transfer pricing and business restructurings · 2010-05-13 · 7. changes to the business model as...

Transfer Pricing and BusinessRestructurings

Streamlining all the way

Edited byAnuschka Bakker

IBFD

Table of Contents

Foreword v

Acknowledgements ix

Abbreviations and Common References xi

Part ASetting the Scene

Chapter 1: Introduction

1. Drivers of business restructuring 31.1. Global business models to maximize synergies and

economies of scale 41.2. Improvement of productivity of the supply chain 51.3. Other external and internal factors 7

2. Business restructuring from an economic perspective 82.1. Business perspective 8

2.2. Stakeholder's perspective 9

3. Tension between commercial aims and tax environment 9

Chapter 2: Business Models

1. Introduction 13

2. Business modelling for tax and transfer pricing purposes 162.1. Manufacturer 192.1.1. Toll manufacturer 202.1.2. Contract manufacturer 212.1.3. Fully fledged manufacturer 222.2. Distributor 242.2.1. Commission agent 262.2.2. Commissionaire 272.2.3. Classic buy-sell distributor 292.2.4. Fully fledged distributor 30

X l l l

Table of Contents

2.3. Service provider 32

3. Business restructurings 363.1. Intangible property transfers 373.2. Conversion from fully fledged to contract manufacturing

model 413.3. Conversion from fully fledged distributor to stripped

distributor model 43

4. Centralized services and cost allocation agreements 45

Chapter 3: OECD Policy Framework

1. OECD policy framework in the area of internationaltaxation 49

.1. OECD in general 49

.2. OECD tax work 50

.3. Arm's length principle and OECD Guidelines 50

.3.1. Comparability analysis 51

.3.2. Transfer pricing methods 52

.3.3. Recent developments 54

.3.4. Other relevant guidance in the OECD Guidelines 541.4. Permanent establishment issues 541.4.1. Definition of a permanent establishment 541.4.2. Attribution of profits to permanent establishments 56

2. Prevention and resolution of transfer pricing and otherinternational tax disputes 58

2.1. Dispute resolution 582.2. Dispute prevention 60

3. OECD project on business restructuring 613.1. Restructurings that are within the scope of the OECD

project 613.2. Origins of the project 623.3. Transfer pricing dimension of business restructurings 623.4. Presentation of the OECD Discussion Draft 643.4.1. Relationship with permanent establishment issues 643.4.2. Relationship with domestic anti-abuse rules 653.5. Main tentative conclusions from the OECD Discussion

Draft 653.5.1. Issues Note 1: Special considerations for risks 65

xiv

Table of Contents

3.5.2. Issues Note 2: Arm's length compensation for therestructuring itself 68

3.5.3. Issues Note 3: Remuneration of post-restructuringcontrolled transactions 74

3.5.4. Issues Note 4: Recognition of the actual transactionsundertaken 78

4. Conclusion 83

Chapter 4: EU Policy Framework

1. Developments with EU legislation 851.1. Impact of existing secondary EC law on business

restructuring 851.1.1. Parent-Subsidiary Directive 851.1.2. Merger Directive 871.1.3. Interest and Royalties Directive 881.1.4. Arbitration Convention 881.2. Impact of proposed secondary EC law on business

restructuring: Common Consolidated Corporate TaxBase and Home State taxation 89

1.2.1. Common Consolidated Corporate Tax Base 891.2.2. Home State taxation 901.2.3. Impact of Common Consolidated Corporate Tax Base

and Home State taxation 901.3. Impact of proposals of the EU Joint Transfer Pricing

Forum on business restructuring 91

2. Impact of case law on business restructuring 912.1. General 912.2. CLT-UFA S.A. case 92

2.3. FCE Bank case 94

3. Coordination in the field of exit taxes 96

Chapter 5: Art 9 of the OECD Model Convention

1. Introduction 99

2. Arm's length (comparability) analysis and recognition,or non-recognition of transactions undertaken 100

2.1. Introduction 100

xv

Table of Contents

2.2. Meaning of "conduct of parties" 1012.3. Determining whether terms and conditions between the

respective parties are arm's length from a commercial orfinancial perspective 102

2.4. Choice between comparability adjustment or non-recognition of (part of) a transaction 106

2.5. Endeavouring to understand the envisaged tests bymeans of examples 111

2.6. Trade-off between equity and efficiency 1172.7. Valuing the restructuring itself and the post-restructuring

transactions 118

3. Arm's length compensation for intangibles and relatedrisks 120

3.1. Introduction 1203.2. Building the commercial business case 1213.2.1. Comparison of pre- and post-restructuring scenarios 1213.2.2. Business reasons for and the expected benefits from the

restructuring 1263.2.3. Existence of probable alternative commercial choices;

possible indemnities 1293.3. Determining exit values: valuation methods used by

appraisers and valuation practitioners 1313.3.1. Income-based approach: excess earnings approach 1323.3.2. Income-based approach: incremental margin analysis 1353.3.3. Market-based methods 1363.3.4. Methods to establish bargaining power 1373.3.5. Rule of thumb used in civil court cases as a last resort 1383.3.6. Intangible transferred at a point in time where it does not

have an established value 1393.4. Impact of intangibles and related risks in the post-

restructuring valuation 1403.5. The use of one-sided transfer pricing methods 1413.5.1. More emphasis on two-sided methods, especially profit

split methods 1413.5.2. Role of control in a post-restructuring situation 143

Chapter 6: Permanent Establishment Issues

1. The presence of a permanent establishment 145

xvi

Table of Contents

2. Allocation of profits to permanent establishments: Art. 7

of the OECD Model 153

Chapter 7: VAT Aspects of Business Restructuring

1. Introduction 1591.1. General 159

1.2. Introduction to the VAT system of the European Union 160

2. Group financing activities 161

3. Transfer of assets 1633.1. Scope of the non-taxability 1643.2. Definition of "totality of assets" 1653.3. Successor's intention to continue the business 1663.4. Business licence or authorization 1663.5. Right to deduct VAT 1674. Transfer of shares 1694.1. General 1694.2. Selling of shares outside the scope of VAT 1705. Issue of new shares 170

6. Outsourcing 172

7. Changes to the business model as described in Chapter 2 1747.1. Transfer of intellectual property 1747.2. From fully fledged manufacturer to contract

manufacturer 1757.3. From fully fledged distributor to stripped distributor 1757.4. Commissionaires 175

Chapter 8: Customs Duties

1. Introduction 177

2. Customs law 177

3. General Agreement on Tariffs and Trade; World TradeOrganization 180

3.1. General Agreement on Tariffs and Trade 180

xvu

Table of Contents

3.1.1.3.1.2.3.2.3.2.1.3.2.2.

4.4.1.

4.2.4.3.

The Geneva ConferenceFundamental principlesWorld Trade OrganizationUruguay RoundNew order

The European UnionThe European Communities: ECSC, EEC and EAEC/EuratomEU customs lawBasic legal provisions

180180181181182

183

183185186

5. Customs in the United States 1875.1. The Customs Modernization Act 1875.2. Valuation 1885.3. Free trade agreements 188

6. Association of Southeast Asian Nations 1896.1. ASEAN Free Trade Area 1896.2. Customs rules 1906.3. Valuation 190

7. Determining the value of goods 1917.1. Transaction value 1917.2. Significance of "relationships" between buyer and seller 1927.3. Alternative measures of value 1937.4. Additions and exclusions to the transaction value 194

8. Customs value and transfer pricing 1958.1. Two sides of the same coin 1958.2. A new trend: the holistic approach 1978.3. Arm's length principle: a shared principle? 1998.4. Controls of transactions: an operational convergence 2008.5. How to reconcile methods for determining customs

values and transfer prices 202

9. The strength of the double approach before tax audits 204

Chapter 9: Tax Accounting Considerations

1. Introduction 207

xviu

Table of Contents

2. International accounting framework 2092.1. General 2092.2. Income tax accounting standards 210

3. Tax law considerations 2143.1. Plant closures 2153.2. Migration of intangibles 2163.3. Conversion into limited-risk entities 217

4. Specific tax accounting impacts 2184.1. Transfer pricing uncertainties 2194.1.1. FIN 48: a further overview 2204.1.2. IAS 12 versus FIN 48: overview and key differences 2264.1.3. Accounting for transfer pricing tax uncertainties: specific

considerations 2284.2. Deferred tax accounting 2304.2.1. Pre-tax accounting: deferred tax implications 2314.2.2. Intercompany asset transfers 2314.2.3. Realizability of deferred tax assets 2344.2.4. Outside basis differences 2364.3. Comprehensive example 237

5. Conclusion 244

PartBCountry Chapters

Chapter 10: China

1. Introduction 249

2. Corporate income tax framework 2502.1. Corporate income tax system 2502.2. Taxable entities 2502.3. Taxable income 2512.4. Tax losses 2512.5. Tax rates 2512.6. Tax treatment of R&D expenses 2512.7. Taxation of intellectual property 252

3. Tax consequences of various models 252

xix

Table of Contents

3.1. Characterization of manufacturing entities 2523.2. Principal manufacturer versus contract or toll

manufacturer 2533.3. Characterization of distributing/selling companies 2553.4. Conversion from fully fledged distributor to a

limited-risk distributor 2563.5. Service company or commissionaire or agent 2573.6. Contract service providers 258

4. Transfer pricing details 2584.1. Issues arising upon restructuring 2584.2. Issues arising with regard to intangibles 2604.3. Post-restructuring issues 2604.4. Recognition of transactions 2614.5. Consequences of restructurings not subject to

recharacterization 2624.6. Treatment of business restructuring expenses 2624.7. The bargaining theory applied to business restructuring 2634.8. Specific industries 2644.8.1. Automotive industry 2644.8.2. Pharmaceutical industry 2644.8.3. Banking industry 264

5. Permanent establishment perspective 2655.1. Existence of a permanent establishment 2655.2. Allocation of profits to a permanent establishment 2665.2.1. General concept 2665.2.2. Allocation of assets 2665.2.3. Valuation and depreciation of assets 2675.2.4. Capital gains 2675.2.5. Allocation of risks 2685.2.6. Intra-company dealings 2685.2.7. Difference with authorized OECD approach 268

5.2.8. Specific industries 268

6. Anti-avoidance provisions 269

7. Case law 271

Chapter 11: Germany

1. Corporate income tax framework 273

xx

Table of Contents

1.1. Corporate income tax system, taxable entities, taxableincome 273

1.2. Tax losses 2741.3. Tax rates 2741.4. Tax treatment of R&D expenses and taxation of

intellectual property 2741.5. Specific rules on business restructurings 2741.5.1. Hypothetical arm's length test 2741.5.2. Implications of EU law and income tax treaties 2751.5.3. Transfer of function 2761.5.4. Transfer package 277

2. Tax consequences of various models 2782.1. Characterization of manufacturing entities 2782.1.1. Assembler or toll manufacturer 2782.1.2. Contract manufacturer 2792.1.3. Manufacturer under licence 2792.1.4. Fully fledged manufacturer 2802.2. Principal manufacturer versus contract or toll

manufacturer 2802.2.1. Physical carve-out and transfer 2802.2.2. Duplication of activities 2802.2.3. Termination of inbound licence 2812.2.4. Conversion to toll or contract manufacturing 2812.3. Characterization of distributing/selling companies 2812.3.1. Commission agent 2822.3.2. Commissionaire 2822.3.3. Limited-risk distributor 2822.3.4. Fully fledged distributor 2822.4. Conversion from fully fledged distributor to a

limited-risk distributor 2832.5. Business restructuring including commissionaires or

commission agents 2842.5.1. Conversion from full-risk distributor to commissionaire

or commission agent 2842.5.2. Termination of distribution activities 2852.6. Contract service providers 285

3. Transfer pricing details 2863.1. Issues arising upon restructuring 2863.1.1. Contractual basis of restructuring 2863.1.2. Documentation 287

xxi

Table of Contents

3.2. Issues arising with respect to intangibles 2873.3. Post-restructuring issues 2883.3.1. Adjustment period for uncertainties in valuation 2883.3.2. Duplication of functions 2893.4. Recognition of transactions as presented by a taxpayer 2893.5. Consequences of restructurings not subject to

recharacterization 2903.6. Treatment of business restructuring expenses 2913.7. The bargaining theory applied to business restructuring 2923.8. Specific industries 2923.8.1. Automotive industry 2923.8.2. Pharmaceutical industry 2933.8.3. Financial services industry 293

4. Permanent establishment 2934.1. Existence of a permanent establishment 2944.2. Allocation of profits to a permanent establishment 2944.2.1. General concept 2944.2.2. Allocation of assets 2954.2.3. Valuation and depreciation of assets 2964.2.4. Capital gains 2964.2.5. Allocation of risks 2964.2.6. Intra-company dealings 2964.2.7. Difference with authorized OECD approach 296



6. Case law 297

Chapter 12: India

Corporate income tax framework 299

. 1. Corporate income tax system 299

.2. Taxable entities 300

.3. Taxable income 300

.4. Tax losses 300

.5. Tax rates 300

.6. Tax treatment of R&D expenses 301

.7. Taxation of intellectual property 3012. Tax consequences of various models 301

xxu

Table of Contents

2.1. Characterization of manufacturing entities 3012.2. Principal manufacturer versus contract or toll

manufacturer 3022.3. Characterization of distributing and selling entities 3032.4. Conversion of fully fledged distributor to a limited-risk

distributor 3032.5. Service company or commissionaire or agent 3042.5.1. Commission agent 3042.5.2. Characterization of service-based companies 3052.6. Contract service providers: centralization of R&D

activities, contract maintenance and contract marketing 306

3. Transfer pricing details 3073.1. Issues arising upon restructuring in case of stopping

activities and post-restructuring issues 3083.2. Issues arising in case of transfer of intangibles 3113.3. Post-restructuring issues 3133.4. Recognition of transactions as presented by the taxpayer 3153.5. Consequences of restructurings not subject to

recharacterization 3163.6. The bargaining theory and business restructuring 3163.7. Specific industries 3173.7.1. Automotive industry 3173.7.2. Pharmaceutical industry 3183.7.3. Global trading of financial instruments 319

4. Permanent establishment 3194.1. Existence of a permanent establishment 3194.1.1. Fixed place permanent establishment 3194.1.2. Agency permanent establishment 3214.1.3. Service permanent establishment 3224.2. Allocation of profits to a permanent establishment 3254.2.1. General concept 3254.2.2. Allocation of assets 3264.2.3. Valuation and depreciation of assets 3264.2.4. Capital gains 3264.2.5. Allocation of risks 3264.2.6. Intra-company dealings 3264.2.7. Difference with authorized OECD approach 327


xxm

Table of Contents

6. Case law 329

Chapter 13: Switzerland

Corporate income tax system 331.1. Taxable entities 332.2. Taxable income 332.2.1. General corporate income tax regime 332.2.2. Federal and cantonal tax privileges 333.3. Tax losses 334.4. Tax rates 334.5. Tax treatment of R&D expenses 335

1.5.1. General provisions 3351.5.2. R&D incentives 3361.5.3. Other incentives applicable for R&D activities 3361.6. Taxation of intellectual property 3361.6.1. Swiss holding company as beneficial owner of

intellectual property 3371.6.2. Cantonal and communal tax privileges and beneficial IP

ownership 3371.7. Transfer pricing rules and regulations 338

2. Tax consequences of various conversion structures 3392.1. General comments 3392.2. Current approach 3402.3. Characterization of manufacturing entities 3412.3.1. Key features 3412.3.2. Tax consequences of a conversion 3422.4. Principal manufacturers versus contract/toll

manufacturers 3432.5. Characterization of distribution and selling companies 3442.6. Conversion from fully fledged distributor to limited-risk

distributor 3462.6.1. General observations 3462.6.2. Conversion of an existing Swiss company into a

principal company 3472.7. Service company or commissionaire or agent 3472.8. Contract service providers 349

3. Transfer pricing details 3503.1. Legal framework 3503.1.1. Transfer pricing and international tax law 350

xxiv

Table of Contents

3.1.2. Transfer pricing and Swiss internal tax law 3503.2. Issues arising upon restructuring: indemnification for

terminating activities 3513.3. Issues arising with regard to intangibles 3533.4. Post-restructuring issues 3533.5. Recognition of transactions as presented by a taxpayer 3533.6. Treatment of business restructuring expenses 3543.7. The bargaining theory applied to business restructuring 3543.8. Specific industries 355

4. Permanent establishments 3554.1. Definition of "permanent establishment" under Swiss tax

law 3554.1.1. Taxation of a permanent establishment 3564.1.2. Existence of a permanent establishment in various

arrangements 3564.2. Allocation of profits to a permanent establishment 3574.2.1. General concept 3574.2.2. Allocation of assets 3584.2.3. Valuation and depreciation of assets 3594.2.4. Capital gains 3604.2.5. Allocation of risks 3604.2.6. Intra-company dealings 3604.2.7. Difference with authorized OECD approach 3614.2.8. Specific industries 361


6. Case law 363

Chapter 14: United Kingdom

1. Corporate income tax framework 3671.1. Corporate income tax system 3671.2. Taxable entities 3671.3. Taxable income 3681.4. Tax losses 3681.5. Tax rates 3691.6. Tax treatment of R&D expenses 3691.7. Taxation of intellectual property 369


xxv

Table of Contents

2.1. Characterization of manufacturing entities 3692.2. Principal manufacturers versus contract or toll

manufacturers 3712.3. Characterization of distributing/selling companies 3722.4. Conversion from full distributor into limited-risk

distributor 3732.5. Service company, commissionaire or agent 3742.6. Contract service providers 3752.6.1. General 3752.6.2. R&D credits 375

3. Transfer pricing details 3763.1. Issues arising upon restructuring 3763.2. Issues arising with respect to intangibles 3773.2.1. Goodwill 3773.2.2. Other intangible assets 3783.2.3. Valuation 3793.3. Post-restructuring issues 3793.3.1. Substance 3793.4. Recognition of transactions as presented 3803.4.1. Disregarding transactions 3803.4.2. Recharacterizing transactions 3813.5. Consequences of restructurings not subject to

recharacterization 3813.5.1. Compensation 3813.5.2. Commercial agents 3823.5.3. Transfer pricing 3833.6. Treatment of business restructuring expenses 3833.7. The bargaining theory applied to business restructuring 3843.8. Specific industries 3853.8.1. Automotive industry 3853.8.2. Pharmaceutical industry 3853.8.3. Banking industry 3853.8.4. Global trading 3863.8.5. Insurance industry 387

4. Permanent establishments 3874.1. Existence of a permanent establishment 3884.1.1. Agents 3894.1.2. Commissionaires 3894.1.3. Limited-risk distributors 3894.1.4. Contract or toll manufacturers 390

xxvi

Table of Contents

4.2. Allocation of profits to a permanent establishment 3904.2.1. General concept 3914.2.2. Allocation of assets 3914.2.3. Valuation and depreciation of assets 3924.2.4. Capital gains 3924.2.5. Allocation of risks 3924.2.6. Intra-company dealings 3934.2.7. Difference with authorized OECD approach 393



6. Case law 396

Chapter 15: United States

Corporate income tax framework 399.1. Corporate income tax system 399.2. Taxable entities 400.3. Taxable income 401.4. Tax losses 401.5. Tax rates 402.6. Tax treatment of R&D expenses 402.7. Taxation of intellectual property 403

2. Tax consequences of various models 4032.1. Characterization of manufacturing entities 4062.2. Principal manufacturer versus contract/toll manufacturer 4082.3. Characterization of distributing/selling companies 4102.4. Conversion from a fully fledged distributor to a

limited-risk distributor 4112.5. Conversion from a fully fledged distributor to a service

company or commissionaire 4132.6. Contract service providers: centralization of R&D

activities, contract maintenance and contract marketing 413

3. Transfer pricing details 4153.1. Issues arising upon restructuring, such as indemnification

for termination of activities 4173.2. Issues arising with respect to intangibles 4183.3. Post-restructuring issues 4203.4. Recognition of transactions as presented by a taxpayer 422

xxvu

Table of Contents

3.5.

3.6.3.7.3.8.3.8.1.3.8.2.3.8.3.3.8.4.3.8.5.

4.4.1.4.2.4.2.1.4.2.2.4.2.3.4.2.4.4.2.5.4.2.6.4.2.7.4.2.8.

5.5.1.5.1.1.5.1.2.5.2.5.3.

6.6.1.6.2.6.3.6.4.6.5.

Consequences of restructurings not subject torecharacterizationTreatment of business restructuring expensesThe bargaining theory applied to business restructuringSpecific industriesAutomotive industryPharmaceutical industryBanking industryGlobal tradingInsurance industry

Permanent establishment perspectiveExistence of a permanent establishmentAllocation of profits to a permanent establishmentGeneral conceptAllocation of assetsValuation and depreciation of assetsCapital gainsAllocation of risksIntra-company dealingsDifference with authorized OECD approachSpecific industries

Anti-avoidance provisionsThe Code and Treasury RegulationsInversionsOtherCommon lawSummary

Case lawJohnson Bronze Company caseHospital Corporation of America caseUnited Parcel Service of America, Inc. caseE.I. Du Pont de Nemours caseBausch & Lomb. Inc. case

426426427428428429430430431

431431433433434434434434434435435

435435436436437437

438438440442443444

XXVUl

Table of Contents

Chapter 16: Case Study

China - Case Study 452

Germany - Case Study 457

India - Case Study 460

Switzerland - Case Study 463

United Kingdom - Case Study 466

United States - Case Study 473

PartCConclusion

Chapter 17: Conclusion

1. Introduction 481

2. Business perspective and business models 483


4. Indirect taxes 488

5. Tax accounting 489

6. OECD Report 490

7. Future prospects 493

xxix

transfer pricing and business restructurings · 2010-05-13 · 7. changes to the business model as...

Documents