Transfer Pricing - International Tax Review · transfer pricing legislation and provides an update of new measures. 21 Chile Transfer pricing rules and the Chilean tax reform Lorenzo

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Transfer Pricing 16th edition

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03 Taxpayer insightSupply chain management and externalchangesThe global nature of business continues to pushcompanies for meaningful business synergiesand scale. Vineet Rachh, a multinational taxdirector, discusses supply chain management ina rapidly developing global business environ-ment.

07 GlobalThe OECD BEPS action plan:What it means for multinationals nowMichael Patton, of DLA Piper (US), runsthrough the OECD BEPS action plan in termsof how it is being received by multinationals.

13 EMEIASubstance and transparency in the context ofthe BEPS developmentsOliver Wehnert and Ivo Tankov of EY focus onthe issue of substance and transparency.

17 BrazilBrazilian transfer pricing rulesThiago Medaglia of Felsberg Advogados dis-cusses the unique features of the Braziliantransfer pricing legislation and provides anupdate of new measures.

21 ChileTransfer pricing rules and the Chilean taxreformLorenzo Gálmez M and Roberto Carlos Rivasof PwC provide an update on the Chilean taxreform and its impact on transfer pricing.

25 FranceOverview of the French TP regulation anddocumentation requirementsPhilippe Drouillot and Matthieu Philippe, ofLexCase Société d’Avocats, provide an updateon the French TP environment.

29 GermanyGerman insights on price-setting versusoutcome testing approachSusann van der Ham & Karin Ruëtz of PwCdiscuss the fundamental question of timing insetting transfer pricing, including recent OECDand EU JTPF publications on this topic, andcritically examine German tax authorities’ viewon compensating adjustments.

34 RussiaCompliance and reporting outsourcing inRussiaRussia continues to be a priority market formany multinational groups (MNE) and remainsone of the most profitable markets in the worldfor Western investors. Yulia Timonina andKarina Arakelyan of EY describe the trends incompliance and reporting and how they affectRussian taxpayers.

38 UKHow BEPS will affect UK transfer pricinglegislationIn the UK there is a great deal of interest in theG20 and OECD’s BEPS project and thechanges this may bring. Wendy Nicholls andLiz Hughes of Grant Thornton UK LLPdescribe how the new initiative will impact theUK transfer pricing landscape.

43 USUS transfer pricing developmentsThere has been a growing focus on transferpricing across the globe and there have been anumber of important US transfer pricing devel-opments in the last year. Larissa Neumann ofFenwick & West takes readers through themost significant issues of the past year.

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T he OECD’s base erosion and profit shifting (BEPS) project, commis-sioned by the G20, has now taken centre stage in global transfer pricing.

With a deadline of September 2014 for initial outputs, following araft of public consultations, and a final deadline for completion set forSeptember 2015, it’s an ambitious project and nothing has yet been decided.But that hasn’t stopped taxpayers and their advisers trying to forward planas to how the final guidelines will impact their businesses and tax structures.

The project has also seen the first serious international discussion aboutcountry-by-country reporting, which before the public consultations hadbegun, was considered a fringe issue and the brainchild of left-wing taxcampaigners; rather than something that would ever be accepted by multi-national companies.

Tax directors still have a number of concerns about how country-by-country reporting will be adopted by tax authorities around the world, notleast because they fear it will provide competitors with sensitive informa-tion that will put them at an economic disadvantage.

The OECD needs to iron out the grey areas of country-by-countryreporting to ensure that all the information that taxpayers submit to rev-enue authorities will be crucial and, most importantly, understood andused by revenue officials.

BEPS is, therefore, a big theme in this year’s Transfer Pricing supple-ment with articles looking at what it means for multinational companies,substance and transparency in the context of BEPS and a specific look athow it will impact certain jurisdictions, such as the UK and Germany.

The publication also features an article from Vineet Rachh, a multina-tional taxpayer, who focusses on the external changes that can impact acompany’s supply chain and how to manage these issues to promote effi-ciency in the tax department.

Readers will also benefit from advice about how to choose between theprice-setting approach versus the outcome testing approach in Germany,from advisers at PwC; new developments in the Brazilian transfer pricingrules, in an article written by Felsberg Advogados; the Chilean tax reform,by PwC; documentation requirements in France, by LexCase Societed’Avocats; compliance and reporting outsourcing in Russia, by EY; and UStransfer pricing developments from Fenwick & West.

Sophie AshleyManaging editorTPWeek.com

BEPS iscentre stage

TA X PAY E R I N S I G H T


Supply chain management andexternal changes

The global nature ofbusiness continues topush companies formeaningful businesssynergies and scale.Vineet Rachh, amultinational taxdirector, discussessupply chainmanagement in arapidly developingglobal businessenvironment.

O rganisations that operate in centralised models continue to look todecentralisation, and organisations that are decentralised continue tolook to some form of centralisation.

The extent of change depends upon an individual organisation’s situa-tion; some may tweak their existing model while others may make a signif-icant shift. Reorganisations that move towards centralisation generally consider

one or more of the following models (or variations thereto): • Manufacturing: Toller, contract manufacturer or fully fledged manufac-turer;

• Sales and marketing: Agent, commissionaire, limited risk or fullyfledged distributor; and

• Supply chain: Procurement, management services, principal.With the developments in the OECD base erosion and profit shifting

(BEPS) project including 15 action items to address and aggressive milestonesto reach through to September 2015, the challenge for an in-house tax advis-er, when dealing with reorganisation, is to ensure that the reorganisation doesnot fall flat once BEPS recommendations are rolled out and adopted. At a very high level, the BEPS action plans emphasises substance, trans-

parency, data reporting and documentation requirements in addition tocurbing harmful tax practices and treaty abuse during reorganisations.Keeping these broad parameters in mind, this article aims to provide apractical guide to in-house tax advisers when handling reorganisations. The list is not, and is not intended to be, exhaustive but aims to facili-

tate local tax compliance obligations and to demonstrate substance to taxauthorities and external auditors (who sign-off on the adequacy or other-wise, of the tax provisions). These pointers may also be leveraged for aninternal health check in respect of recent reorganisations.

1. Business purpose and benefitsThe reorganisation has to be business initiated and business driven. Thereshould be a clear business trigger for the reorganisation, for example, costefficiencies with centralisation and scale, a need for faster market penetra-tion strategy, consolidating a similar size or similar customer profile acrossmultiple markets, mergers and acquisitions. A multifunctional team shouldbe mobilised to list the pros and cons of the reorganisation for their respec-tive function. Both qualitative and quantitative benefits assessments shouldbe made. Analysis should also include rationale on why the reorganisationis happening now versus earlier or later. If functions and risks are moved to



a different location, detailed analysis of the value drivers andwhere they should reside (RACI analysis), as well as the loca-tion study with rationale behind the location of choice,should be undertaken. Formal recommendation for reorganisation and internal

approval from senior management should be obtained.Strategically, reorganisation should be approved by a corpo-rate committee of senior management and even the board ofdirectors. Minutes of such meetings should be recorded.

2. Industry and peer reviewBenchmarking with suppliers’, customers’ and competitors’business models should be made to support the reorganisa-tions. Internal analysis and external consultants’ reportsshould be developed and maintained. Third party benchmarkscould serve as CUPs in tax discussions. For example, in amanufacturing set-up, where customers and competitorsoperate on a regional basis via a centralised organisation, toremain competitive and to service the customer effectively,the company may reorganise regionally and centrally; other-wise, the company may lose out to competition.

3. Overall end-state visionOrganisations should develop the overall end-state long-termvision immediately following the reorganisation. While somereorganisation could be undertaken as a big-bang, others maybe undertaken in a phased manner. Hence, it is important thatthe total value proposition of the entire reorganisation, acrossthe entire value stream, is determined and laid out upfront. Anoverall transition roadmap should include a step-by-step planand milestones. Clear timelines and approacesh should be putin place and this should be based on specific business criteria.Factors such as new business, new markets, new product /customer introduction and M&A should be considered indeveloping transition priorities. If only certain divisions andgeographies are being reorganised, exclusion of other divisionsand geographies should be rationalised and documented.

4. Change management strategy and new operatingmodel rolloutAny business reorganisation requires change management.Having a change management strategy and team, stakeholderneed / reaction assessment, targeted communication plans,etcetera, will not only facilitate the change but also facilitatereorganisation. Top management needs to communicate thatthis change has been followed through. Reorganisations aregenerally smoother and better achieved if senior leadershipspeaks the same language and cascades the same messageacross the organisation. Formal announcements should bemade to the board, and, if feasible, in corporate annualreports. Webcasts, podcasts, town halls, internal and externalcommunications and announcements of changes should beincluded in the rollout plan.

5. Organisation and process redesign (substancedetermination)Substance is not defined in the rule book. There is no one-size-fits-all. Organisation set-up, workflows and processesdiffer from industry to industry, company to company andoften, division to division within the same company. Realsubstance reflects a company’s true business propositionwhich meets business need, commonsense test and opticstest. Let us assume that a company intends to establish a cen-

tralised global supply chain organisation in a particular loca-tion. Having just the chief supply chain officer (CSO) in thecentralised location would be insufficient. Regardless of theexperience that the CSO may have, for the CSO to be effec-tive, the CSO would need functional heads (such as finance,logistics, purchasing, supply chain, quality, legal, HR andother supporting resources) alongside them to effectivelydefine, implement and monitor global supply chain strate-gies. In other words, the CSO would need a team to effec-tively and efficiently run the global supply chain functioncentrally. A one person, or wafer thin, organisation structurein a centralised location does not meet the sense and optictest. However, this also does not mean that anyone andeveryone involved in supply chain activities has to be cen-tralised. Distinction may be drawn between the strategic andvalue driver activities versus tactical and implementationactivities. The following criteria may be applied when designing a

meaningful organisation and process:

(a) Mirror commercial realityThe organisation design and processes should reflect the com-pany’s commercial reality. Artificial segregation or consolida-tion of activities will be detrimental to a smooth operation.

(b) Stick to the basicsFocus on the fundamentals – functions, assets and risks(FAR). Ensure value driver functions are identified and treat-ed and compensated appropriately. An appropriate compensa-tion benchmark report based on FAR should be developedand updated, and kept available at all times.

(c) Before and after designsWith the reorganisation, one would expect the organisationstructure, processes and workflows to change. Having clarityon what has changed before and after organisation charts,RACI charts, process flows and workflows will effectivelydemonstrate that the change is real.

(d) Operating manualA business operating manual detailing the new operatingframework should be developed and institutionalised acrossthe impacted organisation, division and geographies.



(e) Headcount changesReorganisation has an impact, not just on roles but also ontotal bench strength. Particularly with centralisation, wherethe activities are consolidated, there is an expectation that cer-tain roles will be eliminated. Likewise, where activities aretransferred to another location, the transferee location shouldexpect a reduction in roles. Capturing head count rationalisa-tion and/or redeployment will support the transition and bereflective of process efficiencies.

(f) Key performance indicator (KPI) realignmentOften KPI realignment with the new model and new func-tionality gets ignored. It is important to have a new set ofKPIs for the functions impacted, both at legal entity and eachfunction level.

(g) Get the emotion out of the wayWhen reorganisations are undertaken, there is a tendency todefine roles and locations keeping specific individuals in mindversus organisation needs. To build the right substance, startwith the role-needs and ideal location, and then identify thebest resource to fit the role in that identified location.

6. IT infrastructureWhile technology is an enabler to the organisation, ironically,systems issues turn out to be the hardest to manage, secondonly to change management. Serious dollars are invested toupdate and / or replace existing systems. All systems-relatedchanges, such as system process flows, infrastructure andarchitecture changes, etcetera, should be tracked. For exam-ple, order to cash system, new capabilities in SAP, systemaccess grants and restrictions. Location of servers, digitaltrades, e-commerce business models are relevant considera-tions especially given the BEPS focus on these items.

7. Awareness and trainingsExtensive awareness and training programmes should be con-ducted across the organisation. Working sessions should beheld with impacted parties so that before and after processflows and work flows are clearly understood, including ration-ale for the change. Trainings should be on-going and part ofthe new hire and role change on-boarding material.

8. Post project implementation reviewOnce the project is implemented, a post implementationreview should be undertaken to ascertain whether the busi-ness benefits that were expected have been materialised ornot. Implementation of appropriate corrective actions shouldbe tracked. Assessments should be undertaken periodically.Such assessments and reports will assist in demonstrating thatthe reorganisation is business purpose driven. On-goingassessments could also be the stepping stones for future reor-ganisations.

9. Living the modelWhere companies undergo serious reorganisations with sig-nificant changes in the roles and responsibilities, it is impor-tant to ensure that the model lives though long-term. Anannual review and periodic health checks should be undertak-en via special review teams and/or internal audits to ensurethat processes and activities are undertaken in line with thenew world. Such review reports should be preserved todemonstrate governance and controls within the organisa-tion. It is important that the top management commits to liv-ing the model and to the end-to-end process flows and RACIdefinition, post reorganisation. Slippages are easy, especiallywith new teams coming on-broad with a strong desire to chal-lenge and change the status quo. Hence, constant commit-ment from the top is necessary.

10. Record retentionWe all know how critical record-retention is.Reorganisations are easy targets for tax authorities. Mostreviews end up in prolonged disputes. Hence, business andtax teams have to focus on documentation storage and easyaccessibility on demand. Organisations should err on theside of more. Often discussions and decisions are onphones, meeting and video calls. It is a practical nightmareto collate evidence after effect and especially a couple ofyears down the road. Teams would have changed, staff

Vineet RachhHead of TaxJabil Circuit

Vineet Rachh is a senior director and head of tax for Jabil Circuit(Singapore), based in Singapore. He leads Jabil’s global businesscentre’s tax and transfer pricing matters. His role entails develop-ing and implementing global supply chain solutions, and han-dling cross border tax and M&A matters. He also manages taxcompliance, audits and controversies.

In his 20 year career, he has had the opportunity to work withmost tax authorities in the Asia Pacific region on various subjectsincluding advance pricing agreements, mutual agreement proce-dures and audits. He was also the industry representative atOECD’s Task Force on Tax and Development’s sub-group ontransfer pricing in 2011. Before joining Jabil, he worked for otherUS multinational companies and before that for big-four account-ing firms.

He is a member of the Institute of Chartered Accountants ofIndia and a graduate of the Institute of Cost and WorksAccountants of India. He is also a member of several tax net-work groups. He is a regular speaker at tax conferences andevents.



would have moved on, laptops may have crashed, systemsrevamped. Hence, processes have to be put in place to col-late documentation in real time. Leverage on technologyfor recording and retaining workflow and processes fol-lowed by the organisation is highly recommended.Commercial record retention products are gaining popular-ity. Traditional approaches such as minutes recording andgathering, newspaper cuttings, travel data, etcetera areequally reliable if maintained in a sustainable manner.

11. Tax defenceIn today’s environment, tough audits are a given and taxdisputes are expected. As handling disputes is a subject initself, it is not discussed here in detail except that companiesshould plan ahead and put in place upfront risk mitigationand defense strategy. Evaluation of strategies such asadvance pricing agreements versus mutual agreement pro-grammes versus domestic resolution processes is importantto ensure sustainable ETR and shareholder value. Strategiesfor resolving differences in treatments between income tax,

transfer pricing, indirect tax and customs should be part ofthe defence plan. Other usual tax defence preparationshould be undertaken proactively.

The above list is not hard and fast but indicative and it differsbased on facts and circumstances and from organisation toorganisation. It is also recognised that it may not be practicalfor all organisations to ensure all of the above points. LargerMNCs may have more levy and resources to achieve many ofthe above as opposed to SMEs and many others. The bottom line is that an uncompromised and continued

emphasis on business drivers coupled with a strong substanceand commercial rationale behind any internal reorganisation,which is supported adequately with appropriate documenta-tion, is a good safety kit that companies should possess whennavigating the winds of external change. All views expressed herein are strictly his personal views and does not inany way reflect or represent the views of his present or past employers. Hecan be reached at [email protected]

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The OECD BEPS action plan:What it means formultinationals nowMichael Patton, ofDLA Piper (US), runsthrough the OECDBEPS action plan interms of how it is beingreceived bymultinationals.

O n July 19 2013, the Committee on Fiscal Affairs (CFA) of theOECD published its action plan to address base erosion and profitshifting (BEPS). The action plan follows from directives given to the

CFA by the G20 group of countries to better address global corporate tax-ation and builds upon the general concepts set forth in the OCED reporton BEPS issued in January 2013. The action plan asserts that “the BEPS project marks a turning point in

the history of international co-operation on taxation”. The plan calls forthe OECD to issue guidance or action items in the Autumn of 2014 andto publish guidance on all action plan items in 2015.The OECD CFA action plan on BEPS calls for a broad-based interna-

tional effort to combat a comprehensive range of international tax reduc-tion techniques. The action plan will require coordinating individualOECD member (and non-member) country actions on an individualcountry (for example, changes to legislation, regulations, administrativepractices), bilateral (for example, changes to bilateral treaties), or multilat-eral (for example, multilateral treaties, changes to OECD guidelines) basison a scale that is without precedent. The action plan has the support of thefinance ministers of the G-20 group of the world’s largest economies.Besides OECD member countries, G20 group countries actively partici-pating in the BEPS project include China, India, Brazil, Russia and SouthAfrica.The CFA members have reached the following general conclusions with

respect to BEPS: • Fundamental changes are needed to effectively prevent double non-tax-ation, as well as cases of no or low taxation associated with practices thatartificially segregate taxable income from the activities that generate it.

• New standards must be designed to ensure the coherence of corporateincome taxation at the international level.

• A realignment of taxation and relevant substance is needed to restorethe intended effects and benefits of international standards, which maynot have kept pace with changing business models and technologicaldevelopments.

• The actions implemented to counter BEPS cannot succeed without fur-ther transparency, nor without certainty and predictability for business.The BEPS action plan sets forth 15 general areas for further action by

OECD member and non-member interested countries. These 15 steps anda brief summary of each are set forth below:

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1. Address the tax challenges of the digital economyIdentify the main difficulties that the digital economy poses forthe application of existing international tax rules and developdetailed options to address these difficulties, taking a holisticapproach and considering both direct and indirect taxation.

2. Neutralise the effects of hybrid mismatch arrangementsDevelop model treaty provisions and recommendationsregarding the design of domestic rules to neutralise the effect(for example, double non-taxation, double deduction, long-term deferral) of hybrid instruments and entities.

3. Strengthen CFC rulesDevelop recommendations regarding the design of controlledforeign company rules.

4. Limit base erosion via interest deductions and otherfinancial paymentsDevelop recommendations regarding best practices in thedesign of rules to prevent base erosion through the use ofinterest expense, for example through the use of related-partyand third-party debt, to achieve excessive interest deductionsor to finance the production of exempt or deferred income,and other financial payments that are economically equivalentto interest payments.

5. Counter harmful tax practices more effectively, taking intoaccount transparency and substanceRevamp the work on harmful tax practices with a priority onimproving transparency, including compulsory spontaneousexchange on rulings related to preferential regimes, and onrequiring substantial activity for any preferential regime.

6. Prevent treaty abuseDevelop model treaty provisions and recommendationsregarding the design of domestic rules to prevent the granti-ng of treaty benefits in inappropriate circumstances.

7. Prevent the artificial avoidance of PE statusDevelop changes to the definition of PE to prevent the artifi-cial avoidance of PE status in relation to BEPS, includingthrough the use of commissionaire arrangements and the spe-cific activity exemptions.

8, 9 & 10: Assure that transfer pricing outcomes are in linewith value creation8. IntangiblesDevelop rules to prevent BEPS by moving intangibles amonggroup members.

9. Risks and capitalDevelop rules to prevent BEPS by transferring risks among,or allocating excessive capital to, group members.

10. Other high-risk transactionsDevelop rules to prevent BEPS by engaging in transactionswhich would not, or would only very rarely, occur betweenthird parties.

11. Establish methodologies to collect and analyse data onBEPS and the actions to address itDevelop recommendations regarding indicators of the scaleand economic impact of BEPS and ensure that tools are avail-able to monitor and evaluate the effectiveness and economicimpact of the actions taken to address BEPS on an ongoingbasis.

12. Require taxpayers to disclose their aggressive taxplanning arrangementsDevelop recommendations regarding the design of mandato-ry disclosure rules for aggressive or abusive transactions,arrangements, or structures, taking into consideration theadministrative costs for tax administrations and businesses anddrawing on experiences of the increasing number of countriesthat have such rules.

13. Re-examine transfer pricing documentationDevelop rules regarding transfer pricing documentation toenhance transparency for tax administration, taking into con-sideration the compliance costs for business.

14. Make dispute resolution mechanisms more effectiveDevelop solutions to address obstacles that prevent countriesfrom solving treaty-related disputes under MAP, includingthe absence of arbitration provisions in most treaties and thefact that access to MAP and arbitration may be denied in cer-tain cases.

15. Develop a multilateral instrumentAnalyse the tax and public international law issues related tothe development of a multilateral instrument to enable juris-dictions that wish to do so to implement measures developedin the course of the work on BEPS and amend bilateral taxtreaties.

TimingThe action plan sets forth an aggressive timeline, with dead-lines that generally range from 12 to 24 months.

Nearer terms goals (September to December 2014) includeactions relating to:Hybrid mismatch arrangements, treaty abuse, transfer pricingof intangibles, documentation requirements for transfer pric-ing purposes, a report on identifying issues raised by the dig-ital economy and possible actions to address them, and partof the work on harmful tax competition.

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Actions to be delivered in two years (September 2015)include:CFC rules, interest deductibility, preventing the artificialavoidance of PE status, the transfer pricing aspects of intangi-bles, risks, capital and high-risk transactions, part of the workon harmful tax practices, data collection, mandatory disclo-sure, and dispute resolution.

Actions that may require more than two years include:The transfer pricing aspects of financial transactions, part ofthe work on harmful tax practices and the development of amultilateral instrument to implement changes to bilateral taxtreaties.

Country-by-country reporting (CbCR)Action Item 13, CbCR, is perhaps the most controversialagenda item under the BEPS action plan. A preliminaryreport issued earlier this year by the OECD CFA recommendsthat a multi-tiered system of transfer documentation beadopted by OECD members and BEPS participating coun-tries. Under this approach, transfer pricing documentationwould consist of:• Local country documentation that would support thatcontrolled party transactions that affect a specific country’stax base were conducted at arm’s-length.

• A master file transfer pricing report containing informationon a company’s global transfer pricing policies and positions.

• A transfer pricing template that would provide globaldetails, among other things, of the location of employees,assets and taxes paid by country and business line.Business groups commenting on the proposed CbCR rec-

ommendations have raised serious concerns over theincreased burdens that will be imposed on business to complywith the proposals, as well as with the confidentiality of sensi-tive, non-public business information (such as business seg-ment information) that would be required to be disclosed. Inaddition, many wonder whether the information beingrequired regarding the location of employees and assets isnecessary to enforce arm’s-length transfer pricing rules or,rather, is a first step towards recommendations to adopt aglobal formulary apportionment of income tax. Some business groups argue that, rather than filing a mas-

ter report and CbCR template with all countries where thecompany does business, the parent company instead shouldfile the information with the tax authority in the parent com-pany’s home jurisdiction, and that this jurisdiction shouldshare the information with other countries under the infor-mation exchange provisions of the jurisdiction’s bilateral taxtreaties. According to published reports, the US favours the treaty

disclosure approach because of the protection afforded tocompanies under treaty confidentiality rules. However, theCFA is still discussing the best way for countries to obtain the

template and master file and the CFA has yet to make a finaldecision.

Selective country reactions to BEPSGiven the commitment of G20 Finance Ministers and Headsof State to the goals of the BEPS project it is not surprising

Michael F PattonPartnerDLA Piper

2000 Avenue of the Stars, Suite 400North TowerLos Angeles, CA 90067-4704USTel: +1 310 595 3199Fax: +1 310 595 [email protected]

Mike Patton is a partner in DLA Piper’s tax practice, based in LosAngeles. He focuses his practice on international transfer pricing.Mr. Patton has assisted many multinational corporations in a

variety of industries in resolving IRS or foreign tax authority trans-fer pricing and other tax disputes as well as in planning majorcross-border transactions. He was instrumental in obtaining theworld’s first advance pricing agreement and he has assistedclients in negotiating more than 100 APAs. Mr. Patton was previously an attorney in the IRS Chief

Counsel’s Office where he had national responsibility at IRS fortechnical issues, regulations and litigation of cases relating totransfer pricing. Mr. Patton was editor of, and a major contributorto, the Treasury/IRS Transfer Pricing White Paper. The White Paperlaid the theoretical ground work for the profit-based transfer pric-ing methods adopted by the US and the OECD. Mr. Patton has been named one of the Best of the Best US

transfer pricing advisers as well as one of the leading Asia Pacifictax advisers by Euromoney and the Legal Media Group. He is aneditorial advisory board member of Tax Management and is theauthor of the BNA portfolio Treatment of Advance PricingAgreements.

EducationUniversity of Maryland J.D. with honorsOrder of the CoifGeorgetown University Law Center LL.M.University of Maryland B.A.

AdmissionsCaliforniaNew York

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that some countries have already begun adopting steps toreact to the BEPS initiative.

Ireland passed a law eliminating double Irish statelessstructures, which were perceived as an example of the type oflegal framework that facilitated BEPS. Under the new legisla-tion, companies incorporated in Ireland, which are managedand controlled in another country, will be treated as tax resi-dent in Ireland unless such companies are tax resident in thecountry where they are managed and controlled.Notwithstanding enactment of this legislation, Ireland has noplans to increase the 12.5% general corporate tax rate or toeliminate the Irish non-resident tax regime.The Netherlands has codified substance requirements for

obtaining treaty benefits, including requiring declarationsregarding substance on tax returns.Because of concerns that it may run afoul of rules on harm-

ful tax practices, Switzerland has indicated it will move awayfrom granting cantonal tax rulings. However, Switzerlandmay replace such rulings with an IP Box regime, similar to theUK Patent Box regime.The French government published a commissioned report

written by two economists, which recommended that thetreaty definition of a permanent establishment (PE) beexpanded to include users of social media websites.The Italian parliament passed legislation requiring that

Italian companies purchase internet advertisements fromcompanies registered for Italian VAT. Due to controversyengendered by this law, Italy first delayed implementation of,and then repealed the law.

Australia has strengthened its general anti-avoidance rules,modernised its transfer pricing regime, and now requires pub-lication of taxes paid by the largest Australian companies.

US reactions to BEPSUS reactions to BEPS have largely been in the form of com-prehensive tax reform proposals. In the past few years,President Obama has made a number of tax reform proposalsand members of congress have held many tax reform relatedhearings. The tax reform plans generally involve lowering theUS corporate income tax rate to some level in the mid-20%range, while overhauling the international tax system to elim-inate the lock-out effect that occurs under current US taxrules that discourage US multi-nationals from repatriatingforeign earnings and profits. Most pundits think that compre-hensive US legislation to reform the system for taxing non-US income of US multi-nationals will be enacted in 2015. A number of likely proposals to be included in final legis-

lation (with modifications) include:

A repatriation holidayA one-time mandatory 8.75% tax imposed on US sharehold-ers (10% or more) of their foreign subsidiaries’ earnings andprofits accumulated since 1986 that have not previously been

subject to tax. Non-cash earning reinvested in plant, proper-ty and equipment would be taxed at 3.5%. The tax could bepaid in installments over eight years and foreign taxes paid onthe earning would be credited against this tax.

A participation exemption95% of dividends paid by foreign corporations to US corpo-rate shareholders (10% or more) would be excluded from USincome. At a 25% statutory rate, this provision results in a1.25% effective tax rate on foreign earned income. Indirectforeign tax credits would no longer be allowed with respect todividends paid to US shareholders.

Subpart FUS shareholders would be taxed under Subpart F on their,and their controlled foreign corporations’ (CFC), foreignbase company intangible income (FBCII) at a reduced 15%rate. FBCII is defined as the excess of a CFC’s gross incomeover 10% of CFC’s adjusted basis in depreciable tangibleproperty. An exception to taxation of FBCII would apply forincome subject to foreign tax at a rate of 15% or greater.

Earnings strippingUS corporations denied an interest deduction under §163(j)can no longer carry it forward. Also, the threshold for “excessinterest expense” is reduced from 50% to 40% of adjusted tax-able income

Treaty benefitsUS withholding tax would not be reduced or eliminated if thepayment is deductible in the US and both the payor and payeeare controlled by the same foreign parent.

What it all means and what multinationals should donowThe BEPS project is aimed at low-taxed or non-taxed profitsthat have been artificially shifted away from the jurisdictionswhere value is being created – not at low taxed profits per se.Therefore, it should be possible, even after the BEPS recom-mendations are adopted, to support low-taxed profits, providedsignificant value-creating activities are conducted in tax-favor-able jurisdictions. Although many countries will jump the gunand implement anti-BEPS initiatives before all the OECD workis completed, most of the BEPS action plan items will requirelocal jurisdictions to adopt changes in laws, regulations ortreaties. Multinationals should therefore monitor these developsto make sure that their views are heard and taken into accountbefore final changes to existing rules and procedures are made. In this vein, multinationals should expect:

• CbCR disclosures of complete taxpayer structures andlegal entity profits to all relevant tax authorities;

• Increased tax controversy, including more tax authorityassertions of PE issues;

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• New country restrictions on the use of hybrid entities andhybrid transactions;

• Some enhanced US CFC rules, perhaps accompanied bysome sort of territorial system; and

• Enhanced taxpayer reliance on tax treaty networks to elim-inate the potential for increased double taxation. The OECD plans to invite comments from business and

civil society representatives as the action plan is implemented.

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W W W . I N T E R N A T I O N A L T A X R E V I E W . C O M 1 3

Substance and transparency inthe context of the BEPSdevelopmentsOliver Wehnert andIvo Tankov of EY focuson the issue ofsubstance andtransparency.

S ignificant changes in the international tax scene have arisen through-out 2013 and 2014. The release of the action plan on base erosion andprofit shifting in July 2013 (BEPS action plan) clearly set the direction

in which the discussion between national ax authorities and multinationalenterprises (MNEs) will be heading. According to the latest BEPS OECDwebcast, broadcasted on May 26, the BEPS initiative focuses on severalthemes specifically: coherence, substance and transparency. In our article wewould like to focus and further analyse the aspect of substance in the con-text of the BEPS action plan discussions. We will begin by examining theBEPS action plan contents in the context of the substance issue as well asthe corresponding developments pertaining to the new transfer pricing doc-umentation approach set forth by the OECD, and finally concluding witha German perspective on the substance developments.

Substance in the BEPS action plan and its significance In line with OECD discussions, member states have been increasinglyfocusing on the issue of substance and the location of companies in so-called preferential tax jurisdictions. Tax authorities, often through the useof the EU Directive on Mutual Assistance as well as double tax treaties, willexchange information on the types of activities taking place in various juris-dictions with the intention of analysing whether an MNE’s supply chainvalue drivers are indeed located in the so-called preferential tax regimejurisdictions or not. Another method that is often applied by tax authori-ties is the application of local controlled foreign company rules (CFC)which allow local authorities to examine the MNEs in the context of sub-stance. Depending on the jurisdiction, tax authorities may choose to applyCFC rules when there is no economic substance, for instance when profithas not been allocated in accordance with supply chain value driversand/or if a subsidiary is located in a tax preferential jurisdiction as stipulat-ed by local tax law. In these cases the CFC rules would allow the local taxauthorities to apply local corporate tax rates to the income allocated to thesubsidiary lacking substance thereby making the subsidiary transparent forlocal tax purposes. The issue of substance has been specifically addressed inactions five through to 10 of the BEPS action plan. Action five the BEPS action plan stipulates that harmful tax practices

need to be countered through increasing tax authority cooperation, trans-parency and substance analysis. Instruments such as compulsory exchangeof court rulings between tax authorities and uniform requirements for sig-nificant substance in preferential tax jurisdictions should be applied to

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effectively minimise harmful tax practices. Furthermore, theBEPS action plan stipulates that rules which are already inplace often will not take into account the use of multiple lay-ers of legal entities such as branches that allow for the legal re-allocation of profits to tax preferential jurisdictions. Doubletax treaties should also be modified to ensure that treaty shop-ping situations leading to a double non-taxation are avoided.Treaty abuse is further expanded upon in action six, where

the development of model treaty provisions preventing thegranting of treaty benefits in false circumstances is carried out.This would ultimately lead to making sure that double taxtreaties are not used for double non-taxation. Essentially theoverall definition of a permanent establishment (PE) needs tobe modified in such a way whereby abuses would not takeplace. The example used by the OECD is the use of commis-sionaire structures, by MNEs, instead of local distributionentities to shift profits resulting from local sales out of thecountry in which the sales were made. The BEPS action planspecifically argues that these profit shifts take place without asignificant functional profile alteration of the activities previ-ously carried out by local distribution entities.The OECD examines the issues of artificial PE status

avoidance in Action 7. The BEPS action plan argues thatMNEs, often through the use of inappropriate transfer pricing

mechanisms (intangibles transfer and/or over capitaliaation oflow taxed subsidiaries), will tend to separate profit from thevalue generating economic activities and will then shift theseprofits to tax preferential jurisdictions. A potential resolutionto this problem, as suggested by the OECD, could be theapplication of formula based systems that would allocate prof-it in an exact way leaving no room for interpretation. Theongoing discussions pertaining to the new transfer pricingdocumentation approach including the country-by-countryreporting template could also open the door to further dis-cussions on applying a formulaic profit allocation system tointercompany transactions. Actions eight through to 10 of the BEPS action plan have

been grouped together as they pertain to transfer pricingprinciples and the appropriate allocation of profits by ensur-ing the accurate amount of economic substance in each legalentity participating in intercompany transactions. Clear defi-nitions of intangibles as well as hard-to-value intangibles andthe corresponding profit allocated to these items need to bealigned with the value drivers of an MNE’s supply chain.Furthermore a further analysis on risk and capital allocationshould be carried out, according to action nine, to ensure thatprofits are not allocated to entities simply because these enti-ties have contractually assumed risks for any given transaction.Action 10 further elaborates on ensuring that transactionsthat would rarely take place between third parties are thor-oughly examined, that profit splits should be analysed in thecontext of global value chains and that protection againstBEPS behaviour such as head office as well as managementfee charges is avoided.

Transparency under the BEPS action plan and transferpricing documentation developments Action 10 further elaborates on the issue of transparencywhich seems to go hand in hand with the theme of econom-ic substance. The OECD states that transparency is requiredat all levels to prevent BEPS. Furthermore, taxpayers shoulddisclose more targeted information including their tax plan-ning strategies. The OECD refers to several studies and datasources that have indicated there is a disconnect between thelocation where value creating activities are taking place andwhere the corresponding profits are actually taxed. As a resultof the aforementioned hypothesis the OECD began investi-gating possibilities that would allow for greater transparencyon the level of the transfer pricing documentation with a spe-cific country-by-country reporting template being developedto provide a better understanding of the value driving func-tions and their corresponding locations. Substance and transparency was further discussed by the

OECD in May of this year during the public consultationmeetings between representatives of the OECD, non-govern-mental organisations (NGOs) and business. In accordancewith the latest live webcast carried out by the OECD, the

Oliver WehnertPartner - ITS transfer pricing – EMEIA TPleader & head of practice GSAErnst & Young

Tel: +49 211 9352 10627Email: [email protected]/DE

Oliver Wehnert is an international tax partner in the Düsseldorfoffice of EY. He is EY's EMEIA transfer pricing leader and alsoheads EY's transfer pricing practice in Germany, Switzerland andAustria. He joined EY in 1998 after spending six years at PwC. Heis a certified tax consultant and completed his MBA at theUniversity of Paderborn in 1992.

Oliver Wehnert has vast experience in client services on trans-fer pricing design, international tax planning for intangible trans-fers, operating model effectiveness projects as well ascontroversy cases in scope of mutual agreement procedures andbi- and multi-lateral advance pricing agreement projects. OliverWehnert is focused on German based multinational enterprisesinteracting with their subsidiaries in particular in North America,Asia & Pacific as well as Europe. His biggest clients are multina-tional enterprises in the pharmaceutical, chemical, consumerproducts and automotive industry.

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organisation has gathered 183 comment papers and morethan 1,400 pages of comments from various organisations ontheir suggested approach for transfer pricing documentationas well as the corresponding country-by-country reportingtemplate. Furthermore, an agreement on a three-tierapproach using the country-by-country reporting template,master file and local file has been reached. The transfer pricing documentation developments includ-

ing the country-by-country reporting template can be seen asa direct result of the substance discussions first published inJuly of 2013. The OECD is taking the necessary steps toensure that the subsidiary substance of MNEs can be trackedin the context of their global activities. Although the OECDhas time until September 2014, MNEs should closely moni-tor the transfer pricing documentation and country-by-coun-try template developments because these will certainly havean impact on their compliance as well as tax planning policies.

German approach and concluding remarks The German Ministry of Finance (GMF) has been a strongsupporter of the BEPS action plan and has provided signifi-cant input during the plan’s preparation process. Germanyhas strongly supported, and also assisted with, the develop-ment of the BEPS action plan, from both a tax as well as a

political standpoint. The coalition agreement signed in 2013by the three largest German political parties – CDU, CSUand SPD – further outlined the political support for the BEPSaction plan both in terms of MNEs as well as banking sectortransparency. It is important to mention, however, thatGermany already has a significant amount of local tax regula-tions in place, which allows for a high degree of transparencyand substance determination. Article 4 of the German regulations regarding the docu-

mentation of profit allocations already requires some of theinformation described in the new OECD transfer pricing andcountry-by-country template approach such as, for example, alist of intangible goods that the taxpayer owns and uses(Article 4.2b). Other tax law allows the German tax authorityto request full tax and financial information from companiesheadquartered in Germany. Furthermore double tax treatyprovisions, as well as the EU Directive on Mutual Assistance,make it possible for tax authorities (TAs) in Germany torequest additional financial information from foreign TAs. Even though the German Tax Law already has in place sev-

eral mechanisms that allow for increased transparency andsubstance monitoring, for example through the local CFCrules, the OECD developments that have taken place in thelast year will most likely allow for the further expansion of thelocal tax regulations in an effort to more effectively monitorcross border transactions. Germany, as one of the world’s leading export nations, also

possesses several MNEs as well as small and mid-sized enter-prises, which may potentially be affected by the currentOECD developments. Over the past five years the percentageof tax to GDP revenue in Germany, according to OECD’sstatistical website, has remained relatively stable with fluctua-tions of roughly 1%. Furthermore, it is important to note thatthe tax revenue in Euros has, in fact, been steadily increasingsince 2009. Based on the OECD’s figures, despite remainingcompetitive on a global level, German companies do not seemto be engaged in overly aggressive tax planning with much ofthe taxable profit remaining in Germany as may be suggestedby a historically high tax to GDP revenue percentage in 2012. In spite of the aforementioned statistical results, current

OECD developments may have an impact on all corporateGerman taxpayers if the new transfer pricing documentationand country-by-country reporting template would be adopt-ed in to local law. It is important to note that under the cur-rent BEPS approach many corporate taxpayers may have toinvest further time into re-analysing their international taxpolicies as well as future tax planning projects to ensure theyare BEPS compliant. The BEPS action plan has laid out a setof deadlines for the substance developments to take place inthe near future. For this reason it is particularly importantthat MNEs, not only in Germany, follow the developmentspertaining to substance as well as transparency set to takeplace between September 2014 and December 2015.

Ivo TankovManager - ITS transfer pricingErnst & Young

Tel: +49 211 9352 [email protected]/DE

Ivo Tankov is a transfer pricing manager within EY’s EMEIA andGSA transfer pricing team. Ivo has been specialising in largescale projects including APAs, business restructurings and globaltransfer pricing documentation for both German DAX 30 and USFortune 100 multinationals. Before joining the EY team inGermany, Ivo had also worked in the Big 4 consulting sector inPoland participating in projects for some of the largest Polishcompanies on the Warsaw Stock Exchange. Fluent in four lan-guages he holds degrees from Boston University andNortheastern University and has also participated in governmentand business programmes at Tufts University, Harvard Universityand the University of Chicago Booth School of Business. Co-author of various articles on transfer pricing for several maga-zines, Ivo also works in the area of corporate operating modeleffectiveness.

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Brazilian transfer pricing rules

Thiago Medaglia ofFelsberg Advogadosdiscusses the uniquefeatures of the Braziliantransfer pricinglegislation and providesan update of newmeasures.

B razilian transfer pricing rules determine the maximum deductibleprice on imports and the minimum taxable price on exports forincome tax purposes, which are imposed in Brazil at a combined rate

of 34%. If the actual price of a given import is considered not to satisfytransfer pricing rules, a portion of it is considered non-deductible and apositive primary adjustment is made for income tax purposes. In turn, aminimum taxable revenue should be booked if the actual price of a givenexport does not satisfy the transfer pricing rules. Nonetheless, it is important to bear in mind that the Brazilian trans-

fer pricing system is absolutely unique, differing enormously from therules found in the majority of the developed countries and even fromthe OECD guidelines. In this sense, Brazilian transfer pricing rules areusually better understood if their differences are explained from thestart. Accordingly, this introductory topic aims at presenting some ofthe unique features of the Brazilian rules before addressing them inmore detail.The biggest difference between the Brazilian rules and the reality

worldwide is found in the fact that Brazil does not adopt the arm’s-lengthstandard (ALS) to calculate transfer prices. Brazil adopts a formularyapportionment system of transfer pricing, meaning that a given company’sworldwide net income before taxes is calculated and apportioned betweendifferent countries based on pre-established arithmetic formulas. It isworth pointing out that several Brazilian scholars and some internationalprofessors affirm that the formulary apportionment system does representa form of achieving the arm’s-length price. Another important difference is that Brazil does not adopt what is inter-

nationally known as the best method rule. In the majority of jurisdictions,taxpayers should adopt the methodology that provides the most reliablemeasure of an arm’s-length result. In Brazil, taxpayers are entitled to freelychoose any of the existing methods. Certain scholars even defend that,should a tax inspection on transfer pricing be initiated, tax authorities arerequired to choose the methodology that offers the best result for the tax-payer (the less burdensome methodology).In Brazil, transfer pricing rules only apply to international transactions.

Local transactions are subject to an even less sophisticated system knownas the improper allocation of profits (distribuição disfarçada de lucros),which has the same underlying rationale.Transactions entered into with companies located in low tax jurisdic-

tions are immediately subject to transfer pricing rules regardless of the

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existence of any corporate or business relationship connect-ing the parties. The low tax jurisdictions are blacklisted byNormative Instruction No. 1,037/2010. Rumour has it thata new blacklist will be released in the near future.Another unique feature of the Brazilian transfer pricing

system is that royalties paid in consideration for the licensingof intangibles are not subject to transfer pricing rules(although certain restrictions for deducting expenses withroyalties are found in ordinary legislation).It is also worth mentioning that the statutory language of

Law No. 9,430 only establishes that transfer pricing rulesshould apply for imports and exports. However, Brazil beinga civil law country, where the law expressly defines the mean-ing of imports and exports, certain transactions may not fallwithin such concepts (contracts, certain intangibles, corporatereorganisations, etcetera). This creates practical problemsabout whether certain transactions should, or should not, besubject to transfer pricing control. A recent change in the leg-islation was made whereby it was expressly defined that back-to-back transactions are also subject to transfer pricingcontrol.Another consequence of using the formulary apportion-

ment system refers to advance pricing agreements (APA).Although Brazilian companies are entitled to enter into anAPA with the IRS, practically speaking such instrument onlymakes sense if a company does not comply with any of themethodologies set forth in the legislation. In turn, theBrazilian IRS tends to be extremely conservative whenapproving anything that could lead to a reduction of the taxesto be paid by companies. Consequently, APAs are rarely usedin Brazil.Finally, Brazilian legislation only provides for primary

transfer pricing adjustments. On the other hand, Brazilian

transfer pricing rules provide for neither correlative nor con-firming adjustments (which may lead to double taxation). With the main differences of the Brazilian system having

been outlined, there follows below a summary of the Braziliantransfer pricing rules. Before addressing the methodologies inmore detail, it is worth keeping in mind that Brazilian trans-fer pricing rules are relatively new when compared with thoseof other countries. Several situations therefore still remainunclear. Additionally, case law has still not yet been consoli-dated and the existing precedents mainly refer to imports.This is one of the reasons the recent changes in the transferpricing legislation mainly refer to imports rather than exports.It is also worth pointing out that transfer pricing primary

adjustments should be informed to the IRS by means of theincome tax return named a “DIPJ”, which is usually submit-ted once a year (May or June). As part of this tax return, com-panies should also state the transfer pricing method they haveadopted regardless of the existence of any primary adjust-ment.

Transfer pricing methods – imports:As previously mentioned, imports from related parties and/orfrom entities located in tax havens are subject to transfer pric-ing control. If the actual price of a given import is considerednot to satisfy transfer pricing rules, a portion of it is consid-ered non-deductible and a positive adjustment is made forincome tax purposes. Given that Brazil adopts the formulary apportionment sys-

tem to calculate transfer prices, the following methods areavailable for calculating transfer prices on imports of goods,services and transfers of rights: (i) comparable uncontrolledprice method; (ii) resale price method; and (iii) cost plusmethod. More recently, a fourth method was created toaddress the import of commodities: the commodity exchangeimport price.

Comparable uncontrolled price (CUP) methodAn arm’s-length price under the CUP method is the averageprice of the same or similar goods, services or rights under thesame contractual conditions in Brazil or abroad in the samefiscal year. The Brazilian IRS provides that comparabilityadjustments should be made whenever necessary to minimisethe differences between the prices to be confronted (forexample, payment terms, negotiated quantities, liability forfreight and insurance). If it is impossible to identify compara-bles in the same period, the Brazilian IRS allows the use ofcomparables identified in the previous year, to the extent thatcurrency exchange adjustments be made.It is worth mentioning that multinationals generally do

not adopt this method since the universe of comparables tobe analysed is still not clear. In addition, the Brazilian IRShas access to information concerning all imports andexports of goods in and out of Brazil; multinationals do

Thiago MedagliaFelsberg Advogados

Tel: +55 (11) 3141 3660 Fax: +55 (11) 3141 [email protected]

Thiago Medaglia heads the tax practice of Felsberg Advogados,one of the most prestigious Brazilian law firms. He holds a LL.M.degree in domestic taxation from the Catholic University of SãoPaulo. He also holds another LL.M. degree in international taxa-tion from Georgetown University Law Center, where he was des-ignated graduate tax scholar and awarded with a full tuitionscholarship.

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not, meaning the position of the tax authorities in a disputewould be stronger.

Resale price (PRL) method Historically speaking, the resale price method (locally knownas PRL) has always been the methodology most frequentlyused by Brazilian taxpayers. Under PRL, an arm’s-lengthprice represents the average price of goods, services or rightssold/resold minus unconditional discounts, turnover taxes,commissions, and a presumed profit margin over thesale/resale price (less unconditional discounts) in the samefiscal year. Such presumed profit margin may vary from 20%up to 40% depending on the activity conducted by the com-pany, as listed in Table 1. The price of goods resold is the effective price (wholesale

or retail) used by the company with independent customers.In the transfer pricing regulations, the Brazilian IRS clarifiesthat this method is destined for both sale and resale of goods,services or rights, with or without addition of any value by theBrazilian company. A recent change in the transfer pricing legislation modified

how the PRL is calculated. Such change aimed at adapting thePRL to those transactions in which the imported productwould not be resold, but rather be subject to a manufacturingprocess. According to the new legislation, although the calcu-lation would still be based on the liquid sales’ price, the ratiobetween products, services or rights purchased from a foreignrelated party and the final cost of the product, service or rightsold to third parties, should also be taken into account.

Cost plus methodThe cost plus method provides that an arm’s-length price isthe average cost incurred abroad in a fiscal year to produce

goods, services and rights, with the addition of taxes imposedby the other state on exports, plus a 20% margin appliedexclusively on the cost. To apply this method, the Brazilian company may use

information provided by the related party that incurred costsabroad. Additionally, the Brazilian company may obtain infor-mation from third parties located in the same country of therelated company that bore the cost.

Commodity exchange import price (PCI)Under PCI, transfer prices are defined based on the averagecommodity exchange price for the concerned item on thedate of the transaction. Positive and negative adjustments canbe implemented based on the premium paid in respect tosuch item. For those products not negotiated in commodityexchanges, Brazilian legislation authorises the use of pricesobtained from reputable institutions.

Transfer pricing methods – exportsThe methods established by Brazilian legislation to calculatetransfer prices on the export of goods, services or rightsbetween related parties are: (i) export sales price method; (ii)wholesale price in country of destination less profit method;(iii) retail price in country of destination less profit method;and (iv) acquisition or production cost plus taxes and profitmethod. The only recent change in respect to exports refersto the creation of a fifth method, which is destined to calcu-late transfer prices connected with the export of commodities:commodity exchange export price.It is worth mentioning that companies falling within the

safe harbour set forth in the applicable legislation are notrequired to prepare a study to demonstrate the legality oftheir transfer prices. If a given company has registered more

Table 1

Gross profit margin Sector/activity

40% Pharmachemical and pharmaceutical products

Tobacco-related products

Optics, photography and cinematographic equipment and instruments

Medical and dentistry-related machinery/equipment

Extraction of oil and natural gas

30% Chemical products

Glass and glass-related products

Cellulose, paper and paper products

Metallurgy

20% All other sectors

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than 10% of the export revenue in the transactions withrelated parties as profit, it is entitled to demonstrate the cor-rectness of its transfer pricing control based solely on thetransaction’s documentation (this percentage used to be5%). However, please note that such safe harbour onlyapplies if the net export revenue derived from transactionswith related parties represents up to 20% of the total netexport revenues.

Export sales price method (PVEx) Under PVEx, transfer prices correspond to the average of theexport sales price charged by the company to other customersor other national exporters of identical or similar goods, serv-ices or rights during the same tax year using similar paymentterms.

Wholesale price in country of destination less profit method(PVA) This is defined as the average wholesale price of identical orsimilar goods, services or rights in the country of destinationunder similar payment terms, reduced by the taxes included inthe price imposed by that country and a profit margin of 15%of the wholesale price.

Retail price in country of destination less profit method (PVV) This is defined as the average retail price of identical or simi-lar goods, services or rights in the country of destinationunder similar payment terms, reduced by the taxes included inthe price imposed by that country and a profit margin of 30%of the resale price.

Acquisition or production cost plus taxes and profit method(CAP)This is defined as the average cost of acquisition or produc-tion of exported goods, services, increased by taxes and dutiesimposed by Brazil, plus a profit margin of 15% includingexchange gain variation, calculated based on the sum of thecost and taxes.

Commodity exchange export price (PECEX)Similar to PCI, transfer prices under PECEX are definedbased on the average commodity exchange price for the con-cerned item on the date of the transaction. Positive and neg-ative adjustments can be implemented based on the premiumpaid with respect to such item. For those products not nego-tiated in commodity exchanges, Brazilian legislation authoris-es the use of prices obtained from reputable institutions.

Transfer pricing on intercompany loansFor many years, interest practiced in cross-border loansbetween related companies was only subject to transfer pricingrules when such loans were not registered with the CentralBank of Brazil. For these cases, interest should not exceed theLibor rate for six-month US dollar deposits plus a spread of3%, otherwise the excess was not deductible by the Brazilianborrower. On the other hand, the same amount should beaccounted as taxable income by the Brazilian lender. As of January 2013, all intercompany loans are subject to

transfer pricing control, including the loans signed beforesuch date. The definition of a maximum interest expense forBrazilian borrowers or a minimal interest income for Brazilianborrowers is now defined based on the following rules:• Transactions in US Dollars (USD) at a fixed rate: the trans-fer pricing rate shall correspond to the market rate of thoseBrazilian sovereign bonds indexed in USD issued by thegovernment on the external market;

• Transactions in Brazilian Reais (BRL) at a fixed rate: thetransfer pricing rate shall correspond to the market rate ofthose Brazilian sovereign bonds indexed in BRL issued bythe government on the external market; and

• Other cases: the transfer pricing rate shall correspond tothe LIBOR for six-month deposits.On top of such rate, a spread rate will be added to determine

the interest rate for transfer pricing purposes. The Treasury willdefine such spread rate periodically. In 2013, the IRS defined aspread rate of 3.5% for regular transactions and 2.5% for trans-actions entered into with residents in low tax jurisdictions.

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Transfer pricing rules and theChilean tax reform

Lorenzo Gálmez Mand Roberto CarlosRivas of PwC providean update on theChilean tax reform andits impact on transferpricing.

O n April 1 2014, a new and extensive Tax Reform Bill was presentedto the Chilean Parliament by the Executive. The tax reform shouldbe expected, in accordance with the message of the Government, to

introduce profound and structural changes to the Chilean tax system toincrease the actual tax burden and to be able to finance relevant modifica-tions to the education system.

Furthermore, in accordance with the Executive, the tax reform will tryto correct the existing tax disparity situation by generating a higher redis-tribution of the income, together with the concern of making sure thattaxes are paid as they are due in accordance with the law, diminishing taxavoidance and tax elusion possibilities.

The Tax Reform has been presented as a gradual modification of theTax System with full effects from year 2017 onwards, but its first changeswill come into force within taxable year 2015. The Tax Reform is current-ly under the analysis and discussion of the Senate so some changes may stillbe expected.

The tax reform considers, among other matters, an increase of tax ratesand tax bases, the elimination of certain tax benefits and tax incentives, theempowerment of the Chilean tax authority, and the elimination of the tax-able earnings ledger (FUT). This last point, the elimination of the FUT, isconsidered by the Executive, as being the core of the tax reform and com-prehends a significant alteration of the Chilean tax system where final tax-payers will be taxed over income on an attributed basis, whilst today a typeof legal tax deferral is available.

Together with the above, the tax reform considers the inclusion of a sortof substance-over-form regulation and new general and significant anti-elusion rules into the Chilean Income Tax Law (ITL).

Article 41E of the Chilean ITL contains Chilean local transfer pricing(TP) rules applicable for Chilean taxpayers. These rules have been in forcesince September 27 2012 and in general resemble TP rules from theOECD guidelines. Article 41E will not face any structural changes with thetax reform, but it will become a key element of interpretation and a toolfor fiscal control of the Tax Authority. The awareness, understanding andapplication of TP rules and economic substance will become essential inthe Chilean tax arena in general.

Transfer pricing rules and the Chilean tax reformThe tax reform considers the inclusion of a sort of general substance-over-form regulation and new significant anti-elusion rules into the Chilean

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ITL. These rules, among other effects, will incentivise the useof legal structures only for cases where a relevant economicingredient and its effects can be demonstrated.

The local tax authority will be empowered to interpret andassess the legal form of operations according to the businessbeing carried out, notwithstanding the labels or legal formsthat the parties have disclosed.

Furthermore, where a deferral of taxes is obtained by theuse of specific legal structures or business reorganisations,which have no other economic reason than to obtain such taxdeferral, the operation could be seen as abusive and thereforebe subject to strong penalties.

Thus, all of the above will imply that every and any type ofoperation, transaction, tax or business planning, businessrestructure or other corporate modification, will have to bringan explicit, or implicit but yet identifiable and demonstrable,business purpose and be performed under a credible econom-ic rationale, with strict compliance to the general arm’s-lengthprinciple.

Moreover, as it has been recognised among the experts,the only, or at least the most evident, way to sustain, prove,and justify the aforesaid conditions will have to be based on

general TP methods in accordance to local regulation and theOECD guidelines, for which proper guidance and expertadvice will become even more crucial.

Besides the above, article 41E is either referenced directlyor linked indirectly by the tax reform a number of times. TPrules are considered in general to indicate when, how or whytwo or more parties should be considered as related partiesfor purposes of the new law (since they comprehend moreand broader situations than other relationship rules within theITL), or to show how a certain transaction or situation maybe analysed by the tax authority to see if it complies with thearm’s-length principle (becoming the basic legal tool for fis-cal assessment).

However, the most recurrent, although indirect, referenceto TP rules and its methods comes with the new proceduresthat regulate how the tax authority will be empowered toassess the allocation of profits arrangement that the taxpayersuse to comply with the new core of the local ITL.

As anticipated above, the so called final taxes, (taxation atthe level of local individuals or foreign taxpayers) could bedeferred up until their income was effectively paid andreceived by them. With the elimination of the FUT, final

Lorenzo Gálmez MTax & Legal - managerPwC

Tel: +56 2 2940 [email protected]/cl

Lorenzo has a tax management LLM Degree from UniversidadAdolfo Ibañez. He is a Lawyer (JD.) from Pontificia UniversidadCatólica de Chile. During his university programme he participat-ed on several specialisation courses at the University ofCalifornia-Berkeley, USA, and at the University of Sussex, England.He joined PWC on December 2008 and is currently a manager

of the tax and legal department, where he is involved in severaltax and legal projects focusing on multinational corporations andforeign investors. Lorenzo is also part of the transfer pricing teamof the firm. He also advises local clients directly in new businessorganisation, incorporation of companies, and drafting of legaldocuments and agreements. Before joining PwC, Lorenzo was responsible for transactions

in Gestión Externa S.A. (COO) where he was in charge of internalaudit and implementation of the International Certification ISO9001:2000, being certified as internal auditor.He also worked as a specialised lawyer providing advice in

the corporate department of the legal firm Claro y Compañía.

Roberto Carlos RivasTax partnerPwC

Tel: +56 2 2940 [email protected]/cl

Roberto Rivas is a partner in the tax and legal services depart-ment of PwC, Chile.During 2001 and 2002 he obtained a master in law degree in

international taxation at Leiden University, Netherlands.During years 2002 and 2003 he was attached on a second-

ment to the international taxation department of PwC, Rotterdam,Netherlands, taking active part in international tax planning proj-ects concerning investments between Europe and Latin America.He joined PwC in April 1993 and he has also been assigned

to PwC Buenos Aires until May 2004. He is a transfer pricingexpert.Roberto Carlos Rivas is member of the International Fiscal

Association in Chile and he has written many articles on interna-tional tax matters. He has been lecturer in international tax semi-nars taking place in Rotterdam, Amsterdam, Barcelona, BuenosAires, Punta del Este and Santiago.

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taxpayers will be taxed over income on an accrued basis,meaning that local entities will have to perform a sort ofupstream theoretical allocation of their profits among theirowners or shareholders until they have been completelyattributed to the final taxpayers, be them local individuals orforeign entities or individuals. This so called attribution ofincome shall be performed as agreed by the parties (share-holders or partners of a Chilean legal entity) under certaincircumstances or in accordance to the interest they holdover the paid capital of the entity. However – and notwith-standing the method of attribution performed by the tax-payers – the tax authority will be empowered to assess suchattribution/allocation in accordance to the TP methodsstated in article 41E to remunerate the stockholders inaccordance to their functions and activities in relation to theentity that is designating its profits.

Additionally, the Tax Reform Bill, considers two relevantdirect changes to the local TP rules:

Exit charge/taxThe tax reform modifies Article 41E of the Chilean ITL clar-ify that the local tax authority is empowered to assess anytype of corporate or business restructuring process that isfound to be removing or shifting from Chile to foreign coun-tries any sort of tangible or intangible asset, or otherwisetransferring an activity that could potentially have generatedtaxable income in Chile.

This assessment would be allowed when the tax authorityis able to determine that the restructuring, with its embeddedremoval of assets or transfer of rights and the correspondinglegal agreements or activities being performed for that reason,would have considered an arm’s-length price, value or other-wise profitability, if it had been agreed upon non-related par-ties or when the price, value or profitability agreed, as aconsequence of the restructuring, does not comply with saidarm’s-length principle.

Until now, according to the wording of the local ITL,business reorganisations would have been susceptible of taxassessment for an exit charge, if the transfer/shifting of assetsand/or activities are moved to a tax heaven country.

Note that the Chilean IRS has pronounced an administra-tive interpretation of the current rule stating that it needs notto be a tax heaven, but the fact that the new law bill is includ-ing this express change would corroborate our restrictive legalinterpretation of the current rule.

Penalty tax rate increased The Tax Reform Bill modifies Article 21 of the Chilean ITL,which in turn will bring an increase from 35% to 40% rate for thepenalty tax applicable in cases where the tax authority has deter-mined a transfer pricing adjustment in accordance with the law.

Note that this rate could be raised to 45% in certain assess-ment cases if the taxpayer does not cooperate in due time andform with the fiscal investigation.

F R A N C E


Overview of the French TPregulation and documentationrequirementsPhilippe Drouillot andMatthieu Philippe, ofLexCase Sociétéd’Avocats, provide anupdate on the FrenchTP environment.

W ithin French legislation for the repression of international tax eva-sion, article 57 of the French Tax Code (hereafter, FTC), allowsthe tax authorities to contest the prices and conditions practiced

by companies belonging to a single group, and established in differentcountries. The notion of group should be understood in the economic sense as:

“companies which are under the dependence or which control companieslocated outside of France”, as well as those “which are under the depend-ence of a company or a group which also controls companies outside ofFrance”. The tax authorities should demonstrate the dependencies (in deed or in

law), unless the transfer is undertaken with companies established in a “lowtax” country or region, as defined under article 238 A of FTC, namely ifthese companies “are subject to corporation tax or income tax of which thetotal is lower than one half of the corporation tax or income tax for whichthey would have been liable under legislation in France, if they were tax-able there”.Quite naturally, in the event of a tax audit, the burden of proof in

demonstrating the abnormality of transfer prices falls on the French taxauthorities. However, in practice, the transfer pricing documentationrequirements introduced in France by the amended 2009 Finance Bill leadto reverse the burden of proof. These requirements have been codified under articles L. 13 AA and L.

13 AB of the French Tax Procedure Code (hereafter FTPC). Then, on January 4 2011, the French tax authorities issued guidelines

on transfer prices documentation (BOI-BIC-BASE-80-10-20), and,more recently, the law against fraud and tax evasion enacted in December2013 introduces new rules and obligations under article 223d B of theFTC.In practice, this set of rules provides that, for certain companies:

• a full transfer pricing documentation justifying the transfer price policymust be presented “at first demand” in case of a tax audit; and

• a basic transfer pricing documentation must be filed annually, within sixmonths, following the deadline for filing the annual income tax return.

Companies subject to the transfer pricing documentationrequirements The documentation requirements are applicable to all companies with annu-al pre-tax turnover or gross assets exceeding €400 million ($540 million),

F R A N C E


as well as all companies that are members of a tax consolidat-ed group, insofar as one of the members is individually sub-ject to this obligation. Moreover, such obligation additionally concerns French

subsidiaries of which the foreign parent companies – hold-ing, whether directly or indirectly, over 50% of their capitalor voting rights – exceeds this threshold abroad, as well asFrench companies having subsidiaries abroad exceeding thisthreshold (also held by over 50% of financial rights or vot-ing rights). As this threshold does not take into account the materi-

ality of the intercompany transactions, the definition of thescope of these obligations is a tricky issue; notably when theshareholder is an investment company, whose gross assetvalue exceeds this threshold of €400 million because of thediversity of its investments, whilst the French company is anSME. The fact that this investment company simply holdsshares could lead the tax authorities to consider that theSME should be subject to the documentation requirements. Finally, it must also be noted that in a situation where the

companies do not fall into the scope of article L. 13 AA and223d B of the FTC, they will be subject to article L. 13 B ofFTPC, which – whilst being a little more flexible than articleL. 13 AA in terms of deadlines for response (the companymust respond to the tax authorities within two to threemonths) – also lays down the obligation for the company, inpractice, to prepare all information to justify the transfer pricepolicy before any tax audit. In other words, in all instances, itis necessary to prepare a documentation, which will justify thetransfer prices applied within the group.

Transactions concernedIn practice, the scope of the transactions concerned isextremely large, since all intra-group transactions involvingthe French company should be documented, insofar as thesetransactions are concluded with foreign entities, for instance,recurring transactions, but also exceptional transactions suchas transfers of fixed assets, or business restructuring.

The full transfer pricing documentation (Article L. 13 AAof FTPC)Documentation requirementsThe documentation should include two sections:

1) General information on the group of associated companies,including:• a general description of all business activities, includingchanges occurred during each audited tax year;

• a general description of the legal and operational structuresof the group of associated companies, including the iden-tification of the associated companies of the groupinvolved in audited transactions;

• a general description of the functions undertaken and risksassumed by each associated companies insofar as theseaffect the audited company;

• a list of the main intangible assets held, notably patents,brands, trading names and know-how, in relation to theaudited company; and

• a general description of the transfer price policy of thegroup;

2) Specific information concerning the audited company:• a description of activities, including changes whichoccurred during each audited tax year;

• a description of transactions undertaken with related enti-ties, including the nature and total of flows, including fees;

• a list of agreements concerning the distribution of costs aswell as a copy of the prior agreements in terms of transferprices and rulings pertaining to transfer price calculation,affecting the results of the audited company;

• a presentation of the method(s) used to determine thetransfer pricing policy in respect of the arm’s-length prin-ciple, including an analysis of the functions undertaken,assets used and risks assumed as well as an explanation ofthe selection and application of the methods used; and

• where the method selected requires this, an analysis ofcomparative elements considered as pertinent by thecompany.

Additionally, the new rules introduced by the French tax billfor 2014 provide that, as from January 1 2014, the Frenchtaxpayer must also include in its documentation the tax rul-ings granted by foreign tax authorities to any associatedcompany.

Philippe DrouillotLexCase

Tel: +33 1 40 20 22 [email protected]

Partner of LexCase since 2009, Philippe Drouillot studied a taxlaw postgraduate degree at the University of Bourgogne. Hestarted his law career in 1997 at Arthur Andersen, then he joinedEY, followed Soulier Avocats. Philippe has consequently devel-oped, in the course of his professional experiences, a specificexpertise in tax assistance to French and foreign corporategroups, especially in transfer pricing matters. Moreover, Philippeis an associated lecturer on national and international taxation inbusiness schools and universities and he is member of theInternational Fiscal Association (IFA).

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If the French Constitutional Council (ConseilConstitutionnel) has confirmed the actual constitutionalityof this new obligation, it has also indicated that the commu-nication does not concern tax rulings that are not “in thepossession” of the French taxpayers. As of today, the way theFrench tax authorities will apply these new rules still remainsunclear.Finally, it should also be noted that the administrative

guidelines indicate that the French tax authorities are enti-tled to ask for a French translation of any document.

Transfer prices justificationIn principle, only the analysis of the comparative elementswith transactions between independent companies (arm’s-length price) can justify a transfer price without any possi-ble contestation. Consequently, concerning certain common services such

as management fees, and whilst the group would considerpracticing a reasonable margin (for instance, mark-up of 5%applied to costs), it is however necessary to perform this com-parative analysis. In practice, the compared transactions veryrarely concern identical transactions and companies shouldmake their best efforts to seek the most pertinent compar-isons possible (certain services such as management fees are inprinciple intra-group services which are not found with inde-pendent third parties). Moreover, the French administrative guidelines provide

that the documentation should be based on contemporaryelements, namely data available when companies set theirtransfer price. This requirement is particularly problematic,as the comparative data are only, by their very nature, avail-able subsequent to the end of the tax year considered.However, in practice, the French tax authorities are quitepragmatic on this issue, and do accept to take into accountthe data provided (even though they are not exactly con-temporary), if the taxpayer can demonstrate that they areactually relevant.

TimingThis documentation must be presented “at first demand” incase of a tax audit. French taxpayers must then anticipate sucha request, and draft their documentation in a timely manner,as soon as proper information is available.

PenaltiesA penalty of €10,000 per financial year is handed down inthe event of insufficient or incomplete documentation(then, as the standard French tax audit period is three years,the theoretical risk is €30,000). Legal texts also make pro-vision for a fine of 5% of transferred profits, but fortunate-ly this fine will only be applied in the most serious matters,namely if there is no documentation or if the documenta-tion “is entirely irrelevant”.

The light transfer pricing documentation (Article 223d Bof the FTC)The Law against fraud and tax evasion enacted inDecember 2013 introduces an additional transfer pricingdocumentation requirement under Article 223d B of theFTC, applicable to all French taxpayers already subject tothe full documentation requirements (Article L 13 AA ofFTPC): as from December 2013, the taxpayers must nowspontaneously file to the tax authorities, each fiscal year, aspecific documentation. It must be stressed that the filingof the light transfer pricing documentation does not replacethe existing full documentation requirements, which stillapplies in case of tax audit.

Documentation requirementsIn practice, the light transfer pricing documentation consistsof some extracts of the full documentation, as it mustinclude:

1) General information on the group of associated companies:• a general description of all business activities, includingchanges that occurred during the last fiscal year;

• a list of the main intangible assets held, notably patents,brands, trading names and expertise, in relation with theFrench company; and

• a general description of the transfer price policy of thegroup, including changes that occurred during the last fis-cal year.

2) Specific information concerning the French company:• a description of all business activities, including changesthat occurred during the last fiscal year;

Matthieu PhilippeLexCase

Tel: +33 1 40 20 22 [email protected]

Matthieu Philippe joined the tax department of LexCase in 2010.Matthieu succeeded his post-graduation degree – Company andBusiness Law – DJCE – at the University of Nancy II, and hasbeen a member of the Bar since 2009. He started his career in2009 at EY (Paris office). His areas of practice vary from counselto litigation for corporate taxation and individuals, both in anational or international context. Matthieu is also an associatedlecturer on corporate tax law in the University of Lyon.

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• a summary of the transactions undertaken with relatedcompanies, presented by transaction type and by amount,when the total amount per transaction exceeds €100,000;and

• a presentation of the method(s) used to determine thetransfer pricing policy in respect of the arm’s-length prin-ciple, indicating the main method used, and includingchanges that occurred during the last fiscal year.It should also be noted that, because of all filings to the

French tax authorities, this light documentation should, inprinciple, be provided in French, except for specific agree-ments from tax authorities for a foreign language version(English in practice).

TimingThe light transfer pricing documentation must be filed to thetax authorities within six months following the deadline forfiling their annual income tax return.Because French taxpayers have a three-month period fol-

lowing the closing date of their account to submit their annu-al tax return (four-month period when the closing date isDecember 31), the light documentation should then be filedwithin nine months following the closing date of the accounts(or 10 months after, when the closing date is December 31therefore at the very beginning of November).

PenaltiesNo specific penalty has been introduced in the FTC for abreach of these provisions and then, only the standard penal-ty of €150 should apply.However, these new rules will certainly be used by the tax

authorities to enhance their tax audit selection process, toidentify potential transfer pricing issues, but also for taxpayersunable to document them properly. Therefore, the impor-tance of this new transfer pricing documentation requirementmust be appreciated irrespective of the insignificant amountof the penalty.

Advance pricing agreementsIn France, as in the vast majority of the OECD states, Frenchand foreign companies can request that the tax authoritiesissue a prior agreement on the calculation method of transferprices to be applicable during future transactions within thegroup (Article L. 80. B 7° of FTPC).In practice, this procedure has rarely been used by French

groups, because they often fear that a concrete agreementcould be detrimental to them, given the constant changes intheir organisation and processes. Finally, given the documen-tary obligations that now apply, one may prefer to have a well-prepared tax audit, rather than an agreement with uncertaineffects.

G E R M A N Y


German insights onprice-setting versus outcometesting approachSusann van der Ham &Karin Ruëtz of PwCdiscuss the fundamentalquestion of timing insetting transfer pricing,including recent OECDand EU JTPFpublications on thistopic, and criticallyexamine German taxauthorities’ view oncompensatingadjustments.

Arm’s length price setting versus outcome testing approachTwo distinctive approaches are known when it comes to price setting. Thetopic discussed here relates to the underlying fundamental question ofwhich information should be used to establish and document arm’s-lengthtransfer prices: Should information be used for determining and docu-menting transfer prices that is available at the time when the intercompa-ny transaction takes place (ex-ante or price setting approach)? Or shouldthe actual outcome of the transaction between related parties be used whendemonstrating whether the conditions actually comply with the arm’s-length principle (ex-post or outcome testing approach)?The main difference between these two methods is the latter may lead

to compensating adjustments before closing of the books or alternativelybefore the tax return is filed, in case the actual outcome of the transfer pric-ing is outside the arm’s-length range of results. Whereas, the first approachmight render the initial transfer pricing to be binding without the possibil-ity of any retroactive adjustments.

Fiscal year

Ex-ante: Price Setting ApproachForward-looking adjustments

Ex-post: Outcome Testing ApproachRetroactive adjustments

• Information available at the time when the intercompany transaction takes place

• Regular monitoring process between budget and actual figures required

• No retroactive adjustments• Documentation of the price setting process itself

• Information available at the time before closing of the books or before the tax return is filed

• Retroactive adjustments in order to achieve an arm’s length outcome

• Documentation often based on database studies

G E R M A N Y


The different methods can result in significantly deviatingoutcomes mainly relating to three areas when it comes toproving the arm’s-length nature of transfer pricing. Firstly, which financial data of the transaction partner(s)

should be used in determining and testing transfer pricing? Incase of the first approach, budget figures based on informa-tion of the economic and market conditions including finan-cial projections at the time of the transaction need to beapplied, whereas under the latter, actual figures on revenuesand cost structures are already available. This may lead to sig-nificant deviations.Secondly, which financial information on uncontrolled

comparable transactions is available? As a practical constraintregarding availability and collection of comparable data, suffi-cient information from external databases, such as Bureau vanDijk’s databases, is generally only obtainable with a certaintime lag. Thus, comparable data used for calculating compen-sating adjustments under the outcome testing approach islikely to be more recent. In addition, the outcome testingapproach may be based on information on economic andmarket changes that occurred after the time the transactionwas undertaken.Thirdly, under the price setting approach transfer pricing

documentation may look significantly different compared tothe outcome testing approach. Under the first approach, thetaxpayer is obliged to prove that all information concerningeconomic and market conditions (including financial projec-tions reasonably available at the time of the transaction) isutilised in the price setting process and documented accord-ingly. Whereas, under the latter approach a simple comparisonof the actual results of the tested party to the results of com-parable transactions may be sufficient.Due to the differences in those three areas, related party

transactions between countries where tax authorities applydifferent approaches may lead to disputes and potential dou-ble taxation for the taxpayer. So far, both OECD and EU JTPF accept both methods.

However they provide only limited guidance under which cir-cumstances one of the approaches may be preferred. In thelast few months, this rather fundamental question has becomea hot topic in the transfer pricing arena due to recent publica-tions of the OECD and the EU JTPF, which will be outlinedbelow.

OECD regulations and reform initiativeBased on para. 3.67ff. of the 2010 OECD guidelines, bothmethods are allowed. Furthermore, the OECD emphasisesthat both approaches, as well as combinations of these, arefollowed by OECD member countries and that these mayresult in different outcomes and potential disputes with taxauthorities. However, apart from the description, no furtherguidance is provided about which method should be takenunder specific circumstances.

To manage the discrepancy of the conflicting views and inresponse to the need for more advice to taxpayers, WorkingParty No 6 started a reform initiative in 2012. This initiativeaimed at revising paragraphs 3.67 to 3.71 of the OECD guide-lines (2010) and providing more practical guidance regardingthe application of the two methods. The OECD published adiscussion draft that made an effort to clarify the methods andasked the business community for comments. Unfortunately,the project was abandoned in spring 2013 due to the extreme-ly conflicting views within Working Party No 6.

EU Joint Transfer Pricing Forum’s report oncompensating adjustmentsThe EU JTPF analysed the views of its member states’ taxauthorities with respect to the timing issue, which resulted inthe recently issued report on Compensating Adjustments(January 2014). Similar to the approach taken by the OECD,the report does not yield at bridging the gap between the dif-ferent views or defines one approach to be the preferred oneunder certain circumstances. The report, rather, gives practi-cal guidance in case tax authorities follow different approach-es to reduce disputes.

Susann van der HamTransfer pricing partnerPwC

Tel: +49 211 981 [email protected]

Susan van der Ham is a transfer pricing partner at PwCDüsseldorf.Susann has more than 10 years of experience in consulting

multinationals in the field of transfer pricing. Her expertiseencompasses transfer pricing structuring, value chains transfor-mation, system implementation, documentation and tax auditdefence. She advises large international clients (both Germanand foreign headquartered) and has led a variety of projects inthe retail & consumer and automation/automotive industryamong others.Susann frequently publishes articles in international and

domestic tax and transfer pricing journals and she is a regularspeaker on transfer pricing events. Susann holds a degree ineconomics and she is a German certified tax adviser(Steuerberaterin).

G E R M A N Y


In particular the EU JTPF provides for conditions underwhich potential compensating adjustments, as a result of theapplication of the outcome testing approach, should beaccepted. This should be the case wherever the taxpayer:• Made reasonable efforts to achieve an arm’s-length outcomeat the time of the transaction and documents such efforts;

• Applies the approach symmetrically in the accounts of bothcompanies;

• Applies the approach consistently over time;• Makes the compensating adjustment before filing of thetax return; and

• Documents the reasons for deviations between budget andactual figures (in case required by one of the member statesinvolved).It should be noted that the EU JTPF explicitly stresses that

this practical solution should not encourage member states tointroduce stricter regulations on this topic and that acceptinga compensating adjustment based on the outlined conditionsshould not be regarded as a change in the view of one mem-ber state.This aspect is important to emphasise because, although

the EU JTPF provides a framework to reduce future disputes,

member states do not come to a common understanding onthe described timing issue. Unfortunately, given the contro-versies on an OECD and EU JTPF level, such commonunderstanding on which method should be applied underwhich circumstances in related party transactions seems to beout of reach for the moment.

German regulations on compensating adjustmentsGerman tax authorities outline their views on the timing issuein their Administrative Principles – Procedures. It should bementioned that the Administrative Principles are (as alladministrative principles) only an internal interpretation ofthe tax authorities’ view of the legal requirements and onlybinding for tax authorities. According to the principles, com-pensating adjustments are only allowed in case the provisionof services has been agreed on in advance, including all factorsdetermining prices and a predefined calculation process forthe adjustment (adjustment mechanism). The only reason forjustifying the adjustment is because of existing uncertaintyregarding one or more factors relevant for the price setting.The adjustment is therefore considered to be acceptable if,later-on, certainty regarding the respective factor is achieved.In this respect the view of the authorities is in line with acourt ruling of the Federal Tax Court dated December 171997. German tax authorities go beyond the position taken in

the court ruling because they express that retroactive priceadjustments shall be accepted but not changes based on thelevel of profit itself. However, from our point of view it is dif-ficult to defend why price adjustments naturally leading to adifferent profit shall be accepted whereas an adjustment basedon the sole price determinant profit is refused.German tax authorities argue that unrelated parties would

not agree on retroactive adjustments to their profits butinstead only accept changes to the pricing and this only basedon a forward-looking basis. It is claimed that a guaranteedprofit in the form of a fixed net margin, as often agreed on(for example, limited-risk distributors), would not beobserved between third parties. Looking at the regulations regarding relocation of func-

tions, German tax authorities take quite the opposite view. Under section 1 paragraph 3 of the Foreign Tax Code it is

refutably assumed that third parties would have agreed onretroactive price adjustments under such circumstances.Therefore, in cases where the transaction parties have notagreed on a specific price adjustment clause, the regulationstipulates that tax authorities may assume price adjustmentswithin a 10 year period. This shows that retroactive adjust-ments are not a priori rejected by German tax authorities.However, overall German tax authorities strongly prefer

the price setting approach over the outcome testing approachand allow only under specific circumstances that transferprices are adjusted retroactively.

Karin Ruëtz, CFATransfer pricing senior managerPwC

Tel: +49 211 981 2226 [email protected]

Karin Ruëtz is a transfer pricing senior manager at PwCDüsseldorf.After her studies in Economics at the University of Munich,

Copenhagen and Cologne, Karin started her career in transferpricing in 2007 with a Big-4 company in Germany. From 2012 to 2013, Karin worked for the TP practice in

Rotterdam, the Netherlands, and specialised in the areas oftransfer pricing system design and implementation. In January2014, she joined the TP practice of PwC.Karin advises her multinational clients in various transfer pric-

ing matters such as (transfer pricing) implementation, tax auditdefence, dispute resolution and efficient global documentationapproaches. She consults large multinationals from differentindustries and has led a variety of projects in the automotive,technology and medical industries, among others.Karin holds a degree in economics from the University of

Cologne. She is a Chartered Financial Analyst and member of theCFA Institute.

G E R M A N Y


Expected decree law regarding the application of thearm’s-length principleNotwithstanding the international discussions on ways tobridge the discrepancy between the two methods and theexplicit advice of the EU JTPF to its member states not tointroduce any further regulations, it is expected thatGerman tax authorities will issue detailed regulations in ananticipated decree law on the application of the arm’s-length principle. It should be highlighted that compared toadministrative principles, decree laws are binding for taxauthorities and taxpayers. Given the views of the German tax authorities it is

doubtful they will, in general, accept the outcome testingapproach. It is, rather, to be expected that the price settingapproach will manifest. However, in line with the FederalTax Court ruling and the Administrative Principles –Procedures, it is anticipated that compensating adjustmentsremain possible within very narrow limits and subject tovery specific conditions.

Recommended actions for German and EU taxpayersAlthough guidance on the application of the different meth-ods is unlikely to be provided soon by any of the multination-al organisational bodies as described earlier, taxpayers shouldnow analyse their transfer pricing systems to see whether theseare fit to comply with the conditions laid out by the EU JTPFto reduce disputes in Germany and within the EU. In particular, although a recent Federal Tax Court ruling

limits tax adjustments based on the violation of formalrequirements alone (see Federal Tax Court, Court Rulingdated 11 October 2012, I R 75/11.), it is nevertheless rec-ommended that any agreement between related parties apply-ing the outcome testing approach should provide for apre-defined adjustment mechanism, ensuring that adjust-ments follow only a pure calculation exercise.Finally, taxpayers should review their documentation and

see whether it fulfils the requirements as laid out by the EUJTPF in particular regarding the proof that reasonable effortshave been made to achieve an arm’s-length outcome at thetime of the transaction.

R U S S I A


Compliance and reportingoutsourcing in Russia

Russia continues to bea priority market formany multinationalgroups (MNE) andremains one of themost profitable marketsin the world forWestern investors. Yulia Timonina andKarina Arakelyan of EYdescribe the trends incompliance andreporting and how theyaffect Russiantaxpayers.

A recent corporate survey showed that 35% to 40% of MNEs still planto increase their investment in Russia (CEEMEA Business GroupCorporate Survey, April 2014). Now more than ever, MNEs operat-

ing in Russia need a high level of control, transparency and responsibilityin respect of compliance with domestic regulations relevant to financial andtax reports.

Global trends in compliance and reporting In the context of the continuing trend towards globalisation of businesses,MNEs are facing increasing complexity in dealing with and conforming toreporting requirements across numerous regions.

One of the key tasks for financial and tax administration personnel isensuring compliance with relevant laws and requirements when preparingand submitting reports to avoid disputes over the complete and accuratepresentation of a company’s financial position to local supervisory andinspection bodies.

Governments continue to pursue day-to-day legislative change and taxreform at a national level. Additional layers of complexity are added as gov-ernments strive to balance tax competition with raising sufficient revenue tofund ongoing spending commitments. The effective deployment of tax func-tion resources within MNEs may be even more important than their overallnumber. The divide between current and future tax-risk management mod-els will not be easy to bridge. Enterprises will need to flawlessly execute awell-thought-out, well-resourced strategy and at the same time remain flex-ible enough to deal with today’s changing economic and tax environment.

Many companies take it upon themselves to prepare reports meeting therequirements of the particular jurisdiction in which they operate, or hiredifferent consultants in each country of operation, which affects the opti-misation of internal processes and controls within companies and gives riseto additional costs and inefficiencies.

EY surveyed more than 200 finance and tax executives from FortuneGlobal 500 and Forbes Global 2000 companies on the subject of compli-ance with legislation in preparing and submitting reports. The purpose ofthe survey was to identify the main approaches taken to organising theprocess of preparing and submitting reports, including:• Corporate tax statements• Statements for indirect taxes• Financial accounting and reporting• Tax accounting and calculation of tax provisions

R U S S I A


Most of the respondents indicated that the historicalapproaches they have taken to the organisation and prepara-tion of financial and tax reports in countries in which theyoperate are inadequate in the current tax and financial envi-ronment. For example, 64% of respondents pointed tounplanned tax audits and 45% to unexpected tax assessments.

Furthermore, almost two thirds of respondents stated thatchanges to regulatory requirements will lead to serious prob-lems in the reporting process. A more rationally organised,efficient and controlled reporting process in accordance withthe requirements of the jurisdictions in which companiesoperate might help reduce these risks and unforeseen expens-es.

Significant changes in the global tax environment, such as,for example, those suggested in the OECD’s BEPS actionplan, as well as continuing amendments made by individualjurisdictions to their local legislation, are resulting in an envi-ronment where local tax authorities are increasingly focusedon the collection of tax payments and the exchange of taxinformation with other jurisdictions. Financial, reputationand business risks related to taxes, compliance and reportingsignificantly increase in this new environment.

At the same time, in financial terms there is a trendtowards reducing or redistributing in-country financialresources which have traditionally supported local reporting

processes in favour of global or regional centres. These cost-reduction measures may expose companies to additional tax,compliance and reporting risks locally, since local-countryresources are vital to successful compliance with tax and reg-ulatory requirements (as indicated by 64% to 78% of surveyrespondents). Moreover, insufficient resources to cover thetax function are cited as the primary source of operational taxrisk by three fourths of the respondents of the EY 2014 taxrisk and controversy survey.

To balance both financial and risk management needs,companies have been searching for a new approach to themanagement of compliance and reporting worldwide. Manycompanies surveyed have outsourced (partially or fully) oneor more of their compliance and reporting processes or intendto do so in the next few years. To make the approach botheffective and successful, companies are developing new waysof partnering with outside providers to ensure that key skillsets are available in-house, whilst the expertise, know-howand scale of outside service providers are accessed whereappropriate. The survey showed that companies that use out-side service providers for one or more compliance and report-ing processes have found this effective in achieving many keyelements of efficiency, control and value.

Increasingly, companies realise that they must transformcompliance and reporting to deliver greater efficiency, control

Karina ArakelyanTax managerEY

Tel: +7 495 660 4876Email: [email protected]

Karina Arakelyan is a tax manager in global compliance andreporting team at EY in Moscow.

Karina has more than seven years of experience within theareas of tax compliance, corporate tax and VAT advisory, taxplanning and optimisation; continuously involved in multinationaltax compliance projects of EY global tax operate and has specificexpertise providing compliance services to Russian clients andmultinational clients carrying business over Russia. She has morethan six years of experience advising multinational companies inretail and consumer products and professional services firmssectors.

Karina graduated from Russian State Tax Academy (EconomicDepartment).

Yulia TimoninaPartner, CIS global compliance andreporting leaderEY

Tel: +7 495 755 9838Email: [email protected]

Yulia Timonina is a partner and a head of global compliance andreporting practice for EY in the CIS.

Yulia has 17 years of experience in tax compliance and report-ing projects, including global compliance and reporting projects,development and implementation of tax strategy and tactics formultinational and Russian head quartered companies, corporatetaxation consulting to large foreign and local corporate investors,advisory on structuring of investments and tax support of trans-actions and post transaction integration, coordination and projectmanagement of large multi-country and multi-service lineengagements.

Yulia graduated from Moscow State Institute of Electronics andMathematics (Technical University), has Diploma with honors inApplied Mathematics; New Economic School, Master’s degree inEconomics.

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and value and to mitigate risk in an increasingly global andsometimes hostile tax and regulatory environment.Companies are increasingly using the experience of internalpurchasing specialists worldwide to secure a higher standardof services from such global service providers. This is oftendone by co-ordinating and signing contracts which covermultiple countries and in many cases by concluding global-level agreements.

Russia: Response to global trendsRussia makes ongoing efforts to create a more transparentand effective business environment, but the Russian tax andlegal system remains complex. The pace of regulatory and taxchange is accelerating, significantly impacting companies’compliance and reporting requirements in Russia as well asthe level of tax-related risks for companies operating in theRussian market.

Following a trend of increasing integration into the worldeconomy, Russia is, in many aspects, in line with global trendsin the area of taxation. For example, two of the top three tax-risk areas named by worldwide respondents of the EY 2014survey – transfer pricing and indirect taxes – are clearly hottopics in Russia. The third risk – permanent establishment –is also now resulting in tax assessments in Russia.

Historically, specifics of the Russian tax and legal systemdictated that companies operating in Russia would concen-trate their tax function, including compliance and reportingobligations, in-house. This was driven by various factors,including specific factors influencing labour markets and busi-ness culture to keep such functions in-house, as well as by theavailability of reasonably priced accounting software specificto the Russian market that allows users to address the major-ity of Russian statutory and tax compliance and reportingrequirements.

The recent global trend of MNEs redesigning their oper-ating models worldwide, including finance transformations, ishaving a significant impact on operating models for financeand tax. This is especially relevant for Russia because of signif-icant differences in statutory and tax reporting rules andrequirements (for example, tax and accounting are still close-ly focused on the availability and execution of primary docu-mentation).

Although Russia is a significant market for many MNEs,Russian subsidiaries and branches are generally forced toadopt new transformation models. The ability to adapt thesemodels to Russian requirements varies from company to com-

pany. In the new reality, companies need to rely on data gen-erated in shared service centres, frequently located outsideRussia, as well as use global accounting systems not necessar-ily fine-tuned for Russian rules and needs. On the one hand,this creates additional operational Russian tax risks and on theother hand changes the whole tax and statutory reportingprocess for Russian subsidiaries. Much more often than before,we see that full or partial outsourcing to an outside provider ofone or more compliance and reporting processes is viewed asa solution in the new environment. It is our expectation thatin this area Russia will increasingly follow the global trend.

Russian-headquartered companies are also responding toglobal trends. Recently many Russian companies have maderapid progress on the international market, moving into newregions. This has resulted in greater and more complex tasksfor financial and tax administration personnel based inRussian groups, whose duties include co-ordination andmonitoring of the relevant areas of business of companiesoperating in foreign jurisdictions. Financial managers have todetermine and rationalise the range of reports to be preparedwithin each particular company in a group. It is also necessaryto allocate responsibility and accountability, set timeframesand specify disclosures to be made in reports. Financial andtax directors must additionally make sure that their modelallows for the effects of permanent changes (changes in thelaw, in the financial sphere and in the business environment)which affect the reporting process.

The management of compliance and reporting processesby Russian-headquartered companies is often more a productof piecemeal evolution than of conscious design. However, inview of the rapidly changing tax environment both in Russiaand worldwide, Russian MNEs will very soon inevitably facethe need to centralise the management of compliance andreporting requirements to conform to evolving requirements.For example, new CFC rules that are likely to be introducedin Russia from 2015 will require many Russian-based groupsto centrally collect and process information about foreignsubsidiaries and their profits, which immediately increases theimportance of real-time control over the financials of foreignoperations at the headquarters level in Russia. Country-by-country reporting and increased cross-country exchange ofinformation will have a similar effect.

We expect that in the immediate future many RussianMNEs will need to review their approach to organising thereporting process in their region(s) of operation in line withglobal trends.

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How BEPS will affect UKtransfer pricing legislation

In the UK there is agreat deal of interest inthe G20 and OECD’sBEPS project and thechanges this may bring.Wendy Nicholls and LizHughes of GrantThornton UK LLPdescribe how the newinitiative will impact theUK transfer pricinglandscape.

T he BEPS project was endorsed by the UK and other G20 financeministers in July 2013. HM Revenue and Customs (HMRC), the UKtax authority and HM Treasury are heavily involved in the OECD’s

15 point action plan. HMRC has mentioned in its report on tacklingaggressive tax planning in the global economy that it hopes the BEPSactions will “succeed in fundamentally changing the international taxlandscape, and shift the balance of the rules in favour of tax authori-ties…”. The UK government also looks forward to the introduction ofnew rules which will deal with this issue on a global basis. HMRC isincreasing efforts to defend the local tax base and has been given extrafunding for transfer pricing (TP) enquiries which it estimates will bring in£2 billion in receipts by 2018. On the plus side the UK government is keen to market the UK as open

for business and attract investment to kick-start growth, through a seriesof incentivisation plans. These include the patent box (eventual tax rate of10%), research and development (R&D) expenditure credits and a single20% corporation tax rate from April 2015. The UK’s TP legislation is to be found at Part 4 of the Taxation

(International and Other Provisions) Act 2010 (TIOPA 2010), and isbased on the arm’s-length principle as stated in Article 9 of the OECDModel Tax Convention on Income and Capital. The legislation not onlyapplies to international transactions between related parties but alsoencompasses transactions between two UK related parties (includingbranches and permanent establishments). Thus UK businesses will needto ensure that services, finance, goods and intellectual property provid-ed from one to another or jointly developed or exploited are takingplace on arm’s-length terms and be prepared to demonstrate this toHMRC.The UK’s corporation tax self-assessment regime in respect of trans-

fer pricing puts the onus on the taxpayer to verify the arm’s-length pricein respect of all related-party transactions, including UK-UK transac-tions. Interest and penalties may be imposed for non-compliance, evenfor companies with losses. There are exemptions for small and medium-sized enterprises (SMEs), although these exemptions are set aside wherethe transaction is with certain countries, and in some other circum-stances. There is also an exemption for some transactions involving dor-mant companies.UK TP legislation expressly refers to the OECD transfer pricing guide-

lines (OECD guidelines) in terms of interpretation. Therefore, updates to

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some of the OECD guidelines shall automatically be insert-ed into UK tax legislation and the BEPS changes will takeeffect in the UK well before they are enacted (if ever) inother countries.

Compensating adjustmentsWhere double tax arises from cross-border transfer pricing,the mutual assistance procedure (MAP) in the UK’s widenetwork of treaties can be invoked, and is generally a well-run process. MAP is not available for UK-UK transactions.However, if both parties are subject to UK tax and thetransfer pricing rules apply to adjust prices to increase thetaxable profits of one party, then the counterparty cannormally make a claim to reduce its taxable profitsaccordingly. Such an adjustment is known as acompensating adjustment.On October 25 2013, HMRC issued draft legislation

preventing future claims for compensating adjustments byany person within the charge to income tax other than acompany, where the counterparty to the transaction is acompany. This legislation effectively means that, as ofOctober 25 2013, individuals and partnerships will nolonger be able to claim compensating adjustments, wherethe counterparty to the transaction is a company.Significantly, the restriction will not be limited to tax avoid-ance arrangements and there will be no exceptions for gen-uine commercial arrangements.

AdministrationDocumentationHMRC has issued guidance on how it interprets the record-keeping requirements of the self-assessment provisions for thepurposes of transfer pricing. Unlike other countries, the UKdoes not have a prescribed list of documentation require-ments and detailed disclosures are not currently requiredwithin tax returns. One key reform of action 13 of the BEPS project is the

introduction of country-by-country reporting. The UK gov-ernment has played a leading role in initiating the proposalfor a country-by-country reporting template to be produced.It believes that this will enhance transparency between busi-ness and tax authorities and provide tax authorities withhigh-level information to help them efficiently identify andassess risks. There is concern from taxpayers on the confidentiality

issues raised by sharing commercially sensitive informationwith other territories. There also remains a risk that thesereforms may not be adopted by all countries and thereforeUK taxpayers may see little benefit from their extra work. The UK accepts the EU transfer pricing documentation

(EU TPD) model which provides multinational groups withthe option to create a master file, containing high level infor-mation relating to the group, and a country file, which docu-

ments the local entities in detail. This is similar, but not iden-tical to the master file and local country file approach beingrecommended as part of action 13 of the BEPS project.

DeadlinesA tax return will not be considered correct by HMRC unlesstransactions reflected within it are at arm’s-length. It is neces-sary to determine the correct arm’s-length price before the fil-ing date, for each separate tax return.

Wendy NichollsPartnerGrant Thornton UK LLP

Tel: +44 (0)20 7383 [email protected]

Wendy Nicholls is an experienced partner and leads GrantThornton’s UK transfer pricing practice and is based in theLondon office. Wendy has more than 25 years of internationaltax experience advising clients in the UK and overseas, andleads Grant Thornton’s transfer pricing practice, which wasnamed 2012, 2013 and 2014 UK Transfer Pricing Firm of the Yearat the International Tax Review European Tax Awards. Beforejoining Grant Thornton in October 2009, she worked for a ‘big 4’firm, responsible for transfer pricing for the South of England.

Wendy is a member of the Grant Thornton International GlobalTransfer Pricing Leadership team and is acknowledged in theLegal Media Guide as one of the World’s Leading Transfer PricingAdvisers. She has also been recognised by the World’s LeadingWomen in Business Law. She is on the Business and IndustryAdvisory Committee to the OECD, and presented at the recentOECD meetings on intangibles.

Wendy advises clients in a wide range of industries on trans-fer pricing planning, dispute resolution, advance pricing agree-ments, compliance and documentation. She is a regular speakerand author and has acted as an expert witness in relation totransfer pricing for a large pension fund. Wendy has particularexpertise in sectors where intellectual property is important,including technology and brands.

Her recent projects have included transfer pricing advice to amajor international retailer, royalty planning for a technologygroup, co-ordinating benchmarking studies across several coun-tries for a FTSE 100 industrial products group and managing anenquiry into attribution of profits to permanent establishments.Wendy has a leading role in Grant Thornton’s patent box special-ism and was involved in the consultation process with HMTreasury and HMRC.

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While evidence to demonstrate an arm’s-length resultneed only be produced upon HMRC’s request, suchrequests are frequently accompanied by deadlines (typically30 days from the date of the enquiry letter). In practice,therefore, it is advisable to maintain contemporaneous TPdocumentation.

Advanced pricing agreements (APAs)UK taxpayers can agree with HMRC a basis to determine thearm’s-length pricing that should be applied in the UK taxreturn, typically for up to five years. APAs may be unilateral orbilateral. There is no associated fee. Overt preference forbilateral APAs has now been removed. However, there is acomplexity threshold, below which HMRC can refuse toaccept an APA application. This results in some uncertaintyand a lower take-up of APAs than in some other countries. There were 45 applications made during 2012/2013 and

27 agreements with HMRC made during the same period.

Thin capitalisation and financingThere are several ways that HMRC may limit interest deduc-tions for UK resident companies, including anti-arbitrage andworldwide debt cap rules.

The thin capitalisation rules within the UK’s transfer pric-ing legislation also act to limit the extent to which a taxdeduction can be obtained for interest payable on borrowingsbetween related entities. These rules apply to financingarrangements between two UK related parties and also insome cases, borrowings from a third party. Acting-togetherprovisions extend the UK thin capitalisation rules to bringlending between parties that are not otherwise connected forthe purposes of UK tax within the legislation.The effect of these rules includes the imposition of inter-

est income or the denial of tax relief for interest payments,for loans between two UK parties or in situations where oneis deemed to have guaranteed borrowing by another.However, it may be possible for parties to claim compensat-ing adjustments to their taxable profits in some situations, asnoted above.It is possible to enter into a unilateral APA with HMRC,

known as an advance thin capitalisation agreement (ATCA),to determine the arm’s-length amount of interest that shouldbe deductible in the UK taxpayer’s tax return. ATCAs arefairly popular and there were 144 agreements with HMRC in2012/2013.

Transfer pricing aspects of intangiblesThe OECD guidelines update to chapter 6 on intangibles isnow close to finalisation and, as noted above, will become rel-evant immediately to UK groups. It should be noted that theBEPS changes are not being adopted fully by many countrieswhich have nevertheless had major input into the wording.The emphasis in the drafts on significant functions as opposedto ownership, capital and risk, is potentially a move away fromthe arm’s-length principle. This may increase the number ofdisputes and MAP claims in the coming years.

Intellectual property incentivesAs part of the UK government’s strategy for reforming thecorporate tax system to create the most competitive tax envi-ronment in the G20, it has introduced incentives for invest-ment in intellectual property (IP) such as introducing thepatent box and the R&D expenditure credit which is poten-tially payable in cash, even for larger companies. Under the patent box legislation, profits that are attributa-

ble to sales of items including qualifying patents will be subjectto a corporation tax rate as low as 10%. An important aspect isthat the patent box rules can apply even where R&D tax reliefhas already been claimed on a project to develop the IP. However, it should be noted that where a UK group com-

pany performs R&D services for an overseas group company,HMRC may consider that a cost-plus methodology is notalways appropriate. For cost-plus to be appropriate, it wouldbe expected that the recipient of the services should retainresponsibility for the project and that the R&D serviceprovider should bear little risk.

Liz HughesDirectorGrant Thornton UK LLP

Tel: +44 (0)20 7728 3214 [email protected]

Liz Hughes is a transfer pricing director with over 14 years’ expe-rience of advising UK and international based groups on theirtransfer pricing affairs. Liz joined Grant Thornton in February2006. Before joining Grant Thornton, Liz worked as a transferpricing specialist at PwC, in their London and Zurich offices.

Liz has a wide experience of transfer pricing projects includingtax efficient supply chain reorganisations, devising and imple-menting planning ideas, dispute resolution and audit defence,thin capitalisation, documentation and due diligence projects.

She has experience across a wide variety of industries helpingclients to set and document their transfer pricing policies includ-ing profit splits, as well as TP defence work.

Liz has a particular interest in thin capitalisation and hasnegotiated advance thin capitalisation agreements on behalf ofthe firm’s clients since the inception of the scheme. Liz is aninvited member of HMRC’s consultative panel on thin capitalisa-tion matters.

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Permanent establishments Branches of foreign entities operating in the UK are consid-ered to be a separate legal entity operating as UK resident per-manent establishments (PE) for corporation tax purposes.The BEPS project plans to develop changes to the definitionof a PE to prevent what it refers to as “the artificial avoidanceof PE status” in relation to BEPS.

Controlled foreign companiesBEPS action 3 is intended to strengthen controlled foreigncompany (CFC) rules. Recommendations on this action areexpected in September 2015. However, it is not likely thatthese changes will have a large impact on multinationals oper-ating in the UK as a result of the recent reforms to the UKCFC rules. This action point should be of particular interest to compa-

nies operating within the digital economy. Specific guidance

identifying the main difficulties and options to address themfor such companies is in process as one of the 2014 actions forBEPS.

Concluding commentsBusinesses operating in the UK need to be alert to anychanges made to the OECD guidelines and other aspects ofBEPS, particularly as some of these changes may be incorpo-rated automatically into UK tax legislation. HMRC is a sophisticated tax authority and generally is

open to discussion with businesses and other tax administra-tions around TP. Rather than setting out ever expanding listsof rules to tick off, it wants to see mindful compliance by tax-payers with the principles of TP. In the current environment,where BEPS is resulting in an increasing burden on taxpayerswithout a corresponding convergence of tax and TP rulesinternationally, this is a refreshing approach.

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US transfer pricingdevelopments

There has been agrowing focus ontransfer pricing acrossthe globe and therehave been a number ofimportant US transferpricing developments inthe last year. LarissaNeumann of Fenwick& West takes readersthrough the mostsignificant issues of thepast year.

The arm’s-length standardThe arm’s-length standard has served as the foundation of the world’stransfer pricing for the last half century. However, in for the past year, at least, it has been under significant attack

as a result of the OECD’s base erosion and profit shifting (BEPS) papers. Arm’s-length principles are based on what unrelated parties would agree

to under similar circumstances. It is a simple concept that can be appliedconsistently. According to Treas. Reg. § 1.482-1(b)(1), the standard to beapplied “in every case” under Section 482 is the arm’s-length standard. According to the OECD BEPS discussion drafts: “Special measures,

either within or beyond the arm’s-length principle, may be required withrespect to intangible assets, risk and over-capitalisation”, to address pur-ported flaws in the transfer pricing system. The OECD is considering cir-cumstances in which related-party contracts can, or should be, ignoredunder a “special measure”. The concept of a “special measure” involvessubjectivity and vagueness, which obscure the arm’s-length standard. A “special measure” by its very nature suggests a movement away from

a consistent pricing methodology. It will be difficult to build a consensusamong countries on the application and administration of “special meas-ures”. No country wants to lose revenue as a result of a transfer pricing“special measure”. The US Treasury, although it has its own discomfort with the arm’s-

length standard (as discussed below), is not supportive of the OECD’sefforts. Robert Stack, deputy assistant secretary for international tax affairswith the US Treasury and the US delegate to the OECD, recently said theUS wants a thorough discussion paper on the arm’s-length principle thatdeals with how to price hard-to-value intangibles. While the US supports the arm’s-length standard internationally, domes-

tically the IRS itself has sought to undermine the arm’s-length standard inrecent transfer pricing disputes and in the cost sharing regulations. In AlteraCorp. v. Commissioner, T.C. Dkt Nos. 6253-12, 9963-12, the IRS assertsthat unrelated party comparable data is irrelevant in determining whetherparties to a cost sharing agreement must include stock-based compensation. In Xilinx v. Commissioner, 598 F.3d 1191 (9th Cir. 2010), the IRS made

the same argument and lost. As a result of the Xilinx case, the IRS revisedTreas. Reg. § 1.482-7(d)(2) in 2003 to specifically require the cost sharing ofstock-based compensation. The validity of that regulation is at issue in Altera. Companies typically have provisions allowing them to adjust their cost

sharing payments attributable to stock-based compensation in the event

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that the 2003 cost sharing regulations are held to be invalid,including Amazon.com. The Altera case will be critical tomany companies.

Transfer pricing documentation requirementsUS businesses have become increasingly concerned about therapidly growing transfer pricing documentation requirementsutilised by governments around the globe. Transfer pricingcompliance has become extremely costly for multinationalcorporations. This year, more than ever, companies havevocalised their concerns about the burdens and inefficienciesof the global transfer pricing requirements. One of the BEPS action plan points seeks to modify the

global rules to make transfer pricing compliance easier andmore straightforward, while at the same time enhancing trans-parency. The goal is to create documentation standards thatprovide tax authorities with useful and more focused informa-tion. The slant of the OECD’s discussion drafts, however, isstrongly towards transparency at the cost of compliance.BEPS’ country-by-country (CbC) reporting is a part of

this growing complexity. The OECD recently announced thatit will reduce the number of required items in the originallyproposed CbC reporting template. The original list of seven-teen items has been reduced to seven. The seven CbC itemsinclude (1) revenues; (2) earnings before interest, taxes,depreciation and amortisation; (3) case taxes; (4) current-yeartax accruals; (5) stated capital and accumulated earnings fromthe balance sheet; (6) number of employees; and (7) tangibleassets. However, this can still be enormously burdensome. Moreover, another concern the US, and US companies,

has with CbC reporting is how the information will be sharedamong tax authorities. US companies want to ensure thatthere is no public disclosure of trade secrets, scientific secrets,or other confidential information. Many tax advisers in theUS are concerned that CbC reporting leads in the directionof formulary apportionment.The language requirement for the local country filing is

controversial and has yet to be resolved.

Section 482 roadmapFollowing a number of defeats in transfer pricing litigation, theIRS recently published its new “Transfer Pricing AuditRoadmap” on February 14 2014. The 482 roadmap is designedto provide audit techniques and tools to assist with the planning,execution and resolution of transfer pricing examinations. SamMaruca, transfer pricing director, has expressed hope that theroadmap will result in less transfer pricing litigation. The roadmap encourages open communication and coop-

eration with taxpayers, instructing exam to engage in up-frontplanning and to involve transfer pricing specialists at the ear-liest stage. The roadmap asserts that transfer pricing special-ists can ensure that the audit timeline is appropriate given thecomplexity of the case, provide guidance regarding resources

and staffing, and help determine which issues are not worthpursuing. The roadmap states that if the taxpayer’s financialresults are reasonable, the transfer pricing issue may not beworth pursuing. Transfer pricing cases are usually won and lost on the facts.

The key in transfer pricing cases, the roadmap explains, is toput together a compelling factual story based on a thoroughanalysis of functions, assets, and risks, and an accurate under-standing of the relevant financial information. This advice isequally applicable to corporate taxpayers, of course. One road block to the roadmap, however, may prove to be

the IRS’s recent new rules on information document requests(IDRs) used in IRS corporate tax examinations which likelywill lead to the more frequent use and threatened use of sum-mons to enforce IDRs.

Transfer pricing cases3M Company v. Commissioner, T.C. Dkt. No. 5816-13, involvesthe IRS’s allocation of royalty income from a Brazilian sub-sidiary to its US parent. The taxpayer asserts that the royalty isprohibited under Brazilian law and argues that the IRS does nothave the authority to reallocate income if foreign law prohibitspayment or receipt. Under different facts, the US SupremeCourt has held that the IRS does not have such authority, whichthe IRS sought to overrule with regulations. The validity of thisregulation, Treas. Reg. § 1.482-1(h)(2), is in issue.

Amazon.com, Inc. v. Commissioner, T.C. Dkt. 31197-12,involves cost sharing and valuing pre-existing intangible prop-erty. Amazon challenges the IRS’s $3.4 billion transfer pric-ing adjustment. It involves the same issues that were litigatedin Veritas v. Commissioner, 133 T.C. 297 (2009), nonacq,which is cited in Amazon’s Tax Court petition.

BMC Software, Inc. v. Commissioner, 141 T.C. No. 5(2013), involved the treatment of a secondary adjustmentunder section 965 (the one-time repatriation provision) byreason of a Rev. Proc. 99-32 election. The revenue procedureallows the taxpayer to repatriate an amount of its CFC’s earn-ings, US tax-free, to the extent the income is allocated to thetaxpayer from the CFC under § 482. An appeal of the case ispending in the Fifth Circuit. BMC has important transfer pric-ing ramifications since Rev. Proc. 99-32 is commonly used intransfer pricing adjustments.

Advance pricing agreement (APA) report The IRS recently released its annual advance pricing agreement(APA) report covering the calendar year 2013. The number ofexecuted APAs in 2013 (145) increased from the previous year(140). The number of executed APAs exceeded the number ofAPA applications for the second year in row as the IRS contin-ues to work through its backlog of pending APA applications. The number of applications received in 2013 decreased

from 126 to 111. The termination of Eaton’s APA may havehad an impact on the number of APA applications. Two of

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Eaton’s APAs were unilaterally cancelled by the IRS. Eatonargued in court that APAs are enforceable contracts. The IRSasserted that it has the authority to cancel APAs. In Eaton Corp.v. Commissioner, 140 T.C. No. 18 (2013), the Tax Court heldfor the IRS on cross motions for summary judgment. The median completion time for an APA decreased by

seven months, to just under three years (32.7 months). TheIRS has been trying to improve APA processing time.However, the median time to complete new bilateral APAs isstill over three years (38.8 months).As with prior years, inbound APAs involving foreign par-

ent companies and US subsidiaries accounted for more thanhalf of the APAs (55%). The large majority of bilateral APAsinvolved Japan (53%). The other separately listed countrieswere Canada (19%), the UK (8%) and Australia (5%). It isinteresting that just four countries accounted for such a largemajority (85%) of all US bilateral APAs. All other countriescombined only accounted for just 15%. A substantial number of the APAs involved the comparable

profits method (CPM) / transaction net margin method(TNMM) (77%). The TNMM is used in Japan and is similarto the CPM, which is frequently used in the US.

Competent authority reportThe IRS recently issued its competent authority statistics for the15-month period from October 1 2012 through December 312013. In moving to a year-end reporting date, the statisticsinclude three extra months. There are two categories of com-petent authority statistics: the first is the allocation of businessand profits, which is undoubtedly mostly transfer pricing, andthe second is all other treaty areas, which is generally not rele-vant to transfer pricing and not covered in this article.In the allocation of business profits category, over 80% of

the competent authority cases were resolved favourably forthe taxpayer through either a total adjustment withdrawal bythe initiating tax authority, full correlative relief, or part andpart (partial correlative relief and partial withdrawal resultingin full relief). Partial relief was granted in 8% of cases and norelief was given in 7% of cases. Of the 35 US-initiated adjustments that were resolved, zero

resulted in no relief, one resulted in partial relief, and theremaining 34 were favourably resolved. A 97% full-relieffavourable resolution rate for US-initiated adjustments indi-cates that the competent authority programme is working well. Consistent with prior years, the average processing time

remained at about two years. The number of competentauthority case requests increased. The number of US-initiat-ed adjustments remained constant, but the number of for-eign-initiated adjustments almost doubled. The number of foreign-initiated adjustment resolutions

(119) far exceeded the number of US-initiated adjustmentresolutions (40). Of the 40 US-initiated adjustments five werewithdrawn by the taxpayer.

Larissa NeumannTax attorneyFenwick & West

Tel: +1 650 335 [email protected]

Larissa Neumann focuses her practice on US tax planning, taxcontroversy, and tax litigation for corporations, with an emphasison international transactions. She has broad experience advisingUS companies and foreign-based clients on the taxation ofcross-border operations, acquisitions, dispositions, restructuringsand transfer pricing issues. She has successfully representedclients in federal tax controversies at all levels and has substan-tial experience managing complex tax controversies. She repre-sents clients from a diverse set of industries and geographicareas. Her clients range in size from high technology start-ups tolarge Fortune 500 companies.

In 2014, Euromoney selected Larissa for inclusion in the“Americas Women in Business Law Awards” shortlist for Best inTax Dispute Resolution. Larissa appears as a rising star inEuromoney’s “World’s Leading Tax Advisers.”

Larissa received her J.D. from the University of California,Berkeley, School of Law in 2005. She received her M.A. in publichealth from Yale University in 2002 and her B.S. in molecular cellbiology from University of California, Berkeley, in 2000.

Larissa frequently speaks on US corporate and internationaltax issues at conferences for professional tax groups, includingTax Executives Institute, International Fiscal Association, PacificRim Tax Institute, Bloomberg BNA, and the American BarAssociation. She is a member of the ABA Section of Taxation andthe International Fiscal Association.

Larissa has published several articles, including recently: • US Tax Developments, International Tax Review 2013• US International Tax Developments, The Euromoney Corporate

Tax Handbook 2012• Character and Source of Income from Internet Business

Activities, The Contemporary Tax Journal (July 2011)Fenwick & West has one of the World’s Top Tax Planning and

Tax Transactional Practices, according to International Tax Review(2014), and is first tier in tax, according to World Tax 2014.International Tax Review gave Fenwick & West its San FranciscoTax Firm of the Year Award a total of five times and its US TaxLitigation Firm of the Year Award a total of three times.