Transfer Pricing Handbook

Robert Feinschreiber (Key Biscayne, FL) is an attorney with Feinschreiber and Associates. He has had numerous career highlights (e.g., member of the litigation team for the first Asian transfer pricing case (Toyota)). In addition, he is a consultant with the United Nations (Brazil, China, and Russia). Feinschreiber is on the editorial board of Wolters Kluwer - CCH, and Thomson - RIA. He has written over 25 books and is the co-editor of Corporate Business Taxation Monthly (CCH). He speaks at numerous conferences in the United States and Asia. Margaret Kent (Key Biscayne, FL) is an attorney with Feinschreiber and Associates. She focuses on law and international taxation. She has been involved in a number of international transactions (i.e., structured the termination of the $2 billion per year aid from Russia to Cuba; structured transfer pricing in Latin America: Argentina, Chile, Colombia, Costa Rica, and Venezuela). Kent is also the co-editor of Corporate Business Taxation Monthly (CCH).

• Preface xviiPart I: Basic Transfer Pricing Standards 1Chapter 1: Introduction 3Control 4Tax Havens 5Complexities 5Chapter 2: Arm’s Length Principle 7General Explanation of the Arm’s Length Principle 8Formal Statement as to the Arm’s Length Principle 10Comparability Considerations 11Rationale behind the Arm’s Length Principle 11Compensation Issues 12Applying the Arm’s Length Principle to Contribution Analysis 13Oligopolistic Conditions 14Transactions That Independent Enterprises Would Not Undertake 15Administrative Burdens of the Arm’s Length Principle 15Maintaining the Arm’s Length Principle as the International Consensus 16Rejection of Alternative Transfer Pricing Approaches 17Notes 18Chapter 3: Arm’s Length Range 19Single-Figure Approach to the Arm’s Length Range 19Reliability Requirement 20Comparability Considerations 20Consequences of Applying More Than One Transfer Pricing Method 21Selecting the ‘‘Most Appropriate Point’’ in the Range 22Extreme Results: Comparability Considerations 23Notes 24Chapter 4: Safe Harbor Simplification 27Safe Harbor Burdens and Benefits 28Defining ‘‘Safe Harbor’’ 29Scope of the Safe Harbor Provisions 30How Arbitrary are the Safe Harbor Provisions? 31Factors Supporting the Use of Safe Harbors 31Problems That Safe Harbors Present 33Multiple Jurisdictions 39Possibility of Opening Avenues for Tax Planning 40Statistical Data and a Safe Harbor Example 40Undertaxation 41Safe Harbor Principles 41Equity and Uniformity Issues 41Recommendations as to the Use of Safe Harbors 42Safe Harbors as Surrender of the Tax Administration’s Discretionary Power 43Flexible Practices 43Country-Specific Practices 44Comprehensive Example 44Notes 45Chapter 5: Modifying Safe Harbor Simplification 47The Study 47Eleven Specific Transfer Pricing Measures 48Notes 55Chapter 6: Global Formulary Apportionment 57Profit Split Methodologies 58Global Dealing 58Attack on Global Formulary Apportionment 58Impact of the Arm’s Length Principle 59Comparing Global Formulary Apportionment with the Arm’s Length Principle 60Double Taxation 60Lack of a Common Accounting System 61Factor Selection 62Transitional Issues 62Economic Issues 62Impact of Exchange Rate Movements 63Compliance Costs and Data Requirements 63Valuation Difficulties 64Separate Entity Approach versus Global Formulary Apportionment 64Bilateral Tax Treaties 65Members of the Multinational Group Excluded from Global Formulary Apportionment 65OECD’s Rejection of Non–Arm’s Length Methods 66Safe Harbors 66Notes 67Part II: Transfer Pricing Methodologies 69Chapter 7: Transactional Profit Split Measures 71Transactional Profit Split Method Concepts 72Strengths and Weaknesses of the Transactional Profit Split Method 73Availability of Comparables in Applying the Transactional Profit Split Method 74Importance of Functional Analysis in Applying Transactional Profit Split Methods 74Transactional Profit Split Method Weaknesses 75Applying Transactional Profit Split Methods 76Guidelines Profit Splitting Approaches 77Determining the Combined Profits to Be Split 79Actual Profits versus Projected Profits 80Different Profit Measures When Applying the Transactional Profit Split 81How to Split the Combined Profits 82Reliance on Comparable Uncontrolled Transactions Data 83Allocation Keys 83Reliance on Internal Data 86Conclusions as to Transactional Profit Split Methods 88Notes 89Chapter 8: Profit Split Illustrations 91Three Basic Assumptions 91Three Residual Profit Split Alternatives 92Commentary 96Notes 97Chapter 9: Residual Profit Split Examples 99Presumptions and Preconditions 99Essential Factual Pattern Conflict 100Functional Activities 100Selecting Transfer Pricing Approaches 101Applying the Residual Profit Split Approach 101Drafters’ Disclaimer 104Contribution Approach 104Notes 105Chapter 10: Transactional Net Margin Method 107Initial TNMM Considerations 107How the Transactional Net Margin Method Works 108TNMM Reliability 109Strengths of the TNMM 110Weaknesses of the TNMM 111Applying the Comparability Standard to the TNMM 112Database Issues: The Audio Player Example 114Impact on the Arm’s Length Range 114Selecting the TNMM 115Selecting the Net Profit Indicator 115Exclusion and Measurability 120Cases in Which Net Profits are Weighted to Sales 120Cases in Which Net Profits are Weighted to Costs 121Cases in Which Net Profits are Weighted to Assets 123Berry Ratios 124Other Guidance 126TNMM Examples 126How the OECD Views the TNMM 128Notes 128Chapter 11: Selecting Profit Indicators 133Illustration 1 134Illustration 2 136Illustration 3 138Notes 139Chapter 12: Selecting Transfer Pricing Methods 141When Can a Business Apply a Multisided Transfer Pricing Method? 142When Should a Business Not Apply a Multisided Transfer Pricing Method? 144Part III: Comparability Analysis 147Chapter 13: How Comparability Analysis Works 149Determining When Transactions are Comparable 149Factors and Comparability 152Functional Analysis 155Economic Circumstances 161Business Strategies 162Return on Investment 164Recognizing the Actual Transactions Undertaken 165Associated Enterprises and Independent Enterprises: In Contrast 167Alternatively Structured Transactions 167Losses 168Multinational Enterprises 168Implementing Business Strategies 169Impact of Governmental Policies 170Notes 173Chapter 14: Comparability Techniques 177General Comparability Guidance 177Typical Comparability Processes 179Broad-Based Analysis of the Taxpayer’s Circumstances 181Controlled Transaction and Choice of a Tested Party 181Comparable Uncontrolled Transactions 188Selecting or Rejecting Potential Comparables 193Additive Approach 193Comparability Adjustments 196Arm’s Length Range 199Notes 202Chapter 15: Timing and Comparability 205Timing of Origin 206Timing of Collection 206Valuation That is Highly Uncertain 207Data from Years Following the Year of the Transaction 208Multiple-Year Data 208Compliance Tools 210Notes 210Part IV: Administrative Approaches 213Chapter 16: Transfer Pricing Audits 215Transactional Profit Split Method 216Simultaneous Tax Examinations and Transfer Pricing 216Tax Arrangements 217Potential Levels of Cooperation between Tax Administrations 218Examples 220Notes 224Chapter 17: Monitoring the Guidelines 227Understanding the Monitoring Process 228Method Selection 228Specific Monitoring Processes 229Working Party No. 6 Peer Reviews 229Three Peer Review Levels 230Peer Review Selection Criteria 231Difficult Case Paradigms 231Biennial Members of Tax Examiners 232Business Community Involvement 233Business Industry Advisory Committee 233Business’s Role in Contributing to the OECD 235Peer Reviews and the Business Community 235Business Community’s Updates on Legislation and Practice 236Role of the U.S. Council for International Business 236Notes 237Part V: Advanced OECD Analysis 239Chapter 18: Documentation Requirements 241Introductory Issues and Burden of Proof 241Guidance on Documentation Rules and Procedures 242Useful Information for Determining Transfer Pricing 244Summary of Recommendations on Documentation 245Notes 245Chapter 19: Intangible Property 247Basic OECD Intangible Property Provisions 247Future Intangible Property Developments 248Arm’s Length Intangible Property Issues 249OECD Intangible Property Developments 249Soft Intangibles 250Highly Uncertain Valuation Issues 250Steps That an Independent Enterprise Might Undertake to Resolve Uncertainty 251Tax Administrator’s Response 253Timing Considerations 254OECD Highly Uncertain Valuation Examples 254What the OECD Should Do Now 259Notes 260Chapter 20: Service Arrangements 263Overview 263Scope of Intragroup Arrangements 264Shareholder Activities and Stewardship Activities 267Adjusting to the Form of the Arm’s Length Consideration 270‘‘On Call’’ Services 270Evaluating ‘‘On Call’’ Services 271Determining an Arm’s Length Charge for the Intragroup Service 272Including Service Costs in the Transfer of Goods 275Double-Taxation Risks 276Examining the Actual Use of the Services 276Calculating the Arm’s Length Consideration 276Applying Transfer Pricing Methods 277Functional Analysis 278Business Strategies: Profits for the Service Provider 278Applying the Cost-Plus Method for Intragroup Services 279Cost-Benefit Issues and Safe Harbor 280Intragroup Service Examples 281Specialized Services 283Multinational Service Enterprises 283Specialized Service Industries 284Applying the Transactional Profit Split Method to Services 284Notes 285Chapter 21: Cost Contribution Arrangements 289Overview 289Cost Contribution Arrangement Criteria 291Mandatory CCA Arm’s Length Requirements 296Applying an Applicable Allocation Key 300Tax Treatment of Contributions and Balancing Payments 302Entry, Withdrawal, and Termination of a Cost Contribution Arrangement 306Recommendations for Monitoring and Structuring Cost Contribution Arrangements 309Documentation 310Notes 312Chapter 22: Business Restructuring 315Special Risk Considerations 316Compensation for Undertaking the Restructuring 318Postrestructuring Remuneration 321Recognition of the Actual Transactions Undertaken 323Notes 325Part VI: Putting The Guidelines to Work 327Chapter 23: Malaysia-Singapore Allocation Keys 329Importance of Allocation Keys 329When the Transactional Profit Split Method is the ‘‘Most Applicable’’ Transfer Pricing Method 330Specialized Services 331Applying the Transactional Profit Split Method 332Four Allocation Key Categories 333Key Functions 333Selecting Potential Allocation Keys 334Selecting among Allocation Keys 336‘‘Strong Correlation’’ Standard 337Allocation Keys 337Transfer Pricing Strategies 342Notes 343Chapter 24: China-Taiwan Trade 345Taiwan and China: A History Lesson 345Tax Considerations 348Transactional Profit Split Method Criteria 352APA Process 355Notes 356Chapter 25: Reverse Engineering the Transfer Pricing Process 357Transactional Profit Split 358Simultaneous Tax Examinations and Transfer Pricing 358Tax Arrangements 359How the Reverse Engineering Transfer Pricing Process Works 367Functional Analysis Considerations 369Transactional Profit Split Method 370Success Parameters to the Reverse Engineering Process 370Synergistic Activities 371Undertaking Multijurisdictional Production Processes 372Engaging in Extensive R&D Activities 373Dealing in Unique Intangibles 374Participating in a Cost Contribution Arrangement 374Creating or Providing Specialized Services 375Distributions of Generic Goods or Standardized Goods 376Contract Manufacturers and Contract Service Activities 377Planning 377International LP Gas Companies Face Multinational Tax Claims 377Multinational Service Enterprises 379Notes 380Part VII: Connecting Transfer Pricing and Permanent Establishment 383Chapter 26: Permanent Establishment Parameters 385OECD’s Permanent Establishment Provisions 386Overall Tax Considerations 388OECD Approach to Determine Permanent Establishment 389Hong Kong Applies the OECD Permanent Establishment Provisions 389Common Law Permanent Establishment Criteria 391Declining Businesses 394‘‘Preparatory to’’ and ‘‘Auxiliary from’’ Exemptions 395Will the OECD Approach Prevail? 395Notes 396Chapter 27: Focus on Permanent Establishment 397Background Considerations 398Twenty-five Proposed Changes 398Notes 413About the Authors 415Index 417