Transfer Pricing: Issues, Risks & Opportunities for Multinationals

1. Transfer Pricing: Issues, Risks & Opportunities for Multinationals 8-9 May 2013 • Chair: Mukesh Butani – Taxand India • Panelists: • Shiv Mahalingham – Taxand UK • Clemens Thym – Standard and Poor • Sam Sim – Standard Chartered • Steven Carey – Quantera Global

2. Contents • UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison • Intangibles: Tax Controversies, Enforcement & Litigation in Asia • The OECD BEPS Study & the “Grey Area” Definition • Valuation in Business Restructurings: the Different Approaches of Tax Authorities • Developments in Policy on Advance Pricing Agreements • Intercompany Loans Focus • Managing TP In-House Across Asia-Pacific • Taxand’s Take • Key Contacts & About Taxand

3. UN Manual & the Acceptance of Arm’s Length Principle & OECD 8-9 May 2013

4. UN Manual, Arm’s Length Principle & OECD 1 UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison • UN Manual was prepared by the Subcommittee on Transfer Pricing, constituted in 2009 • Developed with a purpose to provide a practical manual on transfer pricing for developing countries • Manual covers aspects starting from methodologies to documentation to dispute resolution. It also covers country specific chapters on Brazil, China, India and South Africa

5. UN Manual, Arm’s Length Principle & OECD 1 UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison • Issues to be debated: • Discussions on important aspects covered in India and China chapter • Comparison with OECD Guidelines • Implications on non-OECD member countries

6. UN Manual - India Chapter 1 UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison Key topics covered in the India Chapter of UN Manual include: • Location savings • India provides ‘Location Specific Advantages’ (LSA) in addition to location savings • LSAs include access to market, skilled manpower, large customer base, information and distribution networks • Quantification and allocation of location savings and location rent (in case of LSA) to be an important area of concern • Use of Profit Split Method endorsed by Indian Revenue (in case of absence of Comparable Uncontrolled transactions)

7. UN Manual - India Chapter 1 UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison • Intangibles • Marketing intangibles and co-branding activities - particularly relevant for India owing to unique market characteristics • Enhancement of brand, creation of efficient supply chain, conducting market research identified as factors relevant to creation of marketing intangible • Ways of compensation for creation of marketing intangibleseg: Reimbursement of extra-ordinary expenses, with a mark-up; or share of profits in relation to marketing intangible

8. UN Manual - India Chapter 1 UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison • R&D related intangibles • Remuneration received by captive providers should commensurate to functions performed and risks assumed • Routine and low cost plus mark up perceived to be insufficient – day to day decision making and operational risks lie in India • Additional compensation on account of creation of intangibles and ‘more than’ routine functions / risks required

9. UN Manual - India Chapter 1 UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison • Intra-group services • Categorised as high risk area • Nature of allocation keys is a grey area • Non-receipt of mark-up on provision of services considered as a ‘pain-point’ by Indian Revenue • Use of contemporaneous data – relevance of current year data re-emphasised

10. UN Manual - India Chapter 1 UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison • Allocation of risks between taxpayer and AEs – contingent on core functions, responsibility and decision making • Comparability adjustments • Burden to proof on taxpayers • Difficulty in undertaking risk adjustment highlighted, however no guidance / solutions provided in Manual

11. UN Manual - China Chapter UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison 1 • Lack of reliable local comparables • Location specific advantages (LSAs) • Location savings • Market premium • Very structured approach to defining and calculating

12. UN Manual - China Chapter UN Manual & the Acceptance of Arm’s Length Principle – an OECD Comparison 1 • Intangibles • General position that Chinese intangibles under-compensated • Confidence in effectiveness of documentation and audits to achieve compliance

13. Intangibles: Tax Controversies, Enforcement & Litigation in Asia 8-9 May 2013

14. Intangibles 2 Intangibles: Tax Controversies, Enforcement & Litigation in Asia • Increased interest of tax authorities regarding: • Economic ownership vs legal ownership of intangible • Attribution of benefits of intangibles to parties • OECD’s draft guidelines on intangibles (released in June 2012) - emphasis on FAR for intangible related returns

15. Intangibles 2 Intangibles: Tax Controversies, Enforcement & Litigation in Asia • Issues to be debated • Views of tax administrators and taxpayers on intangibles and transfer pricing in relevant jurisdiction • Recent tax controversies

16. Intangibles - India Perspective 2 Intangibles: Tax Controversies, Enforcement & Litigation in Asia • Legislative developments • Definition of intangibles introduced vide Finance Bill 2012 • New definition includes marketing, human capital, customer related intangibles • Definition introduced retrospectively

17. Intangibles - India Perspective 2 Intangibles: Tax Controversies, Enforcement & Litigation in Asia • Disputes in India primarily focus on: • Creation of marketing intangibles by Indian entities manufacturing / distributing branded products • Contribution of Indian contract software service providers to the overall product development lifecycle • Recent Special Bench ruling in case of LG Electronics

18. The OECD BEPS Study & the “Grey Area” Definition 8-9 May 2013

19. The OECD BEPS Study - An Overview 3 The OECD BEPS Study & the “Grey Area” Definition • BEPS – a debate gaining recognition across BRICS and G20 nations • Meeting of G20 leaders in July 2012 and November 2012 emphasisedon “the need to prevent base erosion and profit shifting” • OECD highlights the ‘grey area’ between tax planning and tax evasion

20. The OECD BEPS Study - An Overview 3 The OECD BEPS Study & the “Grey Area” Definition • Joint Communiqué issued by BRICS identified the following as primary reasons leading to erosion of the tax base: • Abuse of tax treaty benefits • Incomplete disclosure of information between tax administrations

21. The OECD BEPS Study - An Overview 3 The OECD BEPS Study & the “Grey Area” Definition • Primary ways of cross-border profit shifting: • Pricing of international transactions between two associated enterprises • Capital structuring / financing between associated enterprises • Development of international standards, improving access to data and information and capacity building is ‘need of the hour’

22. The OECD BEPS Study 3 The OECD BEPS Study & the “Grey Area” Definition Issues to be debated: • How to draw the line between tax planning and tax evasion • Impact of BEPS on emerging economies • Learning from international best practices • Suggest improvements that may be made to transfer pricing rules • Other ways to resolve BEPS (areas such as GAAR, thin capitalization to be discussed)

23. Valuation in Business restructurings & Tax Authorities 8-9 May 2013

24. Valuation in Business Restructurings - India 4 Valuation in Business Restructurings: the Different Approaches of Tax Authorities • Historical stand - transfer pricing provisions do not apply to cross-border business restructuring if there is no bearing on taxable income • Important amendment introduced (with retrospective effect) in Budget 2012 – ‘business restructuring’ to be considered an international transaction irrespective of its bearing on taxable income (at the time of transaction or in future years)

25. Valuation in Business Restructurings - India 4 Valuation in Business Restructurings: the Different Approaches of Tax Authorities • Transactions such as issuance, conversion, buy-back of shares targeted • Discounted cash flow (DCF) preferred by Indian Revenue • Valuation reports and methods such as DCF and NAV likely to gain acceptance with introduction of ‘Other Method’ • Highly litigative area at present

26. Developments in Policy on Advance Pricing Agreements 8-9 May 2013

27. Developments in APAs - India Perspective 5 Developments in Policy on Advance Pricing Agreements • Guidelines notified on August 31, 2012 • Taxpayer community reposing faith in the APA regime • Encouraging response – about 150 pre-filings in 8 months • Approx 80% of the pre-filings are for unilateral APA

28. Developments in APAs - India Perspective 5 Developments in Policy on Advance Pricing Agreements • Relationship between Indian – US Competent Authority cause of concern • In absence of Art 9(2), bilateral APAs not available • Transactions targeted – Royalty, Contract R&D, software, management fees, contract manufacturing, cost allocations

29. Developments in APAs - Asia Perspective Developments in Policy on Advance Pricing Agreements 5 • Proliferation of countries now with APA rules • Various countries such as HK growing DTA network partly to support APAs • Indonesia and Vietnam now on steep learning curve • HK IRD enthusiastic but only limited cases underway so far • China focus on bilateral/multilateral due to severe limitations on resources

30. Intercompany Loans Focus 8-9 May 2013

31. Intercompany Loans Focus - India Perspective 6 Intercompany Loans Focus • Financial transactions such as loans and guarantees – highly litigative area in Indian TP arena • Expressly introduced in definition of international transaction vide Finance Act 2012 • CUP mostly relied upon as the most appropriate method – PLR, LIBOR typically used for benchmarking • More sophisticated quantification techniques gaining importance: Credit rating comparison of borrower & its AEs

32. Managing TP In-House Across Asia-Pacific 8-9 May 2013

33. Transfer Pricing is the Number One Challenge 7 Managing TP In-House Across Asia-Pacific Response to a Taxand survey of tax professionals • Increasingly sophisticated tax authorities are utilising commercial databases for risk- based audit selection, increasing the number of audit and calculated adjustments • Lack of consistency from country to country pose added difficulties • Dispute resolution on undocumented cases is a very challenging and potentially expensive problem • Business continues to change as a result of globalisation, M&A and reorganisation • Importance of business aligned tax planning is rising

34. Transfer Pricing – Managing the Challenge Managing TP In-House Across Asia-Pacific 7 • Considerations in establishing best practice • Market rates for interest • Credit premium reflecting credit risk? • Quantifiable? (spreads, historical default information) • Comparables? (bonds, credit default swap spreads, liquidity issues) • Challenges in emerging markets • Sovereign intervention • Country risk • Resulting risk / pricing impact

35. Example: How do Intercompany Loan Issues Originate? 7 Managing TP In-House Across Asia-Pacific ?

36. Example: Credit Default Spreads at the Parent Level 7 Managing TP In-House Across Asia-Pacific • CDS are good proxy for actual risk premium • Most responsive market to changes in risk perception • Very liquid market for parent company’s funding • High credit quality, high liquidity => low spreads

37. Example: Using an Objective Model to Score Where no Risk Indicators are Available 7 Managing TP In-House Across Asia-Pacific S&P Capital IQ – Credit Model Standard & Poor’s Ratings ? CMS - CDS Prices Source: S&P Capital IQ, Standard & Poor’s Ratings =* Source: S&P Capital IQ, Standard & Poor’s Ratings * … broadly the same credit quality; within +/- 1 notch

38. Alternatives in Establishing Effective Reference Prices 7 Managing TP In-House Across Asia-Pacific • Establishing a market based comparable requires: • Transparent methodology • Appropriate segmentation (geography, industry, credit rating, duration, etc.) • Cover all risk factors (sovereign risk, T&C) • Strong grounding on empirical data Credit Spread Models

39. Emerging Markets – Look Beyond Sovereign Risk 7 Managing TP In-House Across Asia-Pacific Sovereign Default Risk (LC / FC) Risk associated with the non-repayment of a sovereign’s financial obligations issued in local or foreign currency The risk that a government will discriminatorily change the laws, regulations, or contracts governing an investment—or will fail to enforce them—in a way that reduces an investor’s financial returns is what we call “policy risk.” Policy Risk Likelihood of sovereign interference in the exchange rate market to prevent non-sovereign entities to repay their financial obligations in foreign currency Transfer & Convertibility Risk “Country risk is the risk that economic, social, and political conditions and events in a foreign country will adversely affect an institution’s financial interests. […] Country risk includes the possibility of nationalization or expropriation of assets, government repudiation of external indebtedness, exchange controls, and currency depreciation or devaluation. Country Risk

40. Concentrating on Country Risk - Its Impact on Corporations 7 Managing TP In-House Across Asia-Pacific Incongruity Between Country Risk Scores & Sovereign Ratings Source: S&P Capital IQ Country Risk Framework and Rating information from Global Credit Portal (R) as of September 30, 2011 and provided for illustrative purposes.

41. Impact of Sovereign & Country Risk Scores to Individual Co.s 7 Managing TP In-House Across Asia-Pacific Scoring the same financial profile across different countries… * FC… Foreign Currency • Country risk impacts the standalone score significantly and across a number of countries with different risk, that leads to 4 notches difference • Where the sovereign rating is low (Cambodia), it would limit the company’s ability to get a higher rating, even if the standalone score is stronger • The range of scores, depending on industry and country selection is from bbb- to b (5 notches)!

42. Managing TP Risk In-house Across Asia-Pacific 7 Managing TP In-House Across Asia-Pacific • Global consistency vs local customisation • Adapting Master-file to local circumstances • Preference for local methods, comparables • Reconciling different local studies • Optimal TP team structure & infrastructure • Governance • Engagement of key stakeholders (business, tax, finance, legal/compliance) and local teams • Operational: embedding TP into BAU

43. Taxand’s Take 8-9 May 2013

44. Taxand’s Take 8 Managing TP In-House Across Asia-Pacific • Financial transactions, intangibles gaining focus globally • Need for “glocal” documentation - MNEs should tailor their global documentation to manage risks in complex jurisdictions • Involvement of in-house tax department in operational changes critical • Proactive approach towards controversy management • Convergence of global tax policies with local risks • Increased transparency and sharing of information - need of the hour • Exploring alternate dispute resolution mechanisms

45. Key Contacts Key Contacts 6 • Mukesh Butani • Taxand India • E. mukesh.butani@bmradvisors.com • T. +91 124 339 5011 • Shiv Mahalingham • Taxand UK • E. smahalingham@alvarezandmarsal.com • T. +44 207 715 5234 • Clemens Thym • Standard and Poors • E. Clemens_Thym@spcapitaliq.com • Steven Carey • Quantera Global • E. s.carey@quanteraglobal.com

46. Our Global Service Commitment 9 Key Contacts & About Taxand • Understanding and managing the tax consequences of cross-border tax transactions • Considering organisational (re)structuring options in full awareness of the tax implications • Realising tax, supply chain and overall operational efficiencies • Interpreting technical tax provisions • Lowering effective tax rates • Addressing and preventing tax leakages • Ensuring tax compliance • Managing relationships with tax authorities

47. Global Coverage Key Contacts & About Taxand 9 • From 9 to 48 countries in just 7 years • 59 ITR awards won since 2009 • 95% recommended in World Tax 2012

48. Why Taxand? 9 Key Contacts & About Taxand • Dedicated to tax • Independence advantage – conflict free, un-bureaucratic, best practice • Local knowledge, global view • Partner led from start to finish • Complex problems, customised advice • Passionate about working together • Practical advice, responsively delivered