Taxation of Large Companies:
Transfer Pricing
Hilton Trinidad & Conference Center,
Port of Spain, Trinidad and Tobago
June 12, 2014
© Ednaldo Silva, Ph.D.
[email protected]
Sponsors:
The content of these slides is not for public distribution and may not be copied or distributed without the Author’s permission. All Copyrights Reserved.
Agenda
1)
Information for the identification of comparables in the Caribbean;
1)
Opportunities offered by commercial databases to countries that implement
transfer pricing rules and controls;
1)
Product strengths and weaknesses, and advantages to the Caribbean countries;
1)
Main experiences in Latin-America and the Caribbean.
2
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Purpose of Transfer Pricing Audit
For tax administrations, transfer pricing audits serve to:
1)Ensure tax parity between controlled and uncontrolled taxpayers;
2)Ensure that taxpayers report “true” (arm’s length) taxable income;
3)Prevent tax base erosion and profit shifting. See BEPS Action Plan:
http://www.oecd.org/ctp/BEPSActionPlan.pdf;
A well constructed and applied transfer pricing policy may reduce the gap of tax to
GDP ratio between LAC and OECD countries. See http://www.oecdilibrary.org/taxation/revenue-statistics-in-latin-america-2014_9789264207943-en-fr
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Databases for Audit Screening
Company financials and “material contract” (agreement) databases can be used for
audit screening. An audit screen principle is that a controlled taxpayer cannot hide
in the distribution tails of the Operating Profit Margin (“OPM”), Operating Profit
Markup (“Markup”) or royalty rates of uncontrolled taxpayers. Considering OPM
as an example, audit screen techniques to identify potential transfer pricing
violations can be established as follows:
(1)Calculate the OPM of uncontrolled companies with positive revenue and positive
operating profit in the industry of the taxpayer;
(2)Calculate Tukey’s low outlier limit using the formula Q1 − 1.5 × IQR, where the
IQR is Q3 − Q1;
(3)If an inbound taxpayer has an OPM lower than Tukey’s low outlier limit of
uncontrolled companies, the taxpayer should be subject to further audit scrutiny.
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Databases to Support TP Adjustments
In addition to audit screening, company and agreement databases can be used to
support tax adjustments. Taxpayers identified for further audit scrutiny may be
subject to the following transfer pricing analysis:
1)Identify transfer pricing issues by testing potential violations of the arm’s length
principle. Potential violations may reflect:
a) Mispricing in COGS (excess purchases);
b) Excess expenses in OPEX (management fees, royalties, advertising);
c) Net Operating Losses (NOL) carried forward from prior transfer pricing
violations.
1)Find comparables to the taxpayer (tested party) with respect to the property
transferred, functions performed (industry), and geographic market (country or
region).
1)Use the selected comparables to determine an arm’s length range of OPM,
Markup or royalty rates. Else, use a specified OPM safe harbor.
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5
Databases Used to Compute Statistical Intervals
The OECD Transfer Pricing Guidelines (“OECD Guidelines”) and the U.S.
Treasury Regulations (“Treas. Reg.”) § 482 state that the IQR provides an
acceptable measure of the arm’s length range. However, a different statistical
interval may be used if it provides a more reliable measure of the arm’s length
range. See OECD Guidelines, ¶ 3.57 and Treas. Reg. § 1.485-1(e)(2)(iii)(B).
The IQR is adopted by several tax authorities innocent of the fact that it is wider
than other statistical intervals. As a result, the arm’s length range defined by the
IQR maybe impractical.
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6
Transfer Pricing Workflow
Local
comparables?
Yes
No
(a) Use regional comparables (e.g., PanEuropean, Pan-Asian)
(b) Use comparables from leading trade
partners (e.g., U.S. distributors)
(c) Use safe harbors (e.g., OPM ≥ 3%)
(d) Use industry statistics (IRS practice
prior to 1994 Treas. Reg. § 482)
Determine a range of arm’s
length consideration
(OPM, Markup,
royalty rates)
Report results
(Contemporaneous
documentation)
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Information for the Identification of
Comparables in the Caribbean
1)
Databases to benchmark transfer of tangible goods and services:
a) Standard & Poor’s Capital IQ Compustat;
b) Mergent (ex Moody’s).
2)
Databases to benchmark transfer of intangibles and mineral resources:
RoyaltyStat (proprietary database of royalty rates and license agreements)
Databases of privately held company financials are not a good solution for
the lack of local comparables, because inter alia they include
heterogeneous accounting standards, and the elements constituting basic
accounting items (net sales, operating expenses, operating profits)
cannot be verified due to the absence of annual reports accompanied by
accounting footnotes.
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8
Database Usage by the IRS
For the majority of the APAs executed in 2012 and 2013, the data source for
comparables was Standard & Poor’s Compustat database. See U.S. APA Statutory
Report on March, 2014 available at http://www.irs.gov/pub/irs-drop/a-13-17.pdf;
and http://www.irs.gov/pub/irs-drop/a-14-14.pdf
Previous APA Statutory Reports provided the database usage per number of APAs
completed in a particular year:
Year
Compustat Global
(including North
America and Global
Vantage)
Compact
Disclosure
and
Worldscope
Mergent
(ex Moody’s)
Amadeus
Orbis
2011
57
21
15
4
≤3
2010
79
28
15
5
≤3
2009
64
24
9
≤3
≤3
2008
101
40
14
≤3
2007
101
40
14
≤3
Source: http://www.irs.gov/Businesses/Corporations/Annual-APA-Statutory-Reports
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Local Comparables?
RoyaltyStat/Compustat database was searched for companies with net sales > 0 and
operating profit > 0 in FYE 2012:
Country
Manufacturers
Distributors
of Durable
Goods
Distributors of
Non-Durable
Goods
Business
Services
Professional
Services
Caribbean
233
11
11
62
3
Canada
166
15
10
37
7
Mexico
39
0
2
0
0
1,194
74
62
349
50
United States
Caribbean includes Antigua, Bahamas, Barbados, British Virgin Islands, Cayman Islands, Curacao,
Dominican Republic, Jamaica, Montserrat, Puerto Rico, Trinidad & Tobago.
Business Services include advertising, equipment rental, and computer programing.
Professional services include engineering, accounting, research and management.
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10
Opportunities Offered by Commercial Databases to
Countries that Implement Transfer Pricing
RoyaltyStat includes tools useful for tax authorities to audit transfer pricing issues:
1) Audit screening: RoyaltyStat provides industry statistics (including the IQR) to
identify the distribution of OPM, Markup and royalty rates of uncontrolled
taxpayers;
2) Review of taxpayer documentation: RoyaltyStat provides information to benchmark
transactions involving tangible goods (distribution and manufacturing), services, and
intangible property, including financial information from companies worldwide, and
license agreement with disclosed royalty rates;
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11
Opportunities Offered by Commercial Databases to
Countries that Implement Transfer Pricing
3)
Determination of arm’s length rage: RoyaltyStat provides on-the-fly statistical
intervals in addition to the IQR, including Tukey’s notches, and confidence
intervals for the median and for the average, enabling the selection of the most
reliable measure of the arm’s length range;
3)
Tax adjustments: RoyaltyStat/Compustat’s company financials database allows
the calculation of several adjustments, including for working capital, intangibles
and operating assets. The analytical tools also allow on-the-fly examination of
the factors influencing the behavior of profit elements and royalty rates;
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Opportunities Offered by Commercial Databases to
Countries that Implement Transfer Pricing
5)
Preparation of transfer pricing documentation: RoyaltyStat’s team of experts is
qualified to perform on site training for tax authorities on issues related to
transfer pricing;
6)
Settlement negotiation: RoyaltyStat has experience in negotiating transfer pricing
cases with taxpayers and tax authorities involving several countries, and
provides support for alternative dispute resolution, including expert testimony.
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13
Benefits and Solutions of RoyaltyStat
RoyaltyStat offers three premier online databases to support transfer pricing analysis
involving the transfer of tangible goods, the provision of services, and the transfer
(sale or license) of intangibles:
1)
Proprietary license agreements database, including 16,500 full-text agreements
with a disclosed royalty rate. Relevant information is extracted and normalized;
1)
Global company financials database licensed from S&P Capital IQ Compustat
including over 45,800 worldwide companies, and enhanced with our proprietary
transfer pricing tools;
1)
Annual reports database, with over 500,000 current and historical annual
reports from publicly traded companies worldwide.
The three databases are updated every business day.
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Benefits and Solutions of RoyaltyStat
In addition to content, the three databases have a uniform and user-friendly
architecture, designed to search and select comparables, determine an arm’s length
range of consideration, and perform sensitivity analysis. RoyaltyStat’s comparative
advantages:
1)Powerful online search engine to find comparable companies or agreements,
including more search operators than available in Microsoft SQL Server;
1)Description of license agreements and the business of companies can be
translated from English to French, Portuguese, Spanish and six other languages;
1)Charts and tools to determine statistical ranges of consideration (including the
IQR) and diagnose the comparable data (e.g., measure the effect of company size on
profitability);
1)Online and onsite training, and customized research assistance in English, French,
Portuguese, and Spanish.
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Advantages to the Caribbean
1)
Knowledgeable: RoyaltyStat’s team has over 20 years of experience with
transfer pricing in various jurisdictions worldwide;
1)
Flexible: RoyaltyStat has flexibility to travel to tax authorities and clients
locations, and to accommodate specific tax or legal requirements from each
country;
2)
Affordability: database can be accessed through different subscription options,
depending on data requirements.
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Experience in Latin America & Caribbean
1)
Customized database: RoyaltyStat has capabilities to develop specialty databases
or extract information according to specific requirements;
1)
Database training: RoyaltyStat does online and onsite training and provides
technical assistance in designing search strategies and using available statistical
tools for transfer pricing;
1)
Transfer pricing training, including personalized workshops for tax authorities
in Mexico (SAT), Ecuador (SRT), Peru (SUNAT), Dominican Republic (DGII),
Panama (DGI), and Argentina (AFIP);
1)
Consulting on transfer pricing cases involving the United States and Mexico;
1)
Major accounting, consulting and law firms in Latin America use RoyaltyStat.
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Please send questions and comments to
Ednaldo Silva, Ph.D.
[email protected]
+1 (202) 468-3102
The content of these slides is not for public distribution and may not be copied or distributed without the Author’s permission. All Copyrights Reserved.
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