KPMG Webcast: OECD Developments Transfer Pricing Aspects of Intangibles and Documentation September 11, 2013
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Today s Speakers Clark Chandler, PhD, Principal, Economic & Valuation Services, Washington National Tax, KPMG LLP (U.S.) Stephen Blough, PhD, Principal, Economic & Valuation Services, Washington National Tax, KPMG LLP (U.S.) Prita Subramanian, PhD, Managing g Director, Economic & Valuation Services, Washington National Tax, KPMG LLP (U.S.) Matthew Whipp, Director, Global Transfer Pricing Services, KPMG LLP (U.K.) 3
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Today s Agenda Background and Overview OECD White Paper on Transfer Pricing Documentation OECD Revised Discussion Draft on Intangibles Q&A 5
Background and Overview To ask a question, click ask a question on your media player. 6
Tax and Regulatory Climate Rise of political and media focus U.S. Senate Permanent Subcommittee on Investigations hearings, U.K. Parliament s Public Accounts Committee hearings, investigative media reporting Base Erosion and Profit Shifting (BEPS) initiatives OECD BEPS Action Plan, July 2013 Actions 8, 9, 10 Assure that transfer pricing outcomes are in line with value creation (Action 8 intangibles) Action 13 Re-examine transfer pricing documentation Trend toward worldwide reporting/transparency 7
OECD Intangibles and Documentation Projects On July 30, 2013, OECD released Revised Discussion Draft on Transfer Pricing Aspects of Intangibles White Paper on Transfer Pricing Documentation Both projects have evolved into significant components of the OECD s BEPS project Comments requested by October 1, 2013 Public consultation in Paris on November 12-13 13, 2013 By September 2014, the OECD expects to Finalize revised Chapter VI on intangibles of OECD Guidelines Recommend changes to OECD and domestic documentation guidelines/rules 8
OECD White Paper on Transfer Pricing Documentation To ask a question, click 'ask a question on your media player. 9
White Paper on Transfer Pricing Documentation The White Paper invites public comments on how transfer pricing documentation rules can be modified to Make transfer pricing compliance simpler, and Provide tax authorities with more useful information for transfer pricing risk assessment and audits The White Paper Surveys existing guidance and initiatives on transfer pricing documentation Considers the purposes of transfer pricing documentation requirements Suggests a two-tiered tiered approach to documentation Global masterfile for big picture risk assessment, and Local detailed information on individual transactions 10
Proposed Global Masterfile Proposed Global Masterfile available to all tax authorities will include, according to White Paper: General description of MNE s business including profit drivers, supply chain, related party service arrangements, functional analysis showing principal contribution to value creation by individual entities Information on group treatment of intangibles including: Description of strategy for development, ownership, and exploitation of intangibles including location of primary R&D facilities and location of R&D management List of material intangibles and details of which group companies are entitled to intangible returns List of important t related party agreements and description of TP policies i related to R&D and intangibles ibl Description of material transfers of intangibles including entities, geographies, and compensation Description of intercompany loans and other financial arrangements including hybrid financing List and brief description of APAs and other tax rulings related to allocation of income Additional information including consolidated financial accounts, as well as employee headcount by jurisdiction 11
Polling Question #1 Assuring that transfer pricing outcomes are in line with value creation is an item in the BEPS Action Plan. True False 12
OECD Revised Discussion Draft on Transfer Pricing Aspects of Intangibles To ask a question, click 'ask a question on your media player. 13
Revised Chapter VI Change in Wind Direction Topic Existing Chapter VI Revised Discussion Draft Approach Definition Entitlement Valuation Only 39 paragraphs Essentially a light touch revision i in 1996 of 1979 Guidelines No definitions Description of some commercial and marketing intangibles Concept of Legal and Economic ownership If not legal owner, criterion of sharing in the potential benefits No explicit consideration of methodologies, but CUP gets most coverage Reflects influence of Chapter IX and BEPS Action Plan 223 paragraphs (additional 107 paragraphs of 27 examples) Additional methods Reflects interests of newer economies A more systematic approach Potentially more scope to re-characterize transaction Definitions (but not legal and accounting definitions) Illustrations of what is and what is not an intangible Legal ownership does not inherently command economic returns Centrality of control functions to economic attribution More explicit recognition of valuation techniques (e.g. DCF) Focus on CUP comparability issues; acquisition price as potential CUP Potentially greater use of profit split 14
Key Implications Do you... Chapter VI Discussion Draft...fund development of IP?...have contract R&D services in the group? Is funding sufficient to create entitlement to intangible related returns? Is the low-risk contract sufficient to determine that the principal has entitlement and not the service provider? Probably Probably No No...have high h Does the level l of Possibly Possibly marketing expenditure in sales/marketing operations? expenditure create entitlement? 15
Definition of Intangibles To ask a question, click ask a question on your media player. 16
What Is an Intangible? Something which is not a physical asset or a financial asset, which is capable of being owned or controlled for use in commercial activities, and whose use or transfer would be compensated had it occurred in a transaction between independent parties in comparable circumstances. (Paragraph 40 of Revised Discussion Draft) 17
What Is Required According to the Revised Discussion Draft: Not a tangible asset or a financial asset Capable of being used in commercial activities Capable of being owned or controlled by single entity Does not include local market conditions such as the high purchasing power in a particular country Does not include MNE group synergies which are not owned or controlled by a single member of an MNE group Use or transfer would be compensated in transactions between independent parties 18
What Is Not Required Need not be an intangible for accounting purposes Need not be an intangible for general tax or treaty withholding tax purposes Article 12 Model Tax Convention Need not be legally protected Need not be separately transferable 19
Examples Examples of Intangibles Patents Know-how and trade secrets Trademarks, trade names and brands Rights under contracts and government licenses Licenses and similar limited rights in intangibles Goodwill and ongoing concern value... Not necessary... to establish a precise definition of goodwill... for transfer pricing purposes. It is important to recognize, however, that a... significant part of the compensation paid between independent enterprises... may represent compensation for... goodwill or ongoing concern value. (Paragraph 61) Items that are not Intangibles Group synergies Market specific characteristics 20
Comparability Factors To ask a question, click ask a question on your media player. 21
Additional Factors Added to Chapter I of OECD Guidelines Location savings and other local market features Assembled workforce Group synergies 22
Location Savings and Other Local Market Features in Revised Discussion Draft Definition Location Savings: Cost savings attributable to operating in particular geographic market Local Market Features: Features of local market that affect comparability and pricing, e.g., size of market, availability of trained labor Chapter IX guidance is generally applicable no new approach Determine Whether local market advantage or disadvantage exists The amount of any profits/losses attributable to local market features The degree to which they are passed on to independent customers or suppliers How any net benefits not passed on to customers and suppliers should be allocated If available, good local market comparables provide the most reliable evidence of allocation If not available, all relevant facts and circumstances should be considered 23
Group Synergies in Revised Discussion Draft Is there a need for comparability adjustments? If the group synergy occurs purely as a result of group membership No comparability adjustment is needed If the group synergy occurs because of a specific action of the group The benefit of the synergy should be shared by group members on the basis of their contributions to the creation of the synergy Examples Lending arrangements (Examples 1 and 2 in Chapter I) Centralized purchasing and volume discounts (Examples 3, 4 and 5 in Chapter I) 24
Group Synergies Examples from Revised Discussion Draft Example 1 Parent P has AAA credit rating; affiliate S would have had Baa rating on stand-alone basis S borrows from an unrelated third party at an interest rate premised on A rating S borrows an equal amount from a related party on the same terms Related party rate is arm s length since it is the same rate charged by unrelated lender in comparable transaction No payment or comparability adjustment required for group synergy benefit that allows S to borrow at rate lower than it would have received had it not been a member of the MNE group Example 3 Company A is central purchasing manager on behalf of entire MNE group Based on leverage provided by purchasing power of group, A negotiates price reduction from $200 to $110 per widget Company A receives arm s-length compensation at cost plus mark-up equal to $6 per widget Each member of group derives benefits attributable to group purchasing power of $84 per widget 25
Polling Question #2 Location savings are considered an intangible under the revised discussion draft. True False 26
Ownership of Intangibles and Rights to Returns Attributable t bl to Intangibles To ask a question, click ask a question on your media player. 27
Six Step Framework for Analyzing Intangibles Transactions in Revised Discussion Draft Identify the legal owner Identify parties performing functions, using assets, and assuming risks related to the development, enhancement, maintenance and protection of intangibles Confirm consistency between agreements and conduct Identify relevant controlled transactions Where possible determine an arm's-length price for relevant transactions identified In the exceptional cases described in paragraphs 1.64 1.68 of the OECD Guidelines, re-characterize transactions as necessary to reflect arm'slength conditions 28
Legal Ownership Legal ownership is simply a reference point Legal ownership alone does not convey the right to ultimately retain any income attributable to intangibles The legal owner must compensate associated enterprises that perform functions, contribute assets, and assume risks related to intangibles with an arm's-length payment reflecting the anticipated value of those contributions That compensation can constitute all or a large share of the return attributable to intangibles 29
Key Role of Functions Certain important functions have special significance Examples Design and control of research and development Management and control over budgets Control over strategic decisions related to intangible development Decisions regarding defense and protection of intangibles Ongoing quality control Does not follow OECD Guidelines Chapter IX approach of starting with a reference to arm's-length arrangements The reliability of a one-sided transfer pricing method will be substantially reduced if the party performing the important functions is treated as the tested party. (Paragraph 81 of Revised Discussion Draft) 30
Funding and Risk Funding and risk-taking should be analyzed separately An entity merely providing funding but not performing functions or assuming risks should receive a lower return than entities that t perform functions and assume risks Risk-adjusted rate of anticipated return on capital invested, but not more Similar to the investor model in U.S. cost sharing Risk can be important and should be compensated Guidance on risk in OECD Guidelines Chapter IX should be applied 31
Polling Question #3 Design and control of research and development programs is provided as an example of an important function in the revised OECD Revised Discussion Draft on Intangibles. True False 32
Identifying and Characterizing Relevant Transactions To ask a question, click ask a question on your media player. 33
Intangibles in Two Types of Transactions in Revised Discussion Draft Transfers of intangibles or rights in intangibles Sale of intangibles, including other transactions that have the same economic effect Licenses of intangibles and other transactions involving transfers of partial interests in intangibles. Tangible goods, services, and other transactions where intangibles are used but not transferred Have an impact on pricing that is analogous to that of other comparability factors 34
Some Factors to Consider in Characterizing Intangible Transfers Terms of the transfer Conduct of the parties Specific identification of all transferred intangibles, including combinations of intangibles Relevant restrictions or limitations on the rights transferred Include transactions where intangibles are transferred in combination with other transactions undertaken (e.g. sale of goods or performance of services) Examples in Revised Discussion Draft 16 Goodwill in the context t of a business restructuring ring 18 Goodwill in the context of an acquisition 21 Acquisition Synergies 35
Examples from Revised Discussion Draft Example 18 Birincil acquires 100 percent of equity interest in Company T for 100 PPA allocates 20 to tangible property and identified d intangibles ibl and 80 to goodwill Birincil causes Company T to transfer all technology intangibles to Company S The 100 paid by Birincil for Company T s shares is arm s-length price for Company T s business The full value of the business should be reflected Either in the value of intangible assets transferred to Company S, or Value of the tangible and intangible assets and workforce retained by Company T Depending on facts, a large portion of value described in PPA as goodwill may have been transferred to Company S with other Company T intangibles Value does not disappear, nor is it destroyed, as part of an internal business restructuring 36
Polling Question #4 The revised discussion draft considers the transfer of intangibles only, not their use. True False 37
Arm s-length Prices To ask a question, click ask a question on your media player. 38
General Principles in Revised Discussion Draft (Transfer and/or Use of Intangibles) Guidance in OECD Guidelines Chapters I III apply Realistic alternatives for each of the parties need to be considered Comparability Comparability of the intangibles being examined is a critical concern Especially important because intangibles often have unique feature Often will not be able to identify sufficiently comparable intangibles to support an analysis based on comparables 39
Valuation Approaches Use of valuation techniques specifically approved But No comprehensive summary of acceptable valuation techniques No endorsement of particular valuation practices or standards Purchase price valuations are not determinative for transfer pricing purposes Techniques based on discounted value of cash flows can be especially useful But assumptions must be consistent with the arm's-length principle Financial projections Growth rates Discount rates Useful life and terminal values Taxes Example 24 of Revised Discussion Draft 40
Hard to Value Intangibles Include Partially developed intangibles with no financial track record Intangibles that are extremely critical to the business and have no real comparables Additional work is deferred and will be considered under the BEPS Action Plan 41
Polling Question #5 Would you like a KPMG professional to contact you regarding the topics discussed today? Yes No 42
Q&A To ask a question, click ask a question on your media player. 43
Today s Presenters Name Phone e-mail Stephen Blough 202-533-3108 sblough@kpmg.com Clark Chandler 202-533-3186 cjchandler@kpmg.com Prita Subramanian 617-988-1260 psubramanian@kpmg.com Matthew Whipp +44-20-73114104 matthew.whipp@kpmg.co.uk Visit KPMG s Tax Transparency Website at www.kpmginstitutes.com/taxwatch/insights/2013/tax-transparency.aspx for updates and insights on this emerging issue 44
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