Transfer Pricing Manual. Technical Editor: Gareth Green

Transfer Pricing Manual Technical Editor: Gareth Green

Contents List of abbreviations xiv List of contributors. xvii Foreword xxvii Preface xxxiii Part A: General principles 1 Introduction 3 Gareth Green TRANSFER PRICING SOLUTIONS, UK 1.1 The evolving importance of transfer pricing 3 1.2 Why is transfer pricing such a major issue? 5 1.3 Alternatives to the arm's length principle 8 1.4 Nomenclature 9 1.5 Conclusion 10 2 The arm's length principle 11 Koichiro Fujimori DELOITTE TOUCHE TOHMATSU, TOKYO 2.1 OECD efforts to create a harmonised principle 12 2.2 Interpretation of the arm's length principle 13 2.3 Associated enterprise 15 2.4 Factors distorting the arm's length principle 25 2.5 Application of the arm's length principle 17 2.6 Conclusion 20

vi Contents 3 Transfer pricing methods 21 Carsten Kratzer ROLFSPARTNER, DUSSELDORF 3.1 Introduction 21 3.1.1 Overview of methods 21 3.1.2 Selection of a transfer pricing method 23 3.2 Comparable Uncontrolled Price method 24 3.2.1 Application 24 3.2.2 Types of Comparable Uncontrolled Price method 25 3.2.3 Comparability 28 3.2.4 Strengths and weaknesses 32 3.3 Resale Price method 32 3.3.1 Application 32 3.3.2 Types of Resale Price method 33 3.3.3 Comparability 35 3.3.4 Strengths and weaknesses 38 3.4 Cost Plus method 39 3.4.1 Application 39 3.4.2 Types of Cost Plus method 39 3.4.3 Comparability 40 3.4.4 Strengths and weaknesses 42 3.5 Transactional Net Margin method 42 3.5.1 Application 42 3.5.2 Procedure 43 3.5.3 Example of application 50 3.5.4 Comparison with the Comparable Profits method 52 3.5.5 Strengths and weaknesses 52 3.6 Unspecified methods 54 4 Profit Split methods 55 Dr Alexander Voegele NERA, GERMANY 4.1 Application of Profit Split methods 55 4.2 Forms of the Profit Split method 57 4.2.1 Overall Profit Split method 58 4.2.2 Comparable Profit Split method 59 4.2.3 Residual Profit Split method 62 4.3 OPSM for the determination of IP royalties 63 4.3.1 Selected method: Overall Profit Split method 64 4.3.2 The Overall Profit Split method 65 4.4 Strengths and weaknesses of profit splits 73

Contents vii 5 Permanent establishments and profit apportionment 75 Andrew Senior RABOBANK INTERNATIONAL, LONDON BRANCH 5.1 Introduction 75 5.2 The technical and practical landscape 78 5.2.1 Domestic law and Article 7, OECD Model Treaty 78 5.2.2 UN model treaty 79 5.2.3 The two treaty concepts in practice 80 5.2.4 OECD principles 81 5.2.5 Accounts of the PE 85 5.2.6 Avoidance of double taxation 87 5.2.7 Financial institutions 88 5.2.8 Agency 95 5.3 Live issues and some practical examples 97 5.3.1 Introduction 97 5.3.2 Separate entity hypothesis and independent dealings 97 5.3.3 Inventory transfer 98 5.3.4 The treatment of fixed assets 99 5.3.5 Intangibles 100 5.3.6 Finance costs 201 5.3.7 Business reorganisations 102 5.3.8 Provision of services involving PEs 203 6 Practical issues in implementing a transfer pricing study 105 Dick de Boer PRICEWATERHOUSECOOPERS, AMSTERDAM 6.1 Key message 105 6.1.1 Introduction 105 6.1.2 Guide to the reader 106 6.2 Definition of transfer pricing implementation 207 6.3 Potential implementation issues 207 6.3.1 Financial/administrative issues 208 6.3.2 Operational issues 222 6.4 Transfer pricing in a changing business environment 229 6.4.1 Corporate governance rules 120 6.4.2 Changing attitude of tax authorities 122 6.4.3 Financial reporting requirements 222 6.5 Steps to implementation of a transfer pricing system 223 6.5.1 COSO enterprise risk management 123 6.5.2 Steps to achieve a TP control framework 224 6.6 Conclusions and recommendations 232

viii Contents 7 Practical issues in carrying out a transfer pricing study 133 Leslie Prescott-Haar ERNST & YOUNG, NEW ZEALAND 7.1 Design and compliance objectives 133 7.1.1 Design and planning documentation 234 7.1.2 Compliance documentation 235 7.1.3 Unilateral or multilateral documentation 236 7.2 Planning a transfer pricing study 242 7.2.1 Understand the objective of the study 242 7.2.2 Scoping the study 242 7.3 The ideal transfer pricing team 244 7.4 Contents of transfer pricing document 247 7.4.1 Business overview and financial analysis 247 7.4.2 Industry analysis 149 7.4.3 Functional analysis 249 7.4.4 Economic analysis 150 7.5 Comparability considerations and issues 253 7.5.1 Finding benchmarking information 153 7.5.2 Level of comparability achievable in practice 258 7.5.3 Practical view on adjustments in a TP context 2 62 7.5.4 Importance of comparable data vs. other factors 2 63 7.5.5 Interquartile outside the USA 165 7.6 Post-completion stage 167 Part B: Types of transactions 8 Intra-group services 171 Peter Male TRANSFER PRICING SOLUTIONS, UK 8.1 Introduction 272 8.2 The OECD Guidelines 272 8.2.1 What constitutes an intra-group service? 172 8.2.2 Has there been a supply of intra-group services? 2 73 8.3 Determining the arm's length price 2 78 8.3.1 Direct charge method 279 8.3.2 Indirect charge method 279 8.3.3 Situations for an indirect charging method 280 8.4 Use of allocation keys 282 8.5 Calculating the arm's length price 283 8.6 To profit or not to profit? 184 8.6.1 The "no profit" concession 187 8.6.2 Pass-throughs 287 8.7 Some practical aspects 188

Contents ix 8.7.1 Benchmarking of management services 189 8.8 Intra-group service contracts 292 8.9 Operating an intra-group services charging system 293 8.10 US code for controlled services transactions 293 8.10.1 Introduction and background 193 8.10.2 The Regulations 194 8.10.3 The methods 195 8.11 Conclusion 200 9 Intra-group financing 201 Alfredo J. Urquidi MARSH & MCLENNAN COMPANIES, INC., USA 9.1 Introduction 202 9.1.1 Definition and scope 202 9.2 Loans 202 9.2.1 OECD perspective 203 9.2.2 US perspective 207 9.2.3 Thin capitalisation 210 9.3 Guarantee fees 222 9.3.1 Overview 212 9.3.2 Is an arm's length charge warranted? 224 9.3.3 Pricing financial loan guarantees 227 9.4 Conclusion 222 10 Intangible property 223 Michael Heimert CETERJS, INC., CHICAGO 10.1 What is intangible property? 223 10.1.1 Identification of intangible property 225 10.1.2 Legal versus economic ownership 227 10.2 Transferring intangible property 229 10.3 Licence agreements 230 10.3.1 Royalty payments 230 10.3.2 Lump sum payments 231 10.3.3 Cross-licensing 232 10.3.4 Bundled payments 233 10.4 Valuation of intangible property 233 10.4.1 CUP method 234 10.4.2 Transactional Net Margin method 234 10.4.3 Profit Split methods 235 10.4.4 Other methods 236 10.5 Implementation 237 10.5.1 Developing inter-company agreements 237 10.5.2 Creating documentation 237

x Contents 10.5.3 Monitoring inter-company payments 238 10.5.4 "Commensurate with income" concerns 238 10.6 Conclusion 239 11 Cost contribution agreements 241 Stephane Gelin CMS BUREAU FRANCIS LEFEBVRE, PARIS 11.1 Introduction 242 11.2 Definition of cost contribution agreements 242 11.2.1 OECD/US definition 242 11.2.2 CCA vs. other forms of joint venture 243 11.2.3 Alternatives to CCA: licensing model 244 11.2.4 CCA vs. licensing model 246 11.3 Creation of a cost contribution agreement 247 11.3.1 Participants 247 11.3.2 Definition of costs 249 11.3.3 Allocation of costs 252 11.3.4 Contributions and balancing payments 252 11.4 Management of cost contribution agreement 254 11.4.1 Ownership of intangibles 254 11.4.2 Buy-in and buy-out payments 255 11.5 CCA as a tax optimisation tool 257 11.5.1 "Cost sharing out" technique 257 11.5.2 Hurdles 259 11.6 Challenging a cost contribution agreement 260 11.6.1 Adjusting contributions 260 11.6.2 Disregarding the agreement 260 11.7 Termination of a cost contribution agreement 261 11.7.1 Surrendering interest: tax treatment 261 11.7.2 Sharing intangibles 262 11.8 Documentation of a cost contribution agreement 263 11.8.1 Terms of the CCA 263 11.8.2 Documents outside cost contribution agreement 265 11.8.3 US Documentation specific to CSA 265

Contents xi Part C: Planning and controversy 12 Considering transfer pricing in tax planning 269 Dick Clark, Arindam Mitra and Jeff Mensch DELOITTE TAX LLP, WASHINGTON DC AND PITTSBURGH 12.1 Considering changes to transfer pricing charges 269 12.1.1 Tax attributes and profiles 270 12.1.2 Transfer pricing considerations 271 12.1.3 Implementation hurdles 273 12.1.4 Planning for the future state 274 12.2 Use of central entrepreneur structures 275 12.2.1 Opportunities arising from business changes 276 12.2.2 Typical structural elements 277 12.2.3 Implementation hurdles 279 12.2.4 Planning for an alternative future state 281 13 Eliminating double taxation 283 John Hobster and Sean Trahan ERNST & YOUNG, LONDON AND ATLANTA 13.1 What gives rise to double taxation? 283 13.2 Overview of available remedies 283 13.3 Mutual Agreement Procedure (MAP) 284 13.3.1 Internal transfer pricing adjustment mechanisms 286 13.3.2 Common forms of transactions challenged 287 13.3.3 Profile of transfer pricing audits 287 13.3.4 European Arbitration Convention 288 13.3.5 OECD and arbitration 289 13.3.6 Global legislative and enforcement trends 289 13.4 Practical examples 291 13.5 EU guidance: code of practice 292 13.6 Advance pricing agreements 293 13.6.1 Legal framework 293 13.6.2 Frequency and availability 294 13.6.3 Coverage and duration 295 13.6.4 APAs as a dispute resolution tool 13.6.5 Appetite of taxpayers to use APAs 296 13.6.6 What type of APA? 297 13.6.7 Litigation 298 13.7 Conclusion 299

xii Contents Part D: Specific industries 14 Banking and global trading of financial instruments 303 Sherif Assef CETERIS, NEW YORK 14.1 Introduction 303 14.1.1 Commercial banking 303 14.1.2 Investment banking 303 14.1.3 Trading of financial instruments 304 14.2 Typical transfer pricing issues 305 14.2.1 Commercial banking 305 14.2.2 Investment banking 306 14.2.3 Trading 308 14.2.4 Common issues 320 14.3 Applicable methods and data 322 14.3.1 Commercial banking 322 14.3.2 Investment banking 315 14.3.3 Trading 327 14.3.4 Common transfer pricing issues 320 15 Insurance and investment management 323 Stephen Labrum, Martin Zetter, Jenny Coletta, Jonathan Thompson ERNST & YOUNG, LONDON AND TOKYO 15.1 Introduction 323 15.2 Insurance 324 15.2.1 Objectives of section 324 15.2.2 Industry developments - insurance 324 15.2.3 Common issues in the insurance industry 325 15.2.4 Leading practices in TP methods 333 15.2.5 Case study 338 15.2.6 Conclusion - insurance 342 15.3 Investment management 342 15.3.1 Objectives of section 342 15.3.2 Industry developments 343 15.3.3 Common issues in investment management industry 344 15.3.4 Case study 354 15.3.5 Conclusion - investment management 357 15.4 Summary 357 16 Telecommunications 359 Ted Keen and Anjali Bhasin CRAI, WASHINGTON DC 16.1 An overview of the industry and the players 359 16.1.1 Wireline 359. 16.1.2 Wireless 362

Contents xiii 16.1.3 Telecom equipment 362 16.1.4 The evolving competitive landscape 365 16.2 Transfer pricing models in the telecom industry 365 16.2.1 Shared entrepreneurial risk model 367 16.2.2 Service provider model 372 16.2.3 Hybrid model 375 16.2.4 Cost-sharing arrangements 376 17 Professional services and global contracts 377 Gareth Green TRANSFER PRICING SOLUTIONS, UK 17.1 Scope 377 17.2 Subcontracted work and global contracts 378 17.2.1 Pricing of subcontract work 379 17.2.2 Referrals 382 17.2.3 Write-offs 383 17.2A Global contracts 384 17.3 Secondments 388 17.3.1 Pricing 389 17.3.2 Interaction with OECD Model DTA 390 17A Issues for partnerships 390 17.4.1 Introduction 390 17.4.2 Shareholder costs 392 17.4.3 Charging for partners 393 17 A A Branches of partnerships 395 17.5 Network benefits 396 17.5.1 Transfer pricing treatment 398 17.5.2 Pricing 400 17.6 Conclusion 401 18 Pharmaceuticals 403 Herve Couttier and Molly Minnear DELOITTE, AUSTRALIA AND CRAI, WASHINGTON DC 18.1 Background 403 18.2 Introduction 404 18.3 Research and development 406 ISA Clinical trials 409 18.5 Manufacturing 420 18.6 Pre-launch and launch expenses 413 18.7 Marketing 415 18.8 Generics 429 18.9 Conclusions 419 Index 421