: VPC (M) sells to wholesalers, while Cayman Third Party sells to end-user

141 Evaluation of methods TNMM: Would be difficult to find companies that are similar to RSA entity: R&D, Manufacturing, on-line selling, integrated company, owning a very unique brand TNMM would not be appropriate Profit Split: all that is left Used by taxpayer Based on cost contribution: development, manufacturing and distribution (good objectively verifiable basis) Parent: manufacturing and R&D: $2 500 Sub: distribution cost: $500 Total cost: $3 000 Profit split: Parent: 83% (2500/3000); Sub: 17% (500/3000)

142 CONCLUSION Contact Details: Prof D N Erasmus +1 561 568 7115 daniel@taxriskmanagement.com www.taxriskmanagement.com More notes at www.IITF.net


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