Global Tax and Transfer Pricing Webinar

Tax Transfer Pricing

Intra-group financing and management fees

18 September 2013

Speakers

18 September 2013 2

Sandra Hazan

Partner, Paris, France

D +33 1 42 68 47 85

[email protected]

Theodor J. van Stephoudt

Economist, New York, United States

D +1 212 768 6863

[email protected]

Jules Lewy

Partner, Toronto, Canada

D +1 416 367 6810

[email protected]

http://www.dentons.com/sandra-hazan

http://www.dentons.com/theodor-vanstephoudt

http://www.dentons.com/en/jules-lewy

Table of Contents

18 September 2013 3

• Introduction

• Intra-Group Financing

• Management Fees

• Summary

• Questions & Answers

Introduction Current view of transfer pricing in the U.S.A.

4

• 40 page memorandum released Monday, May 20 by the Senate's

Permanent Subcommittee on Investigations on Apple.

• Apple also uses two conventional offshore tax practices typical of

multinational companies' tax-avoidance strategies, the report said.

• Multinational corporations value goods and services moving across

international borders from one corporate unit to another. Known as

"transfer pricing," these moves are frequently managed to reduce

corporations' global tax costs.

18 September 2013

Introduction General Overview - France

5

• Applicable Rules

• OECD Transfer pricing guidelines

• OECD’s Draft Handbook on Transfer Pricing Risk Assessment – April 30, 3013

• Section 57 of the French Tax Code (“FTC”)

• French administrative guideline

• French case law

18 September 2013

Introduction OECD’s Draft Handbook on Transfer Pricing Risk Assessment – April 30,

2013

6

• “Another indication is whether the taxpayer makes large payments to

related parties that have the result of eroding the local country tax base.

The types of payments that raise such issues could include large royalty

and rental payments, large management fees and other payments for

related party services, payments to related parties for insurance,

potentially transactions involving financial derivative contracts, and

large payments of deductible interest.”

18 September 2013

Introduction General Overview – Canada

7

• Canadian transfer pricing policies are administered by the Canada

Revenue Agency (“CRA”).

• CRA has over 400 dedicated transfer pricing auditors, economists and

senior analysts.

• Over 2000 transfer pricing audits annually.

18 September 2013

Introduction General Overview – Canada

18 September 2013 8

• Since 1998 – S. 247 of Canadian Income Tax Act.

• (Before 1998 – s. 69 of Canadian Income Tax Act.)

• S. 247

• Utilizes arm’s length principle

• GlaxoSmithKline (2012 SCC 52) – Supreme Court of Canada – range of

reasonable amounts

• Transfer pricing adjustment

• 10% penalty

• Secondary adjustment

Introductions CRA publications on transfer pricing

18 September 2013 9

• Information Circular IC 87 – 2R

• Transfer Pricing memorandum TPM – 14 (updates IC 87 – 2R)

• Other CRA Publications

• Information Circular IC 71-17R5 (Competent Authority)

• Information Circular IC 06 - 1 (Customs Valuations)

• Information Circular IC 94 – 4R (Advance Pricing Arrangements (“APA”))

• Information Circular IC 94 – 4R (SR) (Small Business APA)

• 14 Transfer Pricing Memoranda

• Web site: www.cra-arc.gc.ca

Intra-Group Financing

Guarantee fees – Canada

18 September 2013 10

• General Electric Capital Canada Inc. decisions 2010 FCA 344 (Federal

Court of Appeal) affirming 2009 TCC 563 (Tax Court of Canada)

• Involved deduction of $136 Million in guarantee fees paid to GE Capital,

the taxpayer’s parent during the taxpayer’s 1996 – 2000 taxation years.

• Issue of implicit guarantee

• Method to determine fee – “yield” method approved

Intra-Group Financing Issues related to guarantee fees – Canada


• Several additional guarantee fee cases are being litigated, including

additional GE case and Burlington Resources Finance Co.

• McKesson – discount rate for factoring accounts receivable – Tax Court

of Canada trial ended in February 2012

• Legal Costs of Appealing (General Electric Capital Corporation – 2010

TCC 490 (Tax Court of Canada))

• No guarantee fee required if guarantee by a Canadian corporation in

respect of a borrowing by its controlled foreign affiliate if borrowing used

in connection with the active business of the controlled foreign affiliate

Intra-Group Financing Guarantee fees - France


• No specific rules provided under French law

• Case law is the only source regarding the tax treatment of guarantee

fees in France

Explicit Guarantees

Implicit Guarantees

Should the guarantee be remunerated? • According to French case law, a guarantee granted by

a French company to its foreign subsidiaries should

generally be duly remunerated (CE, 9 mars 1979,

n°10454; CAA Paris 6 avril 1993 n°91-699, MetalEurop; CE

17 février 1992, n°81690-82787, Carrefour)

How the remuneration should be fixed? • No rules or guidance for the determination of an arm’s

length remuneration for guarantees

• Existing case law tend to refer to the rule of thumb for

the determination of an acceptable remuneration for

guarantee

Witholding tax issues • If higher than an arm’s length remuneration, the

payment may be characterized as a deemed

distributed income and subject to the French

withholding tax

• It is generally considered that implicit guarantees

are not remunerated at arm’s length (paragraph

7.13 of the OECD guidelines)

• Neither French courts nor French tax authorities

had taken position on this matter.



• Case law

Carrefour CE, 17 February 1992

It is deemed to be abnormal act of

management to provide a financial

guarantee free of charge, unless direct

actual benefit for the entity providing

this support can be justified.

The French supreme court suggested a

rate of 0,25% for this service, while the

FTA was seeking 1%.

The remuneration asked for this service

should be commensurate with the risk

incurred as well as with the market

value of this service.

CE, 7 March 1979

The fact that a parent company

provide a guarantee to it foreigner

subsidiary without receiving

payment for this service has to be

considered as an indirect transfer

of profit abroad.

Thus, FTA is allowed to reintegrate

as taxable benefits the amount

related to the advantage provided

to the subsidiaries.



• Case law

Additional decision Metal Europ, CAA Paris 6 April 6 1993

The advantage given by the parent company to its Brazilian subsidiaries without payment in return had

been qualified as an abnormal act of management even though such compensation is prohibited under

the Brazilian law where the subsidiary was located even if these subsidiaries are not allowed to pay the

guarantee given by The parent company doesn’t prove the existence of a consideration for this

advantage.

The only reason given by the company is that it was necessary to maintain important commercial

opportunities (which according to the court is not a direct consideration serving its own commercial

interest).

Lainière de Picardie, CE march 17 1992

In this case, a group of companies had to face a similar problem (compensation for guarantee is

prohibited under Brazilian law where the subsidiary is located).

In such case the compensation can take the form of consideration agreed at the time of another matter.

A huge increase in the subsidiary’s sales can be considered as a direct consideration serving its own

commercial interest.

Intra-Group Financing Loans and advances – difficulties relating to comparable transactions -

France


• Loans and advances granted by a French company to a foreign affiliate

should bear arm’s length interest

• The interest rate to be charged between related parties is the one the

company could have obtained from a financial institution for a similar

investment (CE, 7 October 1988, 8ème et 7ème s.-s.,n°50-256; CE, 31 July 2009, no. 301935 and

301935)


France


• Perspective from a French borrower

• Interest rate paid by the French borrower should generally be assessed by

reference to the French borrower’s market rate

• Various parameters can be relevant

Evaluate key terms of the loan

Estimate credit rating of the

borrower

Determine arm’s length

interest rate

Some key terms of a loan :

Principal amount

Currency

Interest rate basis

Security

Etc…

Some commonly used methods :

Use Moody’s RiskCalc/ S&P’s

Credit Model

Create a model using rating

agencie’s guidance

Benchmarking analysis :

Identify interest rates in comparable

loan/bond transactions


France


• Perspective from a French lender

• According to French case law, the interest rate applied by the lender should not

be assessed by reference to the lender’s own funding costs but rather on the

compensation that it could have obtained from a bank if the amount were

invested in a financial institution under similar conditions as the loan (CE, 31 July

2009, no. 301936 and CAA Paris, 29 Sept. 2009, no. 08PA00082; CAA Douai, 13 Jan.

2011, no. 9DA01423 )

• The interest rate of variable or reimbursable advances cannot be fixed at the

same rate as fixed term investments or as the interbank exchange rate (CAA

Lyon, 5 February 1997, n°94-427, société Montlaur Sakakini). The interest rate

charged to a subsidiary by a French entity must be comparable with the interest

rate the French entity would receive from a French bank for an investment

similar in terms and risk.


France


• From a practical point of view, the French tax authorities are departing from their traditional

stand-alone approach and require that the rating obtained for the borrowing entity be

aligned to the parent company or overall group rating

• This news position seems to be inspired by the GE decision in Canada

Decision of the Canadian Court : - GE Capital Canada could not have raised the necessary

funds at the low interest rates it benefited from without the

explicit guarantee from GE. The guarantee was necessary

in order for the subsidiary to run its business plan.

- Correct methodology : - Estimating a stand-alone or status-quo credit rating and

then analysing that credit rating for the effect on the

parent-subsidiary relationship

- Looking at the spread in corporate bond yields between

the parents credit rating of AAA and the estimated credit

rating of GE Capital Canada

- The parent-subsidiary relationship must be considered in

determining the credit rating of subsidiary, but that is not

reasonable to expect that implicit support would equalise

the subsidiary’s credit rating to that of its parents

Intra-Group Financing Cash-pooling


Cash-pooling entity should receive an arm’s length remuneration for the services

it provides to the cash pool members on the basis of a functional analysis

Transfer of a cash-pooling activity – Nestlé case :

France Switzerland

Parent company

Nestlé enterprises

Subsidiary

1

Subsidiary 2

Nestlé Finance

France

Treasury

function

activity

Transfer of Cash

pooling function

Nestlé group

Does a transfer of cash pooling activity

without consideration constitutes an

indirect transfer of earnings ?

Intra-Group Financing Loan guarantees are covered by the U.S. regulations for services


• Applies to Controlled Services Transactions (“CST”)

• Definition of CST:

• An “activity” that is performed by one controlled group member that results in “benefit” to

other members of the controlled group

• “Activity”-

• Performance of functions

• Assumptions of risks

• Use by a renderer of tangible or intangible property or other resources, capabilities or

knowledge

• Making available to the recipient any property or resources

• Comment: New definition is much broader than the prior regulations. Clearly applies to

loan guarantees, performance guarantees, insurance.

• However, not yet any guidance on how to calculate loan guarantee fees (future IRS project)

- various approaches available

• Query whether this definition impacts withholding taxes on loan guarantees

Management Fees Stewardship expenses in the U.S.A


• Activities that do not provide a benefit:

• Activities that recipient would not be willing to pay to uncontrolled party because benefits

are so indirect or remote

• Activities that would duplicate an activity of the recipient, unless an additional benefit

• Shareholder activities: if the sole effect of the activity is either to protect the renderer’s

investment or facilitate compliance with regulatory requirements of renderer

• Benefits from “passive association” (i.e., benefit results from the controlled taxpayer’s

status as a member of the controlled group)

• Twenty-one examples provided:

• Sub has Legal Dept. and Parent’s Legal Dept. also reviews transaction documents; Sub

has received a benefit since risks of transaction are reduced

• Parent’s Internal Audit Dept. reviews Sub’s adherence to policies and US anti-bribery

laws; activities are for Parent’s protection of investment and own compliance

Management Fees U.S. methods for services


• Methods to Determine Arm’s Length Amount:

1. Services Cost Method (SCM)

2. Comparable Uncontrolled Services Price Method (CUSP)

3. Gross Services Margin Method (GSM)

4. Cost of Services Plus Method (CSM)

5. Comparable Profits Method (CPM)

Note: This is the method we typically use for “total cost plus” arrangements

6. Profit Split Method (PSM)

7. Unspecified Methods

Management Fees SCM requirements in the U.S.A.

23

• The Business Judgment Test must be met

• Taxpayer must reasonably conclude in its business judgment that such services do not

contribute significantly to key competitive advantages, core capabilities, or fundamental risks of

renderer, recipient, or both; AND

• Services must qualify as “covered services”-

• Specified covered services – on a list provided by IRS (Announcement 2006-50 and Rev. Proc.

2007-13); OR

• Low margin covered services – median markup on total services costs is less than or equal to

7%; AND

• Not an excluded category of high value services (manufacturing; production; extraction,

exploration or processing of natural resources; construction; reselling, distribution, acting as a

sales or purchasing agent, or acting under a commission or other similar arrangement; research,

development, or experimentation; engineering or scientific; financial transactions, including

guarantees; and insurance or reinsurance); AND

• Taxpayer maintains documentation.

• Comment: G&A, marketing not excluded; some sales expenses probably OK, too, depending on

facts

18 September 2013

Management Fees SCM requirements in the U.S.A.


• Comment: Rev. Proc. 2007-13 provides a list of 101 qualifying activities, which cover

typical G&A type functions. Each major category of activities also includes “Other similar

activities.” Therefore, it is likely taxpayers will take the position that all activities within most

(if not all) G&A departments qualify for the SCM.

• Best practice suggestion: Transfer pricing documentation should link individuals or

departments with the appropriate item from the list of 101 activities.

• Comment: Rev. Proc. 2007-13 does not cover sales or marketing activities. Marketing

activities will likely qualify for the 7% or below median “low margin covered services”

category, assuming an appropriate marketing comparables set is developed by the

taxpayer. The IRS does not intend to maintain comparables sets for taxpayers.

• Comment: The IRS may take the view that sales activities are an excluded category of

high value services, and therefore do not qualify for the SCM.

• Comment: Is there an inference that a taxpayer’s mark-up for excluded, high value

service activities (e.g., R&D) should be more than 7%?

• Comment: Stock option expense must be included in the cost base. Either GAAP 123R

method or tax-based spread-at-exercise method may be used.

Management Fees Actual charging mechanism of a multinational enterprise – U.S.A.


Other Costs

IT P&C Costs

Other Costs

IT P&C Costs

SRZ Total

Costs

Master Recharge

Agreement

Master Recharge

Agreement

Recharge QuestionnaireRecharge Questionnaire

Pricing of Services

Cost Drivers

Unit Costs

Relevant Entities

Pricing of Services

Cost Drivers

Unit Costs

Relevant Entities

Invoicing/CollectionInvoicing/Collection

Input From Operations

Amendments

AB

A

B

Management Fees General principles - France


• OECD

According to the OECD guideline, when a company makes services available to its members,

it is necessary to determine whether the amount of the charge, if any, is in accordance with the

arm’s length principle.

• Section 57 of the FTC - transfer pricing rules

“To determine the income tax owed by companies that either depend on or control enterprises

outside France, any profits transferred to those enterprises indirectly via increases or decreases in

purchase or selling prices, or by any other means, shall be added back into the taxable income

shown in the companies’ account. The same procedure shall apply to company that depend on

enterprise or a group that also controls enterprises outside of France”

• Transfer pricing penalties

• Adjustment of the taxable profits for corporate income tax purposes

• Withholding tax (depends on the relevant tax treaty)

• The new 3% tax on dividend distributions

• Late interest payment of 4,8% a year and potentially bad faith penalties (40%) or fraud

penalties (80%)

Management Fees Allocation method


• To set out an allocation key for a service we take into account:

• The nature of the service

• The subsidiaries which benefited from this service

• A relevant indicator (turnover, assets, gross profit,..)

Once the key is determined, it must be :

• Steadily applied to subsidiaries;

• Justified to Tax Authorities in the occurrence of a tax audit

• Burden sharing between different group entities presents obvious practical problems which led

the French supreme court and the FTA to accept the use of lump sum methods.

• The least controversial method in this respect is the allocation of common charges by applying

the ratio existing between the turnovers (CE 25 avril 1960, 45089)

• Turnover as a common rule for all services can be questioned :

• Particularly true if the company does not have satisfactory supporting documentation to

justify the magnitude of services rendered

• Authorities can also question the relevance of certain services when the benefiting company

has in-house qualified resources (recent case law in domestic management fees framework

for directors)

Management Fees Case law - France


TA Montreuil, 5 Jan. 2012, no. 1001410, Office Dépôt France

Facts : a US company recharged to its French company a portion of audit costs relating to a report

meant to check the efficiency of internal control within the group in compliance with the Sarbannes-

Oxley legislation.

FTA & Judges positions : Such costs were incurred in the interest of the of the US company only and

were accordingly not tax deductible in France

CE, 21 Nov. 2012, no.348864 and 348865, PricewaterhouseCoopers

Expenses incurred for network development are deductible in France since the French company

benefits from its membership (according to the court the French company had a personal interest

because of the renowned network, training and technical assistance of the latter)

CAA Paris Eduard Kettner, 29 March 2012, n°10PA04193

Facts : a French distributor had been charged with services fees from its German parents company

FTA : these fees were not commensurate with the service received and were able to show

discrepancies in the invoicing and a lack of supporting information for expenses charged back to the

French distributor

Court : the FTA did not demonstrate a transfer of profit abroad because it did not make any

comparison with independent companies in order to show to which extent the fees paid for the

services were excessive and did not meet the arm’s length character

Management Fees Summary - France


Type of

Intra-group service

In the interest of the shareholder Excluded

In the interest of the Group as a whole

Indirect allocation?

Cost Plus ?

CUP ?

TNMM ?

In the interest of specific members of the Group ("on call services")

Direct charge ?

CUP ?

Cost plus ?

Transfer of intangible

(e.g. know-how) Royalty?

Management Fees General Principles – Canada


• CRA generally follows OECD Commentary

• See: Part 6, Information Circular IC 87 – 2R

• Two Part Test

• Is any charge justified – must have a benefit for recipient of service.

• If charge is justified, charge should be determined in accordance with arm’s

length principle (from point of view of both the supplier and the recipient)

• Note: Acting as agent vs. providing services directly

• Direct charge method vs. Indirect charge method.

Management Fees Issues Related to Management Fees - Canada


• Mark-up applied to the costs

• Charge all management fees

• Do not use “ball-park” numbers or percentage of charges based on

revenue unless supportable

• Reg 105 – 15% federal withholding (+ 9% Quebec) if services rendered

in Canada by a non- resident. (Different requirements if non-resident

employees rendering services in Canada).

Summary


• Parent companies or regional headquarters provide administrative or

other general services for members of the Group.

• Even when such services are charged at cost or at cost plus a small

mark-up, questions may arise as to whether the level of the overhead

charge is appropriate to the size of the subsidiary.

• Intercompany services can be difficult to value and are very often not

fully documented.

• As services are growing in general, the transfer pricing aspects of

intercompany services, including intercompany financial services, are

increasingly complex and the documentation aspects are not

standardized yet.

• Management fees and financial instruments are viewed as a key transfer

pricing risk by the CRA, the OECD and the IRS.

Thank you

© 2013 Dentons

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