New KPMG publication: Complex supply chains can have transfer pricing implications
KPMG ROMÂNIA S.R.L. - 21 June 2011
New KPMG International publication examines how companies can navigate through the myriad of transfer pricing issues created by complex supply chains.
Economic realities have an impact on how multinational enterprises organize their business and enter into transactions that involve entities from different jurisdictions. What is the reality of the current world seen through transfer pricing? There are three main issues which are equally important both for the management of multinational enterprises and for the tax authorities:
1) Reorganization of business and of related transactions
Although business reorganization of multinational enterprises is not a new issue for either specialists' debates or for company groups, in July 2010, significant changes were made to the OECD Guidelines on transfer pricing, which should be carefully considered both by those who are involved in restructuring operations and by the tax authorities.
The mere definition of the business reorganization concept widens the area of debate for transfer pricing professionals. Basically, any substantial change in a business relationship may be considered as reorganization.
Business reorganization and a change in the day to day operations of a multinational enterprise is sometimes required both to rise to the challenge of changes in the economic environment and to explore more efficient business opportunities. From a transfer pricing viewpoint, the transfer of business and of day to day operations from one group entity to another is analyzed in terms of transfer of functions and risks between entities.
Tax authorities see such a transfer from the following perspective: the more functions and risks are brought to an entity in a certain jurisdiction, the more taxable profits should be registered in that jurisdiction. On the other hand, when risks and functions are transferred to an entity located in another jurisdiction, taxable profits in the originating tax jurisdiction are expected to drop. If the enterprise in the originating jurisdiction is completely closed down, the predicted taxable profits will not be matched by the actual ones.
Countries such as Germany, Canada, Denmark and France have solved the issue of decreasing taxable profits as a result of business transfers (and implicitly of functions and risks involved) to another tax jurisdiction by imposing the so-called 'exit charges'.
In other words, companies are required to pay corporate tax as if their activities (including functions, risks and/or related assets) had not been transferred outside of the jurisdiction in question. The methodology used to estimate the level of notional corporate tax due ranges from generally applied methods to specific formulae.
If a company decides to put an end to its distribution activity and transfer all related risks and functions to another jurisdiction, the question that would arise is whether an independent entity would have acted in the same way under similar economic conditions and circumstances. If the answer to this question is negative, the tax authorities in the entity's originating jurisdiction can consider that it has deliberately given up the profits it could have generated. As such, the entity in question should continue to be subject to corporate tax.
Even in countries which do not apply a specific mechanism for assessing exit charges, 'the cross border re-deployment by a multinational enterprise of functions, assets and/or risks' qualifies as a reorganization which should follow the transfer pricing principles provided by the OECD guidelines on TP as amended in July 2010 through the introduction of a specific chapter (Chapter IX); Report on the transfer pricing aspects of business restructuring.
Besides re-deployment of functions and risks, the definition of business restructuring is very broad. Therefore, such major changes made to business operations must be documented from a TP point of view.
2) Supply chain
In business terms, it is obvious that selling goods through a certain supply chain implies a certain price level and, therefore, a certain profit rate, whereas selling the same goods through a different supply chain can trigger a different price level and a different profit rate. A typical example is the consecutive sale of goods to end consumers in China. In this case the sale price is higher due to customs duties being added to the final price. This additional cost may lead to lower profit margins obtained by the intermediaries in the supply chain, by comparison to the sale of goods to end consumers from another country where no customs duties are charged when the goods are introduced into that state.
For logistical reasons, a company can contract one or three intermediaries, depending on the geographical coverage area. The price for the end consumer is influenced by the demand and supply in the relevant geographical area and the difference between the sale price to end consumers and the production costs along with the related marketing and logistics costs represents a profit which should be reasonably divided between all participants in the supply chain.
The differences between profit margins derived by different participants in consecutive sales are difficult to quantify when dealing with different supply chains. It is for this reason that the transfer pricing documentation should be carefully analyzed.
3) Taxpayers' options when defending their position before the tax authorities
Tax authorities' growing interest in assessing the application of transfer pricing policies in the light of the taxable profits in their tax jurisdiction should encourage taxpayers to pay greater attention to documenting transfer pricing, both planned and actually applied.
The mutual agreement procedure of disputes provided by the Conventions for the avoidance of double taxation should not be ignored, as they allow representatives of the tax authorities from two different countries to come together at the negotiating table for the purpose of avoiding the double taxation that would otherwise occur if transfer prices were adjusted for just a part of the transaction.
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While business restructuring is not a new issue, the broadening of the scope of the OECD's Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations in July of 2010, has changed its definition. In essence, a business restructuring can involve almost any substantive change in a business relationship.
A new publication released yesterday by KPMG's Global Transfer Pricing Services practice entitled A World in Transition: Managing the Transfer Pricing Implications of Complex Supply Chains helps organizations navigate through the many issues and challenges that exist.
The publication focuses on three distinct types of supply chain issue: implications of the new OECD guidelines, multinational enterprise (MNE) supply chains, and controversy.
The section on the new OECD Guidelines includes specific country perspectives on business restructuring concepts from: Australia, Belgium, Canada, China, Denmark, France, Germany, Italy, Japan, the Netherlands, Spain, the United States and the United Kingdom.
'The OECD Guidelines on Business Restructuring effectively treat a wide range of non-tax business decisions as transfer pricing issues,' says Steve Fortier, leader of KPMG's Global Transfer Pricing Services. 'In evaluating the implications of the new guidance on business restructuring, the key question is how local tax authorities will interpret it. The answer to this question will vary by tax authority and although we have some indication from early conversations that are reflected in this publication, it will continue to evolve.'
A World in Transition: Managing the Transfer Pricing Implications of Complex Supply Chains also focuses on several selected issues that arise in many MNEs' supply chains specifically operating in Asia, including:
- the interaction between transfer pricing and customs, which is especially important in Asia due to relatively high duty rates
- centralized sourcing/procurement companies
- the treatment of location savings
- a recent training course in China for State Administration of Taxation (SAT) officials on auto industry issues, which provides useful insight into how the SAT approaches certain key transfer pricing issues.
'European and American MNEs increasingly source from Asian suppliers and establish centralized purchasing functions in Asia to achieve business objectives. Depending on the purchasing centralization strategy, these restructurings could shift profits away from the US and European taxpayers, and American and European tax authorities may have concerns over the resulting lost tax revenue,' comments Fortier.
'Although the Romanian tax authorities are aware of the challenging economic environment Romanian companies have been facing in recent years, they are nevertheless very reluctant to accept business restructuring, seeing financial resources flee the country. Consequently, we encourage Romanian companies to prepare thorough documentation to substantiate any such business decision.' says Niculae Done (photo), Senior Tax Partner of KPMG in Romania.
A further section of A World in Transition: Managing the Transfer Pricing Implications of Complex Supply Chains focuses on transfer pricing controversy, including a discussion of two new tools to help taxpayers resolve controversy – accelerated competent authority procedures (ACAP) and binding arbitration—as well as a discussion on navigating transfer pricing disputes in India. The section also looks at the rapid growth of advance pricing agreements (APAs) in Asia and includes APA statistics in Australia, China, Japan and Korea. Finally, the publication includes a discussion of two court cases that have significant implications for supply chain management and restructuring—the General Electric case in Canada and the Veritas case in the US.
'This publication is particularly interesting as, in the light of the recent developments of the OECD Guidelines, it indicates an increasing preference for MNEs around the world to approach transfer pricing issues by way of alternative dispute resolutions to reduce the risk of tax adjustments arising from different interpretations of the OECD Guidelines by the tax authorities in different jurisdictions. Although experience of APAs in Romania has been limited up to now, we expect to see a lot more interest in the market in times to come from MNEs looking to mitigate such risks by applying for APAs as well.' says Teodora Alecu, PhD, Senior Manager, Transfer Pricing Services, KPMG Romania.
'In many countries, the number of procedural options for resolving transfer pricing disputes is rising. The APA reports issued by Australia, China, Japan, and Korea all suggest vibrant and growing APA programs. Accelerated competent authority procedures in the United States and Canada are bringing more years into a single competent authority negotiation, which also can have the effect of resolving more recent years. Finally, mandatory arbitration provisions are being incorporated into a greater number of treaties, including those of the United States, Canada and the EU generally. In some cases, however, litigation appears to be the only answer where court decisions have been needed to resolve difficult transfer pricing issues.' concludes Fortier.
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KPMG is a global network of professional firms providing Audit, Tax and Advisory services. We operate in 150 countries and have 138,000 people working in member firms around the world. The independent member firms of the KPMG network are affiliated with KPMG International Cooperative ('KPMG International'), a Swiss entity. Each KPMG firm is a legally distinct and separate entity and describes itself as such.
KPMG in Romania operates from five offices located in Bucharest, Cluj-Napoca, Constanta, Iasi, Timisoara. We currently employ more than 600 partners and staff, both Romanians and expatriates.
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