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1 8/21/2012 Intrductin t Transfer Pricing: The Basics David Whitmer, Managing Cnsultant dwhitmer@bkd.cm Elizabeth Hazzard, Supervising Cnsultant ehazzard@bkd.cm T Receive CPE Credit Participate in entire webinar Answer plls when they are prvided If yu are viewing this webinar in a grup Cmplete grup attendance frm with Title & date f live webinar Yur cmpany name Yur printed name, signature & address All grup attendance sheets must be submitted t training@bkd.cm within 24 hurs f live webinar Answer plls when they are prvided If all eligibility requirements are met, each participant will be ed their CPE certificates within 15 business days f live webinar 2 1

2 Agenda What is Transfer Pricing? Why is Transfer Pricing Imprtant? Examples f Intercmpany Transactins Functinal Analysis Overview f U.S. Transfer Pricing Methds Imprtance f Gd Dcumentatin Develpments in Enfrcement Other 3 3 What is Transfer Pricing? Analyzes related-party transactins in different tax jurisdictins Internatinal bundaries State/prvincial bundaries (dmestic transfer pricing) Transfer prices shuld be n arm s length basis As if related parties were unrelated Relevant rules/regulatins U.S. Sectin 482 f Internal Revenue Cde Other cuntries Have largely adpted OECD s Transfer Pricing Guidelines fr Multinatinal Enterprises and Tax Administratins ( OECD Guidelines ) 4 2

3 What Is Transfer Pricing? Arm s length standard In determining the true taxable incme f a cntrlled taxpayer, the standard t be applied in every case is that f a taxpayer dealing at arm s length with an uncntrlled taxpayer. A cntrlled transactin meets the arm s length standard if the results f the transactin are cnsistent with the results that wuld have been realized if uncntrlled taxpayers had engaged in the same transactin under the same circumstances. (arm s length result) (Treas. Reg (b)(1)) 5 5 What Is Transfer Pricing? Definitin f Cntrl ( (i)(4)) Cntrlled includes any kind f cntrl, direct r indirect, whether legally enfrceable r nt, and hwever exercisable r exercised, including cntrl resulting frm the actins f tw r mre taxpayers acting in cncert r with a cmmn gal r purpse. It is the reality f the cntrl that is decisive, nt its frm r the mde f its exercise. A presumptin f cntrl arises if incme r deductins have been arbitrarily shifted

4 Why Is Transfer Pricing Imprtant? Cmpliance Duble taxatin Mst transfer pricing adjustments result in duble taxatin Mutual agreement (r cmpetent authrity) prcess is slw & expensive fr taxpayers Penalties Failure t prepare & maintain cntempraneus dcumentatin leads t penalties Mst majr taxing jurisdictins have transfer pricing-related penalties U.S. 20% r 40% f tax adjustment U.K. Up t 100% f tax adjustment Canada Up t 10% f transfer pricing (incme) adjustment Penalties & interest are nt deductible in mst cuntries 7 Why Is Transfer Pricing Imprtant? Planning Planning lwers effective tax rate Establishes, as ppsed t defending, prices Internatinal Arbitrages between tax rates t place prfits in lw tax jurisdictins States Lwer net incme in separate filing states where cmpany has nexus 8 4

5 Why Is Transfer Pricing Imprtant? Other Reprting Issues Undcumented transactins can present reprting issues FIN 48 Reserving fr uncertain tax psitins ( UTPs ) Schedule UTP Ranking f UTPs fr which reserves were recrded Labeling f T next transfer pricing issues Identifying individual psitins that accunt fr 10% r greater f FIN 48 reserves Phased in between 2010 t 2014 based n ttal assets f taxpayer 9 Plling Questin 1 Per the U.S. Internal Revenue Cde, U.S. cmpanies are expected t abide by which standard? High-Five Standard Knee-Height Standard Arm s-length Standard Magic 8-Ball Standard Unsure 10 5

6 Examples f Intercmpany Transactins Intercmpany sale f tangible gds Sale f finished gds Sale f raw materials & wrk in prgress Cmmissin & purchasing agent services Transfer f prductin machinery XYZ U.S. (Manufacturing C.) Sale f gds Transfer price payment XYZ Japan (Distributin C.) Market price fr sale f gds Third Parties 11 Examples f Intercmpany Transactins Transfer f intangible prperty (IP) Transfer f technlgy IP Transfer f marketing IP Knw-hw Patents Prcesses Frmulatins Cpyrights, etc. XYZ U.S. (Research & Develpment C.) Trademarks Trade names Brand names Reputatin Custmer relatinships Custmer lists Sales frce, etc. License f technlgy Payment f ryalty (transfer price) XYZ Germany (Manufacturing C.) Market price fr sale f gds Third Parties 12 6

7 Examples f Intercmpany Transactins Prvisin f intercmpany services Management & administrative services Strategic management Other services Finance Technical services IT HR Marketing Legal Administrative, etc. Research & develpment services Value-added services Other supprt services XYZ U.K. (Subsidiary) XYZ U.S. (Head Office) Management Services Cst r Cst Plus XYZ Canada (Subsidiary) XYZ Australia (Subsidiary) 13 Examples f Intercmpany Transactins Financing Prvisin f intercmpany lans Guarantee fees by parent cmpany Leasing f tangible prperty XYZ Luxemburg (Finance C.) Repayment f Principal & Interest Lan XYZ U.S. (Debtr C.) 14 7

8 Functinal Analysis Functins Executive functins Cre business functins Manufacturing/distributins/services/ cnstructin/extractin Sales, general & administrative functins Research & develpment r value-added engineering r technical supprt functins Risks Market risks Custmers/custmer relatinships Vender risks Supply chain Inventry risks Prduct liability/warranty Financial risks Bad debts Assets utilized (tangible/intangible) 15 Overview f U.S. Transfer Pricing Methds Specified Methds Tangible Gds Intangible Gds Services Cmparable Uncntrlled Price Cmparable Uncntrlled Transactin Cmparable Uncntrlled Services Price Resale Price Prfit Split Grss Services Margin Cst Plus Cmparable Prfits Methd Cst f Services Plus Prfit Split Prfit Split Cmparable Prfits Methd Cmparable Prfits Methd Services Cst Methd 16 8

9 Overview f U.S. Transfer Pricing Methds Best Methd Analysis The arm s length result f a cntrlled transactin must be determined under the methd that, under the facts and circumstances, prvides the mst reliable measure f an arm s length result. (Treas. Reg (c)(1)). N hierarchy f methds Need t dcument why methd chsen is best methd & why ther methds were nt applicable In determining best methd, need t cnsider the fllwing: Degree f cmparability between cntrlled & uncntrlled transactins Quality & cmpleteness f underlying data & assumptins used in analysis 17 Plling Questin 2 Transfer pricing is mre art than science. True False Unsure 18 9

10 Imprtance f Gd Dcumentatin Penalties Internal Revenue Cde 6662 impses accuracy-related penalty fr underpayment f tax attributable t imprper transfer pricing (valuatin misstatement) Penalty Transactinal Net Adjustment Substantial Valuatin (20% penalty) Price r value is 200% r mre (50% r less) than Net adjustment exceeds the lesser f $5 millin r 10% Grss Valuatin (40% penalty) Price r value is 400% r mre (25% r less) than Net adjustment exceeds the lesser f $20 millin r 20% 19 Imprtance f Gd Dcumentatin General Gd dcumentatin prvides penalty relief Reasnably applied 482 t determine transfer pricing Dcumentatin is in existence at time f tax return filing Dcumentatin is prvided t IRS within 30 days f request Less expensive than IRS r freign tax authrity audit defense Cntempraneus vs. nncntempraneus Ideal fr dcumentatin t be in place at time tax return is filed Ptential penalty fr nncntempraneus dcumentatin Dcumentatin eases pain f transfer pricing audit Shrtens length f audit n (r pr) dcumentatin irritates auditrs Third-party specialists prvide mre credibility Frmally explains events. e.g., lsses, nw that might trigger audit in the future 20 10

11 Imprtance f Gd Dcumentatin Requirements 1. Overview f taxpayer s business including ecnmic & legal factrs which affect pricing 2. Descriptin f rganizatinal structure cvering all related-party transactins 3. Any specific dcuments required by Sectin 482 regulatins, e.g., cst-sharing agreements r market penetratin 4. Descriptin f selected methd & explanatin f ratinale fr selecting methd 5. Descriptin f unselected methds cnsidered & explanatin f why they were nt selected 21 Imprtance f Gd Dcumentatin Requirements 6. Descriptin f cntrlled transactins, including terms f sale & any internal data used t analyze thse transactins 7. Descriptin f cmparables used, hw cmparability was evaluated & adjustments made 8. Explanatin f ecnmic analysis & prjectins used in develping methd 9. Summary f relevant dcuments cllected between end f tax year & date return was filed 10. General index f principal & backgrund dcuments & recrdkeeping f thse dcuments 22 11

12 Imprtance f Gd Dcumentatin Typical Study Frmat Executive summary Scpe & use f study Descriptin f cntrlled transactin(s) Descriptin f taxpayer s business Organizatin structure Industry analysis Functinal analysis Regulatry framewrk Selectin f apprpriate r best methd Ecnmic analysis Relevant exhibits 23 Plling Questin 3 Transfer pricing dcumentatin must be prepared by which time t receive penalty prtectin? Befre (audit year) tax return is filed After (audit year) tax return is filed After IRS cmpletes audit Unsure 24 12

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14 IRS Enfrcement Develpments Given ecnmic crisis, IRS will vigrusly investigate U.S. multinatinal enterprises, which are seen as shpping fr best tax deals accrding t Cmmissiner Duglas Shulman Will need tax revenues t fund bailuts & ther stimulus spending There will be increased public pressure f crprate taxpayers t adhere t nt nly the letter f the law, but the spirit f the law in their hme cuntry law 27 IRS Enfrcement Develpments Transfer Pricing Cmpliance Initiative (Overview) January 2003 IRS LMSB* Cmmissiner issued directive launching new transfer pricing cmpliance initiative Directive instructs agents t Request transfer pricing dcumentatin at pening cnference f all audits Enfrce 30-day deadline fr prviding dcumentatin Prvide dcumentatin t IRS Internatinal Examiner r IRS ecnmist Penalties cannt be waived unless dcumentatin was prepared & submitted timely & apprved by Penalty Review Bard * Large and Mid Size Business Divisin (nw called Large Business & Internatinal Divisin) Cmpanies with assets ver $10 millin 28 14

15 IRS Enfrcement Develpments Transfer Pricing Cmpliance Initiative (Results) IRS cntinuing t audit mre small & mid-size cmpanies as part f mandate IRS rutinely requests transfer pricing studies as ppsed t listing TP dcumentatin requirements under Sectin 6662 IRS enfrcing requirement that TP dcumentatin be cntempraneus IRS interviewing individuals wh prepared dcumentatin & taxpayer persnnel Challenging taxpayer s dcumentatin 29 IRS Enfrcement Develpments Transfer Pricing Cmpliance Initiative (Results) Impsitin f penalties Reviewing Frm 5471/5472s fr data cnsistency IRS will audit taxpayer fr subsequent tax year if they find adjustment Can n lnger ignre U.S. TP dcumentatin requirements Dcumentatin shuld be kept current 30 15

16 IRS Enfrcement Develpments IRS Rerganizatin December 2009: IRS Cmmissiner Duglas Shulman annunced Transfer Pricing Practice within Large and Mid-Size Business (LMSB) Divisin f IRS Octber 2010: LMSB becmes Large Business and Internatinal (LB&I) Divisin New key psitins Internatinal Business Cmpliance (IBC) Directr Transfer Pricing Directr Chief Ecnmist IRS plans t add 2,000 staff t expand internatinal audit cverage Ecnmists t increase frm 80 t 120 Transfer Pricing Specialists (nn-cmpetent Authrity) t increase t 1, IRS Enfrcement Develpments Areas f Fcus Inbund cmpanies with lw prfitability All cmpanies with cst sharing arrangements Cmpanies with amended tax returns Services transactins Transfers f intangible prperty fr nil r insufficient cmpensatin 32 16

17 Plling Questin 4 The IRS has decreased transfer pricing enfrcement effrts since the 2008 recessin. True False Unsure 33 U.S. Tax Return Disclsures Disclsures Cvered in Tax Returns? Shrt answer yes Disclsure frms Frm 5471 U.S. Entity Owns Freign Subsidiary Schedule M details transactins between freign entities Frm 5472 Freign Entity Owns U.S. Subsidiary Frm shuld be filed with incme tax return f affected sharehlder $10,000 penalty fr failure t file per instance IRS has recently started t vigrusly assess penalties fr imprper filings 34 17

18 IRS Circular 230 Disclsure T ensure cmpliance with requirements impsed by the IRS, we infrm yu that any U.S. federal tax advice cntained in this cmmunicatin (including any attachments) is nt intended r written t be used, & cannt be used, fr the purpse f (i) aviding penalties under the Internal Revenue Cde r (ii) prmting, marketing r recmmending t anther party any transactin r matter addressed herein. 35 David Whitmer Managing Cnsultant dwhitmer@bkd.cm Elizabeth Hazzard Supervising Cnsultant ehazzard@bkd.cm 18

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