Transfer pricing methods and business model optimization

Transcription

1 32E Tax Planning of International Enterprises Transfer pricing methods and business model optimization Aalto BIZ / April 27, 2016 Petteri Rapo Alder & Sound Mannerheimintie 16 A FI Helsinki firstname.lastname@aldersound.fi The Finnish Transfer Pricing Firm of the Year in 2015 & 2011 The European Tax Innovator of the Year in 2013 The Best European Newcomer in 2012

2 Agenda April 27, 2016 Transfer pricing methods and business model optimization Introduction Transfer pricing National and international regulatory framework Transfer pricing Key concepts & terminology Transfer pricing methods Main features and differences Transfer pricing & international tax planning External & internal factors Business model optimization Centralized operating model Transfer pricing methods and business model optimization April 27, 2016 Page 1

3 Guest speaker Petteri Rapo, Senior Associate, Acting CEO, Alder & Sound Master of Science (Business Law, Finance) Aalto University, School of Business (former HSE) Joined A&S in 2011, previous work experience from accounting and financial administration. Acting CEO as of January 1, 2016 Professional experience from working with multinational corporations from a range of industries, including construction, consumer goods, chemicals, food products, engineering, mining and software. Specialized in demanding transfer pricing engagements, intra-group financing, intangible assets and tax considerations related to operating in BRICS and other developing regions. Selected recent reference work: Assumed the overall responsibility for managing the transfer pricing compliance of a multinational group as an in-house resource (TP BackOffice) Assisted a multinational corporation in a tax optimization process, with over 3.3 million Euros in estimated annual cash tax savings Assisted a multinational corporation in a tax audit process regarding intra-group financing, with estimated tax risk exceeding 7 million Euros Designed a calculation model for determining arm s length intra-group charges on intangibles in a highly decentralized operating model Participated in APA negotiations involving multiple jurisdictions Transfer pricing methods and business model optimization April 27, 2016 Page 2

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5 Transfer pricing National and international regulatory framework The regulatory framework for transfer pricing consists of both national and international guidelines and legislation OECD: Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations YK: Practical Manual on Transfer Pricing for Developing Countries EU: Joint Transfer Pricing Forum (JTPF) Code of conduct for the effective implementation of the Arbitration Convention Code of conduct on transfer pricing documentation for associated enterprises in the EU Guidelines for Advance Pricing Agreements (APAs) in the EU Guidelines on low-value-adding intra-group services Potential approaches to non-eu triangular cases Report on Small and Medium Enterprises (SMEs) and Transfer Pricing Report on Cost Contribution Arrangements on Services not creating Intangible Property (IP) Report on Secondary Adjustments Report on Transfer Pricing Risk Management Report on Compensating Adjustments Finland: VML 14 a-c, 31 ja 32.4 Transfer pricing methods and business model optimization April 27, 2016 Page 4

6 Transfer pricing National and international regulatory framework (cont d) The amount of countries with national transfer pricing legislation has steadily increased since 1990s United States OECD:n jäsen Regulations since 1986, revision in 2011 Russia OECD candidate Regulations since 2012 Germany OECD key member Regulations since 1983, revision in 2008 China OECD key partner Regulations since 1991, revision in 2008 Brazil OECD key partner Regulations since 1997, revision in 2012 South Africa OECD key partner Regulations since 1995, revision in 2012 India OECD key partner Regulations since 2001, revision in 2013 Transfer pricing methods and business model optimization April 27, 2016 Page 5

7 Transfer pricing Key concepts & terminology Arm s length principle Associated enterprises Transfer pricing Transfer pricing refers to the setting of the price for goods, services, intangibles and financing sold or transferred between associated (or related) parties (legal entities) within a multinational enterprise (MNE). Associated enterprises (also related or affiliated parties) Two enterprises are associated enterprises with respect to each other if one of the enterprises meets the conditions of Article 9, sub-paragraphs 1a) or 1b) of the OECD Model Tax Convention with respect to the other enterprise. same individuals Direct or indirect participation in the 1) management, 2) control or 3) capital Company 1 Company 2 Arm s length principle A standard adopted by the OECD according to which transactions between two related parties should be conducted as if the parties were unrelated. Transfer pricing methods and business model optimization April 27, 2016 Page 6

8 Transfer pricing Key concepts & terminology (cont d) Functional analysis seeks to identify the economically significant activities, assets and risks P/L statement: Sales COGS / COGM 50 Gross profit 50 - OPEX 30 Operating profit 20 Return on investment (ROI) = Net profit / Total assets Functional analysis The functional analysis seeks to identify the economically significant activities and responsibilities undertaken, assets used and risks assumed by the parties to this explicit transaction and then assign the parties to the transaction with economic and tax characterizations. Economic characterization Economic characterization reflects the managerial perception related to the role of such entity in the value chain. Often utilized economic characterizations are expense / cost center, revenue center, profit center and investment center. Tax characterization Tax characterization reflects the relation between functions & risks and the anticipated profit level of a party to the transaction. Often utilized economic characterizations assigned to a party to the transaction are principal, fully-fledged / full-risk operator and limited-risk operator. Transfer pricing methods and business model optimization April 27, 2016 Page 7

9 Transfer pricing Key concepts & terminology (cont d) Comparable uncontrolled transaction Comparability analysis Comparable uncontrolled transaction A transaction between two independent parties that is comparable to the controlled transaction under examination. It can be either a transaction between one party to the controlled transaction and an independent party (internal comparable) or between two independent parties (external comparable). Controlled transaction Company 1 Company 2 Uncontrolled transaction Uncontrolled transaction Independent party Uncontrolled transaction Independent party Comparability analysis A comparison of a controlled transaction with an uncontrolled transaction or transactions. Transfer pricing methods and business model optimization April 27, 2016 Page 8

10 Transfer pricing methods Main features and differences CUP Cost Plus Resale Price TNMM PS Comparable uncontrolled price method (CUP) A method of pricing that compares the price for property or services in a controlled transaction to the price charged for property or services transferred in a comparable uncontrolled transaction in comparable circumstances. Cost Plus method (C+) A method of pricing based on the costs incurred plus an appropriate mark-up. Resale Price Method (also Resale Minus, R-) A pricing method based on the price at which a product that has been purchased from an associated enterprise is resold to an independent enterprise. The resale price is reduced by the resale price margin. Transactional net margin method (TNMM) A profit-based method that compares the profitability of a taxpayer to the profits of comparable entities undertaking similar transactions. Profit Split Method (PS) A method of pricing where the profit or loss of a multinational enterprise is divided in a way that would be expected of independent enterprises in a similar, highly integrated relationship (e.g. joint venture). + Other method Internal vs. external transfer pricing method OECD / the most appropriate method vs. YK / the most suitable method vs. IRS (US) / the best method -principle Transfer pricing methods and business model optimization April 27, 2016 Page 9

11 Transfer pricing methods Main features and differences (cont d) Example The effect of transfer price used in the intra-group transaction on the profitability of the parties Group company 1 Group company Sales COGM 50 = Gross profit 50 - Operating expenses 30 = Operating profit 20 Sales COGM 100 = Gross profit 50 - Operating expenses 30 = Operating profit 20 Transfer pricing methods and business model optimization April 27, 2016 Page 10

12 Transfer pricing methods Main features and differences (cont d) Example The effect of transfer price used in the intra-group transaction on the profitability of the parties Group company 1 Group company Sales COGM = Gross profit Operating expenses = Operating profit Sales COGM = Gross profit Operating expenses = Operating profit Transfer pricing methods and business model optimization April 27, 2016 Page 11

13 Transfer pricing methods Main features and differences (cont d) Example The effect of transfer price used in the intra-group transaction on the profitability of the parties Group company 1 Group company Sales COGM = Gross profit Operating expenses = Operating profit Sales COGM = Gross profit Operating expenses = Operating profit Transfer pricing methods and business model optimization April 27, 2016 Page 12

14 Transfer pricing methods Main features and differences (cont d) CUP Cost Plus Resale Price TNMM PS C+ CUP R- Company 1 Company 2 TNMM PS TNMM P/L statement Applicable TP method Turnover (sales) CUP - Cost of goods manufactured / Cost of goods sold = Gross profit C+ / R- - Operating expenses = Operating profit (EBIT) TNMM / PS Transfer pricing methods and business model optimization April 27, 2016 Page 13

15 Transfer pricing methods Main features and differences (cont d) Case example Company A operates in different roles depending on the intra-group transaction at hand Transaction 1 Provision of contract manufacturing by Company A to group companies Company A Tested party C+ / TNMM Group companies Contract manufacturer (limited risk profile) Cost center Cost plus / TNMM Transaction 2 Sale of goods by company A to group companies Company A R- / TNMM / RPS Group companies Tested party Principal (bears significant risks) Profit center Resale minus,tnmm, residual profit split Transfer pricing methods and business model optimization April 27, 2016 Page 14

16 Transfer pricing & international tax planning External factors Changing corporate tax rates create constantly changing operating environment for MNEs Transfer pricing methods and business model optimization April 27, 2016 Page 15

17 Transfer pricing & international tax planning Internal factors Business model optimization project aims at creating value through changes in the internal operating model Growth (through organic expansion or acquisitions) often leads over time to a suboptimal business model and inefficient organizational structure. As a result, the following challenges are often observed when analyzing the performance of the group as a whole: Missed business opportunities and unutilized intra-group synergies; Duplicating and / or overlapping functions leading to high cost structure; Proliferation of legal entities causing both high transaction costs and complicated strategic view and steering; Operational inefficiency and underutilization of resources; Insufficient level of process organization and standardization preventing full obtainment of benefits stemming from the economies of scale; Increased tax leakage, potential double taxation and, thus, high effective global tax rate; Increased pricing and compliance risks related to intra-group transactions. From the transfer pricing point of view, the main problems of a suboptimal business model relate to a high effective global tax rate and increased intra-group pricing / compliance risks. As a solution, the business model optimization (BMO) process aims at creating value through changes in the internal operating model. Transfer pricing methods and business model optimization April 27, 2016 Page 16

18 Business model optimization (BMO) Prequisities & triggering factors There are certain prequisities and triggering factors for a business model optimization process Prerequisities: - Legal & operational presence in multiple jurisdictions - Cross-border value chain & significant intra-group trade Triggering factors: - Shifting from local operations towards regional or global operating model - Restructuring & mergers / acquisitions - Improvement of cross-border delivery, trade and value chains - Standardization of operating processes and / or harmonization of systems - Implementation of group-wide enterprise resource planning (ERP) system - High local CIT rates, high effective tax rate - Lack of systematic approach & processes for tax payments Transfer pricing methods and business model optimization April 27, 2016 Page 17

19 Business model optimization (BMO) Traditional decentralized operating model The traditional decentralized operating model often creates a spider web of intra-group transactions MNE Headquarter / Management Manufacturer & Patent owner Distributor / Manufacturer Manufacturer / Distributor Distributor / Local brand owner Manufacturer / Researcher Distributor / Manufacturer Manufacturer / Distributor Agent Transfer pricing methods and business model optimization April 27, 2016 Page 18

20 Business model optimization (BMO) Centralized operating model Centralized operating models have been increasing their global popularity throughout the last decades Decentralized operating model Centralized operating model Principal company Risks Value adding functions Local company 1 Local company 2 Local company 3 Risks Risks Value adding functions Basic functions Risks Value adding functions Basic functions Risks Value adding functions Basic functions BMO Local company 1 Local company 2 Local company 3 Basic functions Basic functions Basic functions Value adding functions Risks Value adding functions CIT rate 20 % CIT rate 25 % CIT rate 30 % CIT rate 20 % CIT rate 25 % CIT rate 30 % CIT rate < 20 % Effective tax rate: % Effective tax rate: < 20 % Transfer pricing methods and business model optimization April 27, 2016 Page 19

21 Business model optimization (BMO) Centralized operating model - Publicly known examples Transfer pricing methods and business model optimization April 27, 2016 Page 20

22 Business model optimization (BMO) Practical & compliance considerations Business model optimization project aims at creating value through changes in the internal operating model From practical point of view, there are various factors and issues to be considered in connection with business model optimization process: Operational model & transfer pricing model Legal & organizational structure Tax and other obligations (WHT, VAT, customs) Financing structure (internal / external) Intangibles / IPR Agreements (internal / external) IT and other systems HR and management incentives From compliance point of view, there are two main considerations: Are the business reasons for the reorganization / optimization? Is there need for compensation in relation to transfer of functions, assets and / or risks? Transfer pricing methods and business model optimization April 27, 2016 Page 21

23 Transfer pricing & BEPS Key changes and anticipated development BEPS Action Plan 1. Tax challenges of the digital economy 2. Neutralize the effects of hybrid mismatch arrangements 3. Strengthen CFC rules 4. Limit base erosion via interest deductions and other financial payments 5. Counter harmful tax practices more effectively, taking into account transparency and substance 6. Prevent treaty abuse 7. Prevent the artificial avoidance of PE status 8. [Transfer pricing & value creation] Intangibles 9. [Transfer pricing & value creation] Risks and capital 10. [Transfer pricing & value creation] Other high-risk transactions 11. Establish methodologies to collect and analyse data on BEPS and the actions to address it 12. Require taxpayers to disclose their aggressive tax planning arrangements 13. Re-examine transfer pricing documentation 14. Make dispute resolution mechanisms more effective 15. Develop a multilateral instrument Transfer pricing methods and business model optimization April 27, 2016 Page 22

24 BEPS Actions 8-10 Intangibles, risks and capital, other high-risk transactions BEPS Actions 8-10 aim at ensuring alignment of transfer pricing outcomes with value creation As a result of deliverables from BEPS Actions 8-10, the following chapters of OECD transfer pricing guidelines have been updated & revised: I (The Arm s Length Principle), II (Transfer Pricing Methods), VI (Special Considerations for Intangible Property), VII (Special Considerations for Intra-Group Services) and VIII (Cost Contribution Arrangements) The aim is to ensure alignment of transfer pricing outcomes and value creation by comparing the agreement terms and actual activities (functions, assets, risks) of the parties Connection with BEPS Actions 3 (CFC), 4 (interest deductions and financial payments), 6 (treaty abuse), 13 (transfer pricing documentation) and 14 (dispute resolution mechanisms) Transfer pricing methods and business model optimization April 27, 2016 Page 23

25 BEPS Action 13 Re-examine transfer pricing documentation The three-tiered transfer pricing documentation model was introduced in September 2014 Three-tiered transfer pricing documentation model was introduced in September 2014 Emphasis on up-to-date documentation Ex ante vs. ex post approach to pricing and arm s length validation Three-tiered transfer pricing documentation model Master file: An overview of the multinational group Local file: Details specific to a local taxpayer s business, intercompany transactions and supporting analysis Country-by-Country (CbC) reporting: Aggregate tax jurisdiction-wide information relating to revenues, taxes paid and indicators of economic activity Transfer pricing methods and business model optimization April 27, 2016 Page 24

26 What next? The international transfer pricing landscape is in the state of constant change Increasing interest towards transfer pricing practices of MNEs by supranational organizations, local tax authorities and media Intangibles & intra-group financing Transparency & information exchange National implementation of OECD BEPS measures EU is looking for a more active role within the union Shifting focus towards proactive approach Culture of compliance Ex ante vs. ex post Real-time (horizontal) monitoring Advance pricing agreements (APAs) Transfer pricing methods and business model optimization April 27, 2016 Page 25

27 Petteri Rapo Senior Associate, Acting CEO Mobile Alder & Sound - Your trusted partner in international business The Finnish Transfer Pricing Firm of the Year in 2015 & 2011 The European Tax Innovator of the Year in 2013 Alder & Sound Mannerheimintie 16 A FI Helsinki firstname.lastname@aldersound.fi