Transfer Pricing Documentation Guidelines in Bulgaria Overview 13 April 2010

Table of contents What is Transfer pricing (“TP”)? International background and developments Bulgarian TP developments Transfer pricing documentation guidelines TP documentation files – contents and methodology Closing remarks. EY recommendations

What is Transfer pricing (“TP”)? Transfer pricing definition Pricing of related party transactions Transfer pricing issues Integrated business processes Comparable transactions Different national rules and practice

Transfer pricing issues R&D Shared Services Board of Directors Sales administrative services after-sales service management services sales services purchasing sale of end product Supplier Central Company Customer raw-material transportation manufacturing distribution services transportation property physical movement services Manufacture Warehouse 6

Applicable common standard The Arm’s length principle International standard advocated by OECD Refers to the price at which third parties would transact under similar terms and conditions

International background and developments Response of OECD, EC and tax authorities 1995 OECD Guidelines – www.oecd.org The “Arm’s Length Principle” EU Joint Transfer Pricing Forum Code of Conduct for effective implementation of the "Arbitration Convention " and proposal for September 2009 revision http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2006:176:0008:0012:EN:PDF http://ec.europa.eu/taxation_customs/resources/documents/taxation/company_tax/transfer_pricing/COM(2009)472_en.pdf Code of Conduct on transfer pricing documentation for 2006 EU associated enterprises http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2006:176:0001:0007:EN:PDF Guidelines for Advance Pricing Agreements (APAs) within the EU http://ec.europa.eu/taxation_customs/resources/documents/taxation/company_tax/transfer_pricing/COM(2007)71_en.pdf

Countries with effective TP documentation rules U.S.A. India Sweden Australia Portugal Israel France Colombia Finland Mexico Netherlands Estonia Brazil Thailand China Canada Malaysia Russia Korea Indonesia Kenya U.K. Norway Turkey Denmark New Zealand Italy Venezuela Peru Egypt S. Africa Spain Slovakia Germany Taiwan Czech Republic Belgium Hungary Romania Argentina Lithuania Greece Japan Ecuador Bulgaria Poland Vietnam Kazakhstan Singapore

Ernst & Young’s TP Survey Published on 29 September 2009 www.ey.com/tpsurvey Main messages: Transfer pricing – under the scrutiny of tax authorities worldwide China, Slovakia and Greece - other countries introducing detailed requirements for maintaining theTransfer pricing documentation file with information and analysis Tax authorities dedicate more resources to TP investigations setting transfer pricing examination teams

Ernst & Young’s TP Survey, cont. Industries, countries and transactions in the spotlight The main targeted industries are automotive, consumer products, financial services, oil and gas, and pharmaceuticals. Focus on transactions with perceived tax havens and ‘blacklisted’ countries TP investigation could be triggered by unusually big losses in a group company; corporate restructurings involving closures or reductions in operations; significant inter-company management fees

Bulgarian developments in a nutshell Arm’s length principle introduced in 1993 (Decree 56 on Business Activity) TP methods introduced in the Corporate Income Tax Act of 1998 Ordinance 5/1999 on the methods used to establish market prices Ordinance N-9/2006 on the TP methods based on the OECD TP Guidelines Transfer Pricing Manual of NRA of 2008 Transfer pricing documentation chapter included in the Manual, published on 8 February on NRA’s official website http://portal.nap.bg/

Internal legislation in force Corporate Income Tax Act (CITA) Arm’s length principle: Article 15 of CITA; Article 9 of Double Tax Conventions of Bulgaria Tax Code Setting the TP methods in § 1, item 10 Definition of related parties for tax purposes: a 5 % shareholding relationship is sufficient (§ 1, item 3) Documents submitted upon request Burden of proof – Article 116 Exchange of information procedure, Article 143a – Article 143l Regulation N-9

Internal legislation in force Burden of proof on the taxpayer Art. 116 of the Tax Code : For transfer pricing matters, the burden of proof that prices are at arm’s length is on the taxpayer

Internal legislation in force Accounting standards/principles The notes to the financial statements should include information on transactions with related parties Definition of related party for accounting purposes: where common control exists

Related parties For accounting purposes: For tax purposes: Where common control exists 5 % shareholding relationship is sufficient (§ 1, item 3 from the Tax Code)

Status of the Guidelines The Guidelines are part of the NRA’s TP audit manual, approved by NRA Executive Director order Technically, they are not part of the law It is in the interest of taxpayers to comply with the Guidelines since they define what the NRA requires Compliance with the Guidelines will greatly reduce the scope for disputes about transfer pricing

Effect of the Guidelines TP documentation based on the Guidelines may be required for any open tax year and for tax obligations not covered by the statute of limitations period

Lack of TP documentation There is only insignificant penalty if no TP documentation is available The burden of proof is on the taxpayer to demonstrate that the transfer prices applied are at arm’s length Without a documentation prepared according to the Guidelines, the NRA may reassess the tax liabilities based upon any publicly available information

Structure of the Guidelines Two parts methodology on how to audit transfer prices, TP documentation requirements Notes of the financial statements Focus on the differences in related party definitions TPD documentation can be required after reviewing the notes Our conclusion: it is time-consuming to prepare a documentation according to the requirements of the Guidelines. Therefore, the time set by the NRA is likely to be insufficient.

Aggregation of similar transactions TP documentation should support each related party transaction Similar transactions may be aggregated in one TP documentation file: Contracts of long duration, i.e. above 12 months Where the objects of the transactions are similar Periodic supplies of one and the same product or product groups Complex price for supply of equipment and guarantee service Compound transactions, e.g. franchise agreements

Exception for micro business Micro business will not be expected to prepare TP documentation Exception: when the operating profit margin is 20 % lower than the industry average for each of the last three preceding years, simplified TP documentation file should be prepared NSI and other publicly available sources to be used Summary of the operating profit margin for the last three years List of competitors

Documenting restructuring of functions and risks Comparability analysis should be carried out before and after restructuring What shall be documented? The actual changes which have occurred as a result of this process The economic reasons underlying the restructuring and expected benefits Realistic options that would have been available to the parties in the event of independent market relations The way restructuring compensations (if any) are affected by the compensation paid to the company

Simplified TP documentation May be prepared for lower value transactions based upon annual thresholds: BGN200,000, where the object of the transaction is supply of goods BGN200,000, where the object of the transaction is supply of services BGN400,000, where the object of the transaction is supply of intangible articles BGN400,000, where the object of the transaction is granting of a loan (the threshold relates to the amount of interest) Combination of aggregation and the above thresholds: The above thresholds apply to the aggregated amount The above thresholds apply to the transaction with the greatest value among the aggregated transactions, e.g. franchise

TP documentation for offshore business Offshore zone definition: Art. 116(3) from the Tax Code Presumption for related parties Shifted burden of proof Requirement for simplified TP documentation Detailed version may be required

Obligation for presentation TP documentation should be presented upon the request of the tax authority, e.g. during a tax audit or DTT clearance No obligation to be submitted to NRA on a regular basis In case of non-compliance: EUR250 fine Reassessment, based on any publicly available pricing information

Keeping TP documentation up-to-date TP documentation should be prepared for each tax year and should be kept up-to-date if changes occur in relevant factors No changes are also documented

Retention of TP documentation TP documentation should be retained for a period of five years after the expiry of the statute of limitations for the relevant tax year.

Language of documentation The country-specific file should be prepared in Bulgarian The master file may contain documentation in other languages but the NRA may require certified translations of all or any part of it

TP documentation files TP documentation should consist of two parts: Group information – Master file Information on the local entity and the transfer methodology applied – Country-specific file

Contents of master file Legal, functional, financial and management organization of the Group: description/chart Economic role of each member of the Group – functions and risks assumed; Allocation and financing of the intellectual property Explanation of the transfer pricing policy of the Group Description of the controlled transactions A list of any agreements for allocation of expenses, advance pricing agreements (APAs), decisions of courts, etc.

Contents of country-specific file Description of the functions, assets and risks of the local company Description of the controlled transactions in view of their nature and scope Excerpts of the financial statements of the taxpayer in relation to its related party transactions The transfer pricing methodology of the Bulgarian company Description of the method selected and reasons underlying the selection Internal and/or external comparable transactions Description of the information sources Explanation of the adjustments to the comparable transactions applied with the aim to eliminate the differences Any other information evidencing the compliance with the arm’s length principle

Contents vs. methodology in drafting a TP documentation file Description of the functions, assets and risks of the local company Description of the controlled transactions Excerpts of the financial statements of the taxpayer in relation to its related party transactions Transfer pricing methodology of the Bulgarian company Industry Analysis Company Analysis Transaction Description Functional Analysis Economic Analysis Page 31

Final conclusions The TP documentation file is not just a comparables search or a mechanical comparison of financial ratios. It should involve business analysis. There is not one proper price or margin BUT a range of prices and margins that are compatible with the arm’s length principle that the Company can use, provided that they are documented properly. The TP documentation file will lead to a better understanding of the value drivers in the business concerned.

Closing remarks Wide range of international rules TP rules have been in BG legislation since 1993 However, they have not been forced by the NRA as the expectations as to how to document transfer prices were not set TP Guidelines remove uncertainties but create expectations The Guidelines are not technically part of the law. However, it is in the interest of the taxpayers to follow them. We do not see any reason why the NRA will not require TP documentation according to the Guidelines and for any open tax years.

Closing remarks Increase in the number of TP audits/reviews should be expected. Therefore, Ernst & Young recommends: Health checks to identify and analyze exposures and planning opportunities Review of group TP policies in view of their compatibility with the Bulgarian rules Preparation/review of local TP documentation file

Your key contacts Laszlo Szakal laszlo.szakal@bg.ey.com Trevor Link trevor.link@bg.ey.com Evguenia Tzenova evguenia.tzenova@bg.ey.com Mitko Stoykov mitko.stoykov@bg.ey.com Main tel: +359 2 81 77 100 Fax: +359 2 81 77 111

Thank you for your attention!