Post on 09-May-2020
Control over transfer pricing
22 November 2018
PwC
Agenda
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1. Importance of having a transfer pricing control framework2. Pricing under control? IFRS 16 changes!3. IFRS 15 − Agent versus principal4. Key takeaways
Transfer pricing control framework
PwC 4
Tax audits reaching record numbers
“Fair share”
Reputational risk
External audits
Emerging tax systems
Tax Technology
Data sharing
Governments competing
Tax governance
Digitisation
Increasing attention and exposure
Transparency
PwC 5
What clients tell us about their lack of control over transfer pricing
‘Near misses’
Inconsistent TP results Informal processes and reliance on
‘goodwill’
Patchwork of data sources
Ambiguous terms in intercompany agreements
Hero dependency
Frustrating quarterly/annual close
Difficulty in ETR forecasting
Excel dependency
Lack of TP monitoring
Lack of controls
PwC
Main purpose of a transfer pricing control framework (TPCF) is safeguarding the level of certainty with regard to the transfer pricing-related financial statements / tax position(s) for the relevant parties involved.
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Internal
Tax Department Management Internal auditors CSR Communications
External
Tax authorities External auditors Others: e.g. regulators
This means: risk mitigation – for example: double taxation, reputation, etc.
Who are the relevant parties?
PwC 7
Transfer Pricing Control Framework
Based on OECD Tax control framework
PwC
Transfer Pricing Control Framework (cont’d)
Strategy Operational
Consulted / Informed
Responsible / Accountable
TP Policy
Documentation /Compliance
Monitoring /
implementation
Responsibilities Tax Department
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Transfer Pricing Control FrameworkTransfer Pricing Strategy EstablishedApplied Comprehensively
Responsibility Assigned
Governance Documented
Testing Performed
Assurance Provided
Tax Policy
TP Policy
ManufacturingTP Procedure
Sales TP procedure
Corporate services TP procedure
High level Adherence to the arm’s length
principle One pagers Communication/update process
PwC
Transfer Pricing Control Framework
Simple One pager policies Detailed implementation
documents Communication/update process
Sales TP procedure
Corporate services
TP procedure
Job profiles
Business design model
Functional governance documents
Intercompany agreements
Cost base definitions
Product Costing
guidelinesRACI’s
Documentation procedure
Controversy procedure
Exceptions procedure
Transfer Pricing Strategy Established
Applied ComprehensivelyResponsibility Assigned
Governance Documented
Testing Performed
Assurance Provided
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ManufacturingTP Procedure
TP Policy
Tax Policy
PwC
Transfer Pricing Control Framework
Sales TP procedure
Corporate services
TP procedure
Documentation procedure
Controversy procedure
Job profiles
Business design model
Functional governance documents
Intercompany agreements
Cost base definitions
Product Costing
guidelinesRACI’s
Head of Tax
Local ManagementController
HR
Transfer Pricing Strategy Established
Applied Comprehensively
Responsibility AssignedGovernance Documented
Testing Performed
Assurance Provided
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ManufacturingTP Procedure
Exceptions procedure
TP Policy
Tax Policy Legal HR Local management Head of tax
PwC
Transfer Pricing Control Framework
Sales TP procedure
Corporate services
TP procedure
Documentation procedure
Controversy procedure
Job profiles
Business design model
Functional governance documents
Intercompany agreements
Cost base definitions
Product Costing
guidelinesRACI’s
Transfer Pricing Strategy Established
Applied Comprehensively
Responsibility Assigned
Governance DocumentedTesting Performed
Assurance Provided
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ManufacturingTP Procedure
Exceptions procedure
TP Policy
Tax Policy
Includes: By what date When is action required Communication/update process Escalation process
PwC
Transfer Pricing Control Framework
Sales TP procedure
Corporate services
TP procedure
Documentation procedure
Controversy procedure
Job profiles
Business design model
Functional governance documents
Intercompany agreements
Cost base definitions
Product Costing
guidelinesRACI’s
Transfer Pricing Strategy Established
Applied Comprehensively
Responsibility Assigned
Governance Documented
Testing Performed
Assurance Provided
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ManufacturingTP Procedure
Exceptions procedure
TP Policy
Tax Policy
Agree process to test outcome Monitoring throughout the year Agree adjustment process Year-end testing Numbers and operational
processes
PwC
Transfer Pricing Control Framework Model Adherence review in
management meeting Questionnaires / interviews Documentation review Internal Audit? External confirmation Sign off by responsible managers
Transfer Pricing Strategy Established
Applied Comprehensively
Responsibility Assigned
Governance Documented
Testing Performed
Assurance Provided
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PwC
Tax
Objective is to comply with national transfer pricing legislation
Remember: Transfer Pricing has multiple stakeholders
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Management accounting
Objective is to set rules relating to performance measurement
There can be overlap and there can be alignment
There can also be friction between these areas
Financial accounting
Objective to transact arm’s length
PwC
…and that transfer pricing lives in multiple Departments
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Pricing & Accounting
policies
Documentation & compliance
Transactional accounting
Adjustments
Monitoring
Testing
Finance / accounting
Transfer Pricing
Tax Department
Controllong
Management
Pricing under control ?
IFRS 16 changes!
PwC
The reason for implementing IFRS 16
Criticisms of the existing accounting standard
IFRS 16
Lessor Lessee
• Continue to recognise underlying asset
• Recognise right of use asset
• Recognise obligation for future lease instalments
Similar accounting for purchased assets
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Lack of transparency regarding operating lease commitments
Lack of comparability between companies that buy versus lease their assets
PwC
Impact might be significant
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PwC
IFRS 16 at a glance
The new standard
• All leases > 12 months on balance sheet• Exemption for low value asset leases• Effective as of 1 January 2019
What is different?• Single, on-balance sheet model• Front-loaded lease expenses for lessees
• Balance sheet gross-up• Change in Profit or Loss presentation• Change in Cash Flow presentation
Balance sheet IAS 17 IFRS 16Finance lease Operational lease All leases
Assets Asset ---- Right-of-use asset
Liabilities ----
Off balance sheetobligations ----
Off-balance sheet commitment ----
Profit or loss IAS 17 IFRS 16Finance lease Operational lease All leases
Revenue ---- ---- ----
Operating costs ---- Lease expense Service expense
EBITDA
Depreciation Depreciation expense ---- Depreciation
expense
Operating profit/EBIT
Finance costs Interest expense ---- Interest expense
Profit before tax
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• How does this impact a MNEs transfer pricing policy?• Similar effect under all transfer pricing methodologies?
PwC
• Lease term of 5 year • Interest rate 5% • Straight line depreciation on asset
Impact on financials – example (1)
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Lease liability
• Present value 435• Yearly lease fee 100
Year Opening carrying amount
Interest accrued
Payments Closing carrying amount
2019 435 22 (100) 357
2020 357 17 (100) 274
2021 274 13 (100) 187
2022 187 9 (100) 96
2023 96 4 (100) -
Total 65 (500)
Year Opening carrying amount
Depreciation Closing carrying amount
2019 435 (87) 348
2020 348 (87) 261
2021 261 (87) 174
2022 174 (87) 87
2023 87 (87) -
Total (435)
Lease assets - Right of Use
PwC
Impact on financials – example (2)
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Difference P&L and tax deduction2019 2020 2021 2022 2023 Total
Depreciation (87) (87) (87) (87) (87) (435)
Interest expense (22) (17) (13) (9) (4) (65)
Total P&L (109) (104) (100) (96) (91) (500)
Tax deduction (100) (100) (100) (100) (100) (500)
Timing difference
(9) (4) 0 4 9 0
EBIT effect
PBT effect
• Lease term of 5 year • Interest rate 5% • Straight line depreciation on asset
• Present value 435• Yearly lease fee 100
PwC
Impact on financials – example (3)
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80
90
100
110
120
1 2 3 4 5
Leas
e ex
pens
e
Year
Frontloading of overall lease expenses under IFRS 16
IAS 17 IFRS 16
-13 Under IFRS 16 there is a profit (PBT) fluctuation due to timing difference.
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How does and/or should this impact a MNEs transfer pricing policy?
PwC
Management Accounting/ Consolidated financial statement
IFRS 16
Dutch Statutory Accounts
Dutch GAAP versus IFRS 16
Tax return
Goedkoopmansgebruik / Article 8b CITA (OECD Guidelines)
IFRS 16 - Netherlands
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• How is your transfer pricing mechanism set? • How do you test your transfer pricing?• How do auditors and tax authorities test your transfer pricing?• What will be the standard applied by the benchmark comparables?• If and how to eliminate the timing difference from your transfer pricing policies?
PwC
Global principal Residual profit
Limited risk distributorOperating margin 5%
Benchmark – LQ 4% - UQ 6%
Impact IFRS 16
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EBIT Effect
Benchmark risk
PBT Effect neutralized
IFRS 16
EBIT Effect
Benchmark risk
PBT Effect
No matching solution
PwC
LRD IAS 17 - 2018 2019 2020 2021 2022 2023 Total Average
Revenue 1,000 1,000 1,000 1,000 1,000 1,000 5,000 1,000
(COGS) (700) (700) (700) (700) (700) (700) (3,500) (700)
Gross margin 300 300 300 300 300 300 1,500 300
(Opex) (150) (150) (150) (150) (150) (150) (750) (150)
(Lease) (100) 0 0 0 0 0 0 0
(Depreciation) 0 (87) (87) (87) (87) (87) (435) (87)
EBIT 50 63 63 63 63 63 315 63
Interest income/expenses
0 (22) (17) (13) (9) (4) (65) (13)
PBT 50 41 46 50 54 59 250 50
Timing Difference
(9) (4) (0) 4 9 0 0
Operating Margin
5.0% 6.3% 6.3% 6.3% 6.3% 6.3% 32% 6.3%
Tax expenses at 25%
12.5 10.25 11.5 12.5 13.5 14.75 62.5 12.5
TP reimbursement by Principal
(950) (937) (937) (937) (937) (937) (4,685) (937)
Increasing EBIT
Neutralizing timing effect PBT
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Principal IAS 17 - 2018 2019 2020 2021 2022 2023 Total Average
Revenue 1,000 1,000 1,000 1,000 1,000 1,000 5,000 1,000
LRD (950) (937) (937) (937) (937) (937) (4,750) (950)
Gross margin 50 50 50 50 50 50 315 63
(Opex) (10) (10) (10) (10) (10) (10) (50) (10)
EBIT/PBT 40 53 53 53 53 53 265 53
Operating Margin
4.0% 5.3% 5.3% 5.3% 5.3% 5.3% 27% 5,3%
Tax expenses at 25%
10 13,25 13,25 13,25 13,25 13,25 66,25 13,25
Total EBIT 90 116 116 116 116 116 580 116
Total PBT 90 94 99 103 107 112 515 103
Total tax 22,5 23,5 24,75 25,75 26,75 28 128,75 25,75
Depreciation versus Lease Expense
No full set-off for timing difference due to TP method @ EBIT
Increase total tax for annual accounting purposes
PwC
LRD - 2018 2019 2020 2021 2022 2023 Total Average
Revenue 1,000 1,000 1,000 1,000 1,000 1,000 5,000 1,000
(COGS) (700) (700) (700) (700) (700) (700) (3,500) (700)
Correction (COGS) (13) (13) (13) (13) (13) (65) (13)
Gross margin 300 283 283 283 283 283 1415 283
(Opex) (150) (150) (150) (150) (150) (150) (750) (150)
(Lease) (100) 0 0 0 0 0 0 0
(Depreciation) 0 (87) (87) (87) (87) (87) (435) (87)
EBIT 50 50 50 50 50 50 250 50
Interest income/expenses
0 (22) (17) (13) (9) (4) (65) (13)
Correction (interest) 22 17 13 9 4 65 13
PBT 50 50 50 50 50 50 250 50
Total Correction 9 4 0 (4) (9) 0 0
Operating Margin 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 25% 5.0%
Tax expenses at 25% 12.5 12.5 12.5 12.5 12.5 12.5 62.5 12.5
Amended reimbursement
(950) (959) (954) (950) (946) (941) (4,750) (950)
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Principal IAS 17 - 2018 2019 2020 2021 2022 2023 Total Average
Revenue 1,000 1,000 1,000 1,000 1,000 1,000 5,000 1,000
LRD (950) (959) (954) (950) (946) (941) (4,750) (950)
Gross margin 50 41 46 50 54 59 315 50
(Opex) (10) (10) (10) (10) (10) (10) (50) (10)
EBIT/PBT 40 31 36 40 44 49 200 40
OM 4.0% 3.1% 3.6% 4% 4.4% 4.9% 20% 4.0%
Timing Difference (9) (4) (0) 4 9 0 0
Elimination of timing difference required?
9 4 0 -4 9
EBIT/PBT 40 31/40 36/40 40 44/40 49/40 200 40
OM 4.0% 3.1%/4.0% 3.6%4.0% 4.0% 4.4%/4.0% 4.8%/4.0% 20% 4.0%
Tax expenses at 25%
10 7.75/10 9/10 10 11/10 12.25/10 50 10
Total EBIT 90 81/90 86/90 90 94/90 99/90 450 90
Total PBT 90 81/90 86/90 90 94/90 99/90 450 90
Total tax 22.5 20.25/22.5 21.5/22.5 22.5 23.5/22.5 24.75/22.5 112.5 22.5Imported IFRS timing difference – to be eliminated for Local Stat/ Tax purposes
Neutralizing the LRD
PwC
Management Accounting/ Consolidated financial statement
IFRS 16
Dutch Statutory Accounts
Dutch GAAP versus IFRS 16
Tax return
Goedkoopmansgebruik / Article 8b CITA (OECD Guidelines)
IFRS 16 - Netherlands
• How is your transfer pricing mechanism set? • How do you test your transfer pricing?• How do auditors and tax authorities test your transfer pricing?• What will be the standard applied by the benchmark comparables?• If and how to eliminate the timing difference from your transfer pricing policies?
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IFRS 15 −Agent versus principal
PwC
IFRS 15 – Revenue from Contracts with Customers
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Relevant indicators to assess whether an entity is a ‘principal’ or ‘agent’ for statutory reporting purposes
Current IFRS 15 standards New IFRS 15 standards
Focus on whether company has risks and rewards of a principal
Focus on whether company controls the specified good/service
Fulfilment Primary responsibility for contract fulfilment?
✅ ✅
Inventory risk Inventory risk at any point during the transaction (that is, before the order, during shipment, or upon return)?
✅ ✅Clarification: Obtaining title momentarily beforetransferring a specified good orservice to a customer (i.e. ‘flash title’) does not necessarily constitute control.
Pricing Discretion in establishing prices for the other party’s good or service?
✅ ✅
Credit risk Customer credit risk for the receivable amounts?
✅ ❌
Remuneration Consideration in form of a commission or otherwise?
✅ ❌
PwC
Management Accounting/ Consolidated financial statement
IFRS 15
Dutch Statutory Accounts
Dutch GAAP – IFRS 15 allowed
Tax return
Goed koopmansgebruik/Article 8b CITA (OECD Guidelines)
IFRS 15 at a glance - Netherlands
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• How do you want to set your transfer pricing policies?• How do auditors and tax authorities test your transfer pricing?
PwC
2,5% markup according to BM
IFRS 15 – Example – FactsNew IFRS 15
standards
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P&L - LRD
Revenue 500COGS 287,5----------------------------------Gross margin
212,5Opex 200----------------------------------EBIT 12,5
RoS 2.50%
NLDE
ConsequencesPossible mismatch between Stat versus TP/Tax
P&L - PrincipalRevenue Agent 500
For statutory purposes
P&L - AgentRevenue commission 212,5
For statutory purposes For TP purposes
Tensions / Disconnect statutory vs. tax positionThe basis for transfer pricing control framework?
Ways to mitigate this issue?
Current IFRS 15 standards
2.5% markup according to BM
Alignment treatment for statutory and tax purposes
LRD will for IFRS purposes be labeled as an Agent with respect to revenue recognition. No revenue recognition at level of Agent
• No 3rd party revenue base available to establish TNMM - RoS.
• Intercompany contracts and legal flows/physiscal flows remain the same
• Cost-based remuneration or commission to be applied?
• To be determined how this can be defended from TP perspective and how the arm’s length nature of the mark-up can be substantiated.
LRD
Third-party customers
EMEA Principal
Cost-based or commission remuneration required?
PwC
IFRS 15 – Example – Impact
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Lower quartile
Median
Upper quartile
1.50 %
2.50 %
5.00 %
Tax/TP Benchmark Results (RoS):
TP P&L - LRD
Revenue 500COGS 288------------------------------------Gross margin 212Opex 200-------------------------------------EBIT 12RoS 2.40%
EBIT 12C+ 6%
EBIT 10C+ / ROS 5.00% / 2.00%
TP P&L - LRD
Revenue 500COGS 285-------------------------------------Gross margin 215Opex 200-------------------------------------EBIT 15RoS 3.00%
EBIT 15C+ 7.5%
EBIT 10C+/ROS 5.00% / 2.00%
TP P&L - LRD
Revenue 500COGS 290-------------------------------------Gross margin 210Opex 200-------------------------------------EBIT 10RoS 2.00%
EBIT 10C+ 5%
EBIT 10C+ / ROS 5.00% / 2.00%
FY2018
Annual fluctuations in remuneration for LRD activities mitigate potential adverse exposures regarding ‘revenue recognition’ based on IFRS 15
2.0 %
3.0 %
Lower quartile
Median
Upper quartile
3.0 %
5 %
7.00 %
3.0 %
6.0 %
“Agent” Stat - Benchmark Results (C+):
• Seek TP alignment for financial statement and tax purposes Review intercompany
contracts – terms and remuneration
Assess whether or not to amend intercompany agreements
• Review APAs• Update TCF
Actions
OR OR OR
FY2019 FY2020
Key takeaways
PwC
Key takeaways
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TPCFHaving a solid Transfer Pricing Control framework safeguards the level of certainty on your tax position
IFRS 16Impact of operational leaseIFRS 15Changes in revenue recognition
Considerations• Is your policy IFRS 15 & 16 compliant?• Adjust policy/guidelines where required• Consider for Local File 2018 on wards• Consider impact on CbCR 2019
PwC
© November 2018, PricewaterhouseCoopers Belastingadviseurs N.V. (PwC). All rights reserved. PwC refers to the Netherlands member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see http://www.pwc.com/structure for further details.
Pieter van LunenDirector06 - 20 92 69 10Pieter.van.lunen@pwc.com
Bert MiddelkoopDirector06 - 22 18 52 73Bert.middelkoop@pwc.com