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BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms.
BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms.
BDO KNOWLEDGE Tax Webinar Series Cost Allocation Can be as Easy as ABC Kirk Hesser, Transfer Pricing Senior Director, BDO USA, LLP Michiko Hamada Haney, Transfer Pricing Senior Director, BDO USA, LLP October 17, 2013
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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CPE AND SUPPORT CPE Participation Requirements ‒ To receive CPE credit for this webcast: • You’ll need to actively participate throughout the program. • Be responsive to at least 75% of the participation pop-ups.
Certificate of Attendance: If you are logged in the entire time and respond to all participation pop-ups, you will be able to print your certificate from the “Participation” section at the end of the webcast. If you log out before printing your certificate: • BDO USA professionals ‒ CPE will automatically be issued in CPE Tracking & Reporting at the end of
every week. A copy of your certificate will be sent after you have been issued credit. • All others will be emailed instructions on how to access your certificate.
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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CPE AND SUPPORT (CONTINUED) Group Participation ‒ To receive credit: • Sign-in sheets must list a Proctor name and CPA license number. • BDO USA professionals ‒ Submit your sign-in sheets using a General Training & Development Request in
BDO Service Now found at: BDOWorld > Applications & Resources > BDO Service Now > Click “Service Catalog” in the left menu, then under Training & Development, “Make a Request”.
• Clients and contacts ‒ Email sign-in sheets to [email protected] within 24 hours of the webcast. • Alliance members ‒ Should proctor their own group participants. This process is detailed in the LearnLive
Participant Guide, which can be found by searching “LearnLive Participant Guide” on the Alliance Portal. Call LearnLive Support below for questions.
• Unfortunately, we cannot currently support group CPE for International Firms. Those wanting CPE must register and log in on their own computer.
Q&A: Submit all questions using the Q&A feature on the lower right corner of the screen. At the end of the presentation, the presenter(s) will review and answer all questions submitted. Technical Support: If you should have technical issues, please contact LearnLive: • Click on the Live Chat icon under the Support tab, OR • Call: 1-888-228-4088.
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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WITH YOU TODAY
Kirk Hesser Transfer Pricing Senior Director 330 N. Wabash, 32nd Floor Chicago, IL 60611 Direct: 312-233-1802 Fax: 312-856-1379 [email protected]
Michiko Hamada Haney Transfer Pricing Senior Director 100 Park Avenue New York, NY 10017 Direct: 212-885-8577 Fax: 212-697-1299 [email protected]
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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OBJECTIVES
You will understand how the US regulations and OECD guidelines treat services and the concept of cost allocation, specifically activity-based costing (ABC) and how transfer pricing can be an important aspect.
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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AGENDA
What are services transactions?
The Process: Calculating a Management Fee
The Toolkit
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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SERVICES TRANSACTIONS
IRC §482 provides the tax authority with the right to make an adjustment to a taxpayer’s income or expenses if one member of a group of related entities has either not charged for services that it provided to, or on behalf of another related part, or charged a price that did not meet the arm’s length standard.
A transfer price must be charged whenever an entity is performing services that either: (i) actually provides a benefit to a related party, or (ii) was intended to do so. Services that are duplicative, ancillary, or that are of a stewardship nature, do not pass the benefit test.
Services that contribute to key competitive advantages, core capabilities, in one or more trades or businesses of the renderer, the recipient, or both, must include a markup.
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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SERVICES TRANSACTIONS (continued)
Some definitions:
‒ Shared Services Arrangement (“SSA”) This is not cost sharing!
‒ Costs or fully-loaded costs
‒ Stewardship or Shareholder
‒ “Business Judgment Rule”
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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METHODS FOR SERVICES TRANSACTIONS
Services Cost Method – References total cost of service with no mark-up
Comparable Uncontrolled Service Price – References price charged in comparable uncontrolled transactions
Gross Service Margin Method – References gross profit margin in comparable uncontrolled transactions
Cost of Services Plus Method - References gross profit markup in comparable uncontrolled transactions
Comparable Profits Method - References objective measures of profitability
Profit Split Method – Evaluates relative value of contribution
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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SERVICES COST METHOD
A transaction is eligible to apply the Services Cost Method with no markup if it meets the following criteria:
‒ Covered Service – General administrative and low margin services
‒ The services is not an excluded activity – For example, manufacturing or engineering
‒ The service does not contribute to competitive advantage of the relevant parties
‒ Adequate books and records are maintained
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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TO MARK-UP OR NOT MARK-UP?
While the markup is important, the costs to be charged are really the bigger issue
‒ No “cost safe-harbor” in OECD Guidelines
‒ Some countries take issue with allocated costs (e.g. Mexico and China)
‒ Double standard by many tax authorities: Markup outbound but not inbound
‒ Third-party or “pass-through” costs
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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BENEFITS BENEFITS BENEFITS
Analyzing services from the beneficiaries’ perspective is often overlooked, but is key
‒ Describe specific benefits
No local personnel perform activity
No duplication
No stewardship
‒ Important to interview personnel at beneficiary
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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DOCUMENTATION
Global report consistent with the US regulations and OECD Guidelines (a.k.a. “Masterfile”)
‒ Overview of business
‒ Description of services
‒ Benefits received by foreign recipients
‒ Cost definition and allocation methodology
‒ Markup substantiation ‒ comparables
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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DOCUMENTATION (continued)
Specific language recommendations:
‒ “Allocation of HQ costs is less than if the foreign beneficiary had to perform the services on its own or hire a third party.”
‒ “If the service was not provided, the foreign beneficiary would have to hire an employee or a third party to perform the service.”
Global US/OECD Masterfile
‒ Do I need local reports?
‒ Local review?
Have local management at each foreign beneficiary review and sign-off on recommendations
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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INTERCOMPANY SERVICE AGREEMENTS
Things to include:
‒ Term of agreement
‒ High-level description of services provided
‒ Definition of costs
Stock-based compensation?
‒ Currency of payment
‒ Frequency of payment
‒ True-up provision
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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The Process: Calculating a Management Fee
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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TRANSFER PRICING IS LIKE A PUZZLE
It is a riddle wrapped in a mystery inside an enigma, but perhaps there is a key.
‒ Winston Churchill, 1939
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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TYPICAL FACT PATTERN AND OBJECTIVES
Fact Pattern:
‒ One entity or several entities providing services to related parties within a group
‒ Costs associated with the provision of these services are currently solely funded by the service provider(s)
Objectives:
‒ Appropriately assign costs incurred in the provision of services to entities benefiting from the services
‒ Apply arm’s length markups, document and defend the deductions for recipient entities.
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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FOUR STEP ALLOCATION PROCESS
Step 1 - Determine total costs, carve out shareholder costs
Step 2 - Identify costs directly attributable to each entity
Step 3 - Assign shared costs to each entity based on time
Step 4 - Allocate remaining costs based on allocation key
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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DATA INPUT REQUIRED
Identify service providers
Determine allocable costs by service, by provider
Identify service recipients and determine costs attributable to each recipient
Establish appropriate allocation key for each service
Arm’s-length mark-up to be confirmed by transfer pricing study
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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LET’S GO OVER AN EXAMPLE - FACTS
There are 4 related entities, US, HK, UK, and Japan
US provides services to all 4 entities
Services provided include accounting and customer support
US currently funds all costs of these services
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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STEP 1A: DETERMINE TOTAL COSTS – BY SERVICE
For each service, capture total costs, include direct costs such as salary and benefits, and indirect costs such as rent and overhead.
Let’s look at the accounting department. Assume total costs for the accounting department are $120.
Salaries 60
Benefits 20
Overhead 20
Travel, expenses 20
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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STEP 1B: CARVE OUT SHAREHOLDER EXPENSES
Services that benefit only the shareholders, for example, SEC compliance reporting, must be excluded.
Shareholders 10
Others 110
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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STEP 2: IDENTIFY DIRECT COST
Assume US purchased an accounting software, “Digital Counter” for HK. This expense, and all others that can be directly allocated to a specific entity should be charged to that entity.
Shareholders 10
HK - accounting software 10
Balance 100
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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STEP 3A: CHARGE TO ENTITIES BASED ON TIME
Of the $100 remaining, we must identify time spent on each recipient for accounting services
Let’s say 30 hours (a) at $1 per hour (b) are spent on each of UK and US Therefore direct cost of 30hrs x $1 = $30 should be charged to each of UK and US
The remaining cost is spent on works not directly related to any specific country
Hours Assign by time (c )=(a) x (b)
UK - by time 30 $30
US - by time 30 $30
Total 60 $60
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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STEP 3B: CHARGE TO ENTITIES BASED ON TIME
After taking charging direct costs of $30 each to US and UK, the remaining $40 will be allocated based on allocation key.
Shareholders 10 HK -
accounting software 10
UK - by time 30
US - by time 30
FOR ALLOCATION
40
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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STEP 4: ALLOCATE REMAINING COSTS
In general, cost and benefit have a causal relationship
Assume management determined that revenue is the most appropriate allocation key for accounting services
The remaining $40 (d) is allocated by revenue, as follows:
=> US $16 + UK $12 + Japan $8 + HK $4 = $40
Revenue ($ Million)
% of Total Revenue (e)
Allocation (f)= (d) * (e)
US 40 40% $16
UK 30 30% $12
Japan 20 20% $ 8
HK 10 10% $ 4
Total 100 100% $40
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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ALLOCATION BY ENTITY SUMMARY
• Costs attributable to the Shareholders = $10 • Costs attributable to the US Direct Accounting cost = $0 + Direct cost based on time = $30 + Allocation by revenue = $16 = Total US = $46
• Costs attributable to the HK Direct Accounting cost(software) = $10 + Direct cost based on time = $0 + Allocation by revenue = $4
= Total HK = $14
• Costs attributable to UK Direct Accounting cost = $0 + Direct cost based on time = $30 + Allocation by revenue = $12 = Total UK = $42
• Costs attributable to Japan Direct Accounting cost = $0 + Direct cost based on time = $0 + Allocation by revenue = $8 = Total Japan = $8
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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MARK UP AND CHARGE OUT
Transfer pricing study provides markup percentage for Accounting = 3%
Accounting Costs Charged to UK = $42.0
+ 3% mark up ($42 * 3%) = $1.3
=> US charges the UK = $43.3
Accounting Costs Charged to HK = $14.0
+ 3% mark up ($14* 3%) = $0.4
=> US charges the UK = $14.4
Accounting Costs Charged to Japan = $8.0
+ 3% mark up ($8 * 3%) = $0.2
=> US charges the UK = $ 8.2
For accounting services provided, US receives = $65.9
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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The Toolkit
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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Questions and Answers
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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Speaker Biographies
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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BIOGRAPHY Kirk Hesser Kirk Hesser Transfer Pricing Senior Director 330 N. Wabash, 32nd Floor Chicago, IL 60611 Direct: 312-233-1802 Fax: 312-856-1379 [email protected]
Kirk has more than 18 years of transfer pricing experience and is a Senior Director in the Chicago office of BDO. Throughout his career, Kirk has worked with multinational companies to provide practical advice and comprehensive transfer pricing services including: documentation for penalty protection, APAs, controversy, FIN 48 calculations, planning analyses, and assistance with international supply chain restructurings.
Kirk has also performed similar services and analyses for state & local tax planning purposes. He has extensive industry expertise, including automotive, manufacturing, consumer products, medical instrumentation, pharmaceuticals, transportation services, and chemicals/specialty chemicals processing.
Prior to joining BDO, Kirk was the regional leader for Grant Thornton’s Midwest practice and more recently the North Central Transfer Pricing Leader for Ernst & Young.
Kirk has spoken at numerous conferences and events sponsored by accounting firms and professional associations.
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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BIOGRAPHY Michiko Hamada Haney
Michiko Hamada Haney Transfer Pricing Senior Director 100 Park Avenue New York, NY 10017 Direct: 212-885-8577 Fax: 212-697-1299 [email protected]
Michiko Hamada is a Senior Director with the transfer pricing group at BDO USA, LLP. Michiko brings more than 15 years of experience in conducting transfer pricing studies.
Michiko has provided transfer pricing planning and documentation services to both U.S.- and non-U.S.-based multi-national companies in all aspects of global business operations. Her experience covers matters involving IP licensing, valuation, migration and cost sharing; financial services, including interest rate and guarantee fee analysis; manufacturing services, including quality control, contract and toll manufacturing; distribution, commissionaire and limited risk distributor structures; insurance and leasing; and shared services, including headquarters cost allocations, research and development, procurement, logistics and credit functions. In addition, she has assisted U.S. companies with a variety of state and local transfer pricing issues, and has conducted global transfer pricing planning and documentation, and FIN 48 documentation and review.
Michiko has worked with clients across numerous industries, including computer software, hardware, components and peripherals, pharmaceuticals, medical equipment and supplies, telecommunications, heavy machinery, automotive, automotive equipment and supplies, food and food commodities, sports apparel and footwear, jewelry, luxury leather products, consulting and engineering, photographic equipment and supplies, oil and gas services, industrial equipment and consumer products, chemical products, financial services, services and retail trade.
Prior to joining BDO USA, LLP, Michiko worked at Arthur Andersen LLP in the Office of Federal Tax Services, in-house at a footwear and apparel manufacturer, and at two smaller boutique economic consulting firms working on matters in transfer pricing and international trade.
BDO KNOWLEDGE Tax Webinar Series ‒ Cost Allocation Can be as Easy as ABC
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BDO is the brand name for BDO USA, LLP, a U.S. professional services firm providing assurance, tax, financial advisory and consulting services to a wide range of publicly traded and privately held companies. For more than 100 years, BDO has provided quality service through the active involvement of experienced and committed professionals. The firm serves clients through 41 offices and more than 400 independent alliance firm locations nationwide. As an independent Member Firm of BDO International Limited, BDO serves multinational clients through a global network of 1,204 offices in 138 countries. BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms. www.bdo.com To ensure compliance with Treasury Department regulations, we wish to inform you that any tax advice that may be contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or applicable state or local tax or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein. Material discussed in this publication is meant to provide general information and should not be acted on without professional advice tailored to your individual needs. © 2013 BDO USA, LLP. All rights reserved. www.bdo.com
