Gary Thomas, White & Case, Tokyo

Sam Sim, Standard Chartered Bank, Singapore

Clemens Thyme, S&P Capital IQ, Hong Kong
Michael Quigley, White & Case, Washington DC

TRANSFER PRICING IN ASIA:

THE GROWING ACCEPTANCE OF THE
ARMS LENGTH PRINCIPLE
Asia Tax Forum 2012
Raffles Hotel, Singapore
May 9-10, 2012

TOPICS
INTRODUCTION
II.
MATURING OF THE ARMS LENGTH PRINCIPLE IN JAPAN: A LESSON
FOR THE REST OF ASIA?
III. COMPETENT AUTHORITY AND TRANSFER PRICING: HOW IS IT
WORKING IN ASIA?
IV. CURRENT TRANSFER PRICING ISSUES IN FINANCIAL SERVICES
V.
TRANSFER PRICING CREDIT RISK ASPECTS
VI. CURRENT ISSUES BEING RAISED IN LITIGATION
VII. CUSTOMS AND TRANSFER PRICING: WHAT YOU SHOULD BE
AWARE OF
VIII. FUTURE OF TRANSFER PRICING IN ASIA
IX. QUESTIONS
I.

May 9, 2012

I. INTRODUCTION
Introduction of Panelists
Overall Panel Topic: Growing Acceptance of the Arms Length Principle in
Asia

1.
2.
1)
2)

3.
4.
5.
6.
7.
8.

Merits The Arms Length Principle is accepted!

Demerits The Arms Length Principle (whatever it is) is required!

Using Japan as an Example of How Application of Arms Length Principle Has

Evolved Over Time
Competent Authority: Is It Working in Asia?
Special Challenges in Financial Services
Applying the Arms Length Principle to Intra-Group Loans and Guarantees
Recent Litigation Issues
Transfer Pricing and Customs
May 9, 2012

II. MATURING OF THE ARMS LENGTH PRINCIPLE IN JAPAN: A

LESSON FOR THE REST OF ASIA
A. Outline
Historical Background
Recent History
Application of the Arms Length Principle Over the Years
Advance Pricing Arrangements
New Transfer Pricing Enforcement Approach in Japan: Focus on Taxpayer
Voluntary Compliance
Japan as a Lesson for the Rest of Asia?

May 9, 2012

Historical Background of Transfer Pricing Enforcement in Japan

Adoption of Transfer Pricing Rules in 1986
Reaction to US Internal Revenue Service assessments against US subsidiaries of major
Japanese corporations from early 1980s
Transfer Pricing Rules Take Effect in 1987
Initial NTA Enforcement Policies (1987-1989)
Collection of Information by Survey
Soft Touch Enforcement Approach
Adoption of Centralized Management by International Examination Section in NTA
Early Japanese Transfer Pricing Cases Focused on Foreign-Based Firms (1989

1996)
Expansion of Focus Toward Japanese Firms Outbound Transactions (from 1996)
Impact of APA Program in Recent Years in Reducing Number of Audits
Continuing Aggressive Audit Activity
Impact of Introduction of Transfer Pricing Documentation Requirements in 2010
May 9, 2012

Recent History in Transfer Pricing Compliance Rules

Release of NTA Transfer Pricing Guidelines (2001)
Addition of Transfer Pricing Provisions for Consolidated Corporations (2002)
Requirement of Disclosure of Transfer Pricing Methodologies in Schedule 17-3

(2003)
Introduction of Transactional Net Margin Method (TNMM) (2004)
Expansion of Coverage of Foreign Related Parties (2005)
Introduction of the Profit Methods (TNMM and PSM) in Presumptive Taxation
(2006)
Introduction of Tax Payment Suspension Regime Specifically for Transfer
Pricing Assessments in Competent Authority (2007)
Expansion of Exchange of Information Rules (2009)
Codification of Transfer Pricing Documentation Requirements (2010)
Introduction of Most Appropriate Method Rule (2011)

May 9, 2012

Transfer Pricing Assessments Since FYE 1999

Historical Chart of Transfer Pricing Assessment in Japan since FYE 1999

(Source: NTA Press Release)

*Each fiscal year shows FYE June XXX

May 9, 2012

Threshold Question: Is Comparability of Transactions to be

Based on Single Transactions or Groupings of Transactions?
Historical NTA Position: Singular and strictly transactional, with

aggregations within product group or business segment permitted in

limited circumstances
where setting of price is performed taking into consideration transactions

belonging to same product group or same business segment

Use of mini-baskets in practice but no overall company comparisons
were accepted
Historical NTA Position: There is only one arms length price. Japanese

transfer pricing law does not recognize ranges

But, in recent practice, NTA accepts overall company comparisons and
considers the use of ranges

May 9, 2012

Comparable Uncontrolled Price Method

Early application of secret comparables based on single transaction

interpretation
Failure of NTA to disclose identity of comparable product, comparable
transaction or comparable company secret comparables
Taxpayer was prevented from performing an effective comparability analysis.

Failure to make appropriate adjustments for differences in commercial

level, transaction volume and other factors, such as business strategies

Subsequent difficulty to sustain secret comparables in competent
authority negotiations
Use of CUP now seems to be the exception.

May 9, 2012

Resale Price Method

Singular or Plural?
NTA officials originally interpreted the Resale Price Method provisions as referring to

transactions in the singular, resulting in application on a strictly transactional,

product-by-product basis, with no aggregations of products and transactions
recognized.
Criticisms of strict transactional approach
Taxpayers without internal comparables could not use the Resale Price Method unless they could

identify (from information on competitors) specific gross margins of specific competing products
which are similar to the Taxpayers products (and will be considered similar by the NTA on audit)
and make necessary adjustments for differences in functions or other matters in regard to such
specific transactions.
Requires use of secret comparables by tax authorities

Gradual adoption of company-wide comparison approach

Ultimately, difficult to sustain in competent authority negotiations
NTA now accepts company-wide comparison approach and has become more flexible in applying

the Resale Price Method

May 9, 2012

10

Profit Split Methods

Early preference for profit split methods in US/Japan competent authority

cases
Development of conceptual arguments for applying profit splits
Early criticism of one-sided approaches and concern for income creation

NTA Guidelines instruct examiners to compare Japanese profits vs.

foreign profits
In past, NTA favored contribution profit split and use of two factors
indicating relative value added: depreciation expense and personnel
expense
Critics argue that Japanese Contribution Profit Split fails to take into account the value

of intangible property embedded in products provided by foreign suppliers.

NTA has also used advertising and promotion expenses and other selling expenses of
Japanese subsidiary of foreign based firm, resulting in high allocations of overall profits
to Japan.
May 9, 2012

11

Profit Split Methods (contd)

NTA adopted residual profit split and comparable profit split by

circular based on OECD Transfer Pricing Guidelines

NTA sometimes applied Residual Profit Split but ignored contracts and
legal ownership to attribute high value to alleged marketing intangibles
in Japan.
More recently, NTA has favored use of Residual Profit Split on outbound
intangible transactions of Japanese companies
Document requirements included disclosure of foreign segment profitand-loss data.
Recent defeat in court case involving profit splits

May 9, 2012

12

Transactional Net Margin Method

NTA historical antipathy toward TNMM
History of US assessments against Japanese firms based on Comparable
Profits Method (CPM) and income creation issue
Active Japan involvement in drafting OECD 1995 Transfer Pricing
Guidelines paragraphs limiting use of TNMM
Gradual acceptance from late 1990s of modified resale price method

to resolve MAP cases and reach bilateral APAs

TNMM finally adopted into Japanese tax law in 2006

Policy objective seemed to be to apply to Japanese firms outbound

transactions.
But adoption occurred at same time as agreement to revise US/Japan
income tax treaty
TNMM was positioned as an other method with lesser priority than RPM
or other basic methods

May 9, 2012

13

Transactional Net Margin Method (contd)

NTA was reluctant to apply TNMM in transfer pricing audits just after its

introduction in 2004
But from 2006 or so, NTA increasingly accepted TNMM in bilateral APAs
and unilateral APAs and later on in audits as well
TNMM was included as a presumptive taxation method in 2006.
It is expected that TNMM will be applied more extensively going forward,
although tax authorities views on comparables will likely be different
from those of taxpayers.

May 9, 2012

14

Seeking Certainty:
Advance Pricing Arrangements Become More Prevalent
Advance Pricing Arrangements (APA) confirm that, once a tax authority

evaluates the transfer pricing methodology and its validity, and accepts them as
reasonable, as long as the firm conducts transactions according to the
contents under certain preconditions, there would be no taxation on transfer
prices.

Principal merits and demerits

Merit: Secure predictability in transfer pricing
Merit: Mitigate the transfer pricing risks (presumptive taxation, secret comparables
and penalty)
Merit: More flexibility in applying methods as compared to an audit
Demerit: Required to submit much information to tax authorities for APA review,
which can be like an audit
Demerit: Administrative burdens and expenses
On balance: Should now be seriously considered!

May 9, 2012

15

Trends in Bilateral APAs in Japan

Increasing number of APA applications

(Source: NTA Press Release)

May 9, 2012

16

Trends in Bilateral APAs in Japan

Increased number of APAs with Asian countries

(Source: NTA Press Release)

May 9, 2012

17

Trends in Bilateral APAs in Japan

Significant increase in application of TNMM in recent years

(Source: NTA Press Release)

May 9, 2012

18

New Transfer Pricing Enforcement Approach:

Voluntary Compliance as a Matter of Corporate Governance
Public announcement at a Tax Seminar in Tokyo on April 24, 2012
Mr. Toshiyuki Fushimi, Director, Large Enterprise Examination and Criminal Investigation Department

National Tax Agency of Japan

International Trends in Tax Enforcement

Efforts to Enhance Corporate Governance Concerning Taxes
Efforts to Maintain and Enhance Tax Compliance in Transfer Pricing
Key Actions Expected of Enterprises to Prevent Occurrence of Transfer Pricing Problems
Check Sheet to Confirm the Status of Efforts Concerning Transfer Pricing

May 9, 2012

19

International Trends in Tax Enforcement:

Meeting of the Forum on Tax Administration in January 2012
1. The January 2012 meeting in Buenos Aires of the Forum on Tax Administration brought

together the heads of the tax administrations from 43 countries under the auspices of the
OECD and concluded with a unified and strengthened commitment to combat offshore tax
abuse.

2. The tax administrators focused on the need to work smarter in times of shrinking budgets,

and how to strengthen their relationship with large corporations through efficient and effective
strategies that benefit both the taxpayer and taxing authority.

3. Although there have been some high-profile successes in the fight against offshore tax

abuse, resulting in significant additional tax revenues and real improvements in transparency
and exchange of information, it is far too soon to declare victory.

4. The tax administrations agreed that collaboration must now include coordinated actions by

countries to finally put an end to offshore non-compliance.

May 9, 2012

20

International Trends in Tax Enforcement:

Meeting of the Forum on Tax Administration in January 2012
5.

A key agreed objective was to promote the relationship between tax

administrations and Large Business Taxpayers
An adversarial relationship between tax administrations and multinational corporate
taxpayers serves neither of our purposes well and is contrary to our common goals,
which are earlier and greater certainty, consistency, and efficiency.
We will pay particular attention to the process of conducting and resolving transfer
pricing cases. Overall, we intend to move away from a hide and seek approach to one
based on greater transparency on the part of both taxpayers and tax administrations. As
more companies put good tax compliance at the heart of their corporate governance, this
will be easier to achieve.

May 9, 2012

21

International Trends in Tax Enforcement:

OECD Guidelines for Multinational Enterprises - 2011
Part I : Recommendations for responsible business conduct in a global
context
Section XI - Taxation
1.Tax compliance includes such measures as providing to the relevant authorities

timely information that is relevant or required by law for purposes of the correct
determination of taxes to be assessed in connection with their operations and
conforming transfer pricing practices to the arms length principle. (Para 1)

2.Enterprises should treat tax governance and tax compliance as important elements of

their oversight and broader risk management systems. In particular, corporate boards
should adopt tax risk management strategies to ensure that the financial, regulatory and
reputational risks associated with taxation are fully identified and evaluated. (Para 2)

May 9, 2012

22

International Trends in Tax Enforcement:

OECD Guidelines for Multinational Enterprises - 2011
Part I, Section XI - Taxation
3.In the case of enterprises having a corporate legal form, corporate boards are in a position to

oversee tax risk in a number of ways. For example, corporate boards should proactively
develop appropriate tax policy principles, as well as establish internal tax control systems so
that the actions of management are consistent with the views of the board with regard to tax
risk. (Para. 102)

4.Tax authorities may need information from outside their jurisdiction in order to be able to ..

determine the tax liability of the member of the MNE group in their jurisdiction. Again, the
information to be provided is limited to that which is relevant to or required by law for the
proposed evaluation of those economic relationships for the purpose of determining the
correct tax liability of the member of the MNE group. MNEs should co-operate in providing that
information. (Para. 103)

May 9, 2012

23

International Trends in Tax Enforcement:

OECD Guidelines for Multinational Enterprises - 2011
Part I, Section XI - Taxation
5.Application of the arms length principle avoids inappropriate shifting of profits or losses and

minimises risks of double taxation. Its proper application requires multinational enterprises to
cooperate with tax authorities and to furnish all information that is relevant or required by law
regarding the selection of the transfer pricing method adopted for the international
transactions undertaken by them and their related party. (Para. 104)
6.The OECD Transfer Pricing Guidelines aim to help tax administrations (of both OECD

member countries and non-member countries) and multinational enterprises by (partially

omitted) minimising conflict among tax administrations and between tax administrations and
multinational enterprises and avoiding costly litigation. Multinational enterprises are
encouraged to follow the guidance in the OECD Transfer Pricing Guidelines, as amended and
supplemented, in order to ensure that their transfer prices reflect the arms length principle.
(Para. 106)

May 9, 2012

24

Efforts to Enhance Corporate Governance Concerning Taxes

From the perspective of the maintenance and improvement of the level of tax
reporting throughout Japan, it is important to maintain and improve tax compliance by
large business taxpayers.
1. The economic activities of large business taxpayers occupy a large portion of the economy in

Japan and the amount of their reported income is high.

2. For example, large business taxpayers comprise 0.02% of the number of corporations, but
26% of the reported income of all corporations.
3. Large business taxpayers lead industries and regions. Tax compliance by large business
taxpayers greatly affects tax compliance by their enterprise groups as well as small to
medium taxpayers and individual taxpayers.
4. When the tax compliance by large business taxpayers, which require significant
administrative resources in tax examinations, is enhanced, the tax administration will be able
to allocate more administrative resources to the corporations with a high level of need to be
examined and to plan for improvement in their level of reported income.

May 9, 2012

25

Results of Enhancing Corporate Governance Concerning Taxes

It is beneficial for both enterprises and the tax administration when tax compliance is
improved through the enhancement of corporate governance.
1.

Benefits for Enterprises

1) Minimizing tax risks
2) Minimizing the burden of audit defenses in tax examinations.

2.

Benefits for the Tax Administration

1) Greater focus on tax examinations of corporations with a high need for examinations

May 9, 2012

26

Efforts by the National Tax Authorities*

The national tax authorities will maintain and improve tax compliance through the

enhancement of corporate governance by large business taxpayers, by confirming the

status of corporate governance concerning taxes by large business taxpayers during
tax examinations and carrying out exchanges of views with top management.
1. Conducting of Orientation Sessions
In meetings attended by top management of large business taxpayers, we will encourage the
enhancement of corporate governance concerning taxes (such as by introducing examples of
effective efforts).

* National tax authorities refers to regional taxation bureaus, which have jurisdiction over large
business taxpayers.

May 9, 2012

27

Efforts by the National Tax Authorities

2.

Approaches towards Individual Enterprises

1)

During the opportunity of a tax examination by Special Examiners in the Large Enterprise
Examination Department in each regional tax bureau, the national tax authorities will
confirm the status of the corporate governance concerning taxes by large business
taxpayers through a request to them to describe the current status of their corporate
governance including the involvement and direction by top management and the
maintenance of an organization and functions in the finance and audit departments, in a
Confirmation Sheet on Corporate Governance Concerning Taxes.

2)

Upon the closing of a tax examination, the top management of a large business taxpayer
and the top officials of a regional tax bureau will exchange views for the enhancement of
corporate governance concerning taxes (such as by introducing examples of effective
efforts).

May 9, 2012

28

Efforts by the National Tax Authorities

3. Use in Determining the Need for an Examination
Going forward, when determining the need for an examination, the national tax authorities will
utilize the status of corporate governance concerning taxes as an important decision-making
material and will allocate tax examination resources more heavily toward corporations with a
high need for an examination.
4. Efforts in Transfer Pricing
Also on transfer pricing, in order to maintain and improve tax compliance, the national tax
authorities will carry out a detailed plan as part of its efforts for the enhancement of
corporate governance concerning taxes.

May 9, 2012

29

Efforts to Maintain and Enhance Tax Compliance

in Transfer Pricing
In order to prevent the occurrence of problems concerning transfer pricing, the national tax
authorities will promote the voluntary and appropriate actions of enterprises through cooperation
between the national tax authorities and the enterprises.
o Merits for both the enterprises and the tax authorities through maintaining and enhancing

tax compliance in transfer pricing

Benefits for enterprises

Minimizing tax risks
Minimizing the burden of audit defenses in tax examinations
Benefits for the tax authorities
Greater focus on tax examinations of corporations with a high need for an examination
Preventing the problem of international double taxation (Mutual Agreement Procedures
with foreign tax authorities)
May 9, 2012

30

Particular Compliance Concerns in Transfer Pricing

1.

In a self-assessment system, the taxpayer is required to themselves calculate the arms

length prices for their transfer pricing and to file tax returns based on such calculations.

2.

Because transfer pricing issues involve huge risks and costs, it requires even more
voluntary and appropriate actions by the enterprises.

3.

The importance of improving tax compliance, including transfer pricing, has been
highlighted as an international trend.

4.

In foreign countries, the enforcement of transfer pricing rules has been strengthened,
and it is expected that transfer pricing assessments (double taxation) and the competent
authority negotiations resulting from the same will increase. Accordingly, there is an
increased need to consider measures, etc. for advance prevention of double taxation.

May 9, 2012

31

Particular Compliance Concerns in Transfer Pricing

5.

Currently, the national tax authorities are moving ahead with efforts toward the
enhancement of corporate governance concerning taxes, and it is possible to characterize
the measures for transfer pricing as one part of such efforts.

6.

In addition, in the 2010 tax reforms, the scope of required transfer pricing documentation
was clarified, and the environment for the preparation of transfer pricing documentation
was improved.

7.

This means that the documents that are recognized to be necessary for the purpose of
computing arms length prices were clarified in the ministerial order that sets for the
presumptive taxation rules, which could be invoked if the tax administrations are not
able to obtain the taxpayers cooperation through providing such necessary documents.

May 9, 2012

32

Key Actions Expected of Enterprises to Prevent Occurrence

of Transfer Pricing Problems
1.
2.
3.
4.
5.
6.
7.

Knowledge of Transfer Pricing Legislation

Involvement of Top Management
Recognition of Status and Problem Areas in Foreign Related Party Transactions
Implementation of Global Transfer Pricing Policies
Transaction Price Setting Taking into Account Transfer Pricing Methodologies
Transfer Pricing Compliance of Related Parties Overseas (Governance by Parent Company)
Communications with the Tax Administration

Based on the above, a Check Sheet to Confirm the Status of Efforts Concerning Transfer
Pricing should be prepared.

May 9, 2012

33

Efforts to Maintain and Improve Compliance in Transfer Pricing

As part of their efforts directed toward the enhancement of corporate governance
concerning taxes, the national tax authorities will encourage enterprises to
themselves plan for the maintenance and improvement of tax compliance in transfer
pricing, while confirming the status of the efforts of the enterprises concerning
transfer pricing.
1.

Facilitation through Orientation Sessions

Along with an explanation of the domestic and foreign trends in transfer pricing, the national tax
authorities will explain the importance for enterprises to themselves maintain and improve
their tax compliance in transfer pricing.

May 9, 2012

34

Efforts to Maintain and Improve Compliance in Transfer Pricing

2.

Facilitation through Individual Contacts with Enterprises

1)

The national tax authorities will confirm the status of efforts on transfer pricing through a
request to fill in a Check Sheet to Confirm the Status of Efforts Concerning Transfer
Pricing.

2)

As the time of exchanges of views between the top management of the enterprises and the
tax bureaus with regard to corporate governance concerning taxes, the national tax
authorities will also exchange views concerning transfer pricing.

3)

Views will be exchanged between the enterprises and the tax officials in charge of transfer
pricing, based on the contents of the Check Sheet to Confirm the Status of Efforts
Concerning Transfer Pricing.

May 9, 2012

35

Japan as a Lesson for the Rest of Asia?

1. What can we learn from Japans history of attempting to

apply the Arms Length Principle using the various transfer

pricing methods?
2. What have the Japanese tax authorities told other
governments in Asia over time and now today about Japans
experience?
3. What are the implications of Japans new transfer pricing
enforcement approaches seeking greater taxpayer
compliance based on corporate governance objectives?

May 9, 2012

36

III.

COMPETENT AUTHORITY AND TRANSFER PRICING: HOW

IS IT WORKING IN ASIA?

Panel Discussion
Gary Thomas, White & Case, Tokyo
Sam Sim, Standard Chartered Bank, Hong Kong
Clemens Thyme, S&P Capital IQ, Hong Kong
Michael Quigley, White & Case, Washington DC

May 9, 2012

37

IV.

CURRENT TRANSFER PRICING ISSUES IN FINANCIAL

SERVICES IN ASIA THE BIG PICTURE

IPO Volume 2011

Financial Sector FDI 2011

May 9, 2012

38

IV.

CURRENT TRANSFER PRICING ISSUES IN FINANCIAL

SERVICES IN ASIA CONTRASTING FLAVOURS

Some Macro Factors Impacting Level of Cross-border Activity

Crisis, really?
European withdrawal vs Regionals Stepping up
Bank Finance to Capital Markets
Simpler Products vs Increasing Sophistication
Increased Regulations vs Internationalization

Ring-fencing liquidity vs Outlet for excess savings

Asia cross-border FS has vast room for growth

But so does sophistication of authorities & TP rules !

May 9, 2012

39

IV.

CURRENT TRANSFER PRICING ISSUES IN FINANCIAL

SERVICES IN ASIA DIFFERENT STROKES

A. Familiar Global Themes

Challenge to management fees/Head-office charges
Related party lending, capital, liquidity and guarantee fees
Increased documentation & reporting/compliance burden
Regulatory change and restructuring

B. More so in Asia
Intervention/influence of prudential regulators
Sophistication of tax authorities, advisors and taxpayers

- Target vs Principles based; Cultural aspects

Bespoke & evolving business/product/pricing models

Legislative framework is young and in flux (Treaties/ APA/MAP, TP jurisprudence)
Beyond OECD?: BRIIC, UN model
Implications of state ownership

May 9, 2012

40

IV.

CURRENT TRANSFER PRICING ISSUES IN FINANCIAL

SERVICES IN ASIA - MORE SPICE TO THE POT

A. APA/MAPs
-Are they worth the trouble?
-First in class? Do you have the resources?

B. Reconciling Differences
-Different TP methods and mark-ups; Global consistency vs Local appropriate
-Tax/TP vs Accounting (Financial vs Management view)

C. GAAR, Thin-Cap, Indirect Taxes & TP

-Interaction of such evolving tax principles with transfer pricing

D. Branch banking to Subsidiaries

-Subsidarisation, Securities companies, SPEs

E. TP Infrastructure
-Tax vs Finance: Roles & Responsibilities
-Outsourcing
May 9, 2012

41

V.

TRANSFER PRICING CREDIT RISK ASPECTS

Transfer pricing standards require financial transactions such as

loans and guarantees between related entities to utilize arms

length pricing.
Key question: At what rate could a subsidiary fund itself if it

were an independent entity?

May 9, 2012

42

Establish a Risk Based Framework

for Intercompany Loans and Guarantees
Use a risk based approach that

Example: Coca-Cola

differentiates credit quality

Find appropriate comparable market

rates for interest spreads or guarantee

fees
Use globally consistent methodology
Document sound economic theory

around assessments

May 9, 2012

43

May 9, 2012

44

Classification - Credit Assessment Methodologies

Internal or Third Party

Ratings

Method

Sector,
Size

Input

Output

Advantage

Limitation

Public and
Private Ratings

All

3 years
financials,
management
meeting

Rating

- Easy to access and

interpret
- Additional coverage
through Private Estimates

- Limited coverage
- No standalone
assessments of subs
- Costs of Individual
assessments

Credit
Scorecard

All

Current
Quantitative
and Qualitative
Data

Score that can

be mapped to a
rating

- Comprehensive sector
coverage (Corp, FI, Ins)

-Requires qualitative &

quantitative analysis
- If outsourced, cost of
individual assessment

Credit Model
rating score

US$ 2050M and

above

Current
Quantitative
Data

Score that can

be mapped to a
rating

- Quantitative and objectified

information only
- Large numbers of subs can
be assessed quickly
- Links to Ratings data

-Limitation in sectors, as
some are hard to
quantitatively model and
size over USD c20m

Credit Model

SME
(US$1M
and
above)

Current
Quantitative
Data

Probability of
Default

- Direct and quantified

default measure
- Smaller entities with USD
1-100m revenue

- Requires comprehensive
empirical datasets including
local/regional default data,
which is hard to obtain

- PD

May 9, 2012

45

Build fundamentals
driven comparables

Establish consistent approach for internal ratings on subs:

Model based approach (most objectified, limitations)
Internal Ratings Based approach (most detailed, expensive)
Internal vs. external assessment

Generate custom
comparable yield
curves

May 9, 2012

46

Alternatives in Establishing Effective Reference Prices

Establishing a market
based comparable
requires:
Transparent
methodology
Appropriate
segmentation
(geography, industry,
credit rating, duration,
etc.)
Cover all risk factors
(sovereign risk, T&C)
Strong grounding on
empirical data

Credit Spread Models

May 9, 2012

47

VI. CURRENT ISSUES BEING RAISED IN LITIGATION AND

WHAT THIS MEANS FOR ASIA
A. Status of Selected Recent Cases
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.

US: Medtronic Inc. v. Commr

US: Guidant LLC v. Commr, T.C. No. 5989-11
US: Veritas Software Corp. v. Commr
US: Xilinx, Inc. v. Commr
US: Intersport Fashions West Inc. v. United States
Australia: SNF (Australia) Pty. Ltd. v. Commr
Canada: GlaxoSmithKline Inc. v. The Queen
Canada: The Queen v. General Electric Capital Canada Inc.
Canada: Alberta Printed Circuits Ltd. v. The Queen
India: Vodafone
Spain: Roche Vitamins Europe Ltd.
Russia: Gazprom Extraction Astrakhan LLC
Toyota Argentina SA c/AFIP-DGI

B. What These Cases Mean for Asia

May 9, 2012

48

Medtronic Inc. v. Commr, T.C. No. 6944-11

SUMMARY:
Leads and devices adjustment: $1.2 billion
The IRS challenged payments from Medtronic Puerto Rico (PR) to Medtronic
U.S. for the use of patents and other IP and to purchase medical device
components. PR used the components to assemble finished products, which it
sold to Medtronic USA Inc., another U.S. affiliate that distributed the products in
the U.S. and abroad.
Medtronic used a CUT as its primary method, with a profit split as a corroborating
method.
IRS argument in the alternative: significant value transferred under 367(d)
Medtronic also challenges a royalty true-up in the amount of $4
Swiss Supply Agreement Issue: $39 million
Under the agreement, Medtronics Swiss subsidiary assists PR by
manufacturing and supplying the U.S. with devices to meet excess U.S. demand.
The Swiss subsidiary pays the leads and devices royalty and the trademark

royalty that PR would have paid if it had manufactured the product itself.

May 9, 2012

49

Medtronic Inc. v. Commr, T.C. No. 6944-11

Spinal Screw Operations: $90 million
Medtronic claims that the IRS improperly treated its PR as a contract

manufacturer rather than a risk-bearing, autonomous manufacturer

Interest Income from Prior Buy-In Case: $14 million
In 2010, Medtronic and the IRS signed a closing agreement to resolve a
2008 Tax Court case (Medtronic Inc. v. Commr, T.C. No. 17488-08) relating
to the buy-in paid by Medtronics Swiss subsidiary for the right to use
preexisting intangibles.
Medtronic disputes the inclusion of the interest amounts in its 2005-2006
returns because it has a competent authority request pending pursuant to
the U.S.-Switzerland treaty.

May 9, 2012

50

Medtronic Inc. v. Commr, T.C. No. 6944-11

STATUS:
Medtronic Inc. filed a petition in the Tax Court on March 23, 2011,
challenging $2.7 billion in upward income adjustments to its 2005 and
2006 taxable years.
Approximately $1.4 billion of the adjustments were transfer pricing

adjustments related to licensing and manufacturing transactions with

Medtronics affiliates in Switzerland and Puerto Rico.
The case is currently scheduled for trial on May 21, 2012 in the Tax

Court, although the parties have moved for a continuance.

May 9, 2012

51

Guidant LLC v. Commr, T.C. No. 5989-11

SUMMARY:
Like Medtronic, involves licensed IP and manufacturing arrangements:
Guidants Irish affiliate purchased components from Guidant U.S. and used the components

to manufacture units that generate pulses in pacemakers

Guidant Ireland sterilized and packaged the finished products, then sold them back to Guidant
U.S., foreign related parties, and third-party distributors
IRS challenged royalties for use of licensed intangibles, prices of components, and

intercompany sales of finished products in transactions with Irish and Puerto Rican
affiliates

The IRS used a CPM and concluded that a cost plus 13.9 percent markup (Puerto Rico) and a

cost plus 11 percent markup (Ireland) should be applied to labor and overhead
The IRS did not calculate a markup on other costs
Guidant claims that the IRS did not specify the portions of the adjustment attributable to the
individual affiliates

As in Medtronic, the IRS argued in the alternative that the transferred intangibles should

be taxed under Section 367(d).

May 9, 2012

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Guidant LLC v. Commr, T.C. No. 5989-11

STATUS:
Guidant LLC, which was acquired by Boston Scientific Corporation in
2006, filed a petition in the Tax Court on March 11, 2011, challenging $1
billion in transfer pricing adjustments to its 2001 and 2002 taxable years.
The adjustments related to technology licenses and manufacturing

arrangements between Guidant U.S. and its subsidiaries in Puerto Rico and
Ireland.
The case is currently pending in the Tax Court and is scheduled to be

tried on June 18, 2012.

May 9, 2012

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Veritas Software Corp. V. Commr, 133 T.C. 297(2009)

SUMMARY:
Valuation dispute over Veritas U.S.s buy-in payment under a costsharing arrangement (CSA) from its Irish subsidiary.
Veritas U.S. reported a $166 million lump-sum buy-in payment from Veritas

Ireland on its 2000 return.

In 2002, Veritas U.S. amended its 2000 return to reduce the payment to $118
million.
During audit, the IRS proposed an adjustment to increase the buy-in to $2.5
billion but at trial, the IRS reduced the proposed buy-in to $1.675 billion.
In Veritas Software Corp. v. Commr, 133 T.C. 297 (2009), the Tax Court

held for the Taxpayer

Upheld the Taxpayers use of CUTs to value the contributed intangibles

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Veritas Software Corp. V. Commr, 133 T.C. 297(2009)

On December 6, 2010, the IRS issued an Action on Decision, AOD 2010-

05, 2010-49 I.R.B.

The IRS declined to appeal the Tax Court decision but characterized it as

erroneous
IRS announced that it will continue to litigate cost sharing cases using
approaches to valuation that distinguish between make-sell rights (to preexisting intangibles) and platform rights (to technology developed in the
future)

May 9, 2012

55

Veritas Software Corp. V. Commr, 133 T.C. 297(2009)

Issue was valuation of intangibles conveyed in a CSA
Veritas U.S. contributed pre-existing computer software programs to the CSA,

including the right to further develop the programs.

Veritas used CUTs to value the intangibles contributed to the CSA using licenses to
unrelated original equipment manufacturers such as HP and Dell
The IRS rejected comparables as involving make-sell rights to preexisting intangibles
rather than platform rights to future developed intangibles
Court accepted licenses as comparables under a functional, rather than contractual,
analysis
The IRS valued the intangibles as having perpetual useful lives and in the aggregate,
rather than individually
Treated the contribution as akin to a sale of Veritas U.S.s business to its Irish affiliate
Court rejected this approach

May 9, 2012

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Xilinx, Inc. v. Commr, 598 F.3d 1191 (9th Cir. 2010)

SUMMARY:
Issue was proper cost base to be used in a qualified cost-sharing
arrangement (QCSA) for Xilinxs 1997-1999 taxable years
The Tax Court held in favor of Xilinx. Xilinx, Inc. v. Commr, 125 T.C. 37
(2005).
In Xilinx I, 567 F.3d 482 (9th Cir. 2009), the Ninth Circuit reversed in favor of
the IRS.
In Xilinx II, 598 F.3d 1191 (9th Cir. 2010), the Ninth Circuit withdrew its
opinion in Xilinx I and affirmed the Tax Courts decision in favor of the
taxpayer.
The IRS issued an Action on Decision, AOD 2010-03, I.R.B. 2010-33, in which it

acquiesced in result only because the 2003 amendment of the regulations

rendered the decision moot for subsequent years.

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Xilinx, Inc. v. Commr, 598 F.3d 1191 (9th Cir. 2010)

While a QCSA between Xilinx and its Irish subsidiary was in effect, Xilinx granted stock

options to its employees, which they exercised.

The IRS claimed that stock-based compensation should have been included in the cost-sharing

pool.
Xilinxs position was that uncontrolled parties engaging in comparable transactions would not
share the cost of the stock options.
Competing rules:
Cost-sharing rules provided that QCSA participants must share all costs
But the arms length standard is a general standard to be applied in every case
Xilinx I: held for IRS
Cost-sharing rules were specific rules that trumped general Section 482 rule

Xilinx II: held for Xilinx

Resolve ambiguity by looking at:
Purpose of regulations parity between controlled and uncontrolled transactions
Consistency with U.S.-Ireland treaty

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Veritas and Xilinx after the 2011 Cost-Sharing Regulations

STATUS:
In April 2012, the IRS warned that taxpayers entering into CSAs should not
rely on Veritas or Xilinx now that the final 2011 cost-sharing regulations are in
force.
As we transition to the 2008 temporary and 2011 final cost-sharing regulations,

we will be moving beyond the reach of Veritas and Xilinx.

- Joseph Tobin, IRS Office of Associate Chief Counsel (International)
Tax Notes Today, April 23, 2012).

(published in

Citing the Supreme Courts decision in Mayo, the IRS has said that its new

cost-sharing regulations were specifically and intentionally drafted to resolve

the issues raised in Veritas and Xilinx.
In Mayo, the Supreme Court held that Treasury regulations that have been

subject to a notice and comment period are entitled to Chevron deference.

May 9, 2012

59

Intersport Fashions West Inc. v. United States, 2012 TNT 30-21

(Fed. Cl. 2012)
SUMMARY:
Subsidiary of German motorcycle apparel company not permitted to
claim refunds for restructuring expenses incurred by its parent
because the expenses were not claimed on a timely filed return.
STATUS:
Government prevailed on motion for summary judgment a taxpayer
cannot affirmatively invoke Section 482. See Treas. Reg. 1.482-1(a)(3).

May 9, 2012

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SNF (Australia) Pty. Ltd. v. Commr, [2010] FCA 635

SUMMARY:
SNF Australia, decided on June 25, 2010, is the Federal Court of Australias first written guidance on the
application of the transfer pricing methods in Australia.
Facts:
SNF Australia imported polyacrylamide products from affiliates in France, the U.S., and China, and then sold

these products to Australian customers.

SNF Australia used the CUP method, with sales of products by SNF France to non-Australian third parties as
comparables.
SNF Australia reported losses back to 1998 despite evidence of sales growth. SNF Australia explained these as
resulting from poor management, high levels of competition, low sales per salesperson, and excessive stock
levels.

The Australian Tax Office used the TNMM (with an operating profit of 1.7 percent) to adjust SNF

Australias income upwards.

The Australian Tax Office challenged SNF Australias use of the CUP, arguing that the French sales were not

comparable.

The Court rejected the use of the TNMM, faulting it and other profits-based methods for inevitably

attribut[ing] any loss to the pricing

The Court accepted SNF Australias CUP analysis and its evidence demonstrating that the losses were caused

by poor management and not by its transfer prices

The Australian Tax Office appealed the decision to the Full Federal Court.

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SNF (Australia) Pty. Ltd. v. Commr, [2011] FCAFC 74

STATUS:
On June 1, 2011, the Full Federal Court dismissed the Commissioner's appeal.
The Court conducted a re-examination of much of the evidence presented by the taxpayer to support its

pricing under the CUP method and concluded that, in light of the following factors, comparability had been
established:
characteristics of the property
the functions (activities of the companies conducting the comparable transactions)
the contractual terms and conditions in the comparable transactions
economic circumstances of the markets in which the transactions took place and
Business strategies of the respective parties
The Court concluded that there was a single global market, leading to its acceptance of comparable data
from different geographic markets.

In its Decision Impact Statement dated November 7, 2011, the ATO narrowly interpreted the impact

of the Courts decision.

The ATO also alluded to proposed legislation to reform the transfer pricing rules, in which case the legal

position would probably be materially different.

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GlaxoSmithKline Inc. v. The Queen, [2010] FCA A-345-08

SUMMARY:
On July 26, 2010, the Federal Court of Appeal issued a taxpayer-favorable decision in
GlaxoSmithKline.
At issue were Glaxos Canadian subsidiarys payments to a related Swiss distributor
for the active pharmaceutical ingredient in Zantac during the companys 1990-1993
taxable years.
Glaxo used the resale price method, which produced prices ranging from $1,512 - $1,615
The Canadian tax authorities used the CUP method, which produced prices ranging from

$194 - $304 using prices paid by unrelated generic manufacturers for the same ingredient.

The Tax Court of Canada largely upheld the assessments.

On appeal to the Federal Court, Glaxo argued that a license agreement, by which it

used the Zantac trademarks, must be considered in evaluating its transfer prices.

Glaxos position was that no third party could sell Zantac without the license agreement
The CRA argued that only the supply agreement should be considered in determining

what was reasonable in the circumstances.

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GlaxoSmithKline Inc. v. The Queen, [2010] FCA A-345-08

The Federal Court of Appeal upheld the use of the CUP but agreed with Glaxo that the

valuation must consider the license agreement and all other relevant circumstances.
The Tax Court of Canada largely upheld the assessments.
The Federal Court of Appeal upheld the use of the CUP but adjusted the pricing determination to

account for the Zantac brand name.

STATUS:
The Supreme Court granted the parties motions for leave to appeal and cross appeal and

the appeal was heard on January 13, 2012.

During the hearing, several judges asked whether it made a difference that the active ingredient

purchased by Glaxo Canada was to be marketed and sold as Zantac, a branded product that
would yield a higher retail price than the generic product.
The Chief Justice asked about bundling and its relationship to transfer pricing if the price included
something other than the substance (IP), why was withholding tax not remitted?
A decision is not expected before the end of the year.

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The Queen v. General Electric Capital Canada Inc., [2010] FCA 344
SUMMARY:
On December 15, 2010, the Federal Court of Appeal upheld the Tax Court of
Canadas taxpayer-favorable decision in GE Capital Canada Inc. (GECCI).
Facts:
GECCI is a financial services company doing business in Canada. It financed much of its

business with debt guaranteed by its U.S. parent company. Beginning in 1995, GECCI
paid a guarantee fee of 1% of the principal amount of the debt outstanding during the
year to its U.S. parent.
GECCI deducted the guarantee fees in its 1996 through 2000 tax returns, totalling
approximately $136.4 million in deductions
The CRA disallowed the deductions, claiming that the 1% guarantee fee exceeded an
arms length price.

The Tax Court of Canada held for the taxpayer, finding that the U.S. parents implicit

support should be taken into account in determining the guarantee fee.

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The Queen v. General Electric Capital Canada Inc., [2010] FCA 344
The Federal Court of Appeal upheld the Tax Courts decision:
Held that implicit support must be taken into account in evaluating transfer

prices because an arms length party standing in the shoes of the taxpayer
would consider it relevant.
STATUS:
The CRA is attempting to re-litigate the case after denying General Electric Canada
Company (GECC), successor by amalgamation to GECCI, a deduction for these
same fees paid to the U.S. parent corporation. (2010-3493(IT)G and 20103494(IT)G).
In December 2011, the Tax Court denied GECCs motion that res judicata prevented the

re-litigation of this issue.

Although the issues are similar, the Tax Court denied the motion because there are
different taxpayers and different tax years involved.

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Alberta Printed Circuits Ltd. v. The Queen, 2011 TCC 232 (June
2011)
SUMMARY:
APC manufactured custom circuit boards for customers in Canada and
the U.S., and for several years many of the design and setup services
were performed by a Barbados company controlled by a key employee
of APC. The founders of APC and the key employee had interests in
both APC and the Barbados company, but there was no common legal
control of the two entities.
STATUS:
However, the Tax Court held that the two companies did not factually
deal with one another at arms length and were thus subject to
Canadas transfer pricing rules.

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India Vodafone Intl Holdings B.V. v. Union of India (Supreme

Court, Jan. 20, 2012)
SUMMARY:
Vodafone, a U.K. telecommunications company, purchased an Indian mobile phone
company from a Hong Kong-based company for $11.2 billion in 2007.
Indian tax authorities assessed $2.2 billion in capital gains tax against Vodafone in

connection with the transaction, claiming that

The Bombay High Court ruled in favor of the CBDT in 2010.

STATUS:
In January 2012, the Supreme Court reversed, holding that in the absence of a specific
look-through provision in Indias domestic law, a sale of shares by companies outside of
India cannot be taxed by India simply because the underlying assets are located in India.
The Supreme Court stated that allowing taxation under these circumstances would amount

to imposing capital punishment for capital investment since it lacks authority of law.

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India Vodafone Intl Holdings B.V. v. Union of India (Supreme

Court, Jan. 20, 2012)
AFTERMATH:
On February 17, 2012, Indian tax authorities filed a petition with the
Supreme Court requesting a review of the January decision. The
Supreme Court rejected the petition on March 20, 2012.
However, in March 2012 the government proposed amendments to the
Income Tax Act that would permit the retroactive taxation of cross-border
transactions involving assets located in India.
Separately, in December 2011, Vodafone was subject to a $1.7 billion
transfer pricing assessment in India. It recently filed an appeal citing
certain favorable observations in the above-mentioned Supreme Court
decision.

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Roche Vitamins Europe Ltd, Supreme Court of Spain, Case No.

1626/2008 (Jan. 11, 2012).
SUMMARY:
The Supreme Court affirmed the National Courts holding that Roche Europe, a Swiss
company, had a PE in Spain through its stripped risk subsidiary, Roche Spain.
Roche Spain was a contract manufacturer receiving a cost plus 3.3 percent markup
and also served as a sales representative for Roche Europe, for which it received a
commission of 2 percent of sales in Spain.
Roche Spain had no authority to negotiate the terms of sale or to conclude contracts,
it merely represented, protected, and promoted the interests of Roche Europe.
The National Court concluded (and the Supreme Court affirmed) that although Roche
Spains facilities were not a fixed place of business of Roche Europe, Roche Spain
was a dependent agent because it was legally and economically dependent on Roche
Europe, which both directed and controlled all relevant activities of Roche Spain and
bore all economic risks associated therewith.

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Roche Vitamins Europe Ltd, Supreme Court of Spain, Case No.

1626/2008 (Jan. 11, 2012).
TRANSFER PRICING :
The Supreme Court also addressed the attributable income issue, which has
transfer pricing implications.
Practitioners typically argue that , even if there is a PE in a country from which risk

has been stripped, a transfer pricing analysis would conclude that the fees allocated
to the stripped-risk affiliate are adequate to compensate it for its routine functions.
But the Court held that Roche Spain was not adequately compensated for all of the
functions it was performing for Roche Europe.
The Court concluded that product sales in Spain were taxable to Roche Europes PE
and Roche Spain should take into account a portion of European sales for this it had
assisted in promotion.
The Court held that. under Paragraph 34 of the OECD Commentary to Article 5, once
a PE is established, it exists to the extent that the agent acts for the principal, not
only to the extent of the agents contracts.
As a result, all of the economic activity conducted by Roche Spain on behalf of
Roche Europe is part of the PE.

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Gazprom Extraction Astrakhan LLC, Federal Arbitration Court

(Russia), Case No. KA-A40/13304-10 (June 2011)
SUMMARY:
The Russian tax authorities attempted to apply the net-back
approach (an adjusted CUP method) to Gazproms sales of sulfur to a
related party outside of Russia.
STATUS:
The court rejected the Russian tax authorities attempt because the
method is not mentioned in the Russian Tax Codes transfer pricing
article.

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Toyota Argentina SA c/AFIP-DGI, Argentina National Tax Court (April

28, 2011)
SUMMARY:
The tax authorities had retroactively applied new transfer pricing rules
to reject the taxpayers transfer pricing study and methodology.
STATUS
National Tax Court found for the taxpayer and revoked a notice of
deficiency.

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VI. CURRENT ISSUES BEING RAISED IN LITIGATION WHAT IT

MEANS FOR ASIA
B. Is Litigation a Viable Method for Managing Transfer Pricing Risks?
1. Are transfer pricing disputes about the facts, the applicable law and/or the

economics?
2. Can courts be expected to find the right answer?
3. What about the path forward after litigation?
C. Impact of Litigation Elsewhere on Transfer Pricing in Asia
1. Precedential value?
2. Highlighting issues for potential local enforcement?
3. Greater likelihood of litigation in the courts to resolve disputes?

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VII. CUSTOMS AND TRANSFER PRICING: WHAT YOU

SHOULD BE AWARE OF

Customs Taxes: Valuation methods transfer pricing rules vs. customs valuation rules

Joint OECD/WCO conferences in 2006 and 2007

Transfer pricing rules acknowledge modern transactions involving tangibles, intangibles and services, while
customs valuation rules are item-based and old school.
Transaction values supported by OECD arms length pricing study should be accepted as showing no related
party influence, so customs officials should accept arms length pricing adjustments or at least accept some
mechanism to consider same.

Customs reactions

Transfer pricing OECD, tax advisors and industry representatives

Customs WCO, country representatives, customs advisors
2006 optimism for convergence between the two sets of rules; but in 2007, did reality set in?

Transfer pricing positions

Arms length price under OECD TP guidelines as acceptable transaction value method?
Resale price method vs. deductive value method
Cost-plus method vs. constructed value method

Importance of well-accepted customs rules adopted on multilateral basis under GATT

Skepticism of profit methods in transfer pricing
Most inter-company transactions are accepted under transaction value method anyway.

Specific challenge: Use of profits-based method (e.g., TNMM) that requires prospective or retroactive
pricing adjustments to reach profit targets. Acceptable for customs? What procedures?
Any convergence in transfer pricing and customs practices in Asia countries?
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VIII. FUTURE OF TRANSFER PRICING IN ASIA

Where are we headed during the next 5 years?
PANEL DISCUSSION
Most Appropriate Method Rule
Use of Comparative Methods vs. Profit Methods
Documentation Requirements
Enforcement Approaches
Cooperation Among Tax Authorities
Litigation
MAPs and APAs
Transfer pricing and customs

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IX. Q & A
Questions?

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Thank you for your attention

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