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2010 Global Transfer Pricing Survey


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E&Y latest survey of tax directors and international tax professionals about Transfer Prices.

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2010 Global Transfer Pricing Survey

  1. 1. 2010 Global TransferPricing SurveyAddressing the challengesof globalization
  2. 2. ContentsIntroduction 1Executive summary 2Key trends in global taxation and transfer pricing 5Insights from the survey 7Transfer pricing still dominates the tax agenda 7Companies are paying closer attention to documentation 9The risk of audit is rising ... 11... as the controversy management tool chest is growing 12Transfer pricing rules are in flux 13Restructuring efforts and the pursuit of a more tax-efficientsupply chain are becoming more complex 15Conclusion 18
  3. 3. Country-specific findings from the survey 20Americas Asia-Pacific EMEIA22 Argentina 28 Australia 34 Belgium 42 Netherlands23 Brazil 29 China 35 Denmark 43 Norway24 Canada 30 Japan 36 Finland 44 South Africa25 Mexico 31 New Zealand 37 France 45 Spain26 United States 32 South Korea 38 Germany 46 Sweden 39 India 47 Switzerland 40 Ireland 48 United Kingdom 41 ItalyMethodology 49Glossary of terms 52Ernst & Young Transfer Pricing country contacts 54
  4. 4. Introduction Transfer pricing remains a key tax challenge for the world’s leading companies. That’s the major observation from our latest Ernst & Young survey of tax directors and international tax practitioners. And with good reason. Faced with a slowly recovering global economy and record deficits, governments are increasingly focused on raising revenues through taxation. As a result, more and more jurisdictions are ramping up their enforcement efforts — not only in developed nations but also in many emerging markets such as China, India, Russia and Brazil. At the same time, the Organisation for Economic Co-operation and Development (OECD), whose work largely defines the transfer pricing rules adopted by member nations, continues to refine and update its transfer pricing guidelines. In 2010, among other initiatives, the OECD issued a thorough update of its guidance on comparability and profit methods. For 2011, the OECD is shifting its transfer pricing focus to better defining the issues surrounding intangibles such as trademarks, patents and even business models. The OECD will be issuing guidance, hopefully within the next few months, that will form the basis of many governments’ attitudes in dealing with these difficult subjects. This year also saw the publication of the OECD’s new chapter on business restructurings and its new report on the attribution of profits to permanent establishments. Most global businesses, in the face of mounting pressure to improve profitability, have been undertaking some form of cost reduction or business change program. In many cases, this process includes substantial changes to everything from strategic planning to supply chain. Each and every business change brings with it transfer pricing implications. Since 1995, Ernst & Young has surveyed multinational enterprises (MNEs) on international tax matters with special emphasis on what continues to be a leading international tax issue — transfer pricing. The ever-increasing scope of our transfer pricing research reflects the growing number of countries that devote attention to transfer pricing. This is noted through increased enforcement and regulatory activity, as well as the increasing variety of transfer pricing issues facing MNEs. For this survey, we commissioned Consensus Research International to conduct a series of independent interviews of 877 MNEs across 25 countries. The resulting report summarizes the transfer pricing practices, perceptions and audit experiences of a wide range of global corporate tax practitioners. The survey provides insights into how MNEs are dealing with the myriad of economic, regulatory and fiscal changes taking place around the world. For the first time, our survey queries MNEs on their business restructuring activities, an area in which many of our clients express keen interest. We trust that you will find our 2010 Survey results, together with our insights and recommendations, useful and informative. In our view, there is no question that transfer pricing will remain one of the most important tax issues over the next few years and that tax authorities will continue to increase their focus in this area. Every business needs to be well-prepared for the coming challenges as enforcement efforts will undoubtedly increase significantly. John Hobster Thomas Borstell Head of Global Accounts Global Director Transfer Pricing Transfer Pricing Services1 2010 Global Transfer Pricing Survey
  5. 5. Executive summaryImportance of transfer pricingTransfer pricing is one of the key tax issues today — it is actually moreimportant today than it was two years ago.Audit experiencesTransfer pricing audits are increasing in significance, intrusiveness andscope.Controversy managementLitigation remains infrequent — but is on the rise. Meanwhile, the use ofand degree of comfort with APAs are increasing — while experience withnew arbitration processes remains extremely limited.Trends in transfer pricing issues and approachesEnforcement actions are placing greater emphasis on intercompanyfinancing transactions and service transactions.Taxpayer approachesTaxpayers are taking a more coordinated and globalized approachto transfer pricing documentation.Tax and efficient supply chain managementTax considerations relating to business restructuring are expected tobecome more important in the coming years. Addressing the challenges of globalization 2
  6. 6. Importance of transfer pricing Audit experiences Controversy management Transfer pricing is one of the key tax Transfer pricing audits are increasing Litigation remains infrequent — but issues today — it is actually more in significance, intrusiveness and is on the rise. Meanwhile, the use of important today than it was two years scope. and degree of comfort with APAs are ago. increasing — while experience with new arbitration processes remains extremely limited. • 74% of parent respondents believe • Two-thirds of respondents have • 23% of parent respondents use that transfer pricing documentation undergone an audit in the 2010 advance pricing agreements (APAs) is more important now than it was Survey, compared with only 52% in as a controversy management tool. two years ago. the 2007 Survey. • The level of satisfaction with APAs • 32% of all respondents identify • 1 in 5 audit adjustments triggered a as a controversy management tool transfer pricing as one of the most material penalty, compared with 1 in is high: 90% of those who have used important tax challenges facing their 25 in 2005. them would do so again. group. • Parent respondents report that • Only 18% of all respondents have • 74% percent of parent respondents tax authorities requested access referred a transfer pricing dispute and 76% of subsidiary respondents to intercompany agreements and to a competent authority in the last believe that transfer pricing will operational personnel in 73% and 41% three years. be “absolutely critical” or “very of examinations, respectively. important” to their organizations • The emerging option of binding over the next two years. • Emerging markets are coming to arbitration has yet to be adopted by the forefront of audit activity. The a significant number of respondents. number of parent respondents Only 2% of all respondents indicate indicating they had undergone a making use of binding arbitration. review in India increased from 6% in 2007 to 11% in 2010, while the • Globally, litigation remains an number undergoing a review in China infrequent but increasing method of increased from 4% to 12%. dispute resolution, with 10% of all respondents indicating that they have litigated a transfer pricing matter in the last three years, compared to only 3% in the 2007 Survey. Trends in transfer pricing issues and approaches Tax and efficient supply chain management Enforcement actions are placing greater emphasis Most respondents consider the tax effects of business on intercompany financing transactions and service change on a concurrent basis. transactions. • Reviews of intercompany financing transactions increased • A majority of respondents indicate that tax implications dramatically from 7% in 2007 to 42% in 2010. were considered in the implementation of all categories of business change. • Parent respondents indicating that their service transactions had undergone review increased from 55% • Cost reduction (78%) and information technology (IT) in 2007 to 66% in 2010. system implementation/improvement (74%) were the most common forms of business change undergone by • Respondents view administrative and management respondents in the past four years. service transactions and intercompany financing as the transactions most susceptible to dispute with tax • Restructurings involving intellectual property were the most authorities. common forms of restructurings. • Moreover, the numbers of respondents holding such views rose substantially. In 2010, 66% of parent respondents say that administrative and management service transactions are susceptible to dispute, up from 54% in 2007. As for intercompany financing, the figure is 63% for 2010, up from 41% in 2007. • Globally, taxpayers expect to devote more resources to transfer pricing compliance — particularly in China, the United States and India. • Survey respondents continue to show a preference for transactional methods in establishing transfer prices for tangible goods, services and intercompany financing.3 2010 Global Transfer Pricing Survey
  7. 7. Taxpayer approachesTaxpayers are taking a more coordinated and globalized approach to transfer pricing documentation, although thenumber of filers following a contemporaneous approach is slightly down.• The number of parent respondents preparing their transfer pricing documentation on a concurrent, globally coordinated basis rose to 41%, a significant increase relative to 2007.• The percentage of parent respondents preparing transfer pricing documentation prior to audit remained stable at 79%.• The percentage of parent respondents preparing their documentation contemporaneously with the filing of their tax return decreased from 60% in 2007 to 54% in 2010. However, the figure was higher in the United States, Mexico, India and Argentina, where contemporaneous documentation is a technical requirement.• Preparation of contemporaneous transfer pricing documentation was lowest in Canada, France, Germany, Italy, Japan and Korea. With the exception of Canada, these countries did not have contemporaneous documentation requirements in place during the survey period.• 69% of parent respondents indicate that upon audit, their transfer pricing documentation was viewed as adequate.• The majority of parent respondents (58%) continue to use pan-regional comparables.Key insights and recommendationsPrevious editions of this survey have concluded that taxpayers should be adopting efficientglobal documentation strategies; devising dispute resolution plans, both preventative andremedial; and embedding tax considerations in business change. This edition re-emphasizesthose points, but with some subtle differences:• ►Audit trends reveal the need for “glocal” documentation. MNEs should tailor their global transfer pricing platform to local requirements in higher-risk, more complex countries.• ►With audits up and material penalties significantly increased, avoiding disputes will be tougher. MNEs should consider a more proactive approach to controversy management, including appropriately targeted APAs.• ►Service, intangibles and financing transactions are increasingly in the sights of tax authorities. Our experience is that documentation of these categories of transactions often lags behind documentation for tangible goods transactions. MNEs should develop or enhance their documentation for these transactions.• ►OECD developments are pushing profit-based methods to the forefront while MNEs continue to rely on transactional methods to determine and document their intercompany pricing policies. MNEs should consider profit-based methods as corroborating or primary methods. Addressing the challenges of globalization 4
  8. 8. Key trends in global taxation and transfer pricing The downturn in the global economy has Transfer pricing has also assumed greater public prominence in the United States as a result of articles in the popular press and raised the profile of transfer pricing. Tax Congressional hearings on tax avoidance through “abusive” authorities are both upgrading and increasing transfer pricing. their staffing while at the same time placing In the United Kingdom, Her Majesty’s Revenue and Customs greater demands on corporations in areas (HMRC) has made a similar, coordinated transfer pricing push. such as documentation. Meanwhile, the OECD In June 2008, HMRC issued its Guidelines for the Conduct of is revising and updating key elements and Transfer Pricing Enquiries, which included the creation of a specialized Transfer Pricing Group, a transfer pricing review provisions of its transfer pricing guidance. board and a risk-based approach to transfer pricing enquiries. As a result, companies are finding they must In late 2010, HMRC also issued guidance to its field teams on work harder to define and adopt a more more extensive use of penalties in transfer pricing cases. proactive stance in defending their transfer The Chinese tax authority has also adopted a targeted pricing policies and practices. approach, designating 30% of Chinese taxpayers as key audit targets based on selected criteria. The criteria include Tax authorities are targeting intercompany transactions in significant intercompany transactions, consecutive years an attempt to protect and increase their tax bases. Since the without taxable income, reduced profit margins and low 2007 Survey, tax authorities in key jurisdictions have taken margins relative to industry peers. The audit initiative will rely steps such as significantly increasing their transfer pricing on profit-based transfer pricing measures in preference to staffing, adopting more centralized approaches to managing transactional approaches. transfer pricing enquiries and establishing a more strategic, The increased focus on transfer pricing extends to smaller risk-based approach to prioritizing transfer pricing reviews. markets, as well. The Australian Taxation Office is continuing In the United States, the Internal Revenue Service (IRS) added to increase transfer pricing personnel and its current strategic 1,200 employees in 2009 to deal with international issues, transfer pricing compliance initiative is focusing on business with another 800 added through the end of 2010. The IRS has restructuring, intra-group financing, mining services and established a goal of achieving a staff of 120 transfer pricing changes in profitability. economists, the highest number in its history. As part of its Along with increased transfer pricing staffing, tax transfer pricing focus, in December 2009 the IRS announced a authorities have or will have at their disposal a number number of important changes. These include: of new or proposed disclosure requirements. These • The creation of a Transfer Pricing Practice. requirements will increase the transparency of taxpayers’ intercompany transactions and their transfer pricing • The establishment of a Transfer Pricing Council to risks. In Latin America, many jurisdictions have mandated coordinate transfer pricing reviews. transfer pricing disclosure forms, and others have regulations • The establishment of a tiered approach to targeting that mandate the submission of transfer pricing reports intercompany transactions based on their potential contemporaneously with the corporate tax return. for abuse.5 2010 Global Transfer Pricing Survey
  9. 9. In the United States, the IRS has also increased penalties for • A trend toward macro-level examinations, such asfailure to accurately file related-party disclosure forms (Forms evaluating the effect of business restructurings on the5471 and 5472). It has also introduced Schedule UTP, which entire value chain or evaluating the aggregate return onrequires the disclosure of detailed information on uncertain investment under a cost-sharing arrangementtax positions, including transfer pricing positions. At the same • Blurring the lines between transaction types through thetime, the IRS is developing protocols to conduct joint audits recognition of so-called “high-value” serviceswith its treaty partners. Even as taxpayers cope with more intense and moreTax authorities are armed with increasingly sophisticated sophisticated scrutiny in developed markets, the geographicand broad transfer pricing tools. Since the 2007 Survey, scope of documentation requirements continues to expand.the IRS has issued final transfer pricing regulations for Since the 2007 Survey, China, France, Greece, Indonesia,intercompany services and revised temporary regulations Malaysia and Vietnam have all instituted new or significantlyfor cost-sharing transactions. During the same period, the enhanced transfer pricing requirements. Even jurisdictionsOECD issued revisions to Chapters I through III of the Transfer traditionally viewed as tax-favorable, such as Hong Kong andPricing Guidelines along with a new chapter on business Ireland, have introduced some level of requirement for transferrestructurings. The Australian tax authorities issued similar pricing documentation.guidance on business restructurings in June 2010, and theGerman administration is expected to soon finalize its July2009 draft circular on this subject. These regulatory and The results of our 2010 Survey reflect bothlegislative developments are characterized by a number of the intensity and the shifting focus of transfercommon features, including: pricing enquiries. Taxpayers find themselves in• Greater sophistication and flexibility in the selection of the challenging position of documenting and transfer pricing methods, including the OECD’s move away defending their transfer pricing in more and from a hierarchy of methods more countries. The transaction types they• The adoption of a “realistic alternatives” criterion into have to cover are increasing, and the emphasis the selection of best method in the US transfer pricing is changing. Controversy is on the rise as regulations and into the OECD guidelines increasingly well-staffed tax authorities apply• A tendency to extend the scope of a transfer pricing more sophisticated and sweeping transfer pricing analysis beyond a single party to examine its effect on the tools. At the same time, fortunately, a wider array profit of the counterparty and/or the full value chain of dispute resolution channels is available and• The OECD’s prohibition of inappropriate shifting of risk being used. (and profit), which includes the use of either intercompany agreements or “low risk” transfer pricing methods, such as cost-plus arrangements, that divorce risk from the entities that control it• Enhanced OECD comparability standards mandating more effort and rigor in the selection of benchmarks More countries, more issues, More countries, more issues, more more tax authority aggression tax authority aggression, and more and more disputes — that’s why disputes – that’s why transfer pricing is the number one international tax issue transfer pricing is a leading for respondents. international tax issue for respondents. Addressing the challenges of globalization 6
  10. 10. Insights from the survey Transfer pricing still dominates the tax agenda Ernst & Young’s 2010 Survey continues to demonstrate the high degree of importance 30% of tax directors in parent tax departments assign to transfer pricing. firms worldwide identify transfer More parent company respondents identified transfer pricing as the most important tax pricing as their most important issue they face. tax issue. Figure 1: Most important tax issues for tax directors (parents) This conclusion is supported by tax directors’ answers to Transfer pricing another question. Asked how important they expect transfer Tax minimization pricing to be over the next two years, 32% called it “absolutely Cash taxes critical,” up from 29% in 2007. This suggests that the survey Value-added taxes respondents are not complacent about their level of transfer Double taxation pricing risk. Tax controversy Cash repatriation Figure 3: Importance of transfer pricing in the next two years Foreign tax credits (parents) Customs duties 2010 2007 0% 5% 10% 15% 20% 25% 30% 35% Absolutely critical 32% 29% Thirty percent of tax directors in parent firms worldwide Very important 42% 45% identify transfer pricing as their most important tax issue. In Fairly important 21% 18% North America, transfer pricing was paramount for 21% of Not very important 4% 5% respondents, but percentages were higher in other regions: Not at all important 1% 1% 30% in Asia-Pacific (APAC) and 33% and in Europe, Middle East, India and Africa (EMEIA). The percentages were highest in Figure 4 summarizes the importance respondents attach to Italy (52%) and Denmark (60%). Figure 1 shows the eight other transfer pricing by industry. Tax authorities typically target topics that registered among many respondents as the most industries with high-value, portable intellectual property important tax issue. Tax minimization was the only issue that and those that generate high margins. It is not surprising, rivaled transfer pricing. therefore, that more respondents in the pharmaceutical Figure 2 summarizes the importance tax directors have industry rank transfer pricing as their most important tax issue attached to transfer pricing over the last seven surveys. The than in any other industry. Because pharmaceutical companies peak of concern was in 2005 when almost 60% described it as typically deploy valuable intangibles in more than one tax “very important.” That percentage dropped in 2007 and 2010, jurisdiction, transfer pricing concerns typically loom large. The but we attribute the declines to respondents’ sense that they pharmaceutical industry has also been exposed to some of the have their transfer pricing issues under better control than most significant transfer pricing litigation of recent years. they did in 2005. The technology and biotechnology industry, which is also heavily reliant on intangible property, shows the second- Figure 2: Importance of transfer pricing from 1997–2010 (parents) highest level of importance. Respondents in industries that 60% typically have lower levels of cross-border transfers, such as 50% transportation, telecommunications and professional services, 40% rank transfer pricing lower among their tax concerns. 30% 20% 10% 0% 2010 2007 2005 2003 2001 1999 1997 Very important Fairly important Not very important Not at all important7 2010 Global Transfer Pricing Survey
  11. 11. The practice of transfer pricing is receivingRespondents confirm ongoing greater attentioninterest of tax authorities in a The increased importance MNEs attach to transfer pricing issmall number of concentrated driving increased deployment of both internal and external transfer pricing resources and elevating the profile of transferindustries. This will change in the pricing within the organization.coming years. Thirty-one percent of parent respondents report some level of increase in internal transfer pricing headcount, 62% report an increase in the use of external consultants, and 23% reportThere seems to be some legacy interest by tax authorities an increase in the use of software and other tools. Sixty-sixin lower-margin industries, such as the automotive and percent indicate that they had at least one full-time equivalenttransportation industries. There is also an inconsistency working on transfer pricing, up from 55% two years ago.between increased tax authority scrutiny of financial Forty-seven percent of parent respondents say that they havetransactions and the rather limited importance banks and become more responsible to their boards of directors forfinancial institutions place on transfer pricing. We expect this transfer pricing matters and 41% say they have become moreperception to change in view of the increasingly sophisticated responsible to their audit committees. As shown in Figure 5,risk-assessment tools deployed by the tax authorities, which ultimate responsibility for transfer pricing remains most oftenwill likely expose financial transactions to more frequent with the tax department (39% of respondents), followed byreview. We also expect the focus on low-margin business to the chief financial officer or parent company director. Onlyerode. By contrast, we expect much more interest in businesses 8% of parent respondents delegate responsibility to the localwith footprints in emerging markets, such as mining, oil and affiliate company.gas and diversified industrial products. Figure 5: Responsibility for transfer pricing within the organization Figure 4: Percentage of respondents ranking transfer pricing as (parents) their most important tax issue (parents and subsidiaries) PharmaceuticalsTechnology and biotechnology 12% Consumer products 3% Retail and wholesale Automotive 8% 39%Diversified industrial products Transportation Power and utilities Mining, oil and gas Professional services 38% Insurance Media and entertainment Chemicals Banking and capital markets Tax department Parent CFO/financial director Delegated responsibility Telecommunications to local leader 0% 10% 20% 30% 40% 50% 60% 70% 80% Audit committee Other Addressing the challenges of globalization 8
  12. 12. Companies are paying closer attention to documentation The heightened scrutiny of transfer pricing, Figure 7: Factors considered highly influential on transfer pricing the widening range of jurisdictions with compliance (parents) documentation requirements and the Tax audit activities increased level of transfer pricing disclosure Tax department leading practices all increase a taxpayer’s transfer pricing External auditor request risk. That increased risk is reflected in the Audit committee request enhanced importance survey respondents FIN 48 requirements or equivalent attach to transfer pricing documentation. Economic crisis Three-quarters of parent respondents in this Internal auditor request year’s survey consider documentation more 0% 10% 20% 30% 40% 50% 60% 70% important now than two years ago. As they pay closer attention to documentation, more companies are adopting a global approach. Most parent respondents cite risk-based motivations for preparing documentation. Thirty-six percent identified risk mitigation as their primary motivation in preparing The number of parent respondents pursuing documentation, while the number of respondents citing a globally coordinated transfer pricing audit defense as their primary motivation has more than documentation strategy increased from 33% doubled from 2007 to 20%. Fewer than 10% of respondents in 2007 to 41% in 2010. were motivated by either financial reporting requirements or planning considerations. Figure 6: Top priority in preparing transfer pricing documentation Despite the potential effect of the economic downturn on (parents) resources, the number of respondents that do not prepare transfer pricing documentation remains low at 3%. Risk mitigation/ reduction Figure 8: Approach to transfer pricing documentation (parents) Audit defense Prepared concurrently, on a globally coordinated basis Consistency of documentation Prepared for a single country, and Ability to identify tax modified to meet the needs of planning opportunities other jurisdictions as necessary Compliance with financial Prepared on an as-necessary, reporting standards country-by-country basis with limited coordination between countries Judged case by case/ strategic or reactive decision Did not prepare transfer pricing documentation Minimize compliance costs Adherence to historic Don’t know/not stated practice/company policy 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% Other 2010 2007 0% 5% 10% 15% 20% 25% 30% 35% 40% Respondents generally take a regional, rather than a country- 2010 2007 specific, approach to comparables analysis. Fifty-eight percent of parent respondents indicate that they use regional samples Consistent with their broader risk-based approach, respondents to one degree or another, while only 38% use local comparables cite tax audit activities as the most influential factor in for all countries (see Figure 9). Perhaps reflecting the difficulty determining their transfer pricing compliance (see Figure 7). large MNEs face in assembling local comparable data for a large This finding seems to suggest some degree of recognition by number of jurisdictions and transactions, the use of regional respondents of increased tax audit activity. comparables was more prevalent among those respondents with revenues of $10 billion or more than among smaller companies. With increasing tax authority aggression, MNEs will have to prepare local, as well as regional, comparables for their transfer pricing documentation.9 2010 Global Transfer Pricing Survey
  13. 13. Most respondents rely on regional comparables, As for the timing of their documentation, just over half (54%) of parent respondents indicate that they prepare documentationbut tax authorities increasingly require contemporaneously with the filing of their corporate income taxlocal comparables. More “glocalization” of return. The level of contemporaneous compliance is generallybenchmarking and comparables studies will be highest in those jurisdictions with specific contemporaneousneeded to mitigate audit risk. documentation requirements, namely Argentina (100%), Mexico (86%), India (78%) and the United States (75%). The level is generally the lowest in those jurisdictions that did not Figure 9: Approach to comparables sets (parents) have contemporaneous documentation requirements at the time of this survey, including Italy (29%), France (25%) and Germany (14%). 4% The results for Canada, which has formal documentation 27% requirements, were anomalous, with only 22% of parent respondents indicating that they prepare their transfer pricing documentation contemporaneously with the filing 38% of the tax return. Figure 11 summarizes contemporaneous documentation practices by jurisdiction. 31% Figure 11: Contemporaneous documentation by parent company jurisdiction (parents) New Zealand Local comparables Pan-regional sets, but Pan-regional Unknown Argentina searches for all with exceptions for comparables sets countries specific jurisdictional across multiple Mexico requirements jurisdictions India USRespondents’ reliance on regional comparables is somewhat South Africasurprising given the broadening range of local documentation Netherlandsrequirements. The disconnect between regulatory trends and Braziltaxpayer practice is reflected in respondents’ audit experiences. UKParent respondents cite insufficient local focus on comparables as Spainthe most frequent basis on which their documentation was judged Irelandinadequate upon audit (see Figure 10). Furthermore, nearly a Australia Belgiumthird of respondents indicate that they were required to perform Denmarkadditional comparables analysis to identify local comparables. No Swedendoubt the hot topic of debate in transfer pricing compliance over Switzerlandthe next decade will be how to reconcile the need for consistency Norwayand simplicity with diverging and increasingly detailed Finlanddocumentation requirements by tax authorities. Italy Japan Figure 10: Basis on which documentation found inadequate upon France audit (parents) Canada Germany Insufficient local focus — comparables Korea Reason not given/arbitrary 0% 20% 40% 60% 80% 100% Incorrect method Insufficient demonstration of business case for transactions Insufficient local focus — functional analysis No documentation prepared Key facts omitted Not contemporaneousEconomic analysis not accepted 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% Addressing the challenges of globalization 10
  14. 14. The risk of audit is rising ... More survey respondents report that Figure 13: Jurisdiction in which transfer pricing policy was examined they have been subjected to a transfer in the past four years (among parent companies that had undergone a review since 2006) pricing review. Sixty-eight percent of 2010 2007 parent respondents indicate their transfer US 36% 31% pricing policy had been examined by tax Germany 32% 31% France 21% 27% authorities, up from 52% in the 2007 Survey UK 19% 27% (see Figure 12). Canada 18% 23% Italy 13% 15% Figure 12: Incidence of transfer pricing review (parents) China 12% 4% Australia 11% 11% 80% India 11% 6% 70% Japan 9% 12% 60% 50% Increasing numbers of respondents are experiencing 40% the pains of transfer pricing audits globally. However, 30% the range of countries in which audits occur is shifting, 20% with mature transfer pricing jurisdictions apparently scaling back and emerging jurisdictions scaling up 10% dramatically. The increasing pressure on governments 0% to raise revenues and the dedication of additional 2010 2007 transfer pricing enforcement resources are likely to lead Respondents’ risk of audit varied depending upon their to reinvigorated scrutiny in all markets. intercompany transactions and their size. The establishment of limited risk distribution structures, material intercompany license transactions and company size are all positively The survey results indicate a substantial increase since 2005 correlated with the risk of transfer pricing review. These in the percentage of adjustments resulting in penalties, as findings are consistent with the application by tax authorities summarized in Figure 14. of a risk-based approach to transfer pricing reviews. The larger the company, the larger the transfer pricing adjustment Figure 14: Percentage of adjustments resulting in penalties (parents) it typically yields. Intercompany licensing transactions and 20% limited-risk distribution arrangements, which frequently involve the conversion of a full-fledged distributor with existing 15% marketing intangibles, are typically susceptible to larger adjustments than tangible goods transactions or even service 10% transactions. While the level of transfer pricing reviews has increased 5% globally, the jurisdictions where those reviews have occurred have shifted since 2007. The United States and other mature 0% transfer pricing jurisdictions head the list of jurisdictions 2010 2007 2005 where respondents had experienced a review, but China and According to the survey results, there is now a 1 in 5 chance of India have shown a significant increase in audit activity. The suffering a material penalty compared with a one in 25 chance countries showing a reduction in activity are generally those in 2005. The increasing imposition of penalties is a function of that face resource constraints, focus on a smaller number of increasing tax authority resources, as well as tax authorities’ high-profile cases or are revising their risk-based approach obvious need to raise more revenues. We expect the trend to case selection. Figure 13 summarizes the geographic toward increased penalties to continue. distribution of the reviews experienced by respondents. Taxpayers are responding to increased audit activity with an increased reliance on risk assessments. Sixty-seven percent of parent respondents indicate they have conducted a risk assessment in the past three years, an increase from 53% in the 2007 Survey.11 2010 Global Transfer Pricing Survey
  15. 15. … as the controversymanagement tool chestis growingA taxpayer’s options for resolving transfer Seventy-nine percent of parents report that they are generally satisfied with the APA process. However, many remainpricing disputes after domestic appeals unconvinced (or unaware) of the benefits of APAs: fewer thanwere historically limited to three: APAs, half (47%) of parent respondents not already using APAs saycompetent authority relief (through the they would consider using them in the future.Mutual Agreement Procedure provision of the The 2010 Survey results show slightly increased reliancerelevant treaty) and litigation. Since the 2007 on the competent authority process, reversing a moderateSurvey, binding arbitration has arisen as an trend from 2003 through 2007 of decreased reliance. While the trend from 2003 to 2007 may have resulted from theadditional mechanism. increased availability of APAs and a general desire by taxpayersPublished statistics from many tax authorities indicate record to manage controversy risk prospectively, the 2010 resultslevels of APA applications overall. For example, the IRS is at a may reflect a global trend toward increased bilateral andfour-year high while the Canada Revenue Agency is at an all- multilateral transfer pricing dispute resolution. Figure 16time high. summarizes the pattern over time.The reported use of APAs in our transfer pricing surveys has Figure 16: Respondents referring a matter to competentnearly doubled since the inception of APA programs around the authority in the previous four yearstime of our 1999 Survey. The growth in APA use is a function 2010 2007 2005 2003of the increasing availability of APA programs and increasing Parents 18% 17% 18% 18%realization of the value of APAs as dispute resolution tools. We Subsidiaries 17% 11% 13% 16%predict that the use of APAs to resolve disputes and to reduceFIN 48 reserves will continue to trend upward. MNEs should The newly available binding arbitration process has yet to beconsider the strategic use of APAs in both of these areas. used by a significant number of respondents, with only 14 parent respondents (2%) indicating they have pursued thisAlthough only 23% of parent respondents indicate using option in a transfer pricing controversy.APAs as a controversy management tool, the level of Litigation of transfer pricing disputes remains infrequent, withsatisfaction with the APA process among users is high. only 11% of parent respondents overall pursuing this avenue.Ninety percent indicate that they would seek an APA in The only jurisdiction with significant litigation activity is India,the future. where 50% of respondents have relied on litigation for the resolution of transfer pricing disputes.The range of jurisdictions in which parent respondents have As summarized in Figure 17, competent authority is thesought APAs is wide (29 countries). But the principal APA preferred method among parent respondents for resolvingjurisdictions remain those with well-developed transfer pricing transfer pricing disputes.regimes, such as the United States, the United Kingdom, theNetherlands, Australia and Japan (see Figure 15). Figure 17: Preferred methods of resolving transfer pricing disputes (parents) Figure 15: Top five jurisdictions in which an APA has been used 40% (parents) 45% 35% 2010 2007 2005 2003 2001 30% 40% 25% 35% 20% 30% 15% 25% 10% 20% 5% 0% 15% Competent authority APA Litigation Binding arbitration 10% 5% 0% US UK Netherlands Australia Japan Addressing the challenges of globalization 12
  16. 16. Transfer pricing rules are in flux Regulations and resulting practice are in Despite the increased importance of profit-based flux all over the world. For example, during methods in the OECD and in many countries in the last three years, both the OECD and the transfer pricing audits, we still observe a minority US Treasury issued significant new transfer of respondents using profit-based methods. pricing regulations or guidelines. Similarly, a We predict that regulatory shifts will result in wide range of countries — from Germany and a dramatic increase in the use of profit-based Italy to Russia and China — have delivered or methods as corroborative, or sometimes primary, are at least in the process of implementing transfer pricing methods. We have already begun significant revisions to their rules and to see this trend in high-profile controversy practices. cases. Survey readers should begin to consider the importance of profit-based methods in their In the United States, the 2008 temporary cost-sharing transfer pricing planning and documentation. regulations and the 2009 final service regulations reflect the increased importance the IRS attaches to service and intangible transactions. These regulations also introduce a new Figure 18: Transfer pricing methods used in establishing tangible level of sophistication, as evidenced by their sheer length in goods pricing (parents) comparison to the original regulations they superseded. Cost plus 30% Benchmark of third-party prices (CUP method) 27% The OECD’s revisions to Chapters I through III of the Transfer Pricing Guidelines signal a shift from the OECD’s historically Profit-based method (CPM/TNMM) 23% strong preference for transactional methods toward accepting RPM (resale price method)/resale minus 12% profit-based methods. The OECD’s Restructuring Chapter Profit split 3% signals a new scrutiny of business restructuring transactions. Other 6% Our survey responses reflect broad awareness of such developments. Sixty-two percent of parent respondents Figure 19: Transfer pricing methods used in establishing service headquartered in OECD countries indicate awareness of the transaction pricing (parents) OECD discussion draft, Transfer Pricing Aspects of Business Cost plus 52% Restructuring. Awareness of the US cost-sharing regulations Benchmark of third-party prices (CUP method) 21% was high among US parent respondents at 66%. However, TNMM 11% the figure is a mere 28% among parent respondents with At cost 7% headquarters in other jurisdictions. Fifty-three percent of parent respondents indicate that they were altering their Value-based service fees 2% transfer pricing policies in response to regulatory changes. Other 6% Based on our survey, taxpayers are not yet moving toward Figure 20: Transfer pricing methods used in establishing intangible profit-based methods — even though such methods are goods licensing (parents) increasingly preferred by tax authorities. Parent respondents Third-party benchmark agreement between the 22% instead continue to show a strong preference for transactional company and an unrelated party methods in establishing pricing for tangible goods, services and Third-party benchmark agreement between two parties 21% intangible goods (see Figures 18 through 20). unrelated to the company Profit-based method (CPM/TNMM) 21% Profit split 9% Other 25% Don’t know/not stated 3%13 2010 Global Transfer Pricing Survey
  17. 17. While MNEs may not be consistent with current regulatory Figure 22: Most significant transfer pricing examination (parents)trends in their choice of transfer pricing methods, theirprioritization of transactions susceptible to review is Servicesaligned with the audit priorities established by the major tax Transfer of sales ofauthorities. Parent respondents ranked services, financing tangible goods Intercompanyand intangible transactions as among the most susceptible to financingtransfer pricing review (see Figure 21). License of intangible property Cost sharing/ cost contribution agreementsParent respondents ranked services, financing Other/don’t knowand intangible transactions as among the most Imputed or increased compensation/indemnificationsusceptible to transfer pricing review, and all payments for business change 0% 10% 20% 30% 40% 50% 60% 70%categories of transactions as more susceptible toreview than in 2007. 2010 2007 Parent respondents also report more intrusive transfer pricing examinations with requests for all categories of documents Figure 21: Transactions most susceptible to review by tax authorities and sources above their 2007 levels. In line with the (parents) increased scrutiny of the commercial basis for intercompany pricing policies, tax authority requests for access to company Administrative or managerial services operational personnel increased significantly from 36% in Intercompany financing 2007 to 49% in the current survey. As tax authorities have Technical services expanded their analyses beyond a single party to examine License of intangible property effects on the profit of the counterparty, requests for foreign Cost sharing/cost contribution agreements affiliate financial records and management accounts have Transfer or sales of finished goods for resale increased. Intercompany agreements (not covered in the 2007 Survey) stood out as an almost universal request in Commission for sales/transfer of goods Sales of raw materials or components transfer pricing audits. between group companies Imputed or increased compensation/indemnification payments for business change Figure 23: Requests made in transfer pricing audit (parents) Treatment of stock-based compensation Financial records of None foreign affiliates Other Access to company operational personnel Don’t know/not stated Access to the company’s EDP system/other computer records 0% 10% 20% 30% 40% 50% 60% 70% Internal documents relating to tax input on business change 2010 2007 Correspondence with tax advisorsTax authority examinations reflect the same Other company documents not specificallyincreased focus on service and intangible transactions, prepared for transfer pricing purposes Disclosure and specification of uncertainwith intercompany loans also showing a striking increase in tax positions in statutory accountsscrutiny. As shown in Figure 22, 42% of respondents that None of theseunderwent a transfer pricing examination report that their 0% 10% 20% 30% 40% 50% 60%intercompany financing was examined, up from only 7% in the2007 Survey. Sixty-six percent report that their intercompany 2010 2007service transactions were examined, up from 55% in the2007 Survey. Addressing the challenges of globalization 14
  18. 18. Restructuring efforts and the pursuit of a more tax-efficient supply chain are becoming more complex At precisely the time when companies need Figure 24: Categories of business change implemented since to achieve greater efficiency in all areas 2006 (parents) Total EMEIA Americas APAC — business and tax alike — a number of Cost reduction 78% 81% 85% 57% transfer pricing developments are presenting IT system 74% 74% 83% 60% challenges to MNEs who are restructuring implementation/ their businesses. The IRS, for example, improvement released a Coordinated Issue Paper on buy- Entry into new 71% 75% 76% 51% markets/new product ins related to cost-sharing arrangements and lines revised cost-sharing regulations. Similarly, Post-merger 63% 67% 66% 46% the OECD has issued its Chapter IX focusing integration/acquisitions on business restructurings. At the same time, Supply chain 50% 53% 49% 39% optimization the tax effects of business restructurings are Centralization 50% 55% 50% 30% receiving increased scrutiny from the press of business or and the US Congress. management functions Outsourcing or off- 26% 26% 35% 14% shoring of supply chain Our 2010 Survey queried respondents in detail on their functions business change and restructuring activities. These questions covered the nature of their business restructurings, the consideration of tax implications in business restructurings and Cost reduction and IT system implementation or improvement the timing of restructuring activity. projects were the most common categories of business change. The focus on cost reduction is unsurprising in the context of Figure 24 presents the types of business changes undertaken the current economic downturn. However, the prevalence of IT by parent respondents since 2006 in total and by region. projects, which are typically costly, is somewhat unexpected. Outsourcing or off-shoring of supply chain functions were the least prevalent business change projects among survey respondents. Approximately half of all parent respondents have embarked on either supply chain optimization or centralization of business or management functions since 2006. The prevalence of these structures varies significantly by industry. In the chemical industry, for example, where products tend to be bulky and supply chains difficult to reengineer, 49% of parent respondents undertook supply chain optimization projects in the last four years. Respondents from the pharmaceuticals and telecommunications industries, on the other hand, indicate considerably higher levels of supply chain optimization. With the increasing relative growth opportunities provided by emerging markets, companies are shifting focus to India, China and Brazil. Such shifts provide opportunities and motivation for supply chain reengineering.15 2010 Global Transfer Pricing Survey
  19. 19. Geographically, there are significant differences in business In spite of greater complexity and added documentationrestructuring activity, with the Americas and EMEIA showing requirements, companies are still pursuing a wide arrayhigher levels of all categories of business change than the of business restructuring, streamlining and supply chainAPAC region. The rapidly changing global business footprint reconfiguration due to business necessity. Figure 26and its eastward shift suggest that the APAC region will require summarizes the business restructurings that parentintense focus by tax departments in the coming years, as MNEs respondents have implemented, both in total and by catch-up to accomplish in the APAC region what theyalready have in EMEIA and the Americas. Figure 26: Business restructurings implemented or being pursued (parents) Figure 25: Centralization of management and supply chain Total EMEIA Americas APAC optimization by industry (parents) Centralized intangible 42% 47% 40% 30% property ownership Telecommunication and management Pharmaceuticals Cost-sharing/buy-in 39% 46% 35% 24% agreements Retail and wholesale Intangible property 36% 37% 40% 26% Media and entertainment planning Transportation Shared service centers 35% 35% 47% 15% in low-cost jurisdiction Banking and capital markets Contract R&D 34% 36% 35% 25% Insurance Centralized or regional 34% 36% 38% 20% procurement company Automotive Limited-risk 30% 33% 34% 12% Consumer products distributor(s) Mining, oil and gas Global or regional 28% 27% 33% 25% principal or centralTechnology and biotechnology entrepreneurDiversified industrial products Limited-risk service 27% 30% 31% 15% providers Chemicals Single regional sales/ 27% 28% 29% 21% Professional services marketing entity Limited-risk 23% 25% 28% 9% Power and utilities manufacturing 0% 10% 20% 30% 40% 50% 60% 70% 80% Centralization of business or Supply chain management functions optimization The survey reveals that a significant portion ofThere is little regional variation in the relative ranking ofbusiness change projects. However, there are marked, if not business restructurings involve intangibles. Givensurprising, variations in the absolute levels of business change governments’ focus on intangibles — both incentivesimplementation. The EMEIA and Americas regions return to retain or attract to their jurisdictions (e.g., thevery similar levels of activity, while APAC respondents, where recent UK announcements on the patent box) andcompanies tend to be less mature, indicate significantly lower enforcement efforts — we can expect continuedlevels of business change. examination, controversy and litigation activity in this area. Addressing the challenges of globalization 16
  20. 20. Given the significant role intangibles play in today’s businesses, Figure 28 summarizes the timing of parent respondents’ restructurings focused on intangibles, including contract business restructuring activities. R&D, are particularly prevalent. Less popular are centralized Figure 28: Timing of business restructuring activities (parents) procurement and global or regional principal structures. Limited-risk manufacturing structures are the least common 2005– 2001– Prior to Don’t forms of restructuring. This is not surprising because many 2010 2004 2000 know companies have already established manufacturing in low-cost, Centralized intangible 37% 18% 36% 9% tax-competitive jurisdictions, employ “manufacturing-lite” property ownership and management business models or are not involved in manufacturing activities at all. Centralized or regional 59% 13% 24% 5% procurement company Again, the survey shows that respondents are generally aware Contract R&D 53% 16% 25% 6% of the need to consider tax implications in the planning and Cost-sharing/buy-in 52% 21% 22% 5% implementation of business restructuring projects. Figure 27 agreements summarizes the consideration of tax implications in the various Global or regional 44% 24% 25% 7% categories of business change. principal or central entrepreneur Figure 27: Consideration of tax implications in business change (parents) Intangible property 51% 15% 25% 9% planning Yes No Don’t know/ Limited-risk service 52% 20% 22% 7% not stated providers Post-merger integration 91% 7% 1% Limited-risk 43% 27% 27% 3% distribution Outsourcing or off-shoring of 81% 17% 2% supply chain functions Limited-risk 43% 24% 28% 5% manufacturing Entry into new market/new 79% 19% 2% product lines Shared service centers 66% 22% 9% 3% in low-cost jurisdiction Centralization of business or 77% 22% 1% management functions Single regional sales/ 47% 21% 26% 6% marketing entity Supply chain optimization 75% 23% 2% IT systems implementation/ 66% 32% 2% The 2005–2010 period saw an upsurge in restructuring improvement activity after a lull in the 2001–2004 period. Centralization Cost reduction 62% 37% 1% of intangible property management, in particular, rebounded Other forms of business change 62% 23% 15% during the 2005–2010 period with a 36 percentage point increase. Other forms of planning related to intangible Awareness of the need to consider tax implications is foremost property, such as contract R&D, also increased in the 2005– in post-merger integration (91%) and outsourcing/off-shoring 2010 period. Regional procurement companies, which were (81%) projects. among the least popular forms of planning before 2005, have moved into first place among planning structures.17 2010 Global Transfer Pricing Survey
  21. 21. ConclusionIn the many years that Ernst & Young has The recession and regulatory uncertainty seem to have stemmed the amount of business-driven tax planning in thebeen tracking transfer pricing trends, a last few years. We see great challenges for MNEs in dealingnumber of core themes have emerged. with the transfer pricing implications of business change. GivenHowever, this year’s survey uncovered some the significant increase in regulations over the past few years,subtle differences and new areas for MNEs more complex transfer pricing designs are warranted to meet the new high standards set by the OECD and regulators into consider. countries like Germany.MNEs must take a more proactive approach to transfer pricing. Taxpayers should reinforce their transfer pricingThe risk of challenge by the authorities continues to increase. documentation for intercompany services, licensing andIn their quest for more revenue, tax authorities have become financing transactions. This year’s survey highlights thebetter at auditing, with higher hit rates for adjustments and increasing scrutiny these transactions are receiving from taxhigher levels of penalties. Documentation needs to cover more authorities. Unlike tangible goods transactions, where costcountries — witness China — and more types of transactions, of production or acquisition can serve as a reference pointas evidenced by the dramatically increased scrutiny of for value, the valuation of services, licensing and financingloans and financial transactions. Despite the need to cover transactions is more complex, being primarily related to valuemore countries, globally consistent documentation will need rather than costs. As a result, tax authorities recognize thatto accommodate the increasing trend toward “glocalization.” these transactions have the potential to generate significantTwo of the most commonly cited reasons for suffering audit adjustments. At the same time, it is our experience thatadjustments were insufficient local tailoring of facts and transfer pricing documentation for services and intercompanyinsufficient local benchmarking of prices or margins. Risk- financing transactions often lags behind documentation ofbased assessments will need to find a balance between global tangible goods transactions. Taxpayers should ensure that theirstrategy and local detail, a change we are seeing first-hand with services, intangibles and financing policies and documentationsome of our largest, most sophisticated transfer pricing clients. can withstand the rigors of the current transfer pricing environment.MNEs should pursue a more proactive and extensive use ofAPAs where there is reliable availability. MNEs will see more Ernst & Young’s Global Transfer Pricing group expects theinstances of potential double taxation. Instead of waiting to next few years to be dynamic and exciting as MNEs exercisereact to controversy, MNEs will need to plan for it by learning greater rigor to meet increasingly onerous requirements. Inhow to handle domestic appeals, competent authority the end, we anticipate more movement across the gamut ofproceedings, alternative dispute resolution mechanisms and transfer pricing areas — preparing documentation to meetAPAs. Although more than a third of respondents prefer compliance requirements and mitigate penalties; managingthe Mutual Agreement Procedure for dispute resolution, we audits, resolving disputes and eliminating double taxation; andanticipate more litigation where it is not an option. harnessing business change in a tax-efficient manner. We look forward to sharing the journey with readers of this survey! Addressing the challenges of globalization 18
  22. 22. 19 2010 Global Transfer Pricing Survey