transfer pricing disputes, adjustments and cases © hugo vollebregt

Transfer Pricing Disputes, Adjustments and Cases

© Hugo Vollebregt

• Why taxpayers and tax administrations find themselves in conflicts on transfer pricing

• The various types of transfer pricing adjustments

• The dispute between the IRS (US) and GlaxoSmithKline (UK)

Purpose of today’s sessionAfter today you will have a better understanding of:

Contact details

Hugo Vollebregt

Amsterdam, The Netherlands

[email protected]

1The origin of transfer pricing disputes

Part

Why is transfer pricing relevant?

• 70% of world trade is intragroup

• Traditional tax disputes- Timing differences- Example: depreciation adjustment

• Modern tax disputes- Permanent differences- Example: transfer pricing adjustment

The origin of transfer pricing disputes

Are all sources aligned?

• National legislation

• Organisation for Economic Cooperation and Development, Paris

• United Nations, New York / Geneva

• European Union, Brussels

• National case law impact different from other case law


Organisation for Economic Cooperation and Development

• OECD Transfer Pricing Guidelines (2010)

• OECD Model Tax Convention (2008)- Article 7 (Business profits - PE)- Article 9 (Associated enterprises; arm’s length principle)


United Nations

• The UN Model Double Taxation Convention between Developed and Developing Countries (2011)

• Practical Manual on Transfer Pricing by Developing Countries (2012; draft)

• “tends to preserve a greater share of taxing rights for the source country”

• Difference OECD/UN


Position for graphic or image

Is there a storm gathering?

• Disagreement among OECD member countries

• Non – OECD member countries

• Competition for tax revenues (70%)


The issues over which disputes ariseNon-technical

• Who will answer to questions: company or individual employee?

• Documentation

• Language of documentation

• Access to foreign information, e.g. the accounts and records of the foreign group company engaged in the i/c transaction


The issues over which disputes ariseComparability

• Some countries require benchmarking based on national database instead of regional database searches for all countries where the group has operations

• EU research has shown that in 94% of 234 searches the profitability in national database searches was the same as in Pan-European database searches

• “Comparables found in regional (as opposed to national; HV) databases should not be rejected automatically”, CoC on EU Transfer Pricing Documentation; OECD TPG 3.35


• Local losses (structural)

• Local performance is less than group (sanity checks)

• Royalties in depressed markets

• Management charges and intercompany services, including elimination of shareholder expenses, evidence of services, evidence of benefits (especially in low cost areas), location savings, mark up, allocation key per cost category and withholding tax

The issues over which disputes ariseTechnical


• Cost plus method: Cost price calculations (local GAAP vs parent company GAAP; frequency of adjustment for prices of raw materials; capacity results, etc)

• Resale Price Method: Resale price unknown at moment of internal invoicing

• Budget vs. actuals (ex ante or ex post; true ups)

• Loans: amount of loan, interest rate and guarantee fees

The issues over which disputes ariseTechnical


• Recognition of intercompany transactions

- Transfer pricing analysis starts at i/c agreement

- Agreements vs. economic reality (actual behavior)

- Two exceptions (OECD TPG 1.65)

- EU Company Tax Study (2001): “MNEs can conduct business in ways independent companies cannot”

The issues over which disputes arise


• Mainly: Australia, Canada, India and US

• Why is foreign case law on transfer pricing relevant to you?

• Bausch & Lomb, US, 1991, tax haven• Compaq, US, 1999, products• DHL, US, 2002, trade mark valuation• GSK, US, 2006 (settlement)• Roche, Australia, 2008, comparables • Xilinx, US, 2010, stock options • GSK, Canada, 2010, CUPs• GE Capital, Canada, 2010, guarantee• Veritas, US, 2010, buy in payment• Rolls Royce, India, 2011, PE• Velcro, Canada, 2012, ownership of IP

Sources: International Transfer Pricing Case Law



• The OECD: It is not exact science and requires the exercise of good judgment (“the prudent business manager”)

• The judiciary: “Transfer pricing … evaluation of transactions … in an art”, Mentor Graphics, India, 2007

• In the end, it is all about fairness – which country may tax which share of the group’s total profits

• Fair share duty (Happé; NL)


Transfer pricing and NGOs


29 November 2010

Slide 18

“ The world's second-largest beer company, SABMiller, is avoiding millions of pounds of tax in India and the African countries where it makes and sells beer by routing profits through a web of tax-haven subsidiaries, according to a report published today by ActionAid today.

The company, whose brands include Grolsch, Peroni and Miller, and African beers Castle and Stone Lager, is accused by the development charity of siphoning profits out of developing countries and parking them offshore.

The SABMiller group is listed in London and makes profits of nearly £2bn a year. ActionAid estimates it may have reduced its African corporation tax bill by as much as a fifth last year, depriving poorer countries of up to £20m in tax, or enough to send a quarter of a million children to school. However, SABMiller said it completely rejected ActionAid's interpretation of its business structures.”

29 November 2010

“ SABMiller does not engage in aggressive tax planning in any part of its operations and the report includes a number of flawed assumptions," it said in a statement. "SABMiller companies pay a significant level of tax."

“ It added that SABMiller was a major direct investor, employer and taxpayer in Africa and other developing countries, making a substantial economic contribution to the continent and elsewhere. The company said there were sound commercial reasons for the location of its subsidiaries and that those offshore were fully taxed in the UK as controlled foreign companies (CFCs).”

Slide 19

MAP/ArbitrationLitigation/ADR

Conflict

Unilateral settlement APAs


Conflict options to the taxpayer

2Adjustments

Part

Types of adjustments

• Primary adjustment

• Secondary adjustment

• Corresponding adjustment

Transfer pricing adjustments

Primary adjustment





• Hindsight

• Can tax office test business decisions?

• The prudent business manager

Secondary transaction and secondary adjustmentWhere did the additional profit go to?







Balance sheet

Assets 100 Capital 60

Reserves 10

Profit 30

Total 100 Total 100



Balance sheet


Reserves 10

Profit 30

Total 100 Total 100

Balance sheetwith primary adjustment


Reserves 10

Profit 30

Adjustment 20

Total 100 Total 120



Balance sheetafter secondary transaction I


Reserves 10

Profit 30

Adjustment 20

Dividend - 20

Total 100 Total 100



Balance sheetafter secondary transaction I


Reserves 10

Profit 30

Adjustment 20

Dividend - 20

Total 100 Total 100

Balance sheetafter secondary transaction II


Receivable 20 Reserves 10

Profit 30

Adjustment 20

Total 120 Total 120






• More profit due to primary adjustment but no change to balance sheet

• Dividend DWHT

• Receivable Repayment

Corresponding adjustment



• Corresponding adjustment- Primary adjustment triggers double

taxation


A B Group

Profit (R) 100 900 1.000

Primary Adj.

300

Profit (A) 400 900 1.300





taxation- Corresponding adjustment

eliminates double taxation- Article 9 (2) OECD MTC- Article 25 OECD MTC


A B Group

Profit (R) 100 900 1.000

Primary Adj.

300

Profit (A) 400 900 1.300

Article 9 OECD Model Tax Convention

ASSOCIATED ENTERPRISES

1. (Arm’s length principle)

2. Where a Contracting State includes in the profits of an enterprise of that State – and taxes accordingly – profits on which an enterprise of the other Contracting State has been charged to tax in that other State and the profits so included are profits which would have accrued to the enterprise of the first mentioned State if the conditions made between two enterprises had been those which would have been made between independent enterprises, then that other State shall make an appropriate adjustment to the amount of the tax charged therein on those profits. In determining such adjustment, due regard shall be had to the other provisions of this Convention and the competent authorities of the Contracting State shall if necessary consult each other.


Article 25 OECD Model Tax Convention

MUTUAL AGREEMENT PROCEDURE

1. 1. Where a person considers that the actions (i.e. the primary adjustment; HV) of one or both of the Contracting States result ... in taxation not in accordance with the provisions of this convention he may ... present his case to the competent authority of the Contracting Sate of which he is a resident ...

2. The competent authority shall endeavour, if the objection appears to it to be justified and if it is not itself able to arrive at a satisfactory solution, to resolve the case by mutual agreement with the competent authority of the other Contracting State, with a view to the avoidance of taxation which is not in accordance with the convention (i.e. the double taxation because of the primary adjustment; HV) …






taxation- Corresponding adjustment

eliminates double taxation- Article 9 (2) OECD MTC- Article 25 OECD MTC


A B Group

Profit (R) 100 900 1.000

Primary Adj.

300

Profit (A) 400 900 1.300

Corresp.

Adj.-300

Profit (A’) 400 600 1.000

3Specific cases

Part

“Least complex” (routine) entity :

• No key value drivers• Routine activities• Routine reward

“Entrepreneur” or “principal”:

• Key value drivers • Management, decisions, authority, etc• Residual profit

Specific cases

Two group companies engage in an i/c transaction

38

H

R &D Plant

Sales office

GSK US 2006

Specific cases

UK US

39

H

R &D Plant

Sales office

GSK US 2006

Specific cases

UK US

40

H

R &D Plant

Sales office

GSK US 2006

Specific cases

UK US

Step 4

Select transfer pricing method that achieves step 3

Step 3

Allocate routine profit to other group company

Step 2Identify which group company owns KVD

Step 1

Identify key value drivers

Specific cases

GSK US 2006

Taxpayer on KVD

• R &D and manufacturing

• In UK

• US Sales office routine reward

Slide 42

Step 4


Step 3



Step 1


Specific cases

GSK US 2006

IRS on KVD

• Marketing and premium market

• In US

• US Sales office residual profit

Slide 43

Step 4


Step 3



Step 1


GSK US 2006

Specific cases

Taxpayer on KVD

• R &D and manufacturing

• In UK

• US Sales office routine reward

44

H

R &D Plant

Sales office

GSK US 2006

Specific cases

UK US

Taxpayer position IRS position

• Double tax not in accordance with the UK/US tax treaty mutual agreement procedure

• Art. 25 OECD Model Convention (1963 – 2008) on MAP: - “The competent authority…shall endeavour.... to resolve…with the

competent authority of the other…state…”

• Update of the OECD Model Tax Convention to include an arbitration clause (2008)

Specific cases

GSK US 2006

“ GlaxoSmithKline agreed to pay approximately $3.4 billion to settle charges by the IRS that the company under-reported profits to avoid paying U.S. taxes. The Internal Revenue Service accused GSK of a practice called "transfer pricing," by which a company claims most of its earnings belong in a country where taxes are low. The transactions at issue, which concerned the way GSK priced drugs for sale through its U.S. subsidiary, occurred between the years 1989 and 2005 ”

Specific cases

Transfer pricing and the mediaFederal Contractor Misconduct Database

Contact details

Hugo Vollebregt

Amsterdam, The Netherlands

[email protected]

transfer pricing disputes, adjustments and cases © hugo vollebregt

Documents

pricing relevant

cases hugo vollebregt

national database searches

oecd model tax convention

withholding tax

tax revenues

tax administrations

regional database searches