Transfer Pricing

1. Transfer Pricing Disputes, Adjustments and Cases • Hugo Vollebregt

2. Purpose of today’s sessionAfter today you will have a better understanding of: • Why taxpayers and tax administrations find themselves in conflicts on transfer pricing • The various types of transfer pricing adjustments • The dispute between the IRS (US) and GlaxoSmithKline (UK)

3. Contact details Hugo Vollebregt Amsterdam, The Netherlands hugo.vollebregt@gmail.com

4. P r a t The origin of transfer pricing disputes 1

5. The origin of transfer pricing disputes Why is transfer pricing relevant? • 70% of world trade is intragroup • Traditional tax disputes • Timing differences • Example: depreciation adjustment • Modern tax disputes • Permanent differences • Example: transfer pricing adjustment

6. The origin of transfer pricing disputes Are all sources aligned? • National legislation • Organisation for Economic Cooperation and Development, Paris • United Nations, New York / Geneva • European Union, Brussels • National case law  impact different from other case law

7. The origin of transfer pricing disputes Organisation for Economic Cooperation and Development • OECD Transfer Pricing Guidelines (2010) • OECD Model Tax Convention (2008) • Article 7 (Business profits - PE) • Article 9 (Associated enterprises; arm’s length principle)

8. The origin of transfer pricing disputes United Nations • The UN Model Double Taxation Convention between Developed and Developing Countries (2011) • Practical Manual on Transfer Pricing by Developing Countries (2012; draft) • “tends to preserve a greater share of taxing rights for the source country” • Difference OECD/UN

9. Disagreement among OECD member countries Non – OECD member countries Competition for tax revenues (70%) The origin of transfer pricing disputes Is there a storm gathering? Position for graphic or image

10. The origin of transfer pricing disputes The issues over which disputes ariseNon-technical • Who will answer to questions: company or individual employee? • Documentation • Language of documentation • Access to foreign information, e.g. the accounts and records of the foreign group company engaged in the i/c transaction

11. The origin of transfer pricing disputes The issues over which disputes ariseComparability • Some countries require benchmarking based on national database instead of regional database  searches for all countries where the group has operations • EU research has shown that in 94% of 234 searches the profitability in national database searches was the same as in Pan-European database searches • “Comparables found in regional (as opposed to national; HV) databases should not be rejected automatically”, CoC on EU Transfer Pricing Documentation; OECD TPG 3.35

12. The origin of transfer pricing disputes The issues over whichdisputesariseTechnical • Local losses (structural) • Local performance is less than group (sanity checks) • Royalties in depressed markets • Management charges and intercompany services, including elimination of shareholder expenses, evidence of services, evidence of benefits (especially in low cost areas), location savings, mark up, allocation key per cost category and withholding tax

13. The origin of transfer pricing disputes The issues over whichdisputesariseTechnical • Cost plus method: Cost price calculations (local GAAP vs parent company GAAP; frequency of adjustment for prices of raw materials; capacity results, etc) • Resale Price Method: Resale price unknown at moment of internal invoicing • Budget vs. actuals (ex ante or ex post; true ups) • Loans: amount of loan, interest rate and guarantee fees

14. The origin of transfer pricing disputes The issues over which disputes arise • Recognition of intercompany transactions • Transfer pricing analysis starts at i/c agreement • Agreements vs. economic reality (actual behavior) • Two exceptions (OECD TPG 1.65) • EU Company Tax Study (2001): “MNEs can conduct business in ways independent companies cannot”

15. Mainly: Australia, Canada, India and US Why is foreign case law on transfer pricing relevant to you? Bausch & Lomb, US, 1991, tax haven Compaq, US, 1999, products DHL, US, 2002, trade mark valuation GSK, US, 2006 (settlement) Roche, Australia, 2008, comparables Xilinx, US, 2010, stock options GSK, Canada, 2010, CUPs GE Capital, Canada, 2010, guarantee Veritas, US, 2010, buy in payment Rolls Royce, India, 2011, PE Velcro, Canada, 2012, ownership of IP The origin of transfer pricing disputes Sources: International Transfer Pricing Case Law

16. The origin of transfer pricing disputes The origin of transfer pricing disputes • The OECD: It is not exact science and requires the exercise of good judgment (“the prudent business manager”) • The judiciary: “Transfer pricing … evaluation of transactions … in an art”, Mentor Graphics, India, 2007 • In the end, it is all about fairness – which country may tax which share of the group’s total profits • Fair share duty (Happé; NL)

17. The origin of transfer pricing disputes Transfer pricing and NGOs

18. 29 November 2010 “ The world'ssecond-largest beer company, SABMiller, is avoidingmillions of pounds of tax in India and the Africancountrieswhereitmakes and sells beer by routing profits through a web of tax-havensubsidiaries, according to a report publishedtodaybyActionAidtoday. The company, whosebrandsinclude Grolsch, Peroni and Miller, and AfricanbeersCastle and Stone Lager, is accusedby the developmentcharity of siphoning profits out of developingcountries and parking them offshore. The SABMillergroup is listed in London and makes profits of nearly £2bn a year. ActionAidestimatesitmay have reduceditsAfricancorporationtaxbillby as much as a fifth last year, deprivingpoorercountries of up to £20m in tax, orenough to send a quarter of a millionchildren to school. However, SABMillersaiditcompletelyrejectedActionAid'sinterpretation of its business structures.”

19. 29 November 2010 “ SABMiller does notengage in aggressivetax planning in any part of itsoperations and the report includes a number of flawedassumptions," itsaid in a statement. "SABMillercompaniespay a significant level of tax." “ ItaddedthatSABMiller was a major direct investor, employer and taxpayer in Africa and otherdevelopingcountries, making a substantialeconomiccontribution to the continent and elsewhere. The companysaidtherewere sound commercial reasonsfor the location of itssubsidiaries and thatthose offshore werefullytaxed in the UK as controlledforeigncompanies (CFCs).”

21. The origin of transfer pricing disputes Conflict options to the taxpayer Conflict Unilateral settlement APAs Litigation/ADR MAP/Arbitration

22. P r a t Adjustments 2

23. Primary adjustment Secondary adjustment Corresponding adjustment Transfer pricing adjustments Types of adjustments

24. Primary adjustment Secondary adjustment Corresponding adjustment Transfer pricing adjustments Primary adjustment • Hindsight • Can tax office test business decisions? • The prudent business manager

25. Primary adjustment Secondary adjustment Corresponding adjustment Transfer pricing adjustments Secondary transaction and secondary adjustmentWhere did the additional profit go to?

26. Transfer pricing adjustments Secondary transaction and secondary adjustmentWhere did the additional profit go to?

27. Transfer pricing adjustments Secondary transaction and secondary adjustmentWhere did the additional profit go to?

28. Transfer pricing adjustments Secondary transaction and secondary adjustmentWhere did the additional profit go to?

29. Transfer pricing adjustments Secondary transaction and secondary adjustmentWhere did the additional profit go to?

30. Primary adjustment Secondary adjustment Corresponding adjustment Transfer pricing adjustments Secondary transaction and secondary adjustmentWhere did the additional profit go to? • More profit due to primary adjustment but no change to balance sheet • Dividend  DWHT • Receivable  Repayment

31. Transfer pricing adjustments Corresponding adjustment • Primary adjustment • Secondary adjustment • Corresponding adjustment • Primary adjustment triggers double taxation

32. Transfer pricing adjustments Corresponding adjustment • Primary adjustment • Secondary adjustment • Corresponding adjustment • Primary adjustment triggers double taxation • Corresponding adjustment eliminates double taxation • Article 9 (2) OECD MTC • Article 25 OECD MTC

33. Transfer pricing adjustments Article 9 OECD Model Tax Convention • ASSOCIATED ENTERPRISES • 1. (Arm’s length principle) • 2. Where a Contracting State includes in the profits of an enterprise of that State – and taxes accordingly – profits on which an enterprise of the other Contracting State has been charged to tax in that other State and the profits so included are profits which would have accrued to the enterprise of the first mentioned State if the conditions made between two enterprises had been those which would have been made between independent enterprises, then that other State shall make an appropriate adjustment to the amount of the tax charged therein on those profits. In determining such adjustment, due regard shall be had to the other provisions of this Convention and the competent authorities of the Contracting State shall if necessary consult each other.

34. Transfer pricing adjustments Article 25 OECD Model Tax Convention • MUTUAL AGREEMENT PROCEDURE • 1. 1. Where a person considers that the actions (i.e. the primary adjustment; HV) of one or both of the Contracting States result ... in taxation not in accordance with the provisions of this convention he may ... present his case to the competent authority of the Contracting Sate of which he is a resident ... • 2. The competent authority shall endeavour, if the objection appears to it to be justified and if it is not itself able to arrive at a satisfactory solution, to resolve the case by mutual agreement with the competent authority of the other Contracting State, with a view to the avoidance of taxation which is not in accordance with the convention (i.e. the double taxation because of the primary adjustment; HV) …

35. Transfer pricing adjustments Corresponding adjustment • Primary adjustment • Secondary adjustment • Corresponding adjustment • Primary adjustment triggers double taxation • Corresponding adjustment eliminates double taxation • Article 9 (2) OECD MTC • Article 25 OECD MTC

36. P r a t Specific cases 3

37. Specific cases Twogroupcompaniesengage in an i/c transaction “Least complex” (routine) entity : • No keyvaluedrivers • Routine activities • Routine reward • “Entrepreneur” or “principal”: • Keyvaluedrivers • Management, decisions, authority, etc • Residual profit

38. Specific cases GSK US 2006 H R &D Plant Sales office UK US

39. Specific cases GSK US 2006 H R &D Plant Sales office UK US

40. Specific cases GSK US 2006 H R &D Plant Sales office UK US

41. Specific cases GSK US 2006

42. Specific cases GSK US 2006 • Taxpayer on KVD • R &D and manufacturing • In UK • US Sales office routine reward

43. Specific cases GSK US 2006 • IRS on KVD • Marketing and premium market • In US • US Sales office residual profit • Taxpayer on KVD • R &D and manufacturing • In UK • US Sales office routine reward

44. Specific cases GSK US 2006 Taxpayer position IRS position H R &D Plant Sales office UK US

45. Specific cases GSK US 2006 • Double tax not in accordance with the UK/US tax treaty  mutual agreement procedure • Art. 25 OECD Model Convention (1963 – 2008) on MAP: • “The competent authority…shall endeavour.... to resolve…with the competent authority of the other…state…” • Update of the OECD Model Tax Convention to include an arbitration clause (2008)

48. Specific cases Transfer pricing and the mediaFederal Contractor Misconduct Database “ GlaxoSmithKline agreed to pay approximately $3.4 billion to settle charges by the IRS that the company under-reported profits to avoid paying U.S. taxes. The Internal Revenue Service accused GSK of a practice called "transfer pricing," by which a company claims most of its earnings belong in a country where taxes are low. The transactions at issue, which concerned the way GSK priced drugs for sale through its U.S. subsidiary, occurred between the years 1989 and 2005 ”

49. Contact details Hugo Vollebregt Amsterdam, The Netherlands hugo.vollebregt@gmail.com