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HOT TOPICS IN TRANSFER PRICING AUDITS Einari Karhu
Michael PulsRenátaBláhová
INTRODUCTION
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INTRODUCTION
Over the recent years tax disputes in cross-border matters have increased rapidly.
The development has been rapid especially in transfer pricing following the OECD
BEPS work and updated OECD TP Guidelines.
The panel discusses the topical aspects recurring in transfer pricing disputes in
different countries through case examples from Finland, Germany and Slovakia.
The cases present variety of transfer pricing issues, including technical cases, a
case related to question of principle, a procedural case, and a case related to a
question of the scope of re-characterisation.
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PANELISTS
EINARI KARHUPartner
Borenius Attorneys
Finland
+ 358 20 713 3488
einari.karhu@borenius.com
Michael PulsPartner
Flick Gocke Schaumburg
Germany
+49 211/6 18 22-0
michael.puls@fgs.de
RENÁTA BLÁHOVÁPartner
BMB Leitner
Slovakia
+421 2 59 10 18-00
renata.blahova@bmbleitner.sk
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THE RISE OF TAX AND TP DISPUTES
WHY HAVE TP DISPUTES INCREASED?
Unilateral fear of base erosion
Revised regulations (e.g. BEPS)
New measures (e.g. multilateral audits) and increase of information exchange
Lack of mechanisms to settle
Increase in taxes and penalties under dispute
WHAT IS DISPUTED?
Centralised services, IP and PEs
BEPS – retrospective application?
State Aid investigations
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CASE STUDIES
CASE STUDIES
Five cases that cover the following matters under dispute
• Selection and application of TP methods
• High-value adding services
• Adjustments on non-EU transactions
• Intra-group financing
• DEMPE functions
1: APPLICABLE TP METHOD & DETERMINATION OF AN ARM’S LENGTH COMPENSATION FOR CONTRACT MANUFACTURING SLOVAKIA (1)
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External suppliers
3rd parties
Production
Production
„WOOD“
„CHAIR Co.“
Retail
Holding „FURNITURE“
Range &
Supply
Slovakia
SaleSale
1: APPLICABLE TP METHOD & DETERMINATION OF AN ARM’S LENGTH COMPENSATION FOR CONTRACT MANUFACTURING SLOVAKIA (2)
Chair Co., a group company characterized as contract manufacturer, was
compensated for its sale of furnitures to Furniture Co. by applying CUP method.
During a tax audit, tax auditors (TA) stated that CUP requirements were not met
and CUP was not applicable.
TA prepared new comparability analysis by applying TNMM method. An
interquartile arm's length range was 3.54% - 13.49%, with a median of 6.86%.
Mark-up level earned by the contract manufacturer was -12.36%. TA conducted a
tax assessment of EUR 3 million.
The company prepared a new comparable analysis with different search criteria,
with an interquartile arm's length range of 0.77% - 4.91% and with a median of
1.96%.
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1: APPLICABLE TP METHOD & DETERMINATION OF AN ARM’S LENGTH COMPENSATION FOR CONTRACT MANUFACTURING SLOVAKIA (3)
TP matters to be discussed
• Applicable TP method: CUP vs Cost Plus
• Review of TP Documentation focused on Function and Risk Profile (FRP), in depth
interviews with staff were performed
• Local GAAP vs IFRS: which one is applicable for the cost plus method
• Discussion points of the benchmarking analysis
• Comparable entities
• Local vs Global Coverage
• Amadeus and its quality
• NACE Code: narrow vs broad
• RESULT?
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1: APPLICABLE TP METHOD & DETERMINATION OF AN ARM’S LENGTH COMPENSATION FOR CONTRACT MANUFACTURING SLOVAKIA (4)
Questions and conclusions
• Local court dispute or a Bilateral procedure?
• In case of Switzerland, can the Arbitration Convention be relevant?
• Can revised BEPS be applied to an old (2011) case?
• Businesses should be prepared for audits of documented function and risk
profile
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2: TRANSFER PRICING OF HIGH-VALUE ADDING SERVICESGERMANY (1)
100%
Chemical B.V.
Chemical GmbH
The Netherlands
Germany
R&D and distribution services
Remuneration: full costs + 5%
Customers
Delivery
2: TRANSFER PRICING OF HIGH-VALUE ADDING SERVICESGERMANY (2)
Chemical B.V., Rotterdam, operates with its international subsidiaries in the R&D,
production and distribution of special chemicals. Chemical B.V. can be considered
as a “strategic company” with respect to staffing, production and distribution
capacities, and it bears most of the risks and opportunities within the group.
Chemical GmbH, a direct subsidiary of Chemical B.V., develops and distributes
special chemicals on the German market (=provision of high-value adding
services). Chemical GmbH provides R&D and distribution services to Chemical
B.V. These services are of significant importance for the German business of
Chemical B.V.
Until 2005, Chemical GmbH was an autonomous research and distribution
company. Following a restructuring of the group, Chemical GmbH now operates as
a service provider on behalf of Chemical B.V. The customer base of Chemical
GmbH was sold to the Dutch parent in 2005 for a relatively small remuneration.
2: TRANSFER PRICING OF HIGH-VALUE ADDING SERVICESGERMANY (3)
The companies concluded a service agreement that settled the remuneration of
Chemical GmbH using the cost-plus method (full costs plus a profit margin of 5%).
The tax audit for the assessment periods 2008 until 2010 challenged the
application of the cost-plus method and the profit margin of 5%. Chemical GmbH
renders high value-adding services and is part of the highly profitable business of
Chemical B.V. Therefore, say the TA, the appropriate transfer pricing method would
be the profit-split method.
2: TRANSFER PRICING OF HIGH-VALUE ADDING SERVICESGERMANY (4)
TP matters to be discussed:
• Is the application of the cost-plus method with a fixed profit margin appropriate?
• Is the application of the profit-split method appropriate if it relates to high value-
adding services? If so: How should the profit be split?
• Might the TA also adjust the transfer price of the customer base that was sold to
Chemical B.V. in 2005?
3: TP INCOME-ORIENTATED ADJUSTMENTS ON NON-EU TRANSACTIONSGERMANY (1)
F GmbH
V Ltd.
Germany
China/India
Delivery of products
Car
manufacturers
100%
Return on sales ratio:
15%–22%
Distribution
to customers
3: TP INCOME-ORIENTATED ADJUSTMENTS ON NON-EU TRANSACTIONSGERMANY (2)
F GmbH is resident for tax purposes in Frankfurt and operates in the automotive
industry.
The goods and products produced by F GmbH are distributed in China and India
via local distributors (V Ltd.), which are subsidiaries of F GmbH.
Transfer prices for the goods and products are based on the resale price method.
The cross margins are calculated on the basis of a benchmark study. The current
return on sales ratio – based on the EBIT – is between 15% and 22%. The high
return on sales ratios can be explained by enormous sales growth, the excellent
local management, and the high prices on the Chinese and Indian markets.
The German tax audit challenges the transfer prices for the product delivery to the
distribution companies. TA’s main argument is that V Ltd. “earns too much” in both
China and India.
3: TP INCOME-ORIENTATED ADJUSTMENTS ON NON-EU TRANSACTIONSGERMANY (3)
TP matters to be discussed:
• Does Sec. 1 Foreign Tax Act cover an income-orientated adjustment?
• Is it possible to avoid double taxation by filing for a MAP between Germany and
China / Germany and India?
• Is it possible to avoid double taxation based on “objective inequity”? Guidance
issued by the German Ministry of Finance on 13 July 2006 provides for this
“equity rule” if the taxable person complied with the obligation to cooperate and
the mutual agreement procedure fails.
• Is it more reasonable to bring the case before a tax court instead of a mutual
agreement procedure?
4: TRANSFER PRICING OF INTRA-GROUP FINANCING WITH A HEDGING CLAUSEFINLAND (1)
2. Loans 2. Interest income
A Oy
B B.V.
1. Equity 1. Shares
Group companies
Agreement on hedging against FX and interest
rate risks etc.
Loans
Equity Shares
Service fee
Provision of financing
related service
Interest income
Group companies
Intra-group financing as implemented and
applied by A GroupTA’s view on A Group’s intra-group financing
A Oy
B B.V.
4: TRANSFER PRICING OF INTRA-GROUP FINANCING WITH A HEDGING CLAUSEFINLAND (2)
A Oy (Finland), is the parent company of the A Group which operates in
construction industry.
B B.V. (Belgium), was established by A Oy in 2008 as part of the A Group’s internal
financial restructuring. B B.V. is responsible for the A Group's internal lending.
Civil law transactions regarding intra-group financing activities have been in line
with the above business model.
In the tax audit report, TA re-characterised the actual business model and the civil
law transactions regarding intra-group finance activities and gave them a new
meaning for the tax purposes (i.e. B B.V. provides financing related support
services).
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4: TRANSFER PRICING OF INTRA-GROUP FINANCING WITH A HEDGING CLAUSEFINLAND (3)
TP matters to be discussed:
• Does the arm’s length principle and a domestic transfer pricing adjustment
clause allow TA to disregard valid and legally binding transactions and
delineate the business model by pricing fictional transactions?
• Should the civil law conditions agreed between group companies be respected
and is the view of TA actually based on the unlawful re-characterisation?
• Whether the economic outcome in consequence of a hedging agreement
(i.e. allocation of economic risk) allows TA to disregard the intra-group
financing model agreed and applied within a multinational group?
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5: TRANSFER PRICING OF INTANGIBLES AND LOCATION OF DEMPE FUNCTIONSFINLAND (1)
Functions:
- Routine
functions
only
Assets:
- No
valuable
assets
Key assets:
- All valuable
intangibles
C Inc. (limited-risk)
B Ltd (limited-risk)
A Oy(parent-like
company)
Licensing of technology
related intangibles
Key assets:
- Technology
related
intangibles
Functions:
- R&D
- Sourcing
- Manufacturi
ng
- Sales
- Services
Assets:
- Intangibles
related to
technology
and sales
channels
royalty
A Oy (Full-risk)
royalty
C Inc.(full-risk)
B Ltd (full-risk)
TP method:
- CUP
TP method:
- TNMM
Business model implemented and applied by A Oy and its sister companies
FTA’s view on the business of A Oy and its
sister companies
5: TRANSFER PRICING OF INTANGIBLES AND LOCATION OF DEMPE FUNCTIONSFINLAND (2)
A Oy (Finland) is part of a multinational technology corporation. A Oy has a
significant role in one of the business lines of the group. A Oy has been subject to
transfer pricing audit regarding its transactions with its sister companies, B Ltd.
(China), and C Inc. (USA).
The tax audit focused on the DEMPE functions in A Oy and its sister companies as
well as the determination of an arm’s length compensation for utilisation of
intangibles in one of the business units the group.
In tax auditors’ view, there were several valuable, technology related intangibles in
the business unit and even if all A Oy, B Ltd and C Inc. have financed and
participated in developing the said intangibles, the B Ltd and C Inc. were viewed as
limited-risk companies performing routine functions only. Further, TA viewed that
valuable assets have been owned and developed by A Oy only.
5: TRANSFER PRICING OF INTANGIBLES AND LOCATION OF DEMPE FUNCTIONSFINLAND (3)
TP matters to be discussed:
• Does the local transfer pricing adjustment clause allow the delineation or should
the business model implemented and applied by a group and intra-group
licensing transactions, tested by applying CUP method, be considered as an
arm’s length model?
• Is it common that TA challenges the functional analysis prepared and
documented by the group, and prepares an own and alternative functional
analysis and an alternative business model?
SPEAKER PROFILES
SPEAKER PROFILE
Einari Karhu is a Partner of Borenius Attorneys Ltd.Einari advises on
corporate taxation and has extensive experience in international tax
matters and M&A structuring, as well as tax litigation.
He has been involved in several major tax disputes with regard to
transfer pricing and international tax planning (e.g. Fortum and Nokian
Tyres), as well as IPOs and other financing transactions.
Einari has successfully advised leading asset management companies in
reclaiming withholding taxes on Finnish-source dividends. Before joining
Borenius in 2008, Einari worked as a senior advisor in the Ministry of
Finance.
Einari Karhu
Borenius Attorneys, Taxand Finland
T: +358 20 713 3488 | E: einari.karhu@borenius.com
SPEAKER PROFILE
Michael Puls is based in Düsseldorf where he has been a partner at Flick
Gocke Schaumburg, Taxand Germany.
Michael has been a lawyer since 2003, and a certified tax advisor since
2006. He studed law and business administration in Osnabrück and
Bonn (2004 Dr. iur.) and regularly lectures for various tax advisors’
associations in NRW in the field of international tax law and transfer
pricing.
He is a member of the German-American Lawyers’ Association, and of
the managers’ circle of the Friedrich Ebert Foundation (Friedrich-Ebert-
Stiftung).
Michael Puls
Flick Gocke Schaumburg, Taxand Germany
T: +49 211/6 18 22-0 | E: michael.puls@fgs.de
SPEAKER PROFILE
Renáta Bláhová is based in Taxand Slovakia where she is a partner at
BMBLeitner. She is the founding partner of BMB Leitner in Bratislava,
Slovakia.
She has 20 years of experience in tax and accounting law, specialising
mainly in Slovak and international tax law, direct taxes, transactional
services and M&A.
Renata graduated from the Slovak University of Technology, gained an
MBA at St Louis University in the United States, and an L.L.M. in
international tax law at Vienna University of Economics and Business
Administration. Besides holding Slovak licences for auditing and tax
advisory, Renata is also a certified FCCA accountant (UK).
Renáta Bláhová
BMB Leitner, Taxand Slovakia
T: +421 2 59 10 18 00 | E: renata.blahova@bmbleitner.sk