Transfer Pricing

TA X R E F E R E N C E L I B R A RY N O 1 0 8
Published in association with:
Deloitte Korea
Gowling WLG
Fenwick & West
Tax Partner AG – Taxand Switzerland
Transfer Pricing 18th edition

Transfer Pricing
03 Canada
IP migration strategies – pre and post BEPS
BEPS aims to prevent aggressive profit-shifting strategies to better align transfer pricing outcomes
with value creation. In this paper, Dale Hill, a partner at Gowling WLG, examines BEPS’s appli-
cation to the transfer pricing aspects of intangibles and the impact on tax-motivated IP migration
strategies.
10 South Korea
There is more to BEPS than meets the eye
Much lies beneath the surface of BEPS. How will BEPS affect Korean multinationals and what do
MNEs need to learn? Tae Hyung Kim, partner and senior transfer pricing economist at Deloitte
Korea, explains exactly what multinationals must consider and what they should fear.
14 Switzerland
Intangibles in a post BEPS world
The framework for analysing intercompany transactions involving intangibles is examined by
Hendrik Blankenstein and Caterina Colling Russo at Tax Partner AG – Taxand Switzerland.
Does the new DEMPE analysis benefit MNEs and tax authorities or simply confuse matters, result-
ing in an increase of intangibles-related disputes?
19 US
Responding to the changes in the transfer pricing landscape
The Internal Revenue Service appears to be strengthening its stand on aggregating transactions and
applying economic substance rationales to override related-party contracts. David Forst and Larissa
Neumann of Fenwick & West discuss US developments including the IRS and Treasury
Department-issued 482 Temporary Regulations.
W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M 1
EDITORIAL
BEPS: 8 Bouverie Street
The endgame
London EC4Y 8AX UK
Tel: +44 20 7779 8308
Fax: +44 20 7779 8500
Managing editor, TPWeek.com Caroline Byrne
caroline.byrne@euromoneyplc.com
Reporter, TPWeek.com Joelle Jefferis
joelle.jefferis@euromoneyplc.com
Managing editor Ralph Cunningham
rcunningham@euromoneyplc.com
Reporter Joe Stanley-Smith
joseph.stanley-smith@euromoneyplc.com
he boldest initiative in transfer pricing history entered the home-
T stretch in October 2015 with the release of the OECD’s final report
on its base erosion and profit shifting (BEPS) project. The reverbera-
tions are being felt across North America, Europe, Asia and beyond.
Reporter Amelia Schwanke
amelia.schwanke@euromoneyplc.com
Production editor João Fernandes
jfernandes@euromoneyplc.com
Multinational enterprises will soon need to provide tax authorities with PublisherOliver Watkins
details of almost every facet of their business through the master file, local owatkins@euromoneyplc.com
file and country-by-country reports: key profit drivers, global value chains, Associate publisher Andrew Tappin
transfer pricing policies for major services and intangibles, MNE financial atappin@euromoneyplc.com
statements, and more. Is there any doubt about who has the upper hand: Online associate publisher Megan Poundall
taxpayers or tax authorities? mpoundall@euromoneyplc.com
The objective of the OECD’s plan is clear: combat aggressive profit- Senior marketing executive Sophie Vipond
shifting strategies. BEPS was designed to ensure MNEs reveal profits in sophie.vipond@euromoneyplc.com
jurisdictions based on assets, risks and actual functions. It is unsurprising Graduate marketing trainee Anna Sheehan
anna.sheehan@euromoneyplc.com
then, that BEPS is shaking up countries and companies.
While tax officials and legislators worldwide are moving quickly, many Subscriptions manager Nick Burroughs
nburroughs@euromoneyplc.com
companies are moving cautiously. Some are concerned about how author-
Divisional director Greg Kilminster
ities will handle tax data. Others worry about confidentiality breaches or
the risk of audits and double taxation But a sense of urgency is needed, © Euromoney Trading Limited, 2016. The copyright of all editorial
otherwise, MNEs risk penalties, reputational risks and additional taxes. matter appearing in this Review is reserved by the publisher.
In his candid assessment of the tension between taxpayers and tax No matter contained herein may be reproduced, duplicated or
authorities, Tae Hyung Kim, a partner at Deloitte Korea, explains what copied by any means without the prior consent of the holder of the
copyright, requests for which should be addressed to the publisher.
multinationals must consider and what they should fear. Although Euromoney Trading Limited has made every effort to
Hendrik Blankenstein and Caterina Colling Russo of Tax Partner AG ensure the accuracy of this publication, neither it nor any
– Taxand Switzerland examine whether the newly introduced DEMPE contributor can accept any legal responsibility whatsoever for
analysis benefits MNEs and tax authorities, or whether it will just con- consequences that may arise from errors or omissions, or any
opinions or advice given. This publication is not a substitute for
fuse matters and result in an increase of intangibles-related transfer pric- professional advice on specific transactions.
ing disputes.
Dale Hill, a partner at Gowling WLG in Canada, considers the applica- Directors John Botts (Chairman), Andrew Rashbass (CEO),
tion of BEPS guidelines to the transfer pricing aspects of intangibles and Sir Patrick Sergeant, The Viscount Rothermere, Colin Jones,
Martin Morgan, David Pritchard, Andrew Ballingal, Tristan Hillgarth
the impact on tax-motivated IP migration strategies. His insightful analysis
encompasses both pre- and post-BEPS strategies. International Tax Review is published 10 times a year by Euromoney
Finally, questions remain about how much change the US is prepared Trading Limited.
to implement, but the OECD’s recommendations are without doubt hav- This publication is not included in the CLA license.
ing an impact. David Forst and Larissa Neumann of Fenwick & West dis- Copying without permission of the publisher is prohibited
cuss US developments including the IRS and Treasury Department-issued ISSN 0958-7594
482 temporary regulations.
Customer services: +44 20 7779 8610
Caroline Byrne UK subscription hotline: +44 20 7779 8999
Managing editor, TPWeek.com US subscription hotline: +1 800 437 9997
2 W W W. I N T E R N AT I O N A LTA X R E V I E W. C O M
CANADA
IP migration strategies –
pre-and post-BEPS
he largest initiative the transfer pricing world has seen, since the intro-
BEPS aims to prevent
aggressive profit-
T duction of the Organisation for Economic Cooperation and
Development’s (OECD) Transfer Pricing Guidelines for
Multinational Enterprises and Tax Administrations (Current TP
Guidelines), is in its final stages and will result in material changes in the
shifting strategies to way the global operations of corporate organisations are structured and
international transactions are reported.
better align transfer On October 5 2015, the OECD released the final report of its 15-point
Action Plan on Base Erosion and Profit Shifting (BEPS). The BEPS Action
pricing outcomes with Plan was an ambitious project that addressed a number of concerns relating
to international corporate tax planning. Actions 8 to 10 and Action 13 deal
value creation. In this specifically with transfer pricing concerns and, in addition to the introduc-
tion of Country-by-Country Reporting (CBCR), contain significant
paper, Dale Hill, a revised guidance in the form of amendments to the Current TP Guidelines
(Amended TP Guidelines).
partner at Gowling In brief, the OECD’s BEPS initiative, as it pertains to transfer pricing,
attempts to prevent aggressive profit-shifting strategies by amending the
WLG, examines Current TP Guidelines to better align transfer pricing outcomes with value
creation. This is accomplished by placing more emphasis on the allocation
BEPS’s application to of profits to the jurisdiction where substantive functions are performed,
including the control functions related to risks assumed and capital
the transfer pricing employed. The Amended TP Guidelines, intended to be clarifying in
nature and not a departure from the arm’s length principle as enshrined in
aspects of intangibles the Current TP Guidelines, now provide the tools and support the Canada
Revenue Agency (CRA), and presumably other tax administrations, need
and the impact on tax- to successfully challenge tax-motivated transfer pricing strategies where
substantive people functions are not transferred with the intangible prop-
motivated IP migration erty (IP).
This paper examines the OECD BEPS initiative as it applies to the
strategies. transfer pricing aspects of intangibles and the impact on tax-motivated IP
migration strategies. It is widely recognised that the primary objective of
an MNE is to maximise profits and, as such, MNEs are constantly evaluat-
ing their international operations in an effort to maximise revenues and
minimise costs, including tax expenses. Historically, where the commercial
opportunity existed, companies often adopted IP migration transfer pric-
ing strategies that allocated significant profits to lower-tax jurisdictions. In
the most extreme cases, no or minimal functionality (i.e. no employees)
was transferred with the IP (e.g. cash box companies). Many of these
strategies, and the tax savings that arose from them, whether rightfully or
CANADA
wrongfully, were thought to be legally effective and in line • An associated enterprise providing funding and assuming
with the arm’s length principle as described in the Current TP the related financial risks, but not performing any func-
Guidelines. Such tax-motivated IP migration cases have often tions relating to the intangible, could generally only expect
come under careful scrutiny by tax administrations. a risk-adjusted return on its funding; and
Notwithstanding such scrutiny, there was a lack of clear guid- • If the associated enterprise providing funding does not
ance and policy application by the CRA’s Audit Division, exercise control over the financial risks associated with the
Appeals Directorate and Competent Authority. In many cases funding, then it is entitled to no more than a risk-free
the CRA accepted these structures as they were generally return.
thought to be tax efficient and in line with the arm’s length
principle regardless that significant profits were allocated to An example of the new approach
that lower tax jurisdiction. This is about to change To see how the allocation of profits from IP transfers differ
between a pre- and post-BEPS world, consider example 17
BEPS changes to current TP guidelines in respect to from the Amended TP Guidelines. In the example, the fol-
intangibles lowing facts/assumptions are assumed:
The OECD’s BEPS Action Plan was an enormous undertak- 1. Parent is a large pharmaceutical company.
ing covering many areas of international tax and only time will 2. Parent conducts its operations in country X.
tell what the collective impact will be as a consequence of all 3. Parent regularly retains independent (unrelated) contract
the final report recommendations. However, what is widely research organisations (CROs) for research and develop-
agreed upon in the international tax community is that the ment (R&D) activities, including designing and conduct-
most immediate, and likely most significant, impact from the ing clinical trials.
BEPS project will be in the world of transfer pricing. The new 4. CROs are not engaged in the blue sky research to identify
CbCR and the Amended TP Guidelines are reality and are new compounds.
here to stay. 5. When retained, Parent actively participates with CRO
The OECD’s work related to transfer pricing under the engaged in clinical research activities.
BEPS Action Plan focused on three key areas. Action 8 6. CROs are paid a negotiated fee for services and do not
looked at transfer pricing issues related to transactions involv- have an ongoing interest in the profits.
ing intangibles, Action 9 considered the contractual alloca- 7. Parent transfers patents related to Product to Subsidiary
tion of risks and the resulting allocation of profits to those operating in country Y.
risks, and Action 10 focused on other high-risk areas includ- 8. Product is early stage pharmaceutical drug (high risk, low
ing the possibility of re-characterisations where transactions probability of commercialisation).
were not commercially rational. The Amended TP Guidelines 9. Payment based on anticipated future cash flows – expect-
arising as a consequence of the OECD’s work on Actions 8 to ed cash flow discounted by appropriate discount rate.
10 are significant and amend several chapters and sections of 10. Subsidiary has no technical personnel for ongoing
the Current TP Guidelines. The following is a brief summary research activities.
of the new guidance dealing with intangibles: 11. Subsidiary contracts with Parent to carry out research
• Legal ownership of intangibles by an associated enterprise related to Product.
alone does not determine entitlement to returns from the 12. Subsidiary funds all Product research, assumes risk, and
exploitation of intangibles; pays Parent based on cost plus margins earned by similar
• Associated enterprises performing important value-creat- CROs.
ing functions related to the development, enhancement, The fact pattern given above is the classic example of an
maintenance, protection and exploitation (DEMPE) of the early stage pharmaceutical company wanting to realise future
intangibles can expect appropriate remuneration; profits in a low-tax jurisdiction. In the pre-BEPS world, a sig-
• An associated enterprise assuming risk in relation to the nificant portion of the profits would have moved to country
DEMPE of the intangibles must exercise control over the Y. It was generally recognised that given the Subsidiary was
risks and have the financial capacity to assume the risks the legal owner, it was entitled to any excess profit or loss after
including the very specific and meaningful control require- paying routine amounts for the R&D activities, even where
ment; the important value-creating functions of the IP did not take
• Entitlement of any member of the MNE group to profit or place in the Subsidiary’s country. The transfer of the IP would
loss relating to differences between actual and expected have been done at a low value (although arm’s length) as the
profits will depend on which entity or entities assume(s) prospects of successful commercialisation were very uncertain
the risks that caused these differences and whether the at the time of the transfer. In regards to future development
entity or entities are performing the important functions in of the intangible property, Parent, as a service provider, would
relation to the DEMPE of the intangibles; have been entitled to a cost plus mark-up on costs incurred.
CANADA
In a post-BEPS world, less emphasis is placed on legal

ownership and more on economic aspects of substance. In
Dale Hill
Partner, Tax Services – National Leader,
the example above, Parent controls functions and manages
Transfer Pricing & Competent Authority
patent risks owned by Subsidiary and is entitled to compen-
Group
sation. The Amended TP Guidelines, including the analysis
Gowling WLG
to example 17, will support that Parent’s compensation is
not appropriately recognised by the profits earned by a Office: +1 (613) 786 0102
CRO. Parent’s transactions with CROs are not comparable Fax: +1 (613) 788 3473
to the Subsidiary/Parent arrangement given that the func- dale.hill@gowlingwlg.com
tional profiles differ, i.e. parent is in control of function and
is the more appropriate party to assume the risks of success Dale Hill is a partner in Gowling WLG’s Ottawa office and is the
or failure. While Subsidiary legally owns the patents it lacks national leader of the Gowling WLG’s Transfer Pricing and
the capability to control research risks while Parent per- Competent Authority team. Dale works in conjunction with the
forms key decision making functions and thus should be firm’s national tax practice group to help organisations optimise
appropriately compensated. their global tax position and reduce exposure to unfavourable
Clearly there has been a fundamental shift in the way we audit assessments through proper tax planning and implementa-
look at the division of profits due to the introduction of tion strategies. Dale’s specialty is audit defence and dispute res-
BEPS. In a pre-BEPS environment, Subsidiary would be bet- olution with many countries around the world.
ter able to keep profits given it legally owned the intangibles
and paid arm’s length prices for development functions. In addition to Dale’s audit defence work, he also oversees the
Post-BEPS, it is clear this will change with an emphasis on group’s transfer pricing documentation and Advanced Pricing
functions, including control of those functions and risks. Agreement (APA) practice and is actively involved in providing liti-
gation advice to the firm clients from a tax perspective. Dale has
Moving intangible property offshore in a transfer pricing worked in a variety of industries including, but not limited to,
setting – pre-BEPS & post-BEPS pharmaceuticals, auto, construction, consumer durables and
Intangibles are becoming an increasingly valuable component computer software industries.
of a company’s value. Intangibles often account for a larger
stake in an enterprise’s value than traditional tangible assets. Dale’s ability to solve contentious issues stems from his vast
When you factor in the mobility of these assets, it is not a sur- experience working at the Canada Revenue Agency (CRA) at a
prise that IP migration strategies have frequently been relied senior level. Prior to joining Gowling WLG in 2005, Dale was
upon to move profit-generating assets to lower tax jurisdic- involved in international transfer pricing and tax avoidance with
tions. However, there are other legitimate reasons for migrat- the CRA for 16 years. During his tenure as a senior manager with
ing intangibles, including: the CRA’s International Tax Directorate, he participated in more
• Protection of intangible property than 40 APAs with numerous countries, as well as hundreds of
• Capital funding Competent Authority requests relating to international transfer
• Sharing in intangible development risks pricing adjustments involving a vast array of issues. He is also
• Tax credit issues experienced in a number of other international tax areas, includ-
From a tax perspective, during both the pre-BEPS and ing interest deductibility, guarantee fees, imputed interest, notion-
post-BEPS era, moving IP from one jurisdiction to another, al expenses, penalties and appeals. Dale has been successful in
including lower tax jurisdictions, can be justified and legally resolving a number of controversial audit issues through negotia-
tax effective if the corresponding functions, assets and risks tions with various tax authorities in a number of countries
are moved with the IP. Historically, the legal owner took all, around the world.
or a material portion of, the residual profits after routine prof-
its were paid to entities that performed functions related to Dale’s expertise has been recognised many times by various
the DEMPE of the intangibles and the management of the institutions. In particular, his group was awarded with Canada
risk. In the post-BEPS environment however, a shift has Transfer Pricing Firm of the year award by International Tax
occurred in that people functions, particularly controlling Review for the years 2011, 2013, and 2015. He acquired his CPA
functions related to the DEMPE of the intangibles and con- and CFP designations in 1991 and 1995, respectively, and com-
trolling functions regarding the assumption and mitigation of pleted the CICA in-depth tax course in 1999.
risk, have far greater value than legal ownership, direct fund-
ing and contractual assumption of risk.
The old transfer pricing adage of “functions, assets and
risk” is now misleading as functionality seems to be highly
CANADA
relevant in all three of those factors. In other words, if transfer TP Guidelines. In other words, tax administrations have
pricing is supposed to be based on economic reality, does eco- routinely settled transfer pricing cases in a manner that is
nomic reality support allocation of residual profits to purely not consistent with the Amended TP Guidelines and have
functions (e.g. labor) rather than ownership (e.g. capital)? allowed varying degrees of profits to be reported in lower-
This is one of the main reasons there is debate in the interna- tax jurisdictions where little functionality has taken place.
tional tax community, and particularly in the Canadian tax In the absence of guidance from the CRA on this matter,
community, regarding whether the Amended TP Guidelines taxpayers should proceed with caution before deciding on a
are clarifying in nature or whether they constitute a funda- rectification strategy. Canadian taxpayers can file amended
mental change to the arm’s length principle. Unfortunately, tax returns for those open taxation years where their
this debate is a moot point because the opinion of the OECD reported transfer prices are inconsistent with the Amended
and tax administrations, which ultimately prevails over that of TP Guidelines. However, if the taxpayer’s pending upward
the taxpayer, is that the revised guidelines are clarifying in transfer pricing adjustments for filed taxation years are sig-
nature and not a fundamental departure from the arm’s nificant and subject to possible penalties, taxpayers may
length principle. The CRA has confirmed its view that the consider the CRA’s voluntary disclosure program (VDP).
revisions are clarifying in nature. The CRA has little experience in its VDP with respect to
In the post-BEPS world, if tax-motivated IP migration transfer pricing cases and the waiver of transfer pricing
strategies are to be carried out in an acceptable manner, it is penalties, so there is some uncertainty in this avenue of
imperative that substantive functions be transferred with the recourse. Also, Canada’s VDP has stringent conditions for
intangibles. From the OECD’s perspective, its BEPS initiative eligibility that often prohibit taxpayers from applying, par-
successfully eliminates the tax benefits behind cash box compa- ticularly those taxpayers who are under constant audit
nies and other structures that were pushing the envelope with activity by CRA. Taxpayers could also consider applying for
respect to lack of functionality in the lower tax jurisdiction. an Advanced Pricing Agreement (APA) which assists tax-
payers in determining transfer pricing methodologies for
Rectifying pre-BEPS structures that are inconsistent with the prospective years (generally three to five years). One of the
amended TP guidelines benefits of the CRA’s APA program is the ability for taxpay-
Many enterprises are concerned about how taxing authorities, ers to ask to apply the terms and conditions of an APA
such as the CRA, will treat existing tax structures involving IP retroactively to non-statute-barred taxation years (i.e., an
migration that were created before BEPS. As mentioned APA rollback). Where APA rollbacks are accepted, the tax-
above, the Amended TP Guidelines are considered by the payer will not be subject to transfer pricing penalties.
OECD and the CRA to be clarifying in nature and are, for all Taxpayers would be well advised to seek tax counsel
intent and purpose, retroactive in effect. If taxpayers believe before deciding on first, whether self-rectification of unau-
that their existing structures are not consistent with the dited filed years is advisable and, if so, what specific course
Amended TP Guidelines and make no attempt to rectify of action to take.
them, they run the risk of being exposed to transfer pricing
adjustments should they be audited by the CRA. In the event Post-BEPS – is there now more uncertainty?
taxpayers decide to rectify the situation on a prospective basis As a consequence of the BEPS project and the resulting
only (e.g. by amending their transfer pricing documentation Amended TP Guidelines, profits must be aligned with the
to reflect the Amended TP Guidelines for future years), this location of value creation. There is no ambiguity in the
could red flag problems and deficiencies to the CRA with OECD’s message to the tax community on this issue.
respect to their filed taxation years. However, the guidance from the OECD, including exam-
To date, the CRA hasn’t made public statements regard- ple 17, does not provide much in the way of how the actual
ing possible relief for taxpayers trying to rectify existing IP intercompany transfer prices should be documented. In a
migration structures that have been reported in a manner typical IP migration strategy, there is often only two inter-
that is inconsistent with the Amended TP Guidelines. In company transactions taking place: i) the initial transfer of
the author’s view, this silence, or lack of concern, is unfor- the IP to the subsidiary located in the lower tax jurisdic-
tunate considering the significance of the changes which tion; and ii) the intercompany R&D service contract. The
are, arguably, beyond clarifying in nature. What is more final sale of the IP or the ultimate exploitation of the IP by
troublesome is the CRA’s position that these changes are the foreign subsidiary will be done with arm’s length par-
clarifying in nature and retroactive in effect despite having ties (i.e. customers). In the event the CRA decides not to
agreed to countless audit, appeal and mutual agreement recharacterise the transaction, the first intercompany trans-
settlements over the years on IP migration structures, sup- action will simply involve valuation issues. With regards to
posedly on a “principled” analysis of the arm’s length prin- the second intercompany transaction, the OECD expects
ciple, in a manner that is not consistent with the Amended future revenues to be properly allocated to the parent
CANADA
company for its efforts in contributing to the value of the This could, for example, be an acceptable strategy where a
IP. However, in the absence of guidance from the OECD start-up company wants to keep its options open (e.g. relo-
and tax administrations on how this should be document- cate the appropriate DEMPE functions to the jurisdiction
ed, taxpayers are left in the dark. that holds legal title of the intangibles) once it has a better
From a practical point of view, profits should be set such idea of the potential value and income earning capacity of the
that the simpler of the two parties be given a routine return intangible. Even though the Amended TP Guidelines will
while the more complex party receives the residual need to be considered regarding the lack of functionality in
profits/losses if such profits materialise. The profits attrib- the low tax jurisdiction in that initial start-up period, there
utable to each party will depend on the functions per- could be future departure tax savings by transferring owner-
formed, assets utilised, and risks assumed by each party. If ship of the intangibles at the earliest stage possible.
the subsidiary is simply the holder of IP with no correspon-
ding functions, it may only be entitled to an unadjusted Conclusions
return on capital. If the subsidiary performs routine func- The BEPS initiative was designed to ensure multinational
tions in addition to holding the IP, a risk adjustment return corporations report profits in jurisdictions based on actual
on capital may be warranted. functions, assets and risks and to combat aggressive tax
The decision to allocate excess profits/losses to the par- planning structures. The new guidance moves away from
ent may cause audit controversy for a number of reasons. It placing significant emphasis on legal ownership and
is the author’s experience that governments are risk averse towards economic substance and control. The introduction
and want to see some level of compensation in the immedi- of the Amended TP Guidelines will provide taxing author-
ate term even though they may only be entitled to larger ities, such as the CRA, more tools to raise and support
atypical profits or losses when the intangibles are fully transfer pricing adjustments. Consequently, taxpayers must
utilised. Consider the possibility that, in the example above, be aware of this new guidance before carryout out any IP
the IP generated large losses in the initial post transfer migration planning.
years. Will the CRA allow the parent company, performing From a Canadian perspective, an unfortunate aspect of the
and controlling key functions and risks, to report the losses BEPS project is the lack of guidance provided by CRA with
even though it did not own the IP and is simply a service respect to these new guidelines. In the author’s opinion, now
provider according to the intercompany R&D service con- that the CRA has endorsed these changes as clarifying in
tract? It’s doubtful. nature, having both retroactive and prospective effect, it is
Tax authorities such as the CRA may have difficulty inappropriate for the CRA to remain silent on self-rectifica-
accepting that a service provider should not receive at least tion and contemporaneous documentation issues.
a cost plus mark-up on services it renders (in addition to The jurisprudence is clear that legal form prevails in
some share of the profits if they materialise). It is very likely Canadian transfer pricing cases. The Supreme Court of
that setting intercompany pricing on an intercompany serv- Canada has on many occasions addressed the doctrine of
ice agreement such that the parent company service economic substance and significantly limited the CRA’s
provider incurs losses will trigger an audit. The guidance, in ability to ignore the facts and circumstances, and substitute
our view, does not shed sufficient light on the mechanics of economic fiction.
profit allocation and seems to add more confusion to an Two recent transfer pricing cases heard by the Tax Court
already uncertain landscape. Example 17 of the Amended of Canada (TCC) also comment on the CRA’s discretion to
TP Guidelines is a common IP migration structure but it is substitute legal reality with economic theory. In McKesson
highly likely that the annual reporting of the service con- (2013 TCC 404)), the TCC concluded that the CRA can
tract during the start-up years where no profits are being only recharacterise the legal reality under paragraph
realised will be treated differently between taxpayers and 247(2)(b), a special GAAR-like anti-avoidance rule in the
tax administrations until further guidance is developed. Canadian taxing statute. In the absence of a reassessment
The Amended TP Guidelines will likely result in fewer under this recharacterisation provision, “[a] reassessment
companies carrying out IP migration strategies, which was under [paragraphs] 247(2)(a) and (c) does not permit a
one of the unwritten goals of the BEPS initiative. recharacterisation of the transactions entered into by non-
Consequently, the OECD and tax authorities may not be arm’s length parties, nor can another different transaction
overly concerned about its lack of guidance on reporting entirely be substituted therefore.” In Marzen (2014 TCC
issues during the start-up years where the legal ownership of 194), the TCC agreed with the respondent’s reference to
IP was in fact transferred offshore. This is unfortunate the Current TP Guidelines in support of respecting legal
because some IP migration strategies involving low-tax juris- reality which states “[a] tax administration’s examination of
dictions may still be carried out, regardless of the Amended a controlled transaction ordinarily should be based on the
TP Guidelines, without the initial movement of functions. transaction actually undertaken by the associated enterprises
CANADA
as it has been structured by them.” Both these transfer pric- value creating function while ignoring the traditional entre-
ing cases are consistent with the earlier Supreme Court of preneurial principle of rewarding legal ownership with all or
Canada decisions concerning the appropriate use of the doc- at least a portion of residual profits. In other words, the
trine of economic substance. OECD seems to want to treat the company that contributes
With Canada’s tax system having such a strong emphasis to the value creation of the IP as the beneficial owner of the
on legal form, one might question how a Canadian court IP in cases where they do not feel they have the grounds to
would view a transfer pricing adjustment made by the CRA recharacterise the transaction. However, issues will arise in
to an R&D service contract as per example 17 above, once the absence of further guidance on how to properly docu-
CRA has chosen not to recharacterise any of the transac- ment these transactions in those early years where no rev-
tions. That is, the OECD’s approach under its Amended enues are generated. It will be interesting to see how these
TP Guidelines is to reward the company that forms the cases will play out in a Canadian court.
SOUTH KOREA
There is more to BEPS than

meets the eye
he Korean National Tax Service (NTS) and the Ministry of Strategy

Much lies beneath the
surface of BEPS. How
T and Finance are gearing up for what’s ahead with BEPS. They are
moving slowly but surely.
The ministry provides the specific guidance for master files and local
files. The details are stipulated in the Law for Coordination of
will BEPS affect Korean International Tax Affairs (LCITA) as Enforcement Decree (ED). The
guidance specifies who should submit what and when. In essence, what is
multinationals and what stipulated in the ED is literally the same as the Korean translation of
OECD Action 13 Annexes I and II. The LCITA-ED provides Korean tem-
do MNEs need to plates for the master file (MF) and local file (LF). In both templates, the
ED itemises each information category and all specific items under each
learn? Tae Hyung Kim, category in Annexes I and II in Korean. Country-by-country reporting
requirements will be put in place certainly, not in fiscal 2016 but in fiscal
partner and senior 2017. That’s all that is planned so far for this year.
On the tax administration side, the NTS is moving rather quickly on the
transfer pricing resource side. The NTS acknowledges that sufficient resources are neces-
sary to perform risk assessments with the files and the information con-
economist at Deloitte tained in the files. The NTS plan to pool the right resources and train them
to perform risk assessments. Most of all, the author would like to see the
Korea, explains exactly NTS bring in economics professionals to provide the necessary training to
the NTS examiners. The NTS has not recruited nor employed an econo-
what multinationals mist since the inception of the LCITA in 1996, as far as the author is
aware.
must consider and what Overall, the NTS and the ministry have been reactive in paying atten-
tion and responding to base erosion and profit shifting (BEPS). They have
they should fear. followed developments at the OECD and monitored developments and
news in other jurisdictions around the globe, but until recently there has
not been much discussion between the government (both the NTS and the
ministry) and taxpayers. The practitioners have been rather active in com-
parison, holding public seminars to discuss and disseminate the OECD
final deliverables on actions.
In this article, the author intends to focus on what is below the surface
of BEPS. What does BEPS really mean to Korean MNEs? What do Korean
MNEs in particular need to think about? Why should the top management
care about BEPS? What’s next?
BEPS is a whole new ball game

There is little doubt that the tax authorities will have the upper hand with
important data and information at their fingertips. It was a different story
SOUTH KOREA
in the past. Under the new rules, the information required in among competent authorities. In particular, MNEs should
the master file (MF), local file (LF), and country-by-country keep this point in mind and take it into consideration when
reports (CbCR) will cover almost every aspect of an MNE’s they engage in disputes with the tax authorities.
business: global value chains and key profit drivers, a list of all
intangibles, the way the group is financed, transfer pricing Consistency should top the priority list
policies for major products, services, intangibles, and financial Inconsistency matters. MNEs need to pay particular attention
arrangements, ties between the financial data used in transfer to transfer pricing methods and polices over the past years. Of
pricing methods and the MNE’s financial statements, and so course, this is the case to the extent that the years fall within
on. The list goes on. The tax authorities can request even the statute of limitation. The information contained in the
more focused details on the information already supplied to MF, LF, and CbCR can be analysed to assess risks in the past
the extent that it is needed. years. If proper documentation is not in place for the past
A few points are worth mentioning here. The objectives years, the information provided in the MF, LF, and CbCR for
are clear with transfer pricing documentation in Action 13. the fiscal year 2016 could provide benchmark information for
What they really mean to MNEs is less clear. The focused and those years. The MNEs should expect that the tax authorities,
specific information required under the MF and LF will be and in particular the NTS, can always confront the MNEs
handed over to the tax authorities before an audit. And the with any inconsistency that exists between the past years and
exact same information will be available to all relevant tax the present year. It is worth double checking whether proper
authorities at the same time. transfer pricing policies were coordinated centrally by the
The author would like to emphasise that a great deal of headquarters of the MNEs in the past.
focused and specific information will be in the hands of tax
authorities. What is clearly different with BEPS is that the Tax authorities lack and need proper training in
time frame for handing over all of this information to the tax economics
authorities will be before an audit. The availability of the A great deal of important information will be at the NTS’s
information to the tax authorities changes who’s calling the fingertips. The NTS will slice and dice the information to
shots in the ball game. Even before the ball game begins, make risk assessments and to determine whether an audit is
information will be fully analysed to assess risks for the audit. necessary. The author expects that tax authorities will contin-
MNEs should not miss the fact that tax authorities will have ue to make investments in human resources. The resources
plenty of time. Not a few weeks or months but even a few will be put in place to educate and train tax examiners and get
years to the extent that the statute of limitation allows. Put them ready before the rubber hits the road. The author
simply, it is enough time. Not to mention fast-changing data doubts, however, that the NTS will bring in economics pro-
analytics technology available everywhere. The information fessionals to train them. That’s what might worry MNEs.
can be sliced, diced, and drilled down on to the very bottom Most of the NTS examiners do not have the appropriate level
of the issue quickly. This is new under the sun. Tax authorities of capabilities needed in performing economic analysis. The
will try to put all available resources to full use before they pin NTS does not have economists and lacks training in econom-
down the objects. In addition, MNEs should always remem- ics and therefore relevant skills. Value creation and profit allo-
ber that the exact same information will be available to virtu- cation is all about economics from the start and also at the
ally all relevant tax authorities at the same time. How will the end of the day. Until the tax authorities are equipped with the
tax authorities in different jurisdictions respond? What can right analytical capabilities, it will pay off if the MNEs are
MNEs do about it? ready to go the extra miles to educate the tax authorities.
Prepare for unilateral actions MNEs need to reset the mindset

MNEs may wish that they had a crystal ball. It will not be easy MNEs vary in terms of the depth and breadth of experience,
to predict the future. The author’s view is that the exact same understanding, and skills they have in BEPS-related issues and
information is more likely to be interpreted differently by dif- matters. In other words, there are MNEs that fully under-
ferent tax authorities across continents. The differences could stand how BEPS will change the landscape of the global play-
be a result of various factors: different kinds of priorities and ground and know what to do about it. There are MNEs that
interests, different ways of approaching issues and resolving do not have any idea about what it really means to them at all.
matters, different educational backgrounds, different levels of Advice and recommendations about what the MNEs need to
experiences, different levels of understanding of the informa- do should vary accordingly as well.
tion, and so on. As a result, they could view and respond dif- When cost concerns come first, it is hard to manage trans-
ferently. All this could contribute to unilateral actions by each fer pricing policies. Getting the job done properly is a chal-
tax authority. The author expects a significant number of lenge. For example, to most Korean MNEs, and also for many
lengthy battles between tax authorities and MNEs and also other non-Korean MNEs, minimising compliance costs tops
SOUTH KOREA
the priority list most of time. That mindset is more likely to

result in poorly prepared, low quality documentation. To
Tae Hyung Kim
Partner & Economist
them, BEPS means just another cost or more costs. The
Deloitte Anjin LLC
author’s view is that they fail to see the woods for the trees.
As a result, they don’t have a serious game plan. Tel: +82 2 6676 2410
The number one challenge, therefore, is to change the taehyungkim@deloitte.com
mindset. Top management at the headquarters of MNEs www.deloitteanjin.co.kr
must understand BEPS in great detail and what it means to
them. They must know what MNEs need to do. MNEs are
required to disclose a lot of information that is sensitive and
confidential. For example, they need to describe the overall Tae Hyung Kim is a senior partner and an economist at Deloitte
R&D strategy including ownership and exploitation of intan- Korea. Kim has represented and advised multinational corporations
gibles, location of principle R&D facilities, and location of in various industries on their global transfer pricing and supply
such management and provide a list of intangibles transferred chain management strategies for more than 19 years. In doing so,
cross-border between related parties and a list of important he has handled and resolved complex transfer pricing disputes
agreements, and so on. It is not a choice. It is a must. and negotiations with both Korean and foreign tax authorities.
To the author’s mind, the people at the top management of Kim has been recognised as a world leading transfer pricing
most of the Korean MNEs need a wake-up call. Tax managers adviser by Euromoney’s Legal Media Group and also as a leader
and executives should make sure that the top management is in tax controversy in Korea by International Tax Review. As a
fully aware of what is required in BEPS. The level of detail for country panellist, he has been a regular contributor to BNA
the information that needs to be disclosed should be managed Bloomberg’s international transfer pricing forum.
properly in a professional manner. For that to happen, the top He holds a Ph.D. in economics from the University of
management must understand the depth and breadth of the Washington and is also a graduate of the advanced manage-
details in the information required. Based on prudent business ment programme of Harvard Business School. He graduated from
judgment, the top management should be able to determine Korea University with BA in economics.
the appropriate level of detail for the information that needs to
be disclosed. This is one of the most important processes in
preparing for BEPS challenges going forward.
Action 13 emphasises that the disclosed information will and pay attention immediately. The MNEs need to put in
be used only for tax risk assessment and audit purposes. Tax place a strong team capable of handling all aspects of potential
administrations in all jurisdictions will do the job to protect risks from all angles. This requires new thinking about the
the confidentiality from their end. However; the level of legal people with the right skill sets with global experiences.
protection in each jurisdiction will vary depending on local It is no use locking the stable door after the horse has bolt-
laws and enforcement efforts. It will be wise for MNEs to ed. If BEPS is not managed properly, there will be the devil
make every effort to ensure that that remains the case. It is to pay. Above all, it could do serious harm to brand and rep-
prudent for MNEs to monitor such efforts being made utation, not to mention operations and businesses. Social net-
around the globe. Again, remember that all confidential infor- works convey news in the wink of an eye. In particular, bad
mation will be accessed and analysed by virtually all relevant news travels fast. It is a big deal.
tax authorities at the end of the day. A sense of urgency is needed. There are a few must-dos for
Korean MNEs. First and foremost, top management and
Time to move with a sense of urgency management executives should grasp the gravity of BEPS as
There is a prevailing perception in Korea that what MNEs are soon as possible. They also need to instill the sense of urgency
paying as taxes is not fair. Nowadays, this perception may in employees to win their buy-in as well. Under the new rules
apply to other jurisdictions as well. Whenever there is news of the international tax game, noncompliance penalties, addi-
about tax matters of MNEs, it is bad news. Bad news grabs tional taxes, reputational risks, and loss of value-enhancing,
public attention quickly. It makes a big impact but in a bad tax-saving opportunities won’t come in a small package.
way. That is why Korean MNEs should worry about BEPS Being wise after the fact is not wise after all.
SWITZERLAND
Intangibles in a post-BEPS
world
n October 5 2015, the OECD delivered a final package of reports

The framework for
analysing intercompany
O providing recommendations and guidance in connection with the 15-
point action plan to address base erosion and profit shifting (BEPS).
The 186-page final report, which covers BEPS Actions 8-10,
Aligning Transfer Pricing Outcomes with Value Creation, Actions 8-10
transactions involving Final Report (in this article referred to as the Report) offers guidance
on a multitude of transfer pricing topics, most importantly guidance for
intangibles is examined applying the arm’s length principle (focusing on economic substance,
risks/control and corresponding rewards) and on intangibles.
by Hendrik The Report replaces various sections of the OECD Transfer Pricing
Guidelines for Multinational Enterprises and Tax Administrations, 2010
Blankenstein and (TPG). For countries that formally subscribe to the TPG, the new guid-
ance offered by the Report takes the form of agreed amendments to the
Caterina Colling Russo TPG. These amendments will become part of the TPG after they have
formally been adopted by the OECD Council.
at Tax Partner AG – Within the Report a strong emphasis is placed on the accurate delin-
eation of the actual intercompany transaction by making use of pre-
Taxand Switzerland. determined analytical frameworks (para. 1.60, p. 22 and para. 6.34, p.
74) offering taxpayers and tax authorities a stepped approach on how to
Does the new DEMPE achieve an accurate delineation of the transaction under review.
Paragraph 6.34 of the Report provides a specific analytical framework
analysis benefit MNEs for analysing intangibles in controlled transactions. Within the pre-
scribed analytical framework, multinational enterprises (MNE) need to
and tax authorities or focus on the DEMPE functions (development, enhancement, mainte-
nance, protection and exploitation) with a view to determining which
simply confuse matters, group entities in the MNE undertake and more importantly control
these functions.
resulting in an increase In this article, we will discuss the framework for analysing intercom-
pany transactions involving intangibles and, in particular, whether the
of intangibles-related newly introduced DEMPE analysis benefits the MNEs and tax authori-
ties in their analysis or whether it will merely confuse matters resulting
disputes? instead in an increase of intangibles-related transfer pricing disputes.
Framework for analysing intercompany transactions involving

intangibles
The steps of the analytical framework will lead to a DEMPE analysis of
the transaction aimed at providing the MNE with all the ingredients to
correctly delineate the transaction before determining the intercompany
pricing.
SWITZERLAND
Caterina Colling Russo Hendrik Blankenstein

Tax Partner AG, Zurich Tax Partner AG, Zurich
Tel: +41 44 215 77 56 Tel: +41 44 215 77 54

caterina.collingrusso@taxpartner.ch hendrik.blankenstein@taxpartner.ch
Caterina Colling Russo, a senior adviser with Tax Partner, has Hendrik Blankenstein is a partner of Tax Partner AG and leads its
more than 10 years’ full-time experience in transfer pricing con- transfer pricing team. From 1989 to 1995, Hendrik was an inter-
sulting. Caterina has previously held specialist transfer pricing national tax consultant at Big 4 firms in both the US and the
positions within global international tax and transfer pricing firms. Netherlands, from 1996-2004 he worked as an in-house interna-
She has worked in Amsterdam, London and Rome. tional tax and transfer pricing counsel at Nestlé’s HQ in
Caterina has extensive experience in tax planning/restructuring Switzerland, and from 2005 to 2015 as a Swiss based partner in
projects and has performed transfer pricing studies for clients in globally operating transfer pricing boutique consultancy firms.
a wide variety of industries including apparel, banking, luxury Hendrik has been providing transfer pricing advice to Swiss
goods, oil and gas, commodities, fast-moving consumer goods and foreign multinational clients in a variety of industries, cover-
and pharmaceutical. Caterina has provided assistance to clients ing design of transfer pricing systems, preparation of
developing strategies for the conclusion of APAs as well as tax masterfile/local file documentation, negotiation and conclusion of
audit defence in multiple European countries. Her technical skills unilateral/bilateral APAs, successful management of complex
include valuation of intangibles, and transfer pricing aspects of transfer pricing audits and setting up transfer pricing risk man-
business restructuring. Moreover, she provides advice relating to agement frameworks.
inter-company financial transactions, ranging from guarantee fee Tax Partner AG, which currently comprises 12 partners and 26
and interest rate projects (transfer pricing policy and benchmark- tax professionals, has become a leading Swiss tax boutique firm,
ing) to providing transfer pricing solutions for intermediate focusing on providing tax services such as international and
finance companies as well as for captive insurance companies. national corporate tax, individual tax and VAT. Each of the 12
partners has their area of specialisation. With regard to related
services such as legal, audit and accounting services, Tax Partner
typically cooperates with local firms. For further information
about Tax Partner, please refer to www.taxpartner.ch.
The framework for analysing transactions involving intan- are, however, only for illustrative purposes and not intended
gibles between associated enterprises requires taking the fol- to be comprehensive. In this context, it is clarified that group
lowing steps: synergies and market-specific characteristics are elements to
take into account in a comparability analysis, but are not
Step 1: Identify the intangibles intangibles.
The MNE has to define the intangibles at stake with specifici- Intangibles used or transferred in a controlled transac-
ty, in conjunction with the specific, economically significant tion already under the existing guidelines needed to be
risks associated with the DEMPE of the intangibles. identified with some specificity. What is new is the DEMPE
In order to support MNEs in performing this step, the analysis, i.e. the MNE has to identify which activities it clas-
Report includes a definition of intangibles only for transfer sifies as development, enhancement, maintenance, protec-
pricing purposes. Paragraph 6.6 defines intangibles as “some- tion and exploitation in relation to the defined intangible
thing which is not a physical asset or a financial asset, which is and analyse the intercompany transactions focusing on
capable of being owned or controlled for use in commercial these activities.
activities, and whose use or transfer would be compensated
had it occurred between independent parties in comparable Step 2: Identify the full contractual arrangement
circumstances”. It is recommended that the MNE maintains the documents
In addition, some guidance is given through examples of necessary to derive the legal basis of their cross-border inter-
what can and cannot be defined as intangibles. The examples company transactions involving intangibles, as these documents
SWITZERLAND
form the starting point for any transfer pricing analysis. The The new guidance reaffirms and reinforces the necessity
terms of a transaction may be found in written contracts, public for alignment between the legal reality and the economic real-
records such as patent or trademark registrations, or in corre- ity already present in the 2010 TPG and more importantly
spondence and/or other communication among the parties. As the prevalence of the economic reality, i.e. the conduct of the
mentioned in the Report at para. 6.35, contracts may describe parties, over the legal reality (terms of the transaction). We
the roles, responsibilities and rights of associated enterprises refer in particular to paragraph 1.48 of the 2010 TPG “in
with respect to intangibles. relation to contractual terms, it may be considered whether a
purported allocation of risk is consistent with the economic
Step 3: Identify the parties performing functions, using assets substance of the transaction. In this regard, the parties’ con-
and managing risks related to intangibles in relation to duct should generally be taken as the best evidence concern-
DEMPE ing the true allocation of risk.” Or paragraph 1.53 of the
The MNE has, by means of the functional analysis, to review 2010 TPG: “The same divergence of interests may not exist
the conduct of the parties under a DEMPE analysis. In other in the case of associated enterprises, and it is therefore impor-
words, MNEs have to clarify which group entities: tant to examine whether the conduct of the parties conforms
• perform the DEMPE functions; to the terms of the contract or whether the parties’ conduct
• use the assets related to the DEMPE functions; and indicates that the contractual terms have not been followed or
• control the economically significant risks related to the are a sham. In such cases, further analysis is required to deter-
DEMPE functions. mine the true terms of the transaction.”
This analysis does not differ from the already well-known The DEMPE analysis should be considered when draft-
and widely applied concept of functional analysis, however, ing or reviewing intra-group agreements, specifically how
now from a DEMPE perspective. Therefore, MNEs are now the allocation of roles, responsibilities and risks are provid-
required to identify specific activities for each DEMPE func- ed for.
tion and ascertain the relative importance of each DEMPE
function. Such detailed analysis may be required not only Step 5: Delineate the actual controlled transactions related to
involving group entities, which are currently involved in the DEMPE of intangibles
DEMPE activities, but also entities which performed This step is the key outcome of the analytical framework. In
DEMPE activities in the past. this step, the MNE has, on the basis of the steps performed
The Report fails to define the DEMPE functions in much so far, access to all the key elements to accurately delineate the
detail. It is clear that DEMPE may have a different meaning actual controlled transaction(s) related to the DEMPE of
depending on the industry. In pharma, the several stages of intangibles, hence offering the required basis for determining
R&D (and the importance of hard-to-value intangibles) may an arm’s length pricing of the delineated intercompany trans-
assume great relevance whereas in consumer goods, the focus action (see next step).
may be more on brand value and the role of marketing and
advertising. However, even in the same industry, MNEs may Step 6: Pricing of the delineated transactions
categorise activities – which are similar in nature – in a differ- The MNE, where possible, has to determine the arm’s length
ent way. prices for the transactions under review consistent with each
party’s contributions of functions performed, assets used and
Step 4: Review the consistency between contractual risks assumed.
arrangements and conduct of the parties through functional Assuming a BEPS-proof DEMPE analysis has been con-
analysis (DEMPE) ducted, a further and likely more far-reaching challenge will
Once the contractual arrangements and the conduct of the be to determine the pricing of the delineated transaction con-
party/-ies have been reviewed within the DEMPE analysis sistent with the respective contribution(s) of the group com-
context, the MNE has to confirm that there is consistency panies to each of the DEMPE functions.
between legal and economic reality while determining The Report addresses the extreme, however not rare, cases
whether the party assuming economically significant risks aris- of so-called “cash boxes”, in which an associated enterprise
ing out of the DEMPE functions also controls these risks and provides funding without either performing any functions
has the financial capacity to assume them. relating to intangibles or control over the financial risk. For
The conduct of the parties is leading. Only where the con- these cases, the cash box would only be entitled to a risk-free
duct of the parties and the legal reality of a transaction match return, whereas in the presence of control over the financial
will a transfer pricing effect be produced: being the legal risk it can expect a risk-adjusted return on its funding.
owner of the intangible does not confer any right ultimately More challenging however, and still lacking clear guid-
to retain returns, even though such returns may initially ance, are all those intercompany transactions where, often
accrue to the legal owner as a result of legal rights. for operational reasons, the DEMPE activities are highly
SWITZERLAND
fragmented amongst associated companies. The compensa- MNEs’ burden of proof is expected to increase, and MNEs
tion for each party’s contribution might not be easy to should not miss the opportunity to explain the necessary
determine, especially in cases where the industry does not company and industry background underlying their transfer
offer good availability of comparable transactions undertak- pricing policies as part of their transfer pricing documenta-
en by independent parties. The authors expect that cases like tion. This includes a detailed description of the group supply
these will probably lead to detailed price adjustment proce- and value chain in the context of the intangibles-related trans-
dures and probably in some more frequent cases to the actions. This is key to support the taxpayer in performing a
adoption of a profit split methodology. satisfactory DEMPE analysis.
In line with the refreshed concept of a transfer pricing mas-
Conclusions ter file, as contained in Annex I to Chapter V of the Transfer
In practice, the authors have observed that tax authorities have Pricing Documentation and Country-by-Country Reporting
started to require the taxpayer in tax audits, in litigation, – Action 13: Final Report – MNEs are now offered the
Advance Pricing Agreement (APA) and Mutual Agreement opportunity to present their supply chain as well as all the rel-
Procedures (MAP) to substantiate their position using the evant information needed to provide a blueprint of the group
approaches laid down in BEPS Actions 8-10. Consequentially, and ultimately to support and justify the selected transfer pric-
MNEs can expect having to demonstrate through the pre- ing policy.
scribed frameworks, leading to a more detailed functional, risk Pricing intercompany transactions in light of a DEMPE
and DEMPE analysis, that the intercompany transactions are analysis in some industries will favour the use of a profit split
delineated accurately and priced correctly. methodology, however guidance on profit split is still under
Most steps in the framework for analysing intercompany review within the BEPS project.
transactions involving intangibles are not new. What is new is The DEMPE analysis will put some pressure on defining
that – for intangibles-related transactions – MNEs need to focus the correct intercompany pricing and identifying comparable
on the DEMPE functions with a view to determining who in the uncontrolled prices, especially for those intercompany trans-
MNE group undertakes and more importantly controls these actions where, often for operational reasons, the DEMPE
functions. Whilst the concept of identifying value-adding func- activities are highly fragmented amongst associated compa-
tions and attributing returns based on the respective value added nies. In these cases, would the taxpayer be able to find com-
is understood, the new OECD guidance fails to define the parable independent parties that have allocated the DEMPE
DEMPE functions. The lack of definition of key terms of the functions in a comparable way? Again some industries will
new guidance will undoubtedly lead to increased uncertainty as offer good availability of comparable deals undertaken among
the interpretation of a) which activities constitute which independent parties, where such comparables will not be
DEMPE function and b) what relative importance should be available, assuming the transaction has been correctly delin-
attributed to each function will likely lead to an increasing num- eated, this would certainly lead to detailed price adjustments
ber of disputes between MNEs and tax authorities. procedures and probably in some more frequent cases to the
MNEs are required to ascertain the relative importance of adoption of a profit split methodology. Additional guidance
each DEMPE function in their respective industry and value on the use of the profit split method, hopefully including
chain and identify specific activities for each DEMPE function in practical commercial examples for both businesses and tax
order to be able to undertake the detailed analysis, as required. authorities, is expected to be provided by the OECD in 2017.
US
Responding to the changes in

the transfer pricing landscape
here have been a number of recent important developments on the

The Internal Revenue
Service appears to be
T US transfer pricing front. The Internal Revenue Service (IRS) issued
new § 482 regulations in what seems to be an effort to strengthen its
positions on aggregating transactions and applying economic substance
rationales to override related-party contracts.
strengthening its stand In a recent Notice, the IRS stated that regulations will be issued apply-
ing the transfer pricing methods in the cost-sharing rules to transfers of
on aggregating intangibles to controlled partnerships.
In the Guidant LLC v. Commissioner, 146 T.C. No. 5 (2016) motion
transactions and for partial summary judgment, the Tax Court ruled in favor of the IRS on
a question of aggregation in a transfer pricing adjustment.
applying economic
New 482 Temporary Regulations
substance rationales to The Treasury Department and the IRS issued new Temporary Regulations
under § 482 that are effective to taxable years ending on or after
override related-party September 14 2015. The stated purpose is to coordinate § 482 with other
Code provisions. However, the changes to the 482 regulations appear to
contracts. David Forst be more aggressive than simple coordination rules and clarifying changes.
The preamble states that controlled transactions always remain subject
and Larissa Neumann of to Section 482 even if other Code provisions apply. In the preamble, the
IRS states that it has encountered taxpayer positions involving incomplete
Fenwick & West discuss assessments of the relevant functions, resources, and risks, and an inappro-
priately narrow analysis of the scope of the transfer pricing rules. It certain-
US developments ly will benefit the taxpayer to have prepared thorough and well-drafted
documentation.
including the IRS and The new provision in Temp. Treas. Reg. § 1.482-1T(f)(2)(i)(A) pro-
vides that arm’s length compensation must be consistent with, and must
Treasury Department- account for all of, the value, without regard to the form or character of the
transaction. The regulation states it is necessary to consider the entire
issued 482 Temporary arrangement as determined by the contractual terms, whether written or
imputed in accordance with the economic substance, in light of the actual
Regulations. conduct of the parties. The IRS will likely attempt to use this regulation to
more aggressively assert that controlled parties’ contractual arrangements
should be ignored in favor of some broader economic substance argument.
Temp. Treas. Reg. § 1.482-1T(f)(2)(i)(B) states that transactions may
be considered together, and taken as a whole, if they are so interrelated
that an aggregate analysis provides the most reliable measure of an arm’s
length result. Prior rules provided for aggregation only in the case of con-
trolled transactions involving related products or services. The preamble
US
calls this a clarification, but the Obama administration pro- a method based on Treas. Reg. § 1.482-7(i)(6)(v), as well as
posed a change in the statute to permit this type of aggrega- any necessary corresponding adjustments to section 704(b) or
tion, but that proposal was never enacted. section 704(c) allocations.
The Temp. Treas. Reg. § 1.482-1T(f)(2)(i)(C) provision The Notice states in its Reasons For Exercising Regulatory
provides that overall value (including any synergies) must be Authority that an example it is concerned about is where a
taken into account. The preamble and regulations repeatedly domestic partner receives a fixed preferred interest in
refer to “synergies”. It is not clear what these “synergies” are. exchange for the contribution of an intangible that is assigned
“Synergies” are not an intangible listed in § 936(h)(3)(B), and a value that is inappropriately low, while a related foreign
parties operating at arm’s length do not license “synergies”. partner is specially allocated a greater share of the income
The Temporary Regulation contains 11 examples. from the intangible.
Examples 1 through 4 are materially the same as prior regula- The Notice appears to take the position that a taxpayer
tions. The remaining examples are new. who contributes intangible property and elects the Gain
Example 5 deals with aggregation. Parent owns 10 individ- Deferral Method, and therefore the application of the reme-
ual patents that together can be used to manufacture and sell dial allocation method, could still be subject to further adjust-
a successful product. Parent anticipates that it can earn $25 ments in excess of its Built-in Gain amount. The Notice states
from the patents as a bundle. Parent licenses all 10 patents to that when intangible property is contributed to a partnership,
a foreign subsidiary to be exploited as a bundle. Comparable the IRS may consider making periodic adjustments under
data indicates that each license is worth $1, implying a total Treas. Reg. § 1.482-4(f)(2) in years subsequent to the contri-
value of $10. The example states that it would not be appro- bution, without regard to whether the taxable year of the
priate to use the $1 dollar comparables because it does not original transfer remains open for statute of limitations pur-
reasonably reflect the enhancement to value resulting from poses. It states that the IRS may do so regardless of whether
the interrelatedness of the 10 patents exploited as a bundle. § 721(a) applies to the initial contribution of intangible prop-
In Example 6, parent and its foreign subsidiary have a cost erty to the partnership. Therefore, in the IRS’s view, even if a
sharing agreement, but the parent continues to perform sup- taxpayer elects the Gain Deferral Method, it still would be
port for the foreign subsidiary. The example states that the subject to adjustments under § 482 even though § 721(a)
IRS may impute agreements or even another platform contri- applies.
bution transaction (PCT) for the support services. This exam- Of course, any new rules that the IRS writes in this regard
ple implies that the IRS’s assertion of economic substance would need to be consistent with the arm’s length standard,
overrides the actual contractual terms. Examples 8 and 9 also which underlies all of § 482. See, e.g., Treas. Reg. § 1.482-
involve cost sharing agreements where the IRS can ignore the 1(b); Xilinx v. Commissioner, 598 F. 3d 1191 (9th Cir. 2010).
contracts. The Notice reiterates the application of § 482 to con-
In Example 10, parent provides R&D services building on trolled transactions involving partnerships under existing law.
the product platform. The example states the parent is provid- See Treas. Reg. §§ 1.704-1(b)(1)(iii), -1(b)(5), Example 28
ing an embedded value to the foreign subsidiary and the for- in this regard. The Notice states that examples of the applica-
eign subsidiary must compensate the US parent for this value. tion of § 482 under current law include adjustments to the
The example states that parent takes the position that the amounts of contributions to, and distributions from, a part-
know-how does not have substantial value independent of the nership; partnership allocations, including allocations under
services of any individual on the R&D Team. This is the posi- § 704(c), and the relative magnitudes of the partners’ part-
tion the taxpayer took in Veritas and won. nership interests in light of their respective contributions and
the related controlled transactions.
Transfers of IP to Controlled Partnerships The Notice also states that the IRS can impute terms to a
In Notice 2015-54 Treasury and the Service state that they partnership agreement that are consistent with the substance
intend to issue regulations similar to the Treas. Reg. § 1.482- of a transaction, for example, when a partner provides services
7 cost-sharing regulations to controlled transactions involving to the partnership but neither the partnership agreement nor
partnerships. Specifically, the Notice states that regulations any other agreement reflects the provision of such services.
will be issued applying the methods specified in Treas. Reg. Further, according to the Notice, the IRS can apply an aggre-
§ 1.482-7(g), as adjusted to take into account the differences gate analysis under Treas. Reg. § 1.482-1(f)(2)(i) to the
between partnerships and cost sharing arrangements. extent that controlled transactions involving a partnership,
Additionally, the Notice states that the regulations will pro- including contributions of tangible and intangible property
vide periodic adjustment rules that are based on the principles and the provision of services by the controlled partners or
of Treas. Reg. § 1.482-7(i)(6) so that in the event of a trigger their affiliates, are interrelated if the aggregate analysis pro-
based on a significant divergence of actual returns from provides the most reliable means of determining the arm’s length
jected returns, the IRS may make periodic adjustments under results for the controlled transactions.
US
David Forst Larissa Neumann

Fenwick & West Partner, Tax Group
Fenwick & West
Tel: +1 650 335 7254
Fax: +1 650 938 5200 Tel: +1 650 335 7253
dforst@fenwick.com lneumann@fenwick.com
www.fenwick.com www.fenwick.com
David Forst is the practice group leader of the tax group of Larissa Neumann focuses her practice on US tax planning and tax
Fenwick & West. He is included in Euromoney’s Guide to the controversy with an emphasis on international transactions. She has
World’s Leading Tax Advisers. He is also included in Law and broad experience advising clients on acquisitions, restructurings and
Business Research’s International Who’s Who of Corporate Tax transfer pricing issues. She has successfully represented clients in
Lawyers (for the last six years). David was named one of the top federal tax controversies at the audit level, in appeals and in court.
tax advisers in the western US by International Tax Review, is Larissa appears in International Tax Review’s “World’s Tax
listed in Chambers USA America’s Leading Lawyers for Business Controversy Leaders” and in Euromoney’s World’s Leading Tax
(2011-2014), and has been named a Northern California Super Advisers. Euromoney selected Larissa for inclusion in the Americas
Lawyer in Tax by San Francisco Magazine. Women in Business Law Awards shortlist for Best in Tax Dispute
David’s practice focuses on international corporate and part- Resolution in 2014 and she was named the 2015 Rising Star: Tax.
nership taxation. He is a lecturer at Stanford Law School on She was also named to the Silicon Valley Business Journal’s 40 Under
international taxation. He is an editor of and regular contributor 40. In 2016, Larissa was named a Rising Star in tax by Law360.
to the Journal of Taxation, where his publications have included Larissa frequently speaks at conferences for professional tax
articles on international joint ventures, international tax aspects groups, including TEI, IFA, Pacific Rim Tax Institute, Bloomberg,
of M&A, the dual consolidated loss regulations, and foreign cur- and the ABA. She is the ABA International Law Tax Liaison.
rency issues. He is a regular contributor to the Journal of Larissa has published several articles, including recently:
Passthrough Entities, where he writes a column on international • US Tax Overview, Euromoney’s LMG Rising Stars 2015
issues. David is a frequent chair and speaker at tax conferences, • US transfer pricing litigation update, International Tax Review
including the NYU Tax Institute, the Tax Executives Institute, and (March 2015)
the International Fiscal Association. • Areas of TP Scrutiny in a pre- and post-BEPS World,
David graduated with an AB, cum laude, Phi Beta Kappa, from International Tax Review (February 2015)
Princeton University’s Woodrow Wilson School of Public and • U.S. International Tax Developments, The Euromoney Corporate
International Affairs, and received his JD, with distinction, from Tax Handbook 2015
Stanford Law School. • U.S. Transfer Pricing Developments, International Tax Review (2014)
• U.S. Tax Developments, International Tax Review
(December/January 2013)
• Character and Source of Income from Internet Business
Activities, The Contemporary Tax Journal (July 2011)
• The Application of the Branch Rule to Partnerships,
International Tax Journal (July – August 2010)
Fenwick has one of the World’s Top Tax Planning and Tax
Transactional Practices, according to International Tax Review, and is
first tier in tax, according to World Tax. International Tax Review gave
Fenwick its San Francisco Tax Firm Award a total of seven times and
its US Tax Litigation Firm Award a total of three times. International Tax
Review has also named Fenwick Americas M&A Tax Firm of the Year.
Larissa is a leader on Fenwick’s Pro Bono Review Committee
and regularly provides pro bono services to various nonprofit
organisations. Fenwick was recognised by The National Law
Journal Pro Bono Hot List (2014) and Larissa’s nonprofit work is
pointed to as exemplary in the profile.
US
Finally, the Notice also states that Treasury and the IRS taxpayer within a consolidated group contemporaneously
are considering issuing regulations under Treas. Reg. with the making of a § 482 adjustment. The court also held
§ 1.6662-6(d) to require additional documentation for cer- that the IRS is permitted to aggregate one or more related
tain controlled transactions involving partnerships. These transactions instead of making specific adjustments with
regulations may require, for example, documentation of pro- respect to each type of transaction.
jected returns for property contributed to a partnership (as While the court stated that Treas. Reg. § 1.482-1(f)(1)(iv)
well as attributable to related controlled transactions) and of requires the IRS to determine both consolidated taxable
projected partnership allocations, including projected reme- income and separate taxable income when making a § 482
dial allocations covered, for a specified number of years. adjustment with respect to income reported on a consolidated
return, the court held that as a matter of law the IRS can
Guidant assert a § 482 adjustment before it determines the separate
Guidant involves a group of US corporations that filed con- taxable income. The court stated that the regulation does not
solidated federal income tax returns (collectively, the “taxpay- preclude the IRS from deferring making the separate taxable
er”). During the years in issue, the taxpayer consummated income determinations for each member until the time when
transactions with its foreign affiliates including the licensing such a determination is actually required.
of intangibles, the purchase and sale of manufactured proper- The court stated that whether the IRS’s decision to delay
ty, and the provision of services. the separate-company taxable income computations consti-
The IRS utilised § 482 to adjust the reported prices of the tutes an abuse of discretion under these circumstances is still
different transactions. The IRS asserted an adjustment to the in dispute and remains to be determined on the basis of the
taxpayer’s income without making specific adjustments to any full record as developed at trial. Thus, the court did not con-
of the subsidiaries’ separate taxable incomes. The IRS also did clusively hold that the IRS’s § 482 adjustments were not arbi-
not make specific adjustments for each separate transaction, trary, capricious or unreasonable as a matter of fact. It only
but rather asserted an aggregated transfer pricing adjustment. held that the IRS’s § 482 adjustments were not arbitrary,
The taxpayer filed a motion for partial summary judgment capricious, or unreasonable as a matter of law.
asserting that the IRS adjustments were arbitrary, capricious, The taxpayer also argued that the IRS’s § 482 adjustments
and unreasonable as a matter of law since the IRS did not were arbitrary, capricious and unreasonable because the serv-
determine “true taxable income” of each controlled taxpayer ice did not make separate adjustments for each transfer of
as required under Treas. Reg. § 1.482-1(f)(iv) and did not intangible property, transfer of tangible property and provi-
make specific adjustments with respect to each transaction. sion of services. The applicable regulations in determining the
The court denied the taxpayer’s motion stating that nei- arm’s length consideration aggregation is permitted if it
ther § 482 nor the regulations thereunder requires the IRS to serves as the most reliable means of determining the arm’s
determine the true taxable income of each separate controlled length consideration for the transactions.

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TA X R E F E R E N C E L I B R A RY N O 1 0 8

Published in association with:

Transfer Pricing 18th edition

BEPS: 8 Bouverie Street

In a post-BEPS world, less emphasis is placed on legal

There is more to BEPS than

he Korean National Tax Service (NTS) and the Ministry of Strategy

BEPS is a whole new ball game

Prepare for unilateral actions MNEs need to reset the mindset

the priority list most of time. That mindset is more likely to

n October 5 2015, the OECD delivered a final package of reports

Framework for analysing intercompany transactions involving

Caterina Colling Russo Hendrik Blankenstein

Tel: +41 44 215 77 56 Tel: +41 44 215 77 54

Responding to the changes in

here have been a number of recent important developments on the

David Forst Larissa Neumann

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