cover

Contents

Cover

Praise for Transfer Pricing Handbook: Guidance for the OECD Regulations

Title Page

Copyright

Dedication

Preface

Part I: Basic Transfer Pricing Standards

Chapter 1: Introduction

Control

Tax Havens

Complexities

Chapter 2: Arm's Length Principle

General Explanation of the Arm's Length Principle

Formal Statement as to the Arm's Length Principle

Comparability Considerations

Rationale behind the Arm's Length Principle

Compensation Issues

Applying the Arm's Length Principle to Contribution Analysis

Oligopolistic Conditions

Transactions That Independent Enterprises Would Not Undertake

Administrative Burdens of the Arm's Length Principle

Maintaining the Arm's Length Principle as the International Consensus

Rejection of Alternative Transfer Pricing Approaches

Chapter 3: Arm's Length Range

Single-Figure Approach to the Arm's Length Range

Reliability Requirement

Comparability Considerations

Consequences of Applying More Than One Transfer Pricing Method

Selecting the “Most Appropriate Point” in the Range

Extreme Results: Comparability Considerations

Chapter 4: Safe Harbor Simplification

Safe Harbor Burdens and Benefits

Defining “Safe Harbor”

Scope of the Safe Harbor Provisions

How Arbitrary Are the Safe Harbor Provisions?

Factors Supporting the Use of Safe Harbors

Problems That Safe Harbors Present

Multiple Jurisdictions

Possibility of Opening Avenues for Tax Planning

Statistical Data and a Safe Harbor Example

Undertaxation

Safe Harbor Principles

Equity and Uniformity Issues

Recommendations as to the Use of Safe Harbors

Safe Harbors as Surrender of the Tax Administration's Discretionary Power

Flexible Practices

Country-Specific Practices

Comprehensive Example

Chapter 5: Modifying Safe Harbor Simplification

The Study

Eleven Specific Transfer Pricing Measures

Chapter 6: Global Formulary Apportionment

Profit Split Methodologies

Global Dealing

Attack on Global Formulary Apportionment

Impact of the Arm's Length Principle

Comparing Global Formulary Apportionment with the Arm's Length Principle

Double Taxation

Lack of a Common Accounting System

Factor Selection

Transitional Issues

Economic Issues

Impact of Exchange Rate Movements

Compliance Costs and Data Requirements

Valuation Difficulties

Separate Entity Approach versus Global Formulary Apportionment

Bilateral Tax Treaties

Members of the Multinational Group Excluded from Global Formulary Apportionment

OECD's Rejection of Non–Arm's Length Methods

Safe Harbors

Part II: Transfer Pricing Methodologies

Chapter 7: Transactional Profit Split Measures

Transactional Profit Split Method Concepts

Strengths and Weaknesses of the Transactional Profit Split Method

Availability of Comparables in Applying the Transactional Profit Split Method

Importance of Functional Analysis in Applying Transactional Profit Split Methods

Transactional Profit Split Method Weaknesses

Applying Transactional Profit Split Methods

Guidelines Profit Splitting Approaches

Determining the Combined Profits to be Split

Actual Profits versus Projected Profits

Different Profit Measures When Applying the Transactional Profit Split

How to Split the Combined Profits

Reliance on Comparable Uncontrolled Transactions Data

Allocation Keys

Reliance on Internal Data

Conclusions as to Transactional Profit Split Methods

Chapter 8: Profit Split Illustrations

Three Basic Assumptions

Three Residual Profit Split Alternatives

Commentary

Chapter 9: Residual Profit Split Examples

Presumptions and Preconditions

Essential Factual Pattern Conflict

Functional Activities

Selecting Transfer Pricing Approaches

Applying the Residual Profit Split Approach

Drafters’ Disclaimer

Contribution Approach

Chapter 10: Transactional Net Margin Method

Initial TNMM Considerations

How the Transactional Net Margin Method Works

TNMM Reliability

Strengths of the TNMM

Weaknesses of the TNMM

Applying the Comparability Standard to the TNMM

Database Issues: The Audio Player Example

Impact on the Arm's Length Range

Selecting the TNMM

Selecting the Net Profit Indicator

Exclusion and Measurability

Cases in Which Net Profits Are Weighted to Sales

Cases in Which Net Profits Are Weighted to Costs

Cases in Which Net Profits Are Weighted to Assets

Berry Ratios

Other Guidance

TNMM Examples

How the OECD Views the TNMM

Chapter 11: Selecting Profit Indicators

Illustration 1

Illustration 2

Illustration 3

Chapter 12: Selecting Transfer Pricing Methods

When Can a Business Apply a Multisided Transfer Pricing Method?

When Should a Business Not Apply a Multisided Transfer Pricing Method?

Part III: Comparability Analysis

Chapter 13: How Comparability Analysis Works

Determining When Transactions Are Comparable

Factors and Comparability

Functional Analysis

Economic Circumstances

Business Strategies

Return on Investment

Recognizing the Actual Transactions Undertaken

Associated Enterprises and Independent Enterprises: In Contrast

Alternatively Structured Transactions

Losses

Multinational Enterprises

Implementing Business Strategies

Impact of Governmental Policies

Chapter 14: Comparability Techniques

General Comparability Guidance

Typical Comparability Processes

Broad-Based Analysis of the Taxpayer's Circumstances

Controlled Transaction and Choice of a Tested Party

Comparable Uncontrolled Transactions

Selecting or Rejecting Potential Comparables

Additive Approach

Comparability Adjustments

Arm's Length Range

Chapter 15: Timing and Comparability

Timing of Origin

Timing of Collection

Valuation That Is Highly Uncertain

Data from Years Following the Year of the Transaction

Multiple-Year Data

Compliance Tools

Part IV: Administrative Approaches

Chapter 16: Transfer Pricing Audits

Transactional Profit Split Method

Simultaneous Tax Examinations and Transfer Pricing

Tax Arrangements

Potential Levels of Cooperation between Tax Administrations

Examples

Chapter 17: Monitoring the Guidelines

Understanding the Monitoring Process

Method Selection

Specific Monitoring Processes

Working Party No. 6 Peer Reviews

Three Peer Review Levels

Peer Review Selection Criteria

Difficult Case Paradigms

Biennial Members of Tax Examiners

Business Community Involvement

Business Industry Advisory Committee

Business's Role in Contributing to the OECD

Peer Reviews and the Business Community

Business Community's Updates on Legislation and Practice

Role of the U.S. Council for International Business

Part V: Advanced OECD Analysis

Chapter 18: Documentation Requirements

Introductory Issues and Burden of Proof

Guidance on Documentation Rules and Procedures

Useful Information for Determining Transfer Pricing

Summary of Recommendations on Documentation

Chapter 19: Intangible Property

Basic OECD Intangible Property Provisions

Future Intangible Property Developments

Arm's Length Intangible Property Issues

OECD Intangible Property Developments

Soft Intangibles

Highly Uncertain Valuation Issues

Steps That an Independent Enterprise Might Undertake to Resolve Uncertainty

Tax Administrator's Response

Timing Considerations

OECD Highly Uncertain Valuation Examples

What the OECD Should Do Now

Chapter 20: Service Arrangements

Overview

Scope of Intragroup Arrangements

Shareholder Activities and Stewardship Activities

Adjusting to the Form of the Arm's Length Consideration

“On Call” Services

Evaluating “On Call” Services

Determining an Arm's Length Charge for the Intragroup Service

Including Service Costs in the Transfer of Goods

Double-Taxation Risks

Examining the Actual Use of the Services

Calculating the Arm's Length Consideration

Applying Transfer Pricing Methods

Functional Analysis

Business Strategies: Profits for the Service Provider

Applying the Cost-Plus Method for Intragroup Services

Cost-Benefit Issues and Safe Harbor

Intragroup Service Examples

Specialized Services

Multinational Service Enterprises

Specialized Service Industries

Applying the Transactional Profit Split Method to Services

Chapter 21: Cost Contribution Arrangements

Overview

Cost Contribution Arrangement Criteria

Mandatory CCA Arm's Length Requirements

Applying an Applicable Allocation Key

Tax Treatment of Contributions and Balancing Payments

Entry, Withdrawal, and Termination of a Cost Contribution Arrangement

Recommendations for Monitoring and Structuring Cost Contribution Arrangements

Documentation

Chapter 22: Business Restructuring

Special Risk Considerations

Compensation for Undertaking the Restructuring

Postrestructuring Remuneration

Recognition of the Actual Transactions Undertaken

Part VI: Putting the Guidelines to Work

Chapter 23: Malaysia-Singapore Allocation Keys

Importance of Allocation Keys

When the Transactional Profit Split Method Is the “Most Applicable” Transfer Pricing Method

Specialized Services

Applying the Transactional Profit Split Method

Four Allocation Key Categories

Key Functions

Selecting Potential Allocation Keys

Selecting among Allocation Keys

“Strong Correlation” Standard

Allocation Keys

Transfer Pricing Strategies

Chapter 24: China-Taiwan Trade

Taiwan and China: A History Lesson

Tax Considerations

Transactional Profit Split Method Criteria

APA Process

Chapter 25: Reverse Engineering the Transfer Pricing Process

Transactional Profit Split

Simultaneous Tax Examinations and Transfer Pricing

Tax Arrangements

How the Reverse Engineering Transfer Pricing Process Works

Functional Analysis Considerations

Transactional Profit Split Method

Success Parameters to the Reverse Engineering Process

Synergistic Activities

Undertaking Multijurisdictional Production Processes

Engaging in Extensive R&D Activities

Dealing in Unique Intangibles

Participating in a Cost Contribution Arrangement

Creating or Providing Specialized Services

Distributions of Generic Goods or Standardized Goods

Contract Manufacturers and Contract Service Activities

Planning

International LP Gas Companies Face Multinational Tax Claims

Multinational Service Enterprises

Part VII: Connecting Transfer Pricing and Permanent Establishment

Chapter 26: Permanent Establishment Parameters

OECD's Permanent Establishment Provisions

Overall Tax Considerations

OECD Approach to Determine Permanent Establishment

Hong Kong Applies the OECD Permanent Establishment Provisions

Common Law Permanent Establishment Criteria

Declining Businesses

“Preparatory to” and “Auxiliary from” Exemptions

Will the OECD Approach Prevail?

Chapter 27: Focus on Permanent Establishment

Background Considerations

Twenty-five Proposed Changes

About the Authors

Index

Praise for Transfer Pricing Handbook: Guidance for the OECD Regulations

“Margaret Kent and Robert Feinschreiber are nationally recognized international tax and transfer pricing specialists who have a wealth of experience in the area. For years, they have been providing useful insight on the transfer pricing practices around the globe. Their latest book reflects their passion for the area.”

Joseph Calianno
Partner, International Technical Tax Practice Leader,
Grant Thornton LLP

“Feinschreiber and Kent have produced another book which is of great value to a transfer pricing practitioner. Whether you are in charge of transfer pricing for your company or arguing with the tax authority, this book is essential to substantiate your position. It is a must for any corporate tax department.”

Gregorio Torres
Manager of Taxation,
Roche (Mexico)

“A most intriguing view on the OECD Transfer Pricing Guidelines from a practitioner's perspective. Feinschreiber and Kent provide a multitude of case studies and offer insights into transfer pricing trends in the OECD. Helpful for anyone involved in transfer pricing.”

Alexander Vöegele
Chairman of the Advisory Board,
NERA Economic Consulting

“Bob Feinschreiber and Margaret Kent have once again produced a well-written treatise that presents a complex and challenging subject in a concise and practical manner. This book should be a staple in any transfer pricing practitioner's library.”

William T. Bradfield
Partner, Rödl & Partner

“I found this book to be extremely insightful and interesting. It should be required reading for anyone involved in transfer pricing.”

Lawrence J. Chastang
Managing Partner of International Services,
CliftonLarsonAllen, LLP

“The authors have sought to provide the reader with an example-focused, practical guide as to how to identify transfer pricing and corollary issues, determine a transfer pricing method and document the considerations and determinations. This Handbook is a useful primer to navigate the contentious issue of transfer pricing.”

Alan Winston Granwell
DLA Piper LLP (U.S.)

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The Wiley Corporate F&A series provides information, tools, and insights to corporate professionals responsible for issues affecting the profitability of their company, from accounting and finance to internal controls and performance management.

Title Page

Copyright © 2012 by Robert Feinschreiber and Margaret Kent. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.

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Library of Congress Cataloging-in-Publication Data:

Feinschreiber, Robert.

Transfer pricing handbook : guidance on the OECD regulations / Robert Feinschreiber, Margaret Kent.

p.cm. – (Wiley corporate F&A series)

Includes bibliographical references and index.

ISBN 978-1-118-34761-4 (cloth); ISBN 978-1-118-37655-3 (ebk.); ISBN 978-1-118-37656-0 (ebk.); ISBN 978-1-118-37657-7 (ebk.)

1. Transfer pricing-Taxation. 2. Transfer pricing-Taxation-Law and legislation. I. Kent, Margaret, 1942–  II. Title.

HJ2305.F45 2012

338.8′8–dc23

2012012435

To Steven Feinschreiber and Kathryn Feinschreiber Hagedorn,
and to our grandchildren, Alexander, Elizabeth, and Henry,
in the hope that they will follow in our footsteps.

Preface

Welcome to the Transfer Pricing Handbook: Guidance on the OECD Regulations. This book is the fifth volume of Transfer Pricing Handbook series, which we began 20 years ago with Wiley. The first two transfer pricing volumes have a U.S. perspective; the third volume focuses on the rest of the world; and the fourth volume addresses transfer pricing methods. The fifth volume, which you now have before you, examines the 2010 Organisation of Economic Co-Operation and Development (OECD) Regulations, OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, which we call the Guidelines. Watch out for our sixth volume, Transfer Pricing Handbook: Asia-Pacific.

The OECD was comparatively late to the transfer pricing arena. The OECD's first promulgation on transfer pricing was the OECD report Transfer Pricing and Multinational Enterprises, in 1979. The OECD transfer pricing provisions are dynamic, not static, and the OECD expects to issue more guidance in the years to come. We are thankful to those at the OECD who assisted us in this venture. The Guidelines are now 371 pages, with more to come in the future.

We have examined many facets of the 2010 Guidelines, doing so to make this analysis comprehensive for both multinational enterprises and tax administrations. We address the difficulties in applying the arm's length standard, transfer pricing methodologies, and the determination of comparables. We examine administrative approaches to resolve transfer pricing disputes and transfer pricing documentation. Then we examine intangibles, intragroup services, and cost contribution arrangements. Finally, we examine the business aspects of business restructuring, practical transfer pricing applications, and permanent establishment considerations. We divide the handbook into seven parts:

img Part I looks at the basic OECD transfer pricing standards, beginning with the arm's length principle and the limits to this arm's length range concept. We examine the OECD's safe harbors simplification approaches and its safe harbor modifications. Then we analyze the global formulary apportionment alternative.
img Part II looks at the OECD's transfer pricing methodologies, recognizing the importance of the transactional profit split alternative, the application of the residual profit split, and limitations on the transactional net margin method. Then we examine profit indicators and other transfer pricing ramifications.
img Part III provides a comprehensive look at comparability analysis, examining how the specifics of the comparability process and comparability analysis techniques, as well as the timing issues that arise in assessing comparability.
img Part IV examines the OECD's administrative approaches. We look at audits and advance pricing agreement techniques, and we examine the monitoring process itself.
img Part V provides advanced OECD analysis. We examine the documentation requirements, intangible properties, and services arrangements. Then we analyze cost contribution arrangements and business restructuring.
img Part VI puts the Guidelines to work. We examine factual patterns we developed in Malaysia as to Singapore operations and in Taiwan as to Chinese operations. Then we analyze techniques to reverse engineer the transfer pricing process.
img Part VII connects transfer pricing with permanent establishment under the OECD provisions.

One again, we are pleased to be selected by John Wiley & Sons to be the authors of this comprehensive book on transfer pricing. We are grateful to Sheck Cho at John Wiley & Sons for developing and nurturing the transfer pricing project and to both Tim Burgard and Stacey Rivera at John Wiley & Sons. In addition, we have a debt of gratitude to Natu Patel, then the principal tax official at John Wiley & Sons, for continuing to encourage us to undertake this project despite our extensive international schedule.

Readers are welcome to contact us to suggest additional topics or suggestions or to inform us about transfer pricing planning or audit and litigation techniques. Our e-mail address is multijur@aol.com. Our web site is TransferPricingConsortium.com.

Robert Feinschreiber
Margaret Kent
Key Biscayne, Florida
May 2012

Part I

Basic Transfer Pricing Standards

Chapter 1

Introduction

The Organisation of Economic Co-Operation and Development (OECD) Transfer Pricing Guidelines are becoming the international pricing standard. This pricing standard applies to multinational enterprises that have business relationships with their related enterprises or have business activities that have associated enterprises in differing tax jurisdictions. This pricing standard applies to the tax administrations that monitor these multinational enterprises. The OECD developed these Transfer Pricing Guidelines in July 2010 to impact multinational enterprises and tax administrations in equal fashion.

The OECD promulgated its Transfer Pricing and Multinational Enterprises in 1979. The OECD's Committee on Fiscal Affairs then issued the initial Transfer Pricing Guidelines on June 27, 1995, and the OECD Council approved publication of the Guidelines on July 13, 1995. The initial Guidelines included five chapters: the arm's length principle, transfer pricing methods, comparability analysis, administrative approaches to avoiding and resolving transfer pricing disputes, and documentation.

The Committee on Fiscal Affairs adopted the transfer pricing report as to property and services on January 23, 1996 (DAFFE/CFA[96]2). The OECD Council on April 11, 1996, incorporated Chapter VI, pertaining to intangibles, and Chapter VII, pertaining to services (C[96]46).

The Committee on Fiscal Affairs adopted the transfer pricing report as to cost contribution arrangements on June 25, 1997 (DAFFE/CFA[97] 27). The OECD Council on July 24, 1997, incorporated Chapter VIII (C[97]144).

The OECD has 34 members. All of these members apply many facets of the 2010 Guidelines. In addition to the 34 members, the OECD has 9 near members that follow the OECD precepts. Then, in addition to these 34 members and 9 near members, at least 7 countries voluntarily follow the OECD precepts. It is fair to state that these 50 or so countries that follow the 2010 OECD Transfer Pricing Guidelines are participants in a voluntary but pervasive international tax system that includes virtually all nations that participate in international trade.

Despite the importance of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, these Guidelines are an invention, taking 30 or so years to reach maturity. Some key dates to bear in mind are

img The discussion on transfer pricing began in 1979 with the OECD report Transfer Pricing and Multinational Enterprises.
img The OECD published the original Guidelines in 1995—but the Guidelines excluded intangible property, services, cost contribution arrangements, monitoring procedures, advance pricing agreements, and business restructurings.
img The OECD included guidance for intangible property and services in 1996.
img The OECD included guidance for cost contribution arrangements in 1997.
img The OECD included guidance for monitoring procedures in 1997.
img The OECD included guidance for advance pricing agreement procedures in 1999.
img The OECD included guidance for business restructuring in 2010.

The OECD has spent considerable effort in developing transfer pricing methodologies beyond the traditional comparable uncontrolled price method, the resale method, or the cost-plus method. These newer methods are the transactional net margin method and, most recently, the transactional profit split method.

Despite these great strides that the OECD has already undertaken to develop the transfer pricing system, it our view that the Guidelines themselves have three major defects:

1. Control
2. Tax havens
3. Complexities

Control

The 2010 Guidelines are 371 pages in length. Absent from these Guidelines are control mechanisms—the manner in which one party is assumed to control another party. The Guidelines are quick to ascertain the consequences that are to take place if a controlled relationship exists, but the Guidelines are short on establishing the control parameters themselves and are very short on addressing one crucial facet: the presence or absence of “control.”

img Countries might seek to ascertain the presence of control empirically, based on a data analysis, contractual provisions, or both.
img Alternatively, a government might issue its own transfer pricing control standards, based on common ownership, ownership over the second company, family ownership, or other criteria.

Regrettably, the OECD has chosen not to pursue this path of defining control, thus allowing countries to have differing definitions of control. Not having a universal definition of control, the taxpayer is at the mercy of each country regarding control issues.

Tax Havens

It is our view that the OECD has failed to pursue an examination of tax haven structures in the transfer pricing context. Outsourcing and reinvoicing are part and parcel of schemes that culprits undertake to shift income to tax havens, while hiding affiliated ownership in non–tax haven countries. As we shall see, the tax administrations are, even now, unprepared to challenge these tax-evading devices.

Complexities

The OECD has undertaken some steps to eliminate transfer pricing complexities. Nevertheless, taxpayers need more guidance in complex areas. As of now, the OECD has been opposed to permitting taxpayers to apply safe harbors. Clearly, there is much to be done.