Transfer Pricing Workshop Paul Reck Gerard Feeney

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Transfer Pricing Workshop Paul Reck Gerard Feeney Tadhg O’Connell

John Stewart Austin McGlade Antonio Pina

Liz Donoghue March 2014

TOPIC 1

How to satisfy Irish transfer pricing documentation requirements including implementation and monitoring

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Contents • Introduction • Grandfathering of pre 1 July 2010 transactions • SME considerations • Reliance on counterparty documentation

• Preparing Irish transfer pricing documentation • Issues to consider if preparing transfer pricing reports for other jurisdictions • True ups and year end adjustments • VAT & Customs interaction with transfer pricing • Policy implementation and technology solutions to support monitoring of transfer pricing policies

Introduction • Transfer pricing legislation introduced in Ireland with effect from 1 January 2011. • Companies that are taxed at the 12½% corporation tax rate in Ireland within scope. (Irish branches also within scope where they trade with other group companies). • Irish regime is aligned with the OECD Transfer Pricing Guidelines.

• Grandfathering of pre-existing arrangements before 1 July 2010 out of scope. • Counterparty documentation may suffice provided it is current. • Self-assessment: onus on taxpayer to demonstrate related party pricing is at arm’s length.

Grandfathering of pre 1 July 2010 transactions

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Grandfathering of transactions • Arrangements (written and unwritten) in place before 1 July 2010 specifically fall outside the scope of Irish transfer pricing law. • Effectively only means that the transaction(s) fall outside the documentation requirements. • Other tax provisions still applicable: eg. Section 81 TCA 1997 (“wholly and exclusively”). • Four years since companies undertook grandfathering exercise – how long can an arrangement remain unchanged commercially?

Grandfathering of transactions • Revenue Operational Manual 35A-01-01 issued in November 2012 on grandfathering: “Transactions (referred to in the legislation as arrangements) all the terms of which were agreed before 1 July 2010 are not subject to the rules, and are “grandfathered”. In deciding whether, in relation to an arrangement, the terms were agreed before 1 July 2010 it should be established that – (a) the relevant agreement envisaged the arrangement or transaction concerned;

(b) the relevant agreement provides the price; and (c) the relevant agreement is not merely an agreement for future agreements.”

Grandfathering of transactions • Issues to consider when considering if existing arrangement still “grandfathered”: o

introduction of new products and services

o

amendment in pricing

o

renewal of agreement – automatic and optional renewal

o

assignment

• Transfer of trade in the course of a scheme of reconstruction / amalgamation • How to demonstrate a tax inspector that existing arrangement still grandfathered: o

written legal agreement in place entered into before 1 July 2010

o

board minutes / e-mails where parties agree pricing

o

transfer pricing policy document

o

journal entries

SME exemption

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SME exemption • Taxpayers that meet the SME exemption are outside the scope of the Irish transfer pricing legislation. • Consider other domestic provisions such as S81 TCA 1997.

• Certain thresholds to be met in order to fall within definition of SME exemption.

Headcount

< 250

And less than or equal to one of the following limits: Annual turnover

Balance sheet total

≤ €50m

≤ €43m

SME exemption • Staff and financial data of connected and associated enterprises are included in determining the limits. • Definition of staff includes employees, owner managers, partners and individuals seconded to work for a business. • Irish Revenue interpret the definition of employees as not including contractors. • Balance sheet total is gross rather than net asset value. • Test is an annual test. • UK companies relying on SME exemption - €/UK£ FX movements.

Counterparty documentation

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Reliance on counterparty documentation • Irish transfer pricing regime allows counterparty documentation to satisfy the Irish documentation requirement. • Care to be taken if availing of a related party’s documentation: o

last update of counterparty documentation

o

translation required

o

sufficient detail in relation to the Irish company’s activities included

o

transaction at arm’s length from foreign affiliate’s perspective but not necessarily for the Irish company

Preparing Irish transfer pricing documentation

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Preparing Irish transfer pricing documentation

Approach to Transfer Pricing Documents Functional Analysis Economic analysis Local country involvement

Deliverable

Relative cost Level of comfort

Level 1

Level 2

Level 3

Separate country Transfer Pricing documentation

Centrally-prepared Masterfile Local country rules

Centrally-prepared Masterfile OECD Guidelines

Local functional analysis

Local or regional functional analysis

Local or regional functional analysis

Local comparability analysis

Local or regional comparability analysis

Local or regional comparability analysis

Locally-performed analysis that leverages centrally- prepared core information

Local participation in fact gathering and review

Restricted local involvement

Locally-prepared documentation report (incorporating centrally prepared core elements)

Centrally-prepared masterfile & separate country file including review by local affiliate

Centrally-prepared, OECDbased documentation report with restricted local review

High

Medium

Low

Penalty-resistant

Penalty-resistant

Customisation needed in the event of a tax audit

Preparing Irish transfer pricing documentation

Identify transactions Scoping and planning

Risk rating

Prepare documentation

Project execution

Functional analysis Economic analysis

Monitoring and adjustment

Execute transfer pricing policy strategy Identify enhancements and improvements

Preparing Irish transfer pricing documentation – process Functional analysis

Benchmarking

Establish the functions undertaken, risks assumed, assets employed and capital committed by each business entity, and the relative importance of each.

Select comparables (internal or through databases)

2 Gather Background Information Gathering of qualitative and quantitative data

3 Documentation

1

4

Record each stage of the process to form a defence document in support of future tax filings.

Preparing Irish transfer pricing documentation – functional analysis • Documentation of the transactions, functions and risks of the entities involved • Functional analysis impacts: o

choice of transfer pricing method

o

choice of comparables chosen

o

audit issues

• Identification of key personnel in organisation to interview. • Advance preparation – use of questionnaires (see attached IRS questionnaire in pack). • Ensure risks and assets (in particular intangibles) are covered.

Preparing Irish transfer pricing documentation – economic analysis • Determine appropriate transfer pricing method based on fact pattern in functional analysis. • Transfer pricing methods (see worked examples in your pack). • Undertake benchmarking process – internal comparables or use of a third party database. • Determine any necessary adjustments to comparable data. • Form conclusion from comparison of controlled and uncontrolled results.

Preparing Irish transfer pricing documentation – documentation package contents

Issues to consider if preparing transfer pricing reports for other jurisdictions

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Preparing transfer pricing reports for other jurisdictions Overview of differences in domestic laws

USA • Does not follow OECD Guidelines but own domestic laws. • 2 categories of documentation needed – principal and secondary documentation. • Local comparables preferred.

China • Documentation must be in Chinese. • Certain thresholds apply before documentation is required. • Loss making companies, no matter the size, must prepare documentation. • Local comparables preferred but may accept foreign (Asian) comparables.

UK • SME exemption applies but not for transactions to a nonqualifying territory. • Preference for UK comparables but Pan-European accepted.

Some local issues to watch out for!

• Follows OECD principles but with enhanced local documentation requirements. • Italian masterfile required in certain cases. • Must include details of all I/C transactions even if not material. • Required to sign every page and store on CD. • No obligation to accept reports in a foreign language • Benchmarking needed annually for large companies • Must declare availability of documentation in tax return for penalty protection.

Spain

Germany • Documentation must be in German but approval can be obtained to prepare in English. • Tighter independence criteria – 25%. • Tax authorities require use of the interquartile range. • Special rules on business restructuring.

Italy

France • Tax authorities can request documentation in French. • Contemporaneous requirement. • Additional documentation to be provided within 6 months of tax return. • Pan-European comparables acceptable if include meaningful subset of local companies. • Bad faith penalties may preclude access to MAP

• Definition of “associated enterprise” is 5%. • If documentation required for evidence in courts, needs to be translated into Spanish. • In principle, Pan-European comparables accepted, but if results of local comparables benefit STA, they may prefer these. • Transactions over a certain threshold to be disclosed in tax return. • Bad faith penalties may preclude access to MAP (eg. if no documentation).

True ups and year end adjustments

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Why make post transaction transfer pricing adjustments? •

•

Year end adjustments are being made with increasing frequency o

results are not consistent with projections

o

new or overlooked transactions

o

late implementation of planned changes

Required for documentation o

•

most countries require results to be within the range to avoid documentation penalties

Exploring and making transfer pricing adjustments before year-end allows greater flexibility: o

reduce tax authority exposure to transfer pricing adjustments

o

monitor profits and losses arising across multiple jurisdictions reasonableness test

Timing of transfer pricing adjustments

Year end

Create transactions

Closing of books

Make adjustments and avoid book-tax differences

Filing of return

Make adjustments after statutory accounts finalised

Amend return

Aspects of year end adjustments •

Size of adjustment – which point within the interquartile range to target?

•

Does the intercompany legal agreement allow for adjustments?

•

Acceptance under domestic law

•

Process of making adjustment: o

booked in financial system (Period 13?)

o

issue invoice?

o

provisions

o

employee participation

o

VAT and customs implications

VAT and customs interaction with transfer pricing

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VAT and customs interaction with transfer pricing

VAT

Contractual agreement Acceptance under domestic law

Other items

Aspects of yearend adjustments

Documentation

Employee Participation

Customs

Inventory valuation

Impact on

Provisions

management accounts

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VAT aspects of year end adjustments

• An increase / decrease in the transfer price of a transaction can result in additional consideration or credit – direct link between the consideration and the transaction to be established.

• VAT treatment follows the treatment applied to the original supply.

• Requirement to issue an invoice / credit note – time limits.

• Statistical reporting implications.

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Customs issues relating to year end adjustments • Transfer pricing rules for direct tax purposes and customs valuation rules based on OECD guidelines but with some important differences. • Direct tax authorities focus on the accuracy of a transfer price as reflected on a tax return (aggregated income across the entire business). • Customs authorities focus on the determination of the value of goods at the time of entry into their customs territory (transaction-by-transaction and product-by product).

© 2010 Deloitte Development LLC. Private and confidential.

Customs issues relating to year end adjustments • Where a year end adjustment is linked to the importation of goods from a non EU country, the following issues should be considered;

o Does the customs value change due to the year-end adjustment?. o What is the appropriate rate of duty for the goods? o If there is an increase does it give rise to a liability? o If there is a decrease is it possible to get a of refund of customs duty paid?

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Customs issues relating to year end The Link Between Transfer Pricing and Customs Valuation 2014 Country Guide

• Published by Deloitte’s global CGT practice.

• Updated annually.

• Provides information on how over 40 countries treat transfer prices and adjustments from a Customs and VAT perspective.

• Link to download the latest version.

© 2010 Deloitte Development LLC. Private and confidential.

Policy implementation and technology solutions to support monitoring of transfer pricing policies

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From policy to practice – a holistic framework Tax / Transfer Pricing: • development of transfer pricing policies • producing transfer pricing documentation

• defending policies against tax authority challenge

Interface: • implementation • data gathering

• monitoring • identifying changes of fact

Accounting / Finance: • production of management accounts for business • legal entity reporting

Common problems with implementation and monitoring • Intercompany legal agreements not completed / inadequate. • Costs omitted and not recharged creating non deductible costs.

• Incorrect costs included. • Flow through costs incorrectly allocated a mark-up. • Anticipated results / budgets used to determine margins so inaccurate that even true up gives non-arm's length results. • Policies not aligned with accounting system and manual calculations required increased risk of human error, staff continuity and lack of audit trail. • Business entities not aligned with recharges and refuse some element of recharge.

Technology solutions options

Specialised software solutions

Technology solutions where following issues arise • Significant number of intercompany transactions.

• History of year-end transfer pricing adjustments and/or difficult audits due to transfer pricing issues. • Manual/spreadsheet processes for calculating transfer pricing . • Delays in the accounting close process due to intercompany accounting. • Non-centralised accountability for transfer pricing .

TOPIC 2 Finance and treasury transfer pricing: What you need to know

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Contents

• Introduction

• Loan pricing

• Provision of guarantees

• Cash pooling

Introduction • Type of transactions to consider include: o

Intercompany loans

o

Guarantees

o

Cash pooling

o

Long-term intercompany balances

o

Short term accounts receivable/payable – consistent with third-party credit terms?

• Trading versus non-trading activities o

Non-treasury companies can still provide interest free loans as not within the scope of transfer pricing.

• Other pricing considerations o

Section 247 loans – normal commercial rate of return

o

Requests from third parties for support for intercompany financial arrangements e.g. banks, M&A, due diligence etc.

o

Robust grandfathering documentation?

Loan pricing

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Loan pricing - Introduction • Applicable where a company is paying interest for which a trading deduction is being sought or where interest is taxable as a trading receipt.

• Need to ensure that the interest received or paid is arm’s length.

• Ensure there sufficient documentation to support the arm’s length nature of the interest rate.

• Normally considered on a transaction by transaction basis but large groups may use a pooled approach to determining interest rates on intercompany borrowings.

Loan pricing – Stages in a transfer pricing analysis

Loan pricing – Key terms of a loan agreement •

Borrower / credit rating

•

Ranking / Structural Subordination

•

Loan Effective Date

•

Tenure / Term

•

Details on security or collateral attached, if any

•

Guarantees

•

Purpose

•

Features/options, if any (e.g., prepayment rights, etc.)

•

Currency

•

Type of loan (i.e., term loan, revolving facility, etc.)

•

Loan Amount

•

Interest rate (if any at this stage)

•

Principal Repayment (at maturity, amortising, etc.)

•

Interest Payments (monthly, quarterly, annually, at maturity, etc.)

Loan pricing – Synthetic credit rating tools Moody’s RiskCalc • Online tool which uses financial ratio analysis to generate a probability of default for the borrower company over 1 and 5 years.

• Various models available for different jurisdictions.

Moody’s Rating Methodologies • Methodology papers that explain how credit ratings are derived across different industries by Moody’s. • Provides ratios, benchmarks and weights. • Uses qualitative as well as quantitative data.

Notching • Assigning the subsidiary a credit rating based on the rating of the parent. • This method is generally used if the subsidiary is a core or strategic component of the parent’s business.

Loan pricing – Financial information required for credit analysis • Generally, historical financial data is preferred over projected financial data Historical •The actual financial statements for the year in which the loan was taken out •Latest full-year actual financial statements •Financial statements needed for a credit rating analysis: o

Aggregate financial statements of the Borrower and its subsidiaries

o

Balance sheet

o

Income statement

Projected •Projected financial statements may be used if: o

You are undertaking a planning study

o

Historical/actual financial data are not available

o

The most recent financial statements do not reflect “normal” or “reasonably expected” business operations

o

In cases of mergers or acquisitions, should consolidate financial statements of the companies and reflect and other structural changes

Loan pricing – Market data for analysis Thomson Reuters’ DealScan • DealScan is a database of historical funding deals executed on the global loan markets • It covers wide-ranging terms and conditions on over 220,000 loan and bond transactions

Bloomberg Professional • Bloomberg Professional is a large data stream program offering historic and current market information across a number of different securities including fixed income, equities, derivatives, commodities and foreign exchange

Loan pricing – Typical adjustments • Seek to obtain a sample of loans and bonds with similar terms and conditions to the tested loan but not always possible so adjustments are usually required in order to improve comparability. o o o o o

o

Maturity Adjustment Credit Rating Adjustment Fixed vs. Floating Rate Adjustment Currency Adjustment Country risk adjustments Put/Call options

• Important to ensure that any adjustments can be defended and are applied consistently. • Tax authorities becoming more sophisticated with regards to the transfer pricing aspects of intercompany financing.

Loan pricing – Documentation and ongoing monitoring • Preparation of transfer pricing documentation report for presentation to tax authority on request.

• Regular review of intercompany pricing arrangements

•

o

Ensure terms of the loan agreement are being followed

o

If the agreement contains an early repayment clause, would a third party have exercised this clause and refinanced due to falling rates?

Potential advantages to refinancing loans, increase/ reduce interest to low/high tax jurisdictions.

Financial guarantees

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Provision of guarantees - Introduction •

A guarantee is a contract to assume economic liability if the guaranteed party should default on their obligations.

•

A guarantee enables the guaranteed entity to borrow funds at lower interest rates than it would have been able to borrow as a stand-alone enterprise.

•

To determine whether a guarantee has value, it must be shown that the standalone enterprise, in the absence of the guarantee, would have faced a higher rate of interest or not been able to access funds in the absence of the guarantee.

•

It is a contingent liability for the guarantor and the entity providing the guarantee should be compensated for providing same even if the guarantee is not called upon.

•

More focus from tax authorities on guarantees in recent years.

Provision of guarantees – Transfer pricing approaches Yield approach - Determine a credit rating for the debtor on a stand-alone basis and perform a loan pricing analysis to determine their borrowing rate. We then compare the stand alone borrowing rate with the rate achieved with the guarantee. The interest saved by the borrower is the maximum amount that they are willing to pay to obtain the guarantee.

Insurance approach – This gives the minimum fee that the guarantor would be willing to accept for issuing a guarantee. It is comprised of the estimate probability of default multiplied by the guarantor's required rate of return on the additional capital requirement from providing the guarantee.

Credit default swaps (“CDS”) - A CDS is a contract that provides insurance against the risk of a default by particular company. CDS transactions are similar to guarantees in substance. Data on CDS are publically available and can be used as a benchmark for intercompany guarantees.

CUP – Third party information may be available in relation to guarantees provided to the borrower by third-party financial institutions.

Provision of guarantees – Passive association •

GE Capital Canada Case – Court found that when estimating the credit rating of a borrower, a third-party financial institution would take account of the fact that the borrower was part of a larger group of companies. Even in the absence of an implicit guarantee, the standalone credit rating of the borrower would be uplifted by simply being a member of a group.

•

Implicit support – not widely endorsed in other jurisdictions as not strictly inline with the arm’s length principle.

Cash pooling

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Cash pooling - Introduction •

MNCs increasingly establish cross-border cash pooling systems

•

Aggregating and offsetting cash-flows within one common cash pool generates benefits Improved liquidity management o Interest savings through reduced borrowings or obtaining cheaper funds in the market o Transaction cost savings o

Cash pooling • A cash pool is a master account through which a group can coordinate group liquidity • The organiser of the master account is often called the cash pool header (“CPH”) to distinguish it from pool participants

Cash Pool Header

CashInflow

Cash Providers = Creditors

CashOutflow

Cash Consumers = Debtors

TOPIC 3 Current hot topics

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Contents

• Transfer pricing compliance reviews

• Foreign tax authority audits

• Base erosion and profit shifting (“BEPS”)

Transfer pricing compliance reviews

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Transfer pricing compliance reviews by Irish Revenue • The TPCR program allows authorised officers from the Irish Revenue to send out notifications to selected taxpayers inviting them to self-review their transfer pricing and report back to the Irish Revenue within three months. • Letters issued under the TPCR have been for a specific accounting period.

• The report to be provided to the Irish Revenue based on this self-review will address: o

The group structure;

o

Details of transactions by type and associated companies involved;

o

Pricing and transfer pricing method for each transaction or group of transactions;

o

Functions, assets, and risks of the parties involved;

o

List of documentation available or reviewed by the taxpayer; and

o

The basis for establishing if the arm’s length standard has been satisfied.

• In most circumstances, an existing transfer pricing study should suffice. • The TPCR process is not a formal tax audit

Foreign tax authority audits

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Tax Authority Audit Environment: Recent Survey

Foreign Tax Authority Audits Country-specific positions / trends – Italy, Spain and France Italy

Spain

France

Rise in number, complexity and aggressiveness of tax audits (especially transfer pricing audits) conducted by the tax authorities

X

X

X

Rise in bad faith penalties (France & Spain) and criminal investigations (Italy)

X

X

X

Raids conducted by the tax authorities in order to collect evidence without notice

X

X

X

X

X

(computerized tax audits)

(computerized tax audits)

X Use of tools in tax audits

(public databases for transfer pricing benchmarks)

Recommendation to criminally prosecute

X

Tax officers have received transfer pricing training and special teams dedicated to cross-border transactions have been created at the tax offices directorates of each region and province

X

X

X

Spain

Statistics

Tax Periods

Tax Audits

Assessments Raised (€m)

Tax Crime Cases

2010

23,923

6,002

696

2011

24,199

5,510

909

2012

24,772

6,069

604

Tax Audit Procedure Framework • Statute of limitation: 4 years from the filing of the relevant tax return • Selection of taxpayers: General programs and yearly guidelines detailing the action priority areas (transfer pricing , International Reorganizations)

• Spanish electronic notification system (NEO): The system obliges taxpayers to check an electronic inbox at least every ten days. Where the taxpayer does not access the electronic inbox, the notification is deemed to be validly made, and therefore, filing deadlines, appeals, etc. run from that date • Notification to the taxpayer: Partial or general tax audit • Tax audit term: Maximum 12 months from the notification. Can be extended up to a maximum 24 months in case of special complexity • Termination: Different type of assessments (Agreement vs. Disagreement)

Italy - Statistics Large businesses ( > €100m)

Medium businesses ( > €10m and