Gary Thomas, White & Case, TokyoSam Sim, Standard Chartered Bank, SingaporeClemens Thyme, S&P Capital IQ, Hong KongMichael Quigley, White & Case, Washington DCAsia Tax Forum 2012Raffles Hotel, SingaporeMay 9-10, 2012TRANSFER PRICING IN ASIA: THE GROWING ACCEPTANCE OF THE ARMS LENGTH PRINCIPLE

TRANSFER PRICING IN ASIA

May 9, 2012*

TOPICSINTRODUCTIONMATURING OF THE ARMS LENGTH PRINCIPLE IN JAPAN: A LESSON FOR THE REST OF ASIA?COMPETENT AUTHORITY AND TRANSFER PRICING: HOW IS IT WORKING IN ASIA? CURRENT TRANSFER PRICING ISSUES IN FINANCIAL SERVICESTRANSFER PRICING CREDIT RISK ASPECTS CURRENT ISSUES BEING RAISED IN LITIGATIONCUSTOMS AND TRANSFER PRICING: WHAT YOU SHOULD BE AWARE OF FUTURE OF TRANSFER PRICING IN ASIAQUESTIONS

May 9, 2012*

I. INTRODUCTIONIntroduction of PanelistsOverall Panel Topic: Growing Acceptance of the Arms Length Principle in AsiaMerits The Arms Length Principle is accepted!Demerits The Arms Length Principle (whatever it is) is required!Using Japan as an Example of How Application of Arms Length Principle Has Evolved Over TimeCompetent Authority: Is It Working in Asia? Special Challenges in Financial Services Applying the Arms Length Principle to Intra-Group Loans and GuaranteesRecent Litigation IssuesTransfer Pricing and Customs

May 9, 2012*

II.MATURING OF THE ARMS LENGTH PRINCIPLE IN JAPAN: A LESSON FOR THE REST OF ASIAOutlineHistorical Background Recent HistoryApplication of the Arms Length Principle Over the YearsAdvance Pricing ArrangementsNew Transfer Pricing Enforcement Approach in Japan: Focus on Taxpayer Voluntary ComplianceJapan as a Lesson for the Rest of Asia?

May 9, 2012*

Historical Background of Transfer Pricing Enforcement in JapanAdoption of Transfer Pricing Rules in 1986Reaction to US Internal Revenue Service assessments against US subsidiaries of major Japanese corporations from early 1980sTransfer Pricing Rules Take Effect in 1987 Initial NTA Enforcement Policies (1987-1989)Collection of Information by SurveySoft Touch Enforcement ApproachAdoption of Centralized Management by International Examination Section in NTAEarly Japanese Transfer Pricing Cases Focused on Foreign-Based Firms (1989-1996)Expansion of Focus Toward Japanese Firms Outbound Transactions (from 1996)Impact of APA Program in Recent Years in Reducing Number of AuditsContinuing Aggressive Audit Activity Impact of Introduction of Transfer Pricing Documentation Requirements in 2010

May 9, 2012*

Recent History in Transfer Pricing Compliance Rules Release of NTA Transfer Pricing Guidelines (2001)Addition of Transfer Pricing Provisions for Consolidated Corporations (2002)Requirement of Disclosure of Transfer Pricing Methodologies in Schedule 17-3 (2003)Introduction of Transactional Net Margin Method (TNMM) (2004)Expansion of Coverage of Foreign Related Parties (2005)Introduction of the Profit Methods (TNMM and PSM) in Presumptive Taxation (2006)Introduction of Tax Payment Suspension Regime Specifically for Transfer Pricing Assessments in Competent Authority (2007)Expansion of Exchange of Information Rules (2009)Codification of Transfer Pricing Documentation Requirements (2010)Introduction of Most Appropriate Method Rule (2011)

May 9, 2012*

Transfer Pricing Assessments Since FYE 1999Historical Chart of Transfer Pricing Assessment in Japan since FYE 1999

*Each fiscal year shows FYE June XXX(Source: NTA Press Release)

May 9, 2012*

Threshold Question: Is Comparability of Transactions to be Based on Single Transactions or Groupings of Transactions? Historical NTA Position: Singular and strictly transactional, with aggregations within product group or business segment permitted in limited circumstanceswhere setting of price is performed taking into consideration transactions belonging to same product group or same business segmentUse of mini-baskets in practice but no overall company comparisons were acceptedHistorical NTA Position: There is only one arms length price. Japanese transfer pricing law does not recognize rangesBut, in recent practice, NTA accepts overall company comparisons and considers the use of ranges

May 9, 2012*

Comparable Uncontrolled Price MethodEarly application of secret comparables based on single transaction interpretationFailure of NTA to disclose identity of comparable product, comparable transaction or comparable company secret comparablesTaxpayer was prevented from performing an effective comparability analysis.Failure to make appropriate adjustments for differences in commercial level, transaction volume and other factors, such as business strategiesSubsequent difficulty to sustain secret comparables in competent authority negotiationsUse of CUP now seems to be the exception.

May 9, 2012*

Resale Price MethodSingular or Plural?NTA officials originally interpreted the Resale Price Method provisions as referring to transactions in the singular, resulting in application on a strictly transactional, product-by-product basis, with no aggregations of products and transactions recognized.Criticisms of strict transactional approachTaxpayers without internal comparables could not use the Resale Price Method unless they could identify (from information on competitors) specific gross margins of specific competing products which are similar to the Taxpayers products (and will be considered similar by the NTA on audit) and make necessary adjustments for differences in functions or other matters in regard to such specific transactions. Requires use of secret comparables by tax authoritiesGradual adoption of company-wide comparison approachUltimately, difficult to sustain in competent authority negotiationsNTA now accepts company-wide comparison approach and has become more flexible in applying the Resale Price Method

May 9, 2012*

Profit Split MethodsEarly preference for profit split methods in US/Japan competent authority casesDevelopment of conceptual arguments for applying profit splits Early criticism of one-sided approaches and concern for income creationNTA Guidelines instruct examiners to compare Japanese profits vs. foreign profitsIn past, NTA favored contribution profit split and use of two factors indicating relative value added: depreciation expense and personnel expenseCritics argue that Japanese Contribution Profit Split fails to take into account the value of intangible property embedded in products provided by foreign suppliers.NTA has also used advertising and promotion expenses and other selling expenses of Japanese subsidiary of foreign based firm, resulting in high allocations of overall profits to Japan.

May 9, 2012*

Profit Split Methods (contd)NTA adopted residual profit split and comparable profit split by circular based on OECD Transfer Pricing GuidelinesNTA sometimes applied Residual Profit Split but ignored contracts and legal ownership to attribute high value to alleged marketing intangibles in Japan.More recently, NTA has favored use of Residual Profit Split on outbound intangible transactions of Japanese companiesDocument requirements included disclosure of foreign segment profit-and-loss data.Recent defeat in court case involving profit splits

May 9, 2012*

Transactional Net Margin MethodNTA historical antipathy toward TNMMHistory of US assessments against Japanese firms based on Comparable Profits Method (CPM) and income creation issueActive Japan involvement in drafting OECD 1995 Transfer Pricing Guidelines paragraphs limiting use of TNMMGradual acceptance from late 1990s of modified resale price method to resolve MAP cases and reach bilateral APAsTNMM finally adopted into Japanese tax law in 2006Policy objective seemed to be to apply to Japanese firms outbound transactions.But adoption occurred at same time as agreement to revise US/Japan income tax treatyTNMM was positioned as an other method with lesser priority than RPM or other basic methods

May 9, 2012*

Transactional Net Margin Method (contd)NTA was reluctant to apply TNMM in transfer pricing audits just after its introduction in 2004But from 2006 or so, NTA increasingly accepted TNMM in bilateral APAs and unilateral APAs and later on in audits as wellTNMM was included as a presumptive taxation method in 2006.It is expected that TNMM will be applied more extensively going forward, although tax authorities views on comparables will likely be different from those of taxpayers.

May 9, 2012*

Seeking Certainty: Advance Pricing Arrangements Become More Prevalent

Advance Pricing Arrangements (APA) confirm that, once a tax authority evaluates the transfer pricing methodology and its validity, and accepts them as reasonable, as long as the firm conducts transactions according to the contents under certain preconditions, there would be no taxation on transfer prices.

Principal merits and demerits Merit: Secure predictability in transfer pricingMerit: Mitigate the transfer pricing risks (presumptive taxation, secret comparables and penalty)Merit: More flexibility in applying methods as compared to an auditDemerit: Required to submit much information to tax authorities for APA review, which can be like an auditDemerit: Administrative burdens and expensesOn balance: Should now be seriously considered!

May 9, 2012*

Trends in Bilateral APAs in JapanIncreasing number of APA applications(Source: NTA Press Release)

May 9, 2012*

Trends in Bilateral APAs in JapanIncreased number of APAs with Asian countries(Source: NTA Press Release)

May 9, 2012*

Trends in Bilateral APAs in JapanSignificant increase in application of TNMM in recent years(Source: NTA Press Release)

May 9, 2012*

New Transfer Pricing Enforcement Approach: Voluntary Compliance as a Matter of Corporate Governance

Public announcement at a Tax Seminar in Tokyo on April 24, 2012Mr. Toshiyuki Fushimi, Director, Large Enterprise Examination and Criminal Investigation DepartmentNational Tax Agency of Japan

International Trends in Tax Enforcement

Efforts to Enhance Corporate Governance Concerning Taxes

Efforts to Maintain and Enhance Tax Compliance in Transfer Pricing

Key Actions Expected of Enterprises to Prevent Occurrence of Transfer Pricing Problems

Check Sheet to Confirm the Status of Efforts Concerning Transfer Pricing

May 9, 2012*

International Trends in Tax Enforcement:Meeting of the Forum on Tax Administration in January 2012

The January 2012 meeting in Buenos Aires of the Forum on Tax Administration brought together the heads of the tax administrations from 43 countries under the auspices of the OECD and concluded with a unified and strengthened commitment to combat offshore tax abuse.

The tax administrators focused on the need to work smarter in times of shrinking budgets, and how to strengthen their relationship with large corporations through efficient and effective strategies that benefit both the taxpayer and taxing authority.

Although there have been some high-profile successes in the fight against offshore tax abuse, resulting in significant additional tax revenues and real improvements in transparency and exchange of information, it is far too soon to declare victory.

The tax administrations agreed that collaboration must now include coordinated actions by countries to finally put an end to offshore non-compliance.

May 9, 2012*

International Trends in Tax Enforcement:Meeting of the Forum on Tax Administration in January 2012A key agreed objective was to promote the relationship between tax administrations and Large Business Taxpayers

An adversarial relationship between tax administrations and multinational corporate taxpayers serves neither of our purposes well and is contrary to our common goals, which are earlier and greater certainty, consistency, and efficiency.

We will pay particular attention to the process of conducting and resolving transfer pricing cases. Overall, we intend to move away from a hide and seek approach to one based on greater transparency on the part of both taxpayers and tax administrations. As more companies put good tax compliance at the heart of their corporate governance, this will be easier to achieve.

May 9, 2012*

International Trends in Tax Enforcement:OECD Guidelines for Multinational Enterprises - 2011Part I : Recommendations for responsible business conduct in a global contextSection XI - Taxation

Tax compliance includes such measures as providing to the relevant authorities timely information that is relevant or required by law for purposes of the correct determination of taxes to be assessed in connection with their operations and conforming transfer pricing practices to the arms length principle. (Para 1)

Enterprises should treat tax governance and tax compliance as important elements of their oversight and broader risk management systems. In particular, corporate boards should adopt tax risk management strategies to ensure that the financial, regulatory and reputational risks associated with taxation are fully identified and evaluated. (Para 2)

May 9, 2012*

International Trends in Tax Enforcement:OECD Guidelines for Multinational Enterprises - 2011Part I, Section XI - Taxation

In the case of enterprises having a corporate legal form, corporate boards are in a position to oversee tax risk in a number of ways. For example, corporate boards should proactively develop appropriate tax policy principles, as well as establish internal tax control systems so that the actions of management are consistent with the views of the board with regard to tax risk. (Para. 102)

Tax authorities may need information from outside their jurisdiction in order to be able to .. determine the tax liability of the member of the MNE group in their jurisdiction. Again, the information to be provided is limited to that which is relevant to or required by law for the proposed evaluation of those economic relationships for the purpose of determining the correct tax liability of the member of the MNE group. MNEs should co-operate in providing that information. (Para. 103)

May 9, 2012*

International Trends in Tax Enforcement:OECD Guidelines for Multinational Enterprises - 2011Part I, Section XI - Taxation

Application of the arms length principle avoids inappropriate shifting of profits or losses and minimises risks of double taxation. Its proper application requires multinational enterprises to cooperate with tax authorities and to furnish all information that is relevant or required by law regarding the selection of the transfer pricing method adopted for the international transactions undertaken by them and their related party. (Para. 104)

The OECD Transfer Pricing Guidelines aim to help tax administrations (of both OECD member countries and non-member countries) and multinational enterprises by (partially omitted) minimising conflict among tax administrations and between tax administrations and multinational enterprises and avoiding costly litigation. Multinational enterprises are encouraged to follow the guidance in the OECD Transfer Pricing Guidelines, as amended and supplemented, in order to ensure that their transfer prices reflect the arms length principle. (Para. 106)

May 9, 2012*

Efforts to Enhance Corporate Governance Concerning TaxesThe economic activities of large business taxpayers occupy a large portion of the economy in Japan and the amount of their reported income is high.For example, large business taxpayers comprise 0.02% of the number of corporations, but 26% of the reported income of all corporations. Large business taxpayers lead industries and regions. Tax compliance by large business taxpayers greatly affects tax compliance by their enterprise groups as well as small to medium taxpayers and individual taxpayers.When the tax compliance by large business taxpayers, which require significant administrative resources in tax examinations, is enhanced, the tax administration will be able to allocate more administrative resources to the corporations with a high level of need to be examined and to plan for improvement in their level of reported income.From the perspective of the maintenance and improvement of the level of tax reporting throughout Japan, it is important to maintain and improve tax compliance by large business taxpayers.

May 9, 2012*

Results of Enhancing Corporate Governance Concerning TaxesBenefits for EnterprisesMinimizing tax risksMinimizing the burden of audit defenses in tax examinations.Benefits for the Tax AdministrationGreater focus on tax examinations of corporations with a high need for examinations

It is beneficial for both enterprises and the tax administration when tax compliance is improved through the enhancement of corporate governance.

May 9, 2012*

Efforts by the National Tax Authorities*

1. Conducting of Orientation Sessions

In meetings attended by top management of large business taxpayers, we will encourage the enhancement of corporate governance concerning taxes (such as by introducing examples of effective efforts).The national tax authorities will maintain and improve tax compliance through the enhancement of corporate governance by large business taxpayers, by confirming the status of corporate governance concerning taxes by large business taxpayers during tax examinations and carrying out exchanges of views with top management.* National tax authorities refers to regional taxation bureaus, which have jurisdiction over large business taxpayers.

May 9, 2012*

Efforts by the National Tax AuthoritiesApproaches towards Individual EnterprisesDuring the opportunity of a tax examination by Special Examiners in the Large Enterprise Examination Department in each regional tax bureau, the national tax authorities will confirm the status of the corporate governance concerning taxes by large business taxpayers through a request to them to describe the current status of their corporate governance including the involvement and direction by top management and the maintenance of an organization and functions in the finance and audit departments, in a Confirmation Sheet on Corporate Governance Concerning Taxes.

Upon the closing of a tax examination, the top management of a large business taxpayer and the top officials of a regional tax bureau will exchange views for the enhancement of corporate governance concerning taxes (such as by introducing examples of effective efforts).

May 9, 2012*

Efforts by the National Tax Authorities3. Use in Determining the Need for an Examination

Going forward, when determining the need for an examination, the national tax authorities will utilize the status of corporate governance concerning taxes as an important decision-making material and will allocate tax examination resources more heavily toward corporations with a high need for an examination.

Efforts in Transfer Pricing

Also on transfer pricing, in order to maintain and improve tax compliance, the national tax authorities will carry out a detailed plan as part of its efforts for the enhancement of corporate governance concerning taxes.

May 9, 2012*

Efforts to Maintain and Enhance Tax Compliance in Transfer PricingMerits for both the enterprises and the tax authorities through maintaining and enhancing tax compliance in transfer pricing

Benefits for enterprisesMinimizing tax risksMinimizing the burden of audit defenses in tax examinations

Benefits for the tax authoritiesGreater focus on tax examinations of corporations with a high need for an examinationPreventing the problem of international double taxation (Mutual Agreement Procedures with foreign tax authorities)

In order to prevent the occurrence of problems concerning transfer pricing, the national tax authorities will promote the voluntary and appropriate actions of enterprises through cooperation between the national tax authorities and the enterprises.

May 9, 2012*

Particular Compliance Concerns in Transfer PricingIn a self-assessment system, the taxpayer is required to themselves calculate the arms length prices for their transfer pricing and to file tax returns based on such calculations.

Because transfer pricing issues involve huge risks and costs, it requires even more voluntary and appropriate actions by the enterprises.

The importance of improving tax compliance, including transfer pricing, has been highlighted as an international trend.

In foreign countries, the enforcement of transfer pricing rules has been strengthened, and it is expected that transfer pricing assessments (double taxation) and the competent authority negotiations resulting from the same will increase. Accordingly, there is an increased need to consider measures, etc. for advance prevention of double taxation.

May 9, 2012*

Particular Compliance Concerns in Transfer PricingCurrently, the national tax authorities are moving ahead with efforts toward the enhancement of corporate governance concerning taxes, and it is possible to characterize the measures for transfer pricing as one part of such efforts.

In addition, in the 2010 tax reforms, the scope of required transfer pricing documentation was clarified, and the environment for the preparation of transfer pricing documentation was improved.

This means that the documents that are recognized to be necessary for the purpose of computing arms length prices were clarified in the ministerial order that sets for the presumptive taxation rules, which could be invoked if the tax administrations are not able to obtain the taxpayers cooperation through providing such necessary documents.

May 9, 2012*

Key Actions Expected of Enterprises to Prevent Occurrence of Transfer Pricing ProblemsKnowledge of Transfer Pricing LegislationInvolvement of Top ManagementRecognition of Status and Problem Areas in Foreign Related Party TransactionsImplementation of Global Transfer Pricing PoliciesTransaction Price Setting Taking into Account Transfer Pricing MethodologiesTransfer Pricing Compliance of Related Parties Overseas (Governance by Parent Company)Communications with the Tax AdministrationBased on the above, a Check Sheet to Confirm the Status of Efforts Concerning Transfer Pricing should be prepared.

May 9, 2012*

Efforts to Maintain and Improve Compliance in Transfer PricingFacilitation through Orientation Sessions

Along with an explanation of the domestic and foreign trends in transfer pricing, the national tax authorities will explain the importance for enterprises to themselves maintain and improve their tax compliance in transfer pricing.As part of their efforts directed toward the enhancement of corporate governance concerning taxes, the national tax authorities will encourage enterprises to themselves plan for the maintenance and improvement of tax compliance in transfer pricing, while confirming the status of the efforts of the enterprises concerning transfer pricing.

May 9, 2012*

Efforts to Maintain and Improve Compliance in Transfer PricingFacilitation through Individual Contacts with Enterprises

The national tax authorities will confirm the status of efforts on transfer pricing through a request to fill in a Check Sheet to Confirm the Status of Efforts Concerning Transfer Pricing.

As the time of exchanges of views between the top management of the enterprises and the tax bureaus with regard to corporate governance concerning taxes, the national tax authorities will also exchange views concerning transfer pricing.

Views will be exchanged between the enterprises and the tax officials in charge of transfer pricing, based on the contents of the Check Sheet to Confirm the Status of Efforts Concerning Transfer Pricing.

May 9, 2012*

Japan as a Lesson for the Rest of Asia?What can we learn from Japans history of attempting to apply the Arms Length Principle using the various transfer pricing methods?What have the Japanese tax authorities told other governments in Asia over time and now today about Japans experience?What are the implications of Japans new transfer pricing enforcement approaches seeking greater taxpayer compliance based on corporate governance objectives?

May 9, 2012*

III.COMPETENT AUTHORITY AND TRANSFER PRICING: HOW IS IT WORKING IN ASIA?

Panel Discussion

Gary Thomas, White & Case, TokyoSam Sim, Standard Chartered Bank, Hong KongClemens Thyme, S&P Capital IQ, Hong KongMichael Quigley, White & Case, Washington DC

May 9, 2012*

IV.CURRENT TRANSFER PRICING ISSUES IN FINANCIAL SERVICES IN ASIA THE BIG PICTUREFinancial Sector FDI 2011IPO Volume 2011

May 9, 2012*

IV.CURRENT TRANSFER PRICING ISSUES IN FINANCIAL SERVICES IN ASIA CONTRASTING FLAVOURSSome Macro Factors Impacting Level of Cross-border ActivityCrisis, really?European withdrawal vs Regionals Stepping upBank Finance to Capital MarketsSimpler Products vs Increasing SophisticationIncreased Regulations vs InternationalizationRing-fencing liquidity vs Outlet for excess savings

Asia cross-border FS has vast room for growthBut so does sophistication of authorities & TP rules !

May 9, 2012*

IV.CURRENT TRANSFER PRICING ISSUES IN FINANCIAL SERVICES IN ASIA DIFFERENT STROKESA. Familiar Global ThemesChallenge to management fees/Head-office chargesRelated party lending, capital, liquidity and guarantee feesIncreased documentation & reporting/compliance burdenRegulatory change and restructuringB. More so in Asia Intervention/influence of prudential regulatorsSophistication of tax authorities, advisors and taxpayers- Target vs Principles based; Cultural aspectsBespoke & evolving business/product/pricing modelsLegislative framework is young and in flux (Treaties/APA/MAP, TP jurisprudence)Beyond OECD?: BRIIC, UN modelImplications of state ownership

May 9, 2012*

IV.CURRENT TRANSFER PRICING ISSUES IN FINANCIAL SERVICES IN ASIA - MORE SPICE TO THE POTA. APA/MAPs-Are they worth the trouble?-First in class? Do you have the resources?B. Reconciling Differences -Different TP methods and mark-ups; Global consistency vs Local appropriate-Tax/TP vs Accounting (Financial vs Management view)C. GAAR, Thin-Cap, Indirect Taxes & TP-Interaction of such evolving tax principles with transfer pricingD. Branch banking to Subsidiaries-Subsidarisation, Securities companies, SPEsE. TP Infrastructure-Tax vs Finance: Roles & Responsibilities-Outsourcing

May 9, 2012*

TRANSFER PRICING CREDIT RISK ASPECTS Transfer pricing standards require financial transactions such as loans and guarantees between related entities to utilize arms length pricing.

Key question: At what rate could a subsidiary fund itself if it were an independent entity?

May 9, 2012*

Use a risk based approach that differentiates credit qualityFind appropriate comparable market rates for interest spreads or guarantee feesUse globally consistent methodologyDocument sound economic theory around assessments

Establish a Risk Based Framework for Intercompany Loans and GuaranteesExample: Coca-Cola

May 9, 2012*

May 9, 2012*

Classification - Credit Assessment MethodologiesRatingsInternal or Third Party

MethodSector, SizeInputOutputAdvantageLimitationPublic and Private RatingsAll3 years financials, management meetingRatingEasy to access and interpret Additional coverage through Private Estimates Limited coverage No standalone assessments of subs - Costs of Individual assessmentsCredit ScorecardAllCurrent Quantitative and Qualitative DataScore that can be mapped to a rating- Comprehensive sector coverage (Corp, FI, Ins)Requires qualitative & quantitative analysis If outsourced, cost of individual assessmentCredit Model rating scoreUS$ 20-50M and aboveCurrent Quantitative DataScore that can be mapped to a ratingQuantitative and objectified information only Large numbers of subs can be assessed quickly Links to Ratings dataLimitation in sectors, as some are hard to quantitatively model and size over USD c20m Credit Model- PDSME (US$1M and above)Current Quantitative DataProbability of Default Direct and quantified default measure Smaller entities with USD 1-100m revenue- Requires comprehensive empirical datasets including local/regional default data, which is hard to obtain

May 9, 2012*

Build fundamentals driven comparablesEstablish consistent approach for internal ratings on subs: Model based approach (most objectified, limitations) Internal Ratings Based approach (most detailed, expensive) Internal vs. external assessmentGenerate custom comparable yield curves

May 9, 2012*

Establishing a market based comparable requires:Transparent methodologyAppropriate segmentation (geography, industry, credit rating, duration, etc.)Cover all risk factors (sovereign risk, T&C)Strong grounding on empirical data Alternatives in Establishing Effective Reference PricesCredit Spread Models

May 9, 2012*

VI.CURRENT ISSUES BEING RAISED IN LITIGATION AND WHAT THIS MEANS FOR ASIAStatus of Selected Recent Cases US: Medtronic Inc. v. CommrUS: Guidant LLC v. Commr, T.C. No. 5989-11US: Veritas Software Corp. v. CommrUS: Xilinx, Inc. v. CommrUS: Intersport Fashions West Inc. v. United StatesAustralia: SNF (Australia) Pty. Ltd. v. CommrCanada: GlaxoSmithKline Inc. v. The QueenCanada: The Queen v. General Electric Capital Canada Inc.Canada: Alberta Printed Circuits Ltd. v. The QueenIndia: Vodafone Spain: Roche Vitamins Europe Ltd.Russia: Gazprom Extraction Astrakhan LLCToyota Argentina SA c/AFIP-DGIWhat These Cases Mean for Asia

May 9, 2012*

Medtronic Inc. v. Commr, T.C. No. 6944-11SUMMARY:Leads and devices adjustment: $1.2 billion The IRS challenged payments from Medtronic Puerto Rico (PR) to Medtronic U.S. for the use of patents and other IP and to purchase medical device components. PR used the components to assemble finished products, which it sold to Medtronic USA Inc., another U.S. affiliate that distributed the products in the U.S. and abroad.Medtronic used a CUT as its primary method, with a profit split as a corroborating method.IRS argument in the alternative: significant value transferred under 367(d)Medtronic also challenges a royalty true-up in the amount of $4Swiss Supply Agreement Issue: $39 millionUnder the agreement, Medtronics Swiss subsidiary assists PR by manufacturing and supplying the U.S. with devices to meet excess U.S. demand. The Swiss subsidiary pays the leads and devices royalty and the trademark royalty that PR would have paid if it had manufactured the product itself.

May 9, 2012*

Medtronic Inc. v. Commr, T.C. No. 6944-11Spinal Screw Operations: $90 millionMedtronic claims that the IRS improperly treated its PR as a contract manufacturer rather than a risk-bearing, autonomous manufacturerInterest Income from Prior Buy-In Case: $14 millionIn 2010, Medtronic and the IRS signed a closing agreement to resolve a 2008 Tax Court case (Medtronic Inc. v. Commr, T.C. No. 17488-08) relating to the buy-in paid by Medtronics Swiss subsidiary for the right to use preexisting intangibles.Medtronic disputes the inclusion of the interest amounts in its 2005-2006 returns because it has a competent authority request pending pursuant to the U.S.-Switzerland treaty.

May 9, 2012*

Medtronic Inc. v. Commr, T.C. No. 6944-11STATUS:Medtronic Inc. filed a petition in the Tax Court on March 23, 2011, challenging $2.7 billion in upward income adjustments to its 2005 and 2006 taxable years.Approximately $1.4 billion of the adjustments were transfer pricing adjustments related to licensing and manufacturing transactions with Medtronics affiliates in Switzerland and Puerto Rico.The case is currently scheduled for trial on May 21, 2012 in the Tax Court, although the parties have moved for a continuance.

May 9, 2012*

Guidant LLC v. Commr, T.C. No. 5989-11SUMMARY:Like Medtronic, involves licensed IP and manufacturing arrangements:Guidants Irish affiliate purchased components from Guidant U.S. and used the components to manufacture units that generate pulses in pacemakersGuidant Ireland sterilized and packaged the finished products, then sold them back to Guidant U.S., foreign related parties, and third-party distributorsIRS challenged royalties for use of licensed intangibles, prices of components, and intercompany sales of finished products in transactions with Irish and Puerto Rican affiliatesThe IRS used a CPM and concluded that a cost plus 13.9 percent markup (Puerto Rico) and a cost plus 11 percent markup (Ireland) should be applied to labor and overheadThe IRS did not calculate a markup on other costsGuidant claims that the IRS did not specify the portions of the adjustment attributable to the individual affiliatesAs in Medtronic, the IRS argued in the alternative that the transferred intangibles should be taxed under Section 367(d).

May 9, 2012*

Guidant LLC v. Commr, T.C. No. 5989-11STATUS:Guidant LLC, which was acquired by Boston Scientific Corporation in 2006, filed a petition in the Tax Court on March 11, 2011, challenging $1 billion in transfer pricing adjustments to its 2001 and 2002 taxable years.The adjustments related to technology licenses and manufacturing arrangements between Guidant U.S. and its subsidiaries in Puerto Rico and Ireland.The case is currently pending in the Tax Court and is scheduled to be tried on June 18, 2012.

May 9, 2012*

Veritas Software Corp. V. Commr, 133 T.C. 297(2009) SUMMARY:Valuation dispute over Veritas U.S.s buy-in payment under a cost-sharing arrangement (CSA) from its Irish subsidiary.Veritas U.S. reported a $166 million lump-sum buy-in payment from Veritas Ireland on its 2000 return. In 2002, Veritas U.S. amended its 2000 return to reduce the payment to $118 million.During audit, the IRS proposed an adjustment to increase the buy-in to $2.5 billion but at trial, the IRS reduced the proposed buy-in to $1.675 billion.In Veritas Software Corp. v. Commr, 133 T.C. 297 (2009), the Tax Court held for the TaxpayerUpheld the Taxpayers use of CUTs to value the contributed intangibles

May 9, 2012*

Veritas Software Corp. V. Commr, 133 T.C. 297(2009)On December 6, 2010, the IRS issued an Action on Decision, AOD 2010-05, 2010-49 I.R.B.The IRS declined to appeal the Tax Court decision but characterized it as erroneousIRS announced that it will continue to litigate cost sharing cases using approaches to valuation that distinguish between make-sell rights (to pre-existing intangibles) and platform rights (to technology developed in the future)

May 9, 2012*

Veritas Software Corp. V. Commr, 133 T.C. 297(2009)Issue was valuation of intangibles conveyed in a CSAVeritas U.S. contributed pre-existing computer software programs to the CSA, including the right to further develop the programs.Veritas used CUTs to value the intangibles contributed to the CSA using licenses to unrelated original equipment manufacturers such as HP and DellThe IRS rejected comparables as involving make-sell rights to preexisting intangibles rather than platform rights to future developed intangiblesCourt accepted licenses as comparables under a functional, rather than contractual, analysisThe IRS valued the intangibles as having perpetual useful lives and in the aggregate, rather than individuallyTreated the contribution as akin to a sale of Veritas U.S.s business to its Irish affiliateCourt rejected this approach

May 9, 2012*

Xilinx, Inc. v. Commr, 598 F.3d 1191 (9th Cir. 2010)SUMMARY:Issue was proper cost base to be used in a qualified cost-sharing arrangement (QCSA) for Xilinxs 1997-1999 taxable yearsThe Tax Court held in favor of Xilinx. Xilinx, Inc. v. Commr, 125 T.C. 37 (2005).In Xilinx I, 567 F.3d 482 (9th Cir. 2009), the Ninth Circuit reversed in favor of the IRS.In Xilinx II, 598 F.3d 1191 (9th Cir. 2010), the Ninth Circuit withdrew its opinion in Xilinx I and affirmed the Tax Courts decision in favor of the taxpayer.The IRS issued an Action on Decision, AOD 2010-03, I.R.B. 2010-33, in which it acquiesced in result only because the 2003 amendment of the regulations rendered the decision moot for subsequent years.

May 9, 2012*

Xilinx, Inc. v. Commr, 598 F.3d 1191 (9th Cir. 2010)While a QCSA between Xilinx and its Irish subsidiary was in effect, Xilinx granted stock options to its employees, which they exercised.The IRS claimed that stock-based compensation should have been included in the cost-sharing pool.Xilinxs position was that uncontrolled parties engaging in comparable transactions would not share the cost of the stock options.Competing rules: Cost-sharing rules provided that QCSA participants must share all costsBut the arms length standard is a general standard to be applied in every caseXilinx I: held for IRSCost-sharing rules were specific rules that trumped general Section 482 ruleXilinx II: held for XilinxResolve ambiguity by looking at:Purpose of regulations parity between controlled and uncontrolled transactionsConsistency with U.S.-Ireland treaty

May 9, 2012*

Veritas and Xilinx after the 2011 Cost-Sharing RegulationsSTATUS:In April 2012, the IRS warned that taxpayers entering into CSAs should not rely on Veritas or Xilinx now that the final 2011 cost-sharing regulations are in force. As we transition to the 2008 temporary and 2011 final cost-sharing regulations, we will be moving beyond the reach of Veritas and Xilinx. - Joseph Tobin, IRS Office of Associate Chief Counsel (International) (published in Tax Notes Today, April 23, 2012).

Citing the Supreme Courts decision in Mayo, the IRS has said that its new cost-sharing regulations were specifically and intentionally drafted to resolve the issues raised in Veritas and Xilinx. In Mayo, the Supreme Court held that Treasury regulations that have been subject to a notice and comment period are entitled to Chevron deference.

May 9, 2012*

Intersport Fashions West Inc. v. United States, 2012 TNT 30-21 (Fed. Cl. 2012)

SUMMARY:Subsidiary of German motorcycle apparel company not permitted to claim refunds for restructuring expenses incurred by its parent because the expenses were not claimed on a timely filed return.

STATUS:Government prevailed on motion for summary judgment a taxpayer cannot affirmatively invoke Section 482. See Treas. Reg. 1.482-1(a)(3).

May 9, 2012*

SNF (Australia) Pty. Ltd. v. Commr, [2010] FCA 635SUMMARY:SNF Australia, decided on June 25, 2010, is the Federal Court of Australias first written guidance on the application of the transfer pricing methods in Australia.Facts:SNF Australia imported polyacrylamide products from affiliates in France, the U.S., and China, and then sold these products to Australian customers.SNF Australia used the CUP method, with sales of products by SNF France to non-Australian third parties as comparables.SNF Australia reported losses back to 1998 despite evidence of sales growth. SNF Australia explained these as resulting from poor management, high levels of competition, low sales per salesperson, and excessive stock levels.The Australian Tax Office used the TNMM (with an operating profit of 1.7 percent) to adjust SNF Australias income upwards.The Australian Tax Office challenged SNF Australias use of the CUP, arguing that the French sales were not comparable.The Court rejected the use of the TNMM, faulting it and other profits-based methods for inevitably attribut[ing] any loss to the pricingThe Court accepted SNF Australias CUP analysis and its evidence demonstrating that the losses were caused by poor management and not by its transfer pricesThe Australian Tax Office appealed the decision to the Full Federal Court.

May 9, 2012*

SNF (Australia) Pty. Ltd. v. Commr, [2011] FCAFC 74STATUS:On June 1, 2011, the Full Federal Court dismissed the Commissioner's appeal.The Court conducted a re-examination of much of the evidence presented by the taxpayer to support its pricing under the CUP method and concluded that, in light of the following factors, comparability had been established:characteristics of the property the functions (activities of the companies conducting the comparable transactions)the contractual terms and conditions in the comparable transactionseconomic circumstances of the markets in which the transactions took place andBusiness strategies of the respective partiesThe Court concluded that there was a single global market, leading to its acceptance of comparable data from different geographic markets.In its Decision Impact Statement dated November 7, 2011, the ATO narrowly interpreted the impact of the Courts decision. The ATO also alluded to proposed legislation to reform the transfer pricing rules, in which case the legal position would probably be materially different.

May 9, 2012*

GlaxoSmithKline Inc. v. The Queen, [2010] FCA A-345-08SUMMARY:On July 26, 2010, the Federal Court of Appeal issued a taxpayer-favorable decision in GlaxoSmithKline. At issue were Glaxos Canadian subsidiarys payments to a related Swiss distributor for the active pharmaceutical ingredient in Zantac during the companys 1990-1993 taxable years.Glaxo used the resale price method, which produced prices ranging from $1,512 - $1,615The Canadian tax authorities used the CUP method, which produced prices ranging from $194 - $304 using prices paid by unrelated generic manufacturers for the same ingredient.The Tax Court of Canada largely upheld the assessments.On appeal to the Federal Court, Glaxo argued that a license agreement, by which it used the Zantac trademarks, must be considered in evaluating its transfer prices.Glaxos position was that no third party could sell Zantac without the license agreementThe CRA argued that only the supply agreement should be considered in determining what was reasonable in the circumstances.

May 9, 2012*

GlaxoSmithKline Inc. v. The Queen, [2010] FCA A-345-08The Federal Court of Appeal upheld the use of the CUP but agreed with Glaxo that the valuation must consider the license agreement and all other relevant circumstances.The Tax Court of Canada largely upheld the assessments. The Federal Court of Appeal upheld the use of the CUP but adjusted the pricing determination to account for the Zantac brand name.

STATUS:The Supreme Court granted the parties motions for leave to appeal and cross appeal and the appeal was heard on January 13, 2012. During the hearing, several judges asked whether it made a difference that the active ingredient purchased by Glaxo Canada was to be marketed and sold as Zantac, a branded product that would yield a higher retail price than the generic product.The Chief Justice asked about bundling and its relationship to transfer pricing if the price included something other than the substance (IP), why was withholding tax not remitted?A decision is not expected before the end of the year.

May 9, 2012*

The Queen v. General Electric Capital Canada Inc., [2010] FCA 344 SUMMARY:On December 15, 2010, the Federal Court of Appeal upheld the Tax Court of Canadas taxpayer-favorable decision in GE Capital Canada Inc. (GECCI).Facts:GECCI is a financial services company doing business in Canada. It financed much of its business with debt guaranteed by its U.S. parent company. Beginning in 1995, GECCI paid a guarantee fee of 1% of the principal amount of the debt outstanding during the year to its U.S. parent.GECCI deducted the guarantee fees in its 1996 through 2000 tax returns, totalling approximately $136.4 million in deductionsThe CRA disallowed the deductions, claiming that the 1% guarantee fee exceeded an arms length price.The Tax Court of Canada held for the taxpayer, finding that the U.S. parents implicit support should be taken into account in determining the guarantee fee.

May 9, 2012*

The Queen v. General Electric Capital Canada Inc., [2010] FCA 344The Federal Court of Appeal upheld the Tax Courts decision:Held that implicit support must be taken into account in evaluating transfer prices because an arms length party standing in the shoes of the taxpayer would consider it relevant.

STATUS:The CRA is attempting to re-litigate the case after denying General Electric Canada Company (GECC), successor by amalgamation to GECCI, a deduction for these same fees paid to the U.S. parent corporation. (2010-3493(IT)G and 2010-3494(IT)G).In December 2011, the Tax Court denied GECCs motion that res judicata prevented the re-litigation of this issue.Although the issues are similar, the Tax Court denied the motion because there are different taxpayers and different tax years involved.

May 9, 2012*

Alberta Printed Circuits Ltd. v. The Queen, 2011 TCC 232 (June 2011)SUMMARY:APC manufactured custom circuit boards for customers in Canada and the U.S., and for several years many of the design and setup services were performed by a Barbados company controlled by a key employee of APC. The founders of APC and the key employee had interests in both APC and the Barbados company, but there was no common legal control of the two entities. STATUS:However, the Tax Court held that the two companies did not factually deal with one another at arms length and were thus subject to Canadas transfer pricing rules.

May 9, 2012*

India Vodafone Intl Holdings B.V. v. Union of India (Supreme Court, Jan. 20, 2012) SUMMARY:Vodafone, a U.K. telecommunications company, purchased an Indian mobile phone company from a Hong Kong-based company for $11.2 billion in 2007. Indian tax authorities assessed $2.2 billion in capital gains tax against Vodafone in connection with the transaction, claiming that The Bombay High Court ruled in favor of the CBDT in 2010.

STATUS:In January 2012, the Supreme Court reversed, holding that in the absence of a specific look-through provision in Indias domestic law, a sale of shares by companies outside of India cannot be taxed by India simply because the underlying assets are located in India. The Supreme Court stated that allowing taxation under these circumstances would amount to imposing capital punishment for capital investment since it lacks authority of law.

May 9, 2012*

India Vodafone Intl Holdings B.V. v. Union of India (Supreme Court, Jan. 20, 2012)AFTERMATH:On February 17, 2012, Indian tax authorities filed a petition with the Supreme Court requesting a review of the January decision. The Supreme Court rejected the petition on March 20, 2012. However, in March 2012 the government proposed amendments to the Income Tax Act that would permit the retroactive taxation of cross-border transactions involving assets located in India. Separately, in December 2011, Vodafone was subject to a $1.7 billion transfer pricing assessment in India. It recently filed an appeal citing certain favorable observations in the above-mentioned Supreme Court decision.

May 9, 2012*

Roche Vitamins Europe Ltd, Supreme Court of Spain, Case No. 1626/2008 (Jan. 11, 2012).SUMMARY:The Supreme Court affirmed the National Courts holding that Roche Europe, a Swiss company, had a PE in Spain through its stripped risk subsidiary, Roche Spain.Roche Spain was a contract manufacturer receiving a cost plus 3.3 percent markup and also served as a sales representative for Roche Europe, for which it received a commission of 2 percent of sales in Spain. Roche Spain had no authority to negotiate the terms of sale or to conclude contracts, it merely represented, protected, and promoted the interests of Roche Europe. The National Court concluded (and the Supreme Court affirmed) that although Roche Spains facilities were not a fixed place of business of Roche Europe, Roche Spain was a dependent agent because it was legally and economically dependent on Roche Europe, which both directed and controlled all relevant activities of Roche Spain and bore all economic risks associated therewith.

May 9, 2012*

Roche Vitamins Europe Ltd, Supreme Court of Spain, Case No. 1626/2008 (Jan. 11, 2012).TRANSFER PRICING :The Supreme Court also addressed the attributable income issue, which has transfer pricing implications.Practitioners typically argue that , even if there is a PE in a country from which risk has been stripped, a transfer pricing analysis would conclude that the fees allocated to the stripped-risk affiliate are adequate to compensate it for its routine functions.But the Court held that Roche Spain was not adequately compensated for all of the functions it was performing for Roche Europe.The Court concluded that product sales in Spain were taxable to Roche Europes PE and Roche Spain should take into account a portion of European sales for this it had assisted in promotion.The Court held that. under Paragraph 34 of the OECD Commentary to Article 5, once a PE is established, it exists to the extent that the agent acts for the principal, not only to the extent of the agents contracts.As a result, all of the economic activity conducted by Roche Spain on behalf of Roche Europe is part of the PE.

May 9, 2012*

Gazprom Extraction Astrakhan LLC, Federal Arbitration Court (Russia), Case No. KA-A40/13304-10 (June 2011)

SUMMARY:The Russian tax authorities attempted to apply the net-back approach (an adjusted CUP method) to Gazproms sales of sulfur to a related party outside of Russia.

STATUS:The court rejected the Russian tax authorities attempt because the method is not mentioned in the Russian Tax Codes transfer pricing article.

May 9, 2012*

Toyota Argentina SA c/AFIP-DGI, Argentina National Tax Court (April 28, 2011)

SUMMARY:The tax authorities had retroactively applied new transfer pricing rules to reject the taxpayers transfer pricing study and methodology.

STATUSNational Tax Court found for the taxpayer and revoked a notice of deficiency.

May 9, 2012*

VI. CURRENT ISSUES BEING RAISED IN LITIGATION WHAT IT MEANS FOR ASIAIs Litigation a Viable Method for Managing Transfer Pricing Risks?Are transfer pricing disputes about the facts, the applicable law and/or the economics? Can courts be expected to find the right answer?What about the path forward after litigation?Impact of Litigation Elsewhere on Transfer Pricing in AsiaPrecedential value?Highlighting issues for potential local enforcement?Greater likelihood of litigation in the courts to resolve disputes?

May 9, 2012*

VII. CUSTOMS AND TRANSFER PRICING: WHAT YOU SHOULD BE AWARE OFCustoms Taxes: Valuation methods transfer pricing rules vs. customs valuation rulesArms length price under OECD TP guidelines as acceptable transaction value method?Resale price method vs. deductive value methodCost-plus method vs. constructed value methodJoint OECD/WCO conferences in 2006 and 2007Transfer pricing OECD, tax advisors and industry representativesCustoms WCO, country representatives, customs advisors2006 optimism for convergence between the two sets of rules; but in 2007, did reality set in?Transfer pricing positionsTransfer pricing rules acknowledge modern transactions involving tangibles, intangibles and services, while customs valuation rules are item-based and old school.Transaction values supported by OECD arms length pricing study should be accepted as showing no related party influence, so customs officials should accept arms length pricing adjustments or at least accept some mechanism to consider same.Customs reactionsImportance of well-accepted customs rules adopted on multilateral basis under GATTSkepticism of profit methods in transfer pricingMost inter-company transactions are accepted under transaction value method anyway.Specific challenge: Use of profits-based method (e.g., TNMM) that requires prospective or retroactive pricing adjustments to reach profit targets. Acceptable for customs? What procedures? Any convergence in transfer pricing and customs practices in Asia countries?

May 9, 2012*

VIII. FUTURE OF TRANSFER PRICING IN ASIA

Where are we headed during the next 5 years?

PANEL DISCUSSION

Most Appropriate Method Rule Use of Comparative Methods vs. Profit MethodsDocumentation RequirementsEnforcement ApproachesCooperation Among Tax AuthoritiesLitigationMAPs and APAsTransfer pricing and customs

May 9, 2012*

IX. Q & AQuestions?

May 9, 2012*

Thank you for your attention

*****CROSS-BORDER bank lending to Asias developing economies has been shrinking recently. European banks in particular have been retrenching as they seek to meet new capital targets. That may prompt many borrowers to turn instead to the capital marketsas they did during the last financial crisis. European bank lending to emerging Asia fell by over a fifth in the year to March 2009. In response, firms in these countries issued a flurry of bonds: over $240 billion in 2009, compared with $122 billion the year before. Asia's growing bond-markets may provide a useful "spare tyre" in a region that still mostly bounces along on bank lending.Indonesia upgraded, Myanmar opening upJapanese/Australian Fis, CIMB, DBSTrade, local MNCs going abroad, natural resources, financial center aspirations, opening up Myanmar, Vietnam, open up domestic marketsTop 3 Asia ex-Japan Loans Mandated Arranger for 1Q12 Bloomberg are State Bank of India, China Development Bank and Bank of China.Top sovereign wealth funds 6 out of 11 4 from China, SAFE Investment Company, China Investment Corporation, HKMA, National Social Security Fund, GIC and Temasek. Abu Dhabi and Kuwait Investment Authority, Australia future fund.

UAE Abu DhabiAbu Dhabi Investment Authority$6271976Oil5NorwayGovernment Pension Fund Global$6111990Oil10ChinaSAFE Investment Company$567.9**1997Non-Commodity4Saudi ArabiaSAMA Foreign Holdings$532.8n/aOil4ChinaChina Investment Corporation$439.62007Non-Commodity7KuwaitKuwait Investment Authority$2961953Oil6China Hong KongHong Kong Monetary Authority Investment Portfolio$293.31993Non-Commodity8SingaporeGovernment of Singapore Investment Corporation$247.51981Non-Commodity6SingaporeTemasek Holdings$157.21974Non-Commodity10RussiaNational Welfare Fund$149.7*2008Oil5ChinaNational Social Security Fund$134.52000Non-Commodity5QatarQatar Investment Authority$1002005Oil5AustraliaAustralian Future Fund$802006Non-Commodity10*Data = rated debt market transactions**Standard & Poors established the Risk Solutions group at the beginning of the year to With 140 years of credit assessment experience to build on, you wont be surprised to hear our focus is on credit.

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