PricewaterhouseCoopers

Global Transfer Pricing Perspective

Shyamal Mukherjee

April 23, 2010

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Agenda

• Global Transfer Pricing Landscape

• Significant Developments

• Key Global Issues

• Best Practices

April 2010Slide 2

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Global Transfer Pricing Landscape - Global Economy

• Global economy beginning to pull out of recession

• Main burden to support demand has been falling on fiscal policy

• Public Finances will go through a trade-off between short-term expansionary policies and reassurance for medium-term prospects:

- Fiscal deficits to remain high in next years

- Rise in public debt creates market concerns about sustainability of public finances

Global transfer pricing landscape…..a function of state of the global economy

Fiscal and debt pressures in the coming years will lead governments

to focus on revenues enhancement, with Transfer Pricing as

a “hot topic” on the agenda

April 2010Slide 3

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• Competitive pressures vs shareholder expectations

• Entry to new geographic markets and introduction of new products/ services

• Constant and stringent regulatory changes

• New, varied and complex intra-group transactions

• Increased intra-group financing transactions

• Optimization of global effective tax rate

Global Transfer Pricing Landscape - MNC Challenges

India MNCs are facing similar challenges

April 2010Slide 4

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Global Transfer Pricing Landscape – Audit Environment

• Increasing and aggressive tax audits - developed and emerging countries

• Introduction and/or provision of detailed guidance of TP rules/documentation in several countries – burdensome, rigorous enforcement, penalty exposure

• Cooperation and competition among nations and tax administrations

• Coordinated global action to prevent income shifting to tax havens

• Increased inventory of APAs and competent authority/MAP cases

• Surging controversies vs. new dispute resolution techniques

• Harmonization of customs and TP regulations?

MNCs world over facing a "Perfect Storm" in managing Transfer Pricing Audits

April 2010Slide 5

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OECD United Nations• Revision of Transfer Pricing Guidelines (Chapters I –III) - priority of methods - comparability tests/data- guidance on application of

TNMM/PSM

• Attribution of profits to Permanent Establishments – Article 7

• Permanent Establishment threshold issues – Article 5

• Discussion draft on Business Restructuring – application of arms’ length principle/ TP rules upon and/ or after business restructurings

• Transfer Pricing Practical Manual for Developing Countries - approach to be used by developing countries tax policymakers and administrators - discussions on issues including market penetration strategies, business restructurings, intangibles, intra-group finance structures

• Revised commentary to article 7 (OECD report on attribution of profits to PE) of OECD Model may have implications for countries using the UN Model

Role of OECD and United Nations – Key Initiatives

Convergence of OECD approach and UN approach – Need of the hour

April 2010Slide 6

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Significant Developments – US

IRS Transfer Pricing Practice

Provide/ develop expertise on TP issuesDevelop risk assessment techniques Develop examination best practices

Obama proposals on IP To limit shifting of income through

IP transfers

Alternative dispute resolution “Mandatory binding arbitration” in five

US treaties: Belgium, Canada, France, Germany, Switzerland

Splitting of losses US Competent Authority is meeting with Competent Authorities of UK,

Canada, and Australia to discuss and strategize this issue

IRS issues Final Service Regulations

(effective July 31, 2009)- Service Cost Method

- Benefits Test - Stewardship activities

- Ownership of intangible property (legal vs economic)

- IRS to impute contractual terms for consistency with economic substance

- Cost definition (stock based compensation)

April 2010Slide 7

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Significant Developments – Other Countries

European Commission’s proposed revised Code of Conduct

Facilitate MAP and arbitration process Reduce corporate double taxation

ATO’s Strategic Compliance Initiative

- intra-group financing- business restructuring - IP related transactions

- arrangements with businesses in tax havens- low profit/ loss makers

German Government’s Business Restructuring Rules

– requires exit taxes for transfer of businesses out of Germany

– valuation of and what constitutes a “transfer package”

ATO’s Draft Rulings and Practice Statement on Thin Capitalization Rules

Interaction between Transfer Pricing and Double Tax Agreements

Canada’s “ACAP Program” provides for resolution of a MAP case

to be applied to subsequent years through use of

Accelerated Competent Authority Procedure (“ACAP”)

April 2010Slide 8

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Significant Developments – India

Safe Harbour Rules Rules being framed for

specific industries including IT and ITES

Advance Pricing Arrangement (proposed)Likely to be effective April 2011

under new DTC - Unilateral APA

- Valid for up to 5 years

Dispute Resolution PanelA time bound alternative

dispute resolution mechanism

General Anti-Avoidance Rules(GAAR)

Likely to be effective April 2011 under new DTC

To be invoked where primary motive of an arrangement is to obtain tax

benefit and inter-alia the arrangement lacks commercial substance

Others- DTC- IFRS- GST

- New Companies Bill- Competition Bill

April 2010Slide 9

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Key Global Issues – Business Restructuring

TollManufacturer

IP company

Limited riskservice provider

Contractmanufacturer Limited risk

distributor

Commissionaire

Single entityProcurementcompany

Entrepreneur

Issues

• Application of TP rules upon and/or after conversion

• Recognition or non-recognition of transactions

• Re-characterization of transactions – even piece-meal re-characterization of individual contractual terms

• Profit potential – is it an asset?

• Recognition that AEs may engage in transactions that independent enterprises would not undertake

• Importance of economic substance

Conversion to alternate models

Migration of functions

Migration of intangibles

April 2010Slide 10

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What makes this significant:

• Increasing cross border acquisitions funded vide inter-company loans/ guarantees

• Typically high value transactions

• Thin capitalization rules

• Pricing - requires expertise and structured approach, is yet subjective, owing to lack of guidance from authorities

Issues:

• Interest rates appearing higher than local benchmarks - reliability of LIBOR

• Benchmarking from lender’s rather than borrower’s end

• A high guarantee fee, or the lack of it – GE Capital

• Loans out of sync with peer group debt-equity ratios and thin-cap norms

• Transactions not supported by appropriate written contracts

• Impact of market conditions – fixed vs floating rates, credit rating of borrower, market borrowing cost, prepayment options, etc.

Key Global Issues – Intra-group Financing

Analysis of Loan

Agreement

Analysis of Variance

Credit Rating

Use Moody’s RiskCalc

Rating

Bloomberg Benchmarking

Arms’ Length

Interest Rate

Compare S&P Industry

Ratios

Analysis of Financials

History of Capital

Structure

Computation of Key Ratios

April 2010Slide 11

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Recent Developments:

• Impact of “Passive Association”–growing controversy–case of GE Capital

- Banks and rating agencies consider financial stability and willingness of the parent in estimating the credit strength of subsidiaries (“implicit support”)- Explicit guarantee provides stronger protection and legally enforceable recourse to lender (“explicit support”)

• ATO’s Practice Statement on “Rule of Thumb” - Taxpayers will be at low risk if they price debt using parent’s weighted average cost of debt. Evident drawbacks include:

- Attributes parent’s financial position to subsidiary

- Outcome inconsistent with arm’s length principle as it may not have nexus with terms and conditions of actual loan

- No adjustment for different geographical markets, Fx, etc

- Could lead to double taxation issues

Key Global Issues – Intra-group Financing

April 2010Slide 12

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Issues:

• Legal vs. economic ownership

• Analysis of contractual terms – nature of rights, term of the contract, responsibility split, etc.

• Analysis of actual conduct relating to marketing activities, analysis of:

- roles and responsibilities, - costs and risks, - benefits and rewards, - assets owned/ utilised/ developed

• Distinguish between routine business expenditure/ investment and return for distribution operations vs. additional expenditure/ investment and return for brand building (Bright Line test)

• Evaluate possibility of reimbursing “excessive” marketing spend

Key Global Issues – Marketing Intangibles

Significant International Rulings – DHL and Glaxo Significant Indian Rulings – Fosters and Nestle

April 2010Slide 13

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• Stock Based Compensation

• Carbon Credits

• Procurement

• IFRS

Key Global Issues – Others

April 2010Slide 14

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Corporate tax function would need to manage all elements of the transfer pricing value chain so as to mitigate associated transfer pricing risks

Best PracticesThe Transfer Pricing Value Chain

April 2010Slide 15

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Thank You

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