Transfer Pricing Alert - EY - United States · the FTS and the taxpayer to conclude a unilateral...

Transfer Pricing AlertEY Han Young newsletterSeptember 2017

Transfer Pricing Alert September 2017

Transfer PricingCurrent issue.Russia, Vietnam, China, India


TP Current Issues

Russia issues draft Procedure on multilateral APAs

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Executive summary

On 3 March 2017, the Russian Finance Ministry published a draft Procedure outlining the process for handling multilateral Advanced Pricing Agreements (APAs). Although such APAs are technically allowed for any large taxpayer since 2012, to date the Rus-sian tax authorities have signed only unilateral APAs.

Detailed discussion

The Russian Finance Ministry has entrusted the Federal Tax Service (FTS) with the right to negotiate bilateral or multilateral APAs, and the FTS will carry out a mutual agree-ment procedures with competent authorities of the tax treaty partner countries.

Procedures of the bilateral APA process

(1) Preliminary discussion with the FTS

This stage is generally informal and optional. The results of the preliminary discus-sion are not binding on the taxpayer or on the FTS. Whatever the outcome of the preliminary discussion, the taxpayer may still apply to the FTS for the conclusion of an APA in relation to foreign trade transactions.

(2) Formal Application

The Procedure contains the recommended form of an APA application and a list of documents required to initiate the APA process. The list of documents is open but should include, among others, a draft of the APA wording, whereby the Ministry has suggested a possible APA structure as a guidance. It follows therefore that the taxpayer must, inter alia:

• Demonstrate the application of the suggested transfer pricing methodology by reference to the last three years and by reference to periods to be covered by the APA (based on available forecast data)

• Specify critical assumptions for the purposes of an APA

Under the Procedure, a formal APA application should be submitted in both ju-risdictions in order for the FTS to commence communication with the competent authority of the other state. All documents (information) submitted to the foreign competent authority must also be presented to the FTS.

(3) FTS consideration of the taxpayer’s application

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The FTS will consider the application from the standpoint of whether:

• The proposed transfer pricing methodology meets the arm’s length stand-ard as outlined by the Russian Tax Code

• The proposed pricing methodology enables the elimination of double taxa-tion

• TIntheabsenceofanAPA,thereareuncertaintiesorsignificanttechnicalissues related to the pricing approach

• TA transaction is of a long term nature

• Thereisthepossibilityofanunjustifiedtaxbenefitasaresultofthetransac-tion

In addition, the FTS can conduct mutual consultations with the taxpayer and the foreign competent authorities on matters relating to the conclusion of the APA.

(4) Negotiations between competent authorities

An important stage in the process of the conclusion of a pricing agreement is the conduct of negotiations between the FTS and the foreign competent authori-ty, which may result in a mutual agreement between them. A copy of the mutual agreement itself is not made available to the taxpayer, but is used as a basis for signing an APA with the taxpayer at a later stage in the process. . If a mutual agree-ment cannot be reached with the foreign competent authority, it is still possible for the FTS and the taxpayer to conclude a unilateral APA, without the involvement of the foreign competent authority.

(5) Implementation of the mutual agreement of the competent authorities

If a mutual agreement is reached between the FTS and the foreign competent au-thority, the FTS will suggest to the taxpayer the conclusion of an APA on the terms agreed to in the mutual agreement or to amend the draft APA in order to comply with the mutual agreement. If the taxpayer agrees, an APA will be concluded.

Implications

For the Procedure to be effective in practice, there are a number of important issues to still be addressed. One example is the arm’s length standard which is to be followed by the FTS in its negotiations with the foreign competent authority and whether the standard will be set by reference to the Russian Tax Code (as currently stands in the Procedure) or the OECD Transfer Pricing Guidelines (which may be a preferred scenario enabling some consensus).

The timing of the bilateral/multilateral APA process may also be very relevant to the practical implication of the Procedure since, based on worldwide APA practices, the cur-rent timing set for APAs in the Russian Tax Code (up to nine months for internal review bythetaxauthority)isunlikelytobesufficientforthebilateralormultilateralprocess.It

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TP Current Issues

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is possible that resolving some of these issues may require amendments to the Russian Tax Code.

Russia


TP Current Issues

Vietnam issues new transfer pricing decree effective 1 May 2017

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Executive summary

On 24 February 2017, Vietnam’s Government issued Decree No. 20/2017/ND-CP on the tax administration of enterprises with related party transactions (the Decree). The Decree is effective from 1 May 2017.

Detailed discussion

Related party relationships and transactions

The Decree expands and covers more detailed types of related party transactions sub-jecttoTPcompliance,includingspecificallytheuseofcommonresourcessuchasgroupsynergies, a shared service center and cost sharing between related parties.

The Decree increases the 20% direct or indirect ownership threshold to 25% when deter-mining whether parties are related. In addition, enterprises are also related if they are under the common control of an individual through that person’s contributed capital or direct management.

TheDecreeremovesspecificpercentagesindeterminingacontrolelement;however,where a company is in substance controlled or managed by the other party, the parties will generally be considered related for TP purposes.

Three-tiered TP documentation and annual TP disclosure

The Decree introduces three-tiered TP documentation requirements in line with the Or-ganizationforEconomicCo-operationandDevelopment’sBaseErosionandProfitShift-ing Action Plan 13 covering:

• Groupbusinessinformation(orGlobalMasterfile)

• LocalTPdocumentation(orLocalfile)

• ReportonthetransactionalprofitabilityresultsintheformofaCountry-by-Country(CbC) Report

The Decree requires taxpayers to prepare their TP documentation before the submis-sion of their annual corporate income tax (CIT) return. Given that CIT returns are due within 90 days of the taxpayer’s year-end, preparation of the TP documentation require-ments will become extremely challenging.

In addition, taxpayers must submit their TP documentation to the tax authorities within 15 working days upon request during a tax/TP audit, reducing the period from the cur-

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TP Current Issues

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rent30workingdays;accordingly,itiscrucialthattaxpayershavetheirTPdocumenta-tioncompletedpriortoreceivingnotificationofataxaudit.

The revised TP Disclosure Form has some additional information requirements including the quantum of reimbursements and the allocated revenue/expenses to a permanent establishment as well as further detail on the arm’s length pricing breakdowns based on the income statement.

AVietnamesetaxpayerisrequiredtofileCbCRinformationifithasanoverseasparentand the ultimate parent company overseas is required to prepare and maintain such report in its country of residence. Where a taxpayer has its ultimate parent in Vietnam and has global consolidated revenue in the tax period of VND18,000 billion or more (US$789 million or more), it is also required to prepare this report.

Inparticular,thecontentofaCbCreportincludesidentificationdetailsandinformationon the main business activities/functions of all subsidiaries in the group, along with key financialandtaxindicatorsofaninternationalgroup(suchasrevenue,profit,taxespay-able, number of employees, amount of registered capital and tangible assets) for each jurisdiction in which an international group operates.

TP Compliance Exemption

The following exemptions are provided to a taxpayer that:

• Has sales revenue of less than VND50 billion (US$2.5 million) and the value of its related party transactions is less than VND30 billion (US$1.5 million).

• Engages in simple functions, has revenue of less than VND200 billion (US$100 mil-lion) and achieves a ratio of earnings before interest and taxes to revenue of at least 5%fordistributionfunction;10%formanufacturingfunction;and15%forprocessingfunction).

• Has signed an Advance Pricing Agreement (APA) and submitted annual APA re-port(s).

In addition, a partial exemption is available if:

• The taxpayer only has transactions with related parties who are subject to CIT in Vietnam.

• The taxpayer and its related parties apply the same CIT rate and enjoy no CIT incen-tives.

Substance over Form Principle

The Decree introduces the “substance over form” principle for deductibility of related party services and interest expense. Under the Decree, the following requirements and conditionsmustbesatisfiedforinter-groupserviceexpensetobedeductible:

• Servicesprovidedmustbedirectlybeneficialtothebusinessoperationofthetaxpay-er

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• Services from related parties are determined to “have been provided” only if inde-pendent companies under similar circumstances pay for such services

• Service fees are paid at arms’ length, the TP method or allocation keys are consist-ently applied among the group members and the taxpayer provides documents to substantiate the receipt of services

The maximum total deductible interest expenses paid to related parties in a tax period is capped at 20% of earnings before interest, taxes, depreciation and amortization.

Application of TP Methods

The Decree provides guidance on the application of TP methods as follows:

• Application of the Comparable Uncontrolled Price Method and supporting documents arerequiredforfixedassetpurchasetransactions

• Direct costs and total costs are distinguished as different cost bases for the applica-tionoftheCostPlusMethodandComparableProfitMethod(CPM)respectively

• In applying the CPM, a taxpayer with simple functions, low added-value transactions and non-strategic decisions must not incur losses

Benchmarking analysis and TP adjustments

The following guidance applies to comparability analysis and TP adjustments:

• Comparablefinancialdataisgenerallyrequiredtobeinthesamefinancialyearasthat of the tested party

• Hierarchy for the selection of comparable transactions/companies is stipulated

• Comparability analysis of intangible assets with unique characteristics is provided

• Materialadjustmentsmusttakeintoaccountthelocation-specificadvantages

• Conditions for the use of the median of the interquartile range

• Limitation on taxpayer’s use of TP adjustments

Implications

The newly introduced three-tiered TP documentation requirement carries a heavy administrative burden for Vietnamese-based subsidiaries. In addition, taxpayers may expect a more aggressive TP enforcement environment in Vietnam. A Circular that provides more detailed guidance and instruction on the Decree will be expected to be issued later this year

Vietnam


TP Current Issues

China issues updated transfer pricing and Mutual Agreement Procedure rules

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Executive summary

On 1 April 2017, China’s State Administration of Taxation (SAT) issued SAT Bulle-tin Gonggao [2017] No. 6 (Bulletin 6) providing new transfer pricing guidance and strengthening the Mutual Agreement Procedure (MAP) process. Bulletin 6 is effective 1 May 2017. Bulletin 6 strengthens MAP procedures in advance of peer reviews and enhances alignment of China’s transfer pricing rules with the Organisation for Economic Co-operation and Development (OECD) standards.

Detailed discussion

MAP Process

Pursuant to Bulletin 6, taxpayers should apply directly to the SAT if they wish to invoke the MAP for their transfer pricing cases. Taxpayers with ongoing special tax investi-gations or those who have not paid taxes assessed in an investigation may be denied access to MAP.

DEMPEP analysis requirements for intangible asset transactions and guidance for royalties transactions

Bulletin6containsthefivefunctionsunderOECDGuidelinesthatarerelevantindeter-miningtheallocationofprofitsfromuseofintangibleproperty.Thesearedevelopment,enhancement, maintenance, protection and exploitation (DEMPE functions). Bulletin 6 adds promotion as a sixth function (i.e., DEMPEP functions), demonstrating the impor-tance China places on value created through marketing activities undertaken by Chi-nese companies.

In addition, Bulletin 6 provides guidance as to how Chinese tax authorities should review intercompany royalties. Tax inspectors are advised to pay particular attention to wheth-er: (i) the value of the licensed intangibles has declined since the royalty was initially established;(ii)priceadjustmentclausesarecommonlyfoundinthirdpartycontractsintheindustry;(iii)functionsaswellasassetsandriskshavechanged;and(iv)thelicenseehas performed DEMPEP functions for which it has not been reasonably compensated.

Inaddition,Bulletin6incorporatestwoprovisionsthatreflectBaseErosionandProfitShifting guidance: (1) an entity that merely funds intangible development activities but does not perform any DEMPEP functions should only be entitled to earn a reasonable financingreturn;and(2)anentitythatownsmerelegalownershipbutdoesnotcontrolfinancingfunctionsorrisksshouldnotbeentitledtoanyintangible-relatedprofits.

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TP Current Issues

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Intercompany services transactions

Bulletin6followstheinternationallyacceptedandOECDsanctionedbenefittest.Bulletin 6 also incorporates a provision that empowers tax authorities to disallow adeductionforservicefeespaidtoarelatedpartythatdoesnothavesignificantsubstance.

Location specific advantages (LSA)

Bulletin 6 provides that LSA adjustments are only required if the comparables operate in different economic conditions. In addition, Bulletin 6 recognizes that the existence of LSAs is a comparability factor for transfer pricing analysis and that LSAs are not themselves intangible property.

Transfer pricing methods

Bulletin6isconsistentwiththeOECDGuidelineswithrespecttospecifiedtrans-fer pricing methods. Bulletin 6 provides for the comparable uncontrolled price method, the resale price method, the cost plus method, the transactional net marginmethod(TNMM)andtheprofitsplitmethod(PSM).Inaddition,Bulletin6allows for use of “other methods” where appropriate.

Bulletin 6 provides that a TNMM is generally not appropriate in transactions wherethetestedpartyhassignificantintangibleassets.Inaddition,wheretheChinesetaxpayerundertakessignificantDEMPEPfunctions,includingpromotionactivities, tax authorities may argue that a PSM should be applied.

Procedural Aspects

Bulletin 6 has made a number of changes to procedural aspects of the Chinese transfer pricing regime. Most notably, if a taxpayer initiates a self-adjustment, thetaxpayermustcompleteanewform.Further,Bulletin6specificallystatesthat taxpayers will not be subject to an audit on transactions that are covered by an advance pricing agreement submission or renewal application. Further, Bulletin 6 makes it clear that tax authorities’ examination power is extended to nonresidents.

Other Matters

• Secret comparables: Historically, tax authorities were allowed to use non-pub-lic information (i.e., so-called “secret comparables”). However, Bulletin 6 states that publicly available data is preferred.

• Single function entities: Loss-making single function entities still must prepare transfer pricing documentation even if their transaction levels are below the general documentation requirement thresholds

• Domestic transactions: Under Bulletin 6, transfer pricing adjustments will gen-erally not be made with respect to wholly domestic transactions unless there is an overall loss of tax revenue.

• Toll manufacturing: If comparable companies with the same business model

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cannotbeidentified,thevalueofmaterialsandequipmentprovidedbytheprincipalmust be added back to the cost base when applying a cost plus method. While working capital adjustments are not allowed in any other case, they are allowed in toll manu-facturingcasesiftheadjustmentonprofitisnomorethan10%.

• Transferoffinancialassets:Bulletin6providesdetailsoncomparabilityfactorsrelat-edtotransfersoffinancialassets(includingequityshares).

China


TP Current Issues

India introduces secondary adjustment and interest limitation rules

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Executive summary

On 31 March 2017, India’s Finance Bill, 2017, presented before the Indian Parliament on 1 February 2017, received Presidential assent and was enacted with effect from 1 April 2017. From a transfer pricing (TP) perspective, the two key changes relate to the introduction of a secondary adjustment provision and an interest limitation rule.

Detailed discussion

Introduction to Secondary Adjustments

A“secondaryadjustment”oftheITLhasbeendefinedtomeananadjustmentinthebooksofaccountsofthetaxpayeranditsAEtoreflectthattheactualallocationofprof-its between the taxpayer and its AE are consistent with the transfer price determined as a result of primary adjustment. The provisions relating to “secondary adjustments” are applicableinthecaseofprimaryTPadjustmentsmadefromthe2016-17financialyearonwards.Theprimaryadjustmentisdefinedtomeanthedeterminationofthetransferprice in accordance with the arm’s length principle resulting in an increase in the total income or reduction in the loss, as the case may be, of the taxpayer. The new provi-sions provide that the taxpayer shall be required to carry out the secondary adjustment where the primary adjustment to the transfer price was:

• Made voluntarily by the taxpayer on its income-tax returns

• Madebythetaxofficerandacceptedbythetaxpayer

• Determined by an APA entered into by the taxpayer with the Indian Tax Administra-tion

• Made as per the safe harbor rules framed under the ITL

• Resulted from the resolution of an audit adjustment by way of the MAP under a double taxation avoidance agreement (tax treaty)

However, an exception has been carved out according to which, such secondary adjust-ments shall not be carried out by the taxpayer if both

• Theamountoftheprimaryadjustmentmadeinthecaseofataxpayerinanyfinancialyear does not exceed INR10 million (approx. US$150,000)

• Theprimaryadjustmentismadeinrespectofthe2015-16financialyearoranyear-lierfinancialyears

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In cases of non-compliance with the above requirement, such “excess money” shall be deemed to be an advance made by the taxpayer to such AE. Further, the interest on such advance shall be computed as the income of the taxpayer in a prescribed manner. The time limit for repatriating the excess money into India and the manner of computa-tion of interest in the event of non-repatriation are yet to be prescribed.

Introduction of interest limitation rules

In line with the best practice recommendations of Action 4 of the Organisation for Eco-nomicCo-operationandDevelopment (OECD)-G-20BaseErosionandProfitShifting(BEPS) project, a new section to limit interest deductions has been introduced in the ITLapplicablefromthe2017-18financialyear.ThesaidprovisionsareapplicabletoanIndian company or a permanent establishment (PE) of a foreign company in India (col-lectively referred to as “borrower”) if the following conditions are met:

• The borrower is engaged in any business or profession other than banking or insur-ance

• The borrower incurs expenditure in the nature of interest or similar consideration ex-ceedingINR10million(approx.US$150,000)inafinancialyear

• Such interest expense or similar consideration is deductible in computing the taxable income of business/profession

• The debt1) is issued by a nonresident AE of the borrower or by a third party lender but an AE either provides an implicit or explicit guarantee to such lender or deposits a corresponding and matching amount of funds with the lender

Iftheaboveconditionsaresatisfied,theinterestdeductionislimitedtothelowerofthefollowings:

(i) 30% of EBITDA, or

(ii) interest actually paid/payable to the AE

Interest expense in excess of limitation prescribed can be carried forward up to the fol-lowingeightfinancialtooffsettaxableincomebythespecifiedlimit.Further,thededuc-tion for such carried forward excess interest would be allowed against the future taxable income so long as the interest expenditure is within the celling as prescribed.

1)

Theterm“debt”isdefinedasloans,financialinstru-

ments, finance leases, financial derivative instru-

ments or arrangements that generate interest, dis-

countsorotherfinancialcosts.

India


Contacts

Transfer Pricing

Sang Min Ahn Partner 02.3787.4602 [email protected]

Sung Han Park Partner 02.3787.6355 [email protected]

Dong Hoon Ha Partner 02.3770.0936 [email protected]

Jae Seong Yun Partner 02.3787.4265 [email protected]

Hoon Seok Chung Director (Singapore) +65.6718.1072 [email protected]

Ki Se Kim Director 02.3770.0918 [email protected]

Kyoung Bae Han Director (Vietnam,Ho Chi Minh ) +84 8 3824 5252 (ext. 8305) [email protected]

Transfer Pricing-Financial Services Organization(FSO)

Stella Kim Director 02.3770.0980 [email protected]

Business Tax Service

Min Yong Kwon Partner 02.3770.0934 [email protected]

Dong Chul Kim Partner 02.3770.0903 [email protected]

Jae Cheol Kim Partner 02.3770.0961 [email protected]

Young Ro Bae Executive Director 02.3770.0936 [email protected]

Song Min Oh Executive Director 02.3770.0983 [email protected]

International Tax Service

Kyung Tae Ko Partner 02.3770.0921 [email protected]

Yeon Ki Ko Partner 02.3787.4637 [email protected]

Nam Wun Jang Partner 02.3787.4539 [email protected]

Financial Services Organization

Jong Yeol Park Partner 02.3770.0904 [email protected]

Jeong Hun You Partner 02.3770.0972 [email protected]

Dong Sung Kim Partner 02.3787.4238 [email protected]

Transaction Tax

Jin Hyun Seok Partner 02.3770.0932 [email protected]

Human Capital

Danielle Suh Partner 02.3770.0902

[email protected]

Min Ah Kim Executive Director 02.3770.1019 [email protected]

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