A World in Transition. Managing the Transfer Pricing Implications of Complex Supply Chains

29 August 2011

KPMG ROMÂNIA S.R.L.

Transfer pricing issues involving corporate supply chains have become increasingly complex and controversial in recent years. Part of this increase is business-driven – there is growing international specialization. In the late 1990s, a typical supply chain might have included manufacturing, distribution and a centralized intangible holding company. But in 2011, that supply chain has grown to add procurement companies, a centralized financing function, contract research and development (R&D) centers, and services centers; split manufacturing functions among multiple legal entities; and moved from traditional distribution to internet sales. Managing the transfer pricing implications of such complex supply chains – a challenge under the best of circumstances – has been further complicated by the growing focus of tax authorities on transfer pricing in an effort to make sure that they are able to tax an appropriate share of corporate income.

This publication focuses on three discrete types of supply chain issues. Section I discusses the implications of the new Organisation for Economic Co-operation and Development (OECD) Guidelines on business restructuring and is divided into the following sections:

• an overview of new Chapter IX of the OECD’s Transfer Pricing Guidelines for Multinational Enterprises
• specific country perspectives on business restructuring concepts
• a short discussion of the new OECD project on intangibles.

In reading the various articles, it is worth focusing on several issues.

• The OECD Guidelines on business restructuring effectively treat a wide range of non-tax business decisions as transfer pricing issues. What steps does a corporate tax department have to take to (i) identify when a business restructuring will be treated as a transfer pricing event and (ii) prevent “foot faults” that may lead to large transfer pricing challenges?

• The OECD Guidelines explicitly did not address the relationship between business restructuring and local tax rules. However, these relationships are often important. On the positive side, certain issues that were viewed as local law and therefore not eligible for competent authority relief are now characterized as transfer pricing issues, and therefore presumably are covered by double tax protection. On the other hand, some business restructuring payments may trigger immediate revenue recognition in one jurisdiction but may be treated as a capital cost that is deductible only over a number of years in the other jurisdiction.

• The OECD Guidelines are based on an economic model of business decision-making in which the decision-maker is located at a specific legal entity. This often does not reflect the business reality of many corporate entities, where the decision-making is “virtual” in that it reflects the input and decisions of a group that spans a number of legal entities.

Section 2 focuses on a few selected issues that arise in the supply chains of many multinational enterprise (MNE) supply chains. The topics we have selected to cover are ones that KPMG’s Global Transfer Pricing practice has found to be of immediate interest to many MNEs.

• The views expressed by the Chinese tax authorities in a recent training session on automotive industry transfer pricing issues. While this article focuses on the automotive industry, many of the issues that are raised apply equally to other industries.

• New developments in the relationship between customs and transfer pricing regulations. This issue is especially important in Asia as many countries have high duty rates, leading to significant potential costs where companies are required to report different prices for transfer pricing and customs tax purposes.

• Issues associated with the use of procurement companies. The MNE supply chain typically includes third-party as well as related suppliers, and many companies have set up specialized procurement companies to manage their dealings with such third-party suppliers. The question of whether such procurement companies should be paid based on the value that they bring to the organization or the costs that they incur (excluding the cost of the materials that they purchase) has been a frequent source of controversy between taxpayers and tax authorities.

• Location savings. Do the cost savings associated with using low-cost sources of supply lead to higher profits, and if so, which entity is entitled to such profits?

Section 3 discusses controversy – what options do taxpayers have in resolving inevitable conflicts with tax authorities? This part of the report starts with a look at the controversy landscape in India, a key country that houses the IT and back-office services of many MNE supply chains and that has what many taxpayers view as an extremely aggressive approach to transfer pricing. The section continues with a discussion of the rapid increase in the use of advance pricing agreements (APA) in Asia and the development of two new tools to help taxpayers resolve controversy – accelerated competent authority procedures (ACAP) and binding arbitration. The section closes with a discussion of two court cases that have significant implications for supply chain management and restructuring – the GE Capital case in Canada dealing with intercompany loan guarantees and the Veritas Software case in the US dealing with the issue of what has to be paid for when intangibles are migrated.

 

Section 1 | Business Restructuring

OVERVIEW OF THE NEW OECD GUIDELINES

Business restructuring is not a new issue – a number of tax authorities (e.g. in Canada, the Netherlands, Denmark, France, and Germany) have not only sought payments for explicit transfers of intangibles, they have also have sought to impose “exit charges” when domestic businesses either close down or downsize. Such charges can be implemented by requiring an explicit payment from the legal entity that initiated and/or benefited from the restructuring, or, as in Spain and Belgium, by simply disallowing deductions for closure costs under domestic tax law.

On July 22, 2010, the Organisation for Economic Co-operation and Development (OECD) broadened the scope of its Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines) nd formally incorporated business restructuring issues with the release of “Chapter IX: Report on the Transfer Pricing Aspects of Business Restructuring.” This new chapter broadly defines business restructuring to include: “… the cross-border re-deployment by a multinational enterprise of functions, assets and/or risks.” In essence, a business restructuring can involve almost any substantive change in a business relationship, including:

• a change in the nature or scope of transactions among controlled entities
• a shift in the allocation of risks
• a change in responsibility for specific functions
• termination of the relationship.

1

2

3

4

5

6

The tricky lag LUCIAN CROITORU Adviser to the Governor - BANCA NAŢIONALĂ A ROMÂNIEI Lucian Croitoru, Adviser on monetary policy issues to the National Bank of Romania Governor, talks about the NBR’s next moves and explains why the decrease ofthe policy rate hasn’t been reflected into lower interest rates on bank loans. mai mult... The turnaround CRISTIAN SPORIS Secretar de Stat - MINISTERUL ECONOMIEI ŞI FINANŢELOR Cristian Sporis, Secretary of State at the Ministry of Public Finance, in charge with the national treasury and public debt, explains how the state managed to borrow money at the lowest costs in the last seven years and how it turned from a clear market taker into a player with a strong position on the market. mai mult...