1. Saturday December 5, 2015 Session 14.00 – 16.00
Transfer Pricing Developments: Future Business Models for Managing Global Companies
Saturday December 5, 2015
Session – 16.00

2. Chairman: Gautam Doshi, Reliance ADA India
Panel leader: Caroline Silberztein, Baker & McKenzie, France
Panellists:
Anis Chakravarty, Deloitte, India
Carol Dunahoo, Baker & McKenzie, USA
Daniel Erasmus, TRM, South Africa, Africa & USA
Sanjiv Malhotra, Baker & McKenzie, Singapore
T.P. Ostwal, T.P. Ostwal & Associates, India 
Kamlesh Varshney, Tax Commissioner responsible for APAs, India

3. 1. “Assure that transfer pricing outcomes are in line with value creation”

4. Transfer pricing questions at each step of the supply chain
R&D, design
Source raw materials, components
Make (process, package)
Market
Sell
Deliver (warehousing, inventory management, transportation)
After sales services, returns
Transfer pricing questions at each step of the supply chain
Back office services, IT systems

5. Creation of value ? Capital Labour Market
Funding the acquisition and development of intangibles
Bearing entrepreneurial and financial risks
Labour
People functions (manufacturing, marketing, sales, R&D)
Strategic decisions, Control over risks
Location savings
Market
Consumers base
Growing demand
Buying power

6. 2. Intangibles and “DEMPE” functions

7. OECD-G20 Definition of intangibles for transfer pricing purposes
Something which is not a physical asset or a financial asset, which is capable of being owned or controlled for use in commercial activities, and whose use or transfer would be compensated had it occurred in a transaction between independent parties in comparable circumstances.
Not always an intangible asset for accounting purposes
Availability and extent of legal, contractual, or other forms of protection may affect the value.
Separate transferability is not a necessary condition for an item to be characterised as an intangible for transfer pricing purposes
Differing country definitions / experiences ?

8. Rewarding contributions of affiliates to the creation of intangible value : the “DEMPE” functions
Determine, by means of a functional analysis,
which member(s) perform and exercise control over development, enhancement, maintenance, protection, and exploitation functions (“DEMPE”),
which member(s) provide funding and other assets, and
which member(s) assume the various risks associated with the intangible,
whether or not legal owner of the intangible.

9. In summary, where the legal owner…
entitled to all of the anticipated returns derived from the exploitation of the intangible
Performs and controls all of the DEMPE functions; provides all assets, including funding, necessary to the DEMPE; and assumes all of the risks related to the DEMPE
generally only expect a risk-adjusted return on its funding
Provides funding and exercises control over the financial risk associated with the provision of funding, without the assumption of, including the control over, any other specific risk
it will have no more than a risk-free return; even less if legal ownership is disregarded
Lacks the capability to control the risk associated with investing in a riskier financial asset

10. 3. IP Holding company

11. High tech company Parent IP Co Existing IP / R&D Market Co1 3 2
High tax; original IP development
Low tax; intragroup acquisition of IP
High tax / low tax; further IP development 4
Market Co
Most controversial issues:
Valuation of IP transfer to IP co by Parent Co (HTVI)
MARIO
(1) Hard to value intangibles. New critical concepts to be considered when valuating and transferring existing IP;
MICHAEL
Valuation of IP transfer to IP co by acquired group (bridge needed to explain gap with acquisition price and future TP policy when conversion to contract R&D)?
HOLLY
This is a long-standing concern of the US IRS, under both US cost-sharing rules, but also for other IP migrations
IRS mostly focuses on the valuation of the outbound IP
IRS not only focuses on whether the taxpayer has properly valued the classic IP (i.e., software), but also has introduced the concept of “platform intangibles” and the research workforce as a non-routine contribution; we now see these themes emerging in the OECD work
While the IRS’ focus has been on the valuation of intangibles on the outbound transaction, another common theme has been for the IRS to minimize the value of the other foreign contributions (i.e., manufacturing)
CAROL
The US Competent Authority remains concerned about the increase in very large unprincipled or ill-founded adjustments against US-headquartered company groups?  I find it interesting that they continue to push back forcefully at the same time that the IRS is proposing very large and controversial adjustments in the other direction, e.g., in MAP cases involving Denmark and Mexico.
2. Arm’s length remuneration for IP ownership / funding / risk bearing : residual, risk weighted financial return, nothing ? Substance? Nexus ?
Incentives, enhanced amortisation, on acquisition of the IP, comparison with BEPS 5 / nexus test and patent box regimes elsewhere
Effectiveness of contract R&D model in APAC, audit pressures (enhanced cost-plus? comparables?), similar comments on royalties to marketing/manufacturing companies
RENE
Swiss perspective ?
3. Arm’s length remuneration for R&D : C+ or PS ?
(2) Control and coordination on outsourced R&D
4. OTHER ISSUES
Manufacturing

12. Legal owner of product intangibles: Royalties
Bermuda cash box
Actions 8-10: Transfer pricing
Bermuda legal owner and funds development
India performs
Design and control of R&D program
Management and control of budget
Control over strategic development
Defence and protection
Ongoing quality control
Three scenarios possible:
No management of funding risk: entitlement to no more than risk-free return
Management of funding risk: entitlement to risk adjusted return
Management of funding risk and operational risk: not a cash box!
Infusion of funds
Parent
Home country
Offshore
Contract R&D
“Cashbox”
Offshore
Subsidiary
Legal owner of IP
Funds R&D
Assumes risk of funding
Performs and controls all activities (DEMPE of IP), including management of operational risk

13. 4. DIGITAL Supplies

14. Digital supplies
Online auction platform, internet search and downloadable digital products
Principal
Actions 8-10: Transfer pricing issues
“Profits should be taxed where economic activities deriving the profits are performed and where value is created.” [G20 Leaders’ Communiqué Brisbane Summit, November 2014]
Particular area of interest
Interplay with Action 1
“Demand” or “supply” creates value?
Fragmented functions:
Who, in fact, controlling the activity? Increased interdependencies create uncertainty
Will “profit split” likely be viewed by some as a reliable method? Value of fragmented functions in the value chain may not be observable in transactions with independent parties $
Services
Source country
Marketing services co.
Services
Server co. $$
Services
Customers
Server
Communication

15. Multisided Business Models – Scenario 2 (from OECD 2014 draft on profit split)
RCo Group provides Internet services to customers worldwide:
Advertising services ; fee based on number of users who click;
Online services free of charge to users; provides RCo with a substantial amount of data
R = Parent company
- Original development and funding of technology IP
Local subs :
Promote use of online services free of charge to users
Generate demand and adapt advertising services

16. 5. sales organisations

17. Low tax; centralise risks; substance
Principal and Sales
Suppliers
IP co
Principal
Low tax; no people;
IP ownership
Low tax; centralise risks; substance
Sales to custo-mers
Most controversial issues:
Cost plus remuneration for Market Co ? or Return on Sales ? Profit Split ?
Permanent establishment exposure for Principal via Market Co functions ?
Loss making situations ?
HOLLY
We have not seen the IRS attacking Principal structures, per se, but focusing on the following issues:
did IP move out of the US, and if so, at what price?  So, the valuation issue from Case 1
what is the Principal doing to earn its return?  Sourcing and other functions are not viewed as particularly high-function or high-risk.  These functions might be given a routine return  [although the BEPS discussions hinted at ascribing greater value to procurement functions]
Sales functions in the US might be argued to be high value, particularly in the pharmaceutical/medical industry, sometimes triggering a profit split approach 
CAROL
Other countries, including Japan and Canada, have taken similar positions in many cases.
MARIO
(1) PE risk in case of commissionaires, sales agents and sales support sp;
(2) Limitations to the contractual allocation of risks to suppliers
MICHAEL
Defensibility of royalty to IP co, appropriate level of returns/method
Location savings/market premium issues in “limited risk” related parties – defensibility of one-sided methods and issues thereon (commenting on CN/IN experiences and new CN guidelines)
Models that work in APAC for marketing companies (LRD vs sales agent vs commissionaires)
Summary of other tax risks in relation to the marketing co such as PE, extent of challenge (practically) in the region (focus on services PE issues which are common in countries using UN model treaty)
Market Co
High tax;
sales support

18. Unique and valuable contributions – Scenario 3
P = manufacturer of high tech equipment;
Extensive R&D; funding and ownership of technology IP;
Global trademark; broad guidance to subs on marketing strategy
S = sales and marketing
Close relationships with customers, on-site services;
Extensive stock of spare parts;
Highly proactive maintenance program; advice to customers and adaptation to local conditions =>
Significant competitive advantage

19. 6. Marketing

20. Example 5 Company P in Country A owns trademark.
It manufactures the products and sells them to Distributor in Country B.
Distributor incurs Advertising, Marketing and Promotional expenses in Country B.
Does Company P acquire / develop
a local marketing intangible ?
“economic ownership” of the trademark ?
co-ownership of the trademark ?
Consider 3 cases :

21. CASE 1 : ROS, no AMP refund
Sales revenue
1,000
COGS (Transfer Pricing)
(550)
Advertising, Marketing, Promotion (AMP)
(100)
Other OPEX
(300)
Return on Sales : 5%
+ 50
CASE 2: ROS, AMP refund
Sales revenue
1,000
COGS (Transfer Pricing)
(650)
Advertising, Marketing, Promotion (AMP)
(100)
Other OPEX
(300)
Reimbursement of AMP
+100
Return on Sales : 5%
+ 50
CASE 3: ROS, partial AMP refund
Sales revenue
1,000
COGS (Transfer Pricing)
(580)
Advertising, Marketing, Promotion (AMP)
(100)
Other OPEX
(300)
Reimbursement of AMP
+30
Return on Sales : 5%
+ 50

22. 7. marketing and procurement hubs

23. Marketing hub (Singapore)
Physical supply
Plants
Sales transactions
/ Invoicing
Marketing hub (Singapore)
Buy-sell affiliated distributors

24. Marketing hub (Singapore) Sales support services
Physical supply
Plants
Sales transactions
/ Invoicing
Marketing hub (Singapore)
Sales support services
Sales support companies

25. Repatriation of excess profit to IP owner ?
Physical supply
Plants
Sales transactions
/ Invoicing
Warehousing / distribution platform (Singapore)
Sales support services
Sales support companies
Repatriation of excess profit
to IP owner ?

26. Marketing hub (Singapore)
Physical supply
Plants
Sales transactions
/ Invoicing
2 – toll-manufacturing
Marketing hub (Singapore)
3 - Sales support services
2 – finished products
1 – raw materials
Sales support companies
Third party suppliers 1

27. 8. Location specific advantages

28. Principal (Singapore)
Location Savings
How to quantify Location Savings:
Compare to whom, what, and where ?
What if no relocation of activity ?
What if products evolve ?
What about “dis-savings”?
How to attribute Location Savings ?
Parent (U.S.)
Principal (Singapore)
Manufacturer
(India)
(China)

29. Principal (Singapore)
Market Premium
Parent (U.S.)
Principal (Singapore)
Manufacturer (India)
Manufacturer
(China)
Distributor
(EMEA)
Distributor
(China)
Distributor
(India)

30. 9. Conclusions, q&A

31. Thank you