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Transfer Pricing Case studies Workshop SAN Jose 31 March - 4 APRIL 2014. 6. Intra-Group S ervices and CCAs.

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transfer pricing case studies workshop san jose 31 march 4 april 2014

Transfer Pricing Case studies WorkshopSAN Jose 31 March - 4 APRIL 2014

6. Intra-Group Services and CCAs

OECD freely authorises the use of this material for non-commercial purposes. All requests for commercial uses of this material or for translation rights should be submitted to rights@oecd.org.

The opinions expressed and arguments employed herein are those of the author and do not necessarily reflect the official views of the OECD or of the governments of its member countries.

slide2

Types of intra-group services

  • All business entities require administrative, technical, financial and other commercial services
    • Management, co-ordination and control functions for the whole group may also be needed
  • Such services may be provided by another entity within an MNE group, or
  • An entity may perform the services itself (in-house), or
  • An entity may acquire services from an independent party
types of intra group services
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)
typical arrangements
Typical Arrangements
  • Parental service arrangements
  • Centralised service companies
  • Cost contribution/sharing arrangements
parental services
Parentalservices
  • Provided by the parent company – often on cost recovery basis, i.e. with no profit element.
  • Examples are:
      • Group finance
      • Group tax
      • Legal
parental services1
Parentalservices

Provision of services

Management fees

centralised services
Centralisedservices
  • 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
centralised services1
Centralised services

Provision of services

Management fee

cost contribution sharing 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
cost contribution sharing arrangements1
Cost contribution/sharing arrangements

Provision of services

Allocation of costs

key issues
Key issues
  • Has an intra-group service has been rendered?
    • Benefit test
    • Shareholder activities?
    • Duplication?
    • Incidental benefits
  • If so, what is the arm’s length price for the services?
benefit test
Benefit test
  • Activity performed must provide to the recipient with economic or commercial value to 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
rendering of intra group services
Rendering of intra-group services
  • Existence of an actual payment is useful, but does not prove that the service has been actually rendered
  • Description as a “management fee” is not prima facie evidence of management services
  • Absence of payment does not necessarily mean that no services have been rendered
  • Consider what an independent party would pay, and what an independent party would charge
not services
Not services
  • Activities not constituting services:
shareholder activities
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
duplicative 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.
incidental benefits passive association
Incidental benefits / Passive association
  • 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.
  • Examples in TPG para. 7.12 - 7.13
special considerations
Special considerations
  • On call services
    • Frequency of use?
    • 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
the arm s length price
The arm’s length price
  • Arm’s Length Price Setting

Minimum price acceptable for provider

Maximum price acceptable for recipient

Range of

AL prices

the arm s length price1
The arm’s length price
  • Transfer pricing methods most commonly used for services:
    • Comparable Uncontrolled Price (CUP)
    • Cost Plus
    • Combination of methods or TNMM
slide24
CUP
  • Preferable when:
    • There is a comparable service provided between independent enterprises in recipient’s market
    • 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!
allocation of costs
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
  • Direct and indirect allocation
direct cost allocation
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 department provided for a specific market or region
indirect cost allocation
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(s)
  • 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 with actual or expected benefit
cost allocation keys
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.

the arm s length price2
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 a comparable enterprise pay for the service?
cost plus
Cost plus
  • Applicable in the absence of a CUP where activities, assets and risks are comparable
  • Cost base is very important
  • Mark-up: special considerations
cost plus mark up
Cost plus mark-up?
  • Normally mark-up (comparison with 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
cost contribution arrangements
Cost Contribution Arrangements
  • Framework agreed among 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
participants shares
Participants’ Shares
  • In a CCA, each participant’s share of contributions to the arrangement will be consistent with their share of expected benefits.
  • Each participant would be entitled to exploit their interest, without paying a royalty or other consideration.

Joint development of an intangible and associated product

A typical CCA

cca an illustration
CCA: an illustration

Participant

Contributions Benefits

CCA

Contributions

Contributions

Benefits

Benefits

Participant

Participant

slide35

Cost Contribution Arrangements

  • Resource and skills are pooled and the consideration is the reasonable expectation of mutual benefit
  • Benefits may be
    • known in advance or uncertain
    • immediate (e.g. services) or expected over a longer term (e.g. R&D)
types of cost contribution arrangements
Types of Cost Contribution Arrangements
  • Joint development of intangibles – each participant receives a right to exploit the resulting intangible property
    • 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
applying arm s length principle
Applying Arm’s Length Principle
  • The expectation of mutual benefit is fundamental to the acceptance by independent enterprises of an arrangement for pooling resource and skills without separate compensation
  • Each party’s contribution is determined by the expected benefits
  • Benefits are expected, but the CCA may not be successful
is the allocation appropriate
Is the allocation appropriate?
  • Estimating the share of benefits expected to be obtained by each participant, and allocating contributions in the same proportions. For instance:
    • Based on the anticipated additional income generated or costs saved by each participant.
    • Using the price charged in sales of comparable assets and services.
    • Using an allocation key or a combination of allocation keys (sales; units used, produced or sold; gross or operating profit; the number of employees; capital invested; etc.)
balancing payments
Balancing payments
  • A participant may be required to make a payment to other participants to adjust its 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
entry withdrawal and termination
Entry, withdrawal, and termination
  • A new participant to an existing CCA might obtain an interest in the results of prior CCA activity: any transfer of pre-existing rights from existing participants to a new entrant must be compensated  a buy-in payment.
  • A participant who leaves a CCA may dispose of its interest in the results of past CCA activity a buy-out payment.
  • When a CCA terminates, each participant should receive a beneficial interest in the results of the CCA activity.
what if a cca is not arm s length
What if a CCA is not arm’s length?
  • When the consideration received / paid by a participant is inadequate, or excessive…
    • The arm’s length principle requires an adjustment (often through a balancing payment)
    • In some cases, part or all of the terms of a CCA may be disregarded if commercially the substance (reality) differs from the form
arm s length structuring of ccas
Arm’s length structuring of CCAs

a) Participants include only enterprises expected to derive benefit from the CCA activity

b) Arrangement specifies the nature and extent of each participant’s beneficial interest.

c) No payment other than CCA contributions, balancing & buy-in payments made for the beneficial interest.

d) Proportionate shares of contributions determined in a proper manner.

e) Arrangement allows for balancing payments or for the allocation of contributions to be changed prospectively.

f) Adjustment made as necessary upon entrance, withdrawal and termination of the CCA.

cca vs intra group services
CCA vs. Intra-group services

CCAs on services not creating IP

Agreement to share costs, risks and benefits where all participants contribute in cash or in kind.

Intra-group services

Limited to the provision or acquisition of a service by members of the MNE Group. The risk of not successfully and efficiently providing the service is generally borne solely by the service provider.

Terminating or extending the service agreement to other participants has generally no implication on other service recipients.

If participants join or leave a CCA, shares should be adjusted or rebalanced in accordance with the arm’s length principle.

cca vs intra group services1
CCA vs. Intra-group services

CCAs on services not creating IP

As all participants are contributing to a common activity and share costs and the contributions reflect the expected benefits; contributions are usually valued at cost.

Intra-group services

The profit element charged by the provider of the service is usually a key element as the provider will not share profits with the recipients.

The allocation of the costs is based on the expected benefits for each participant from the CCA.

The allocation key is based on the extent each company has requested / received or is entitled to the service.