Transfer Pricing Workshop Cairo 14-25 February 2010

1. Transfer Pricing WorkshopCairo14-25 February 2010 Intra-Group Services Management Fees Cost Contribution Arrangements (CCAs)

2. Types of Intra-Group Services • Administrative, technical, financial and commercial services for a specific group member • Management, coordination and control functions for the whole group

3. Types of Intra-Group Services • Intra-group services usually include services ordinarily performed internally (central auditing, financing advice, training of personnel) • Often include services that are typically available externally from independent enterprises (such as legal and accounting services)

4. Typical Arrangements • Parental service arrangements • Centralised service companies (group service centre) • Cost centre • Profit centre • Specialized service centres • Cost contribution/sharing arrangements

5. Typical Arrangements Parental services • Provided by the parent company – often on cost recovery basis, i.e. with no profit element. • Examples are: • Group finance • Group tax • Legal

6. Parental services Provision of services Management fees

7. Typical Arrangements Centralised services • Provided by a service company in the group – usually on a cost plus basis, i.e. including a profit element. • Examples are: • IT support • Technical • Finance and treasury

8. Centralised services Provision of services Management fee

9. Typical Arrangements Cost contribution/sharing arrangements • Provided by each group member for the benefit of the group as a whole always on a cost contribution basis commensurate with (expected) benefit. • Examples are: • Research and development • Procurement

10. Cost contribution arrangement Provision of services Allocation of costs

11. 3 Key Issues re. Intra-Group Services • Determining whether an intra-group service has been rendered • Identifying actual arrangements for charging for intra-group services • Calculating the arm’s length price

12. Rendering of intra-group services

13. Rendering of intra-group services • Activity performed must provide to the recipient with economic or commercial value o enhance its commercial position. • Consider whether an independent enterprise would: • Pay for the activity if performed by an independent enterprise; or • Perform the activity in-house • If not, no intra-group service

14. Rendering of intra-group services • Existence of an actual payment is useful, but does not prove that the service has been actually rendered • Notation of “management fee” is notprima facie evidence of management services • Absence of payment does not necessarily mean that no services have been rendered

15. Rendering of intra-group services • Types of services: 15

16. Rendering of intra-group services • Activities not constituting services:

17. Rendering of intra-group services • Shareholder activities: • Costs related to juridical structure of the parent company itself • Costs related to reporting requirements of the parent • Costs related to raising funds for the acquisition of its participations.

18. Rendering of intra-group services • Duplicative services: • Covers those services already performed by the recipient or by an arm’s length party on its behalf. • However, duplication could be accepted under certain circumstances, e.g. temporary duplication.

19. Rendering of intra-group services • Incidental benefits: • Covers services performed by one group member (e.g. shareholder or coordinating centre) for a particular group member or a set of group member, and incidentally provides a benefit to other group members. • OECD examples in para. 7.12 - 7.13

20. Rendering of intra-group services special considerations • On call services • Use frequency • Degree of benefit obtained. • Consider facts and circumstances. • Aggregation/segregation • E.g. higher price for products because R&D is embedded in the product, rather than a separate service charge.

21. Rendering of intra-group services

22. Allocation of costs • Management fees charged as percentage of sales of the service recipient, e.g. 5% of the sales of the service recipients, possible? • Management fees should be based on the cost of service rendered • Actual vs. budgeted cost • Value added strategic services v. routine support services and low margin services

23. Allocation of costs • Direct cost allocation • Indirect cost allocation

24. Allocation of costs • Direct cost allocation • Group members are charged for specific services • Identify the costs incurred for a particular service to a specific affiliate. • Provides greater transparency to the tax authorities • Costs and time associated with supplying the services will be straightforward to identify • Examples: • R&D performed by central R&D department for a specific company or client • Marketing from the central departmentprovided for a specific market or region • Trademark violation in a specific market that was dealt by the legal department

25. Allocation of costs • Indirect cost allocation • Used where proportion of the value of services rendered to each entity cannot be exactly quantified • Identify all relevant costs and allocate them among all recipients using a sensible allocation key/keys • Indirect cost allocation method must: • Be sensitive to commercial features of individual case • Contain safeguards against manipulation • Follow sound accounting principles • Produce allocations of costs that are commensurate (in proportion) with actual or expected benefit of service recipient

26. Cost allocation keys An indirect charge method may need some adjustments to achieve an arm´s length price. Combination of allocation keys is sometimes useful. 26

27. The arm’s length price • Consider perspectives of both • Service Provider and • Service Recipient • Provider • How much does the service cost? • Recipient • How much is the service worth? • How much would it cost to provide the service in-house? • How much would an external service provider charge?

28. The arm’s length price • Arm’s Length Price Setting Minimum price acceptable for provider Maximum price acceptable for recipient Range of AL prices

29. Applicable transfer pricing methods • Chapters II and III OECD TP Guidelines: • Comparable Uncontrolled Price (CUP) • Cost Plus • Combination of methods or TNMM

30. Applicable transfer pricing methods • CUP • Preferable when: • There is a comparable service provided between independent enterprises in recipient’s country • The associated enterprise providing the service also renders it to independent enterprise in comparable circumstances. • Examples: accounting, auditing, legal or computer services being provided. • Careful! Service infrastructure might impact the price!

31. Applicable transfer pricing methods • Cost Plus Method • Applicable in the absence of a CUP where activities, assets and risks are comparable • Cost base is very important (often more material than mark-up) • Mark-up: special considerations

32. Cost Plus Method • Cost Plus (Profit) Mark-up? • Normallymark-up (comparisonwith independent enterprises) • Factors to consider: nature, significance of the service, efficiency of the service supplier… • In some cases no mark-up required (OECD Guidelines paras. 7.33 - 7.37): • Group enterprise acting as an agent or intermediary • The costs are already equivalent to the market price • Unreasonable administrative burden • Safe harbours for service mark-up in some countries

33. Cost Plus Method • Cost Plus (Profit) Mark-up? Speaking Notes continued

34. Cost Plus Method • Cost base very important • Cost base often more material than mark-up • Functional analysis important – take into account both immediate and long-term impact of service • Example in OECD Guidelines para. 7.36: mere intermediary/agency service – profit mark-up limited to intermediary/agency activities

35. Intra-Group Services Procedure: Step 1: Which services have been performed? Step 2: Identify shareholder´s activities Step3: Determine which income or cost to be charged Step4: Determine the arm´s length price or “service fee” Step 5: Identify costs that could be charged directly Step 6: Determine allocation key for charging indirect costs Step 7: Put together the total base of allocation

36. Cost Contribution Arrangements

37. Cost Contribution Arrangements (CCA) • Framework agreed among business enterprises to share the costs and risks of developing, producing or obtaining assets, services, or rights, and to determine the nature and extent of the interests of each participant in those assets, services, or rights. • A contractual arrangement rather than a judicial entity or permanent establishment • CCA should exist prior to development of the asset/service

38. Cost Contribution ArrangementsExamples 38 • Joint development of intangibles – each participant receives a right to exploit the resulting IP • Legal ownership versus economic ownership • No royalties • Joint provision of services that each entity provides and receives • Separate service company rewarded on an arm’s length basis – generally not a participant • Acquisition of property for mutual use

39. Cost Contribution Arrangements (CCA)

40. Key issues in CCA • Participants • Contributions vs. benefits • Ownership • Amount of participant’s contribution • Buy-in/Buy-out payments • Termination • Non arm’s length character of CCA • Structuring CCAs

41. Participants • Participants: entity with a reasonable expectation that it will benefit from the CCA activity itself. • Exploitation and use can be done directly or indirectly • Question: Participants to a CCA may engage a separate entity to perform part of all of the activities is this separate entity a participant in the CCA?

42. CCA: Contributions vs. Benefits - Participants’ Shares - • In a CCA, each participant’s proportionate share of the contributions to the arrangement must be consistent with his share of expected benefits. • Each participant would be entitled to exploit its interest, without paying a royalty or other compensation. • In a CCA there is always an expected benefit that each participant seeks from his contribution; his interest in the results of the CCA activity should be established from the outset. Joint development of a new product and intangible property derived from it A typical CCA

43. CCA: Contributions vs. Benefits - Illustration - Participant Contributions Benefits CCA Contributions Benefits Contributions Benefits Participant Participant

44. Contributions vs. Benefits 44 • Benefits may be known in advance or uncertain, e.g. R&D • Some may be immediate, e.g. services or over a longer term, e.g. R&D • Always expected benefit • Skills are pooled and the consideration is towards the reasonable expectation of mutual benefit • Similar to a Joint Venture • However, the activity does not need to be successful

45. Ownership • Each participant’s interest in the results of a CCA activity should be established from the outset, even where the interest is interlinked with that of other participants • Participants in the arrangement jointly own the developed asset No need to pay a royalty for the use of the asset/service • Legal v. economic ownership: • Multiple beneficial or economic owners • Usually, one legal owner, e.g. because legal ownership of developed intangible property is vested in only one of them but all of them have effective ownership interest.

46. Amount of participant’s contribution • Under the arm’s length principle, the value of each participant’s contribution should be consistent with the value that independent enterprises would have assigned to that contribution. • Use of cost and market prices as measuring tool • Requires case-by-case determination

47. Amount of participant’s contribution • Is the allocation appropriate?Objective: estimate the shares of benefit to be obtained by each participant and allocate contributions in the same proportion • Estimation of benefits (projections!): • Anticipated additional income generated • Anticipated costs saved • Price charged in sales of comparable assets and services • Allocation key or combination of allocation keys • Sales; units used, produced, or sold; gross or operating profit; number of employees; capital invested; etc. • Adjustments to allocation keys may be necessary!

48. Amount of participant’s contribution • Contributions can be in cash, property and services • Sometimes difficult to assess the participant’s contribution of property and services to the CCA or subsidies and tax incentives

49. Amount of participant’s contribution Balancing Payments 49 • A participant may be required to make a payment to other participants to adjust its proportionate share of contributions • Balancing payments are used to maintain the arm’s length nature of the CCA • They do not constitute a royalty for the use of the intangible • Generally treated as a cost to the payer and a reimbursement to the recipients

50. Buy-in/Buy-out payments • Buy-in/buy-out payments should reflect the value of current intangible property owned • Buy-in payment: payment made by a new entrant to an existing CCA for acquiring an interest in the results of prior activities of the CCA • Buy-out payment: payment made to a departing member of an existing CCA • Payments must be arm’s length!