Centralizing Trade v2

8/10/2019 Centralizing Trade v2

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ENR TAX

Commoditytrading

companiesCentralizing trade as a critical success factor

October 2012

kpmg.com

KPMG INTERNATIONAL


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Contents

04A Global Approach to Commodity Trading Securing top margins while cutting costs 4 24/7 access to commodities markets and exchanges 5 Dynamic supply chain management 5 Cutting freight costs and improving logistics 6Beyond supply chain trading 6

07Locations ComparedCurrent destinations of choice 7

Other destinations 7Potential future destinations 7

14Managing Indirect Tax IssuesRising audit activity puts pressure on VAT/GSTmanagement 14 VAT/GST differences heighten compliance risk 15Managing VAT/GST through centralized teams 15 Customs risk and opportunities 16

10Managing Income Tax IssuesSubstance-based challenges 11 Transfer pricing for related-party transactions 11 Transfer pricing issues on migrating functionsand risks 12Taxable presence 12 Tax implications of contractual arrangements 13

Treaty relief 13Accounting issues 13

Introduction

Looking Ahead

01Key Findings02

18 2012 KPMG International Cooperative (KPMG International), a Swiss e ntity. Member rms of the KPMG network of indepe ndent rms are afliated with KPMG International. KPMG International provides no client services. All rights reser ved.


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Introduction

2012 KPMG International Cooperative (KPMG International), a Swiss e ntity. Member rms of the KPMG network of indepe ndent rms are afliated with KPMG International. KPMG International provides no client services. All rights reser ved.

24-hour trading. Dynamic supply chain management. Logisticalefciency. Tax and investment incentives. The benets of centralized

commodity trading operations are clear, and many of the worldsbiggest oil and gas and mining majors have set up international tradingstructures to win competitive advantage.

W ith an international commodity trading company, acorporate group can manage its global trading andmarketing activities within one or a few specializedentities, unifying trading operations and consolidatingsources of supply. That way, they can better manage andmeet customer demand while improving their prot marginsat the same time.

From North America and Europe to the Middle East and Asia,a number of locations around the world have emerged asvibrant centers for this activity. By offering practical benetsand incentives, business-friendly policies, and sound nancialinfrastructures, many of these locations have activelysought to create the right conditions for commodity tradingoperations to thrive.

But wherever they are located, international tradingcompanies face a world of risks. Given their complex supplychains and the scope of their activities, commodity trading

companies must manage their way through an intricateweb of cross-border income tax, value added tax (VAT) andcustoms issues. They also must be ready to defend theirtransactions and structures against growing aggression andheightened scrutiny on the part of some tax authorities.

In reviewing the potential benets of establishing specializedcommodity trading entities and in assessing existingstructures, companies face a range of complex questions:

What are the potential advantages of centralizingcommodity trading operations?

What factors are most important when deciding where tolocate the operations?

What are the tax risks involved, and what practical stepscan be taken to reduce or eliminate them?

Over the long term, how could the trend toward centralizedtrading affect the oil and gas and mining industries, andindividual companies and markets?

To answer these questions, KPMG International sought the viewsof professionals from its member rms worldwide who specializein international corporate tax, global VAT and customs, transferpricing and tax-efcient supply change management in the energyand natural resource industries. As their combined insights infollowing pages show, the trend to greater centralization ofcommodity trading is likely to continue, and companies that takeup this model with a sound structure that addresses tax andbusiness risk stand to reap substantial benets.


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T

Key Findings

2 | KPMGs Global ENR Tax: Commodity trading companies


An international commodity trading company is a distinct, specializedentity established to centrally manage trading activities and relatedfunctions for specic commodities in the oil and gas and mining industries.The advantages of centralized trading are numerous, and many locationsin the world have arisen as important focus points for this activity.

o help energy and natural resources companies

understand the substantial benets and riskmanagement issues involved in these complexoperations, this publication distills the views of professionalsfrom KPMG member rms worldwide who specialize ina range of global tax and advisory disciplines. Their mostimportant observations and insights about the trend towardcentralized commodity trading are set out in brief below.

What are the advantages of commodity tradingcompanies? Centralizing trading and marketing activities in one or a

few locations allows companies to consolidate sourcesof supply so they can better manage and meet customerdemand.

By managing global trading from a central location, a tradingcompany is positioned to sell product into whatever marketwill fetch the top prot margin. These companies are wellpositioned to match supplies from multiple extraction pointswith the needs of customers in multiple markets.

Even more ef ciencies can be gained by setting up multipletrading companies in various time zones across the globe,allowing the group of companies to boost its margins withnon-stop trading 24 hours a day.

The ability to mix and match supplies from multiple sourcesalso allows for greater supply chain stability, which cantranslate into higher trading margins.

By swapping freight, companies can reduce their highhaulage and control costs and improve logistics.

In addition to supply chain trading, many commodity trading

companies are taking on other types of transactions, rangingfrom proprietary trading to asset optimization, derivativemarket-making, arbitrage, and dynamic hedging of assetportfolios.

What factors should drive decisions over potentiallocations? Deciding where to locate an international trading company is

a tactical and marketing decision. Tax costs are just one of ahost of factors that companies need to consider.

Preferred locations have investment-friendly governmentpolicies, strategic proximity to markets, and good nancial

services infrastructures. Countries that actively seek to provide this mix can gain

substantial economic spin-off benets from the activitiesof these entities. By doing so, for example, Switzerland andSingapore have succeeded in becoming two of the worldsmost popular destinations for international commoditytrading activity.

Other countries that are home to substantial numbers ofthese structures include the United Kingdom (London), theUnited States (Houston), Canada (Calgary), the Netherlandsand Hong Kong. Brazil, Barbados and Dubai could emergeas destinations of choice in the future.

What income tax issues can arise? Like any global business, international trading companies

and their parents need to manage a host of direct andindirect tax matters.


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If these entities are located in a jurisdiction that is differentthan the source of production, tax authorities will often takea closer look to determine:

whether the trading companys activities and functionsadded value to the business

whether it is reasonable for the operations tocompensate that entity.

As a rst line of attack, many tax authorities aroundthe globe would seek to challenge international tradingcompanies under anti-avoidance rules based on a lack ofbusiness substance.

Tax authorities may challenge transactions withinternational trading companies on the basis of theirtransfer prices.

Other income tax issues can involve:

exit charges on moving functions and risks from onejurisdiction to another

the possibility that the trading activities may inadvertentlycreate a taxable presence in a country, for income orindirect taxes, or both

the potential that a tax authority will seek to deny treatybenets based on its position regarding benecialownership of the trading companys income

the impact of differences in the accounting and taxtreatment of certain items.

To guard against income tax challenges, a thorough tax riskexposure analysis should be conducted to anticipate andaddress all possible questions and alternative arguments soyou can make sure all your bases are covered.

What indirect tax issues can arise? International trading companies tend to focus on income

taxes and neglect the potentially high but less visible costsof other taxes. Nevertheless, these companies are likelyto face more scrutiny of their indirect tax compliance and

more aggressive audit activity.

Many of the worlds major oil andgas and mining companies havealready established internationaltrading structures to gain competitiveadvantage, and the trend towardcentralized trading is expected tocontinue.

Centralization and cross-pollinationwith members of the banking sectoris allowing pure energy producersand mining companies to take part

in a more diverse range of nancialactivities.

KPMGs Global ENR Tax: Commodity trading companies | 3


Issues often arise due to differences among various VAT/ GST systems. Differences between European VAT systemsare often overlooked. In countries like China and Korea,VAT systems are relatively new and quite different fromEuropean systems, heightening the risk of complianceerrors and missteps.

The largest commodity trading companies have global VATmanagement strategies and large indirect tax teams tomanage their global VAT obligations and ensure appropriateprocesses are in place.

With their dynamic supply chains, international commoditycompanies are also exposed to customs risk. Internationaltrading companies can optimize their customs costs byavoiding unnecessary customs charges and by taking partin simplied customs procedures and programs.

Looking ahead Many of the worlds major oil and gas and mining

companies have already established international tradingstructures to gain competitive advantage, and the trendtoward centralized trading is expected to continue.

National oil companies are also centralizing their tradingactivities in key international trading centers.

As the majors consolidate their supply chains, downstreamservice companies are under pressure but haveopportunities to diversify their activities.

Centralization and cross-pollination with members of thebanking sector is allowing pure energy producers andmining companies to take part in a more diverse range ofnancial activities.

The greatest uncertainty of international trading companiesis the specter of more stringent tax and trading regulation.

Commodity prices will dictate the future of internationaltrading companies. As long as commodity prices remainhigh, the trend toward centralization in favorable tradinglocations will continue.


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A Global Approach to

Commodity Trading

I

As oil and gas and mining markets grow ever more interconnected,some of the largest companies in the energy and natural resourcessector are proting by taking a more global approach to commoditytrading. Centralizing trading and marketing activities in one or a few

locations allows companies to consolidate sources of supply so theycan better manage and meet customer demand. Around the world,many locations have attracted a critical mass of commodity tradingcompanies and emerged as important hubs for global commoditytrading.

n the past, commodities markets were more regional.Now, products that once could only be sold in New Yorkor London can be offered in Asia and the Middle East.

International commodity trading companies are sophisticatedsales and marketing arms set up by many major oil andgas and mining companies that work to sell product to thehighest bidder. By managing global trading from a centrallocation, a trading company is positioned to sell product

into whatever market will fetch the top prot margin.Centralization makes it easier to re-route product when it isin transit to a new destination and to buy product of similarquality to re-distribute to the original location.

Securing top margins while cutting costsConsider a simple example. Say a trader based in London hascontracted to deliver crude oil to a customer in Spain, and a




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Companys operationsin Nigeria to ll theSpanish order

London

Spain

Nigeria

Opportunity to sellmore crude oil ata higher price perbarrel inside UK.

tanker carrying the crude is en route from the North Sea. Thetrader then develops an opportunity to sell more crude oil ata higher price per barrel to a company in the United Kingdom.

The trader diverts the tanker from the North Sea to meet theUK customers need, and dispatches another tanker from thecompanys operations in Nigeria to ll the Spanish order.

Through such traditional techniques, the trader has increasedthe companys prots by getting the best market price whilereducing its freight costs by changing the rst tankersdestination in transit. Through centralized trading operations,companies are much better positioned to match suppliesfrom multiple extraction points with the needs of customersin multiple markets in a perpetual process that ensuresproduct gets sold at the highest-return delivery point.

24/7 access to commodities markets and exchangesCompanies can gain even more efciencies by setting upmultiple trading companies in various time zones across theglobe. This way, companies can have one company assumethe trading and supply management activities after anothercompanys close of business as the worlds commoditiesexchanges open and close, allowing the group of companiesto boost its margins with non-stop trading 24 hours a day.

Some commodity trading structures have associated satelliteofces. For example, a central company in Singapore couldemploy traders working out of locations in Dubai, Japan and

the United States. This strategy allows companies to benetfrom centralization while retaining the competitive advantagethat stems from the traders local market knowledge.

Dynamic supply chain managementThe ability to mix and match supplies from multiple sourcesallows for greater supply chain stability, which can translateinto higher trading margins. Most customers contract toreceive commodities within a specic window of time asmissed or late deliveries can disrupt their own productionschedules. But it is difcult for a supplier to guaranteedeliveries of commodities from one source. For example,mining operations are unpredictable and rarely hit theirproduction targets. Extraction can halt unexpectedly due tocave-ins or closures for maintenance, losses can occur duringtransport due to the nature of certain products, and extremeweather can delay shipments en route.

If the supplier has only one product source and that sourceis not available to meet commitments to customers ontime, then suppliers are forced to ll shortfalls by payinghigher spot prices to secure product from alternativesources. Because international trading companies can supplycustomers with product from multiple supply points, they areable to anticipate and cover any product shortfalls more cost-effectively and offer more stable supplies.




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Through such traditional techniques,the trader has increased thecompanys prots by getting the bestmarket price while reducing its freightcosts by changing the rst tankersdestination in transit.

Non-stop trading24 hours a day

Central Company

07:21New York (US)

Satellite Ofce

15:21Dubai

Satellite Ofce

19:21Singapore

20:21Japan

Satellite Ofce

Local Market Knowledge

6 KPMGs Global ENR Tax: Commodity trading companies

Centralization in trading

|

Cutting freight costs and improving logisticsThe ability to swap shipments of similar quality to recover thesame price produces savings on transport costs. Becausefreight costs for commodities are so high, their rationalizationthrough centralized trading is a signicant benet. Thisis especially true for generic products such as aluminum,iron ore and uranium. From a freight cost-management

2012 KPMG International Cooperative (KPMG International), a Swiss entity. Member rms of the KPMG network of independent rms are afliated with KPMG International. KPMG International provides no client ser vices. All rights reserved.

perspective, the more generic the product, the bigger thepool and the greater the opportunity to improve margins.

By swapping freight, companies can reduce not only haulageand control costs, they can avoid demurrage costs byrerouting ships away from ports where loading or unloadingmay be delayed. They can also avoid stack-out losses oncommodities that have a limited storage life.

Beyond supply chain tradingInternational trading companies in the oil and gas and miningindustries generally conduct two types of trading:

supply chain trading, in which traders work to meetcustomers needs with available supplies

proprietary trading, in which traders play the commoditiesmarkets using their rst-hand knowledge of supply anddemand.

Other common trading techniques include asset optimization,derivative market-making, arbitrage and dynamic hedging ofasset portfolios.

While supply chain trading is often a primary purpose of thesestructures, major players are increasing their proprietary

trading activities. Their traders are uniquely positioned tounderstand the market and spot opportunities that might notbe apparent from other vantage points.


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Preferred locations have investment-friendly governmentpolicies, strategic proximity to markets, and goodnancial services infrastructures . Countries that get the

mix right stand to gain substantial economic spin-off benetsfrom the activities of these entities.

Current destinations of choiceSwitzerland and Singapore have succeeded in becoming theworlds most popular destinations for international commoditytrading activity. Both countries have actively courtedthis activity by setting scal policies and incentives thatcomplement their existing positive attributes. It is expectedthat the number of international trading companies setting upshop in these countries will continue to rise.

Other destinationsOther countries that are home to substantial numbers ofthese structures include the United Kingdom (London), theUnited States (Houston), Canada (Calgary), the Netherlandsand Hong Kong. These locations are historical destinations of

Deciding where to locate an international trading company is a tacticaland marketing decision. While there is a common misperception thattax planning considerations are the driving factor, tax costs are just oneof a host of factors that companies need to consider in determiningwhere to base their international trading activities.

choice due to of their proximity to European, North Americanor Asian markets or production sources. The United Kingdomand Canada are also attractive due to their critical mass of localexpertise in these sectors and opportunities to raise capital.

Each of these locations has a lot of momentum behind them,and currently established trading companies may have nocompelling business reason to migrate elsewhere. However,unless these countries become more proactive in creating amore attractive environment, they may not attract substantialnew trading operations going forward as other countries takespecic action to attract these businesses.

Potential future destinationsAnother set of countries could emerge as international tradinghubs in the future but only if they can improve in key areas,such as political stability, physical and nancial infrastructure,and business-friendly tax and commercial policies. Dubai,Barbados and Brazil are among these countries.

Locations Compared

Business-friendly policies

Proximity to multiple markets

Attractive location and amenities forexecutives and personnel

Skilled local workforce withunderstanding of the industry andability to manage transactions

What conditions are important for an international trading location? Factors to assess include:

Financial facilities for hedging andtreasury functions

Favorable, stable tax rules andadministrative procedures, includinga binding rulings process

Networks of investment protectionagreements and tax treaties that

follow the OECD model and allow forwithholding tax reductions

Open trade policies and participationin free trade agreements

Political stability

Well developed legal and judicialsystem (e.g., for enforcing contracts)




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Historical destinations Future destinations

Business-friendly environment and policies designed to attract foreigninvestment

Actively seeking to attract international commodity activities Expanding treaty network includes new agreements with a number of Central

and South American and West African countries Barbados International Business Corporations (IBC) are not recognized in many of

its treaties, and so Barbados might soon allow oil and gas and mining operationsto operate in the country through regular Barbados companies (paying more taxthan IBCs but less than in many other countries)

Barbados

Leading nancial center for Latin America Commodity-rich country with a rapidly growing economy Highly skilled talent pool Inwardly focused government policies and complex tax system

create challenges

Brazil

Access to North American markets and proximity to oil elds inTexas and Gulf of Mexico

Sustainable track record as an international commodity trading location Sophisticated nancial infrastructure and skilled workforce No personal taxes at the state and local levels Potential 40 percent effective tax rate and potential subpart F tax issues

Houston

Center for capital-raising activities for investment in mining activitiesoutside Canada

Foreign afliate taxation system allows for tax-free repatriat ion of foreign activebusiness income, with opportunities to reduce or eliminate tax on income fromtrading activities in Canada

Highly skilled talent pool and strong capital market Extensive networks of tax treaties and investment protection agreements, and an

expanding network of free trade agreements Established commercial hub for this activity

Calgary

Current destinations

International trading hubs




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Proximity to European markets and North Sea oil elds Leading nancial center with a highly skilled workforce Attractive location for international employees Location of two domestic oil majors Tax rate is relatively high but it is possible that the rate

could drop to 20 percent in future Very wide tax treaty network English language

United Kingdom

Proximity to European markets and NorthSea oil elds

515 percent effective tax rate Sophisticated nancial infrastructure and

a skilled workforce Historical position and culture as a major

trading nation

Netherlands

Strategic location in Europe, well situated between American and Asiantime zones

Specialized nancial service providers offer highly sophisticated nancingand arbitrage products tailored to the specic needs of the commodityindustry

Effective statutory corporate income tax rates for commodity trading

companies as low as 8 percent, with further reductions possible Financing activities might be taxed at an effective rate as lowas 1 percent

Binding advance tax rulings available, which are not time-limited Dividend income and capital gains on disposals of qualifying investments

are tax-free Extensive network of tax treaties (close to 90) and investment

protection agreements (over 100) VAT rate of 8 percent is by far the lowest in Europe Competitive personal income tax system Unrestricted access for citizens of the European Union to work

in Switzerland Multilingual New trained and specialized workforce coming on the market

each year through a Master in International Trading, Commodity Financeand Shipping program

Building momentum as a hub for this activity

Switzerland

Strategic location in Asia Strong physical infrastructure for serving oil and gas

businesses, with oil storage facilities, ports andshipping and government-run facilities for chemical andoil and gas processing

Sophisticated nancial infrastructure Simple, business-friendly tax system Farm-to-table approach to incentives, with incentives

targeting all points in the supply chain Global Trader Program offers reduced tax rates of 5 or 10 percent

to companies carrying on international trade in commodities, futuresand derivatives

Low personal tax rates 20 percent top rate, reduced for individuals who do signicant foreignbusiness travel

Open immigration policy that facilitates relocation of foreign talent to Singapore

Extensive network of over 60 tax treaties Member of ASEAN free trade network; currently involved in free trade negotiations with

European Union and ve or six other countries

Singapore

Strategic Middle East location andproximity to the Gulf oil elds

Skilled workforce and fairly welldeveloped nancial sector

Less attractive to some foreignworkers than other internationaltrading hubs

Political stability in the region isuncertain

Dubai

Strong nancial services sector 0 percent tax rate on international trading that occurs entirely

outside Hong Kong (raising issues in otherjurisdictions, for example, with controlled foreigncompany regimes)

Working to expand its treaty network No free trade agreements

Hong Kong

Current destinations Historical destinations Future destinations




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Managing IncomeTax Issues



Like any global business, international trading companies and theirparents need to manage a host of direct and indirect tax matters. Ifthese entities are located in a jurisdiction that is different than the

source of production, tax authorities will often take a closer look todetermine whether the trading companys activities and functionsadded value to the business and whether it is reasonable for theoperations to compensate that entity. As a result, those activities andfunctions should be supported by commercial reality and be properlydocumented. The tax considerations can be complex, and robustupfront planning is needed to ensure the structures benets can besustained following a tax authoritys review.


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Top ways to manage transfer pricing risk

Develop a strong transfer pricingframework that meets the complianceneeds of all relevant jurisdictions and tomake sure it is properly implemented,documented and followed.

Fully document your transfer pricingpolicies, including your choice oftransfer pricing method and theinapplicability of other methods.

Identify, quantify and document thevalue added and risks assumed ateach stage of the supply chain.

Be prepared to engage in tax disputeswith local authorities, and developyour strategy for driving audits anddisputes in advance.

Gain more certainty that your transferprices will be accepted by enteringinto an APA with the relevant taxauthorities.


2012 KPMG International Cooperative (KPMG International), a Swiss entity. Member rms of the KPMG network of independent rms are afliated with KPMG International. KPMG International provides no client ser vices. All rights reserved.

Substance-based challengesDespite the many business benets that internationaltrading companies have to offer, tax authorities are often

suspicious when companies move functions and risks toa central location, especially when that location imposeshighly favorable tax rates. Tax authorities in many jurisdictionsrecognize the importance of centralizing certain functionsfor global multinationals. Other jurisdictions are suspiciousof movements of prots associated with national resources.Because some tax authorities may view the transaction assomehow articial or abusive, it is critical for internationaltrading companies to be ready to defend against suchchallenges.

As a rst line of attack, many tax authorities around the globewould seek to challenge international trading companies under

anti-avoidance rules based on a lack of business substance.The number of employees providing value-adding services,the IT and accounting systems, physical facilities and levelof commercial activity involved in most of these operationssupport the companys valid business purpose and substance.In Singapore, companies setting up trading entities are requiredto guarantee they will employ a certain number of workersor undertake a certain level of activities in order to access taxincentives. In many cases, these operations can be quite large,both in volume and number of employees.

To guard against substance-based challenges, documentationis crucial. International trading companies can reduce thepotential for negative determinations by ensuring thatplanning documents are well organized and thoroughand clearly identify the business rationale underlying thecentralized structure. The structure should also be monitoredcontinually to ensure that it is properly maintained and toensure changes in legislation or the business environment donot affect the structures ongoing viability.

Transfer pricing for related-party transactionsTax authorities may challenge transactions with internationaltrading companies on the basis of their transfer prices. Inmost countries, transfer pricing rules only apply to related

party transactions but other countries rules may apply morebroadly. The entire business relationship must be consideredin any event. Generally, under the Organisation for Economic

Cooperation and Developments (OECD) guidelines, whichmost countries follow, companies must be able to showthat their intercompany prices approximate the prices that

would be agreed on by unrelated parties. This entails detaileddocumentation to support the companys transfer pricingmethods and practices.

Transfer pricing disputes are often about the allocation ofprot, based on the amount of value added at each stepalong the supply chain including nancing, development,production, marketing and sales, transportation and delivery.Transfer prices should reect the risks at each stage and beexible enough (e.g., through gross-up clauses) to respondto changing circumstances, such as civil unrest, commodityprice uctuations or extreme weather events, which couldchange the allocation of risk among the parties involved.

In addition to arms length terms, most tax authorities willconsider the spot price for commodities in determining theprice at which those commodities are sold to the tradingcompany. The trading companys functions and risks mustsupport whatever methodology is applied to the prots earnedthere, whether through a cost-plus approach or support for aprice that varies from spot.

Given the complexity of this determination, many LatinAmerican countries are introducing their own specicrules to protect the price at which their national resourcesleave the country. Brazil, for example, recently introduced

rules that apply deemed prot margins for determininginter-company prices rather than the OECDs arms lengthprinciple. The Brazilian legislation is moving toward a changethat would consider the spot prices parameter based oninternational commodities exchanges or even on internationalindependent index institutions. Other countries are aware ofsuch practices, and some may follow suit, especially in LatinAmerica.

Commodity trading companies can reduce their risk of atransfer pricing challenge by entering into advance pricingagreements (APA) with tax authorities. In the jurisdictions thatoffer them, APAs offer security that the tax authorities will

accept the selected transfer pricing methodology to be usedfor related-party transactions over a xed period of time. As a


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result, APAs can help give you more certainty that your supplychain operates as intended. While companies experienceswith tax authorities vary in terms of their exibility in

negotiating APAs, the situation in countries like Singaporeis improving as tax authorities gain more experience andcomfort with the process. Ultimately, it is most importantto establish an APA in the jurisdiction from which thecommodity is sold because that is the jurisdiction most likelyto challenge the transfer price.

Transfer pricing issues on migrating functions and risksExit charges can be an issue when moving functions andrisks from one jurisdiction to another. Most countries insiston compensation when goodwill or intangible value is movedout of the country. Establishing an international tradingcompany often involves moving a part of the business thathas value which is, in effect, a sale of the business to aforeign party. Determining a reasonable value to assign tothat business can be difcult, especially on an arms lengthbasis.

In 2010, the OECD formally incorporated businessrestructuring issues in its model transfer pricing guidelines.These guidelines effectively treat a wide range of non-taxbusiness decisions as transfer pricing issues and would applyto most reorganizations involving the establishment of aninternational trading company.

Under the guidelines, business restructuring is denedto include, the cross border re-deployment by amultinational enterprise of functions, assets and/or risks.In essence, a business restructuring can involve almost anysubstantive change in a business relationship, including:

a change in the nature or scope of transactions amongcontrolled entities

a shift in the allocation of risks

a change in the ownership of assets, including intangibles

a change in responsibility for speci c functions

termination of the relationship.

Importantly, the OECD guidelines state that the armslength principle should not apply differently in the case ofrestructuring than in other transfer pricing contexts.

The guidelines stress the importance of clearly dening thestructure of the transaction in terms of functions, assets andrisks both before and after restructuring, with appropriate armslength comparables where available. Written agreementsthat specify these terms and conditions are recommended.Regarding nancing arrangements, documentation shouldinclude an analysis showing that the interest payments arecommercially realistic.

Taxable presenceInternational trading companies need to be alert to the possibilitythat their transactions may inadvertently create a taxablepresence in a country, for income or indirect taxes, or both. Thetax authorities in Greece, for example, are aggressively seekingto tax their share of global commodity activities, among otherthings, by targeting ex-ship transactions in which products aredelivered aboard a ship in a specied country. In some countries,such as Peru, a foreign company can create a taxable presencemerely by taking title to goods in the country. The level ofbusiness activity that creates a connection to a country variessubstantially.

Global commodity traders need to manage the locationwhere title passes careful to avoid creating unintended taxobligations as goods move from point to point along thesupply chain.

Global commodity traders needto manage the location where titlepasses careful to avoid creatingunintended tax obligations as goodsmove from point to point along thesupply chain.

Organizations thinking about migratingtheir international commodity tradingand other functions should consider and document how the arms lengthstandard applies in terms of:

their initial structure

their new structure the payments (if any) that would

be expected at arms length onconverting from one structure tothe other

the implications (if any) of the priorstructure and the nature of therestructuring for prices under thenew structure.

Top ways to manage transfer pricing risk on restructuring




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Tax implications of contractual arrangementsOn establishing an international trading structure, the legalterms and conditions that govern the dealings between theparties in the supply chain should be arranged, taking intoaccount the tax implications. Contracts differ signicantly,and can produce a range of different tax issues, depending onhow they are structured.

If the arrangement is structured as a nancing contract,

then issues related to limitations on interest deductibilityand withholding tax obligations can arise in the sourcecountry.

If the arrangement involves royalty payments, paymentscan attract withholding taxes.

If the contract is characterized as a purchase and sale, thenVAT and/or customs issues may arise.

Most of these issues can be managed through properplanning, provided they are identied at the arrangementsoutset.

Treaty reliefThe character of payments made to the international tradingcompany must be determined in the jurisdiction from which itis sourced. The determination is important for assessing notonly whether the income results in business activity in thatjurisdiction but also whether that income could be considereda royalty or interest. Cross-border royalties and interest areoften subject to tax withholdings at its source, with possiblerelief under a treaty.

For both income and royalties, the owner of the incomemust be determined. For interest, concerns often arise asto whether the recipient of the income is the owner of

the income. In the case of royalties, concerns also arise overhow the term benecial owner is interpreted in the sourcejurisdiction. In many cases, ownership of income hinges onwhich party has use and enjoyment of the income whetheran intermediary (such as an international trading company) orthe ultimate parent.

The term benecial owner, as used in the OECD model taxtreaty, has given rise to different interpretations by courtsand tax administrations. Tax authorities are increasingly usingbenecial owner concepts to look through structures suchas international trading companies and deny treaty benetson dividends or to treat these entities as conduits for othersources of income where the intermediary essentially acts asan agent for the parent.

Because of risks of double taxation and non-taxation arisingfrom these different interpretations, the Organisation forEconomic Cooperation and Development (OECD) hasissued a discussion draft proposing changes to its model taxtreaty commentary. This is usually left to the source countryto interpret, which can lead to additional uncertainty onassessing whether treaty relief is available.

Accounting issuesIn addition to tax issues discussed earlier regarding themigration of a business, accounting issues can also arise. If atransaction is undertaken to move value out of the operatingjurisdiction this may result in triggering a gain for tax but not foraccounting. The implications to the vendor and the purchasermust be considered for both accounting and tax. Often with taxstructuring, accounting is considered late in the process andmay lead to surprises on the nancial statements.

Documentation The front line of defense

Should tax authorities decide tochallenge an international tradingcompanys arrangements based onsubstance, ownership of the income,transfer prices or some other basis,appropriate strategies for response andcompliance are critical. When dealingwith tax authorities, you need to bewell prepared, well organized and incomplete control of your facts andissues. This means:

understanding why transactions ortax positions were taken

being able to explain the technicalbasis of your understanding

being ready to back up your assertionsthrough clear, comprehensivedocumentation.

When preparing documentation,consider your arguments from a taxauditors standpoint. Undertake athorough tax risk exposure analysisto anticipate and address all possiblequestions and alternative argumentsso you can make sure all your bases

are covered. The analysis should alsoassess whether transactions andstrategies are in line with the companysbusiness goals and appetite for tax risk.Given increased cooperation among taxauthorities, your analysis should addresspotential issues and responses in allcountries in which you do business.




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Managing IndirectTax Issues



Indirect tax issues are often overlooked by international tradingcompanies. In establishing operations, they tend to focus on incometaxes and neglect the potentially high but less visible costs of othertaxes. Value-added taxes and goods and services taxes (VAT/GST) areperceived as a cash ow problem, rather than as bottom-line costs.Traders tend to concentrate on making deals and managing indirect taxproblems afterward.

Countries in Europe are seeking to increase their VATrevenues to help improve their nances, while countriesin emerging markets are imposing lower income taxes toattract investors and making up the reduced revenues throughhigher indirect taxes. Around the world, corporate tax rateshave been steadily falling for a decade, while VAT/GST systems

have proliferated across the globe, rising to higher rates andapplying to more items as indirect tax systems mature.

Rising audit activity puts pressure on VAT/GST managementInternational trading companies are likely to face morescrutiny of their indirect tax compliance and more aggressiveaudit activity. Given the high volumes of far-ung transactionsundertaken by international trading companies, they arelikely to encounter more pressure on their resources and

cash ow as the focus on VAT/GST increases. Changingcommercial circumstances and developing markets require


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skillful management of indirect tax requirements. In contrast,an ineffective assessment of tax regulations in trade-relatedbusinesses can lead to ineffective supply chains and an

increase of costs, eroding global competitiveness.In the event of overpayments, the amount of time it can take toobtain refunds can be lengthy, causing tremendous cash owproblems. For example, Italy is notoriously slow at issuing VATrefunds, sometimes taking up to 3 years.

VAT/GST differences heighten compliance riskFor international trading companies, issues often arise due todifferences among various VAT/GST systems. European VATsystems are relatively mature and European companies aremostly well acquainted with their obligations. Nevertheless,differences between European systems that are overlooked

can lead to costly non-compliance. Beyond Europe,in countries like China and Korea, VAT systems are relativelynew and quite different from European systems, heighteningthe risk of compliance errors and missteps.

Consider this example. In the trading sector, it is commonto have chain of supplies involving companies registeredfor VAT in more than one country. On trading within theEuropean Union, many companies assume that they are ableto avoid multiple registrations by following the simplicationmeasure for triangulation. However, other requirements

EUMember

EUMember

Europe

VAT/GST triangulation in Europe

EUMember

(e.g., administrative practices, special requirement basedon national law) may make the transaction taxable for VATpurposes. For example, some EU member states refuse the

application of the simplication measure for triangulationswhere the middleman company is also registered for VATpurposes in the EU member state of the selling company orof the buying company.

Managing VAT/GST through centralized teamsFor international trading companies, it is important to havein place a global strategy for managing the companysworldwide VAT/GST risks and sufcient resources toimplement that strategy. The biggest commodity tradingcompanies have large indirect tax teams, employing 1015people to manage their global VAT obligations and ensureappropriate processes are in place. This team should haveaccess to local professional advice in all relevant jurisdictionsto identify and resolve VAT/GST compliance issues anywheretaxable transactions may occur.

It is also important to ensure open lines of communicationbetween traders and VAT specialists to ensure traders canget quick answers on the VAT implications of proposedtransactions. The activities of VAT and trading teams shouldbe integrated to ensure that the companys VAT team has theopportunity to vet transactions before they take place.




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Given the huge volumes of transactions that must behandled, a global, technology-based VAT/GST managementplatform can help the companys tax function reduceerrors and increase tax savings. Through automation andstandardization, the company also stands to gain bettercontrol over VAT issues arising in billing procedures, whichcreate VAT obligations, and procurement processes, whichcreate VAT recoveries.

Customs risk and opportunitiesWhile more major international commodity companies areputting in place systems to gain more control over their VAT/ GST compliance, they have yet to recognize how exposed

their activities are to customs risk and bring the same levelof resources to bear on customs issues. With greater focuson customs risks and opportunities, international tradingcompanies can help ensure they are optimizing their customscosts by avoiding unnecessary customs charges and bymaking the most of simplied customs procedures andprograms.

Value for customs For example, when importing commodities into the EuropeanUnion (EU) from foreign (non-EUI) jurisdictions, commoditiesare cleared on the basis of ad valorem. So, based on the EUcustoms code and General Agreement on Tariffs and Trade(GATT) provisions, the value for customs clearance purposesis the transaction value, which is the price actually paid orpayable for the commodities between vendor and buyer.When assessing the costs included in the customs value,however, certain non-dutiable elements may be carved outfrom the valuation criteria, for example, when commissions,warranty payments, or inland haulage are paid by the importerof record, resulting in an optimized cost basis.

Customs compliance programs Within Europe and in other countries, a variety of customsprograms are available that can signicantly reduce supply

chain costs and improve trading margins. Optimizingthe benets of these opportunities requires centralizedplanning combined with local knowledge of various customscompliance procedures and programs. As with VAT/GST,

companies can reduce risk and improve their bottom lines byputting in place central policies and processes for dealing withtheir customs issues.

The Authorized Economic Operator (AEO) program, availablein the EU, the United States, Canada, Australia and othercountries, is one of the most recent and important tradefacilitation and control arrangements. The AEO systembasically involves economic operators who can obtaindifferent types of certication from the customs authoritiesaccording to their economic activities: certication for securityissues, certication for simplication of customs procedure ora combined security/simplication certication. Benets for

successful applicants include easier admittance to customssimplications, fewer physical and document-based controlsand priority treatment if selected for customs inspection.

Additionally, EUs new Single Authorization for SimpliedProcedures (SASP) opens the opportunity of utilizing localclearance procedures to perform customs formalities inthe member state where businesses are established withmovement of cargo in another member state, regardlessof where imports and exports actually occur within the EU.Applicants who obtain AEO status may also apply for theSASP without carrying out any assessment of their businessprocesses. SASP can allow companies to increase their

trading exibility and defer or suspend duty payment byentering commodities on an uncleared basis prior to nalsales and import. SASP can offer signicant operationaladvantages for businesses that are considering reorganizingtheir current supply chain, for example, by centralizinginventory locations and functions or altering product ows.

Customs warehousing schemes Under an international convention, the EU, Switzerland and76 other countries have agreed to adopt standard rules forcustoms procedures under which imported goods can bestored under customs control in a designated place (a privateor public customs warehouse) without payment of importduties and taxes. Traders should be aware of some specialrules that could affect VAT or other exemptions in warehouseprocedures.

Top ways to manage VAT/GST obligations

Ensure the trading and VAT/GST Consider the level of symmetry Look into outsourcing some or allteams are well integrated and that among the VAT/GST systems in the of your regional or worldwide VAT/ processes are in place to ensure countries covered by the international GST compliance to a single serviceconsideration of VAT/GST implications trading structure. provider to access economies ofof commodity trading and related scale, specialized local knowledge Think about taking advantage of VAT/ transactions. and industry best practices.GST and/or customs compliance

Seek local professional advice programs offered by the taxregarding the VAT/GST base and authorities.any available exemptions to ensurecompliance and avoid added costs.




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For example, the EU regulates two different warehousingschemes: the customs warehouse and the tax warehouse.The supply of goods to be placed under customs warehouse

may be VAT-exempt, and the importation and supply ofgoods to be placed under tax warehouses enjoy suspensionof excise duties while the goods are produced, processed,held, received or dispatched. Similarly, Switzerland has twoseparate schemes for customs and duty-free warehouses.

Considering that the oil products might be subject to VAT,excise duties and customs duties, traders of oil productsshould be aware of the different types of warehouse schemes.Commodities traders should also note that VAT is not normallylevied on sales of foreign goods placed under customswarehouse since such transactions often occur before thegoods are released for free circulation or cleared for import.

Excise and energy taxes on oil and gas products Commodity traders should take special note of any exciseor energy taxes that may apply to their products, along with

related tax saving opportunities. Within the EU, the levels oftaxation on energy products and electricity are regulated bythe Energy Taxation Directive, but member states can directlyprovide exemptions or reductions through differentiated ratesor refund mechanisms.

Traders of energy products, particularly oil and gas, should beaware of how their products are characterized under excisetax rules to ensure they are applying the correct excise dutyrate. They should also reect the cost of these taxes in theirprice to consumers and make the most of any possible taxexemptions or reductions.




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Looking Ahead



Strategically, commercially and logistically, the benets of internationaltrading structures for global commodity trading are clear. Many of theworlds major commodities producers already have well establishedcentralized trading operations, and have gained signicant competitiveadvantage.

As commodities trading continues to globalize,operations that focus on only one geographic regionor that rely on point-to-point supply chains will havegreater difculty meeting customer demands. The highermargins that international trading companies can generatecould force some smaller players out of the market.

Some national oil companies of smaller, resource-richcountries (e.g., Finland, Azerbaijan) that are seeking to expandare setting up international trading companies as entry pointsto international commodities markets. Oil producers fromGulf Cooperation Council states and former Soviet Union

members, which traditionally sold commodities throughlong-term contracts, are centralizing their sales and marketingarms to increase margins.

Meanwhile, centralization is allowing pure energy producersand mining companies to evolve from supply chain tradingtoward a more diverse range of nancial activities, fromhedging and proprietary trading to treasury functions. InSwitzerland, banks and energy companies are developinghighly sophisticated hedging products to protect their marketpositions, encouraging more divergence of banks into thecommodity markets. Cross-pollination is encouraging a


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Although more companiesare expected to establish newcentralized trading operations,further centralization among existingstructures may not be practical.

mutually benecial blending of the two industries as nancialexecutives travel between the two industries.

As the majors move into more sophisticated tradingactivities and integrate downstream processes into theirsupply chains, downstream service companies, suchas smelters and reneries, are feeling the squeeze. Butas the large majors shift their focus upstream, there areopportunities for downstream companies to move in. Forexample, some companies in the smelting business arestrengthening their position by buying mines and engagingin primary production.

Although more companies are expected to establish newcentralized trading operations, further centralization amongexisting structures may not be practical. Beyond a certainpoint, centralization can cause a loss of geographic advantagein terms of time zones and proximity to commodities markets.As noted, a multiple trading company structure that allows24-hour trading across time zones is emerging as a commonpractice among the largest commodities companies.

The greatest uncertainty for international trading structuresis the specter of more stringent regulation. For example,the US Dodd-Frank Act represents a sea change for the way

commodities are tracked, for the legal and capital structure ofmarket participants, and potentially for the types of activitiesthat traditional players are willing to continue doing in thefuture. At the same time, the worlds tax authorities could

target international trading activities by imposing strongerlegislative action to curb the use of these structures and gaina greater allocation of taxable prots, for example, throughmore prescriptive transfer pricing rules.

Additional risks arise for global commodity traders fromthe need to comply with economic sanctions. Economicsanctions are published at the international and nationallevels due to foreign policy and national security concerns.Targeted trade restrictions may be directed against nuclearproliferation, the oil and gas sector, and the nancial sector.They may target certain persons and also specic countriesor their governments (e.g., Iran, Sudan, North Korea). Themeasures prevent businesses from facilitating trade withthese countries; violation of economic sanctions is a seriouscrime. A system of effective internal controls can help ensuresuccessful trade compliance. Setting up a global trademanagement program that includes an economic sanctionschapter is essential for global commodity trading.

In the nal analysis, commodity prices will dictate the futureof international trading companies. As long as commodityprices remain high, the trend toward centralization in favorabletrading locations will continue. But if the worlds commodityprices experience a sustained decline, this business modelmay falter as companies with losses decide to keep more oftheir trading activities in higher tax locations.




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Key trends Many of the worlds major oil and gas and mining

companies have established international tradingstructures to gain competitive advantage. National oil companies are increasingly centralizing

their trading activities in key international trading centers. As the majors consolidate their supply chains,

downstream service companies are under pressurebut have opportunities to diversify their activities.

Centralization and cross-pollination with members of

the banking sector is allowing pure energy producersand mining companies to take part in a more diverserange of nancial activities.

Further centralization among existing trading structuresmay not be practical due to the loss of geographic

advantage. T he greatest uncertainty for international trading

companies is the specter of more stringent taxand trading regulation.

Commodity prices will dictate the future of internationaltrading companies. As long as commodity prices remain

high, the trend toward centralization in favorable tradinglocations will continue.




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Contributors


2012 KPMG International Cooperative (KPMG International), a Swiss e ntity. Member rms of the KPMG network of indep endent rms are afliated with KPMG International. KPMG International provides no client services. All rights reser ved.

Many KPMG member rm partners and practitioners contributed to theproduction of this brochure. In particular, we would like to thank:

Christopher AngusSenior Manager, TaxKPMG in the [email protected]

Patrick ConradyPartner, TaxKPMG in [email protected]

Roberto HaddadInternational and M&A Tax PartnerNational Tax Leader for Energy and NaturalResources and Private EquitiesKPMG in [email protected]

Harvey KoenigPartner, TaxKPMG in [email protected]

Mark PricePrincipal, TaxKPMG in the [email protected]

Timothy SarsonDirector, TaxKPMG in the [email protected]

Anthony SevePartner, TaxKPMG in [email protected]

Penelope WoolfordPartner, TaxKPMG in [email protected]


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Contact usAndr BoekhoudtKPMGs Head of Global Energyand Natural Resources Tax Practice T: +31 20 6 561358E: [email protected]

kpmg.com/socialmedia

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individualor entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information isaccurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such informationwithout appropriate professional advice after a thorough examination of the particular situation.

2012 KPMG International Cooperative (KPMG International), a Swiss entity. Member rms of the KPMG network of independentrms are afliated with KPMG International. KPMG International provides no client services. No member rm has any authority toobligate or bind KPMG International or any other member rm vis--vis third parties, nor does KPMG International have any suchauthority to obligate or bind any member rm. All rights reserved.

The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International.

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