International Tax Issues

Transfer Pricing

Stan Hales - EY

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Disclaimer

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• Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited located in the US.

• This presentation is ©2014 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young and its member firms expressly disclaim any liability in connection with use of this presentation or its contents by any third party.

• Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.

• These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice.

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Banking industry return on equity (ROE)

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Source: “At Big Banks, ROE Woe”, Wall Street Journal, October 15, 2012.

2008 and prior Post 2008

20%

15%

10%

5%

15%

8%

ROE often exceeded 15%, driven by strong economies and lenders’ appetite for high-risk, high-reward strategies.

ROE decline as a result of regulatory reform, unforgiving markets and harsher business climate.

With capital costing somewhere between 8% and 12%, executives and analysts believe that a lender has to earn an ROE of around 12% to be a worthwhile investment.

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Contributions to a low ROE and high cost-to-income ratios

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Forc

es fo

r cha

nge

Economic context – global, local, developed, emerging

Regulatory Customer Technology Competition Society

• New global standards challenging the profitability of business lines.

• Regulatory overhaul impacting global banking model and higher, expensive capital requirements.

• Fed IHC.

• Customers require greater transparency, data privacy and cyber security.

• Dodd-Frank Wall Street Reform and Consumer Protection Act.

• Customers expect bank to replace dated systems and processes.

• Refining legacy system to cope with regulatory overhaul and the growing digital business environment.

• Costly management of growing data.

• Better service to customers via mobile bank apps and automated loan processing.

• Bank consolidation and acquisitions post-crisis.

• Regulatorychanges intensify battle for market leadership.

• New reputational standards are introduced locally and globally to rebuild image and trust post financial crisis.

• Shareholderpressure to implement business models that deliver sustainable returns and reward investors.

Regulation and ROE are both driving change in the banking industry.

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Banking industry regulations – at a glance

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Global Regional US

OECD Base Erosion and Profit Shifting (BEPS)

Capital Requirements Directive (CRD IV)

Immediate Holding Company (IHC) Requirements

Regulation W (Section 23A and 23B),

Section 482

What • A plan with 15 actions aiming to address situations where profits are perceived as geographically divorced from activities.

• Intended to implement the Basel III agreement in the EU with enhanced requirements for capital, leverage and new rules for counterparty risk.

• Also makes changes to rules on corporate governance, including remuneration and introduces standardized EU regulatory reporting.

• Enhanced prudential standards for liquidity, risk management and capital, for US Bank Holding Companies (BHC) and foreign banking organizations (FBOs).

• Large FBOs (with US$10B+ in non-branch/agency assets) operating in the US will be required to consolidate all US legal entity ownership interests under a single, top-tier IHC. The IHC will then be subjected the enhanced prudential rules similar to the BHC.

• Regulations for transactions between banks and their affiliates.

• 23A ensures that banks are not unduly exposed to credit risks arising from transactions with affiliates.

• 23B ensures that a bank’s service and other transactions with affiliates are on market terms and conditions.

Who • Banks with global operations; G20 countries.

• Banks and investment firms in the EU. • Banks and affiliates.

When • 2013 – BEPS action plan was published.

• 2014 – Updates on BEPS (September); projected completion of half of action plan.

• 2015 – Completion of remainder of action items.

• Effective on January 1, 2014.

• FBOs are required to submit an implementation plan for the IHC to the Federal Reserve by January 1, 2015.

• Issued in April 2003 by the Board of Governors of the Federal Reserve, strictly enforced.

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B.E.P.S.Another contributor to a lower post-tax ROE.

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What could be the result of BEPS?

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2011 tax revenue – OECD countries

Note: 2011 is the latest year with complete data.Source: OECD Stats, http://stats.oecd.org/ (downloaded on June 5, 2014)

United States25.9%

Japan11.8%

Germany9.3%France

8.5%

Italy6.6%

United Kingdom6.0%

Canada3.8%

Spain3.3%

Australia2.8%

Netherlands2.2%

Korea2.0%

Sweden1.7%

Mexico1.6%

Belgium1.6%

Turkey1.5%

Norway1.5%

Switzerland1.3% Austria

1.2%Poland1.2%

Denmark1.1%

ROW (14 Countries Below 1.0%)

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What is BEPS? – the action plan

►Action 11: Establish methodologies to collect and analyse data on BEPS and actions addressing it.

►Action 12: Require taxpayers to disclose their aggressive tax planning arrangements.

►Action 13: Re-examine transfer pricing documentation.

►Action 14: Making dispute resolution mechanisms more effective.

►Action 15: Develop of a multilateral instrument for amending bilateral tax treaties.

►Action 1: Address the tax challenges of the digital economy.

►Action 2: Neutralise the effects of hybrid mismatch arrangements.

►Action 3: Strengthen CFC rules.

►Action 4: Limit base erosion via interest deductions and other financial payments.

►Action 5: Counter harmful tax practices more effectively, taking into account transparency and substance.

►Action 6: Prevent treaty abuse.

►Action 7: Prevent the artificial avoidance of permanent establishment status.

►Action 8: Consider transfer pricing for intangibles.

►Action 9: Consider transfer pricing for risks and capital.

►Action 10: Consider transfer pricing for other high-risk transactions.

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BEPS – OECD updates from September 16, 2014

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Seven deliverables have been agreed by consensus by OECD and G20 countries including:

Three reports on:

1. Digital economy (DE) (Action 1);• Not possible to ring-fence DE for tax purposes. BEPS risks and specific issues

will be addressed Action 3 (CFC rules), Action 7 (artificial avoidance of PE) and Action 8 to 10 (TP).

2. Feasibility of a multinational instrument (Action 15); and3. Harmful tax competition (Action 5).

Four instruments on:

1. Hybrid mismatch arrangements (Action 2);2. Treaty abuse (Action 6);3. TP intangibles (Action 8);

• Chapter I of the TP Guidelines expanded to discuss: location savings, assembled workforce and group synergies.

• New Chapter VI contains guidance on identifying intangibles and on determining arm’s length conditions including: comparability in intangible transactions; TP methods and use of valuation techniques for intangibles transactions.

4. TP documentation and country-by-country (CBC) template (Action 13)• A 3-tiered approach: master file, local file and CBC report.

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Similar “BEPS” plans?

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Finance Chairman Max Baucus’ proposal:

1. Limitations of income shifting through intangible property transfers. (OECD BEPS Action 8: transfer pricing and intangibles)

2. Prevent avoidance of US tax through reinsurance with nontaxed affiliates. 3. Treatment of gain or loss of foreign persons from sale or exchange of interests in

partnership engaged in trade or business within the US.4. Interest on corporate debt obligations not treated as portfolio interest. (OECD

BEPS Action 6: treaty abuse)5. Denial of deductions for related party payments arising in a base erosion

arrangement. (OECD BEPS Action 2: hybrid mismatch arrangement)

Source: Chapter VI. Provisions to prevent base erosion from the “Technical Explanation of the Senate Committee of Finance Chairman’s Staff Discussion Draft of Provisions to Reform International Business Taxation” prepared by the Joint Committee on Taxation, November 19, 2013, pp 73 – 81.

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Why BEPS?

12Source: The Economist, “Capacity to Pay”, January 28th, 2014.

CountryDebt/Revenue

Ratio

Japan 7.65

Greece 4.95

Ireland 4.51

US 4.20

Portugal 4.14

Italy 3.20

Canada 3.13

UK 3.04

Spain 2.82

France 2.41

Germany 2.35

Belgium 2.27

Netherlands 2.14

Switzerland 1.50

Growing sovereign debt levels.

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Public outcry and BEPS

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Corporate tax paid in top 10 banking hubs

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Source:1. US, UK, Switzerland, Korea, Germany, Luxembourg and Canada - http://data.oecd.org/tax/tax-on-corporate-profits.htm#indicator-chart for 2. Singapore - http://www.iras.gov.sg/irasHome/page.aspx?id=150603. Hong Kong - http://www.ird.gov.hk/dar/2012-13/table/en/revenue.pdf 4. Japan - http://www.nta.go.jp/foreign_language/Report_pdf/2014e.pdf

0.00

20.00

40.00

60.00

80.00

100.00

120.00

% OF  TAX

 TO TOTA

L TA

X RE

VENUE DURING 201

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TOP TEN COUNTRIES CONSIDERED BANKING HUBS OF THE WORLD

Other miscellaneous tax

Capital gains tax

Indirect tax

Personal tax

Corporate tax

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Will BEPS be a solution?

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As a percentage of the economy, corporate tax dollars have declined steadily in the post-World War II period, from more than 5 percent of GDP in 1946.

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US - corporate tax contribution

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Will BEPS be a solution?

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An article from the Economic Policy Institute described 8 progressive revenue options to raise US government revenue:

Progressive Revenue Option

10-Year Revenue

Projection (US$)

1 Reform current income tax rates, create additional brackets for top earners and tax capital gains as ordinary income.

$1.6 trillion

2 Tax carried interest as ordinary income. $21 billion

3 Eliminate the loophole allowing the wealthy to avoid paying taxes on inherited stocks and bonds.

$452 billion

4 Cap the marginal tax rate on itemized deductions. $513 billion

5 Pursue international corporate income tax reform, including repealing deferral of foreign profits.

$606 billion

6 Enact a progressive estate tax. $160 billion

7 Enact a financial transactions tax. $830 billion

8 Enact a carbon tax. $943 billion

Source: Economic Policy Institute “Many options exist for raising revenue in a smart and progressive manner”, April 18, 2013.

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BEPS for banks – what should you do now?

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• De-risk your transfer pricing by reorganizing around people and asset substance.• Obtain an advanced pricing agreement (APA).• Revise existing transfer pricing documentation into master and local files.• Open conversations with finance and IT to create automated system reports with the

CBCR data.• Document the SLAs with new ITCs and ring-fence core service centers.

The master file would contain information within the following categories:

The local file would contain information within the following categories:

• Group information• The business• The group intangibles• The group funding arrangements• The financial and tax positions of the

group• Separate country by country report

• Local entity information• Controlled transactions• Reconciliation with financial data• Business Restructurings• Effects of any transfers of intangibles

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TP risk assessment – top 10 banking hubs

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Financial Hub1

OECD Country

(Y/N)

SpecificTP Doc Required (Y/N) Key TP Developments

APA (Y/N)

GeneralRisk

Category

New York (US)

Y Y Increased interest in financial service companies and financial services transactions by the IRS.

Y High

London (UK) Y N HMRC has made alternative investment managers (AIM) a priority and is widely recognized as being highly sophisticated when auditing AIM.

Y Medium

Hong Kong N N Regulators have shown an interest in TP documentation as evidence of activities taking place in Hong Kong. Moderate audit activities.

Y Low

Singapore N N The Monetary Authority of Singapore (MAS) and the tax authority (IRAS) are well connected. MAS is regulatory positions through TP doc. Increasing audit activities.

Y Low

Zurich (Switzerland)

Y N The SFTA increasing its scrutiny of TP arrangements, in particular, remuneration for transfers of intangibles, services, intercompany financing and restructurings.

N2 Low

Tokyo(Japan)

Y N Asset management is a growing interest of the Japanese tax authorities. Active audit activities. Large financial services institutions seeking APAs to risk manage.

Y Medium

Seoul(Korea)

Y N Very aggressive TP audits and focuses on the financial services industry. Y High

Frankfurt(Germany)

Y Y TP doc required for extraordinary business transactions only. TP requirements are very strict in Germany. Likelihood of audit is high in Germany.

Y Medium

Luxembourg Y N Has become a target of an international push led by the OECD and the European Commission to for illegal state aid.

N2 Low

Toronto(Canada)

Y Y TP is a high priority enforcement area for the CRA. Key areas of focus include management and head office service charges and sub-advisory fees.

Y High

1. From 2014 Global Financial Centres Index. 2. No formal APA process in place, but taxpayer can obtain advance rulings or clearance from tax authorities.

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Are you prepared?

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REVIEW your existing TP arrangements PREPARE TP documentation MANAGE your TP controversy

A key response to the implications of the regulatory reform is a proactive review of your existing transfer pricing arrangements:

• Have you taken inventory of your transfer pricing arrangements.

• Have you assessed and document economic substance and value creation?

• Have you reviewed relevant tax treaty and considered potential permanent establishment exposures?

• Do you have appropriate evidence that transactions between affiliates conducted at arm’s length?

More than 60 countries have regulations on TP, some of which have specific TP doc requirements:

• Do you have a clear understanding of local TP regimes relevant to your business?

• Do you have TP doc in place for high risk jurisdictions/high risk transactions?

• Is your TP doc strategy and approach effective in providing the right coverage at the right jurisdiction?

• Do you have appropriate economic (benchmarking) analyses to support arm’s length pricing?

Audit activities are increasing across different jurisdictions:

• Are you currently under going a TP dispute with tax authority?

• What has been your experience with past audits?

• Are you familiar with the local audit procedures of which you operate?

• Have you considered advance pricing agreements as an option for risk management?

Being proactive is the best defense.

International Tax IssuesInformation ReportingErica Gut - PwC

Information Reporting

FATCA Developments UK CDOT Common Reporting Standards (CRS)

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FATCA Developments

FATCA Developments

Coordination regulations released in July together with changes to the FATCA regulations

Notice 2014-33• Extension of treatment of entity accounts as pre-existing to December 31st

• 2014 and 2015 as ‘transition period’ for enforcement Forms W-8BEN-E and W-8IMY – prior versions valid until the end of

2014 Statements on self-certifications – Treasury will acknowledge minimum

standards but will not review Implementation issues

• Bank account opening is spurring multinationals to review their status• Completion of forms is giving rise to a lot of questions• Standardized procedures are having to be modified to take into account local

customs

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Guidance Required to Operationalize FATCA

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IRS Notices and Announcements

FFI Agreement

U.S. Chapter 3, 61 and section 3406 regulations

IRS website ‐FAQs

FATCA registration,IRS User Guide

U.S. FATCA (chapter 4) Regulations

Operational FATCA and Information Reporting 

Local Guidance issued under IGAs

July 1, 2014….

IRS Forms and Instructions

UK CDOT

UK CDOT - Overview

FATCA-like regime involving the UK and its Crown Dependencies and Overseas Territories

Some agreements are reciprocal and some are unilateral (like US FATCA IGAs)

Will require documentation separate from a W-8/W-9 • Residency concepts are different• Requires identification of controlling UK persons and well as US owners

that would otherwise be identified on a W-8BEN-E Fully effective on July 1, 2014; no delay to track Notice 2014-33

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UK CDOT – High Level Differences

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<Scope / Legal 

Entity

Client Identification 

and Due Diligence

Withholding Reporting

• The definition of a Financial Institution remains unchanged.

• Certain Financial Institutions exemptions available  under the UK‐US IGA are notavailable under UK FATCA.

• Some NFFEs considered as Active NFFEs under UK‐US IGA are considered to be Passive NFFEs under UK FATCA.

• UK FATCA is based on identifying account holders tax residency. Citizenship is not relevant and therefore certain indicia are no longer considered relevant 

• Pre‐existing Cash Value Insurance contracts with a value above $250,000 are now in scope for review subject to threshold elections.

• Pushed‐back timeline for initial reporting – information in relation to reportable years 2014 and 2015 will be reported in 2016. 

• There is no withholding under these agreements and references to withholding has been removed.

• There is no concept of non participation.

UK CDOT – Countries Involved

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Jurisdiction Model Type Reciprocal? Operational Impact

UK Financial Institutions Crown Dependency / Overseas Territories Financial Institutions

Isle of Man Model 1 Yes Identify and report on Financial Accounts held by tax residents of these jurisdictions in addition to reporting on US citizens to HMRC under UK‐US FATCA

Identify and report on Financial Accounts  held by  UK tax residents to the local authorityGuernsey Model 1 Yes

Jersey Model 1 Yes

Gibraltar Model 1 Yes

Cayman Islands Model 1 No UK Financial Institutions do nothave any reporting obligations under this agreement

Identify and report on Financial Accounts  held by  UK tax residents to their local authority.British Virgin 

IslandsModel 1 No

Montserrat Model 1 No

Turks and Caicos Model 1 No

Anguilla Model 1 No

Bermuda Model 2 No UK Financial Institutions do not have any reporting obligations under this agreement

Bermudian Financial Institutions will report UK tax residents directly to HMRC

Common Reporting Standards (CRS)

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CRS Overview

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• Model Agreement published February 13th

• Commentary published on July 21st

• 60 plus jurisdictions committed to adopting CRS

• 46 jurisdictions acting as “early adopters” of CRS

• Proposed start date of 1st January 2016

What does this mean for banks?

Financial institutions resident in CRS countries should report account holder information to their local tax authorities who will then exchange such information with countries where account holders are tax residents

What is CRS? Where are we? What is next?

• Domestic legislation will need to be implemented (UK have )

• There are still a number of countries to join CRS

• Global forum meeting in Berlin 28-29 October

• Global standard for automatic exchange of financial account information between Governments.

CRS – Early Adopters

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August 1, 2014 early adopters in blue; others are committed to implementation:Andorra, Anguilla, Argentina, Australia, Austria, Belgium, Bermuda, Brazil, British Virgin Islands, Bulgaria, Canada, Cayman Islands, Chile, China, Colombia, Costa Rica, Croatia, Cyprus, Czech Republic, Denmark, Estonia, Faroe Islands, Finland, France, Germany, Gibraltar, Greece, Guernsey, Hungary, Iceland, India, Indonesia, Ireland, Isle of Man, Israel, Italy, Japan, Jersey, Korea, Latvia, Liechtenstein, Lithuania, Luxembourg, Malaysia, Malta, Mexico, Montserrat, Netherlands, New Zealand, Norway, Poland, Portugal, Romania, Russia, Saudi Arabia, Singapore, Slovak Republic, Seychelles, Slovenia, South Africa, Spain, Sweden, Switzerland, Turkey, Turks & Caicos Islands, United Kingdom, United States and European Union

Early Adopters

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CRS – US Viewpoint

Treasury Official Says U.S. Adoption of OECD Common Reporting Standard Will Take Time 194 DTR G-3

· Brett York (Office of International Tax Counsel at the US Treasury) said Oct. 6 that the U.S. isn't on the list of 40 countries that have agreed to adopt the standard early, because it would require legislative changes for banks to be able to share some of the information called for under the standard, developed by the Organization for Economic Cooperation and Development.

· Even if that legislation were to be enacted, Treasury and the Internal Revenue Service would still have to issue regulations, York said.

· He noted that the U.S. doesn't anticipate a new agreement on the common reporting standard, but would implement the standard through existing intergovernmental agreements (IGAs) under the Foreign Account Tax Compliance Act.

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CRS – Interaction with FATCA

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Financial institution Account holders

Documentation

Local tax authority

Non participating 

FFI‘Payments’ not including consideration for the provision of goods or non‐financial services

Reporting on reportable accounts

FFI Reporting and Certificationson reportable accounts IRS

• Obtain information on account holders

• Comply with required due diligence and verification procedures

• Obtain applicable waiver of disclosure limitations

Model 1 IGA reportingon US reportable accounts and payments to NPFFIs

As with the Foreign Account Tax Compliance Act (FATCA), the CRS model imposes obligations on financial institutions (FIs) to identify reportable accounts and obtain the accountholder identifying information that is required to be reported for such accounts to their local tax administration.

Automatic Exchange of Information

CRS reporting on reportable accountsNumber of reporting depends on location of Reporting FI

CRS - Timeline

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AccountOpening

PreexistingAccount Due Diligence

Reporting

Ongoing monitoring of regulatoryupdates

1 July 2014

1 Jan 2016 – Go Live US / UK FATCA

Cut off date

CRS

US / UK FATCA

31 May 2015 (UK IGA)

TBA starting in 2017

2017201620152014

CRSCut off date

US FATCA / UK FATCA / CRS

31 May 2016 (UK FATCA)

US / UK FATCA

CRS

Not all countries may have the same Go Live date for CRS

The overlap of cut off date = opportunity to combine efforts.

Although due dates are to be determined, reporting processes should be flexible

A process must be established to monitor progress of countries signing up to CRS

CSR – Select Changes and Impact

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Key Changes Potential Impact 

Modification to Financial Institutions exemptions under the CRS Agreements.

The definition of Passive NFE includes certain Investment Entities located in a jurisdiction that is not participating under the CRS. 

Validation of legal entity classification (a broader scope likely)

Exempt entities may differ across Model Agreements and local laws for implementation

A greater population of passive NFEs will require review for controlling persons

Legal Entity Classification

Scope and Governance

The definition of a Financial Account and associated exclusions may vary across jurisdictions

Equity or debt interests that are regularly traded on an established securities market are included within scope of financial account definition

It will be necessary to perform additional product analysis to ensure there are no Financial Accounts that were not in scope for FATCA but are in scope for CRS

Scope of accounts to be evaluated will increase

10 October 2015

CSR – Select Changes and Impact

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Key Changes Potential Impact

Identification of the tax residency or residencies of account holders

Self certification is required for both individual and entity accounts

Notification required to be sent to  reportable account holders

Undocumented entity account holders assumed to be Passive NFEs and need to be reviewed for controlling persons

Overview of Client  Onboarding  Due Diligence  Process

The scope of reportable accounts will be much greater 

Existing self‐certification forms may not suffice for CRS 

Pre‐existing Account Due Diligence

Modification of indicia for pre‐existing individual accounts

No $50k threshold for individual accounts

Due diligence for pre‐existing accounts can be based on residence address and existing AML procedures

The time table by which these review must be carried out are yet to be specified.

Indicia searches will be performed on multiple jurisdictions 

Expansion of scope for pre‐existing account due diligence. 

Client communications will be essential to ensure differences in CRS and FATCA are clearly understood

CSR – Select Changes and Impact

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Key Changes Potential Impact

Significant increase in the volume of reports distributed  for accounts holders with multiple residences

Tracking  of reporting requirements will be necessary at a country level due to variances between CRS and FATCA

Reporting process design developed for US FATCA is agile enough to accommodate for CRS

Reporting 

Reporting dates are yet to be confirmed but required in 2017  for information relating to 2016.

Countries may have differing reporting requirements

Date and place of birth must be reported unless they do not have to reported according to domestic law

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Q&A

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Stan J. Hales | Principal | Financial Services Transfer Pricing Ernst & Young LLPOffice: +1 415 894 8796 | stan.hales@ey.com

Erica Gut | Financial Instruments, Structured Products and Real EstatePwCOffice: +1(415) 498‐8477 |erica.gut@us.pwc.com