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HOT TOPICS IN TRANSFER PRICING AUDITS Einari Karhu

Michael PulsRenátaBláhová

INTRODUCTION

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INTRODUCTION

Over the recent years tax disputes in cross-border matters have increased rapidly.

The development has been rapid especially in transfer pricing following the OECD

BEPS work and updated OECD TP Guidelines.

The panel discusses the topical aspects recurring in transfer pricing disputes in

different countries through case examples from Finland, Germany and Slovakia.

The cases present variety of transfer pricing issues, including technical cases, a

case related to question of principle, a procedural case, and a case related to a

question of the scope of re-characterisation.

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PANELISTS

EINARI KARHUPartner

Borenius Attorneys

Finland

+ 358 20 713 3488

einari.karhu@borenius.com

Michael PulsPartner

Flick Gocke Schaumburg

Germany

+49 211/6 18 22-0

michael.puls@fgs.de

RENÁTA BLÁHOVÁPartner

BMB Leitner

Slovakia

+421 2 59 10 18-00

renata.blahova@bmbleitner.sk

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THE RISE OF TAX AND TP DISPUTES

WHY HAVE TP DISPUTES INCREASED?

Unilateral fear of base erosion

Revised regulations (e.g. BEPS)

New measures (e.g. multilateral audits) and increase of information exchange

Lack of mechanisms to settle

Increase in taxes and penalties under dispute

WHAT IS DISPUTED?

Centralised services, IP and PEs

BEPS – retrospective application?

State Aid investigations

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CASE STUDIES

CASE STUDIES

Five cases that cover the following matters under dispute

• Selection and application of TP methods

• High-value adding services

• Adjustments on non-EU transactions

• Intra-group financing

• DEMPE functions

1: APPLICABLE TP METHOD & DETERMINATION OF AN ARM’S LENGTH COMPENSATION FOR CONTRACT MANUFACTURING SLOVAKIA (1)

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External suppliers

3rd parties

Production

Production

„WOOD“

„CHAIR Co.“

Retail

Holding „FURNITURE“

Range &

Supply

Slovakia

SaleSale

1: APPLICABLE TP METHOD & DETERMINATION OF AN ARM’S LENGTH COMPENSATION FOR CONTRACT MANUFACTURING SLOVAKIA (2)

Chair Co., a group company characterized as contract manufacturer, was

compensated for its sale of furnitures to Furniture Co. by applying CUP method.

During a tax audit, tax auditors (TA) stated that CUP requirements were not met

and CUP was not applicable.

TA prepared new comparability analysis by applying TNMM method. An

interquartile arm's length range was 3.54% - 13.49%, with a median of 6.86%.

Mark-up level earned by the contract manufacturer was -12.36%. TA conducted a

tax assessment of EUR 3 million.

The company prepared a new comparable analysis with different search criteria,

with an interquartile arm's length range of 0.77% - 4.91% and with a median of

1.96%.

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1: APPLICABLE TP METHOD & DETERMINATION OF AN ARM’S LENGTH COMPENSATION FOR CONTRACT MANUFACTURING SLOVAKIA (3)

TP matters to be discussed

• Applicable TP method: CUP vs Cost Plus

• Review of TP Documentation focused on Function and Risk Profile (FRP), in depth

interviews with staff were performed

• Local GAAP vs IFRS: which one is applicable for the cost plus method

• Discussion points of the benchmarking analysis

• Comparable entities

• Local vs Global Coverage

• Amadeus and its quality

• NACE Code: narrow vs broad

• RESULT?

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1: APPLICABLE TP METHOD & DETERMINATION OF AN ARM’S LENGTH COMPENSATION FOR CONTRACT MANUFACTURING SLOVAKIA (4)

Questions and conclusions

• Local court dispute or a Bilateral procedure?

• In case of Switzerland, can the Arbitration Convention be relevant?

• Can revised BEPS be applied to an old (2011) case?

• Businesses should be prepared for audits of documented function and risk

profile

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2: TRANSFER PRICING OF HIGH-VALUE ADDING SERVICESGERMANY (1)

100%

Chemical B.V.

Chemical GmbH

The Netherlands

Germany

R&D and distribution services

Remuneration: full costs + 5%

Customers

Delivery

2: TRANSFER PRICING OF HIGH-VALUE ADDING SERVICESGERMANY (2)

Chemical B.V., Rotterdam, operates with its international subsidiaries in the R&D,

production and distribution of special chemicals. Chemical B.V. can be considered

as a “strategic company” with respect to staffing, production and distribution

capacities, and it bears most of the risks and opportunities within the group.

Chemical GmbH, a direct subsidiary of Chemical B.V., develops and distributes

special chemicals on the German market (=provision of high-value adding

services). Chemical GmbH provides R&D and distribution services to Chemical

B.V. These services are of significant importance for the German business of

Chemical B.V.

Until 2005, Chemical GmbH was an autonomous research and distribution

company. Following a restructuring of the group, Chemical GmbH now operates as

a service provider on behalf of Chemical B.V. The customer base of Chemical

GmbH was sold to the Dutch parent in 2005 for a relatively small remuneration.

2: TRANSFER PRICING OF HIGH-VALUE ADDING SERVICESGERMANY (3)

The companies concluded a service agreement that settled the remuneration of

Chemical GmbH using the cost-plus method (full costs plus a profit margin of 5%).

The tax audit for the assessment periods 2008 until 2010 challenged the

application of the cost-plus method and the profit margin of 5%. Chemical GmbH

renders high value-adding services and is part of the highly profitable business of

Chemical B.V. Therefore, say the TA, the appropriate transfer pricing method would

be the profit-split method.

2: TRANSFER PRICING OF HIGH-VALUE ADDING SERVICESGERMANY (4)

TP matters to be discussed:

• Is the application of the cost-plus method with a fixed profit margin appropriate?

• Is the application of the profit-split method appropriate if it relates to high value-

adding services? If so: How should the profit be split?

• Might the TA also adjust the transfer price of the customer base that was sold to

Chemical B.V. in 2005?

3: TP INCOME-ORIENTATED ADJUSTMENTS ON NON-EU TRANSACTIONSGERMANY (1)

F GmbH

V Ltd.

Germany

China/India

Delivery of products

Car

manufacturers

100%

Return on sales ratio:

15%–22%

Distribution

to customers

3: TP INCOME-ORIENTATED ADJUSTMENTS ON NON-EU TRANSACTIONSGERMANY (2)

F GmbH is resident for tax purposes in Frankfurt and operates in the automotive

industry.

The goods and products produced by F GmbH are distributed in China and India

via local distributors (V Ltd.), which are subsidiaries of F GmbH.

Transfer prices for the goods and products are based on the resale price method.

The cross margins are calculated on the basis of a benchmark study. The current

return on sales ratio – based on the EBIT – is between 15% and 22%. The high

return on sales ratios can be explained by enormous sales growth, the excellent

local management, and the high prices on the Chinese and Indian markets.

The German tax audit challenges the transfer prices for the product delivery to the

distribution companies. TA’s main argument is that V Ltd. “earns too much” in both

China and India.

3: TP INCOME-ORIENTATED ADJUSTMENTS ON NON-EU TRANSACTIONSGERMANY (3)

TP matters to be discussed:

• Does Sec. 1 Foreign Tax Act cover an income-orientated adjustment?

• Is it possible to avoid double taxation by filing for a MAP between Germany and

China / Germany and India?

• Is it possible to avoid double taxation based on “objective inequity”? Guidance

issued by the German Ministry of Finance on 13 July 2006 provides for this

“equity rule” if the taxable person complied with the obligation to cooperate and

the mutual agreement procedure fails.

• Is it more reasonable to bring the case before a tax court instead of a mutual

agreement procedure?

4: TRANSFER PRICING OF INTRA-GROUP FINANCING WITH A HEDGING CLAUSEFINLAND (1)

2. Loans 2. Interest income

A Oy

B B.V.

1. Equity 1. Shares

Group companies

Agreement on hedging against FX and interest

rate risks etc.

Loans

Equity Shares

Service fee

Provision of financing

related service

Interest income

Group companies

Intra-group financing as implemented and

applied by A GroupTA’s view on A Group’s intra-group financing

A Oy

B B.V.

4: TRANSFER PRICING OF INTRA-GROUP FINANCING WITH A HEDGING CLAUSEFINLAND (2)

A Oy (Finland), is the parent company of the A Group which operates in

construction industry.

B B.V. (Belgium), was established by A Oy in 2008 as part of the A Group’s internal

financial restructuring. B B.V. is responsible for the A Group's internal lending.

Civil law transactions regarding intra-group financing activities have been in line

with the above business model.

In the tax audit report, TA re-characterised the actual business model and the civil

law transactions regarding intra-group finance activities and gave them a new

meaning for the tax purposes (i.e. B B.V. provides financing related support

services).

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4: TRANSFER PRICING OF INTRA-GROUP FINANCING WITH A HEDGING CLAUSEFINLAND (3)

TP matters to be discussed:

• Does the arm’s length principle and a domestic transfer pricing adjustment

clause allow TA to disregard valid and legally binding transactions and

delineate the business model by pricing fictional transactions?

• Should the civil law conditions agreed between group companies be respected

and is the view of TA actually based on the unlawful re-characterisation?

• Whether the economic outcome in consequence of a hedging agreement

(i.e. allocation of economic risk) allows TA to disregard the intra-group

financing model agreed and applied within a multinational group?

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5: TRANSFER PRICING OF INTANGIBLES AND LOCATION OF DEMPE FUNCTIONSFINLAND (1)

Functions:

- Routine

functions

only

Assets:

- No

valuable

assets

Key assets:

- All valuable

intangibles

C Inc. (limited-risk)

B Ltd (limited-risk)

A Oy(parent-like

company)

Licensing of technology

related intangibles

Key assets:

- Technology

related

intangibles

Functions:

- R&D

- Sourcing

- Manufacturi

ng

- Sales

- Services

Assets:

- Intangibles

related to

technology

and sales

channels

royalty

A Oy (Full-risk)

royalty

C Inc.(full-risk)

B Ltd (full-risk)

TP method:

- CUP

TP method:

- TNMM

Business model implemented and applied by A Oy and its sister companies

FTA’s view on the business of A Oy and its

sister companies

5: TRANSFER PRICING OF INTANGIBLES AND LOCATION OF DEMPE FUNCTIONSFINLAND (2)

A Oy (Finland) is part of a multinational technology corporation. A Oy has a

significant role in one of the business lines of the group. A Oy has been subject to

transfer pricing audit regarding its transactions with its sister companies, B Ltd.

(China), and C Inc. (USA).

The tax audit focused on the DEMPE functions in A Oy and its sister companies as

well as the determination of an arm’s length compensation for utilisation of

intangibles in one of the business units the group.

In tax auditors’ view, there were several valuable, technology related intangibles in

the business unit and even if all A Oy, B Ltd and C Inc. have financed and

participated in developing the said intangibles, the B Ltd and C Inc. were viewed as

limited-risk companies performing routine functions only. Further, TA viewed that

valuable assets have been owned and developed by A Oy only.

5: TRANSFER PRICING OF INTANGIBLES AND LOCATION OF DEMPE FUNCTIONSFINLAND (3)

TP matters to be discussed:

• Does the local transfer pricing adjustment clause allow the delineation or should

the business model implemented and applied by a group and intra-group

licensing transactions, tested by applying CUP method, be considered as an

arm’s length model?

• Is it common that TA challenges the functional analysis prepared and

documented by the group, and prepares an own and alternative functional

analysis and an alternative business model?

SPEAKER PROFILES

SPEAKER PROFILE

Einari Karhu is a Partner of Borenius Attorneys Ltd.Einari advises on

corporate taxation and has extensive experience in international tax

matters and M&A structuring, as well as tax litigation.

He has been involved in several major tax disputes with regard to

transfer pricing and international tax planning (e.g. Fortum and Nokian

Tyres), as well as IPOs and other financing transactions.

Einari has successfully advised leading asset management companies in

reclaiming withholding taxes on Finnish-source dividends. Before joining

Borenius in 2008, Einari worked as a senior advisor in the Ministry of

Finance.

Einari Karhu

Borenius Attorneys, Taxand Finland

T: +358 20 713 3488 | E: einari.karhu@borenius.com

SPEAKER PROFILE

Michael Puls is based in Düsseldorf where he has been a partner at Flick

Gocke Schaumburg, Taxand Germany.

Michael has been a lawyer since 2003, and a certified tax advisor since

2006. He studed law and business administration in Osnabrück and

Bonn (2004 Dr. iur.) and regularly lectures for various tax advisors’

associations in NRW in the field of international tax law and transfer

pricing.

He is a member of the German-American Lawyers’ Association, and of

the managers’ circle of the Friedrich Ebert Foundation (Friedrich-Ebert-

Stiftung).

Michael Puls

Flick Gocke Schaumburg, Taxand Germany

T: +49 211/6 18 22-0 | E: michael.puls@fgs.de

SPEAKER PROFILE

Renáta Bláhová is based in Taxand Slovakia where she is a partner at

BMBLeitner. She is the founding partner of BMB Leitner in Bratislava,

Slovakia.

She has 20 years of experience in tax and accounting law, specialising

mainly in Slovak and international tax law, direct taxes, transactional

services and M&A.

Renata graduated from the Slovak University of Technology, gained an

MBA at St Louis University in the United States, and an L.L.M. in

international tax law at Vienna University of Economics and Business

Administration. Besides holding Slovak licences for auditing and tax

advisory, Renata is also a certified FCCA accountant (UK).

Renáta Bláhová

BMB Leitner, Taxand Slovakia

T: +421 2 59 10 18 00 | E: renata.blahova@bmbleitner.sk